Back to GetFilings.com
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
COMMISSION FILE NUMBER 0-26068
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 or 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
--------------
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 whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes |X| No [ ]
As of May 7, 2003, 19,640,808 shares of Acacia Research-Acacia
Technologies common stock were issued and outstanding. As of May 7, 2003,
22,985,186 shares of Acacia Research-CombiMatrix common stock were issued and
outstanding.
================================================================================
ACACIA RESEARCH CORPORATION
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Acacia Research Corporation Consolidated Financial Statements
Consolidated Balance Sheets as of March 31, 2003 and
December 31, 2002 (Unaudited).......................................... 4
Consolidated Statements of Operations and Comprehensive Loss for the
Three Months Ended March 31, 2003 and 2002 (Unaudited)................. 5
Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2003 and 2002 (Unaudited).................................... 6
Notes to Consolidated Financial Statements............................. 7
*CombiMatrix Group Financial Statements
Balance Sheets as of March 31, 2003 and December 31, 2002 (Unaudited).. 19
Statements of Operations for the Three Months Ended
March 31, 2003 and 2002 (Unaudited).................................... 20
Statements of Cash Flows for the Three Months Ended
March 31, 2003 and 2002 (Unaudited).................................... 21
Notes to Financial Statements.......................................... 22
*Acacia Technologies Group Financial Statements
Balance Sheets as of March 31, 2003 and December 31, 2002 (Unaudited).. 25
Statements of Operations for the Three Months Ended
March 31, 2003 and 2002 (Unaudited).................................... 26
Statements of Cash Flows for the Three Months Ended
March 31, 2003 and 2002 (Unaudited).................................... 27
Notes to Financial Statements.......................................... 28
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................. 31
Item 3. Quantitative and Qualitative Disclosures About Market Risk............. 60
Item 4. Controls and Procedures................................................ 60
2
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...................................................... 61
Item 6. Exhibits and Reports on Form 8-K....................................... 61
SIGNATURES............................................................................ 62
CERTIFICATIONS........................................................................ 63
EXHIBIT INDEX ........................................................................ 65
*NOTE: We are presenting the Acacia Research Corporation consolidated unaudited
interim financial statements and the separate unaudited interim 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.
3
ACACIA RESEARCH CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share information)
(Unaudited)
MARCH 31, DECEMBER 31,
2003 2002
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents .............................. $ 40,062 $ 43,083
Short-term investments ................................. 9,605 11,605
Accounts receivable .................................... 277 578
Prepaid expenses, other receivables and other assets ... 1,618 1,221
---------- ----------
Total current assets .......................... 51,562 56,487
Property and equipment, net of accumulated depreciation ..... 3,612 4,075
Investment in affiliate, at cost ............................ 252 252
Patents, net of accumulated amortization .................... 14,880 15,280
Goodwill, net of accumulated amortization ................... 20,693 20,693
Other assets ................................................ 284 284
---------- ----------
$ 91,283 $ 97,071
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued expenses and other ........... $ 4,490 $ 4,826
Deferred revenues ...................................... 12,183 10,675
---------- ----------
Total current liabilities ..................... 16,673 15,501
Deferred income taxes ....................................... 3,469 3,540
---------- ----------
Total liabilities ............................. 20,142 19,041
---------- ----------
Minority interests .......................................... 1,819 2,171
---------- ----------
Stockholders' equity:
Preferred stock
Acacia Research Corporation, par value $0.001 per
share; 10,000,000 shares authorized; no
shares issued or outstanding ...................... -- --
Common stock
Acacia Research - Acacia Technologies stock, par
value $0.001 per share; 50,000,000 shares
authorized; 19,640,808 shares issued and
outstanding as of March 31, 2003 and
December 31, 2002 ................................. 20 20
Acacia Research - CombiMatrix stock, par value
$0.001 per share; 50,000,000 shares authorized;
22,985,186 and 22,964,779 shares issued and
outstanding as of March 31, 2003 and December
31, 2002, respectively ............................ 23 23
Additional paid-in capital ............................. 237,542 238,627
Deferred stock compensation ............................ (2,793) (4,023)
Warrants to purchase common stock ...................... 199 199
Comprehensive loss ..................................... (17) (2)
Accumulated deficit .................................... (165,652) (158,985)
---------- ----------
Total stockholders' equity .................... 69,322 75,859
---------- ----------
$ 91,283 $ 97,071
========== ==========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
4
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(In thousands, except share and per share information)
(Unaudited)
FOR THE THREE MONTHS ENDED
-----------------------------
MARCH 31, 2003 MARCH 31, 2002
------------- -------------
Revenues:
License fee income ...................................... $ 6 $ --
Product revenue ......................................... 209 --
Grant and contract revenue .............................. 7 249
------------- -------------
Total revenues ...................................... 222 249
------------- -------------
Operating expenses:
Cost of sales ........................................... 77 --
Research and development expenses ....................... 2,335 2,668
Non-cash stock compensation expense - research and
development ........................................... 2 421
Marketing, general and administrative expenses .......... 4,255 4,072
Non-cash stock compensation expense - marketing, general
and administrative .................................... 138 1,001
Amortization of patents ................................. 400 564
------------- -------------
Total operating expenses ............................ 7,207 8,726
------------- -------------
Operating loss ...................................... (6,985) (8,477)
------------- -------------
Other income (expense):
Interest and other income (net) ......................... 215 421
Realized gains (losses) on short-term investments ....... 37 (553)
Unrealized losses on short-term investments ............. -- (322)
------------- -------------
Total other income (expense) ........................ 252 (454)
------------- -------------
Loss from continuing operations before income taxes and
minority interests ...................................... (6,733) (8,931)
Benefit for income taxes .................................... 60 69
------------- -------------
Loss from continuing operations before minority interests ... (6,673) (8,862)
Minority interests .......................................... 6 2,435
------------- -------------
Net loss .................................................... (6,667) (6,427)
Unrealized losses on short-term investments ............. (8) (95)
Unrealized losses on foreign currency translation ....... (7) (9)
------------- -------------
Comprehensive loss .......................................... $ (6,682) $ (6,531)
============= =============
Loss per common share:
Attributable to the Acacia Technologies group:
Net loss .................................................. $ (1,494) $ (2,841)
Basic and diluted per share ............................. (0.08) (0.14)
Attributable to the CombiMatrix group:
Net loss .................................................. $ (5,173) $ (3,586)
Basic and diluted per share ............................. (0.23) (0.16)
Weighted average shares - basic and diluted:
Acacia Research - Acacia Technologies stock ............... 19,640,808 19,640,808
============= =============
Acacia Research - CombiMatrix stock ....................... 22,983,278 22,950,551
============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
5
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
FOR THE THREE MONTHS ENDED
---------------------
MARCH 31, MARCH 31,
2003 2002
--------- ---------
Cash flows from operating activities:
Net loss from continuing operations ............................................ $ (6,667) $ (6,427)
Adjustments to reconcile net loss from continuing
operations to net cash used in operating activities:
Depreciation and amortization ............................................... 767 933
Minority interests .......................................................... (6) (2,435)
Non-cash stock compensation ................................................. 140 1,422
Deferred tax benefit ........................................................ (70) (75)
Net purchases of trading securities ......................................... -- (3,358)
Unrealized losses on short-term investments ................................. -- 322
Other ....................................................................... 121 45
Changes in assets and liabilities:
Accounts receivable, prepaid expenses, other receivables and other assets ... (96) (1,322)
Accounts payable, accrued expenses and other ................................ (250) (1,085)
Deferred revenues ........................................................... 1,508 531
--------- ---------
Net cash used in operating activities from continuing operations ............ (4,553) (11,449)
Net cash used in operating activities from discontinued operations .......... (86) (254)
--------- ---------
Net cash used in operating activities ....................................... (4,639) (11,703)
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment, net ..................................... (24) (134)
Purchase of available-for-sale investments .................................. (469) (4,540)
Sale of available-for-sale investments ...................................... 2,462 6,878
Other ....................................................................... -- (101)
--------- ---------
Net cash provided by investing activities from continuing operations ........ 1,969 2,103
Net cash used in investing activities from discontinued operations .......... (344) --
--------- ---------
Net cash provided by investing activities ................................... 1,625 2,103
--------- ---------
Cash flows from financing activities:
Proceeds from the exercise of stock options and warrants .................... -- 214
Capital contributions from minority shareholders of subsidiaries,
net of issuance costs ..................................................... -- 300
Repayment of capital lease obligation ....................................... -- (226)
--------- ---------
Net cash provided by financing activities ................................... -- 288
--------- ---------
Decrease in cash and cash equivalents ............................................ (3,014) (9,312)
--------- ---------
Cash and cash equivalents, beginning ............................................. 43,083 59,451
Effect of exchange rate on cash .................................................. (7) (16)
--------- ---------
Cash and cash equivalents, ending ................................................ $ 40,062 $ 50,123
========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
6
ACACIA RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS
BASIS OF PRESENTATION. The accompanying unaudited consolidated
financial statements have been prepared in accordance with generally accepted
accounting principles for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain
information and footnotes required by generally accepted accounting principles
in annual financial statements have been omitted or condensed in accordance with
quarterly reporting requirements of the Securities and Exchange Commission.
These interim consolidated financial statements should be read in conjunction
with the consolidated financial statements and notes thereto for the year ended
December 31, 2002, as reported by us in our Annual Report on Form 10-K.
The accompanying consolidated financial statements include the accounts
of Acacia Research Corporation, and its wholly owned and majority-owned
subsidiaries. Material intercompany transactions and balances have been
eliminated in consolidation.
