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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
OR
[ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________ TO _________.
COMMISSION FILE NUMBER 0-26068
_______
ACACIA RESEARCH CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 95-4405754
(State or other jurisdiction of (I.R.S. Employer
incorporation organization) Identification No.)
500 NEWPORT CENTER DRIVE, NEWPORT BEACH, CA 92660
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (949) 480-8300
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
ACACIA RESEARCH - ACACIA TECHNOLOGIES COMMON STOCK, $0.001 PAR VALUE
(TITLE OF CLASS)
ACACIA RESEARCH - COMBIMATRIX COMMON STOCK, $0.001 PAR VALUE
(TITLE OF CLASS)
_______
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
filing requirements for the past 90 days. Yes |X| No [ ]
Indicate by check mark that disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ]
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes |X| No [ ]
The aggregate market value of the registrant's Acacia Research - Acacia
Technologies common stock and Acacia Research - CombiMatrix common stock held by
non-affiliates of the registrant, computed by reference to the last sales prices
of such stocks reported on The Nasdaq Stock Market, as of June 30, 2003, was
approximately $23,058,107 and $60,359,784, respectively. (All officers and
directors of the registrant are considered affiliates.)
As of February 27, 2004, 19,746,234 shares of Acacia Research-Acacia
Technologies common stock were issued and outstanding. As of February 27, 2004,
27,639,201 shares of Acacia Research-CombiMatrix common stock were issued and
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement for its Annual
Meeting of Stockholders to be filed with the Commission within 120 days after
the close of its fiscal year are incorporated by reference into Part III.
================================================================================
FORM 10-K ANNUAL REPORT
FISCAL YEAR ENDED DECEMBER 31, 2003
ACACIA RESEARCH CORPORATION
ITEM PAGE
- ---- ----
PART I
1. Business................................................................................................1
2. Properties.............................................................................................15
3. Legal Proceedings......................................................................................15
4. Submission of Matters to a Vote of Security Holders....................................................16
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters..................................17
6. Selected Financial Data................................................................................19
7. Management's Discussion and Analysis of Financial Condition and Results of Operations..................23
7A. Quantitative and Qualitative Disclosures About Market Risk.............................................68
8. Financial Statements and Supplementary Data............................................................68
9. Changes in and Disagreements with Auditors on Accounting and Financial Disclosure......................68
9A. Controls and Procedures................................................................................68
PART III
10. Directors and Executive Officers of the Registrant.....................................................69
11. Executive Compensation.................................................................................69
12. Security Ownership of Certain Beneficial Owners and Management.........................................69
13. Certain Relationships and Related Transactions.........................................................69
14. Principal Accounting Fees and Services.................................................................69
PART IV
15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.......................................70
PART I
CAUTIONARY STATEMENT
This report contains forward-looking statements within the meaning of
the "safe harbor" provisions of the Private Securities Litigation Reform Act of
1995. Reference is made in particular to the description of our plans and
objectives for future operations, assumptions underlying such plans and
objectives, and other forward-looking statements included in this report. Such
statements may be identified by the use of forward-looking terminology such as
"may," "will," "expect," "believe," "estimate," "anticipate," "intend,"
"continue," or similar terms, variations of such terms or the negative of such
terms. Such statements are based on management's current expectations and are
subject to a number of factors and uncertainties, which could cause actual
results to differ materially from those described in the forward-looking
statements. Such statements address future events and conditions concerning
product development, capital expenditures, earnings, litigation, regulatory
matters, markets for products and services, liquidity and capital resources and
accounting matters. Actual results in each case could differ materially from
those anticipated in such statements by reason of factors such as future
economic conditions, changes in consumer demand, legislative, regulatory and
competitive developments in markets in which we and our subsidiaries operate,
and other circumstances affecting anticipated revenues and costs. We expressly
disclaim any obligation or undertaking to release publicly any updates or
revisions to any forward-looking statements contained herein to reflect any
change in our expectations with regard thereto or any change in events,
conditions or circumstances on which any such statement is based. Additional
factors that could cause such results to differ materially from those described
in the forward-looking statements are set forth in connection with the
forward-looking statements.
As used in this Form 10-K, "we," "us" and "our" refer to Acacia
Research Corporation and its subsidiary companies.
ITEM 1. BUSINESS
OVERVIEW
Acacia Research Corporation is comprised of two operating groups.
Our life sciences business, referred to as the "CombiMatrix group," is
comprised of our wholly owned subsidiary, CombiMatrix Corporation and
CombiMatrix Corporation's majority-owned subsidiary, Advanced Material Sciences,
Inc., or Advanced Material Sciences, and wholly owned subsidiary, CombiMatrix
K.K. CombiMatrix Corporation is a life sciences technology company with a
proprietary system for rapid, cost competitive creation of DNA and other
compounds on a programmable semiconductor chip. This proprietary technology has
applications in the areas of genomics, proteomics, biosensors, drug discovery,
drug development, diagnostics, combinatorial chemistry, material sciences and
nanotechnology.
Our intellectual property licensing business, referred to as the
"Acacia Technologies group," is responsible for the development, acquisition,
licensing and protection of intellectual property and proprietary technologies
and is pursuing additional licensing and strategic business alliances with
leading companies in the rapidly growing intellectual property licensing
industry. The Acacia Technologies group owns and out-licenses a portfolio of
pioneering U.S. and foreign patents covering digital audio and video
transmission and receiving systems, commonly known as audio-on-demand,
video-on-demand, and audio/video streaming. The Acacia Technologies group's
patented proprietary digital media transmission, or DMT, technology enables the
digitization, encryption, storage, transmission, receipt and playback of digital
content via several means including the Internet, cable, satellite and wireless
systems. We believe our DMT technology is utilized by a variety of companies in
activities including digital ad insertion, cable programming, satellite
programming, hotel in-room entertainment services, distance learning and other
Internet programming involving digital audio/video content. Our DMT technology
is protected by five U.S. and 31 foreign patents. The Acacia Technologies group
also owns, and has out-licensed to consumer electronics manufacturers, patented
technology known as the V-chip. The V-chip technology was protected by U.S.
Patent No. 4,554,584, which expired in July 2003. 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.
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COMPANY
RECAPITALIZATION AND MERGER TRANSACTIONS
On December 11, 2002, our stockholders voted in favor of a
recapitalization transaction, which became effective on December 13, 2002,
whereby we created two new classes of common stock called Acacia
Research-CombiMatrix stock, or AR-CombiMatrix stock, and Acacia Research-Acacia
Technologies stock, or AR-Acacia Technologies stock, and divided our existing
Acacia Research Corporation common stock into shares of the two new classes of
common stock. AR-CombiMatrix stock is intended to reflect separately the
performance of Acacia Research Corporation's CombiMatrix group. 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.
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.
OTHER
Acacia Research Corporation, a Delaware corporation, was originally
incorporated in California in January 1993 and reincorporated in Delaware in
December 1999. Our website address is www.acaciaresearch.com. We make our
filings with the Securities and Exchange Commission, or SEC, including our
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, and amendments to those reports, available free of charge on our
website as soon as reasonably practicable after we file these reports. In
addition, we post the following information on our website:
o our corporate code of conduct;
o charters for our audit committee, nominating and corporate
governance committee and compensation committee;
The public may read and copy any materials that Acacia Research
Corporation files with the SEC at the SEC's Public Reference Room at 450 Fifth
Street N.W., Washington, D.C. 20549. The public may obtain information on the
operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
Also, the SEC maintains an Internet website that contains reports, proxy and
information statements, and other information regarding issuers, including the
Acacia Research Corporation, that file electronically with the SEC. The public
can obtain any documents that Acacia Research Corporation files with the SEC at
http://www.sec.gov.
2
BUSINESS GROUPS
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BUSINESS
The CombiMatrix group is comprised of CombiMatrix Corporation, a wholly
owned subsidiary of Acacia Research Corporation, and its majority-owned
subsidiary, Advanced Material Sciences and wholly owned subsidiary, CombiMatrix
K.K. The CombiMatrix group includes corporate assets, liabilities and
transactions of Acacia Research Corporation that relate to its life sciences
business. CombiMatrix Corporation is engaged in the development of a proprietary
universal array with applications in the areas of genomics, proteomics,
biosensors, drug discovery, drug development, diagnostics, combinatorial
chemistry, materials sciences and nanotechnology.
The CombiMatrix group's technology enables the rapid, parallel
synthesis, immobilization and detection of molecules and materials at discrete
electrodes on a semiconductor chip. These chips, also known as microelectrode
arrays, are used in multiple applications in the areas described above. The
CombiMatrix group's technology integrates semiconductor micro fabrication,
proprietary software, chemistry and hardware into systems that it believes will
enable it, its customers and its partners to design and fabricate arrays for
biological, material sciences and nanotechnology applications, typically within
a few days. The CombiMatrix group's system should enable researchers to conduct
rapid, iterative experiments in each of these fields.
For biological applications, the CombiMatrix group believes that its
customizable arrays will enable users to reduce the time and costs associated
with the discovery and development of pharmaceutical products. Although there
are numerous applications of the CombiMatrix group's arrays in life sciences
research, each depend on the synthesis, immobilization or detection of molecules
at discrete sites on the array. Some specific applications include studies of
genetic expression in cellular systems, genotyping and mutation analysis,
synthesis of nucleic acid drugs, and others.
The CombiMatrix group is engaged in four major business areas:
o The development, manufacture and sale of research tools and services to
life sciences researchers
o The discovery of drugs based on the mechanism of ribonucleic acid
inhibition (RNAi)
o The development, manufacture and sale of biosensor systems and
technology for national defense and homeland security
o The development of tools for applications in nanotechnology and
materials science.
MARKET OVERVIEW
The markets for the CombiMatrix group's products include pharmaceutical
and biotechnology markets (also referred to as life sciences), national defense
and homeland security applications and the emerging markets for nanotechnology
and new materials. At this time, the majority of the CombiMatrix group's efforts
are focused on the life sciences markets.
GENERAL OVERVIEW OF LIFE SCIENCES.
The pharmaceutical and biotechnology industries are faced with
increasing costs and risks of failure in the drug discovery, development and
commercialization process. According to industry statistics, the time required
to commercialize a new drug averages 15 years, and the direct and indirect costs
of the process averages almost $802 million per drug. Less than 1% of all new
chemical compounds that are developed by pharmaceutical companies result in
pharmaceutical products that are approved for patient use. The pharmaceutical
and biotechnology industries are attempting to reduce their costs and risks of
failure by turning to new technologies to help identify deficiencies in drug
candidates as early as possible in the process so that drug discovery and
development become more efficient and cost-effective. Additionally, with vast
amounts of genomic data becoming available for use in the development of
therapeutics and diagnostic tests, they are searching for ways to expedite their
analysis of available genomic data so that they can be the first to bring new
therapeutics and diagnostic tests to market.
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DRUG DISCOVERY AND DEVELOPMENT
The discovery and development of new drugs for a particular disease
typically involves several steps. First, researchers identify a target for
therapeutic intervention, such as a protein or gene, that is either directly
involved in the disease or lies in a biochemical pathway leading to the disease.
The next step is to identify chemical compounds that interact with and modulate
the target's activity to inhibit or prevent the disease. Promising compounds
advance to subsequent stages, which include animal trials followed by human
trials.
