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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
COMMISSION FILE NUMBER 0-26068
ACACIA RESEARCH CORPORATION
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(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 95-4405754
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
500 NEWPORT CENTER DRIVE, NEWPORT BEACH, CA 92660
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (949) 480-8300
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Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
As of November 7, 2003, 19,723,752 shares of Acacia Research-Acacia
Technologies common stock were issued and outstanding. As of November 7, 2003,
26,184,771 shares of Acacia Research-CombiMatrix common stock were issued and
outstanding.
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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 September 30, 2003 and
December 31, 2002 (Unaudited)....................................................... 1
Consolidated Statements of Operations and Comprehensive Loss for the
Three Months and Nine Months Ended September 30, 2003 and 2002 (Unaudited).......... 2
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2003 and 2002 (Unaudited)............................................. 3
Notes to Consolidated Financial Statements (Unaudited).............................. 4
*CombiMatrix Group Financial Statements
Balance Sheets as of September 30, 2003 and December 31, 2002 (Unaudited)........... 15
Statements of Operations for the Three Months and Nine Months Ended
September 30, 2003 and 2002 (Unaudited)............................................. 16
Statements of Cash Flows for the Nine Months Ended
September 30, 2003 and 2002 (Unaudited)............................................. 17
Notes to Financial Statements (Unaudited)........................................... 18
*Acacia Technologies Group Financial Statements
Balance Sheets as of September 30, 2003 and December 31, 2002 (Unaudited)........... 22
Statements of Operations for the Three Months and Nine Months Ended
September 30, 2003 and 2002 (Unaudited)............................................. 23
Statements of Cash Flows for the Nine Months Ended
September 30, 2003 and 2002 (Unaudited)............................................. 24
Notes to Financial Statements (Unaudited)........................................... 25
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................................... 28
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................... 62
Item 4. Controls and Procedures............................................................. 62
i
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................... 63
Item 2. Changes in Securities and Use of Proceeds........................................... 64
Item 6. Exhibits and Reports on Form 8-K.................................................... 64
SIGNATURES........................................................................................... 65
EXHIBIT INDEX ....................................................................................... 66
*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.
ii
ACACIA RESEARCH CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share information)
(Unaudited)
SEPTEMBER 30, DECEMBER 31,
2003 2002
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ASSETS
Current assets:
Cash and cash equivalents ......................................... $ 34,302 $ 43,083
Short-term investments ............................................ 19,257 11,605
Accounts receivable ............................................... 444 578
Prepaid expenses, inventory, and other assets ..................... 1,445 1,221
---------- ----------
Total current assets ..................................... 55,448 56,487
Property and equipment, net of accumulated depreciation ................ 3,024 4,075
Patents, net of accumulated amortization of $8,811 (2003)
and $7,613 (2002) ................................................. 14,082 15,280
Goodwill, net of accumulated amortization of $3,570 (2003)
and (2002) ........................................................ 21,201 20,693
Other assets ........................................................... 339 536
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$ 94,094 $ 97,071
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued expenses and other ...................... $ 3,862 $ 4,826
Current portion of deferred revenues .............................. 20,308 10,675
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Total current liabilities ................................ 24,170 15,501
Deferred income taxes .................................................. 3,330 3,540
Deferred revenues, net of current portion .............................. 474 --
---------- ----------
Total liabilities ........................................ 27,974 19,041
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Minority interests ..................................................... 1,130 2,171
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Commitments and contingencies (Note 7)
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;
19,688,730 and 19,640,808 shares issued and
outstanding as of September 30, 2003 and December
31, 2002, respectively ................................... 20 20
Acacia Research - CombiMatrix stock, par value $0.001 per
share; 50,000,000 shares authorized; 26,162,994 and
22,964,779 shares issued and outstanding as of
September 30, 2003 and December 31, 2002, respectively ... 26 23
Additional paid-in capital ........................................ 244,432 238,826
Deferred stock compensation ....................................... (1,225) (4,023)
Accumulated comprehensive loss .................................... (5) (2)
Accumulated deficit ............................................... (178,258) (158,985)
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Total stockholders' equity ............................... 64,990 75,859
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$ 94,094 $ 97,071
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THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED
FINANCIAL STATEMENTS.
1
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(In thousands, except share and per share information)
(Unaudited)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
----------------------------- -----------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Revenues:
License fee income ........................................... $ 186 $ 43 $ 211 $ 43
Product revenue .............................................. 171 23 380 297
Grant and contract revenue ................................... 10 113 23 526
------------- ------------- ------------- -------------
Total revenues .......................................... 367 179 614 866
------------- ------------- ------------- -------------
Operating expenses:
Cost of sales ................................................ 17 6 94 259
Research and development expenses ............................ 1,726 6,449 6,219 14,143
Non-cash stock compensation expense - research
and development ............................................ 243 753 525 1,867
Marketing, general and administrative expenses ............... 3,675 4,727 11,482 14,253
Non-cash stock compensation expense - marketing,
general and administrative ................................. 421 1,263 1,055 3,716
Amortization of patents ...................................... 399 550 1,198 1,678
Legal settlement charges ..................................... -- 18,471 -- 18,471
------------- ------------- ------------- -------------
Total operating expenses ................................ 6,481 32,219 20,573 54,387
------------- ------------- ------------- -------------
Operating loss .......................................... (6,114) (32,040) (19,959) (53,521)
------------- ------------- ------------- -------------
Other income (expense) :
Impairment of cost method investment ......................... -- (2,748) (207) (2,748)
Interest income .............................................. 180 266 572 966
Realized gains (losses) on short-term investments ............ 32 -- 94 (1,483)
Unrealized losses on short-term investments .................. -- (213) -- (690)
Interest expense ............................................. -- (49) -- (171)
Other (expense) income ....................................... -- (5) 1 47
------------- ------------- ------------- -------------
Total other income (expenses) ........................... 212 (2,749) 460 (4,079)
------------- ------------- ------------- -------------
Loss from operations before income taxes and minority interests .. (5,902) (34,789) (19,499) (57,600)
Benefit for income taxes ......................................... 70 287 196 431
------------- ------------- ------------- -------------
Loss from operations before minority interests ................... (5,832) (34,502) (19,303) (57,169)
Minority interests ............................................... -- 14,080 30 20,620
------------- ------------- ------------- -------------
Loss from continuing operations .................................. (5,832) (20,422) (19,273) (36,549)
Discontinued operations:
Estimated loss on disposal of Soundbreak.com ................. -- (200) -- (200)
------------- ------------- ------------- -------------
Net loss ......................................................... (5,832) (20,622) (19,273) (36,749)
Unrealized losses on short-term investments .................. (9) (1) (24) (49)
Unrealized gains (losses) on foreign currency translation .... 25 (12) 21 41
------------- ------------- ------------- -------------
Comprehensive loss ............................................... $ (5,816) $ (20,635) $ (19,276) $ (36,757)
============= ============= ============= =============
Loss per common share:
Attributable to the Acacia Technologies group:
Net loss ..................................................... $ (1,296) $ (5,275) $ (4,368) $ (11,920)
Basic and diluted per share ............................. (0.07) (0.27) (0.22) (0.61)
Attributable to the CombiMatrix group:
Net loss ..................................................... $ (4,536) $ (15,347) $ (14,905) $ (24,829)
Basic and diluted per share ............................. (0.18) (0.67) (0.64) (1.08)
Weighted average shares - basic and diluted:
Acacia Research - Acacia Technologies stock .................. 19,645,949 19,640,808 19,642,541 19,640,808
============= ============= ============= =============
Acacia Research - CombiMatrix stock .......................... 25,890,408 22,950,551 23,129,476 22,950,551
============= ============= ============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED
FINANCIAL STATEMENTS.
2
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
NINE MONTHS ENDED
---------------------------------
SEPTEMBER 30, SEPTEMBER 30,
2003 2002
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Cash flows from operating activities:
Net loss from continuing operations ..................................... $ (19,273) $ (36,549)
Adjustments to reconcile net loss from continuing operations to
net cash used in operating activities:
Depreciation and amortization ........................................ 2,293 2,852
Minority interests ................................................... (30) (20,620)
Non-cash stock compensation expense .................................. 1,580 5,583
Deferred tax benefit ................................................. (210) (220)
Net sales of trading securities ...................................... -- 2,688
Unrealized losses on short-term investments .......................... -- 690
Minority interests distributions ..................................... -- 430
Issuance of common stock by subsidiary - legal settlement ............ -- 17,471
Impairment of cost method investment ................................. 207 2,748
Other ................................................................ 69 87
Changes in assets and liabilities:
Accounts receivable .................................................. 134 (2,409)
Prepaid expenses, inventory, and other assets ........................ (173) (990)
Accounts payable, accrued expenses and other ......................... (618) 2,350
Deferred revenues .................................................... 10,107 5,180
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Net cash used in operating activities from continuing operations ..... (5,914) (20,709)
Net cash used in operating activities from discontinued operations ... (350) (812)
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Net cash used in operating activities ................................ (6,264) (21,521)
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Cash flows from investing activities:
Purchase of property and equipment, net .............................. (77) (717)
Sale of property and equipment ....................................... -- 103
Purchase of available-for-sale investments ........................... (26,561) (12,772)
Sale of available-for-sale investments ............................... 18,887 14,292
Purchase of common stock from minority stockholders of subsidiaries .. -- (57)
Other ................................................................ -- (100)
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Net cash (used in) provided by investing activities from
continuing operations .............................................. (7,751) 749
Net cash used in investing activities from discontinued operations ... (356) (3)
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Net cash (used in) provided by investing activities .................. (8,107) 746
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Cash flows from financing activities:
Proceeds from sale of common stock, net of issuance costs ............ 4,862 --
Proceeds from the exercise of stock options and warrants ............. 741 214
Capital contributions from minority shareholders of subsidiaries,
net of issuance costs .............................................. -- 300
Capital distributions to minority shareholders of subsidiaries,
net of issuance costs .............................................. -- (430)
Repayment of capital lease obligation ................................ -- (694)
Other ................................................................ -- (11)
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Net cash provided by (used in) financing activities .................. 5,603 (621)
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Effect of exchange rate on cash ........................................... (13) 71
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Decrease in cash and cash equivalents ..................................... (8,781) (21,325)
Cash and cash equivalents, beginning ...................................... 43,083 59,451
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Cash and cash equivalents, ending ......................................... $ 34,302 $ 38,126
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THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED
FINANCIAL STATEMENTS.
3
ACACIA RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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
year-end consolidated balance sheet data was derived from audited financial
statements but does not include all disclosures required by accounting
principles generally accepted in the United States of America.
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 September 30, 2003 and results of operations and cash flows for the interim
periods presented. The results of operations for the three and nine months ended
September 30, 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 subsidiaries, Advanced Material Sciences, Inc.
("Advanced Material Sciences") and CombiMatrix K.K. Our core technology
opportunity in the life sciences sector has been developed by CombiMatrix
Corporation. CombiMatrix Corporation is a life sciences technology company that
is developing a platform technology to rapidly produce customizable active
biochips, which are semiconductor-based tools for use in identifying and
determining the roles of genes, gene mutations and proteins. CombiMatrix
Corporation's technology has a wide range of potential applications including
DNA synthesis/diagnostics, drug discovery, and immunochemical detection.
CombiMatrix Corporation's Express Track(sm) drug discovery program is a systems
biology approach, using its technology, to target common viral diseases with
siRNA compounds. 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 K.K., an indirect
wholly 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," is primarily comprised of Acacia Research Corporation's interests in two
wholly owned media technologies subsidiaries: (1) Acacia Media Technologies
Corporation and (2) Soundview Technologies, Inc. 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 technology known as the V-chip. The V-chip was adopted by manufacturers of
televisions sold in the United States to provide blocking of certain programming
based upon its content rating code, in compliance with the Telecommunications
Act of 1996. The V-chip technology was protected by U.S. Patent No. 4,554,584,
which expired in July 2003.
RECAPITALIZATION AND MERGER TRANSACTIONS
On December 11, 2002, our stockholders voted in favor of a
recapitalization transaction, which became effective on December 13, 2002,
4
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
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.
On December 11, 2002, Acacia Research Corporation stockholders and
CombiMatrix Corporation stockholders voted in favor of a merger transaction
pursuant to which we acquired the stockholder interests in CombiMatrix
Corporation not already owned by us (52% of the total stockholder interests in
CombiMatrix Corporation). The acquisition was accomplished through a merger,
effective December 13, 2002, in which stockholders of CombiMatrix Corporation
other than Acacia Research Corporation received one share of the new
AR-CombiMatrix stock in exchange for each share of CombiMatrix Corporation
common stock that they owned immediately prior to the merger.
SEPARATE GROUP FINANCIAL STATEMENT PRESENTATION. 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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION. We recognize revenue in accordance with Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
No. 101") and related authoritative pronouncements.
License fee income is recognized as revenue when (i) persuasive
evidence of an arrangement exists, (ii) all obligations have been performed
pursuant to the terms of the license agreement, (iii) amounts are fixed or
determinable and (iv) collectibility of amounts is reasonably assured. License
fees due from licensees for which collectibility is not reasonably assured,
primarily due to lack of credit and/or payment history, are recognized as
revenues in the period in which the license fee payments are received from the
respective licensee. Generally, under the terms of the respective DMT license
agreements with individual licensees, the Acacia Technologies group grants a
one-year or a multi-year, non-exclusive license for the use of its patented DMT
technology in exchange for an annual license fee. License agreements with an
initial one-year term provide for the automatic renewal of the annual license
each year, upon receipt by the Acacia Technologies group of the renewal license
fee payment in accordance with the terms of the agreement. Prepaid license fee
payments received at the inception of the license term are deferred and
amortized to revenue over the license term.
5
Revenues from government grants and contracts are recognized as the
related services are performed, when the services have been accepted by the
grantor and collectibility is reasonably assured. Amounts recognized are limited
to amounts due from the grantor based upon the contract or grant terms.
Revenue from the sale of products and services is recognized when (i)
persuasive evidence of an arrangement exists, (ii) delivery has occurred or
services have been rendered, (iii) the fees are fixed or determinable and (iv)
collectibility is reasonably assured.
Revenues from multiple-element arrangements involving license fees,
up-front payments and milestone payments, which are received or billable by us
in connection with other rights and services that represent continuing
obligations of ours, are deferred until all of the elements have been delivered
or until we have established objective and verifiable evidence of the fair value
of the undelivered elements.
Deferred revenue arises from payments received in advance of the
culmination of the earnings process. Deferred revenue expected to be recognized
within the next twelve months is classified as a current liability. Deferred
revenues related to payments received under multiple element arrangements,
prepaid license fees and other advances totaled $20,782,000 at September 30,
2003. Deferred revenues will be recognized as revenue in future periods when the
applicable revenue recognition criteria as described above are met.
STOCK-BASED COMPENSATION. At September 30, 2003, Acacia Research
Corporation had 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 tables illustrate the effect on net loss and loss per
share if Acacia Research Corporation had applied the fair value recognition
provisions of SFAS No. 123 (in thousands, except per share data):
AR-ACACIA TECHNOLOGIES STOCK AR-COMBIMATRIX STOCK
--------------------------- ---------------------------
THREE MONTHS ENDED THREE MONTHS ENDED
--------------------------- ---------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Loss from continuing operations as reported .............. $ (1,296) $ (5,275) $ (4,536) $ (15,347)
Add: Stock-based compensation, intrinsic value method
reported in net income, net of tax and minority
interests ............................................. -- -- 612 1,159
Deduct: Pro forma stock-based compensation fair value
method, net of tax and minority interests ............. (662) (1,312) (2,157) (1,904)
Loss from continuing operations, pro forma ............... (1,958) (6,587) (6,081) (16,092)
Basic and diluted loss per share from continuing
operations as reported ................................ (0.07) (0.27) (0.18) (0.67)
Basic and diluted loss per share from continuing
operations, pro forma ................................. (0.10) (0.34) (0.23) (0.70)
AR-ACACIA TECHNOLOGIES STOCK AR-COMBIMATRIX STOCK
--------------------------- ---------------------------
NINE MONTHS ENDED NINE MONTHS ENDED
--------------------------- ---------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Loss from continuing operations as reported .............. $ (4,368) $ (11,920) $ (14,905) $ (24,829)
Add: Stock-based compensation, intrinsic value method
reported in net income, net of tax and minority
interests ............................................. -- 19 1,433 3,199
Deduct: Pro forma stock-based compensation fair value
method, net of tax and minority interests ............. (2,685) (3,761) (7,302) (5,587)
Loss from continuing operations, pro forma ............... (7,053) (15,662) (20,774) (27,217)
Basic and diluted loss per share from continuing
operations as reported ................................ (0.22) (0.61) (0.64) (1.08)
Basic and diluted loss per share from continuing
operations, pro forma ................................. (0.36) (0.80) (0.90) (1.19)
- -----------------------
6
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.