The consolidated financial statements of Acacia Research Corporation
include all adjustments of a normal recurring nature which, in the opinion of
management, are necessary for a fair presentation of our financial position as
of March 31, 2003 and results of operations and cash flows for the interim
periods presented. The results of operations for the three months ended March
31, 2003 are not necessarily indicative of the results to be expected for the
entire year.
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. ("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, referred to as "Acacia Technologies
group," owns patented intellectual property in the media technologies sector.
The Acacia Technologies group owns patented 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's U.S. DMT patents expire in
2011 and its international DMT patents expire in 2012. 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.
RECAPITALIZATION TRANSACTION
On December 11, 2002, our stockholders voted in favor of a
recapitalization transaction, which became effective on December 13, 2002,
whereby we 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 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. AR-Acacia
Technologies stock is intended to reflect separately the performance of Acacia
Research Corporation's Acacia Technologies group. Although the AR-CombiMatrix
stock and the AR-Acacia Technologies stock are intended to reflect the
7
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.
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.
STOCK-BASED COMPENSATION. At March 31, 2003, Acacia Research
Corporation has two stock-based employee compensation plans. 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 Statement of Financial
Accounting Standards ("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.
The following table illustrates 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 STOCK AR-COMBIMATRIX STOCK
----------------------- -----------------------
THREE MONTHS ENDED THREE MONTHS ENDED
----------------------- -----------------------
MARCH 31, MARCH 31, MARCH 31, MARCH 31,
2003 2002 2003 2002
---------- ---------- ---------- ----------
Loss from continuing operations as reported .................... $ (1,494) $ (2,841) $ (5,173) $ (3,586)
Add: Stock-based compensation, intrinsic value method
reported in net income, net of tax .......................... -- 10 69 1,412
Deduct: Pro forma stock-based compensation fair value
method, net of tax .......................................... (1,078) (1,237) (2,782) (1,795)
Loss from continuing operations, pro forma ..................... (2,572) (4,068) (7,886) (3,969)
Basic loss per share from continuing operations as reported .... (0.08) (0.14) (0.23) (0.16)
Basic loss per share from continuing operations, pro forma ..... (0.13) (0.21) (0.34) (0.17)
Diluted loss per share from continuing operations as
reported .................................................... (0.08) (0.14) (0.23) (0.16)
Diluted loss per share from continuing operations, pro forma ... (0.13) (0.21) (0.34) (0.17)
Weighted average risk free interest rate........................ 4.75% 5.36% 4.80% 5.51%
- -----------------------
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 the predecessor Acacia Research Corporation common stock
for 2002 has been omitted from the table above.
The fair value of AR-Acacia Technologies stock options and
AR-CombiMatrix stock options was determined using the Black-Scholes
option-pricing model, assuming volatility of approximately 100%, with expected
lives of approximately five years and no expected dividends.
RECLASSIFICATIONS. Certain immaterial reclassifications of prior period
amounts have been made to conform to the 2003 presentation.
2. LOSS PER SHARE
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
8
discretion, change the method of allocating earnings or losses to each class of
common stock at any time. Management currently has no plans to change allocation
methods.
The following table presents a reconciliation of basic and diluted loss per
share:
FOR THE THREE MONTHS ENDED
------------------------
MARCH 31, MARCH 31,
2003 2002
----------- -----------
Acacia Research - Acacia Technologies stock
- -------------------------------------------
Basic weighted average number of common shares outstanding ...... 19,640,808 19,640,808
Dilutive effect of outstanding stock options and warrants (a) ... -- --
----------- -----------
Diluted weighted average number of common and
potential common shares outstanding ........................... 19,640,808 19,640,808
=========== ===========
Acacia Research - CombiMatrix stock
- -----------------------------------
Basic weighted average number of common shares outstanding ...... 22,983,278 22,950,551
Dilutive effect of outstanding stock options and warrants (b) ... -- --
----------- -----------
Diluted weighted average number of common and
potential common shares outstanding ........................... 22,983,278 22,950,551
=========== ===========
- -----------------------
(a) Potential AR - Acacia Technologies common shares of 786 and
46,857 at March 31, 2003 and 2002, respectively, have been
excluded from the per share calculation because the effect of
their inclusion would be anti-dilutive.
(b) Potential AR - CombiMatrix common shares of 441,750 and
305,256 at March 31, 2003 and 2002, respectively, have been
excluded from the per share calculation because the effect of
their inclusion would be anti-dilutive.
3. GOODWILL AND INTANGIBLES
Goodwill is evaluated for impairment in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets" ("SFAS No. 142"), which provides that
goodwill is no longer subject to amortization. Instead, goodwill is subject to a
periodic review for potential impairment that must occur at least annually at a
reporting unit level. As of January 1, 2002, the date of adoption of the
standard, we had unamortized goodwill in the amount of $4,627,000. In 2002, 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 values of our two reporting units were 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 of goodwill at March 31,
2003 and December 31, 2002 (net of $2,258,000 of accumulated amortization). The
CombiMatrix group had $18,859,000 of goodwill at March 31, 2003 and December 31,
2002 (net of $1,312,000 of accumulated amortization).
Acacia Research Corporation's only identifiable intangible assets at
March 31, 2003 and December 31, 2002 are patents totaling $14,880,000 (net of
$8,013,000 of accumulated amortization) and $15,280,000 (net of $7,613,000 of
accumulated amortization), respectively. Patent amortization expense for the
three months ended March 31, 2003 and 2002 was $400,000 and $564,000,
respectively. The gross carrying amounts and accumulated amortization as of
March 31, 2003 and December 31, 2002 and amortization expense for the three
months ended March 31, 2003 and 2002, related to patents, by segment, are as
follows (in thousands):
9
ACACIA TECHNOLOGIES GROUP COMBIMATRIX GROUP
------------------------------- -------------------------------
MARCH 31, 2003 DECEMBER 31, 2002 MARCH 31, 2003 DECEMBER 31, 2002
-------------- -------------- -------------- --------------
Gross carrying amount - patents .... $ 10,798 $ 10,798 $ 12,095 $ 12,095
Accumulated amortization ........... (6,856) (6,730) (1,157) (883)
-------------- -------------- -------------- --------------
Patents, net ....................... $ 3,942 $ 4,068 $ 10,938 $ 11,212
============== ============== ============== ==============
FOR THE THREE MONTHS ENDED FOR THE THREE MONTHS ENDED
------------------------------- -------------------------------
MARCH 31, 2003 MARCH 31, 2002 MARCH 31, 2003 MARCH 31, 2002
-------------- -------------- -------------- --------------
Patent amortization expense......... $ 126 $ 465 $ 274 $ 99
============== ============== ============== ==============
Annual aggregate amortization expense for each of the next five years
through December 31, 2007 is estimated to be $1,595,000 per year ($500,000 for
the Acacia Technologies group and $1,095,000 for the CombiMatrix group).
At March 31, 2003 and December 31, 2002, all of our acquired intangible
assets other than goodwill were subject to amortization.
4. RECENT ACCOUNTING PRONOUNCEMENTS
On January 1, 2003, we adopted 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 adoption of SFAS No. 146 did not 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 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 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 adopted the interim disclosure provisions for our
financial report for the quarter ended March 31, 2003 (see Note 1, "Stock-based
Compensation"). 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. The adoption of FIN 45
did not have a significant impact on Acacia Research Corporation's financial
position or results of operations.
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
10
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.
5. 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 described earlier in Note 1.
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 three months ended March 31, 2003 and 2002 (in
thousands):
ACACIA
TECHNOLOGIES COMBIMATRIX
Three Months Ended March 31, 2003 GROUP GROUP TOTAL
- --------------------------------- ---------- ---------- ----------
Revenue ............................................................ $ 6 $ 216 $ 222
Amortization of patents ............................................ 126 274 400
Interest income .................................................... 148 67 215
Realized gain on investments ....................................... 37 -- 37
Loss from operations before income taxes and minority interests .... 1,520 5,213 6,733
Non-cash stock compensation charges ................................ -- 140 140
Segment assets ..................................................... 42,098 46,810 88,908
Investment in affiliate, at cost ................................... 252 -- 252
Purchase of property and equipment ................................. 2 22 24
11
ACACIA
TECHNOLOGIES COMBIMATRIX
Three Months Ended March 31, 2002 GROUP GROUP TOTAL
- --------------------------------- ---------- ---------- ----------
Revenue ............................................................ $ -- $ 249 $ 249
Amortization of patents ............................................ 465 99 564
Other income ....................................................... 78 -- 78
Interest income .................................................... 153 250 403
Interest expense ................................................... -- 60 60
Realized losses on investments ..................................... 553 -- 553
Unrealized losses on investments ................................... 322 -- 322
Loss from operations before income taxes and minority interests .... 2,907 6,024 8,931
Non-cash stock compensation charges ................................ 10 1,412 1,422
Segment assets ..................................................... 55,772 42,936 98,708
Investment in affiliate, at cost ................................... 3,000 -- 3,000
Purchase of property and equipment ................................. 101 83 184
Segment information excludes discontinued operations related to
Soundbreak.com as of and for the three months ended March 31, 2003 and 2002.
Total assets related to discontinued operations totaled $2,600,000 and
$3,940,000 at March 31, 2003 and 2002, respectively.
6. CONSOLIDATING FINANCIAL INFORMATION
Presented below is consolidating financial information reflecting the
businesses of the CombiMatrix group and the Acacia Technologies 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 that 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.