Recent advances, including the sequencing of the human genome, have led
to the use of genomics in choosing and validating the targets for drug
development. This process begins with the discovery and identification of genes
within the genome and the functions of these genes in regulating biological
processes and disease. This information is used to assess the value of a
particular gene or its protein product as a target for drug discovery. According
to industry statistics, pharmaceutical and biotechnology companies worldwide
spent approximately $62.0 billion on drug research and development during 2003.
GENES AND PROTEINS
The human body is composed of billions of cells each containing DNA
that encodes the basic instructions for cellular function. The complete set of
an individual's DNA is called the genome, and is organized into 23 pairs of
chromosomes, which are further divided into smaller regions called genes. Each
gene is composed of a strand of four types of nucleotide bases, referred to as
A, C, G and T. The bases of one DNA strand bind to the bases of the other strand
in a specific fashion to form base pairs: the base A always binds with the base
T and the base G always binds with the base C.
The human genome has approximately 3.0 billion nucleotides and their
precise order is known as the DNA sequence. When a gene is turned on, or
expressed, the genetic information encoded in the DNA is copied to a specific
type of RNA, called messenger RNA, or mRNA. The mRNA provides instructions for
the synthesis of proteins. Proteins direct cellular function, the development of
individual traits and are involved in many diseases. Abnormal variations in the
sequence of a gene or in the level of gene expression can interfere with the
normal physiology of particular cells and lead to a disease, a predisposition to
a disease or an adverse response to drugs.
GENE EXPRESSION PROFILING
Gene expression profiling is the process of determining which genes are
active in a specific cell or group of cells and is accomplished by measuring
mRNA, the intermediary between genes and proteins. By comparing gene expression
patterns between cells from normal tissue and cells from diseased tissue,
researchers may identify specific genes or groups of genes that play a role in
the presence of disease. Studies of this type, used in drug discovery, require
monitoring thousands, and preferably tens of thousands, of mRNAs in large
numbers of samples. As the correlation between gene expression patterns and
specific diseases is determined, the CombiMatrix group believes that gene
expression profiling will have an increasingly important role as a diagnostic
tool. Diagnostic use of expression profiling tools is anticipated to grow
rapidly with the combination of the sequencing of various genomes and the
availability of more cost-effective technologies.
GENETIC VARIATION AND MUTATIONS
Genetic variation is also due to polymorphisms (mutations) in genomes,
although functional variations may also arise from differences in the way genes
are expressed in a given cell, as well as the timing and levels of their
expression.
The most common form of genetic variation occurs as a result of a
difference in a single nucleotide in the DNA sequence, commonly referred to as a
single nucleotide polymorphism, or SNP. The human genome is estimated to contain
between three and six million SNPs. By screening for polymorphisms, researchers
seek to correlate variability in the sequence of genes with a specific disease.
SNPs are believed to be associated with a large number of human diseases,
although most SNPs are believed to be benign and not to be associated with
disease. Determining which SNPs may be related to a disease is a complex process
requiring investigation of a vast number of SNPs. A SNP association study might
require testing for 300,000 possible SNPs in 1,000 patients. Although only a few
hundred of these SNPs might be clinically relevant, 300 million genotyping
tests, or assays, might be required to complete a study. Using currently
available technologies, this scale of SNP genotyping is both impractical and
prohibitively expensive.
While in some cases one SNP will be responsible for medically important
effects, it is now believed that the genetic component of most major diseases is
associated with a combination of SNPs. As a result, the scientific community has
recognized the importance of investigating combinations of many SNPs in an
attempt to discover medically valuable information. In order to understand how
genetic variation causes disease, researchers must compare gene sequence
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polymorphisms, or conduct SNP genotyping, from healthy and diseased individuals.
Researchers may also compare gene expression patterns, or perform gene
expression profiling, from healthy and diseased tissues.
PROTEOMICS
Proteomics is the process of determining which proteins are present in
cells, how they interact with one another and how they are correlated with
genomic variation. This process is useful in drug discovery and diagnostics
because most drugs target proteins that play a role in the existence or
development of a disease.
CURRENT TECHNOLOGIES
Despite the recent sequencing of the human genome, scientists have a
limited understanding of the function of genes, how they interact with each
other, how they modulate disease, and how they correlate with protein
translation and function. Additionally, the role of specific mutations is poorly
understood.
Traditional technologies for analyzing genetic or protein variation and
function generally perform experiments individually, or serially, and often
require relatively large sample volumes, adding significantly to the cost of
conducting experiments. Arrays were developed to overcome the limitations of
traditional technologies.
An array is a collection of miniaturized test sites arranged in a
manner that permits many tests to be performed simultaneously, or in parallel,
in order to achieve higher throughput. The average size of test sites in an
array and the spacing between them defines the array's density. Higher density
increases parallel processing throughput. In addition to increasing the
throughput, higher density reduces the required volume for the sample being
tested, and thereby lowers costs. Currently, the principal commercially
available ways to produce arrays include mechanical deposition, bead
immobilization, inkjet printing and photolithography.
While current array technologies have advantages over traditional
technologies, the CombiMatrix group believes the full market potential for such
devices has not been realized. This is true for a number of reasons, including
limited flexibility, cost, inconvenience and poor performance.
THE COMBIMATRIX SOLUTION
The CombiMatrix group believes that its integrated system will have
advantages over other existing technologies because it is being designed to be a
cost-effective, fast, flexible, customizable alternative to existing analytical
tools designed for similar purposes. Researchers using the CombiMatrix group's
system should be able to design and order custom arrays or fabricate them
in-house, conduct their tests, analyze the results, and reorder additional
arrays (or fabricate them in-house) incorporating modified test parameters, all
within a few days. The CombiMatrix group believes that its system will offer
advantages over competing products. These advantages arise from a unique
approach to fabricating the arrays utilizing a proprietary electrochemical
synthetic method on an array of microelectrodes that have been fabricated on a
silicon device. The CombiMatrix group believes the key advantages are as
follows:
o RAPIDLY CUSTOMIZABLE. The CombiMatrix group believes its proprietary
software, chemistry and semiconductor system will allow it or its
partners to design, customize and ship biological array processors for
SNP genotyping and gene expression profiling that are tailored to meet
a customer's specifications in a relatively short timeframe, typically
within a few days. The CombiMatrix group's customization time should be
short because it intends to rely on proprietary software and chemical
processes, rather than costly and often imprecise mechanical methods,
to produce its biological array processors. The CombiMatrix group
believes researchers will be able to compress the time required to
complete an iterative series of genomic tests because of the short
turnaround time that should be required for the delivery of its
customized biological array processors.
o VERSATILE. The CombiMatrix group system will be able to design and
create sequences of DNA, RNA, peptides or small molecules in the test
sites on its biological array processors, although its first product
will be limited to DNA sequences.
o ACCURATE AND COST-EFFECTIVE. Relatively large amounts of DNA, RNA,
peptides or small molecules that can be synthesized or immobilized in
the porous reaction layer at each test site generate strong assay
signals that facilitate accurate interpretation of test data which can
be measured using relatively simple instruments.
o MANUFACTURING SCALABILITY. The CombiMatrix group believes it will be
able to increase production to respond to increased demand because its
semiconductors are manufactured by others using conventional
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semiconductor fabrication methods and its customization equipment can
be rapidly assembled by the CombiMatrix group or any entities with
which the CombiMatrix group has joint development efforts.
PRODUCTS AND SERVICES
The CombiMatrix group's technology potentially represents a significant
advance over existing array technologies and other platforms for combinatorial
chemistry. The first application of the technology that the CombiMatrix group is
pursuing is in the field of genomics, where it is developing an array for the
analysis of DNA. The CombiMatrix group believes that this technology may be
applied to the fields of genetic analysis and disease management. The
CombiMatrix group is also developing the array for applications in the emerging
field of proteomics, where analysis of DNA is correlated to the levels of
proteins in patient samples. Many researchers believe that the analysis of
proteomic information will lead to the development of new drugs and better
disease management. Once the CombiMatrix group demonstrates the feasibility of
its approach in each market, it intends to enter into strategic alliances with
major participants to speed commercialization in multiple applications.
In addition, the CombiMatrix group is exploring opportunities to
utilize its technology for the detection of the presence of chemical and
biological warfare agents. For this application, the CombiMatrix group will
develop modified arrays, which are capable of electrochemical array preparation
as well as electrochemical detection.
The CombiMatrix group has also entered into development programs to use
its arrays for the discovery of nano-structured materials. In analogy to the
study of genes and proteins in parallel using a highly-customizable array, the
CombiMatrix group will develop a system, which enables researchers to perform
combinatorial materials discovery work in a rapid, cost effective manner.
DRUG DISCOVERY
The CombiMatrix group has initiated internally focused (Express
Track(TM)) and externally focused (siRNA Solutions(TM) programs to utilize its
arrays to discover nucleic acid drugs, based on the recently discovered
mechanism known as RNAi (Ribonucleic Acid interference). This field is often
referred to as siRNA (small interfering Ribonucleic Acid) or gene silencing.
The underlying principle in this field is that an appropriately
designed, double-stranded sequence of RNA can effectively shut down the
operation of a particular gene. If this inhibition cures a disease or alleviates
its symptom, these RNA molecules can potentially become effective therapeutics.
The process of drug discovery utilizing the RNAi mechanism involves multiple
steps, the first of which is the design and synthesis of potential RNAi
sequences. The CombiMatrix group believes that its expertise in nucleic acid
design and synthesis on its semiconductor-based arrays provides a significant
advantage in discovery.
Express Track(TM) is a comprehensive program that integrates several
key technologies developed by the CombiMatrix group into a rapid process for
designing and producing large libraries of compounds that can be screened for
maximum efficacy. The CombiMatrix group has chosen to initially focus its
integrated RNAi discovery program on viral diseases for the following reasons:
o Viral infections affect millions of individuals throughout the world
each year
o There are relatively few effective anti-viral medications
o Most emerging diseases are viruses such as SARS and West Nile Virus
o The basis of infection is through transfer of viral genetic material
o Complete viral genomic sequences have recently been made available
o The CombiMatrix group's approach is suited to viral research because it
attempts to thwart a virus by building a cocktail of drugs to target
multiple genes or all the genes of a virus
o It is believed that an RNAi effect is already operating when the body
battles viral infections
siRNA Solutions(TM) is an integrated approach to siRNA drug discovery,
which integrates the CombiMatrix group's bioinformatics software and array
technology to design, synthesize, and evaluate potential siRNA drugs. The
CombiMatrix group will seek to provide this program as a service to partners.
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THE COMBIMATRIX GROUP'S STRATEGY
FOCUSING ON HIGH-GROWTH MARKETS
The CombiMatrix group's goal is to provide customers and partners with
tools in their discovery efforts as well as to perform discovery itself.
The CombiMatrix group will focus on markets that it believes are
growing rapidly and where it believes it has a competitive advantage. The first
of these markets are for gene expression, mutation analysis, and other
applications for the development of drugs and diagnostic products. Other markets
include protein analysis, homeland security and military applications,
anti-viral drug development nanotechnology and material sciences.