RECLASSIFICATIONS. Certain reclassifications of prior period amounts
have been made to conform to the 2003 presentation.
3. 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 and warrants.
The earnings or losses allocated to each class of common stock are
determined by Acacia Research Corporation's board of directors. This
determination is generally based on the net income or loss amounts of the
corresponding group determined in accordance with accounting principles
generally accepted in the United States of America, consistently applied. Acacia
Research Corporation believes this method of allocation is systematic and
reasonable. The Acacia Research Corporation board of directors can, at its
discretion, change the method of allocating earnings or losses to each class of
common stock at any time. Management currently has no plans to change allocation
methods.
The following table presents a reconciliation of basic and diluted
loss per share:
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------------- --------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
ACACIA RESEARCH - ACACIA TECHNOLOGIES STOCK
- -------------------------------------------
Basic weighted average number of common shares outstanding ... 19,645,949 19,640,808 19,642,541 19,640,808
Dilutive effect of outstanding stock options and warrants .... -- -- -- --
------------ ------------ ------------ ------------
Diluted weighted average number of common and
potential common shares outstanding ........................ 19,645,949 19,640,808 19,642,541 19,640,808
============ ============ ============ ============
Potential AR-Acacia Technologies stock common shares
excluded from the per share calculation because the
effect of their inclusion would be anti-dilutive ........... 317,000 46,857 3,173 46,857
============ ============ ============ ============
ACACIA RESEARCH - COMBIMATRIX STOCK
- -----------------------------------
Basic weighted average number of common shares outstanding ... 25,890,408 22,950,551 23,129,476 22,950,551
Dilutive effect of outstanding stock options and warrants .... -- -- -- --
------------ ------------ ------------ ------------
Diluted weighted average number of common and
potential common shares outstanding ........................ 25,890,408 22,950,551 23,129,476 22,950,551
============ ============ ============ ============
Potential AR-CombiMatrix stock common shares excluded
from the per share calculation because the effect of
their inclusion would be anti-dilutive ..................... 1,167,778 305,256 587,180 305,256
============ ============ ============ ============
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 at a reporting unit level. Reviews for
potential impairment must occur at least annually and may be performed earlier,
if circumstances indicate that an impairment may have occurred. Acacia Research
Corporation has elected to perform its annual tests for indications of goodwill
impairment as of December 31 of each year. Our reporting units are: 1) Acacia
Media Technologies Corporation and 2) Soundview Technologies, Inc., which are
the primary components of the Acacia Technologies group, and 3) the CombiMatrix
group. 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 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 $1,776,000 and $1,834,000 of goodwill
at September 30, 2003 and December 31, 2002, respectively (net of $2,258,000 of
7
accumulated amortization). The CombiMatrix group had $19,425,000 and $18,859,000
of goodwill at September 30, 2003 and December 31, 2002, respectively (net of
$1,312,000 of accumulated amortization).
On July 2, 2003, Acacia Research Corporation increased its consolidated
ownership interest in Advanced Material Sciences to 99% by acquiring 1,774,750
shares of Advanced Material Sciences common stock in exchange for 295,790 shares
of AR-CombiMatrix stock. The transaction was accounted for as a step acquisition
using the purchase method of accounting. The fair value of the Acacia Research
shares issued in the transaction was based on the quoted market price of
AR-CombiMatrix stock on the exchange date. The total purchase price of $769,000
was allocated to the fair value of assets acquired and liabilities assumed. The
amount attributable to goodwill was $172,000.
On July 11, 2003, Acacia Research Corporation purchased the outstanding
minority interests in CombiMatrix K.K. from Marubeni Corporation ("Marubeni").
Acacia Research Corporation issued 200,000 shares of its AR-CombiMatrix stock to
Marubeni in exchange for Marubeni's 10% minority interest in CombiMatrix K.K.
The transaction was accounted for as a step acquisition using the purchase
method of accounting. The fair value of the AR- CombiMatrix stock issued in the
transaction was based on the quoted market price of AR-CombiMatrix stock on the
exchange date. The total purchase price of $450,000 was allocated to the fair
value of assets acquired and liabilities assumed. The amount attributable to
goodwill was $393,000.
Acacia Research Corporation's interests in Advanced Material Sciences
and CombiMatrix K.K. have been attributed to the CombiMatrix group.
Acacia Research Corporation's only identifiable intangible assets at
September 30, 2003 and December 31, 2002 are patents. The gross carrying amounts
and accumulated amortization as of September 30, 2003 and December 31, 2002 and
amortization expense for the three and nine months ended September 30, 2003 and
2002, related to patents, by segment, are as follows (in thousands):
ACACIA TECHNOLOGIES GROUP COMBIMATRIX GROUP
--------------------------------------- ---------------------------------------
SEPTEMBER 30, 2003 DECEMBER 31, 2002 SEPTEMBER 30, 2003 DECEMBER 31, 2002
------------------ ------------------ ------------------ ------------------
Gross carrying amount - patents ... $ 10,798 $ 10,798 $ 12,095 $ 12,095
Accumulated amortization .......... (7,107) (6,730) (1,704) (883)
------------------ ------------------ ------------------ ------------------
Patents, net ...................... $ 3,691 $ 4,068 $ 10,391 $ 11,212
================== ================== ================== ==================
Patent Amortization Expense:
ACACIA TECHNOLOGIES GROUP COMBIMATRIX GROUP
--------------------------------------- ---------------------------------------
SEPTEMBER 30, 2003 SEPTEMBER 30, 2002 SEPTEMBER 30, 2003 SEPTEMBER 30, 2002
------------------ ------------------ ------------------ ------------------
Three Months Ended ................ $ 125 $ 465 $ 274 $ 85
================== ================== ================== ==================
Nine Months Ended ................. $ 377 $ 1,395 $ 821 $ 283
================== ================== ================== ==================
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 September 30, 2003 and December 31, 2002, all of our acquired
intangible assets other than goodwill were subject to amortization.
5. EQUITY FINANCING
In May 2003, Acacia Research Corporation completed a private equity
financing, raising gross proceeds of $5,247,000 through the issuance of
2,385,000 units. Each unit consists of one share of AR-CombiMatrix common stock
and one-half, five-year callable common stock purchase warrant. Each full common
stock purchase warrant entitles the holder to purchase a share of AR-CombiMatrix
stock at a price of $2.75 per share and is callable by Acacia Research
Corporation beginning in May 2004 once the daily average of the high and low
prices of Acacia Research Corporation's AR-CombiMatrix stock on the Nasdaq
SmallCap Market is equal to or above $4.50 for 20 consecutive trading days.
Acacia Research Corporation issued an additional 31,502 shares of AR-CombiMatrix
stock in lieu of cash payments in conjunction with the private placement for
finder's fees. Net proceeds raised from the private equity financing of
$4,862,000 were attributed to the CombiMatrix Group. In September 2003, proceeds
of $450,000 were received from the issuance of 164,000 shares of AR-CombiMatrix
8
stock related to the exercise of certain warrants issued in connection with the
May 2003 private equity financing. The proceeds from the warrants exercised were
attributed to the CombiMatrix Group.
6. 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
Acacia Research Corporation's, the CombiMatrix group's or the Acacia
Technologies group's financial position or results of operations.
In January 2003, the FASB issued 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, as amended by FASB Staff Position No. 46-6, is effective immediately for
all new variable interest entities created or acquired after January 31, 2003.
Acacia Research Corporation must apply FIN 46 to variable interest entities
existing prior to February 1, 2003, effective December 31, 2003. We do not
expect the adoption of FIN 46 to have a material impact on Acacia Research
Corporation's, the CombiMatrix group's or the Acacia Technologies group's
financial condition or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of SFAS 133 on
Derivative Instruments and Hedging Activities" ("SFAS No. 149"). SFAS No. 149
amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 149 is effective for
contracts entered into or modified after June 30, 2003 and hedging relationships
designated after June 30, 2003. We do not expect the adoption of SFAS No. 149 to
have a material impact on Acacia Research Corporation's, the CombiMatrix group's
or the Acacia Technologies group's financial condition or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Instruments with Characteristics of Both Liabilities and Equity" ("SFAS No.
150"). This standard requires that certain financial instruments embodying an
obligation to transfer assets or to issue equity securities be classified as
liabilities. It is effective for financial instruments, excluding mandatorily
redeemable financial instruments of certain nonpublic entities, entered into or
modified after May 31, 2003, and otherwise is effective for Acacia Research
Corporation on July 1, 2003. For mandatorily redeemable financial instruments of
certain nonpublic entities, SFAS No. 150 is effective for fiscal periods
beginning after December 15, 2004. We do not expect the adoption of SFAS No. 150
to have a material impact on Acacia Research Corporation's, the CombiMatrix
group's or the Acacia Technologies group's financial condition or results of
operations.
7. COMMITMENTS AND CONTIGENCIES
In connection with the purchase of the outstanding ownership interests
in Acacia Media Technologies Corporation in November 2001, Acacia Media
Technologies Corporation also executed related assignment agreements which
granted to the former owners of Acacia Media Technologies Corporation's current
patent portfolio the right to receive a royalty of 15% of future net revenues
generated by Acacia Media Technologies Corporation's current patent portfolio,
which includes its DMT patents. Royalties to be paid will be expensed in the
consolidated statement of operations.
In September 2003, CombiMatrix Corporation paid Nanogen, Inc., or
Nanogen, $500,000, representing the second and final installment of the $1.0
million cash payment due to Nanogen in accordance with the September 30, 2002
settlement agreement entered into between CombiMatrix Corporation, Dr. Don
Montgomery and Nanogen. In addition, CombiMatrix Corporation will be required to
pay 12.5% of certain revenues, subject to minimum and maximum amounts not to
exceed $1.5 million per year, beginning in the fourth quarter of 2003, for the
remaining life of the CombiMatrix group's core patents.
9
8. CONSOLIDATING 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.
Presented below is consolidating financial information for our
reportable segments 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.
10
CONSOLIDATING BALANCE SHEETS
(IN THOUSANDS)
AT SEPTEMBER 30, 2003
---------------------------------------------------------
ACACIA
TECHNOLOGIES COMBIMATRIX
GROUP GROUP ELIMINATIONS CONSOLIDATED
------------ ------------ ------------ ------------
ASSETS
Current assets:
Cash and cash equivalents ............... $ 29,425 $ 4,877 $ -- $ 34,302
Short-term investments .................. 5,100 14,157 -- 19,257
Accounts receivable ..................... 115 329 -- 444
Prepaid expenses, inventory and other
assets ................................ 933 512 -- 1,445
Receivable from CombiMatrix group ....... 159 -- (159) --
------------ ------------ ------------ ------------
Total current assets ............. 35,732 19,875 (159) 55,448
Property and equipment, net of accumulated
depreciation .............................. 90 2,934 -- 3,024
Patents, net of accumulated amortization .... 3,691 10,391 -- 14,082
Goodwill, net of accumulated amortization ... 1,776 19,425 -- 21,201
Other assets ................................ 243 96 -- 339
------------ ------------ ------------ ------------
$ 41,532 $ 52,721 $ (159) $ 94,094
============ ============ ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued expenses and
other ................................. $ 2,086 $ 1,776 $ -- $ 3,862
Current portion of deferred revenues .... 1,560 18,748 -- 20,308
Payable to Acacia Technologies group .... -- 159 (159) --
------------ ------------ ------------ ------------
Total current liabilities ........ 3,646 20,683 (159) 24,170
Deferred income taxes ....................... 1,048 2,282 -- 3,330
Deferred revenues, net of current portion ... -- 474 -- 474
------------ ------------ ------------ ------------
Total liabilities ................ 4,694 23,439 (159) 27,974
------------ ------------ ------------ ------------
Minority interests .......................... 1,130 -- -- 1,130
------------ ------------ ------------ ------------
Stockholders' equity:
AR - Acacia Technologies stock .......... 35,708 -- -- 35,708
AR - CombiMatrix stock .................. -- 29,282 -- 29,282
------------ ------------ ------------ ------------
Total stockholders' equity ....... 35,708 29,282 -- 64,990
------------ ------------ ------------ ------------
$ 41,532 $ 52,721 $ (159) $ 94,094
============ ============ ============ ============
____________________________________________
NOTE: Segment information for the Acacia Technologies group includes
discontinued operations related to Soundbreak.com. Total assets related to
discontinued operations totaled $2,330,000 and $3,282,000 at September 30, 2003
and December 31, 2002, respectively. Total liabilities related to discontinued
operations totaled $575,000 and $918,000 at September 30, 2003 and December 31,
2002, respectively.
11a
CONSOLIDATING BALANCE SHEETS
(IN THOUSANDS)
AT DECEMBER 31, 2002
---------------------------------------------------------
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, inventory 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
Patents, net of accumulated amortization .... 4,068 11,212 -- 15,280
Goodwill, net of accumulated amortization ... 1,834 18,859 -- 20,693
Other assets ................................ 449 87 -- 536
------------ ------------ ------------ ------------
$ 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
Deferred revenues, net of current portion ... -- -- -- --
------------ ------------ ------------ ------------
Total liabilities ................ 5,183 13,972 (114) 19,041
------------ ------------ ------------ ------------
Minority interests .......................... 1,487 684 -- 2,171
------------ ------------ ------------ ------------
Stockholders' equity:
AR - Acacia Technologies stock .......... 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
============ ============ ============ ============
____________________________________________
NOTE: Segment information for the Acacia Technologies group includes
discontinued operations related to Soundbreak.com. Total assets related to
discontinued operations totaled $2,330,000 and $3,282,000 at September 30, 2003
and December 31, 2002, respectively. Total liabilities related to discontinued
operations totaled $575,000 and $918,000 at September 30, 2003 and December 31,
2002, respectively.