12
CONSOLIDATING STATEMENT OF FINANCIAL POSITION AT MARCH 31, 2003 (IN THOUSANDS)
ACACIA
TECHNOLOGIES COMBIMATRIX
GROUP GROUP ELIMINATIONS CONSOLIDATED
-------------- -------------- -------------- --------------
ASSETS
Current assets:
Cash and cash equivalents ................................ $ 37,097 $ 2,965 $ -- $ 40,062
Short-term investments ................................... -- 9,605 -- 9,605
Accounts receivable ...................................... 11 266 -- 277
Prepaid expenses, other receivables and other assets ..... 993 625 -- 1,618
Receivable from CombiMatrix group ........................ 225 -- (225) --
-------------- -------------- -------------- --------------
Total current assets .............................. 38,326 13,461 (225) 51,562
Property and equipment, net of accumulated depreciation ....... 147 3,465 -- 3,612
Investment in affiliate, at cost .............................. 252 -- -- 252
Patents, net of accumulated amortization ...................... 3,942 10,938 -- 14,880
Goodwill, net of accumulated amortization ..................... 1,834 18,859 -- 20,693
Other assets .................................................. 197 87 -- 284
-------------- -------------- -------------- --------------
$ 44,698 $ 46,810 $ (225) $ 91,283
============== ============== ============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued expenses and other ............. $ 2,129 $ 2,361 $ -- $ 4,490
Current portion of deferred revenues ..................... 1,536 10,647 -- 12,183
Payable to Acacia Technologies group ..................... -- 225 (225) --
-------------- -------------- -------------- --------------
Total current liabilities ......................... 3,665 13,233 (225) 16,673
Deferred income taxes ......................................... 1,119 2,350 -- 3,469
-------------- -------------- -------------- --------------
Total liabilities ................................. 4,784 15,583 (225) 20,142
-------------- -------------- -------------- --------------
Minority interests ............................................ 1,142 677 -- 1,819
-------------- -------------- -------------- --------------
Stockholders' equity:
AR - Acacia Technologies stock ........................... 38,772 -- -- 38,772
AR - CombiMatrix stock ................................... -- 30,550 -- 30,550
-------------- -------------- -------------- --------------
Total stockholders' equity ........................ 38,772 30,550 -- 69,322
-------------- -------------- -------------- --------------
$ 44,698 $ 46,810 $ (225) $ 91,283
============== ============== ============== ==============
13
CONSOLIDATING STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2003 (IN THOUSANDS)
ACACIA
TECHNOLOGIES COMBIMATRIX ELIMINATIONS/
GROUP GROUP RECLASSIFICATIONS CONSOLIDATED
-------------- -------------- -------------- --------------
Revenues:
License fee income ........................................ $ 6 $ -- $ -- $ 6
Product revenue ........................................... -- 209 -- 209
Grant revenue ............................................. -- 7 -- 7
-------------- -------------- -------------- --------------
Total revenues ............................................ 6 216 -- 222
-------------- -------------- -------------- --------------
Operating expenses:
Cost of sales ............................................. -- 77 -- 77
Research and development expenses ......................... -- 2,335 -- 2,335
Non-cash stock compensation expense - research and
development ............................................. -- 2 -- 2
Marketing, general and administrative expenses ............ 1,323 2,670 262 4,255
Non-cash stock compensation expense - marketing,
general and administrative .............................. -- 138 -- 138
Legal expenses - patents .................................. 262 -- (262) --
Amortization of patents ................................... 126 274 -- 400
-------------- -------------- -------------- --------------
Total operating expenses .................................. 1,711 5,496 -- 7,207
-------------- -------------- -------------- --------------
Operating loss ............................................ (1,705) (5,280) -- (6,985)
-------------- -------------- -------------- --------------
Other (expense) income:
Interest income ........................................... 148 67 -- 215
Realized gains on short-term investments .................. 37 -- -- 37
-------------- -------------- -------------- --------------
Total other income ........................................ 185 67 -- 252
-------------- -------------- -------------- --------------
Loss from continuing operations
before income taxes and minority interests ................ (1,520) (5,213) -- (6,733)
Benefit for income taxes ...................................... 26 34 -- 60
-------------- -------------- -------------- --------------
Loss from continuing operations before minority interests ..... (1,494) (5,179) -- (6,673)
Minority interests ............................................ -- 6 -- 6
-------------- -------------- -------------- --------------
Net loss ...................................................... $ (1,494) $ (5,173) $ -- $ (6,667)
============== ============== ============== ==============
14
CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2003 (IN THOUSANDS)
ACACIA
TECHNOLOGIES COMBIMATRIX
GROUP GROUP ELIMINATIONS CONSOLIDATED
-------------- -------------- -------------- --------------
Cash flows from operating activities:
Net loss from continuing operations ........................ $ (1,494) $ (5,173) $ -- $ (6,667)
Adjustments to reconcile net loss from continuing
operations to net cash used in operating activities:
Depreciation and amortization .......................... 161 606 -- 767
Minority interests ..................................... -- (6) -- (6)
Non-cash stock compensation ............................ -- 140 -- 140
Deferred tax benefit ................................... (36) (34) -- (70)
Other .................................................. (3) 124 -- 121
Changes in assets and liabilities:
Accounts receivable, prepaid expenses, other
receivables and other assets ......................... (229) 133 -- (96)
Accounts payable, accrued expenses and other ........... (420) 170 -- (250)
Deferred revenue ....................................... 33 1,475 -- 1,508
-------------- -------------- -------------- --------------
Net cash used in operating activities from
continuing operations ................................ (1,988) (2,565) -- (4,553)
Net cash used in operating activities from
discontinued operations .............................. (86) -- -- (86)
-------------- -------------- -------------- --------------
Net cash used in operating activities .................. (2,074) (2,565) -- (4,639)
-------------- -------------- -------------- --------------
Cash flows from investing activities:
Purchase of property and equipment ..................... (2) (22) -- (24)
Purchase of available-for-sale investments ............. -- (469) -- (469)
Sale of available-for-sale investments ................. -- 2,462 -- 2,462
-------------- -------------- -------------- --------------
Net cash (used in) provided by investing activities from
continuing operations ................................ (2) 1,971 -- 1,969
Net cash used in investing activities from
discontinued operations .............................. (344) -- -- (344)
-------------- -------------- -------------- --------------
Net cash (used in) provided by investing activities .... (346) 1,971 -- 1,625
-------------- -------------- -------------- --------------
Cash flows from financing activities:
Net cash attributed to the Acacia Technologies group ... (275) -- -- (275)
Net cash attributed to the CombiMatrix group ........... -- 275 -- 275
-------------- -------------- -------------- --------------
Net cash (used in) provided by financing activities .... (275) 275 -- --
-------------- -------------- -------------- --------------
Decrease in cash and cash equivalents ......................... (2,695) (319) -- (3,014)
-------------- -------------- -------------- --------------
Cash and cash equivalents, beginning .......................... 39,792 3,291 -- 43,083
Effect of exchange rate on cash ............................... -- (7) -- (7)
-------------- -------------- -------------- --------------
Cash and cash equivalents, ending ............................. $ 37,097 $ 2,965 $ -- $ 40,062
============== ============== ============== ==============
15
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
Receivable from CombiMatrix group ........................ 114 -- (114) --
-------------- -------------- -------------- --------------
Total current assets .............................. 40,681 15,920 (114) 56,487
Property and equipment, net of accumulated depreciation ....... 180 3,895 -- 4,075
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
Payable to Acacia Technologies group ..................... -- 114 (114) --
-------------- -------------- -------------- --------------
Total current liabilities ......................... 4,027 11,588 (114) 15,501
Deferred income taxes ......................................... 1,156 2,384 -- 3,540
-------------- -------------- -------------- --------------
Total liabilities ................................. 5,183 13,972 (114) 19,041
-------------- -------------- -------------- --------------
Minority interests ............................................ 1,487 684 -- 2,171
-------------- -------------- -------------- --------------
Stockholders' equity:
AR - Acacia Technologies stock ........................... 40,542 -- -- 40,542
AR - CombiMatrix stock ................................... -- 35,317 -- 35,317
-------------- -------------- -------------- --------------
Total stockholders' equity ........................ 40,542 35,317 -- 75,859
-------------- -------------- -------------- --------------
$ 47,212 $ 49,973 $ (114) $ 97,071
============== ============== ============== ==============
16
CONSOLIDATING STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2002 (IN THOUSANDS)
ACACIA
TECHNOLOGIES COMBIMATRIX
GROUP GROUP ELIMINATIONS CONSOLIDATED
-------------- -------------- -------------- --------------
Revenues:
Grant revenue ............................................. $ -- $ 249 $ -- $ 249
-------------- -------------- -------------- --------------
Total revenues ........................................ -- 249 -- 249
-------------- -------------- -------------- --------------
Operating expenses:
Research and development expenses .......................... -- 2,668 -- 2,668
Non-cash compensation expense - research and development ... -- 421 -- 421
Marketing, general and administrative expenses ............. 1,577 2,284 211 4,072
Non-cash compensation expense - marketing,
general and administrative ............................... 10 991 -- 1,001
Legal expenses - patents ................................... 211 -- (211) --
Amortization of patents and goodwill ....................... 465 99 -- 564
-------------- -------------- -------------- --------------
Total operating expenses .................................... 2,263 6,463 -- 8,726
-------------- -------------- -------------- --------------
Operating loss .............................................. (2,263) (6,214) -- (8,477)
-------------- -------------- -------------- --------------
Other income (expense):
Interest income ........................................... 153 250 -- 403
Realized losses on short-term investments ................. (553) -- -- (553)
Unrealized losses on short-term investments ............... (322) -- -- (322)
Interest expense .......................................... -- (60) -- (60)
Other income .............................................. 78 -- -- 78
-------------- -------------- -------------- --------------
Total other income (expense) .......................... (644) 190 -- (454)