PARTNERING WITH MULTIPLE COMPANIES TO EXPAND MARKET OPPORTUNITY
The CombiMatrix group plans to pursue multiple relationships to
facilitate the expansion of its semiconductor-based array technologies and to
exploit large and diverse markets. The CombiMatrix group expects to enter into
relationships and collaborations to gain access to complementary technologies,
distribution channels, manufacturing infrastructure and information content. The
CombiMatrix group intends to structure relationships that maximize its research
and development efforts with the strong distribution and manufacturing
capabilities of its customers and any entities with which the CombiMatrix group
has joint development efforts.
MAJOR STRATEGIC ALLIANCES
The CombiMatrix group intends to rapidly commercialize its array
technology for gene expression profiling through its own sales and marketing
efforts. In addition, the CombiMatrix group has an agreement with Roche
Diagnostics GmbH, or Roche, to jointly develop its technology. Roche contributes
extensive expertise in instrument and reagent development, as well as offers a
large and experienced worldwide sales and marketing team. The CombiMatrix group
believes that the combination of its array technology with Roche's leadership
position in the genetic analysis and diagnostic markets will enable it to
capture a significant portion of the gene expression profiling and molecular
diagnostic markets.
The CombiMatrix group has also entered into a design, fabrication and
manufacturing relationship with Toppan Printing of Japan, or Toppan, for the
development and manufacture of new designs of its electrochemical detection
arrays.
In addition to Roche and Toppan, the CombiMatrix group has entered into
additional relationships and plans on establishing other relationships for
multiple applications of its technology. This is especially critical for Express
Track(TM). The CombiMatrix group plans to establish relationships with expert
virologists for initial screening of its potential drugs. Subsequent to
identifying key compounds, which may be suitable as drugs, the CombiMatrix group
plans to partner with larger pharmaceutical or biotechnology companies for
downstream development and marketing.
EXPANDING TECHNOLOGIES INTO MULTIPLE PRODUCT LINES
The CombiMatrix group intends to utilize the flexibility of its
semiconductor based array technologies to develop multiple product lines. In
addition to providing new sources of revenue, it believes these product lines
will further its goal of establishing its array technology as the industry
standard for array-based analysis.
STRENGTHENING TECHNOLOGICAL LEADERSHIP
The CombiMatrix group plans to continue advancing its proprietary
technologies through its internal research efforts, collaborations with industry
leaders and strategic licensing. The CombiMatrix group may also pursue
acquisitions of complementary technologies and leverage its technologies into
other value-added businesses.
PROTECTING AND STRENGTHENING INTELLECTUAL PROPERTY
Through the CombiMatrix Corporation's four issued patents in the United
States and one in Europe, its 46 patent applications pending in the United
States, Europe and elsewhere and its trade secrets, the CombiMatrix group
believes it has suitable intellectual property protection for its proprietary
technologies in those markets where it operates and where a market for its
products and services exists. The CombiMatrix group plans to build its
intellectual property portfolio through internal research efforts,
collaborations with industry leaders, strategic licensing and possible
7
acquisitions of complementary technologies. The CombiMatrix group also plans to
pursue patent protection for downstream products created using its proprietary
products.
REGULATORY MATTERS
The CombiMatrix group intends to sell products to the pharmaceutical,
biotechnology and academic communities for research applications as well as
non-life sciences customers. In addition, its drug development efforts are early
stage. Therefore, its initial products will not require approval from, or be
regulated by, the FDA, as a manufacturer nor will they be subject to the FDA's
current good manufacturing practice, or cGMP, regulations. Additionally, the
CombiMatrix group's initial products will not be subject to certain reagent
regulations promulgated by the FDA. However, the manufacture, marketing and sale
of certain products and services for any clinical or diagnostic applications
will be subject to extensive government regulation as medical devices in the
United States by the FDA and in other countries by corresponding foreign
regulatory authorities.
SUBSIDIARIES
Prior to July 11, 2003, CombiMatrix K.K., a majority-owned subsidiary
of CombiMatrix Corporation, was operating under a joint venture agreement with
Marubeni Japan, or Marubeni, one of Japan's leading trading companies. The
primary purpose of the joint venture was to focus on development and licensing
opportunities for CombiMatrix Corporation's array technology with academic,
pharmaceutical and biotechnology organizations in the Japanese market. Marubeni
held a 10% minority interests in the joint venture. On July 11, 2003, Acacia
Research Corporation purchased the outstanding minority interests in CombiMatrix
K.K. from Marubeni. Acacia Research Corporation issued 200,000 shares of its
AR-CombiMatrix stock to Marubeni in exchange for Marubeni's 10% minority
interests in CombiMatrix K.K. This increase in ownership interest has been
attributed to the CombiMatrix group.
Prior to July 2, 2003, CombiMatrix Corporation owned 87% of Advanced
Material Sciences, which in turn holds an exclusive license for CombiMatrix
Corporation's array synthesis technology for the development and discovery of
advanced electronic materials for such purposes as fuel cell catalysts. In
consideration for this exclusive license, CombiMatrix Corporation will share in
the revenues earned by Advanced Material Sciences for commercialization of these
discoveries based on CombiMatrix Corporation's array technology. The term of
this arrangement is 20 years. 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. This increased ownership
interest has been attributed to the CombiMatrix group.
MARKETING AND DISTRIBUTION
Where appropriate, the CombiMatrix group will market and sell its
products either directly or through distribution arrangements and/or through
other strategic alliances. For its initial products addressing the gene
expression market, the CombiMatrix group will sell its product directly, as well
as through a strategic relationship with Roche and may enable other partners to
distribute its products.
In July 2001, CombiMatrix Corporation entered into non-exclusive
worldwide license, supply, research and development agreements with Roche. These
agreements were amended in September 2002, primarily to grant Roche
manufacturing rights with respect to the products under development in return
for additional cash consideration under the agreements. The revised agreements
also make minor modifications to terms of the agreements involving matters such
as milestones, payments and technical specifications, none of which we consider
to be material. Such minor modifications are a standard part of the research and
development process and in our experience are routinely made in development
agreements. Since the inception of our relationship with Roche, CombiMatrix
Corporation has engaged in a continuous process of monitoring and reevaluating
the terms of our agreements, and have amended the agreements in several respects
to establish more meaningful goals, milestones and timelines. The agreements are
non-exclusive with respect to CombiMatrix Corporation's core technology, meaning
that CombiMatrix Corporation remains free to license its core technology to
third parties for applications in the genomics, proteomics and other fields. The
agreements contain exclusivity or co-exclusivity provisions only with respect to
the specific products being co-developed for, and partially funded by, Roche
pursuant to the agreements.
Under the terms of the agreements, it is contemplated that Roche will
co-develop, use, manufacture, market and distribute CombiMatrix Corporation's
array and related technology for rapid production of customizable arrays. The
agreements provide for minimum payments by Roche to CombiMatrix Corporation over
the first three years after product launch, including milestone achievements,
payments for products, royalties and research and development projects.
Nevertheless, because our agreements with Roche contain provisions that would
allow Roche to terminate the agreements, the future payments by Roche to
8
CombiMatrix Corporation might never be realized. Since July 2001, CombiMatrix
Corporation has completed several milestones in its strategic alliance with
Roche including demonstration of several key performance metrics of its custom
in-situ array system, and has received approximately $26.6 million in cash
payments from Roche from July 2001 through December 31, 2003.
MANUFACTURING AND CUSTOMIZATION
The CombiMatrix group is developing automated, computer-directed
manufacturing processes for the synthesis of sequences of DNA, RNA, peptides or
small molecules in the virtual flasks on its arrays. Certain portions of its
manufacturing, such as semiconductor fabrication and processing, will be
outsourced to subcontractors, while the steps involved with synthesis of
biological materials and quality control will be conducted by the CombiMatrix
group.
Substantially all of the components and raw materials used in the
manufacture of the CombiMatrix group's products, including semiconductors and
reagents, are currently provided from a limited number of sources or in some
cases from a single source. Although the CombiMatrix group believes that
alternative sources for those components and raw materials are available, any
supply interruption in a sole-sourced component or raw material might result in
up to a several-month production delay and materially harm the CombiMatrix
group's ability to manufacture products until a new source of supply, if any,
could be located and qualified. In addition, an uncorrected impurity or
supplier's variation in a raw material, either unknown to the CombiMatrix group
or incompatible with its manufacturing process, could have a material adverse
effect on its ability to manufacture products. The CombiMatrix group may be
unable to find a sufficient alternative supply channel in a reasonable time
period, or on commercially reasonable terms, if at all. The CombiMatrix group
utilizes semiconductors made with a 3.0 micron fabrication process that is no
longer in wide use due to increased miniaturization of semiconductors. If the
CombiMatrix group is unable to achieve higher densities of test sites, it may
become difficult or more expensive for the CombiMatrix group to obtain
sufficient quantities of semiconductors as manufacturers phase out 3.0 micron
production capacity.
PATENTS AND LICENSES
CombiMatrix Corporation continues to build its intellectual property
portfolio to protect its product in those markets where it operates and where a
market for its products and services exists. In the United States, CombiMatrix
Corporation has been issued four United States patents. Three of the United
States patents (U.S. Patent No. 6,093,302; U.S. Patent No. 6,280,595 and U.S.
Patent No. 6,444,111) protect CombiMatrix Corporation's core technology relating
to methods for electrochemical synthesis of arrays. The fourth United States
Patent (U.S. Patent No. 6,456,942) describes and claims a network infrastructure
for custom microarray synthesis and analysis. Corresponding CombiMatrix
Corporation core patents describing and claiming methods for electrochemical
synthesis of arrays have been granted in Europe (entire EU) and Australia and
are pending in the remaining major industrialized markets. In total, CombiMatrix
Corporation has 46 patent applications pending in the Unites States, Europe and
elsewhere
The CombiMatrix group seeks to protect its corporate identity with
trademarks and service marks. In addition, its trademark strategy includes
protecting the identity and goodwill associated with its biological array
processor products. The CombiMatrix group purchases chemical reagents from
suppliers who are licensed under appropriate patent rights. It is the
CombiMatrix group's policy to obtain licenses from patent holders if needed to
practice its chemical processes.
The CombiMatrix group's success will depend, in part, upon its ability
to obtain patents and maintain adequate protection of its intellectual property
in the United States and other countries. If it does not protect its
intellectual property adequately, competitors may be able to use its
technologies and thereby erode any competitive advantage that the CombiMatrix
group may have. The laws of some foreign countries do not protect proprietary
rights to the same extent as the laws of the United States, and many companies
have encountered significant problems in protecting their proprietary rights
abroad. These problems can be caused by the absence of rules and methods for
defending intellectual property rights.
The patent positions of companies developing tools and drugs for the
biotechnology and pharmaceutical industries, including the CombiMatrix group's
patent position, generally are uncertain and involve complex legal and factual
questions. The CombiMatrix group will be able to protect its proprietary rights
from unauthorized use by third parties only to the extent that its proprietary
technologies are covered by valid and enforceable patents or are effectively
maintained as trade secrets. The CombiMatrix group's existing patent and any
future patents it obtains may not be sufficiently broad to prevent others from
practicing its technologies or from developing competing products. There also is
risk that others may independently develop similar or alternative technologies
or design around its patented technologies. In addition, others may challenge or
invalidate the CombiMatrix group's patents, or its patents may fail to provide
it with any competitive advantage. Enforcing its intellectual property rights
may be difficult, costly and time consuming, and ultimately may not be
successful.