11b
CONSOLIDATING STATEMENTS OF OPERATIONS
(IN THOUSANDS)
THREE MONTHS ENDED SEPTEMBER 30, 2003
-----------------------------------------------------------------------------
ACACIA
TECHNOLOGIES COMBIMATRIX ELIMINATIONS/
GROUP GROUP RECLASSIFICATIONS CONSOLIDATED
----------------- ----------------- ----------------- -----------------
Revenues:
License fee income ........................ $ 186 $ -- $ -- $ 186
Product revenue ........................... -- 171 -- 171
Contract revenue .......................... -- 10 -- 10
----------------- ----------------- ----------------- -----------------
Total revenues ....................... 186 181 -- 367
----------------- ----------------- ----------------- -----------------
Operating expenses:
Cost of sales ............................. -- 17 -- 17
Research and development expenses ......... -- 1,726 -- 1,726
Non-cash stock compensation expense -
research and development ................ -- 243 -- 243
Marketing, general and administrative
expenses ................................ 955 2,122 -- 3,077
Non-cash stock compensation expense -
marketing, general and administrative ... -- 421 -- 421
Legal expenses - patents .................. 598 -- -- 598
Amortization of patents ................... 125 274 -- 399
----------------- ----------------- ----------------- -----------------
Total operating expenses ............. 1,678 4,803 -- 6,481
----------------- ----------------- ----------------- -----------------
Operating loss ....................... (1,492) (4,622) -- (6,114)
----------------- ----------------- ----------------- -----------------
Other income (expense):
Impairment of cost method investment ...... -- -- -- --
Interest income ........................... 128 52 -- 180
Realized gains on short-term investments .. 32 -- -- 32
Other income .............................. -- -- -- --
----------------- ----------------- ----------------- -----------------
Total other income ................... 160 52 -- 212
----------------- ----------------- ----------------- -----------------
Loss from operations before
income taxes and minority interests ......... (1,332) (4,570) -- (5,902)
Benefit for income taxes ...................... 36 34 -- 70
----------------- ----------------- ----------------- -----------------
Loss from operations before minority
interests ................................... (1,296) (4,536) -- (5,832)
Minority interests ............................ -- -- -- --
----------------- ----------------- ----------------- -----------------
Net loss ...................................... $ (1,296) $ (4,536) $ -- $ (5,832)
================= ================= ================= =================
12a
CONSOLIDATING STATEMENTS OF OPERATIONS
(IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30, 2003
-----------------------------------------------------------------------------
ACACIA
TECHNOLOGIES COMBIMATRIX ELIMINATIONS/
GROUP GROUP RECLASSIFICATIONS CONSOLIDATED
----------------- ----------------- ----------------- -----------------
Revenues:
License fee income ....................... $ 211 $ -- $ -- $ 211
Product revenue .......................... -- 380 -- 380
Contract revenue ......................... -- 23 -- 23
----------------- ----------------- ----------------- -----------------
Total revenues ...................... 211 403 -- 614
----------------- ----------------- ----------------- -----------------
Operating expenses:
Cost of sales ............................ -- 94 -- 94
Research and development expenses ........ -- 6,219 -- 6,219
Non-cash stock compensation expense -
research and development ............... -- 525 -- 525
Marketing, general and administrative
expenses ............................... 3,157 6,890 -- 10,047
Non-cash stock compensation expense -
marketing, general and administrative .. -- 1,055 -- 1,055
Legal expenses - patents ................. 1,435 -- -- 1,435
Amortization of patents .................. 377 821 -- 1,198
----------------- ----------------- ----------------- -----------------
Total operating expenses ............ 4,969 15,604 -- 20,573
----------------- ----------------- ----------------- -----------------
Operating loss ...................... (4,758) (15,201) -- (19,959)
----------------- ----------------- ----------------- -----------------
Other income (expense):
Impairment of cost method investment ..... (207) -- -- (207)
Interest income .......................... 408 164 -- 572
Realized gains on short-term investments . 94 -- -- 94
Other income ............................. 1 -- -- 1
----------------- ----------------- ----------------- -----------------
Total other income .................. 296 164 -- 460
----------------- ----------------- ----------------- -----------------
Loss from operations before
income taxes and minority interests ........ (4,462) (15,037) -- (19,499)
Benefit for income taxes ..................... 94 102 -- 196
----------------- ----------------- ----------------- -----------------
Loss from operations before minority
interests .................................. (4,368) (14,935) -- (19,303)
Minority interests ........................... -- 30 -- 30
----------------- ----------------- ----------------- -----------------
Net loss ..................................... $ (4,368) $ (14,905) $ -- $ (19,273)
================= ================= ================= =================
12b
CONSOLIDATING STATEMENTS OF OPERATIONS (CONTINUED)
(IN THOUSANDS)
THREE MONTHS ENDED SEPTEMBER 30, 2002
-----------------------------------------------------------------------------
ACACIA
TECHNOLOGIES COMBIMATRIX ELIMINATIONS/
GROUP GROUP RECLASSIFICATIONS CONSOLIDATED
----------------- ----------------- ----------------- -----------------
Revenues:
License fee income ........................ $ 43 $ -- $ -- $ 43
Product revenue ........................... -- 23 -- 23
Grant and contract revenue ................ -- 113 -- 113
----------------- ----------------- ----------------- -----------------
Total revenues ............................ 43 136 -- 179
----------------- ----------------- ----------------- -----------------
Operating expenses:
Cost of sales ............................. -- 6 -- 6
Research and development expenses ......... -- 6,449 -- 6,449
Non-cash stock compensation expense -
research and development ................ -- 753 -- 753
Marketing, general and administrative
expenses ................................ 1,423 2,614 -- 4,037
Non-cash stock compensation expense -
marketing, general and administrative ... -- 1,263 -- 1,263
Legal expenses - patents .................. 690 -- -- 690
Amortization of patents ................... 465 85 -- 550
Legal settlement charges .................. -- 18,471 -- 18,471
----------------- ----------------- ----------------- -----------------
Total operating expenses .................. 2,578 29,641 -- 32,219
----------------- ----------------- ----------------- -----------------
Operating loss ............................ (2,535) (29,505) -- (32,040)
----------------- ----------------- ----------------- -----------------
Other (expense) income:
Impairment of cost method investment ...... (2,748) -- -- (2,748)
Interest income ........................... 150 111 -- 261
Realized losses on short-term
investments ............................. -- -- -- --
Unrealized losses on short-term
investments ............................. (213) -- -- (213)
Interest expense .......................... -- (44) -- (44)
Other (expense) income .................... (5) -- -- (5)
----------------- ----------------- ----------------- -----------------
Total other (expense) income .............. (2,816) 67 -- (2,749)
----------------- ----------------- ----------------- -----------------
Loss from operations before income taxes
and minority interests ...................... (5,351) (29,438) -- (34,789)
Benefit for income taxes ...................... 253 34 -- 287
----------------- ----------------- ----------------- -----------------
Loss from operations before minority
interests ................................... (5,098) (29,404) -- (34,502)
Minority interests ............................ 23 14,057 -- 14,080
----------------- ----------------- ----------------- -----------------
Loss from continuing operations ............... (5,075) (15,347) -- (20,422)
Discontinued operations:
Estimated loss on disposal of
Soundbreak.com .......................... (200) -- -- (200)
----------------- ----------------- ----------------- -----------------
Net loss ...................................... $ (5,275) $ (15,347) $ -- $ (20,622)
================= ================= ================= =================
13a
CONSOLIDATING STATEMENTS OF OPERATIONS (CONTINUED)
(IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30, 2002
-----------------------------------------------------------------------------
ACACIA
TECHNOLOGIES COMBIMATRIX ELIMINATIONS/
GROUP GROUP RECLASSIFICATIONS CONSOLIDATED
----------------- ----------------- ----------------- -----------------
Revenues:
License fee income ........................ $ 43 $ -- $ -- $ 43
Product revenue ........................... -- 297 -- 297
Grant and contract revenue ................ -- 526 -- 526
----------------- ----------------- ----------------- -----------------
Total revenues ............................ 43 823 -- 866
----------------- ----------------- ----------------- -----------------
Operating expenses:
Cost of sales ............................. -- 259 -- 259
Research and development expenses ......... -- 14,143 -- 14,143
Non-cash stock compensation expense -
research and development ................ -- 1,867 -- 1,867
Marketing, general and administrative
expenses ................................ 5,288 7,824 -- 13,112
Non-cash stock compensation expense -
marketing, general and administrative ... 19 3,697 -- 3,716
Legal expenses - patents .................. 1,141 -- -- 1,141
Amortization of patents ................... 1,395 283 -- 1,678
Legal settlement charges .................. -- 18,471 -- 18,471
----------------- ----------------- ----------------- -----------------
Total operating expenses .................. 7,843 46,544 -- 54,387
----------------- ----------------- ----------------- -----------------
Operating loss ............................ (7,800) (45,721) -- (53,521)
----------------- ----------------- ----------------- -----------------
Other (expense) income:
Impairment of cost method investment ...... (2,748) -- -- (2,748)
Interest income ........................... 450 510 -- 960
Realized losses on short-term
investments ............................. (1,483) -- -- (1,483)
Unrealized losses on short-term
investments ............................. (690) -- -- (690)
Interest expense .......................... -- (165) -- (165)
Other (expense) income .................... 47 -- -- 47
----------------- ----------------- ----------------- -----------------
Total other (expense) income .............. (4,424) 345 -- (4,079)
----------------- ----------------- ----------------- -----------------
Loss from operations before income taxes
and minority interests ...................... (12,224) (45,376) -- (57,600)
Benefit for income taxes ...................... 318 113 -- 431
----------------- ----------------- ----------------- -----------------
Loss from operations before minority
interests ................................... (11,906) (45,263) -- (57,169)
Minority interests ............................ 186 20,434 -- 20,620
----------------- ----------------- ----------------- -----------------
Loss from continuing operations ............... (11,720) (24,829) -- (36,549)
Discontinued operations:
Estimated loss on disposal of
Soundbreak.com .......................... (200) -- -- (200)
----------------- ----------------- ----------------- -----------------
Net loss ...................................... $ (11,920) $ (24,829) $ -- $ (36,749)
================= ================= ================= =================
13b
CONSOLIDATING STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30, 2003
--------------------------------------------------------
ACACIA
TECHNOLOGIES COMBIMATRIX
GROUP GROUP ELIMINATIONS CONSOLIDATED
------------ ------------ ------------ ------------
Cash flows from operating activities:
Net loss from operations ......................... $ (4,368) $ (14,905) $ -- $ (19,273)
Adjustments to reconcile net loss
from operations to net cash used
in operating activities:
Depreciation and amortization ................. 471 1,822 -- 2,293
Minority interests ............................ -- (30) -- (30)
Non-cash stock compensation expense ........... -- 1,580 -- 1,580
Deferred tax benefit .......................... (108) (102) -- (210)
Net sales of trading securities ............... -- -- -- --
Unrealized losses on short-term investments ... -- -- -- --
Minority interest distributions ............... -- -- -- --
Impairment of cost method investment .......... 207 -- -- 207
Issuance of common stock by
subsidiary - legal settlement ............... -- -- -- --
Other ......................................... (6) 75 -- 69
Changes in assets and liabilities:
Accounts receivable ........................... (115) 249 -- 134
Prepaid expenses, inventory, and
other assets ................................ (98) (75) -- (173)
Accounts payable, accrued expenses
and other ................................... (126) (492) -- (618)
Deferred revenues ............................. 57 10,050 -- 10,107
------------ ------------ ------------ ------------
Net cash used in operating activities
from continuing operations .................. (4,086) (1,828) -- (5,914)
Net cash used in operating activities
from discontinued operations ................ (350) -- -- (350)
------------ ------------ ------------ ------------
Net cash used in operating activities ......... (4,436) (1,828) -- (6,264)
------------ ------------ ------------ ------------
Cash flows from investing activities:
Purchase of property and equipment, net ....... (4) (73) -- (77)
Purchase of available-for-sale investments .... (5,100) (21,461) -- (26,561)
Sale of available-for-sale investments ........ -- 18,887 -- 18,887
Other ......................................... -- -- -- --
------------ ------------ ------------ ------------
Net cash (used in) provided by investing
activities from continuing operations ....... (5,104) (2,647) -- (7,751)
Net cash used in investing activities from
discontinued operations ..................... (356) -- -- (356)
------------ ------------ ------------ ------------
Net cash (used in) provided by investing
activities .................................. (5,460) (2,647) -- (8,107)
------------ ------------ ------------ ------------
Cash flows from financing activities:
Net cash attributed to the Acacia
Technologies group .......................... (471) -- -- (471)
Net cash attributed to the CombiMatrix
group ....................................... -- 6,074 -- 6,074
------------ ------------ ------------ ------------
Net cash (used in) provided by financing
activities .................................. (471) 6,074 -- 5,603
------------ ------------ ------------ ------------
Effect of exchange rate on cash ..................... -- (13) -- (13)
------------ ------------ ------------ ------------
(Increase) decrease in cash and cash equivalents .... (10,367) 1,586 -- (8,781)
Cash and cash equivalents, beginning ................ 39,792 3,291 -- 43,083
------------ ------------ ------------ ------------
Cash and cash equivalents, ending ................... $ 29,425 $ 4,877 $ -- $ 34,302
============ ============ ============ ============
14a
NINE MONTHS ENDED SEPTEMBER 30, 2002
--------------------------------------------------------
ACACIA
TECHNOLOGIES COMBIMATRIX
GROUP GROUP ELIMINATIONS CONSOLIDATED
------------ ------------ ------------ ------------
Cash flows from operating activities:
Net loss from operations ......................... $ (11,720) $ (24,829) $ -- $ (36,549)
Adjustments to reconcile net loss
from operations to net cash used
in operating activities:
Depreciation and amortization ................. 1,556 1,296 -- 2,852
Minority interests ............................ (186) (20,434) -- (20,620)
Non-cash stock compensation expense ........... 19 5,564 -- 5,583
Deferred tax benefit .......................... (107) (113) -- (220)
Net sales of trading securities ............... 2,688 -- -- 2,688
Unrealized losses on short-term investments ... 690 -- -- 690
Minority interest distributions ............... 430 -- -- 430
Impairment of cost method investment .......... 2,748 -- -- 2,748
Issuance of common stock by
subsidiary - legal settlement ............... -- 17,471 -- 17,471
Other ......................................... (8) 95 -- 87
Changes in assets and liabilities:
Accounts receivable ........................... -- (2,409) -- (2,409)
Prepaid expenses, inventory, and
other assets ................................ (846) (144) -- (990)
Accounts payable, accrued expenses
and other ................................... 342 2,008 -- 2,350
Deferred revenues ............................. -- 5,180 -- 5,180
------------ ------------ ------------ ------------
Net cash used in operating activities
from continuing operations .................. (4,394) (16,315) -- (20,709)
Net cash used in operating activities
from discontinued operations ................ (812) -- -- (812)
------------ ------------ ------------ ------------
Net cash used in operating activities ......... (5,206) (16,315) -- (21,521)
------------ ------------ ------------ ------------
Cash flows from investing activities:
Purchase of property and equipment, net ....... (70) (544) -- (614)
Purchase of available-for-sale investments .... (4,500) (8,272) -- (12,772)
Sale of available-for-sale investments ........ -- 14,292 -- 14,292
Other ......................................... (157) -- -- (157)
------------ ------------ ------------ ------------
Net cash (used in) provided by investing
activities from continuing operations ....... (4,727) 5,476 -- 749
Net cash used in investing activities from
discontinued operations ..................... (3) -- -- (3)
------------ ------------ ------------ ------------
Net cash (used in) provided by investing
activities .................................. (4,730) 5,476 -- 746
------------ ------------ ------------ ------------
Cash flows from financing activities:
Net cash attributed to the Acacia
Technologies group .......................... (800) -- -- (800)
Net cash attributed to the CombiMatrix
group ....................................... -- 179 -- 179
------------ ------------ ------------ ------------
Net cash (used in) provided by financing
activities .................................. (800) 179 -- (621)
------------ ------------ ------------ ------------
Effect of exchange rate on cash ..................... -- 71 -- 71
------------ ------------ ------------ ------------
(Increase) decrease in cash and cash equivalents .... (10,736) (10,589) -- (21,325)
Cash and cash equivalents, beginning ................ 46,859 12,592 -- 59,451
------------ ------------ ------------ ------------
Cash and cash equivalents, ending ................... $ 36,123 $ 2,003 $ -- $ 38,126
============ ============ ============ ============
14b
COMBIMATRIX GROUP
(A Division of Acacia Research Corporation)
BALANCE SHEETS
(In thousands)
(Unaudited)
SEPTEMBER 30, DECEMBER 31,
2003 2002
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents ........................ $ 4,877 $ 3,291
Short-term investments ........................... 14,157 11,605
Accounts receivable .............................. 329 578
Prepaid expenses, inventory and other assets ..... 512 446
---------- ----------
Total current assets ........................ 19,875 15,920
Property and equipment, net of accumulated
depreciation and amortization ....................... 2,934 3,895
Patents, net of accumulated amortization of
$1,704 (2003) and $883 (2002) ....................... 10,391 11,212
Goodwill, net of accumulated amortization of
$1,312 (2003) and (2002) ............................ 19,425 18,859
Other assets .......................................... 96 87
---------- ----------
$ 52,721 $ 49,973
========== ==========
LIABILITIES AND ALLOCATED NET WORTH
Current liabilities:
Accounts payable, accrued expenses and other ..... $ 1,776 $ 2,302
Current portion of deferred revenues ............. 18,748 9,172
Payable to Acacia Technologies group ............. 159 114
---------- ----------
Total current liabilities ................... 20,683 11,588
Deferred income taxes ................................. 2,282 2,384
Deferred revenues, net of current portion ............. 474 --
---------- ----------
Total liabilities ........................... 23,439 13,972
---------- ----------
Minority interests .................................... -- 684
---------- ----------
Commitments and contingencies (Note 6)
Allocated net worth:
Funds allocated by Acacia Research Corporation ... 138,156 129,286
Accumulated net losses ........................... (108,874) (93,969)
---------- ----------
Total allocated net worth ................... 29,282 35,317
---------- ----------
$ 52,721 $ 49,973
========== ==========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
FINANCIAL STATEMENTS.
15
COMBIMATRIX GROUP
(A Division of Acacia Research Corporation)
STATEMENTS OF OPERATIONS
(In thousands)
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Revenues:
Product revenue ............................. $ 171 $ 23 $ 380 $ 297
Grant and contract revenue .................. 10 113 23 526
--------- --------- --------- ---------
Total revenues ......................... 181 136 403 823
--------- --------- --------- ---------
Operating expenses:
Cost of sales ............................... 17 6 94 259
Research and development expenses ........... 1,726 6,449 6,219 14,143
Non-cash stock compensation expense -
research and development .................. 243 753 525 1,867
Marketing, general and administrative
expenses .................................. 2,122 2,614 6,890 7,824
Non-cash stock compensation expense -
marketing, general and administrative ..... 421 1,263 1,055 3,697
Amortization of patents ..................... 274 85 821 283
Legal settlement charges .................... -- 18,471 -- 18,471
--------- --------- --------- ---------
Total operating expenses ............... 4,803 29,641 15,604 46,544
--------- --------- --------- ---------
Operating loss ......................... (4,622) (29,505) (15,201) (45,721)
--------- --------- --------- ---------
Other income (expense):
Interest income ............................. 52 111 164 510
Interest expense ............................ -- (44) -- (165)
--------- --------- --------- ---------
Total other income ..................... 52 67 164 345
--------- --------- --------- ---------
Loss from operations before income taxes
and minority interests ......................... (4,570) (29,438) (15,037) (45,376)
Benefit for income taxes ......................... 34 34 102 113
--------- --------- --------- ---------
Loss from operations before minority interests ... (4,536) (29,404) (14,935) (45,263)
Minority interests ............................... -- 14,057 30 20,434
--------- --------- --------- ---------
Division net loss ................................ $ (4,536) $(15,347) $(14,905) $(24,829)
========= ========= ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
FINANCIAL STATEMENTS.