-------------- -------------- -------------- --------------
Loss from continuing operations before income
taxes and minority interests ................................ (2,907) (6,024) -- (8,931)
Benefit for income taxes ...................................... 29 40 -- 69
-------------- -------------- -------------- --------------
Loss from continuing operations before minority interests ..... (2,878) (5,984) -- (8,862)
Minority interests ............................................ 37 2,398 -- 2,435
-------------- -------------- -------------- --------------
Net loss ...................................................... $ (2,841) $ (3,586) $ -- $ (6,427)
============== ============== ============== ==============
17
CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2002 (IN THOUSANDS)
ACACIA
TECHNOLOGIES COMBIMATRIX
GROUP GROUP ELIMINATIONS CONSOLIDATED
-------------- -------------- -------------- --------------
Cash flows from operating activities:
Net loss from continuing operations ........................... $ (2,841) $ (3,586) $ -- $ (6,427)
Adjustments to reconcile net loss from continuing
operations to net cash used in operating activities:
Depreciation and amortization ............................. 502 431 -- 933
Minority interests ........................................ (37) (2,398) -- (2,435)
Non-cash stock compensation expense ....................... 10 1,412 -- 1,422
Deferred tax benefit ...................................... (35) (40) -- (75)
Net purchases of trading securities ....................... (3,358) -- -- (3,358)
Unrealized loss on short-term investments ................. 322 -- -- 322
Other ..................................................... (35) 80 -- 45
Changes in assets and liabilities:
Prepaid expenses, other receivables and other assets ...... (673) (639) (10) (1,322)
Accounts payable, accrued expenses and other .............. (125) (970) 10 (1,085)
Deferred revenues ......................................... -- 531 -- 531
-------------- -------------- -------------- --------------
Net cash used in operating activities from continuing
operations .................................................. (6,270) (5,179) -- (11,449)
Net cash used in operating activities from discontinued
operations .................................................. (254) -- -- (254)
-------------- -------------- -------------- --------------
Net cash used in operating activities ......................... (6,524) (5,179) -- (11,703)
-------------- -------------- -------------- --------------
Cash flows from investing activities:
Purchase of property and equipment .......................... (51) (83) -- (134)
Purchase of available-for-sale investments .................. -- (4,540) -- (4,540)
Sale of available-for-sale investments ...................... -- 6,878 -- 6,878
Other ....................................................... (101) -- -- (101)
-------------- -------------- -------------- --------------
Net cash (used in) provided by investing activities ........... (152) 2,255 -- 2,103
-------------- -------------- -------------- --------------
Cash flows from financing activities:
Net cash attributed to the Acacia Technologies group .......... 153 -- -- 153
Net cash attributed to the CombiMatrix group .................. -- 135 -- 135
-------------- -------------- -------------- --------------
Net cash provided by financing activities ..................... 153 135 -- 288
-------------- -------------- -------------- --------------
Decrease in cash and cash equivalents ......................... (6,523) (2,789) -- (9,312)
Cash and cash equivalents, beginning .......................... 46,859 12,592 -- 59,451
Effect of exchange rate on cash ............................... -- (16) -- (16)
-------------- -------------- -------------- --------------
Cash and cash equivalents, ending ............................. $ 40,336 $ 9,787 $ -- $ 50,123
============== ============== ============== ==============
18
COMBIMATRIX GROUP
(A Division of Acacia Research Corporation)
BALANCE SHEETS
(In thousands)
(Unaudited)
MARCH 31, DECEMBER 31,
2003 2002
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents ................................................. $ 2,965 $ 3,291
Short-term investments .................................................... 9,605 11,605
Accounts receivable ....................................................... 266 578
Inventories, prepaid expenses and other assets ............................ 625 446
------------- -------------
Total current assets ................................................... 13,461 15,920
Property and equipment, net of accumulated depreciation and amortization .... 3,465 3,895
Patents, net of accumulated amortization .................................... 10,938 11,212
Goodwill, net of accumulated amortization ................................... 18,859 18,859
Other assets ................................................................ 87 87
------------- -------------
$ 46,810 $ 49,973
============= =============
LIABILITIES AND ALLOCATED NET WORTH
Current liabilities:
Accounts payable, accrued expenses and other .............................. $ 2,361 $ 2,302
Deferred revenues ......................................................... 10,647 9,172
Payable to Acacia Technologies group ...................................... 225 114
------------- -------------
Total current liabilities .............................................. 13,233 11,588
Deferred income taxes ....................................................... 2,350 2,384
------------- -------------
Total liabilities ...................................................... 15,583 13,972
------------- -------------
Minority interests .......................................................... 677 684
------------- -------------
Allocated net worth:
Funds allocated by Acacia Research Corporation ............................ 129,692 129,286
Accumulated net losses .................................................... (99,142) (93,969)
------------- -------------
Total allocated net worth .............................................. 30,550 35,317
------------- -------------
$ 46,810 $ 49,973
============= =============
The accompanying notes are an integral part of these financial statements.
19
COMBIMATRIX GROUP
(A Division of Acacia Research Corporation)
STATEMENTS OF OPERATIONS
(In thousands)
(Unaudited)
FOR THE THREE MONTHS ENDED
-----------------------------------
MARCH 31, 2003 MARCH 31, 2002
---------------- ----------------
Revenues:
Product revenue ............................................. $ 209 $ --
Grant and contract revenue .................................. 7 249
---------------- ----------------
Total revenues ........................................... 216 249
---------------- ----------------
Operating expenses:
Cost of sales ............................................... 77 --
Research and development expenses ........................... 2,335 2,668
Non-cash compensation expense - research and development .... 2 421
Marketing, general and administrative expenses .............. 2,670 2,284
Non-cash compensation expense - marketing, general
and administrative ........................................ 138 991
Amortization of patents ..................................... 274 99
---------------- ----------------
Total operating expenses ................................. 5,496 6,463
---------------- ----------------
Operating loss ........................................... (5,280) (6,214)
---------------- ----------------
Other income (expense):
Interest income ............................................. 67 250
Interest expense ............................................ -- (60)
---------------- ----------------
Total other income ....................................... 67 190
---------------- ----------------
Loss from operations before income taxes
and minority interests ...................................... (5,213) (6,024)
Benefit for income taxes ...................................... 34 40
---------------- ----------------
Loss from operations before minority interests ................ (5,179) (5,984)
Minority interests ............................................ 6 2,398
---------------- ----------------
Division net loss ............................................. $ (5,173) $ (3,586)
================ ================
The accompanying notes are an integral part of these financial statements.
20
COMBIMATRIX GROUP
(A Division of Acacia Research Corporation)
STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
FOR THE THREE MONTHS ENDED
-----------------------------------
MARCH 31, 2003 MARCH 31, 2002
---------------- ----------------
Cash flows from operating activities:
Division net loss from continuing operations ........................ $ (5,173) $ (3,586)
Adjustments to reconcile division net loss from continuing
operations to net cash used in operating activities:
Depreciation and amortization ................................... 606 431
Minority interests .............................................. (6) (2,398)
Non-cash stock compensation expense ............................. 140 1,412
Deferred tax benefit ............................................ (34) (40)
Other ........................................................... 124 80
Changes in assets and liabilities:
Accounts receivable, prepaid expenses, other receivables and
other assets .................................................. 133 (639)
Accounts payable, accrued expenses and other .................... 170 (970)
Deferred revenues ............................................... 1,475 531
---------------- ----------------
Net cash used in operating activities of continuing operations .. (2,565) (5,179)
---------------- ----------------
Cash flows from investing activities:
Purchase of property and equipment .............................. (22) (83)
Purchase of available-for-sale investments ...................... (469) (4,540)
Sale of available-for-sale investments .......................... 2,462 6,878
---------------- ----------------
Net cash provided by investing activities ....................... 1,971 2,255
---------------- ----------------
Cash flows from financing activities:
Net cash flows attributed to the CombiMatrix group .............. 275 135
---------------- ----------------
Decrease in cash and cash equivalents .............................. (319) (2,789)
---------------- ----------------
Cash and cash equivalents, beginning ............................... 3,291 12,592
Effect of exchange rate on cash .................................... (7) (16)
---------------- ----------------
Cash and cash equivalents, ending .................................. $ 2,965 $ 9,787
================ ================
The accompanying notes are an integral part of these financial statements.
21
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
DESCRIPTION OF BUSINESS. 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.
On December 11, 2002, Acacia Research Corporation's stockholders voted
in favor of a recapitalization transaction, which became effective on December
13, 2002, 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-Acacia
Technologies stock is intended to reflect separately the performance of Acacia
Research Corporation's Acacia Technologies group. AR-CombiMatrix stock is
intended to reflect separately the performance of Acacia Research Corporation's
CombiMatrix group.
BASIS OF PRESENTATION. The unaudited interim CombiMatrix group
financial statements as of March 31, 2003, and for the three months ended March
31, 2003 and 2002 have been prepared in accordance with generally accepted
accounting principles for interim financial information. These interim financial
statements should be read in conjunction with the CombiMatrix group financial
statements and Acacia Research Corporation's consolidated financial statements
and notes thereto for the year ended December 31, 2002.