9
The CombiMatrix group also relies upon trade secret protection for its
confidential and proprietary information. It seeks to protect its proprietary
information by entering into confidentiality and invention disclosure and
transfer agreements with employees, collaborators and consultants. These
measures, however, may not provide adequate protection for the CombiMatrix
group's trade secrets or other proprietary information. Employees, collaborators
or consultants may still disclose its proprietary information, and the
CombiMatrix group may not be able to meaningfully protect its trade secrets. In
addition, others may independently develop substantially equivalent proprietary
information or techniques or otherwise gain access to its trade secrets.
The CombiMatrix group cannot assure you that any of its patent
applications will result in the issuance of any additional patents, that its
patent applications will have priority of invention or filing date over similar
rights of others, or that, if issued, any of its patents will offer protection
against its competitors. Additionally, the CombiMatrix group cannot assure you
that any patent issued to it will not be challenged, invalidated or circumvented
in the future or that the intellectual property rights it has created will
provide a competitive advantage. Litigation may be necessary to enforce its
intellectual property rights or to determine the enforceability, scope of
protection or validity of the intellectual property rights of others.
COMPETITION
The CombiMatrix group expects to encounter competition in the area of
business opportunities from other entities having similar business objectives.
Many of these potential competitors possess greater financial, technical, human
and other resources than does the CombiMatrix group. The CombiMatrix group
anticipates that it will face increased competition in the future as new
companies enter the market and advanced technologies become available. In the
life sciences industry, many competitors have more experience in research and
development than the CombiMatrix group. Technological advances or entirely
different approaches developed by one or more of its competitors could render
the CombiMatrix group's processes obsolete or uneconomical. The existing
approaches of competitors or new approaches or technology developed by
competitors may be more effective than those developed by the CombiMatrix group.
The CombiMatrix group is aware of other companies or companies with
divisions that have, or are developing, technologies for the SNP genotyping,
gene expression profiling and proteomic markets. The CombiMatrix group believes
that its primary competitors will be Affymetrix, Inc., Agilent Technologies,
Inc., Becton, Dickinson and Company, Ciphergen Biosystems, Inc., Gene Logic
Inc., Illumina, Inc., Johnson & Johnson, Nanogen, Inc., Orchid Biosciences,
Inc., Applera Corporation, Roche Diagnostics GmbH and Sequenom, Inc. However,
the CombiMatrix group's market is rapidly changing, and the CombiMatrix group
expects to face additional competition from new market entrants, new product
developments and consolidation of its existing competitors. Many of the
CombiMatrix group's competitors have existing strategic relationships with major
pharmaceutical and biotechnology companies, greater commercial experience and
substantially greater financial and personnel resources than it does. The
CombiMatrix group expects new competitors to emerge and the intensity of
competition to increase in the future.
RESEARCH, DEVELOPMENT AND ENGINEERING
The CombiMatrix group's research and development expenses, excluding
non-cash stock compensation charges and acquired in-process research and
development charges, were $8.1 million, $18.2 million, and $11.7 million in
2003, 2002 and 2001, respectively. The CombiMatrix group intends to invest
aggressively in its proprietary technologies through internal development and,
to the extent available, licensing of third-party technologies to increase and
improve other characteristics of its products. The CombiMatrix group also plans
to continue to invest in improving the cost-effectiveness of its products
through further automation and improved information technologies. The
CombiMatrix group's future research and development efforts may involve research
conducted by the CombiMatrix group, collaborations with other researchers and
the acquisition of chemistries and other technologies developed by universities
and other academic institutions.
The CombiMatrix group is developing a variety of life sciences and
non-life sciences products and services. Potential customers for these products
operate in industries characterized by rapid technological development. The
CombiMatrix group believes that its future success will depend in large part on
its ability to continue to enhance its existing products and services and to
develop other products and services, which complement existing ones. In order to
respond to rapidly changing competitive and technological conditions, the
CombiMatrix group expects to continue to incur significant research and
development expenses during the initial development phase of new products and
services, as well as on an ongoing basis.
GOVERNMENT GRANTS AND CONTRACTS
Government grants and contracts have allowed the CombiMatrix group to
fund certain internal scientific programs and exploratory research. The
CombiMatrix group retains ownership of all intellectual property and commercial
rights generated during these projects. The United States government, however,
retains a non-exclusive, non-transferable, paid-up license to practice the
10
inventions made with federal funds pursuant to applicable statutes and
regulations. The CombiMatrix group does not believe that the retained license
will have any impact on its ability to market its products. The CombiMatrix
group does not need government approval to enter into collaborations or other
relationships with third parties.
The CombiMatrix group has been awarded two grants and two contracts
from the federal government in connection with its biological array processor
technology. In July 1999, the CombiMatrix group was awarded a $60,000 Phase I
Small Business Innovative Research, or SBIR, contract from the U.S. Department
of Defense to develop nanode array sensor microchips to enable simultaneous
detection of numerous chemical and biological warfare agents. Also in July 1999,
the CombiMatrix group was awarded a $100,000 Phase I SBIR Department of Energy
grant to use the CombiMatrix group's proprietary array technology to develop
arrays of affinity probes for the analysis of gene products. In January 2000,
the CombiMatrix group was awarded a $730,000 Phase II SBIR Department of Defense
contract for the use of its array technology to further develop nanode array
sensor microchips. The term of the Phase II SBIR Department of Defense contract
ended July 2002 upon delivery of a prototype electrochemical biological
detection system to the Department of Defense. As such, the CombiMatrix group
will no longer receive grant revenues under the Phase II SBIR Department of
Defense contract beyond 2002. In February 2002, the CombiMatrix group was
awarded a six-month $100,000 Phase I National Institutes of Health grant for the
development of its protein array technology, entitled "Self-Assembling Protein
Microchips." This grant was completed in August of 2002.
The CombiMatrix group will continue to pursue grants and contracts that
complement its research and development efforts.
EMPLOYEES
As of December 31, 2003, the CombiMatrix group had 59 full-time
employees, 11 of whom hold Ph.D. degrees and 40 of whom are engaged in full-time
research and development activities. The CombiMatrix group is not a party to any
collective bargaining agreement. The CombiMatrix group considers its employee
relations to be good.
ENVIRONMENTAL MATTERS
The operations of the CombiMatrix group involve the use,
transportation, storage and disposal of hazardous substances, and as a result,
it is subject to environmental and health and safety laws and regulations. The
cost of complying with these and any future environmental regulations could be
substantial. In addition, if the CombiMatrix group fails to comply with
environmental laws and regulations, or releases any hazardous substance into the
environment, the CombiMatrix group could be exposed to substantial liability in
the form of fines, penalties, remediation costs and other damages, or could
suffer a curtailment or shut down of its operations.
11
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BUSINESS
The Acacia Technologies group is principally comprised of Acacia
Research Corporation's wholly owned subsidiaries, Acacia Media Technologies
Corporation, or Acacia Media Technologies, and Soundview Technologies
Incorporated, or Soundview Technologies, and includes all corporate assets and
liabilities and related transactions of Acacia Research Corporation that relate
to its intellectual property licensing business.
The Acacia Technologies group is responsible for the development,
acquisition, licensing and protection of intellectual property and proprietary
technologies and is pursuing additional licensing and strategic business
alliances with leading companies in the rapidly growing intellectual property
licensing industry.
DIGITAL MEDIA TRANSMISSION TECHNOLOGY
The Acacia Technologies group owns and out-licenses a portfolio of
pioneering U.S. and foreign patents covering digital audio and video
transmission and receiving systems, commonly known as audio-on-demand,
video-on-demand, and audio/video streaming. The Acacia Technologies group's
patented proprietary DMT technology enables the digitization, encryption,
storage, transmission, receipt and playback of digital content via several means
including the Internet, cable, satellite and wireless systems. We believe our
DMT technology is utilized by a variety of companies in activities including
digital ad insertion, cable programming, satellite programming, hotel in-room
entertainment services, distance learning, and other Internet programming
involving digital audio/video content. The Acacia Technologies group's DMT
technology is protected by five U.S. patents which expire in 2011and 31 foreign
patents which expire in 2012.
V-CHIP TECHNOLOGY
The Acacia Technologies group also owns and has out-licensed to
consumer electronics manufacturers, patented technology known as the V-chip. The
V-chip technology was protected by U.S. Patent No. 4,554,584, which expired in
July 2003. The V-chip was adopted by manufacturers of televisions sold in the
U.S. to provide blocking of certain programming based upon its content rating
code, in compliance with the Telecommunications Act of 1996.
MARKET OVERVIEW
DIGITAL MEDIA TRANSMISSION TECHNOLOGY MARKETS
The Acacia Technologies group has launched an extensive DMT technology
licensing program. Potential licensees include cable companies, satellite
companies, hotel in-room entertainment companies and online music, movie, adult
entertainment, e-learning, sports, news and information companies.
The use of DMT technology continues to grow both in the United States
and internationally. The transmission of digital content by cable companies
continues to increase with the use of video-on-demand and digital ad insertion
systems. Satellite companies are switching to hard drive based reception systems
to offer their content with on-demand functionality. Hotel in-room entertainment
companies are switching to electronic distribution systems and digital storage
systems to reduce costs and increase profitability. Entertainment companies are
making more digital content available via the Internet in order to distribute
content directly to the consumer as opposed to using third party distributors
and retail outlets.
V-CHIP TECHNOLOGY MARKETS
All televisions with screens 13 inches or larger sold in the United
States after July 10, 1999 are required to contain V-chip technology. The Acacia
Technologies group's patent on the V-chip technology expired in July 2003. To
date, the Acacia Technologies group has out-licensed its V-chip technology to 13
television manufacturers representing approximately 75% of the television
manufacturing industry. Depending on the outcome of ongoing licensing efforts
and related infringement actions, the Acacia Technologies group may, however,
continue to collect license fees from others in the industry for televisions
sold in the United States during the patent term, which ended in July 2003.
12
THE ACACIA TECHNOLOGIES GROUP'S STRATEGY
The Acacia Technologies group's business strategy includes the following:
IDENTIFY EMERGING GROWTH AREAS WHERE PATENTED TECHNOLOGIES WILL PLAY A
VITAL ROLE
The patent process breeds innovation and invention by granting a
limited monopoly to the inventor in exchange for sharing the invention with the
public. Certain technologies, such as our DMT technology, become core
technologies in the way products and services are manufactured, sold and
delivered. The Acacia Technologies group identifies core, patented technologies
that have or are anticipated to be widely adopted by third parties in connection
with the manufacture or sale of products and services.
CONTACT AND FORM ALLIANCES WITH OWNERS OF CORE, PATENTED TECHNOLOGIES
For years, many large companies have earned substantial revenue
licensing patented technologies to third parties. Other companies that do not
have internal licensing resources and expertise have continued to record the
estimated value of intellectual property on their financial statements without
deriving income from their intellectual property. Recent changes in securities
and financial reporting regulations require these companies to evaluate and
potentially reduce or write-off these intellectual property assets if they are
unable to substantiate these reported values.