16
COMBIMATRIX GROUP
(A Division of Acacia Research Corporation)
STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
NINE MONTHS ENDED
---------------------------------------
SEPTEMBER 30, 2003 SEPTEMBER 30, 2002
------------------ ------------------
Cash flows from operating activities:
Division net loss from operations .................... $ (14,905) $ (24,829)
Adjustments to reconcile division net loss
from operations to net cash used in
operating activities:
Depreciation and amortization ..................... 1,822 1,296
Minority interests ................................ (30) (20,434)
Non-cash stock compensation expense ............... 1,580 5,564
Deferred tax benefit .............................. (102) (113)
Legal settlement charges .......................... -- 17,471
Other ............................................. 75 95
Changes in assets and liabilities:
Accounts receivable ............................... 249 (2,409)
Prepaid expenses, inventory and other assets ...... (75) (144)
Accounts payable, accrued expenses and other ...... (492) 2,008
Deferred revenues ................................. 10,050 5,180
------------------ ------------------
Net cash used in operating activities ............. (1,828) (16,315)
------------------ ------------------
Cash flows from investing activities:
Purchase of property and equipment, net ........... (73) (544)
Purchase of available-for-sale investments ........ (21,461) (8,272)
Sale of available-for-sale investments ............ 18,887 14,292
------------------ ------------------
Net cash (used in) provided by investing
activities ...................................... (2,647) 5,476
------------------ ------------------
Cash flows from financing activities:
Net cash flows attributed to the
CombiMatrix group ............................... 6,074 179
------------------ ------------------
Effect of exchange rate on cash ........................ (13) 71
------------------ ------------------
Increase (decrease) in cash and cash equivalents ....... 1,586 (10,589)
Cash and cash equivalents, beginning ................... 3,291 12,592
------------------ ------------------
Cash and cash equivalents, ending ...................... $ 4,877 $ 2,003
================== ==================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
FINANCIAL STATEMENTS.
17
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
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 subsidiaries, Advanced Material Sciences, Inc. ("Advanced Material
Sciences") and CombiMatrix K.K., 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, a life sciences
technology company that is developing a platform technology to rapidly produce
customizable active biochips, which are semiconductor-based tools for use in
identifying and determining the roles of genes, gene mutations and proteins.
CombiMatrix Corporation's technology has a wide range of potential applications
including DNA synthesis/diagnostics, drug discovery, and immunochemical
detection. CombiMatrix Corporation's Express Track(sm) drug discovery program is
a systems biology approach, using its technology to target common viral diseases
with siRNA compounds. 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.
BASIS OF PRESENTATION. The unaudited interim CombiMatrix group
financial statements as of September 30, 2003, and for the three and nine months
ended September 30, 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 year-end balance sheet data was derived from audited financial
statements but does not include all disclosures required by accounting
principles generally accepted in the United States of America.
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 September 30, 2003, and the
results of its operations and its cash flows for the interim periods presented.
The results of operations for the three and nine months ended September 30, 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 CombiMatrix group, a 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.
18
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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION. The CombiMatrix group recognizes revenue in
accordance with Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements" ("SAB No. 101") and related authoritative pronouncements.
Revenue from government grant and contract activities are recognized as
the related services are performed, when the services have been approved by the
grantor and collectibility is reasonably assured. Amounts recognized are limited
to amounts due from customers based on contract or grant terms.
Revenue from the sale of products and services is recognized when (i)
persuasive evidence of an arrangement exists, (ii) delivery has occurred or
services have been rendered, (iii) the fees are fixed or determinable, and (iv)
collectibility is reasonably assured.
Revenues from multiple-element arrangements involving royalties,
up-front payments and milestone payments, which are received or billable by the
CombiMatrix group in connection with other rights and services that represent
continuing obligations are deferred until all of the elements have been
delivered or until the CombiMatrix group has established objective and
verifiable evidence of the fair value of the undelivered elements.
Deferred revenue arises from payments received in advance of the
culmination of the earnings process. Deferred revenue expected to be recognized
within the next twelve months is classified as a current liability. At September
30, 2003, the CombiMatrix group recorded $19,222,000 as deferred revenues
related to payments received under multiple-element arrangements and other
advances. Deferred revenue balances will be recognized as revenue in future
periods when the applicable revenue recognition criteria as described above are
met.
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 by 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, future stock compensation expense resulting from
the issuance of AR-CombiMatrix stock, if any, will generally be allocated to the
CombiMatrix group.
EARNINGS PER SHARE INFORMATION AND STOCK OPTION AND RELATED OPTION PLAN
INFORMATION. Earnings per share and 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 are stockholders of Acacia Research Corporation. This
presentation reflects the fact that the CombiMatrix group does not have legally
issued common or preferred stock and 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." Refer to the
Acacia Research Corporation consolidated financial statements for disclosures
regarding Acacia Research Corporation's stock option plans.
19
3. RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 6 to the Acacia Research Corporation consolidated
financial statements included elsewhere herein.
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 at a reporting unit level. Reviews for
potential impairment must occur at least annually and may be performed earlier,
if circumstances indicate that an impairment may have occurred. The CombiMatrix
group has elected to perform its annual tests for indications of goodwill
impairment as of December 31 of each year. The CombiMatrix group has one
reporting unit. 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.
On July 2, 2003, Acacia Research Corporation increased its consolidated
ownership interest in Advanced Material Sciences to 99% by acquiring 1,774,750
shares of Advanced Material Sciences common stock in exchange for 295,790 shares
of AR-CombiMatrix stock. The transaction was accounted for as a step acquisition
using the purchase method of accounting. The fair value of the Acacia Research
shares issued in the transaction was based on the quoted market price of
AR-CombiMatrix stock on the exchange date. The total purchase price of $769,000
was allocated to the fair value of assets acquired and liabilities assumed. The
amount attributable to goodwill was $172,000.
On July 11, 2003, Acacia Research Corporation purchased the
outstanding minority interests in CombiMatrix K.K. from Marubeni Corporation
("Marubeni"). Acacia Research Corporation issued 200,000 shares of its
AR-CombiMatrix stock to Marubeni in exchange for Marubeni's 10% minority
interest in CombiMatrix K.K. The transaction was accounted for as a step
acquisition using the purchase method of accounting. The fair value of the AR-
CombiMatrix stock issued in the transaction was based on the quoted market price
of AR-CombiMatrix stock on the exchange date. The total purchase price of
$450,000 was allocated to the fair value of assets acquired and liabilities
assumed. The amount attributable to goodwill was $393,000.
Acacia Research Corporation's interests in Advanced Material Sciences
and CombiMatrix K.K. have been attributed to the CombiMatrix group.
The CombiMatrix group's only identifiable intangible assets are
patents, which have remaining economic useful lives up to 2020. 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 September 30, 2003 and December 31,
2002, all of the CombiMatrix group's acquired intangible assets other than
goodwill were subject to amortization.
5. ALLOCATED NET WORTH
In May 2003, Acacia Research Corporation completed a private equity
financing, raising gross proceeds of $5,247,000 through the issuance of
2,385,000 units. Each unit consists of one share of AR-CombiMatrix common stock
and one-half five-year callable common stock purchase warrant. Each full common
stock purchase warrant entitles the holder to purchase a share of AR-CombiMatrix
stock at a price of $2.75 per share and is callable by Acacia Research
Corporation once the daily average of the high and low prices of Acacia Research
Corporation's AR-CombiMatrix stock on the Nasdaq SmallCap Market is equal to or
above $4.50 for 20 consecutive trading days. Acacia Research Corporation issued
an additional 31,502 shares of AR-CombiMatrix stock in lieu of cash payments in
conjunction with the private placement for finder's fees. Net proceeds raised
from the private equity financing of $4,862,000 have been attributed to the
CombiMatrix Group.
20
6. COMMITMENTS AND CONTIGENCIES
In September 2003, CombiMatrix Corporation paid Nanogen, Inc., or
Nanogen, $500,000, representing the second and final installment of the $1.0
million cash payment due to Nanogen in accordance with the September 30, 2002
settlement agreement entered into between CombiMatrix Corporation, Dr. Don
Montgomery and Nanogen. In addition, CombiMatrix Corporation will be required to
pay 12.5% of certain revenues, subject to minimum and maximum amounts not to
exceed $1.5 million per year, beginning in the fourth quarter of 2003, for the
remaining life of the CombiMatrix group's core patents.
In January 2001, CombiMatrix Corporation entered into a one-year
commitment with an unrelated party to purchase $1.1 million worth of
semiconductor wafers contingent upon successfully developing a next-generation
microarray.
21
ACACIA TECHNOLOGIES GROUP
(A Division of Acacia Research Corporation)
BALANCE SHEETS
(In thousands)
(Unaudited)
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents ....................... $ 29,425 $ 39,792
Short-term investments .......................... 5,100 --
Accounts receivable ............................. 115 --
Prepaid expenses and other assets ............... 933 775
Receivable from CombiMatrix group ............... 159 114
------------- -------------
Total current assets ....................... 35,732 40,681
Property and equipment, net of accumulated
depreciation ....................................... 90 180
Patents, net of accumulated amortization of $7,107
(2003) and $6,730 (2002) ........................... 3,691 4,068
Goodwill, net of accumulated amortization of $2,258
(2003) and (2002) .................................. 1,776 1,834
Other assets ......................................... 243 449
------------- -------------
$ 41,532 $ 47,212
============= =============
LIABILITIES AND ALLOCATED NET WORTH
Current liabilities:
Accounts payable, accrued expenses and other .... $ 2,086 $ 2,524
Deferred revenues ............................... 1,560 1,503
------------- -------------
Total current liabilities .................. 3,646 4,027
Deferred income taxes ................................ 1,048 1,156
------------- -------------
Total liabilities .......................... 4,694 5,183
------------- -------------
Minority interests ................................... 1,130 1,487
------------- -------------
Commitments and contingencies (Note 5)
Allocated net worth:
Funds allocated by Acacia Research Corporation .. 105,091 105,557
Accumulated net losses .......................... (69,383) (65,015)
------------- -------------
Total allocated net worth .................. 35,708 40,542
------------- -------------
$ 41,532 $ 47,212
============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
FINANCIAL STATEMENTS.
22
ACACIA TECHNOLOGIES GROUP
(A Division of Acacia Research Corporation)
STATEMENTS OF OPERATIONS
(In thousands)
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenues:
License fee income .................................. $ 186 $ 43 $ 211 $ 43
------------ ------------ ------------ ------------
Total revenues ................................. 186 43 211 43
------------ ------------ ------------ ------------
Operating expenses:
Marketing, general and administrative expenses ...... 955 1,423 3,157 5,288
Non-cash stock compensation expense - marketing,
general and administrative ........................ -- -- -- 19
Legal expenses - patents ............................ 598 690 1,435 1,141
Amortization of patents ............................. 125 465 377 1,395
------------ ------------ ------------ ------------
Total operating expenses ....................... 1,678 2,578 4,969 7,843
------------ ------------ ------------ ------------
Operating loss ................................. (1,492) (2,535) (4,758) (7,800)
------------ ------------ ------------ ------------
Other income (expense):
Impairment of cost method investment ................ -- (2,748) (207) (2,748)
Interest income ..................................... 128 150 408 450
Realized gains (losses) on short-term investments ... 32 -- 94 (1,483)
Unrealized losses on short-term investments ......... -- (213) -- (690)
Other (expenses) income ............................. -- (5) 1 47
------------ ------------ ------------ ------------
Total other income (expenses) .................. 160 (2,816) 296 (4,424)
------------ ------------ ------------ ------------
Loss from continuing operations before
income taxes and minority interests .................... (1,332) (5,351) (4,462) (12,224)
Benefit for income taxes ................................. 36 253 94 318
------------ ------------ ------------ ------------
Loss from continuing operations before
minority interests ..................................... (1,296) (5,098) (4,368) (11,906)
Minority interests ....................................... -- 23 -- 186
------------ ------------ ------------ ------------
Loss from continuing operations .......................... (1,296) (5,075) (4,368) (11,720)
Discontinued operations:
Estimated loss on disposal of Soundbreak.com ........ -- (200) -- (200)
------------ ------------ ------------ ------------
Division net loss ........................................ $ (1,296) $ (5,275) $ (4,368) $ (11,920)
============ ============ ============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
FINANCIAL STATEMENTS.
23
ACACIA TECHNOLOGIES GROUP
(A Division of Acacia Research Corporation)
STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
NINE MONTHS ENDED
-----------------------------
SEPTEMBER 30, SEPTEMBER 30,
2003 2002
------------- -------------
Cash flows from operating activities:
Division net loss from continuing operations ................ $ (4,368) $ (11,720)
Adjustments to reconcile division net loss from continuing
operations to net cash used in operating activities:
Depreciation and amortization ............................ 471 1,556
Minority interests ....................................... -- (186)
Non-cash stock compensation expense ...................... -- 19
Deferred tax benefit ..................................... (108) (107)
Net sales of trading securities .......................... -- 2,688
Unrealized losses on short-term investments .............. -- 690
Minority interest distributions .......................... -- 430
Impairment of cost method investment ..................... 207 2,748
Other .................................................... (6) (8)
Changes in assets and liabilities:
Accounts receivable ...................................... (115) --
Prepaid expenses and other assets ........................ (98) (846)
Accounts payable, accrued expenses and other ............. (126) 342
Deferred revenues ........................................ 57 --
------------- -------------
Net cash used in operating activities from
continuing operations .................................. (4,086) (4,394)
Net cash used in operating activities from
discontinued operations ................................ (350) (812)
------------- -------------
Net cash used in operating activities .................... (4,436) (5,206)
------------- -------------
Cash flows from investing activities:
Purchase of property and equipment, net .................. (4) (70)
Purchase of available-for-sale investments ............... (5,100) (4,500)
Other .................................................... -- (157)
------------- -------------
Net cash used in investing activities from
continuing operations .................................. (5,104) (4,727)
Net cash used in investing activities from
discontinued operations ................................ (356) (3)
------------- -------------
Net cash used in investing activities .................... (5,460) (4,730)
------------- -------------
Cash flows from financing activities:
Net cash flows attributed to the Acacia
Technologies group ..................................... (471) (800)
------------- -------------
Decrease in cash and cash equivalents ......................... (10,367) (10,736)
Cash and cash equivalents, beginning .......................... 39,792 46,859
------------- -------------
Cash and cash equivalents, ending ............................. $ 29,425 $ 36,123
============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
FINANCIAL STATEMENTS.
24
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
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, a Delaware corporation and (2) Soundview
Technologies, Inc., 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 technology known
as the V-chip. The V-chip was adopted by the manufacturers of televisions sold
in the United States to provide blocking of certain programming based upon its
content rating code, in compliance with the Telecommunications Act of 1996. The
V-chip technology was protected by U.S. Patent No. 4,554,584, which expired 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.
BASIS OF PRESENTATION. The unaudited interim Acacia Technologies group
financial statements as of September 30, 2003, and for the three and nine months
ended September 30, 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 year-end balance sheet data was derived from audited financial
statements but does not include all disclosures required by accounting
principles generally accepted in the United States of America.
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 September
30, 2003, and the results of its operations and its cash flows for the interim
periods presented. The results of operations for the three and nine months ended
September 30, 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 Acacia Technologies group, a 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
25
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
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
REVENUE RECOGNITION. The Acacia Technologies group recognizes revenue
in accordance with Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements" ("SAB No. 101") and related authoritative pronouncements.
License fee income is recognized as revenue when (i) persuasive evidence of an
arrangement exists, (ii) all obligations have been performed pursuant to the
terms of the license agreement, (iii) amounts are fixed or determinable and (iv)
collectibility of amounts is reasonably assured. License fees due from licensees
for which collectibility is not reasonably assured, primarily due to lack of
credit and/or payment history, are recognized as revenues in the period in which
the license fee payments are received from the respective licensee. Generally,
under the terms of the respective DMT license agreements with individual
licensees, the Acacia Technologies group grants a one-year or a multi-year,
non-exclusive license for the use of its patented DMT technology in exchange for
an annual license fee. License agreements with an initial one-year term provide
for the automatic renewal of the annual license each year, upon receipt by the
Acacia Technologies group of the renewal license fee payment in accordance with
the terms of the agreement. Prepaid license fee payments received at the
inception of the license term are deferred and amortized to revenue over the
license term. Deferred revenue arises from payments received in advance of the
culmination of the earnings process and will be recognized as revenue in future
periods when the applicable revenue recognition criteria as described above are
met.