The CombiMatrix group financial statements include all adjustments of a
normal recurring nature which, in the opinion of management, are necessary for a
fair presentation of its financial position as of March 31, 2003, and the
results of its operations and its cash flows for the three months ended March
31, 2003 and 2002. The results of operations for the three months ended March
31, 2003 are not necessarily indicative of the results to be expected for the
entire year.
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 that 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
the 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.
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.
22
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
STOCK-BASED COMPENSATION. Compensation cost of stock options issued to
employees of Acacia Research Corporation 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 Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS No.
123") and related interpretations. As a result of the 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 and Acacia Research Corporation AR-CombiMatrix stock transactions are not
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.
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 and Acacia Research Corporation AR-CombiMatrix stock transactions are not
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."
3. RECENT ACCOUNTING PRONOUNCEMENTS
On January 1, 2003, the CombiMatrix group adopted 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 adoption of SFAS No. 146 did not have
a significant impact on the CombiMatrix group's financial position or results of
operations.
On January 1, 2003, the CombiMatrix group adopted FASB 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. The
adoption of FIN 45 did not have a significant impact on the CombiMatrix group's
financial position or results of operations.
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
23
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.
4. GOODWILL AND INTANGIBLES
Goodwill is evaluated for impairment in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets" ("SFAS No. 142"), which provides that
goodwill is no longer subject to amortization. Instead, goodwill is subject to a
periodic review for potential impairment that must occur at least annually at a
reporting unit level. As of January 1, 2002, the date of adoption of the
standard, the CombiMatrix group had unamortized goodwill in the amount of
$2,851,000. In 2002, the CombiMatrix group 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 the
CombiMatrix group 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 had $18,859,000 of goodwill at March 31, 2003 and
December 31, 2002 (net of $1,312,000 of accumulated amortization).
The CombiMatrix group's only identifiable intangible assets are
patents. The gross carrying amount and accumulated amortization related to
acquired intangible assets as of March 31, 2003 and December 31, 2002 and
related patent amortization expense for the three months ended March 31, 2003
and 2002 are as follows (in thousands):
MARCH 31, 2003 DECEMBER 31, 2002
-------------- --------------
Gross carrying amount - patents ... $ 12,095 $ 12,095
Accumulated amortization .......... (1,157) (883)
-------------- --------------
Patents, net ...................... $ 10,938 $ 11,212
============== ==============
FOR THE THREE MONTHS ENDED
-------------------------------
MARCH 31, 2003 MARCH 31, 2002
-------------- --------------
Patent amortization expense ....... $ 274 $ 99
============== ==============
Annual aggregate amortization expense for each of the next five years
through December 31, 2007 is estimated to be $1,095,000 per year.
At March 31, 2003 and December 31, 2002, all of the CombiMatrix group's
acquired intangible assets other than goodwill were subject to amortization.
5. SUBSEQUENT EVENTS
In the second quarter of 2003, CombiMatrix Corporation entered into a
multi-year strategic alliance with Toppan Printing Corporation to develop and
manufacture microarrays utilizing the CombiMatrix group's proprietary
electrochemical detection approach. Under the terms of the agreement, Toppan
will pay CombiMatrix Corporation an upfront fee of $1,000,000 and additional
development and milestones payments. CombiMatrix Corporation and Toppan will
co-develop semiconductor microarrays for applications in life science research
and development as well as diagnostics.
24
ACACIA TECHNOLOGIES GROUP
(A Division of Acacia Research Corporation)
BALANCE SHEETS
(In thousands)
(Unaudited)
MARCH 31, DECEMBER 31,
2003 2002
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents ................................ $ 37,097 $ 39,792
Prepaid expenses, other receivables and other assets ..... 1,004 775
Receivable from CombiMatrix group ........................ 225 114
------------- -------------
Total current assets .................................. 38,326 40,681
Property and equipment, net of accumulated depreciation .... 147 180
Investment in affiliate, at cost ........................... 252 252
Patents, net of accumulated amortization ................... 3,942 4,068
Goodwill, net of accumulated amortization .................. 1,834 1,834
Other assets ............................................... 197 197
------------- -------------
$ 44,698 $ 47,212
============= =============
LIABILITIES AND ALLOCATED NET WORTH
Current liabilities:
Accounts payable, accrued expenses and other ............. $ 2,129 $ 2,524
Deferred revenues ........................................ 1,536 1,503
------------- -------------
Total current liabilities ............................. 3,665 4,027
Deferred income taxes ...................................... 1,119 1,156
------------- -------------
Total liabilities ..................................... 4,784 5,183
------------- -------------
Minority interests ......................................... 1,142 1,487
------------- -------------
Allocated net worth:
Funds allocated by Acacia Research Corporation ........... 105,281 105,557
Accumulated net losses ................................... (66,509) (65,015)
------------- -------------
Total allocated net worth ............................. 38,772 40,542
------------- -------------
$ 44,698 $ 47,212
============= =============
The accompanying notes are an integral part of these financial statements.
25
ACACIA TECHNOLOGIES GROUP
(A Division of Acacia Research Corporation)
STATEMENTS OF OPERATIONS
(In thousands)
(Unaudited)
FOR THE THREE MONTHS ENDED
-----------------------------------
MARCH 31, 2003 MARCH 31, 2002
---------------- ----------------
Revenues:
License fee income ................................. $ 6 $ --
---------------- ----------------
Total revenues .................................. 6 --
---------------- ----------------
Operating expenses:
Marketing, general and administrative expenses ..... 1,323 1,577
Non-cash stock compensation - marketing, general and
administrative .................................. -- 10
Legal expenses - patents ........................... 262 211
Amortization of patents ............................ 126 465
---------------- ----------------
Total operating expenses ........................ 1,711 2,263
---------------- ----------------
Operating loss .................................. (1,705) (2,263)
---------------- ----------------
Other income (expense):
Interest income ............................... 148 153
Realized gains (losses) on short-term
investments.................................. 37 (553)
Unrealized losses on short-term investments ... -- (322)
Other income .................................. -- 78
---------------- ----------------
Total other income (expenses) ................... 185 (644)
---------------- ----------------
Loss from continuing operations before
income taxes and minority interests ................ (1,520) (2,907)
Benefit for income taxes ............................. 26 29
---------------- ----------------
Loss from continuing operations before
minority interests ................................. (1,494) (2,878)
Minority interests ................................... -- 37
---------------- ----------------
Division net loss .................................... $ (1,494) $ (2,841)
================ ================
The accompanying notes are an integral part of these financial statements.
26
ACACIA TECHNOLOGIES GROUP
(A Division of Acacia Research Corporation)
STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
FOR THE THREE MONTHS ENDED
-------------------------------------
MARCH 31, 2003 MARCH 31, 2002
----------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Division net loss from continuing operations ...................... $ (1,494) $ (2,841)
Adjustments to reconcile division net loss from continuing
operations to net cash used in operating activities:
Depreciation and amortization ................................. 161 502
Minority interests ............................................ -- (37)
Non-cash stock compensation ................................... -- 10
Deferred tax benefit .......................................... (36) (35)
Net purchases of trading securities ........................... -- (3,358)
Unrealized losses on short-term investments ................... -- 322
Other ......................................................... (3) (35)
Changes in assets and liabilities:
Prepaid expenses, other receivables and other assets .......... (229) (673)
Accounts payable, accrued expenses and other .................. (420) (125)
Deferred revenues ............................................. 33 --
----------------- -----------------
Net cash used in operating activities from
continuing operations ....................................... (1,988) (6,270)
Net cash used in operating activities from
discontinued operations ..................................... (86) (254)
----------------- -----------------
Net cash used in operating activities ......................... (2,074) (6,524)
----------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ............................ (2) (51)
Other ......................................................... -- (101)
----------------- -----------------
Net cash used in investing activities from
continuing operations ....................................... (2) (152)
Net cash used in investing activities from
discontinued operations ..................................... (344) --
----------------- -----------------
Net cash used in investing activities ......................... (346) (152)
----------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net cash flows attributed to the Acacia Technologies group .... (275) 153
----------------- -----------------
Decrease in cash and cash equivalents ............................ (2,695) (6,523)
----------------- -----------------
Cash and cash equivalents, beginning ............................. 39,792 46,859
----------------- -----------------
Cash and cash equivalents, ending ................................ $ 37,097 $ 40,336
================= =================
The accompanying notes are an integral part of these financial statements.
27
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
DESCRIPTION OF BUSINESS. 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
("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. Acacia Technologies group's digital media
transmission patent portfolio expires in 2011 in the U.S. and in 2012 in
international markets. 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.
On December 11, 2002, Acacia Research Corporation's stockholders voted
in favor of a recapitalization transaction, which became effective on December
13, 2002, 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-Acacia
Technologies stock is intended to reflect separately the performance of Acacia
Research Corporation's Acacia Technologies group. AR-CombiMatrix stock is
intended to reflect separately the performance of Acacia Research Corporation's
CombiMatrix group.
BASIS OF PRESENTATION. The unaudited interim Acacia Technologies group
financial statements as of March 31, 2003, and for the three months ended March
31, 2003 and 2002, have been prepared in accordance with generally accepted
accounting principles for interim financial information. These interim financial
statements should be read in conjunction with the Acacia Technologies group
financial statements and Acacia Research Corporation's consolidated financial
statements and notes thereto for the year ended December 31, 2002.
The Acacia Technologies group financial statements include all
adjustments of a normal recurring nature which, in the opinion of management,
are necessary for a fair presentation of its financial position as of March 31,
2003, and the results of its operations and its cash flows for the three months
ended March 31, 2003 and 2002. The results of operations for the three months
ended March 31, 2003 are not necessarily indicative of the results to be
expected for the entire year.
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.