The Acacia Technologies group seeks to enter into business agreements
with owners of intellectual property that do not have experience or expertise in
the areas of intellectual property licensing and enforcement or that do not
possess the in-house resources to devote to licensing and enforcement
activities.
EFFECTIVELY AND EFFICIENTLY EVALUATE PATENTED TECHNOLOGIES FOR
ACQUISITION, LICENSING AND ENFORCEMENT
Subtleties in the language of a patent, recorded interactions with the
patent office, and the evaluation of prior art and literature can make a
significant difference in the potential licensing and enforcement revenue
derived from a patent or patent portfolio. The Acacia Technologies group's
specialists are trained and skilled in these areas. It is important to identify
potential problem areas prior to commercialization and determinate whether
potential problem areas can be overcome, before launching a licensing program.
We have developed processes and procedures for identifying problem areas and
evaluating the strength of a patent before the decision is made to allocate
resources to a licensing and enforcement effort.
PURCHASE OR ACQUIRE THE RIGHTS TO PATENTED TECHNOLOGIES
After evaluation, the Acacia Technologies group may elect to purchase
the patented technology, or become the exclusive licensing agent for the
patented technology in all or in specific fields of use. In either case, the
owner of the patent generally retains the rights to a portion of the revenues
generated from a patent's licensing and enforcement program. The Acacia
Technologies group generally controls the licensing and enforcement process and
utilizes its experienced in-house personnel to reduce outside costs, and ensure
that the Acacia Technologies group's capital is allocated and utilized in an
efficient and cost effective manner.
SUCCESSFULLY LICENSE AND ENFORCE PATENTS WITH SIGNIFICANT ROYALTY
POTENTIAL
As part of our patent evaluation process, significant consideration is
also given to the identification of potential infringers, industries within
which the potential infringers exist, longevity of the patented technology, and
a variety of other factors that directly impact the magnitude and potential
success of a licensing and enforcement program. Acacia Technologies group's
specialists are trained in evaluating potentially infringing technologies and
presenting the application of patents to such technologies. These presentations
generally take place in a non-adversarial business setting, but can also occur
through the litigation process, if necessary.
MARKETING AND DISTRIBUTION
DMT TECHNOLOGY LICENSING PROGRAM
Since November 2002, the Acacia Technologies group has entered into 117
license agreements for its DMT technology. One hundred and eight (108) of these
license agreements were executed during 2003. We have executed license
agreements with companies in the hotel in-room entertainment, online music,
movie, adult entertainment, e-learning, and sports, news and information
industries. The Acacia Technologies group is pursuing additional licensing and
strategic business alliances with leading companies in the rapidly growing
intellectual property licensing industry.
13
DMT TECHNOLOGY LITIGATION
In February 2003, Acacia Media Technologies initiated DMT patent
infringement litigation in the Federal District Court for the Central District
of California against approximately 39 defendants who provide adult oriented
digital content over the Internet. As of December 31, 2003, nine of the original
39 defendants remain in the initial litigation. In December 2003, Acacia Media
Technologies added an additional eight defendants to this pending patent
infringement litigation.
In November 2003, Acacia Media Technologies initiated a patent
infringement lawsuit in the Federal District Court for the Central District of
California against On Command Corporation, provider of interactive in-room
entertainment, information and business services to the lodging industry,
regarding Acacia Media Technologies' DMT technology.
V-CHIP LICENSING PROGRAM
The V-chip patent expired in July 2003. The Acacia Technologies group
will not be able to collect royalties for televisions containing V-chip
technology sold after the July 2003 expiration of that patent, but it may still
collect revenues from the sale of such televisions in the United States before
the expiration date. The Acacia Technologies group has licensed 13 major
television manufacturers, representing approximately 75% of the televisions sold
in the United States, including Samsung Electronics, Hitachi America, Ltd., LG
Electronics, Inc., Funai Electric Co., Ltd., Daewoo Electronics Corporation of
America, Sanyo Manufacturing Corporation, Thomson Multimedia, Inc., JVC Americas
Corporation, Matsushita Electric Industrial Co., Ltd., Orion Electric Co. Ltd.,
Pioneer Electronics (USA) Incorporated, Philips Electronics North America
Corporation and Loewe Opta Gmbh.
V-CHIP LITIGATION
Litigation for patent infringement and anti-trust violations is pending
in the U.S. Court of Appeals for the Federal Circuit against Sony Corporation of
America, Mitsubishi Digital Electronics America, Inc., Sharp Electronics
Corporation and Toshiba America Consumer Products, Inc.
In September 2002 and 2003, the United States District Court for the
District of Connecticut, or U.S. District Court - Connecticut, granted the
defendants summary judgment motions for the patent infringement and antitrust
allegations, respectively. The decisions are currently being appealed to the
U.S. Court of Appeals for the Federal Circuit. While we are currently appealing
the two summary judgment rulings, litigation is inherently uncertain and we can
give no assurance that we will be successful in any such appeals.
The rulings have no impact on the revenues that we have recognized to
date from licensees of our patented V-chip technology. Further, none of the
revenues that we have recognized to date are contingent upon any court rulings
or the future outcome of any litigation with unlicensed television
manufacturers.
PATENTS AND LICENSES
The Acacia Technologies group owns five issued U.S. patents relating to
audio and video transmission and receiving systems, commonly known as
audio-on-demand, video-on-demand and audio/video streaming, used for
distributing content via various methods as follows: U.S. Patent No. 5,132,992,
U.S. Patent No. 5,253,275, U.S. Patent No. 5,550,863, U.S. Patent No. 6,002,720
and U.S. Patent No. 6,144,702. In addition, the Acacia Technologies group owns
31 foreign patents also relating to audio and video transmission and receiving
systems technology. Foreign rights include an initial patent granted by the
European Patent Office covering Austria, Belgium, Denmark, Finland, France,
Germany, Greece, Italy, Luxembourg, Monaco, the Netherlands, Spain, Sweden,
Switzerland and the United Kingdom, and patents in Japan, Taiwan and Mexico. In
January 2004, the Acacia Technologies group was issued an additional European
patent for its DMT Technology. The new patent provides additional coverage in
the countries listed above. Acacia Technologies group's U.S. DMT patents expire
in 2011 and its foreign DMT patents expire in 2012.
REGULATORY MATTERS
We believe the Acacia Technologies group's DMT technology is utilized
by satellite, cable and telecommunications systems. The satellite, cable and
telecommunications industries are subject to federal regulation, including FCC
licensing and other requirements. These industries are also often subject to
extensive regulation by local and state authorities. While most satellite, cable
and telecommunication industry regulations do not apply directly to the Acacia
Technologies group, they affect programming distributors, one of the large
potential customers for the technologies covered by the Acacia Technologies
14
group patent portfolio. The Acacia Technologies group monitors pending
legislation and administrative proceedings to ascertain relevance, analyze
impact and develop strategies regarding regulatory trends and developments
within these industries.
Federal law requires cable operators to reserve up to one-third of a
system's channel capacity for local commercial television stations that have
elected must-carry status. In addition, a cable system is generally required to
carry local non-commercial television stations. The FCC has also implemented
comparable rules for satellite carriers requiring that if a satellite system
carries one local broadcast station in a local market pursuant to a royalty-free
license granted under the Satellite Home Viewer Improvement Act of 1999, then it
must carry all local broadcast stations in that market. To meet these
requirements, some cable and satellite systems must decide which programming
services to keep and which to remove in order to make space available for local
television stations. These must-carry requirements may impact the Acacia
Technologies group's information-on-demand and streaming media business by
causing cable and satellite systems operators to reduce the number of channels
on their systems that would have used technologies covered by Acacia
Technologies group's patent portfolio.
COMPETITION
The Acacia Technologies group expects to encounter competition in the
area of business opportunities from other entities having similar business
objectives. Many of these potential competitors may possess financial,
technical, human and other resources greater than those of the Acacia
Technologies group. The Acacia Technologies group anticipates that it will face
increased competition in the future as new companies enter the market and
advanced technologies become available.
Other companies may develop competing technologies that offer better or
less expensive alternatives to our DMT technology and/or other technologies that
we may acquire or out-license. Many potential competitors have significantly
greater resources. Technological advances or entirely different approaches
developed by one or more of its competitors could render Acacia Technologies
group's technologies obsolete or uneconomical.
EMPLOYEES
As of December 31, 2003, the Acacia Technologies group had 20 full-time
employees. None of the companies included in the Acacia Technologies group is a
party to any collective bargaining agreement. The Acacia Technologies group
considers its employee relations to be good.
ITEM 2. PROPERTIES
Acacia Research Corporation leases approximately 7,143 square feet of
office space in Newport Beach, California, under a lease agreement that expires
in February 2007. We also leased approximately 7,019 square feet of office space
in Pasadena, California, which was subleased through the remaining term of the
lease agreement, which expired in November 2003. Our wholly owned subsidiary,
CombiMatrix Corporation, leases office and laboratory space totaling
approximately 90,111 square feet located north of Seattle, Washington, under a
lease agreement that expires in December 2008. Presently, we are not seeking any
additional facilities.
We are a guarantor under a lease agreement for office space in
Hollywood, California that expires in August 2005. The lease agreement was
entered into by Soundbreak.com Incorporated, or Soundbreak.com, which ceased
operations in February 2001. The leased premises is subleased through the
remaining term of the lease agreement.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of business, we are the subject of, or party to,
various pending or threatened legal actions, including various counterclaims in
connection with our intellectual property enforcement activities. We believe
that any liability arising from these actions will not have a material adverse
effect on our financial position, results of operations or cash flows.
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.
15
In September 2002, the U.S. District Court - Connecticut, granted a
motion for summary judgment filed by defendants Sony Corporation of America,
Inc., Sony Electronics, Inc., the Electronics Industries Alliance d/b/a Consumer
Electronics Association, the Consumer Electronics Manufacturers Association,
Mitsubishi Digital Electronics America, Inc., Mitsubishi Electronics America,
Inc., Toshiba America Consumer Products, Inc. and Sharp Electronics Corporation
(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 U.S. District Court - Connecticut on
Soundview Technologies' anti-trust claims due to the court's previous ruling of
non-infringement as described above.
The decisions are currently being appealed to the U.S. Court of
Appeals for the Federal Circuit. While we are currently appealing the two
summary judgment rulings, litigation is inherently uncertain and we can give no
assurance that we will be successful in any such appeals.
The rulings have no impact on the revenues that we have recognized to
date from licensees of our patented V-chip technology. Further, none of the
revenues that we have recognized to date are contingent upon any court rulings
or the future outcome of any litigation with unlicensed television
manufacturers.
ACACIA MEDIA TECHNOLOGIES CORPORATION
In February 2003, Acacia Media Technologies initiated DMT patent
infringement litigation in the Federal District Court for the Central District
of California against approximately 39 defendants who provide adult oriented
digital content over the Internet. As of December 31, 2003, nine of the original
39 defendants remain in the initial litigation. In December 2003, Acacia Media
Technologies added an additional eight defendants to its pending patent
infringement litigation described above. The new complaints, filed with the
Federal District Court for the Central District of California, seek to create a
defendant class for all adult entertainment companies that infringe Acacia Media
Technologies' DMT patents by transmitting pre-recorded, digital audio and
audio/video adult content via any electronic communication channel into or from
the Central District of California, or that operate at least one interactive
website where a user located in Central District of California can exchange
information with a host computer. Defendant class action status, which must be
approved by the court, would permit the court's rulings on certain key issues to
legally bind all members of the class, whether or not they have been
specifically named as defendants in the litigation.