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 by 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, future stock compensation expense resulting from
the issuance of AR-Acacia Technologies stock, if any, will generally be
allocated to the Acacia Technologies group.
EARNINGS PER SHARE INFORMATION AND STOCK OPTION AND RELATED OPTION PLAN
INFORMATION. Earnings per share and 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 are 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 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." Refer to the Acacia Research
Corporation consolidated financial statements for disclosures regarding Acacia
Research Corporation's stock option plans.
26
3. RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 6 to the Acacia Research Corporation consolidated
financial statements included elsewhere herein.
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 at a reporting unit level. Reviews for
potential impairment must occur at least annually and may be performed earlier,
if circumstances indicate that an impairment may have occurred. The Acacia
Technologies group has elected to perform its annual tests for indications of
goodwill impairment as of December 31 of each year. The Acacia Technologies
group has two reporting units: 1) Acacia Media Technologies Corporation and 2)
Soundview Technologies, Inc. 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's only identifiable intangible assets are
patents. Annual aggregate amortization expense for each of the next five years
through December 31, 2007 is estimated to be $500,000 per year. At September 30,
2003 and December 31, 2002, all of the Acacia Technologies group's acquired
intangible assets other than goodwill were subject to amortization.
5. COMMITMENTS AND CONTIGENCIES
In connection with the purchase of the outstanding ownership interests
in Acacia Media Technologies Corporation in November 2001, Acacia Media
Technologies Corporation also executed related assignment agreements which
granted to the former owners of Acacia Media Technologies Corporation's current
patent portfolio the right to receive a royalty of 15% of future net revenues
generated by Acacia Media Technologies Corporation's current patent portfolio,
which includes its DMT patents. Royalties to be paid will be expensed in the
statement of operations.
27
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 September 30, 2003 and on our unaudited
consolidated statement of operations for the period from January 1, 2003 to
September 30, 2003. The discussion compares the activities for the three and
nine months ended September 30, 2003 to the activities for the three and nine
months ended September 30, 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 life sciences and media technologies businesses are referred to as
the "CombiMatrix group" and the "Acacia Technologies group," respectively. 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 platform technology to rapidly produce customizable active
biochips, which are semiconductor-based tools for use in identifying and
determining the roles of genes, gene mutations and proteins. CombiMatrix
Corporation's technology has a wide range of potential applications including
DNA synthesis/diagnostics, drug discovery, and immunochemical detection.
CombiMatrix Corporation's Express Track(sm) drug discovery program is a systems
biology approach, using its technology, to target common viral diseases with
siRNA compounds. 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
28
owns and has licensed technology, commonly known as the V-chip. We will continue
to pursue both licensing and strategic business alliances with leading companies
in the rapidly growing media technologies industry.
Business highlights during the nine months ended September 30, 2003 are as
follows:
COMBIMATRIX GROUP
o During the nine months ended September 30, 2003, CombiMatrix
Corporation received cash payments totaling $11.2 million,
consisting of $9.7 million related to the completion of certain
milestones and delivery of prototype products and services
pursuant to its agreements with Roche, an up-front payment of $1.0
million pursuant to its agreement with Toppan and $495,000 from
customers in Japan related to the sale of DNA microarray
synthesizers and related products and services. Payments received
from Roche and Toppan have been recorded as deferred revenues at
September 30, 2003.
o In August 2003, CombiMatrix Corporation launched siRNA SolutionsTM
which partners its RNAi synthesis platform and custom microarray
technology with sophisticated bioinformatics to provide
collaborators and customers with a fully integrated program for
drug discovery. The CombiMatrix Corporation program is the first
to provide a fully integrated service based on a single research
platform for discovery and allows researchers to design,
synthesize, validate and reiterate gene silencing experiments in
days rather than months for any gene in any organism. RNAi
technologies are predicted to speed discovery of drug development
and significantly reduce costs for biotech and pharmaceutical
companies.
o In August 2003, Dr. David L. Danley, Colonel (ret.) U.S. Army,
joined CombiMatrix Corporation as its Director, Homeland Security
and Defense Programs. Dr. Danley's responsibilities will include
all of the CombiMatrix Corporation's defense related activities,
including the joint development of its proprietary products for
the detection of biological and chemical warfare agents.
o In September 2003, CombiMatrix Corporation initiated
collaborations with Drs. Daniel Sabath and Stephen Schmechel of
the University of Washington to develop a microarray-based test
for the diagnosis of lymphoma. University of Washington
researchers are developing sophisticated nucleic acid-based tests
for diagnosis of lymphoma using CombiMatrix Corporation's
customizable microarrays. In addition, CombiMatrix Corporation has
established a research and collaboration agreement with Rational
Diagnostics of Seattle, Washington for further development and
commercialization of lymphoma diagnostic products.
o In September 2003, it was announced that CombiMatrix Corporation
and the Computational Biology Research Center ("CBRC"), a division
of the Japanese National Institute of Advanced Industrial Science
and Technology, developed a novel method for the preparation and
measurement of DNA methylation in tissue biopsies. The technique
uses CombiMatrix Corporation's customizable microarrays for the
detection of methylation at any CpG dinucleotide position in DNA.
In the third quarter of 2003 the parties together entered into
their first license agreement with a third party in Japan with
respect to the use of this jointly developed technology.
ACACIA TECHNOLOGIES GROUP
o Since November 2002, the Acacia Technologies group has entered
into 58 license agreements for its DMT technology. Sixteen of
these license agreements were executed in the third quarter of
2003. Subsequent to September 30, 2003, the Acacia Technologies
group entered into an additional 17 license agreements. Licensees
include LodgeNet Entertainment Corporation, the industry-leader
for hotel video-on-demand, Grupo Pegaso, a partner with Spain's
Telefonica in Mexico's second largest mobile telephony company,
Virgin Radio, a leading digital broadcast company, CinemaNow,
Inc., a leading Internet movie company and Internet Streaming
Companies including Interactive Gallery, Inc., a wholly owned
subsidiary of New Frontier Media, Inc., L.F.P., Inc. (owner of the
Hustler websites), Vivid Entertainment, LLC., and SBO Pictures,
Inc. d/b/a Wicked Pictures. All of 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
licenses. Based on information provided by our licensees,
annualized revenues from DMT licensing agreements executed to date
are estimated to be between approximately $1.1 million and $1.5
million.
29
o In September 2003, the Acacia Technologies group caused 42
websites owned by Go Entertainment, Inc. to be closed down. The
websites were continuing to utilize Acacia Technologies group's
DMT technology without a license in violation of a court order.
The U.S. District Court for the Central District of California
issued an injunction prohibiting Go Entertainment from continuing
to use Acacia Technologies group's DMT technology without a
license. The Acacia Technologies group successfully enforced the
injunction against Go Entertainment's web hosting company.
ACACIA RESEARCH CORPORATION CONSOLIDATED
RESULTS OF OPERATIONS (IN THOUSANDS)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
--------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Net revenues ....................................... $ 367 $ 179 $ 614 $ 866
Cost of sales ...................................... (17) (6) (94) (259)
Research and development expenses .................. (1,726) (6,449) (6,219) (14,143)
Non-cash stock compensation expense - research
and development .................................. (243) (753) (525) (1,867)
Marketing, general and administrative expenses ..... (3,675) (4,727) (11,482) (14,253)
Non-cash stock compensation expense - marketing,
general and administrative ....................... (421) (1,263) (1,055) (3,716)
Amortization of patents ............................ (399) (550) (1,198) (1,678)
Legal settlement charges ........................... -- (18,471) -- (18,471)
Other income (expenses), net ....................... 212 (2,749) 460 (4,079)
Benefit for income taxes ........................... 70 287 196 431
Minority interests ................................. -- 14,080 30 20,620
Estimated loss on disposal of Soundbreak.com ....... -- (200) -- (200)
------------ ------------ ------------ ------------
Net loss ........................................... $ (5,832) $ (20,622) $ (19,273) $ (36,749)
============ ============ ============ ============
COMPARISON OF THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 TO THE THREE
AND NINE MONTHS ENDED SEPTEMBER 30, 2002
REVENUES
LICENSE FEE INCOME. During the three months ended September 30, 2003,
license fee revenues were $186,000, as compared to $43,000 during the three
months ended September 30, 2002. During the nine months ended September 30,
2003, license fee revenues were $211,000, as compared to $43,000 during the nine
months ended September 30, 2002. License fee income recognized in 2003 relates
solely to DMT technology license fee revenues, 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 deferred and amortized to revenue over the license
term. License fee revenues recognized in the third quarter of 2002 relate to a
V-chip license agreement executed during the period.
PRODUCT REVENUES AND COST OF SALES. During the three months ended
September 30, 2003, product revenues were $171,000, as compared to $23,000
during the three months ended September 30, 2002, with related cost of sales of
$17,000 and $6,000 for the same periods, respectively. During the nine months
ended September 30, 2003, product revenues were $380,000, as compared to
30
$297,000 during the nine months ended September 30, 2002, with related cost of
sales of $94,000 and $259,000 for the same periods, respectively. In 2003,
product revenues and cost of sales were recognized by the CombiMatrix group's
Japanese subsidiary from sales of genomics microarray synthesizers and related
microarray products and services to Japanese research institutions in the first
and third quarters of 2003. In 2002, product revenue and cost of sales relates
to the sale of a gene chip synthesizer, a gene-chip reader and biochips to a
Japanese government institution by CombiMatrix Corporation's Japanese subsidiary
in the second and third quarters of 2002.
GRANT AND CONTRACT REVENUE. During the three months ended September 30,
2003, grant and contract revenues were $10,000, as compared to $113,000 during
the three months ended September 30, 2002. During the nine months ended
September 30, 2003, grant and contract revenues were $23,000, as compared to
$526,000 during the nine months ended September 30, 2002. Contract revenues of
$23,000 recognized during 2003 relate to ongoing contract maintenance and
service revenues earned by CombiMatrix K.K., which were $13,000 in the
comparable 2002 periods. During the comparable periods in 2002, grant revenues
included amounts earned from CombiMatrix Corporation's performance under its
Phase I Small Business Innovative Research, or SBIR, Department of Defense
contract, Phase I NIH grant and one-time contract research and development
revenues. The SBIR Department of Defense and NIH grants were completed during
the third quarter of 2002. There were no grant revenues recognized during 2003.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT EXPENSES. During the three months ended
September 30, 2003, research and development expenses were $1.7 million, as
compared to $6.4 million during the three months ended September 30, 2002.
During the nine months ended September 30, 2003, research and development
expenses were $6.2 million, as compared to $14.1 million during the nine months
ended September 30, 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 and 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 2003, as compared to the same periods in 2002. The CombiMatrix
group expects its research and development expenses to be volatile and such
expenses 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 September 30, 2003, marketing, general and administrative expenses were
$3.7 million, as compared to $4.7 million during the three months ended
September 30, 2002. During the nine months ended September 30, 2003, marketing,
general and administrative expenses were $11.5 million, as compared to $14.3
million during the nine months ended September 30, 2002. The decrease was due
primarily to a decrease in the CombiMatrix group's corporate legal expenses, a
decrease in legal and accounting expenses related to Acacia Research
Corporation's recapitalization and merger transactions completed in December
2002 and a decrease in overhead due to reduced general and administrative
personnel. The decrease was partially offset by an increase in the CombiMatrix
group's rent and utilities expenses as a result of the increase in occupancy of
its corporate headquarters in Mukilteo, Washington, an increase in the
CombiMatrix group's one-time accrued severance related expenses incurred in the
first quarter of 2003 and an increase in costs related to the Acacia
Technologies group's ongoing DMT patent commercialization and enforcement
efforts, including increased legal and engineering costs related to new patent
claims and the identification of additional potential licensees of our DMT
technology.
NON-CASH STOCK COMPENSATION EXPENSE.
RESEARCH AND DEVELOPMENT. During the three months ended
September 30, 2003, research and development related non-cash stock compensation
charges, all of which relate to the CombiMatrix group, were $243,000, as
compared to $753,000 during the three months ended September 30, 2002. During
the nine months ended September 30, 2003, research and development related
non-cash stock compensation charges, all of which relate to the CombiMatrix
group, were $525,000, as compared to $1.9 million during the nine months ended
September 30, 2002.
MARKETING, GENERAL AND ADMINISTRATIVE. During the three months
ended September 30, 2003, marketing, general and administrative non-cash stock
compensation charges, primarily related to the CombiMatrix group, were $421,000,
as compared to $1.3 million during the three months ended September 30, 2002.
31
During the nine months ended September 30, 2003, marketing, general and
administrative non-cash stock compensation charges, primarily related to the
CombiMatrix group, were $1.1 million, as compared to $3.7 million during the
nine months ended September 30, 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 forfeitures of certain unvested options and 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," or FIN No. 28, which results in
higher amounts of amortization in the early vesting periods. The CombiMatrix
group's remaining amount of deferred stock compensation expense of $1.2 million
as of September 30, 2003 is expected to be fully amortized by the end of 2004.
AMORTIZATION OF PATENTS. During the three months ended September 30,
2003, amortization of patents was $399,000, as compared to $550,000 during the
three months ended September 30, 2002. During the nine months ended September
30, 2003, amortization of patents was $1.2 million, as compared to $1.7 million
during the nine months ended September 30, 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 an additional intangible asset
related to CombiMatrix Corporation's core technology valued at $5.3 million,
which is being amortized over an economic useful life of approximately 7 years.
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 September
30, 2003, other income, net was $212,000, as compared to ($2.7 million) in other
expense, net during the three months ended September 30, 2002. During the nine
months ended September 30, 2003, other income, net was $460,000, as compared to
($4.1 million) in other expenses, net during the nine months ended September 30,
2002. The significant components of other income (expense), net were as follows:
IMPAIRMENT OF COST METHOD INVESTMENT. In the second quarter
of 2003, we recorded an impairment charge of $207,000 for an
other-than-temporary decline in the fair value of our cost method investment.
Impairment indicators included a continued decline in the working capital of the
entity and reference to a recent equity transaction and related valuation
indicating an other-than-temporary decline in fair value of the investment. In
September 2002, we recorded an impairment charge of $2.7 million for an
other-than-temporary decline in the fair value of the same cost method
investment. Impairment indicators included recurring losses, a decline in
working capital and the completion of a recent equity transaction at an amount
below our carrying value.
INTEREST INCOME. During the three months ended September 30,
2003, interest income was $180,000, as compared to $266,000 during the three
months ended September 30, 2002. During the nine months ended September 30,
2003, interest income was $572,000, as compared to $966,000 during the nine
months ended September 30, 2002. The decrease was primarily due to a decrease in
average cash balances during the period related to net operating cash outflows
and the continuing impact of declining interest rates and other external
economic factors negatively impacting rates of return on short-term investments
occurring during 2002 and continuing in 2003.
REALIZED AND UNREALIZED GAINS/LOSSES ON SHORT-TERM
INVESTMENTS. During the three months ended September 30, 2003, net realized
gains on investments were $32,000, as compared to net realized and unrealized
losses on investments of $213,000 during the three months ended September 30,
2002. During the nine months ended September 30, 2003, net realized gains on
investments were $94,000, as compared to net realized and unrealized losses on
investments of $2.2 million during the nine months ended September 30, 2002. The
decrease is due to no investments classified as trading securities held during
2003.
MINORITY INTERESTS. During the three months ended September 30, 2003,
minority interests in the losses of consolidated subsidiaries was zero, as
compared to $14.1 million during the three months ended September 30, 2002.
During the nine months ended September 30, 2003, minority interests in the
losses of consolidated subsidiaries was $30,000, as compared to $20.6 million
during the nine months ended September 30, 2002. The decrease was primarily due
to Acacia Research Corporation's acquisition of the remaining ownership
interests in CombiMatrix Corporation in December 2002 and in Advanced Material
Sciences and CombiMatrix K.K. in July 2003.
32
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 $53.6 million at September 30, 2003 compared
to $54.7 million at December 31, 2002.