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
28
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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
STOCK-BASED COMPENSATION. Compensation cost of stock options issued to
employees of Acacia Research Corporation 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 Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS No.
123") and related interpretations. 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 and Acacia Research Corporation AR-Acacia
Technologies stock transactions are not 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.
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
Technologies group does not have legally issued common or preferred stock and
Acacia Research Corporation AR-Acacia Technologies stock transactions are not
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."
3. RECENT ACCOUNTING PRONOUNCEMENTS
On January 1, 2003, the Acacia Technologies group adopted 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 adoption of SFAS No. 146 did not have
a significant impact on the Acacia Technologies group's financial position or
results of operations.
On January 1, 2003, the Acacia Technologies group adopted FASB
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. The
adoption of FIN 45 did not have a significant impact on the Acacia Technologies
group's financial position or results of operations.
29
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.
4. GOODWILL AND INTANGIBLES
Goodwill is evaluated for impairment in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets" ("SFAS No. 142"), which provides that
goodwill is no longer subject to amortization. Instead, goodwill is subject to a
periodic review for potential impairment that must occur at least annually at a
reporting unit level. As of January 1, 2002, the date of adoption of the
standard, the Acacia Technologies group had unamortized goodwill in the amount
of $1,776,000. In 2002, the Acacia Technologies group 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 the
Acacia Technologies group 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 of goodwill at March 31,
2003 and December 31, 2002 (net of $2,258,000 of accumulated amortization).
The Acacia Technologies group's only identifiable intangible assets
are patents. The gross carrying amount and accumulated amortization related to
acquired intangible assets as of March 31, 2003 and December 31, 2002 and
related patent amortization expense for the three months ended March 31, 2003
and 2002 are as follows (in thousands):
MARCH 31, 2003 DECEMBER 31, 2002
-------------- --------------
Gross carrying amount - patents ... $ 10,798 $ 10,798
Accumulated amortization .......... (6,856) (6,730)
-------------- --------------
Patents, net ...................... $ 3,942 $ 4,068
============== ==============
FOR THE THREE MONTHS ENDED
-------------------------------
MARCH 31, 2003 MARCH 31, 2002
-------------- --------------
Patent amortization expense........ $ 126 $ 465
============== ==============
Annual aggregate amortization expense for each of the next five years
through December 31, 2007 is estimated to be $500,000 per year.
At March 31, 2003 and December 31, 2002, all of the Acacia Technologies
group's acquired intangible assets other than goodwill were subject to
amortization.
30
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CAUTIONARY STATEMENT
You should read the following discussion and analysis in conjunction
with the consolidated financial statements and related notes thereto contained
elsewhere in this report. The information contained in this Quarterly Report on
Form 10-Q is not a complete description of our business or the risks associated
with an investment in our common stock. We urge you to carefully review and
consider the various disclosures made by us in this report and in our other
reports filed with the Securities and Exchange Commission, including our Annual
Report on Form 10-K for the year ended December 31, 2002 and our Registration
Statement on Form S-4 filed with the Securities and Exchange Commission on May
7, 2002, as amended, that discuss our business in greater detail.
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.
OVERVIEW
As used in this Form 10-Q, "we," "us" and "our" refer to Acacia
Research Corporation and its subsidiary companies.
Acacia Research Corporation, a Delaware corporation, was originally
incorporated in California in January 1993 and reincorporated in Delaware in
December 1999.
The following discussion is based primarily on our unaudited
consolidated balance sheet as of March 31, 2003 and on our unaudited
consolidated statement of operations for the period from January 1, 2003 to
March 31, 2003. The discussion compares the activities for the three months
ended March 31, 2003 to the activities for the three months ended March 31,
2002. This information should be read in conjunction with the accompanying
unaudited consolidated financial statements and notes thereto.
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.
31
COMBIMATRIX GROUP
o During the first quarter of 2003, the CombiMatrix group's financial
condition and results of operations were highlighted by the CombiMatrix
KK's sale and installation of a genomics microarray synthesizer system
to Keio University of Japan. In addition, CombiMatrix KK received an
advance payment from the Nihon Gene Research Laboratory of Japan for
the sale of a genomics microarray synthesizer system. The installation
of this system is expected to be completed during the third quarter of
2003. Total consideration received by CombiMatrix KK from these genomic
microarray synthesizer system sales and related microarray products and
services to existing customers totaled $487,000, $216,000 of which was
recognized as revenues during the first quarter of 2003 and $271,000 of
which were recorded as deferred revenues as of March 31, 2003. Also
during the first quarter 2003, the CombiMatrix group received
$1,739,000 in milestone payments pursuant to its license, research and
development agreements with Roche. All milestone payments received from
Roche to date have been recorded as deferred revenues.
ACACIA TECHNOLOGIES GROUP
o To date, the Acacia Technologies group has entered into 21 license
agreements for its DMT technology. The Acacia Technologies group's DMT
license agreements provide for recurring license fee payments to be
made by the respective licensees over the term of the license.
o In February 2003, Acacia Media Technologies initiated DMT 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.
o The Acacia Technologies group's patent on the V-chip technology expires
in July 2003. Depending on the outcome of ongoing licensing efforts and
related infringement actions, the Acacia Technologies group may,
however, 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 marketing its
DMT technology and is from time to time may 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 additional technologies or are unable to
successfully commercially license our existing and future technologies,
our financial condition may be adversely impacted.
ACACIA RESEARCH CORPORATION CONSOLIDATED
RESULTS OF OPERATIONS (IN THOUSANDS)
FOR THE THREE MONTHS ENDED
-------------------------------
March 31, 2003 March 31, 2002
-------------- --------------
Net revenues .................................................................. $ 222 $ 249
Cost of sales ................................................................. (77) --
Research and development expenses ............................................. (2,335) (2,668)
Non-cash stock compensation expense - research and development ................ (2) (421)
Marketing, general and administrative expenses ................................ (4,255) (4,072)
Non-cash stock compensation expense - marketing, general and administrative ... (138) (1,001)
Amortization of patents ....................................................... (400) (564)
Other income (expenses), net .................................................. 252 (454)
Benefit for income taxes ...................................................... 60 69
Minority interests ............................................................ 6 2,435
-------------- --------------
Net loss ...................................................................... $ (6,667) $ (6,427)
============== ==============
32
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2003 TO THE THREE MONTHS ENDED
MARCH 31, 2002
REVENUES
LICENSE FEE INCOME. During the three months ended March 31, 2003,
license fee revenues were $6,000, as compared to zero during the three months
ended March 31, 2002. First quarter 2003 revenues relate solely to DMT
technology license fees which the Acacia Technologies group began to recognize
in the first quarter of 2003. Under the terms of the respective DMT license
Agreement with each individual licensee, the Acacia Technologies group granted a
one-year non-exclusive license for the use of its patented DMT technology in
exchange for an annual license fee. Prepaid license fee payments received are
amortized to revenue over the license term.
PRODUCT REVENUES AND COST OF SALES. During the three months ended March
31, 2003, product revenues were $209,000, as compared to zero during the three
months ended March 31, 2002, with related cost of sales of $77,000 and zero for
the same periods, respectively. 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
Japanese research institutions.
GRANT AND CONTRACT REVENUE. During the three months ended March 31,
2003, grant and contract revenues were $7,000, as compared to $249,000 during
the three months ended March 31, 2002. Contract revenues recognized during 2003
relate to ongoing contract maintenance and service revenues earned by
CombiMatrix KK, which were zero in the comparable 2002 period. There were no
grant revenues recognized during the three months ended March 31, 2003. During
the comparable period in 2002, grant and contract revenues included $91,000 from
CombiMatrix Corporation's performance under its Phase I Small Business
Innovative Research, or SBIR, Department of Defense contract, $141,000 in
one-time contract research and development revenues and $17,000 in grant
revenues related to performance under its Phase I National Institutes of Health,
or NIH, grant. The SBIR Department of Defense and NIH grants were completed
during the third quarter of 2002.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT EXPENSES. During the three months ended March
31, 2003, research and development expenses were $2.3 million, as compared to
$2.7 million during the three months ended March 31, 2002. The CombiMatrix
group's research and development activities continue to be driven primarily by
ongoing performance obligations under the product commercialization phase of its
license, research and development agreements with Roche. These activities
include costs associated with direct labor, supplies and materials, development
of prototype microarrays and instruments and the use of outside consultants for
certain engineering efforts. Due to the achievement of several significant
milestones during the third and fourth quarters of 2002, these research and
development activities decreased during the first quarter of 2003 as compared to
the same period in 2002. The CombiMatrix group expects its research and
development expenses to be volatile and could increase in future periods as
additional milestones are achieved for both existing and future contract
research and development agreements.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. During the three
months ended March 31, 2003, marketing, general and administrative expenses were
$4.3 million, as compared to $4.1 million during the three months ended March
31, 2002. The increase was due primarily to an increase in CombiMatrix
Corporation's rent and utilities expenses as a result of the increase in
occupancy of its headquarters in Mukilteo, Washington, an increase in
CombiMatrix group severance-related expenses, and an increase in expenses
related to Acacia Technologies group's ongoing DMT patent marketing and
commercialization efforts, including increased personnel, consulting, research
and engineering costs. The increase was partially offset by a decrease in legal
and accounting related expenses related to the recapitalization and merger
transactions consummated in December 2002.
NON-CASH STOCK COMPENSATION EXPENSE.
RESEARCH AND DEVELOPMENT. During the three months ended March
31, 2003, research and development related non-cash stock compensation charges,
all of which relate to the CombiMatrix group, were $2,000, as compared to
$421,000 during the three months ended March 31, 2002.