In November 2003, Acacia Media Technologies initiated a patent
infringement lawsuit in the Federal District Court for the Central District of
California against On Command Corporation, provider of interactive in-room
entertainment, information and business services to the lodging industry,
regarding Acacia Media Technologies' DMT technology.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
RECENT MARKET PRICES
Acacia Research Corporation's two classes of common stock, Acacia
Research-CombiMatrix common stock and Acacia Research-Acacia Technologies common
stock, commenced trading on the Nasdaq Stock Market on December 16, 2002. The
two classes of common stock were created as a result of Acacia Research
Corporation's recapitalization that was approved by Acacia Research
Corporation's stockholders on December 11, 2002. The two classes of stock
replaced Acacia Research Corporation's common stock formerly traded on the
Nasdaq stock market under the symbol ACRI. Acacia Research-Acacia Technologies
common stock is now listed on the Nasdaq National Market System and Acacia
Research-CombiMatrix common stock is now listed on the Nasdaq SmallCap Market.
Acacia Research-CombiMatrix common stock is intended to reflect the performance
of Acacia Research Corporation's CombiMatrix group, and Acacia Research-Acacia
Technologies stock is intended to reflect the performance of Acacia Research
Corporation's Acacia Technologies group.
Holders of Acacia Research-Acacia Technologies stock and Acacia
Research-CombiMatrix stock are stockholders of Acacia Research Corporation. As a
result, holders of Acacia Research-Acacia Technologies stock and Acacia
Research-CombiMatrix stock continue to be subject to all of the risks of an
investment in Acacia Research Corporation and all of its businesses, assets and
liabilities. The assets Acacia Research Corporation attributes to one group
could be subject to the liabilities of the other group.
The markets for securities such as the two classes of our common stock
have historically experienced extreme price and volume fluctuations during
certain periods. These broad market fluctuations and other factors, such as new
product developments and trends in our industry and the investment markets
generally, as well as economic conditions and quarterly variations in our
results of operations, may adversely affect the market price of our two classes
of common stock.
On October 22, 2001, our board of directors declared a 10% stock
dividend. The stock dividend, totaling 1,777,710 shares, was distributed on
December 5, 2001 for stockholders of record as of November 21, 2001. All share
and per share information presented herein is adjusted for the stock dividend.
The high and low bid prices for our two classes of common stock as
reported by NASDAQ for the periods indicated are as follows. Such prices are
inter-dealer prices without retail markups, markdowns or commissions and may not
necessarily represent actual transactions.
2003 2002(1)
-------------------------------------- ---------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- -------
Acacia Research Corporation
(through December 13, 2002):
High - - - - $5.61 $7.15 $11.50 $13.26
Low - - - - $3.65 $3.50 $5.90 $8.47
Acacia Research-Acacia Technologies stock:
High $8.58 $6.73 $1.75 $2.40 $3.40 - - -
Low $4.71 $1.25 $0.99 $0.96 $1.65 - - -
Acacia Research-CombiMatrix stock:
High $5.05 $5.07 $2.83 $3.65 $4.98 - - -
Low $2.90 $2.25 $1.71 $1.50 $2.70 - - -
- -------------------
(1) 2002 share and per share information gives effect to the recapitalization
transaction described elsewhere herein as of January 1, 2002. Historical
share and per share information for the Acacia Research-Acacia
Technologies stock and Acacia Research-CombiMatrix stock is not presented
as these classes of securities were not part of Acacia Research
Corporation's capital structure during 2001 and prior periods.
On February 27, 2004, there were approximately 162 owners of record of
Acacia Research-Acacia Technologies stock and 188 owners of record of Acacia
Research-CombiMatrix stock. The majority of the outstanding shares of Acacia
Research-Acacia Technologies stock and Acacia Research-CombiMatrix stock are
held by a nominee holder on behalf of an indeterminable number of ultimate
beneficial owners.
17
DIVIDEND POLICY
To date, we have not declared or paid any cash dividends with respect
to our capital stock, and the current policy of the board of directors is to
retain earnings, if any, to provide for the growth of Acacia Research
Corporation. Consequently, we do not expect to pay any cash dividends in the
foreseeable future. Further, there can be no assurance that our proposed
operations will generate revenues and cash flow needed to declare a cash
dividend or that we will have legally available funds to pay dividends.
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information as of December 31, 2003 with
respect to our common shares issuable under our equity compensation plans:
(c) NUMBER OF SECURITIES
(a) NUMBER OF REMAINING AVAILABLE FOR
SECURITIES TO BE FUTURE ISSUANCE UNDER
ISSUED UPON EXERCISE (b) WEIGHTED AVERAGE EQUITY COMPENSATION PLANS
OF OUTSTANDING EXERCISE PRICE OF (EXCLUDING SECURITIES
PLAN CATEGORY OPTIONS OUTSTANDING OPTIONS REFLECTED IN COLUMN (a))
- ------------------------------------------------------ -------------------- --------------------- -------------------------
EQUITY COMPENSATION PLANS APPROVED BY SECURITY HOLDERS
2002 CombiMatrix Stock Incentive Plan(1) 6,617,000 $7.28 2,208,000
2002 Acacia Technologies Stock Incentive Plan(2) 5,139,000 $8.29 470,000
Subtotal(3) N/A N/A N/A
EQUITY COMPENSATION PLANS NOT APPROVED BY SECURITY HOLDERS(4)
- ------------------------------------------------------ -------------------- --------------------- -------------------------
TOTAL(3) N/A N/A N/A
(1) Our 2002 CombiMatrix Stock Incentive Plan, as amended, or the CombiMatrix
Plan, allows for the granting of stock options and other awards to
eligible individuals, which generally includes directors, officers,
employees and consultants. The CombiMatrix Plan does not segregate the
number of securities remaining available for future issuance among stock
options and other awards. The shares authorized for future issuance
represents the total number of shares available through any combination of
stock options or other awards. The share reserve under the CombiMatrix
Plan automatically increases on the first trading day in January each
calendar year by an amount equal to three percent (3%) of the total number
of shares of our Acacia Research-CombiMatrix stock outstanding on the last
trading day of December in the prior calendar year, but in no event will
this annual increase exceed 600,000 shares and in no event will the total
number of common stock in the share reserve (as adjusted for all such
annual increases) exceed twenty million shares. See Note12 to our
consolidated financial statements.
(2) Our 2002 Acacia Technologies Stock Incentive Plan, as amended, or the
Acacia Technologies Plan, allows for the granting of stock options and
other awards to eligible individuals, which generally includes directors,
officers, employees and consultants. The Acacia Technologies Plan does not
segregate the number of securities remaining available for future issuance
among stock options and other awards. The shares authorized for future
issuance represents the total number of shares available through any
combination of stock options or other awards. The share reserve under the
Acacia Technologies Plan automatically increases on the first trading day
in January each calendar year by an amount equal to three percent (3%) of
the total number of shares of our Acacia Research-Acacia Technologies
stock outstanding on the last trading day of December in the prior
calendar year, but in no event will this annual increase exceed 500,000
shares and in no event will the total number of common stock in the share
reserve (as adjusted for all such annual increases) exceed twenty million
shares. See Note 12 to our consolidated financial statements.
(3) Subtotal and total information is not provided because the CombiMatrix
Plan and the Acacia Technologies Plan relate to two different classes of
our common stock.
(4) We have not authorized the issuance of equity securities under any plan
not approved by security holders.
18
ITEM 6. SELECTED FINANCIAL DATA
The consolidating selected balance sheet data as of December 31, 2003
and 2002 and the consolidating selected statement of operations data for the
years ended December 31, 2003, 2002 and 2001 set forth below have been derived
from our audited consolidated financial statements included elsewhere herein,
and should be read in conjunction with those financial statements (including
notes thereto). The consolidating selected financial data as of December 31,
2001, 2000 and 1999 and for the years ended December 31, 2000 and 1999 have been
derived from audited consolidated financial statements not included herein, but
which were previously filed with the SEC.
Acacia Research Corporation derived the Acacia Technologies group and
CombiMatrix group balance sheet data and statement of operations data from the
separate audited financial statements of the Acacia Technologies group and the
CombiMatrix group for the years ended December 31, 2003, 2002 and 2001 included
elsewhere herein, and the table should be read in conjunction with those
financial statements and related notes.
The AR-Acacia Technologies stock and the AR-CombiMatrix stock are
intended to reflect the separate performance of the respective divisions of
Acacia Research Corporation, rather than the performance of Acacia Research
Corporation as a whole. The chief mechanisms intended to cause the AR-Acacia
Technologies stock and the AR-CombiMatrix stock to reflect the financial
performance of the respective groups are provisions in our restated certificate
of incorporation and common stock policies governing dividends and distributions
to each class of stock, which specifically require the allocation of earnings to
each class based upon the performance of the two groups determined in accordance
with generally accepted accounting principles. Under these provisions, Acacia
Research Corporation factors the assets and liabilities and income or losses
attributable to the respective groups, determined as described under Item 7
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Critical Accounting Policies," into the determination of the
amounts available to pay dividends, if any, on the shares issued for the
respective groups and require Acacia Research Corporation to exchange, redeem or
distribute a dividend on the stock of a group if all or substantially all of the
assets allocated to the respective group are sold to a third party.
The Acacia Technologies group and the CombiMatrix group are not
separate legal entities. Holders of AR-Acacia Technologies stock and
AR-CombiMatrix stock are stockholders of Acacia Research Corporation. As a
result, stockholders continue to be subject to all of the risks of an investment
in Acacia Research Corporation and all of its businesses, assets and
liabilities. The assets that Acacia Research Corporation attributes to one group
could be subject to the liabilities of the other group.