Net cash used in continuing operating activities for the nine months
ended September 30, 2003 was $5.9 million compared to $20.7 million for the nine
months ended September 30, 2002. The decrease was due to a reduction in net cash
used in operations (before the impact of changes in working capital), which was
$15.4 million for the nine months ended September 30, 2003, as compared to $28.0
million for the nine months ended September 30, 2002. The change was also due to
a net increase in working capital during the nine months ended September 30,
2003, primarily related to cash payments received by CombiMatrix Corporation
totaling $11.2 million, consisting of $9.7 million related to the completion of
certain milestones and delivery of prototype products and services pursuant to
its agreements with Roche, an up-front payment of $1.0 million pursuant to its
agreement with Toppan, and $495,000 from customers in Japan related to contract
research and development, synthesizer and other product sales by CombiMatrix KK.
The Roche and Toppan cash payments received have been recorded as deferred
revenues at September 30, 2003. The increase in deferred revenues related to
cash receipts, primarily from Roche, for the nine months ended September 30,
2002 was $5.2 million.
Net cash flows used in continuing investing activities was $7.8 million
for the nine months ended September 30, 2003, as compared to net cash provided
by continuing investing activities of $749,000 for the nine months ended
September 30, 2002. The change is primarily due to an increase in short-term
investments purchased during the nine months ended September 30, 2003 in
connection with Acacia Research Corporation's normal cash management activities.
Net cash provided by financing activities was $5.6 million for the nine
months ended September 30, 2003, as compared to net cash used in financing
activities of $621,000 for the nine months ended September 30, 2002. The
increase is due to Acacia Research Corporation's completion of a private equity
financing in May 2003, raising net proceeds of $4.9 million and proceeds from
the exercise of options and warrants totaling $741,000. Cash used in financing
activities for the nine months ended September 30, 2002 was comprised primarily
of payments on CombiMatrix Corporation's capital lease obligation totaling
$694,000 (the capital lease obligation was paid in full in November 2002) and
net capital distributions to minority shareholders of subsidiaries of $130,000,
which were partially offset by proceeds from stock option exercises of $214,000.
We have no commitments for capital expenditures. Our minimum rental
commitments on operating leases related to continuing operations are $579,000
(remaining for 2003), $2.0 million (2004), $2.1 million (2005 and 2006), $2.0
million (2007) and $1.6 million (thereafter). We have no committed lines of
credit or other committed funding or long-term debt.
In November 2001, we increased our ownership interest in Acacia Media
Technologies Corporation from 33% to 100% through the purchase of the ownership
interest of the former limited liability company's other member for a cash
payment. In connection with the purchase of the ownership interest, Acacia Media
Technologies Corporation also executed related assignment agreements which
granted to the former owners of Acacia Media Technologies Corporation's current
patent portfolio the right to receive a royalty of 15% of future net revenues
generated by Acacia Media Technologies Corporation's current patent portfolio,
which includes its DMT patents. Royalties to be paid will be expensed in the
consolidated statement of operations.
In September 2003, CombiMatrix Corporation paid Nanogen, Inc., or
Nanogen, $500,000 representing the second and final installment of the $1.0
million cash payment due to Nanogen in accordance with the September 30, 2002
settlement agreement entered into between CombiMatrix Corporation, Dr. Don
Montgomery and Nanogen. In addition, CombiMatrix Corporation will be required to
pay 12.5% of certain revenues, subject to minimum and maximum amounts not to
exceed $1.5 million per year, beginning in the fourth quarter of 2003, for the
remaining life of the CombiMatrix group's core patents.
33
Management believes that our cash and cash equivalents 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.
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 6 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.
34
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 subsidiaries, CombiMatrix K.K. 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 developed primarily through CombiMatrix Corporation, which was formed
in October 1995. CombiMatrix Corporation is a life sciences technology company
that is developing a platform technology to rapidly produce customizable active
biochips, which are semiconductor-based tools for use in identifying and
determining the roles of genes, gene mutations and proteins. CombiMatrix
Corporation's technology has a wide range of potential applications including
DNA synthesis/diagnostics, drug discovery, and immunochemical detection.
CombiMatrix Corporation's Express Track(sm) drug discovery program is a systems
biology approach, using its technology, to target common viral diseases with
siRNA compounds. 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 K.K., an indirect
wholly 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 CombiMatrix group, 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.
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
RESULTS OF OPERATIONS (IN THOUSANDS)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
------------------------------- -------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- --------------
Product revenue ................................. $ 171 $ 23 $ 380 $ 297
Grant and contract revenue ...................... 10 113 23 526
Cost of sales ................................... (17) (6) (94) (259)
Research and development expenses ............... (1,726) (6,449) (6,219) (14,143)
Non-cash stock compensation expense -
research and development ...................... (243) (753) (525) (1,867)
Marketing, general and administrative expenses... (2,122) (2,614) (6,890) (7,824)
Non-cash stock compensation expense -
marketing, general and administrative ......... (421) (1,263) (1,055) (3,697)
Amortization of patents ......................... (274) (85) (821) (283)
Legal settlement charges ........................ -- (18,471) -- (18,471)
Other income, net ............................... 52 67 164 345
Benefit for income taxes ........................ 34 34 102 113
Minority interests .............................. -- 14,057 30 20,434
-------------- -------------- -------------- --------------
Division net loss ............................... $ (4,536) $ (15,347) $ (14,905) $ (24,829)
============== ============== ============== ==============
35
COMPARISON OF THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 TO THE THREE
AND NINE MONTHS ENDED SEPTEMBER 30, 2002
REVENUES
PRODUCT REVENUES AND COST OF SALES. During the three months ended
September 30, 2003, product revenues were $171,000, as compared to $23,000
during the three months ended September 30, 2002, with related cost of sales of
$17,000 and $6,000 for the same periods, respectively. During the nine months
ended September 30, 2003, product revenues were $380,000, as compared to
$297,000 during the nine months ended September 30, 2002, with related cost of
sales of $94,000 and $259,000 for the same periods, respectively. In 2003,
product revenues and cost of sales were recognized by the CombiMatrix group's
Japanese subsidiary from sales of genomics microarray synthesizers and related
microarray products and services to Japanese research institutions in the first
and third quarters of 2003. In 2002, product revenue and cost of sales relates
to the sale of a gene chip synthesizer, a gene-chip reader and biochips to a
Japanese government institution by the CombiMatrix group's Japanese subsidiary
in the second and third quarters of 2002.
GRANT AND CONTRACT REVENUE. During the three months ended September 30,
2003, grant and contract revenues were $10,000, as compared to $113,000 during
the three months ended September 30, 2002. During the nine months ended
September 30, 2003, grant and contract revenues were $23,000, as compared to
$526,000 during the nine months ended September 30, 2002. Contract revenues of
$23,000 recognized during 2003 relate to ongoing contract maintenance and
service revenues earned by CombiMatrix K.K., which were $13,000 in the
comparable 2002 periods. During the comparable periods in 2002, grant revenues
included amounts earned from CombiMatrix Corporation's performance under its
Phase I Small Business Innovative Research, or SBIR, Department of Defense
contract, Phase I NIH grant and one-time contract research and development
revenues. The SBIR Department of Defense and NIH grants were completed during
the third quarter of 2002. There were no grant revenues recognized during 2003.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT EXPENSES. During the three months ended
September 30, 2003, research and development expenses were $1.7 million, as
compared to $6.4 million during the three months ended September 30, 2002.
During the nine months ended September 30, 2003, research and development
expenses were $6.2 million, as compared to $14.1 million during the nine months
ended September 30, 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 and 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 2003, as compared to the same periods in 2002. The CombiMatrix
group expects that its research and development activities will be volatile and
such expenses could increase in future periods as additional milestones are
achieved for both existing and future contract research and development
agreements.
Since the inception of CombiMatrix Corporation's strategic alliance
with Roche in July 2001, the majority 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 September 30, 2003, marketing, general and administrative expenses were
$2.1 million, as compared to $2.6 million during the three months ended
September 30, 2002. During the nine months ended September 30, 2003, marketing,
general and administrative expenses were $6.9 million, as compared to $7.8
million during the nine months ended September 30, 2002. The decrease was due
primarily to a decrease in the CombiMatrix group's marketing personnel and legal
expenses and a decrease in legal and accounting expenses related to Acacia
Research Corporation's recapitalization and merger transactions completed in
December 2002, which were partially offset by an increase in the CombiMatrix
group's rent and utilities expenses as a result of the increase in occupancy of
its headquarters in Mukilteo, Washington, and an increase in the CombiMatrix
group's one-time accrued severance related expenses incurred in the first
quarter of 2003.
36
NON-CASH STOCK COMPENSATION EXPENSE.
RESEARCH AND DEVELOPMENT. During the three months ended
September 30, 2003, research and development related non-cash stock compensation
charges were $243,000, as compared to $753,000 during the three months ended
September 30, 2002. During the nine months ended September 30, 2003, research
and development related non-cash stock compensation charges were $525,000, as
compared to $1.9 million during the nine months ended September 30, 2002.
MARKETING, GENERAL AND ADMINISTRATIVE. During the three months
ended September 30, 2003, marketing, general and administrative non-cash stock
compensation charges were $421,000, as compared to $1.3 million during the three
months ended September 30, 2002. During the nine months ended September 30,
2003, marketing, general and administrative non-cash stock compensation charges
were $1.1 million, as compared to $3.7 million during the nine months ended
September 30, 2002.
The decrease in non-cash stock compensation charges related to
research and development and marketing, general and administrative expenses is
primarily due to forfeitures of certain unvested options and 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 remaining amount of deferred stock compensation expense
of $1.2 million as of September 30, 2003 is expected to be fully amortized by
the end of 2004.
AMORTIZATION OF PATENTS. During the three months ended
September 30, 2003, amortization of patents was $274,000, as compared to $85,000
during the three months ended September 30, 2002. During the nine months ended
September 30, 2003, amortization of patents was $821,000, as compared to
$283,000 during the nine months ended September 30, 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 an additional
intangible asset related to CombiMatrix Corporation's core technology valued at
$5.3 million, which is being amortized over an economic useful life of
approximately 7 years.
OTHER INCOME (EXPENSES), NET
OTHER INCOME, NET. During the three months ended September 30,
2003, other income, net was $52,000, as compared to $67,000 during the three
months ended September 30, 2002. During the nine months ended September 30,
2003, other income, net was $164,000, as compared to $345,000 during the nine
months ended September 30, 2002. The significant components of other income, net
were as follows:
INTEREST INCOME. During the three months ended September 30,
2003, interest income was $52,000, as compared to $111,000 during the three
months ended September 30, 2002. During the nine months ended September 30,
2003, interest income was $164,000, as compared to $510,000 during the nine
months ended September 30, 2002. The decrease was due primarily to lower average
cash and cash equivalents balances and short-term investments during the three
and nine months ended September 30, 2003, as compared to the same periods 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 September 30,
2003, interest expense was zero, as compared to $44,000 during the three months
ended September 30, 2002. During the nine months ended September 30, 2003,
interest expense was zero, as compared to $165,000 during the nine months ended
September 30, 2002. Interest expense related 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.
MINORITY INTERESTS. During the three months ended September 30, 2003,
minority interests in the losses of consolidated subsidiaries was zero, as
compared to $14.1 million during the three months ended September 30, 2002.
During the nine months ended September 30, 2003, minority interests in the
losses of consolidated subsidiaries was $30,000, as compared to $20.4 million
during the nine months ended September 30, 2002. The decrease was primarily due
to Acacia Research Corporation's acquisition of the remaining ownership
interests in CombiMatrix Corporation in December 2002 and in Advanced Material
Sciences and CombiMatrix K.K. in July 2003. Acacia Research Corporation's
interests in Advanced Material Sciences and CombiMatrix K.K. have been
attributed to the CombiMatrix group.
37
INFLATION
Inflation has not had a significant impact on the CombiMatrix group.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2003 and December 31, 2002, cash and cash
equivalents and short-term investments totaled $19.0 million and $14.9 million,
respectively.
Net cash used in operating activities for the nine months ended
September 30, 2003 was $1.8 million, as compared to $16.3 million for the nine
months ended September 30, 2002. The decrease in net cash used in operating
activities was primarily due to a reduction in net cash used in operations
(before the impact of changes in working capital) which was $11.6 million for
the nine months ended September 30, 2003, as compared to $21.0 million for the
nine months ended September 30, 2002. The change was also due to an increase in
working capital related to cash payments received by the CombiMatrix group
totaling $11.2 million, consisting of $9.7 million related to the completion of
certain milestones and delivery of prototype products and services pursuant to
its agreements with Roche, an up-front payment of $1.0 million pursuant to its
agreement with Toppan and $495,000 from customers in Japan related to the sale
of DNA microarray synthesizers and related products and services. The Roche and
Toppan cash payments received have been recorded as deferred revenues at
September 30, 2003. The increase in deferred revenues related to cash payments
received, primarily from Roche, for the nine months ended September 30, 2002 was
$5.2 million.
Net cash flows used in investing activities was $2.6 million for the
nine months ended September 30, 2003, as compared to net cash provided by
investing activities of $5.5 million for the nine months ended September 30,
2002. The change is primarily due to an increase in short-term investments
purchased during the nine months ended September 30, 2003 in connection with the
CombiMatrix group's normal cash management activities.
Net cash inflows attributed to the CombiMatrix group from financing
activities was $6.1 million for the nine months ended September 30, 2003, as
compared to $179,000 for the nine months ended September 30, 2002. The increase
is primarily due to Acacia Research Corporation's completion of a private equity
financing in May 2003, raising net proceeds of $4.9 million and AR-CombiMatrix
stock option and warrant exercise proceeds totaling $653,000, all of which were
attributed to the CombiMatrix group.
The 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.
Pursuant to the September 30, 2002 settlement agreement entered into
between CombiMatrix Corporation, Dr. Don Montgomery and Nanogen, CombiMatrix
Corporation is required to pay Nanogen 12.5% of certain revenues, subject to
minimum and maximum amounts not to exceed $1.5 million per year, beginning in
the fourth quarter of 2003, for the remaining life of the CombiMatrix group's
core patents. In January 2001, CombiMatrix Corporation also entered into a
one-year commitment with an unrelated party to purchase $1.1 million worth of
semiconductor wafers contingent upon successfully developing a next-generation
microarray.
The CombiMatrix group's long-term capital requirements will be
substantial and the adequacy of our available funds will depend upon many
factors, including:
o the CombiMatrix group's continued progress in research and
development programs;
o the costs involved in filing, prosecuting, enforcing and defending
any patents claims, should they arise;
o the CombiMatrix group's ability to license technology;
o competing technological developments;
o the creation and formation of strategic partnerships;
o the costs associated with leasing and improving our headquarters
in Mukilteo, Washington;
o the costs of commercialization activities; and
38
o other factors that may not be within the CombiMatrix group's
control.
The CombiMatrix group believes that its cash and cash equivalents 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 CombiMatrix 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 September 30, 2003 and December 31, 2002, the CombiMatrix group had
certain assets and liabilities denominated in Japanese Yen as a result of
forming CombiMatrix K.K. 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 Corporation and
Soundview Technologies, Inc., or 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 Acacia Technologies group, 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.
The Acacia Technologies group's patent on the V-chip technology expired
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)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------- ---------------------------------
2003 2002 2003 2002
--------------- --------------- --------------- ---------------
Net revenues ..................................... $ 186 $ 43 $ 211 $ 43
Marketing, general and administrative expenses ... (955) (1,423) (3,157) (5,307)
Legal expenses - patents ......................... (598) (690) (1,435) (1,141)
Amortization of patents .......................... (125) (465) (377) (1,395)
Other income (expenses), net ..................... 160 (2,816) 296 (4,424)
Benefit for income taxes ......................... 36 253 94 318
Minority interests ............................... -- 23 -- 186
Estimated loss on disposal of Soundbreak.com ..... -- (200) -- (200)
--------------- --------------- --------------- ---------------
Division net loss ................................ $ (1,296) $ (5,275) $ (4,368) $ (11,920)
=============== =============== =============== ===============
COMPARISON OF THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 TO THE THREE
AND NINE MONTHS ENDED SEPTEMBER 30, 2002
REVENUES
LICENSE FEE INCOME. During the three months ended September 30, 2003,
license fee revenues were $186,000, as compared to $43,000 during the three
months ended September 30, 2002. During the nine months ended September 30,
2003, license fee revenues were $211,000, as compared to $43,000 during the nine
months ended September 30, 2002. License fee income recognized in 2003 relates
solely to DMT technology license fee revenues, 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 deferred and amortized to revenue over the license
term. License fee revenues recognized in the third quarter of 2002 relate to a
V-chip license agreement executed during the period.