33
MARKETING, GENERAL AND ADMINISTRATIVE. During the three months
ended March 31, 2003, marketing, general and administrative non-cash stock
compensation charges, primarily related to the CombiMatrix group, were $138,000,
as compared to $1.0 million during the three months ended March 31, 2002.
The decrease in non-cash stock compensation charges related
to research and development and marketing, general and administrative related
expenses is primarily due to the accelerated method of amortization utilized
pursuant to Financial Accounting Standards Board Interpretation No. 28,
"Accounting for Stock Appreciation Rights and Other Variable Stock Option or
Award Plans" ("FIN No. 28"), which results in higher amounts of amortization in
the early vesting periods. Total non-cash stock compensation amortization
expense is net of $743,000 and $724,000 in stock compensation expense reversals
related to the forfeiture of certain unvested stock options during the three
months ended March 31, 2003 and 2002, respectively.
AMORTIZATION OF PATENTS. During the three months ended March 31, 2003,
amortization of patents was $400,000, as compared to $564,000 during the three
months ended March 31, 2002. The increase is due to the December 13, 2002 step
acquisition of CombiMatrix Corporation by Acacia Research Corporation, which
resulted in the recognition of additional core technology patent valued at $5.3
million. As a result, Acacia Research Corporation will record additional
amortization expense of approximately $755,000 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. The increase was offset by a reduction in patent
amortization expense due to V-chip technology related patent costs and other
intangibles that were fully amortized during 2002.
OTHER INCOME (EXPENSES), NET
OTHER INCOME (EXPENSES), NET. During the three months ended March 31,
2003, other income, net was $252,000, as compared to $454,000 in other expenses,
net during the three months ended March 31, 2002. The significant components of
other income (expense) were as follows:
INTEREST INCOME. During the three months ended March
31, 2003, interest income was $215,000, as compared to $403,000 during the three
months ended March 31, 2002. The decrease was primarily due to a decrease in
average cash balances related to net operating cash outflows and the impact of a
decrease in interest rates on our short-term investments resulting from 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 2002 and continuing in 2003.
REALIZED AND UNREALIZED LOSSES ON SHORT-TERM INVESTMENTS.
During the three months ended March 31, 2003, net realized gains on investments
was $37,000, as compared to net realized losses on investments of $553,000.
During the three months ended March 31, 2003, net unrealized losses on
investments was zero, as compared to net unrealized losses on investments of
$322,000 during the three months ended March 31, 2002. The decrease is due to an
overall reduction in investments classified as trading securities.
MINORITY INTERESTS. During the three months ended March 31, 2003,
minority interests in the losses of consolidated subsidiaries was $6,000, as
compared to $2.4 million during the three months ended March 31, 2002. Minority
interests recorded during the three months ended March 31, 2002 relate primarily
to our majority ownership interest in CombiMatrix Corporation during 2002. As a
result of our merger with CombiMatrix Corporation in December 2002, which
increased our ownership interest to 100%, we no longer record minority interests
related to our investment in CombiMatrix Corporation.
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
and short-term investments totaled $49.7 million at March 31, 2003, as compared
to $54.7 million at December 31, 2002.
We have no commitments for capital expenditures. Our minimum rental
commitments on operating leases related to continuing operations total $10.0
million through December 2007. We have no committed lines of credit or other
committed funding or long-term debt. Management believes that our cash and cash
equivalent and short term investments, anticipated cash flow from operations and
other external sources of available credit will be sufficient to meet our cash
requirements for the foreseeable future.
34
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 4 to the Acacia Research Corporation consolidated
financial statements included elsewhere herein.
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.
35
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 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.
During the first quarter of 2003, the CombiMatrix group's financial
condition and results of operations were highlighted by the CombiMatrix KK's
sale and installation of a genomics microarray synthesizer system to Keio
University of Japan. In addition, CombiMatrix KK received an advance payment
from the Nihon Gene Research Laboratory of Japan for the sale of a genomics
microarray synthesizer system. The installation of this system is expected to be
completed during the third quarter of 2003. Total consideration received by
CombiMatrix KK from these genomic microarray synthesizer system sales and
related microarray products and services to existing customers totaled $487,000,
$216,000 of which was recognized as revenues and $271,000 of which were recorded
as deferred revenues as of March 31, 2003. Also during the first quarter of
2003, the CombiMatrix group received $1,739,000 in milestone payments pursuant
to its license, research and development agreements with Roche. All milestone
payments received from Roche to date have been recorded as deferred revenues.
36
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
RESULTS OF OPERATIONS (IN THOUSANDS)
FOR THE THREE MONTHS ENDED
-------------------------------
March 31, 2003 MARCH 31, 2002
-------------- --------------
Product revenue ................................................... $ 209 $ --
Grant and contract revenue ........................................ 7 249
Cost of sales ..................................................... (77) --
Research and development expenses ................................. (2,335) (2,668)
Non-cash stock compensation expenses - research and development ... (2) (421)
Marketing, general and administrative expenses .................... (2,670) (2,284)
Non-cash stock compensation expenses - marketing, general and
administrative ................................................. (138) (991)
Amortization of patents ........................................... (274) (99)
Other income, net ................................................. 67 190
Benefit for income taxes .......................................... 34 40
Minority interests ................................................ 6 2,398
-------------- --------------
Division net loss ................................................. $ (5,173) $ (3,586)
============== ==============
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2003 TO THE THREE MONTHS ENDED
MARCH 31, 2002
PRODUCT REVENUES AND COST OF SALES. During the three months ended March
31, 2003, product revenues were $209,000, as compared to zero during the three
months ended March 31, 2002, with related cost of sales of $77,000 and zero for
the same periods, respectively. Product revenues and cost of sales were
recognized by CombiMatrix KK from the sale of a genomics microarray synthesizer
and related microarray products and services to Japanese research institutions.
GRANT AND CONTRACT REVENUES. During the three months ended March 31,
2003, grant and contract revenues were $7,000, as compared to $249,000 during
the three months ended March 31, 2002. Contract revenues recognized during 2003
relate to ongoing contract maintenance and service revenues earned by
CombiMatrix KK, which were zero in the comparable 2002 period. There were no
grant revenues recognized during the three months ended March 31, 2003. During
the comparable period in 2002, grant and contract revenues included $91,000 from
CombiMatrix Corporation's performance under its Phase I Small Business
Innovative Research, or SBIR, Department of Defense contract, $141,000 in
one-time contract research and development revenues and $17,000 in grant
revenues related to performance under its Phase I NIH grant. The SBIR Department
of Defense and NIH grants were completed in the third quarter of 2002.
RESEARCH AND DEVELOPMENT EXPENSES. During the three months ended March
31, 2003, research and development expenses were $2.3 million, as compared to
$2.7 million during the three months ended March 31, 2002. The CombiMatrix
group's research and development activities continue to be driven primarily by
ongoing performance obligations under the product commercialization phase of its
license, research and development agreements with Roche. These activities
include costs associated with direct labor, supplies and materials, development
of prototype microarrays and instruments and the use of outside consultants for
certain engineering efforts. Due to the achievement of several significant
milestones during the third and fourth quarters of 2002, these research and
development activities decreased during the first quarter of 2003 as compared to
the same period in 2002. The CombiMatrix group expects that its research and
development activities will be volatile and could increase in future periods as
additional milestones are achieved for both existing and future contract
research and development agreements. 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 instrumentation and hardware, improved microarray synthesis
techniques, development of higher density microarrays and the development of a
robust manufacturing process for its microarray platform. These projects are
expected to continue into 2005 as determined by the timelines specified in the
agreements.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. During the three months
ended March 31, 2003, marketing, general and administrative expenses were $2.7
37
million, as compared to $2.3 million during the three months ended March 31,
2002. This increase was due primarily to an increase in CombiMatrix
Corporation's rent and utilities expenses as a result of the increase in
occupancy of its headquarters in Mukilteo, Washington, as well as
severance-related expenses incurred during the first quarter of 2003 that were
not incurred in the comparable 2002 period.
NON-CASH STOCK COMPENSATION EXPENSE.
RESEARCH AND DEVELOPMENT. For the three months ended March 31,
2003, research and development related non-cash stock compensation charges were
$2,000, as compared to $421,000 during the three months ended March 31, 2002.
MARKETING, GENERAL AND ADMINISTRATIVE. For the three months
ended March 31, 2003, marketing, general and administrative related non-cash
stock compensation charges were $138,000, as compared to $991,000 during the
three months ended March 31, 2002.
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 total
non-cash stock compensation amortization expense is net of $743,000 and $724,000
in stock compensation expense reversals related to the forfeiture of certain
unvested stock options during the three months ended March 31, 2003 and 2002,
respectively.
AMORTIZATION OF PATENTS. During the three months ended March 31, 2003,
amortization of patents was $274,000, as compared to $99,000 during the three
months ended March 31, 2002. The increase in patent amortization was due to the
December 13, 2002 step acquisition of CombiMatrix Corporation by Acacia Research
Corporation, which resulted in the recognition of additional core technology
patent valued at $5.3 million which was allocated to the CombiMatrix group. As a
result, the CombiMatrix group will record additional amortization expense of
approximately $755,000 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.
OTHER INCOME, NET. During the three months ended March 31, 2003, other
income, net was $67,000, as compared to $190,000 during the three months ended
March 31, 2002. Other income, net is comprised of the following:
INTEREST INCOME. During the three months ended March 31, 2003,
interest income was $67,000, as compared to $250,000 during the three months
ended March 31, 2002. The decrease was due primarily to lower average cash and
cash equivalents balances and short-term investments during the first quarter of
2003, as compared to the same period in 2002, as well as lower market interest
rates earned on the CombiMatrix group's cash and investments.