19
CONSOLIDATING STATEMENT OF OPERATIONS DATA(4)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------- ------------- ------------- ------------- -------------
REVENUES:
Acacia Technologies group ..................... $ 692 $ 43 $ 24,180 $ 40 $ 122
CombiMatrix group ............................. 456 839 456 17 144
------------- ------------- ------------- ------------- -------------
ACACIA RESEARCH CORPORATION ................... $ 1,148 $ 882 $ 24,636 $ 57 $ 266
============= ============= ============= ============= =============
OPERATING (LOSS) INCOME
Acacia Technologies group ..................... $ (6,013) $ (9,865) $ 5,858 $ (12,606) $ (4,955)
CombiMatrix group ............................. (19,349) (70,460) (49,056) (24,557) (2,625)
------------- ------------- ------------- ------------- -------------
ACACIA RESEARCH CORPORATION ................... $ (25,362) $ (80,325) $ (43,198) $ (37,163) $ (7,580)
============= ============= ============= ============= =============
OTHER (EXPENSE) INCOME, NET:
Acacia Technologies group ..................... $ 408 $ (3,503) $ 2,111 $ (2,897) $ (818)
CombiMatrix group ............................. 214 392 2,055 1,662 (224)
------------- ------------- ------------- ------------- -------------
ACACIA RESEARCH CORPORATION ................... $ 622 $ (3,111) $ 4,166 $ (1,235) $ (1,042)
============= ============= ============= ============= =============
(LOSS) INCOME FROM CONTINUING OPERATIONS BEFORE
MINORITY INTERESTS:
Acacia Technologies group ..................... $ (5,468) $ (12,658) $ 7,034 $ (15,509) $ (5,791)
CombiMatrix group ............................. (18,999) (69,921) (46,846) (22,816) (2,851)
------------- ------------- ------------- ------------- -------------
ACACIA RESEARCH CORPORATION ................... $ (24,467) $ (82,579) $ (39,812) $ (38,325) $ (8,642)
============= ============= ============= ============= =============
MINORITY INTERESTS:
Acacia Technologies group ..................... $ 17 $ 104 $ (1,277) $ 866 $ (27)
CombiMatrix group ............................. 30 23,702 18,817 8,300 1,248
------------- ------------- ------------- ------------- -------------
ACACIA RESEARCH CORPORATION ................... $ 47 $ 23,806 $ 17,540 $ 9,166 $ 1,221
============= ============= ============= ============= =============
(LOSS) INCOME FROM CONTINUING OPERATIONS:
Acacia Technologies group ..................... $ (5,451) $ (12,554) $ 5,757 $ (14,643) $ (5,818)
CombiMatrix group ............................. (18,969) (46,219) (28,029) (14,516) (1,603)
------------- ------------- ------------- ------------- -------------
ACACIA RESEARCH CORPORATION ................... $ (24,420) $ (58,773) $ (22,272) $ (29,159) $ (7,421)
============= ============= ============= ============= =============
LOSS FROM DISCONTINUED OPERATIONS (1):
Acacia Technologies group ..................... $ -- $ (200) $ -- $ (9,554) $ (776)
CombiMatrix group ............................. -- -- -- -- --
------------- ------------- ------------- ------------- -------------
ACACIA RESEARCH CORPORATION ................... $ -- $ (200) $ -- $ (9,554) $ (776)
============= ============= ============= ============= =============
NET (LOSS) INCOME:
Acacia Technologies group ..................... $ (5,451) $ (12,754) $ 5,757 $ (24,197) $ (6,594)
CombiMatrix group ............................. (18,969) (46,219) (28,029) (14,762) (1,603)
------------- ------------- ------------- ------------- -------------
ACACIA RESEARCH CORPORATION ................... $ (24,420) $ (58,973) $ (22,272) $ (38,959) $ (8,197)
============= ============= ============= ============= =============
LOSS PER COMMON SHARE - BASIC AND DILUTED(5):
LOSS FROM CONTINUING OPERATIONS
Acacia Research - Acacia Technologies stock ... $ (0.28) $ (0.64) $ -- $ -- $ --
Acacia Research - CombiMatrix stock ........... (0.76) (2.01) -- -- --
Acacia Research Corporation ................... -- -- (1.16) (1.78) (0.59)
LOSS FROM DISCONTINUED OPERATIONS
Acacia Research - Acacia Technologies stock ... $ -- $ (0.01) $ -- $ -- $ --
Acacia Research - CombiMatrix stock ........... -- -- -- -- --
Acacia Research Corporation ................... -- -- -- (0.58) (0.06)
NET LOSS
Acacia Research - Acacia Technologies stock ... $ (0.28) $ (0.65) $ -- $ -- $ --
Acacia Research - CombiMatrix stock ........... (0.76) (2.01) -- -- --
Acacia Research Corporation ................... -- -- (1.16) (2.38) (0.65)
WEIGHTED AVERAGE NUMBER OF COMMON AND POTENTIAL
COMMON SHARES USED IN COMPUTATION OF LOSS PER
COMMON SHARE(2) (5):
BASIC AND DILUTED
Acacia Research - Acacia Technologies stock ... 19,661,655 19,640,808 -- -- --
============= ============= ============= ============= =============
Acacia Research - CombiMatrix stock ........... 24,827,819 22,950,746 -- -- --
============= ============= ============= ============= =============
Acacia Research Corporation ................... -- -- 19,259,256 16,346,099 12,649,133
============= ============= ============= ============= =============
20
CONSOLIDATING BALANCE SHEET DATA(4)
(IN THOUSANDS)
AT DECEMBER 31,
----------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
TOTAL ASSETS:
Acacia Technologies group ...... $ 39,978 $ 47,212 $ 62,926 $ 37,062 $ 49,788
CombiMatrix group .............. 50,161 49,973 47,963 61,561 2,003
Eliminations ................... (99) (114) (30) (107) --
---------- ---------- ---------- ---------- ----------
ACACIA RESEARCH CORPORATION .... $ 90,040 $ 97,071 $ 110,859 $ 98,516 $ 51,791
========== ========== ========== ========== ==========
LONG-TERM INDEBTEDNESS:
Acacia Technologies group ...... $ -- $ -- $ -- $ -- $ --
CombiMatrix group .............. -- -- 1,845 -- --
---------- ---------- ---------- ---------- ----------
ACACIA RESEARCH CORPORATION .... $ -- $ -- $ 1,845 $ -- $ --
========== ========== ========== ========== ==========
TOTAL LIABILITIES(3):
Acacia Technologies group ...... $ 4,188 $ 5,183 $ 5,723 $ 5,075 $ 1,304
CombiMatrix group .............. 24,424 13,972 14,131 15,880 229
Eliminations ................... (99) (114) (30) (107) 100
---------- ---------- ---------- ---------- ----------
ACACIA RESEARCH CORPORATION .... $ 28,513 $ 19,041 $ 19,824 $ 20,848 $ 1,633
========== ========== ========== ========== ==========
MINORITY INTERESTS(3):
Acacia Technologies group ...... $ 1,127 $ 1,487 $ 2,194 $ 2,012 $ 3,992
CombiMatrix group .............. -- 684 30,109 15,512 904
---------- ---------- ---------- ---------- ----------
ACACIA RESEARCH CORPORATION .... $ 1,127 $ 2,171 $ 32,303 $ 17,524 $ 4,896
========== ========== ========== ========== ==========
REDEEMABLE STOCKHOLDERS' EQUITY:
Acacia Technologies group ...... $ 34,663 $ 40,542 $ 55,009 $ 29,975 $ 44,492
CombiMatrix group .............. 25,737 35,317 3,723 30,169 770
---------- ---------- ---------- ---------- ----------
ACACIA RESEARCH CORPORATION .... $ 60,400 $ 75,859 $ 58,732 $ 60,144 $ 45,262
========== ========== ========== ========== ==========
- -----------------
(1) On February 13, 2001, the board of directors of Soundbreak.com, one of our
majority-owned subsidiaries, resolved to cease operations as of February
15, 2001 and liquidate the remaining assets and liabilities of
Soundbreak.com. Operating results in 1999 have been restated to present
Soundbreak.com as discontinued operations. See Note 11 to the Acacia
Research Corporation consolidated financial statements.
(2) Potential common shares in 2003, 2002, 2001, 2000 and 1999 have been
excluded from the per share calculations because the effect of their
inclusion would be anti-dilutive. In addition, all share and per share
information has been adjusted as appropriate for all periods presented to
reflect a two-for-one stock split effected in March 1998 and a ten percent
(10%) stock dividend distributed on December 5, 2001 for stockholders of
record as of November 21, 2001.
(3) Effective January 1, 2001, we changed our accounting policy for balance
sheet classification of employee stock-based compensation resulting from
awards in consolidated subsidiaries. As a result, effective January 1,
2001, amortized non-cash stock compensation charges related to subsidiary
stock options are included in minority interests in our consolidated
balance sheet. Prior to the change in accounting policy, amortized
non-cash stock compensation charges related to subsidiary stock options
were reflected as "accrued stock compensation" in consolidated
liabilities. There is no impact on previous consolidated statements of
operations as a result of this change in accounting policy.
(4) The management and allocation policies applicable to the preparation of
the financial statements of the Acacia Technologies group and the
CombiMatrix group and as a result, to the measurement by which dividends
or performance are determined for each group, may be modified or
rescinded, or additional policies may be adopted, at the sole discretion
of the Acacia Research Board at any time without approval of the
stockholders. The Acacia Technologies group's and the CombiMatrix group's
financial statements reflect the application of the management and
allocation policies adopted by the Acacia Research Corporation's board of
directors to various corporate activities. Management has no plans to
change allocation methods or the composition of the groups. Refer to Item
7 "Management's Discussion and Analysis of Financial Condition - Critical
Accounting Policies" for a description of allocation policies applied.
(5) The 2002 share and per share information gives effect to the
recapitalization transaction described elsewhere herein as of January 1,
2002. Historical share and per share information for the Acacia
Research-Acacia Technologies stock and Acacia Research-CombiMatrix stock
is not presented as these classes of securities were not part of Acacia
Research Corporation's capital structure during 2001 and prior periods.
21
FACTORS AFFECTING COMPARABILITY:
o The Acacia Technologies group revenues reflected in 1999 primarily
relate to capital management fee income, including performance fee
income, recorded by the Acacia Capital Management division. During the
fourth quarter of 1999, Acacia Research Corporation closed its Acacia
Capital Management division. Acacia Capital Management was a general
partner in two private investment partnerships and was an investment
advisor to two offshore private investment corporations.
o In the fourth quarter of 2000, Acacia Research Corporation recorded
$1.0 million in write-offs of other early stage investments and $2.6
million in write-offs of equity investments, attributed to the Acacia
Technologies group.
o During the year ended December 31, 2000, CombiMatrix Corporation
recorded deferred non-cash stock compensation charges aggregating
approximately $53.8 million in connection with the granting of stock
options. Deferred non-cash stock compensation charges are being
amortized by the CombiMatrix group over the respective option grant
vesting periods, which range from one to four years. Non-cash stock
compensation charges totaled $1.7 million, $6.4 million and $20.0
million in 2003, 2002 and 2001, respectively. Non-cash stock
compensation charges were not significant in prior periods.
o In connection with Acacia Research Corporation's increased focus on the
media technologies and life sciences sectors, certain of Acacia
Research Corporation's businesses allocated to the Acacia Technologies
group ceased operations and certain investments were written off in
2000. As a result, marketing, general and administrative costs related
to salaries, benefits, consulting, legal and other professional costs
were significantly reduced in 2001.
o In June 2003 and September 2002, Acacia Research Corporation recorded
impairment charges of $207,000 and $2.7 million, respectively, for an
other-than-temporary decline in the fair value of a cost method
investment, attributed to the Acacia Technologies group.
o On December 13, 2002, Acacia Research Corporation increased its
consolidated ownership interest in CombiMatrix Corporation from 48% to
100% as discussed at Item 7 "Critical Accounting Policies - Accounting
for Business Combinations." $17.2 million of the total purchase price
of $46.0 million was attributed to acquired in-process research and
development, or IPR&D, and was charged to expense in the consolidated
statement of operations and comprehensive loss for the year ended
December 31, 2002. Amounts allocated to IPR&D have been attributed to
the CombiMatrix group.
o On September 30, 2002, CombiMatrix Corporation and Dr. Donald
Montgomery, an officer and stockholder of CombiMatrix Corporation,
entered into a settlement agreement with Nanogen to settle all pending
litigation between the parties. In addition to other terms of the
settlement agreement as described elsewhere herein, CombiMatrix
Corporation agreed to pay Nanogen $1.0 million and issued 4,016,346
shares, or 17.5% of its outstanding shares post issuance, to Nanogen.