OPERATING EXPENSES
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. During the three months
ended September 30, 2003, marketing, general and administrative expenses were
$955,000, as compared to $1.4 million during the three months ended September
30, 2002. During the nine months ended September 30, 2003, marketing, general
and administrative expenses were $3.2 million, as compared to $5.3 million
during the nine months ended September 30, 2002. The decrease was due primarily
to a decrease in legal and accounting related expenses related to Acacia
Research Corporation's recapitalization and merger transactions completed in
December 2002 and a decrease in overhead due to reduced general and
administrative personnel. The decrease was partially offset by an increase in
internal expenses related to the Acacia Technologies group's ongoing DMT patent
commercialization and enforcement efforts, including increased engineering costs
related to new patent claims and the identification of additional potential
licensees of the Acacia Technologies group's DMT technology.
LEGAL EXPENSES - PATENTS. During the three months ended September 30,
2003, patent related legal expenses were $598,000, as compared to $690,000
during the three months ended September 30, 2002. During the nine months ended
September 30, 2003, patent related legal expenses were $1.4 million, as compared
to $1.1 million during the nine months ended September 30, 2002. Patent related
legal expenses in both periods relate to legal fees incurred in connection with
the Acacia Technologies group's ongoing DMT patent commercialization and
enforcement efforts, including legal and engineering costs related to new patent
claims and the identification of additional potential licensees of the Acacia
Technologies group's DMT technology.
AMORTIZATION OF PATENTS. During the three months ended September 30,
2003, amortization of patents was $125,000, as compared to $465,000 during the
three months ended September 30, 2002. During the nine months ended September
30, 2003, amortization of patents was $377,000, as compared to $1.4 million
during the nine months ended September 30, 2002. The decrease is due to a
reduction in patent amortization expense due to V-chip technology related patent
costs and other intangibles that were fully amortized during 2002.
41
OTHER INCOME (EXPENSES), NET
OTHER INCOME (EXPENSES), NET. During the three months ended September
30, 2003, other income, net was $160,000, as compared to ($2.8 million) in other
expenses, net during the three months ended September 30, 2002. During the nine
months ended September 30, 2003, other income, net was $296,000, as compared to
($4.4 million) in other expenses, net during the nine months ended September 30,
2002. The significant components of other income (expense), net were as follows:
IMPAIRMENT OF COST METHOD INVESTMENT. In the second quarter of
2003, the Acacia Technologies group recorded an impairment charge of $207,000
for an other-than-temporary decline in the fair value of its cost method
investment. Impairment indicators included a continued decline in the working
capital of the entity and reference to a recent equity transaction and related
valuation indicating an other-than-temporary decline in fair value of the
investment. In September 2002, the Acacia Technologies group recorded an
impairment charge of $2.7 million for an other-than-temporary decline in the
fair value of the same cost method investment. Impairment indicators included
recurring losses, a decline in working capital and the completion of a recent
equity transaction at an amount below the Acacia Technologies group's carrying
value.
INTEREST INCOME. During the three months ended September 30,
2003, interest income was $128,000, as compared to $150,000 during the three
months ended September 30, 2002. During the nine months ended September 30,
2003, interest income was $408,000, as compared to $450,000 during the nine
months ended September 30, 2002. The decrease was primarily due to a decrease in
average cash balances related to net operating cash outflows and the continuing
impact of declining interest rates and other external economic factors
negatively impacting rates of return on short-term investments occurring during
2002 and continuing in 2003.
REALIZED AND UNREALIZED GAINS/ LOSSES ON SHORT-TERM
INVESTMENTS. During the three months ended September 30, 2003, net realized
gains on investments were $32,000, as compared to net unrealized losses on
investments of $213,000. During the nine months ended September 30, 2003, net
realized gains on investments were $94,000, as compared to net realized and
unrealized losses on investments of $2.2 million during the nine months ended
September 30, 2002. The decrease is due to no investments classified as trading
securities held during 2003.
INFLATION
Inflation has not had a significant impact on the Acacia Technologies
group.
LIQUIDITY AND CAPITAL RESOURCES
The Acacia Technologies group's cash and cash equivalents and
short-term investments totaled $34.5 million at September 30, 2003, as compared
to $39.8 million at December 31, 2002.
Net cash used in continuing operating activities for the nine months
ended September 30, 2003 was $4.1 million, as compared to $4.4 million for the
nine months ended September 30, 2002. Net cash used in continuing operating
activities for the nine months ended September 30, 2002 included net sales of
trading securities and minority interest distributions of $2.7 million and
$430,000, respectively.
Net cash flows used in continuing investing activities was $5.1 million
for the nine months ended September 30, 2003, as compared to $4.7 million for
the nine months ended September 30, 2002. The change is primarily due to an
increase in short-term investments purchased during the nine months ended
September 30, 2003 related to the Acacia Technologies group's ongoing cash
management activities.
Net cash outflows attributed to the Acacia Technologies group from
financing activities was $471,000 for the nine months ended September 30, 2003,
as compared to $800,000 for the nine months ended September 30, 2002. Net cash
outflows attributed to the Acacia Technologies group for the nine months ended
September 30, 2003 and 2002 relate primarily to corporate charges allocated to
the CombiMatrix group in accordance with Acacia Research Corporation management
allocation policies partially offset by proceeds from the exercise of stock
options of $89,000 and $136,000 during the nine months ended September 30, 2003
and 2002, respectively.
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 approximately $100,000
for the remainder of 2003, $300,000 per year through 2006 and $40,000 in 2007.
The Acacia Technologies group has no committed lines of credit or other
committed funding or long-term debt. Management believes that the Acacia
42
Technologies group's cash and cash equivalents 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.
In November 2001, Acacia Research Corporation increased its ownership
interest in Acacia Media Technologies Corporation from 33% to 100% through the
purchase of the ownership interest of the former limited liability company's
other member for a cash payment. In connection with the purchase of the
ownership interest, Acacia Media Technologies Corporation also executed related
assignment agreements which granted to the former owners of Acacia Media
Technologies Corporation's current patent portfolio the right to receive a
royalty of 15% of future net revenues generated by Acacia Media Technologies
Corporation's current patent portfolio, which includes its DMT patents.
Royalties to be paid will be expensed in the consolidated statement of
operations.
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.
43
RISK FACTORS
AN INVESTMENT IN OUR STOCK INVOLVES A NUMBER OF RISKS. BEFORE MAKING A
DECISION TO PURCHASE OUR STOCK, YOU SHOULD CAREFULLY CONSIDER ALL OF THE RISKS
DESCRIBED IN THIS QUARTERLY REPORT. IF ANY OF THE RISKS DISCUSSED IN THIS
QUARTERLY REPORT ACTUALLY OCCUR, OUR BUSINESS, FINANCIAL CONDITION AND RESULTS
OF OPERATIONS COULD BE MATERIALLY AND ADVERSELY AFFECTED. IF THIS WERE TO OCCUR,
THE TRADING PRICES OF OUR STOCK 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, the lingering effects of the war in Iraq, recent
international conflicts and the events of September 11, 2001 and other 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. These conditions make it extremely
difficult for us to accurately forecast and plan future business activities. We
cannot predict the timing, strength and duration of any economic recovery,
worldwide or in our markets. 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 is intense in the industries in which our subsidiaries
do business;
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 September 30, 2003, of $178.3 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 PRICES MAY BE VERY VOLATILE.
Our operating results may vary significantly from quarter to quarter
due to a variety of factors, including:
44
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 September 30, 2003, we had cash and short-term investments of
$53.6 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. Nevertheless, we cannot assure that additional funding will
45
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.
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 our subsidiary companies' 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
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 Messrs. Ryan or Harris nor
Dr. Kumar has an employment or non-competition agreement with us. The loss of
any of these key individuals would be detrimental to our ongoing operations and
prospects.
OUR FUTURE SUCCESS AND THE SUCCESS OF OUR SUBSIDIARY COMPANIES DEPENDS ON OUR
AND THEIR ABILITIES TO ATTRACT AND RETAIN QUALIFIED TECHNICAL PERSONNEL AND
QUALIFIED MANAGEMENT AND MARKETING TEAMS. FAILURE TO DO SO WOULD HARM OUR
ONGOING OPERATIONS AND BUSINESS PROSPECTS.
We believe that our success will depend on continued employment by us
and our subsidiary companies of senior management and key technical personnel.
Our subsidiary companies will need to attract, retain and motivate qualified
management personnel to execute their current business plans and to successfully
develop commercially viable products and services. Competition for qualified
personnel is intense and we cannot assure you that we will successfully retain
our existing key employees or attract and retain any additional personnel we may
require.
Each of our subsidiary companies has key executives upon whom we
significantly depend, and the success of those subsidiary companies depends on
their ability to retain and motivate those individuals.
BECAUSE WE HAVE A LIMITED OPERATING HISTORY, WE CANNOT ASSURE THAT OUR
OPERATIONS WILL BE PROFITABLE.
We commenced operations in 1993 and, accordingly, have a limited
operating history. In addition, certain of our subsidiary companies are in the
early stages of development and or operations and have limited operating
histories. You should consider our prospects in light of the risks, expenses and
difficulties frequently encountered by companies with such limited operating
histories. Since we have a limited operating history, we cannot assure you that
our operations will be profitable or that we will generate sufficient revenues
to meet our expenditures and support our activities.
During the three and nine months ended September 30, 2003 and the
fiscal year ended December 31, 2002, we had operating losses of approximately
$6.1 million, $20.0 million and $80.3 million, respectively, and net losses of
approximately $5.8 million, $19.3 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.
46
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.
RISKS RELATING TO A CAPITAL STRUCTURE WITH TWO SEPARATE CLASSES OF COMMON
STOCK
HOLDERS OF BOTH CLASSES OF OUR STOCK ARE STOCKHOLDERS OF ONE COMPANY, AND THE
FINANCIAL PERFORMANCE OF ONE GROUP COULD AFFECT THE OTHER, THUS EXPOSING THE
HOLDERS OF EACH GROUP'S STOCK TO THE RISKS OF AN INVESTMENT IN THE ENTIRE
COMPANY.
Holders of AR-CombiMatrix stock and AR-Acacia Technologies stock are
stockholders of a single company. The CombiMatrix group and the Acacia
Technologies group are not separate legal entities. As a result, stockholders
will continue to be subject to all of the risks of an investment in Acacia
Research Corporation and all of our businesses, assets and liabilities. The
issuance of our AR-CombiMatrix stock and our AR-Acacia Technologies stock and
the allocation of assets and liabilities and stockholders' equity between the
CombiMatrix group and the Acacia Technologies group did not result in a
distribution or spin-off to stockholders of any of our assets or liabilities and
did not affect ownership of our assets or responsibility for our liabilities or
those of our subsidiaries. The assets we attribute to one group could be subject
to the liabilities of the other group, whether such liabilities arise from
lawsuits, contracts or indebtedness that we attribute to the other group. If we
are unable to satisfy one group's liabilities out of the assets we attribute to
it, we may be required to satisfy those liabilities with assets we have
attributed to the other group.
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.
47
THE MARKET PRICE OF EITHER CLASS OF OUR COMMON STOCK MAY NOT REFLECT THE
SEPARATE PERFORMANCE OF THE GROUP RELATED TO THAT CLASS OF COMMON STOCK.
The market price of our AR-CombiMatrix stock or AR-Acacia Technologies
stock may not reflect the separate performance of the business of the group
relating to that class of common stock. The market price of either class of
common stock could simply reflect the performance of Acacia Research Corporation
as a whole, or the market price of either class of common stock could move
independently of the performance of the business of either group. Investors may
discount the value of either class of common stock because it is part of a
common enterprise rather than a stand-alone company.
THE MARKET PRICE OF EITHER CLASS OF OUR COMMON STOCK MAY BE AFFECTED BY FACTORS
THAT DO NOT AFFECT TRADITIONAL COMMON STOCK.
THE COMPLEX NATURE OF THE TERMS OF OUR AR-COMBIMATRIX STOCK AND
AR-ACACIA TECHNOLOGIES STOCK MAY ADVERSELY AFFECT THE MARKET PRICE OF
EITHER CLASS OF COMMON STOCK.
The complex nature of the terms of our two classes of common stock,
such as the convertibility of AR-CombiMatrix stock into AR-Acacia Technologies
stock, or vice versa, and the potential difficulties investors may have
understanding these terms, may adversely affect the market price of either class
of common stock.
THE MARKET PRICE OF OUR AR-COMBIMATRIX STOCK OR AR-ACACIA TECHNOLOGIES
STOCK MAY BE ADVERSELY AFFECTED BY THE FACT THAT HOLDERS HAVE LIMITED
LEGAL INTERESTS IN THE GROUP RELATING TO THE CLASS OF COMMON STOCK HELD
AS A SEPARATE LEGAL ENTITY.
For example, as described in greater detail in the subsequent risk
factors, holders of either class of common stock generally do not have separate
class voting rights with respect to significant matters affecting either group.
In addition, upon our liquidation or dissolution, holders of either class of
common stock will not have specific rights to the assets of the group relating
to the class of common stock held and will not be entitled to receive proceeds
that are proportional to the relative performance of that group.
THE MARKET PRICE OF OUR AR-COMBIMATRIX STOCK OR AR-ACACIA TECHNOLOGIES
STOCK MAY BE ADVERSELY AFFECTED BY EVENTS INVOLVING THE GROUP RELATING
TO THE OTHER CLASS OF COMMON STOCK OR THE PERFORMANCE OF THE CLASS OF
COMMON STOCK RELATING TO THAT GROUP.
Events, such as earnings announcements or other developments concerning
one group that the market does not view favorably and which thus adversely
affect the market price of the class of common stock relating to that group, may
adversely affect the market price of the class of common stock relating to the
other group. Because both classes of common stock are common stock of Acacia
Research Corporation, an adverse market reaction to one class of common stock
may, by association, cause an adverse reaction to the other class of common
stock. This reaction may occur even if the triggering event was not material to
us as a whole.
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 stockholders).
We will not hold separate stockholder meetings for holders of
AR-CombiMatrix stock and AR-Acacia Technologies stock.
48
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 our AR-CombiMatrix stock or
our 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 our AR-CombiMatrix stock and our 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 our AR-CombiMatrix
stock or our 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.
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
our 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 our restated certificate 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 our 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
49
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 September 30, 2003, our executive officers, directors and their
affiliates beneficially owned approximately 11% of the outstanding
AR-CombiMatrix stock and 20% of the outstanding AR-Acacia Technologies stock.
NUMEROUS POTENTIAL CONFLICTS OF INTERESTS EXIST BETWEEN OUR AR-COMBIMATRIX STOCK
AND OUR 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 our restated certificate of
incorporation, and, to the extent applicable, our management and allocation
policies.
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
our AR-CombiMatrix stock or our AR-Acacia Technologies stock. Determinations as
to future dividends on our AR-CombiMatrix stock and our 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 our AR-CombiMatrix stock and
our AR-Acacia Technologies stock in any amount and could, in its sole
discretion, declare and pay dividends exclusively on our AR-CombiMatrix stock,
exclusively on our 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 our
restated 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
50
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 ATTRIBUTED 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 ATTRIBUTED
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 attributed among the CombiMatrix group 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 attributed to the corresponding group. Such allocations might be
materially more or less for the respective groups than what might have been
attributed had our board of directors chosen a different allocation method.
Also, any designated preferred class may be designed to reflect the performance
of Acacia Research Corporation as a whole, rather than the performance of the
CombiMatrix group or the Acacia Technologies group.
ALLOCATION OF CORPORATE OPPORTUNITIES COULD FAVOR ONE GROUP OVER
ANOTHER.
Our board of directors may be required to allocate corporate
opportunities between the groups. In some cases, our directors could determine
that a corporate opportunity, such as a business that we are acquiring, should
be shared by the groups. Any such decisions could favor one group at the expense
of the other.
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. 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.
51
EITHER GROUP MAY FINANCE THE OTHER GROUP ON TERMS UNFAVORABLE TO ONE OF THE
GROUPS.
We may transfer cash and other property between groups to finance their
business activities. The group providing the financing will be subject to the
risks relating to the group receiving the financing. We will account for those
transfers generally as a short-term or long-term loan between groups or as a
repayment of a previous borrowing.
THERE ARE LIMITS ON THE CONSIDERATION WHICH MAY BE RECEIVED BY THE STOCKHOLDERS
IN THE EVENT OF THE DISPOSITION OF ASSETS OF A GROUP.
Our restated certificate of incorporation provides that if a
disposition of all or substantially all of the properties and assets of either
group occurs, we must, subject to certain exceptions:
o distribute through a dividend or redemption to holders of the
class of common stock relating to such group an amount equal to
the net proceeds of such disposition; or
o convert at a 10% premium such common stock into shares of the
class of common stock relating to the other group.