INTEREST EXPENSE. During the three months ended March 31,
2003, interest expense was zero, as compared to $60,000 during the three months
ended March 31, 2002. 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. As a result, no interest expense charges were incurred during
the first quarter of 2003.
MINORITY INTERESTS. During the three months ended March 31, 2003,
minority interests in the net losses of the CombiMatrix group were $6,000, as
compared to $2.4 million during the three months ended March 31, 2002. As a
result of Acacia Research Corporation's merger with CombiMatrix Corporation in
December 2002, which increased Acacia Research Corporation's ownership interest
to 100%, the CombiMatrix group no longer records minority interests related to
Acacia Research Corporation's investment in CombiMatrix Corporation, resulting
in the overall decrease in minority interests recognized during the first
quarter of 2003, as compared to the same period in 2002.
INFLATION
Inflation has not had a significant impact on the CombiMatrix group.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2003 and December 31, 2002, cash and cash equivalents
and short-term investments totaled $12.6 million and $14.9 million,
respectively.
38
CombiMatrix group'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. The CombiMatrix group has no long-term debt
or commitments for capital expenditures. The CombiMatrix group is required to
pay Nanogen $500,000 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.
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 3 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 March 31, 2003 and 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 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.
39
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 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. The
Acacia Technologies group's patented proprietary digital media transmission
technology is referred to as "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.
To date, the Acacia Technologies group has entered into 21 license
agreements for its DMT technology. The Acacia Technologies group's DMT license
agreements generally provide for recurring license fee payments to be made by
the respective licensees over the term of the license.
In February 2003, Acacia Media Technologies initiated DMT 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.
The 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 marketing 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
successfully commercially license our existing and future technologies, our
financial condition may be adversely impacted.
40
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
RESULTS OF OPERATIONS (IN THOUSANDS)
FOR THE THREE MONTHS ENDED
-------------------------------
MARCH 31, 2003 MARCH 31, 2002
-------------- --------------
Net revenues ...................................... $ 6 $ --
Marketing, general and administrative expenses .... (1,323) (1,577)
Non-cash stock compensation expenses - marketing,
general and administrative ..................... -- (10)
Legal expenses - patents .......................... (262) (211)
Amortization of patents ........................... (126) (465)
Other income (expenses), net ...................... 185 (644)
Benefit for income taxes .......................... 26 29
Minority interests ................................ -- 37
-------------- --------------
Division net loss ................................. $ (1,494) $ (2,841)
============== ==============
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2003 TO THE THREE MONTHS ENDED
MARCH 31, 2002
REVENUES
LICENSE FEE INCOME. During the three months ended March 31, 2003,
license fee revenues were $6,000, as compared to zero during the three months
ended March 31, 2002. First quarter 2003 revenues relate solely to DMT
technology license fees which the Acacia Technologies group began to recognize
in the first quarter of 2003. Under the terms of the respective DMT license
Agreement with each individual licensee, the Acacia Technologies group granted a
one-year non-exclusive license for the use of its patented DMT technology in
exchange for an annual license fee. Prepaid license fee payments received are
amortized to revenue over the license term.
OPERATING EXPENSES
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. During the three months
ended March 31, 2003, marketing, general and administrative expenses were $1.3
million, as compared to $1.6 million during the three months ended March 31,
2002. The decrease is due primarily to a reduction in legal and accounting
related expenses related to the recapitalization and merger transactions
consummated in December 2002, offset by an increase in Acacia Technologies
group's ongoing patent marketing and commercialization efforts, including
increased personnel, consulting, research and engineering costs.
LEGAL EXPENSES - PATENTS. During the three months ended March 31, 2003,
patent related legal expenses were $262,000, as compared to $211,000 during the
three months ended March 31, 2002. Patent related legal expenses in both periods
relates to legal fees incurred in connection with the Acacia Technologies
group's ongoing DMT patent marketing and commercialization efforts, including
patent claims construction, patent prosecution and related research costs.
OTHER INCOME (EXPENSES), NET
OTHER INCOME (EXPENSES), NET. During the three months ended March 31,
2003, other income, net was $185,000, as compared to $644,000 in net other
expenses during the three months ended March 31, 2002. The significant
components of other income (expenses) were as follows:
INTEREST INCOME. During the three months ended March 31,
2003, interest income was $148,000, as compared to $153,000 during the three
months ended March 31, 2002. The decrease was primarily due to a decrease in
average cash balances related to net operating cash outflows and the impact of a
decrease in interest rates on our short-term investments resulting from 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 2002 and continuing during 2003.
41
REALIZED AND UNREALIZED LOSSES ON SHORT-TERM INVESTMENTS.
During the three months ended March 31, 2003, net realized gains on investments
were $37,000, as compared to net realized losses on investments of $553,000.
During the three months ended March 31, 2003, net unrealized losses on
investments were zero, as compared to net unrealized losses on investments of
$322,000 during the three months ended March 31, 2002. The decrease is due to an
overall reduction in investments classified as trading securities.
INFLATION
Inflation has not had a significant impact on Acacia Research
Corporation.
LIQUIDITY AND CAPITAL RESOURCES
The Acacia Technologies group's cash and cash equivalents totaled $37.1
million at March 31, 2003, as compared to $39.8 million at December 31, 2002.
The Acacia Technologies group has no commitments for capital
expenditures. The Acacia Technologies group's minimum rental commitments on
operating leases related to continuing operations total $1.3 million through
December 2007. The Acacia Technologies group has no committed lines of credit or
other committed funding or long-term debt. Management believes that the Acacia
Technologies group's cash and cash equivalent and short term investments,
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 3 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.
42
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, as of March 31 ,2003, of $165.7 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. 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:
43
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 March 31, 2003, we had cash and short-term investments of $49.7
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.
44
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.
45
During the three months ended March 31, 2003 and the fiscal year ended
December 31, 2002, we had operating losses of approximately $7.0 million and
$80.3 million, respectively, and net losses of approximately $6.7 million and
$59.0 million, respectively. 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.
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, Acacia Research Corporation. 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
46
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.
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.
47
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 8.0% of the outstanding
AR-CombiMatrix stock and 13.0% 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.
48
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.
49
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.
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
50
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
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,
51
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.
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 57.
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
52
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.
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.
53
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
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;
54
o its ability to manufacture products in sufficient quantities with
acceptable quality and reliability and at an acceptable cost;
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
55
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.
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
56
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.
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 52.
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 to date 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.
57
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;
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. Additionally, the
V-chip technology patent will expire in July 2003, and the Acacia Technologies
Group will not be able to collect royalties for televisions containing V-chip
technology sold after that date. Furthermore, many potential competitors,
including television manufacturers, have significantly greater resources than we
do.
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
58
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.
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.
59
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Refer to the caption "Quantitative and Qualitative Disclosures About
Market Risk" on pages 35, 39 and 42.
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 March 31, 2003, 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 $40,000 decrease in the fair value of our
available-for-sale securities as of March 31, 2003.
ITEM 4. 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.
60
PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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 defendants Sony Corporation of America,
Inc., Sony Electronics, Inc., the Electronics Industries Alliance d/b/a Consumer
Electronics Association, the Consumer Electronics Manufacturers Association,
Mitsubishi Digital Electronics America, Inc., Mitsubishi Electronics America,
Inc., Toshiba America Consumer Products, Inc. and Sharp Electronics Corporation.
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.
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, 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, Acacia Media Technologies initiated DMT 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 our belief
that their conduct infringes on our patent rights.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
99.1 Certification of Paul R. Ryan, Chairman and Chief Executive
Officer of Acacia Research Corporation, Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of Clayton J. Haynes, Chief Financial Officer of
Acacia Research Corporation, Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
On February 28, 2003, Acacia filed a Current Report on Form 8-K to
report results for the fourth quarter and fiscal year end of 2002.
On April 29, 2003, Acacia filed a Current Report on Form 8-K to report
results for the first quarter of 2003.
61
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ACACIA RESEARCH CORPORATION
By: /S/ Paul R. Ryan
----------------------------------
Paul R. Ryan
Chief Executive Officer
(Authorized Signatory)
By: /S/ Clayton J. Haynes
----------------------------------
Clayton J. Haynes
Chief Financial Officer /Treasurer
(Principal Financial Officer)
Date: May 9, 2003
62
CERTIFICATION
-------------
I, Paul Ryan, certify that:
I have reviewed this quarterly report on Form 10-Q of Acacia Research
Corporation;
Based on my knowledge, this quarterly 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 quarterly report;
Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly report;
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
quarterly 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 quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
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
The registrant's other certifying officers and I have indicated in
this quarterly 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: May 9, 2003
/S/ Paul R. Ryan
----------------------------------
Paul R. Ryan
Chief Executive Officer
63
CERTIFICATION
-------------
I, Clayton J. Haynes, certify that:
I have reviewed this quarterly report on Form 10-Q of Acacia Research
Corporation;
Based on my knowledge, this quarterly 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 quarterly report;
Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly report;
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
quarterly 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 quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
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
The registrant's other certifying officers and I have indicated in
this quarterly 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: May 9, 2003
/S/ Clayton J. Haynes
----------------------------------
Clayton J. Haynes
Chief Financial Officer
64
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT
- ------ -------
99.1 Certification pursuant to 18 U.S.C Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by
Paul R. Ryan
99.2 Certification pursuant to 18 U.S.C Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by
Clayton J. Haynes
65