If the group subject to the disposition were a separate, independent
company and its shares were acquired by another person, certain costs of that
disposition, including corporate level taxes, might not be payable in connection
with that acquisition. As a result, stockholders of the separate, independent
company might receive a greater amount than the net proceeds that would be
received by holders of the class of common stock relating to that group if the
assets of such group were sold. In addition, we cannot assure you that the net
proceeds per share of the common stock relating to that group will be equal to
or more than the market value per share of such common stock prior to or after
announcement of a disposition.
The term "substantially all of the properties and assets" of a group is
subject to potentially conflicting interpretations. Resolution of such a dispute
could adversely impact the holders of either the class of common stock related
to the assets being disposed or the holders of the other class because the
consideration, if any, to be received by the holders of the class related to the
disposed assets may depend on whether the disposition involved "substantially
all" of the properties and assets of that class.
HOLDERS OF EITHER CLASS OF COMMON STOCK MAY BE ADVERSELY AFFECTED BY A
REDEMPTION OF THEIR COMMON STOCK.
We are entitled to redeem the outstanding common stock relating to a
group when all or substantially all of that group's assets are sold. We can
redeem the assets for cash, securities, a combination of cash and securities or
other property at fair value. A disposition-related redemption could occur when
the assets being disposed of are considered undervalued. If that were 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 OUR COMPANY 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, our AR-CombiMatrix stock has a majority of the
voting power. As a result, currently, it might be possible for an acquirer to
obtain control of Acacia Research Corporation by purchasing only shares of
AR-CombiMatrix stock.
52
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 our AR-CombiMatrix stock and our
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 our AR-CombiMatrix stock and our
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 OUR AR-COMBIMATRIX STOCK AND OUR AR-ACACIA TECHNOLOGIES
STOCK BASED ON GROUP FINANCIAL INFORMATION AND POLICIES.
We cannot assure you that investors will value our AR-CombiMatrix stock
and our AR-Acacia Technologies stock based on the reported financial results and
prospects of the separate groups or the dividend policies established by our
board of directors with respect to those groups. Holders of AR-CombiMatrix stock
and AR-Acacia Technologies stock will continue to be common stockholders of
Acacia Research Corporation subject to all the risks associated with an
investment in Acacia Research Corporation as a whole. Additionally, the separate
stockholder rights related to each group are limited and relate to events that
may never occur, such as dividend and liquidation rights and the disposition of
all or substantially all of the assets of a group. Accordingly, investors may
discount the value of AR-CombiMatrix stock and AR-Acacia Technologies stock
because both groups are part of a common enterprise rather than a stand-alone
entity and each class of stock has limited separate stockholder rights.
HOLDERS OF AR-COMBIMATRIX STOCK AND AR-ACACIA TECHNOLOGIES STOCK MAY NOT RECEIVE
A PREMIUM FROM AN INVESTOR ACQUIRING CONTROL OF THEIR RESPECTIVE CLASSES OF
STOCK.
Control of AR-CombiMatrix stock or AR-Acacia Technologies stock may not
provide control of Acacia Research Corporation as a whole. Accordingly, unlike
many acquisition transactions, holders of AR-CombiMatrix stock and
AR-Technologies stock may not receive a controlling interest premium from an
investor acquiring control of their respective classes of stock.
THERE ARE CERTAIN PROVISIONS IN OUR TWO-CLASS CAPITAL STRUCTURE THAT COULD HAVE
ANTITAKEOVER EFFECTS.
The existence of the two classes of common stock could, under certain
circumstances, prevent stockholders from profiting from an increase in the
market value of their shares as a result of a change in control of Acacia
Research Corporation by delaying or preventing such change in control. The
existence of two classes of common stock could present complexities and could,
in certain circumstances, pose obstacles, financial and otherwise, to an
acquiring person. We could, in the sole discretion of our board of directors and
without stockholder approval, exercise the right to convert the shares of one
class of common stock into shares of the other at a 10% premium over their
respective average market values. This conversion could result in additional
dilution to persons seeking control of Acacia Research Corporation.
Our board of directors could issue shares of preferred stock or common
stock that could be used to create voting or other impediments to discourage
persons seeking to gain control of Acacia Research Corporation, and preferred
stock could also be privately placed with purchasers favorable to our board of
directors in opposing such action.
53
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 our AR-CombiMatrix
stock. As such, we also urge you to read carefully the section "Risks Relating
to the Acacia Technologies Group" below.
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 our AR-CombiMatrix stock to decline. The
following are among the factors that could cause the CombiMatrix group's
operating results to fluctuate significantly from period to period:
o its unpredictable revenue sources, as described below;
o the nature, pricing and timing of the CombiMatrix group's and its
competitors' products;
o changes in the CombiMatrix group's and its competitors' research
and development budgets;
o expenses related to, and the CombiMatrix group's ability to comply
with, governmental regulations of its products and processes; and
o expenses related to, and the results of, patent filings and other
proceedings relating to intellectual property rights.
The CombiMatrix group anticipates significant fixed expenses due in
part to its need to continue to invest in product development. It may be unable
to adjust its expenditures if revenues in a particular period fail to meet its
expectations, which would harm its operating results for that period. As a
result of these fluctuations, the CombiMatrix group believes that
period-to-period comparisons of the CombiMatrix group's financial results will
not necessarily be meaningful, and you should not rely on these comparisons as
an indication of its future performance.
THE COMBIMATRIX GROUP'S REVENUES WILL BE UNPREDICTABLE, AND THIS MAY HARM ITS
FINANCIAL CONDITION.
The amount and timing of revenues that the CombiMatrix group may
realize from its business will be unpredictable because:
o whether products are commercialized and generate revenues depends,
in part, on the efforts and timing of its potential customers;
o its sales cycles may be lengthy; and
o it cannot be sure as to the timing of receipt of payment for its
products.
As a result, the CombiMatrix group's revenues may vary significantly
from quarter to quarter, which could make its business difficult to manage and
cause its quarterly results to be below market expectations. If this happens,
the price of the CombiMatrix group's common stock may decline significantly.
54
TECHNOLOGY COMPANY STOCK PRICES ARE ESPECIALLY VOLATILE, AND THIS VOLATILITY MAY
DEPRESS THE PRICE OF OUR 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 our 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 our 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.
55
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 were 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:
56
o the development of a market for its tools for the analysis of
genetic variation and function, the study of proteins and other
purposes;
o the benefits and cost-effectiveness of its products relative to
others available in the market;
o its ability to manufacture products in sufficient quantities with
acceptable quality and reliability and at an acceptable cost;
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.
57
AS THE COMBIMATRIX GROUP'S OPERATIONS EXPAND, ITS COSTS TO COMPLY WITH
ENVIRONMENTAL LAWS AND REGULATIONS WILL INCREASE, AND FAILURE TO COMPLY WITH
THESE LAWS AND REGULATIONS COULD HARM ITS FINANCIAL RESULTS.
The CombiMatrix group's operations involve the use, transportation,
storage and disposal of hazardous substances, and as a result it is subject to
environmental and health and safety laws and regulations. As the CombiMatrix
group expands its operations, its use of hazardous substances will increase and
lead to additional and more stringent requirements. The cost to comply with
these and any future environmental and health and safety regulations could be
substantial. In addition, the CombiMatrix group's failure to comply with laws
and regulations, and any releases of hazardous substances into the environment
or at its disposal sites, could expose the CombiMatrix group to substantial
liability in the form of fines, penalties, remediation costs and other damages,
or could lead to a curtailment or shut down of its operations. These types of
events, if they occur, would adversely impact the group's financial results.
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,
58
others may independently develop substantially equivalent proprietary
information or techniques or otherwise gain access to its trade secrets.
ANY LITIGATION TO PROTECT THE COMBIMATRIX GROUP'S INTELLECTUAL PROPERTY OR ANY
THIRD-PARTY CLAIMS OF INFRINGEMENT, COULD DIVERT SUBSTANTIAL TIME AND MONEY FROM
THE COMBIMATRIX GROUP'S BUSINESS AND COULD SHUT DOWN SOME OF ITS OPERATIONS.
The CombiMatrix group's commercial success depends in part on its
non-infringement of the patents or proprietary rights of third parties. Many
companies developing tools for the biotechnology and pharmaceutical industries
use litigation aggressively as a strategy to protect and expand the scope of
their intellectual property rights. Accordingly, third parties may assert that
the CombiMatrix group is employing their proprietary technology without
authorization. In addition, third parties may claim that use of the CombiMatrix
group's technologies infringes their current or future patents. The CombiMatrix
group could incur substantial costs and the attention of its management and
technical personnel could be diverted while defending ourselves against any of
these claims. The CombiMatrix group may incur the same liabilities in enforcing
its patents against others. The CombiMatrix group has not made any provision in
its financial plans for potential intellectual property related litigation, and
it may not be able to pursue litigation as aggressively as competitors with
substantially greater financial resources.
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 the CombiMatrix group,
we 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" above.
THE ACACIA TECHNOLOGIES GROUP HAS INCURRED LOSSES IN THE PAST AND EXPECTS TO
INCUR ADDITIONAL LOSSES IN THE FUTURE.
The Acacia Technologies group has sustained substantial losses in the
past. We expect the Acacia Technologies group to incur significant research and
development, marketing, general and administrative expenses. As a result, we
expect the Acacia Technologies group to incur significant losses for the
foreseeable future.
THE V-CHIP TECHNOLOGY PATENT HELD BY THE ACACIA TECHNOLOGIES GROUP EXPIRED IN
JULY 2003, AND IF THE GROUP DOES NOT DEVELOP OTHER RECURRING SOURCES OF REVENUE,
ITS FINANCIAL CONDITION WILL BE ADVERSELY IMPACTED.
The Acacia Technologies group, and Acacia Research Corporation as a
whole, has generated substantially all of its revenues from licensing the V-chip
technology to television manufacturers. The Acacia Technologies group's patent
on the V-chip technology expired 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.
59
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'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 Acacia
Technologies group's revenues could fall below the expectations of securities
analysts or investors, which could cause the market price of our AR-Acacia
Technologies stock to decline. The following are among the factors that could
cause the Acacia Technologies group's operating results to fluctuate
significantly from period to period:
o its unpredictable revenue sources, as described below;
o costs related to acquisitions, alliances, licenses and other
efforts to expand its operations;
o the timing of payments under the terms of any customer or license
agreements into which the Acacia Technologies group may enter; and
o expenses related to, and the results of, patent filings and other
proceedings relating to intellectual property rights.
THE ACACIA TECHNOLOGIES GROUP'S REVENUES WILL BE UNPREDICTABLE, AND THIS MAY
HARM ITS FINANCIAL CONDITION.
The amount and timing of revenues that the Acacia Technologies group
may realize from its business will be unpredictable because:
o whether the Acacia Technologies group generates revenues depends,
in part, on the success of its licensing efforts;
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 our AR-Acacia Technologies stock may decline
significantly.
TECHNOLOGY COMPANY STOCK PRICES ARE ESPECIALLY VOLATILE, AND THIS VOLATILITY MAY
DEPRESS THE PRICE OF OUR 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 our
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 our 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.
60
THE ACACIA TECHNOLOGIES GROUP FACES INTENSE COMPETITION, AND WE CANNOT ASSURE
YOU THAT IT WILL BE SUCCESSFUL.
Although the Acacia Technologies group believes that Acacia Media
Technologies has marketing and licensing rights to enforceable patents and other
intellectual property relating to video and audio on demand, the Acacia
Technologies group cannot assure you that other companies will not develop
competing technologies that offer better or less expensive alternatives to those
offered by Acacia Media Technologies. In the event a competing technology
emerges, Acacia Media Technologies would expect substantial additional
competition.
THE MARKETS SERVED BY THE ACACIA TECHNOLOGIES GROUP ARE SUBJECT TO RAPID
TECHNOLOGICAL CHANGE, AND IF THE ACACIA TECHNOLOGIES GROUP IS UNABLE TO DEVELOP
AND INTRODUCE NEW PRODUCTS, ITS REVENUES COULD STOP GROWING OR COULD DECLINE.
The markets served by the Acacia Technologies group frequently undergo
transitions in which products rapidly incorporate new features and performance
standards on an industry-wide basis. Products for communications applications,
as well as for high-speed computing applications, are based on continually
evolving industry standards. A significant portion of the Acacia Technologies
group's revenues in recent periods has been, and is expected to continue to be,
derived from licensing of technologies based on existing transmission standards.
The Acacia Technologies group's ability to compete in the future will, however,
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 did not infringe on Soundview Technologies' patent. If we are
unsuccessful in our intended appeal of this ruling, legal principles will
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.
61
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Refer to Item 2. "Management's Discussion and Analysis of Financial
Condition and Results of Operations" under the caption "Quantitative and
Qualitative Disclosures About Market Risk" for Acacia Research Corporation, the
CombiMatrix group and the Acacia Technologies group.
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 September 30, 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 not have a material impact on the fair value of our
available-for-sale securities as of September 30, 2003.
ITEM 4. CONTROLS AND PROCEDURES
(a) With the participation of management, Acacia Research
Corporation's chief executive officer and its chief financial officer evaluated
the effectiveness of our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended as
of September 30, 2003. 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 has been no change in our internal controls over
financial reporting during the fiscal quarter covered by this report that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
62
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, or District of
Connecticut Court, 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 (the "remaining defendants"). In granting
the motion, the court ruled that the remaining defendants have not infringed on
Soundview Technologies' patent.
In September 2003, a motion for summary judgment filed by the remaining
defendants was granted by the District of Connecticut Court on Soundview
Technologies' anti-trust claims due to the Court's previous ruling of
non-infringement as described above.
While we are currently exploring strategies in response to both rulings
by the District of Connecticut Court and intend to appeal the two summary
judgment rulings, litigation is inherently uncertain and we can give no
assurance that we will be successful in any such appeals.
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.
ACACIA MEDIA TECHNOLOGIES CORPORATION
In February 2003, Acacia Media Technologies Corporation 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.
In July 2003, the United States District Court for the Central District
of California issued injunctions, resulting from Default Judgments, against five
Adult Entertainment companies for violating the Acacia Media Technologies
Corporation's DMT technology patents. The court issued the injunctions against
Extreme Productions, Go Entertainment, Lace Productions, WebZotic LLC, and Wild
Ventures, LLC. The injunctions prohibit these companies from infringing Acacia
Media Technologies Corporation's DMT technology patents by transmitting
compressed digital video information from any of their websites.
In September 2003, Acacia Media Technologies Corporation caused 42
websites owned by Go Entertainment, Inc. to be closed down. The websites were
continuing to utilize Acacia Media Technologies Corporation's DMT technology in
violation of a court order. The District Court for the Central District of
California issued an injunction prohibiting Go Entertainment from continuing to
use Acacia Media Technologies Corporation's DMT technology without a license.
Acacia Media Technologies Corporation successfully enforced the injunction
against Go Entertainment's web hosting company.
63
ITEM 2. CHANGES IN SECURITIES
In July 2003, we increased our consolidated ownership interest in
Advanced Material Sciences to 99% by acquiring 1,774,750 shares of Advanced
Material Sciences common stock in exchange for 295,790 shares of Acacia
Research-CombiMatrix common stock. The fair value of the Acacia Research-
CombiMatrix common stock issued in the transaction, which was based on the
quoted market price of Acacia Research -CombiMatrix stock on the exchange date,
was $769,000.
In July 2003, we purchased the outstanding minority interests in
CombiMatrix K.K. from Marubeni Corporation ("Marubeni"). We issued 200,000
shares of our Acacia Research-CombiMatrix common stock to Marubeni in exchange
for Marubeni's 10% minority interest in CombiMatrix K.K. The fair value of the
Acacia Research-CombiMatrix stock issued in the transaction, which was based on
the quoted market price of AR-CombiMatrix stock on the exchange date, was
$450,000.
The shares of Acacia Research-CombiMatrix common stock issued in these
transactions were issued in private placements pursuant to the exemption from
the registration requirements of the Securities Act of 1933, as amended,
provided by Section 4(2) thereof and Rule 506 of Regulation D promulgated
thereunder to "accredited investors," as defined in Rule 501(a) of Regulation D.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31.1 Certifications of the Chief Executive Officer provided pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certifications of the Chief Financial Officer provided pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certifications of the Chief Executive Officer provided pursuant to
18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certifications of the Chief Financial Officer provided pursuant to
18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
Acacia Research Corporation furnished, but did not file, one Current
Report on Form 8-K during the three months ended September 30, 2003. The report,
dated July 29, 2003, contained the Company's press release announcing its
earnings for the second quarter of 2003.
64
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: November 13, 2003
65
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT
- ------ -------
31.1 Certifications of the Chief Executive Officer provided pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certifications of the Chief Financial Officer provided pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certifications of the Chief Executive Officer provided pursuant to
18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certifications of the Chief Financial Officer provided pursuant to
18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
66