The $1.0 million in payments have been expensed in the consolidated
statement of operations for the year ended December 31, 2002 under
"legal settlement charges." The issuance of the CombiMatrix Corporation
common shares in settlement of the litigation with Nanogen has been
accounted for as a nonmonetary transaction. Accordingly, included in
"legal settlement charges" in the consolidated statements of operations
for the year ended December 31, 2002 is a charge in the amount of $17.5
million based on the fair value of the CombiMatrix Corporation common
shares issued to Nanogen. Amounts related to the settlement have been
attributed to the CombiMatrix group.
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR
FINANCIAL STATEMENTS INCLUDED ELSEWHERE IN THIS FORM 10-K. THIS DISCUSSION
CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE
FORWARD-LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS INCLUDING THOSE SET
FORTH UNDER "RISK FACTORS" HEREIN.
GENERAL
Acacia Research Corporation is comprised of two operating groups, the
CombiMatrix group and the Acacia Technologies group.
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 arrays, which are semiconductor-based tools for use in
identifying and determining the roles of genes, gene mutations and proteins. The
CombiMatrix group's technology has a wide range of potential applications in the
areas of genomics, proteomics, biosensors, drug discovery, drug development,
diagnostics, combinatorial chemistry, material sciences and nanotechnology.
The Acacia Technologies group is responsible for the development,
acquisition, licensing and protection of intellectual property and proprietary
technologies and is pursuing additional licensing and strategic business
alliances with leading companies in the rapidly growing intellectual property
licensing industry. The Acacia Technologies group owns and out-licenses a
portfolio of pioneering U.S. and foreign patents covering digital audio and
video transmission and receiving systems, commonly known as audio-on-demand,
video-on-demand, and audio/video streaming. The Acacia Technologies group's
patented proprietary digital media transmission, or DMT technology, enables the
digitization, encryption, storage, transmission, receipt and playback of digital
content via several means including the Internet, cable, satellite and wireless
systems. The Acacia Technologies group also owns and has out-licensed to
consumer electronics manufacturers, patented technology known as the V-chip. The
V-chip technology was protected by U.S. Patent No. 4,554,584, which expired in
July 2003.
COMBIMATRIX GROUP
During 2003, the CombiMatrix group received significant payments from
its strategic partners and licensees. By continuing the CombiMatrix group's
efforts with these partners and by identifying new strategic relationships, the
CombiMatrix group intends to maximize the opportunities in the life sciences
sector that will be created by commercializing its array system. Highlights of
the operating activities for the year ended December 31, 2003 include the
following:
o For the year ended December 31, 2003, the CombiMatrix group received
cash payments from Roche totaling $9.8 million. Since the inception of
its relationship with Roche in July 2001, the CombiMatrix group has
received cash payments totaling $26.6 million through December 31,
2003. All payments received from Roche have been recorded as deferred
revenues at December 31, 2003.
o In March 2003, the CombiMatrix group's Japanese subsidiary, CombiMatrix
K.K., sold and installed a genomics array synthesizer system to Keio
University of Japan. CombiMatrix K.K. received and recognized $216,000
in revenues related to the sale and installation of the genomics array
synthesizer system in the first quarter of 2003.
o In April 2003, CombiMatrix K.K. sold a DNA array synthesizer to Nihon
Gene Research Laboratory, or NGRL. Under the terms of the agreement,
NGRL purchased a custom slide array synthesizer and entered into a
multi-year agreement to purchase arrays that will be used to provide
contract research services in Japan. CombiMatrix K.K. received an
advance payment of $182,000 from NGRL for the sale of the synthesizer
system, which was recognized as revenue during the third quarter of
2003. CombiMatrix K.K. and NGRL also entered into a co-development and
research agreement to investigate various aspects of genetic analysis.
o In April 2003, the CombiMatrix group designed and fabricated the first
array based on the SARS (Severe Acute Respiratory Syndrome) corona
virus genome. The first arrays were fabricated within 48 hours of
publication of the corona virus genome sequence believed to be
responsible for SARS, underscoring the CombiMatrix group's ability to
rapidly design and build custom arrays. Due to the public health and
economic implications of SARS, the CombiMatrix group made the decision
to provide a limited number of the new SARS arrays to key government
and academic researchers at no cost.
23
o In May 2003, the CombiMatrix group produced pools of small interfering
RNA molecules directed at specific genes of the SARS corona virus. The
CombiMatrix group is collaborating with the National Institute of
Allergy and Infectious Diseases, a division of the National Institutes
of Health, or NIH, and the U.S. Army Medical Research Institute of
Infectious Diseases to conduct the initial screening of the siRNA
samples against the SARS corona virus.
o In May 2003, the CombiMatrix group entered into a multi-year strategic
alliance with Toppan to develop arrays utilizing the CombiMatrix
group's proprietary electrochemical detection approach. Under the terms
of the agreement, Toppan paid the CombiMatrix group an upfront fee of
$1.0 million in the second quarter of 2003 and an additional
development and milestone payment of $1.4 million in December 2003. The
CombiMatrix group and Toppan will co-develop semiconductor arrays for
applications in life sciences research and development as well as
molecular diagnostics. Payments received from Toppan have been recorded
as deferred revenues at December 31, 2003.
o In May 2003, Acacia Research Corporation completed a private equity
financing raising gross proceeds of $5.2 million through the issuance
of 2,417,000 units. Each unit consists of one share of Acacia
Research-CombiMatrix common stock, or AR-CombiMatrix 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. Net proceeds raised from the private equity financing of
$4.9 million have been attributed to the CombiMatrix group.
o In June 2003, CombiMatrix Corporation launched Express Track(TM), a
drug discovery program, which integrates advanced bioinformatic design
applications with the CombiMatrix group's proprietary array-based
synthesis technologies to rapidly produce pools of siRNA molecules. The
initial focus of Express Track(TM) is common viral diseases.
o In June 2003, the CombiMatrix group entered into a license agreement
with Nanomaterials Discovery Corporation, or NDC, based on the
CombiMatrix group's platform technology. Under the terms of the
agreement, NDC will have a license to use the CombiMatrix group's array
technology to augment and accelerate its own nano-materials discovery
program. The CombiMatrix group will share in the revenue from the
commercialization of any newly discovered materials. The CombiMatrix
group will also receive a license to intellectual property owned by
NDC.
o In June 2003, the CombiMatrix group began collaborating with the
research group of Dr. Bonaventura Clotet, M.D., Ph.D., of the
Retrovirology Laboratory irsiCaixa, a leading research and treatment
center for AIDS in Europe, to conduct the initial efficacy screening of
pooled siRNA compounds against Human Immunodeficiency Virus, Type-1.
o In August 2003, the CombiMatrix group launched siRNA Solutions(TM),
which partners its RNAi synthesis platform and custom array technology
with sophisticated bioinformatics to provide collaborators and
customers with a fully integrated program for drug discovery. The
CombiMatrix group 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
the CombiMatrix group as its Director of Homeland Security and Defense
Programs. Dr. Danley's responsibilities will include all of the
CombiMatrix group'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, the CombiMatrix group initiated collaborations with
Drs. Daniel Sabath and Stephen Schmechel of the University of
Washington to develop an array-based test for the diagnosis of
lymphoma. University of Washington researchers are developing
sophisticated nucleic acid-based tests for diagnosis of lymphoma using
the CombiMatrix group's customizable arrays. In addition, the
CombiMatrix group 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 The CombiMatrix group and the
Computational Biology Research Center, or 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
24
the CombiMatrix group's customizable arrays 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.
o In November 2003, the CombiMatrix group announced that they had been
informed by Roche that Roche would not be launching its array platform
based on its collaborative efforts with the CombiMatrix group in 2003,
as previously indicated by Roche. Roche has not set a new launch date.
Within a few days of this release, the CombiMatrix group announced that
it would be launching its own array platform, entitled CustomArray(TM),
to a select group of beta customers in December 2003 and to the
worldwide life sciences community in March 2004.
o In November 2003, the CombiMatrix group announced that Gregory L.
Verdine, Harvard College Professor and Erving Professor of Chemistry in
Harvard University's Department of Chemistry and Chemical Biology, will
use CombiMatrix arrays to map three-dimensional binding sites for
oligonucleotides on folded RNA molecules. This research program aims to
discover, in an unbiased screen, discontinuous RNA epitopes that will
serve as therapeutic targets for drug intervention. This program may
enable the discovery of new drugs and approaches to modulate the
operation of RNA molecules in cells.
o In November 2003, the CombiMatrix group was notified that the U.S. Army
Medical Research Institute of Infectious Diseases, or USAMRIID,
approved a Cooperative Research and Development Agreement, or CRDA with
CombiMatrix Corporation on "Microarray Approaches for Environmental and
Medical Detection of Biothreat Agents." Under the CRDA, USAMRIID and
CombiMatrix Corporation can exchange consultative services, equipment,
reagents, and testing support to demonstrate the effectiveness of the
CombiMatrix group's Electrochemical-Detection System for identifying
biothreat agents.
In 2002, the CombiMatrix's group's operating activities were
highlighted by the receipt of $11.5 million in milestone payments pursuant to
its license, research and development agreements with Roche, which were recorded
as deferred revenues. In addition, the CombiMatrix group recognized $533,000 in
grant and contract revenues, including $274,000 in grant revenue resulting from
completion of its Phase II SBIR Department of Defense contract, $141,000 in
one-time contract research and development revenues, $100,000 in revenue related
to performance and completion of its Phase I National Institutes of Health grant
and $306,000 from the sale of a genomics array synthesizer system and related
array products to two institutions in Japan.
In 2001, the CombiMatrix group's operating activities were highlighted
by the receipt of $6.4 million pursuant to separate license, supply and research
and development agreements with Roche and the National Aeronautics and Space
Administration, or NASA, and continued performance by CombiMatrix Corporation
under its Phase II SBIR contract with the Department of Defense. In addition, in
2001 CombiMatrix Corporation continued its expansion of research and development
activities under its agreements with its strategic partners.
ACACIA TECHNOLOGIES GROUP
In 2003, the Acacia Technologies group's operating activities were
principally focused on the continued development, and commercialization of its
DMT patent portfolio. The Acacia Technologies group began to recognize DMT
license fee revenues in 2003, recognizing $6,000, $19,000, $186,000 and $481,000
in the first, second, third and fourth quarters of 2003, respectively. 2003
operating expenses include increased internal costs 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. Highlights of the operating activities for the year
ended December 31, 2003 include the following:
o Since November 2002, the Acacia Technologies group has entered into 117
license agreements for its DMT technology. One hundred and eight (108)
of these license agreements were executed during 2003. We have executed
license agreements with companies in the hotel in-room entertainment,
online music, movie, adult entertainment, e-learning, and sports, news
and information industries. In most instances, our license agreements
provide for recurring royalty payments for each year that the license
agreements are in effect through the expiration of the patents.
Estimates of the amount of annual license fee revenues that will be
generated from our current licensees is uncertain and would be based
solely on estimates of revenues and other financial information
received from our licensees that could differ materially from actual
periodic results. Annual license fees are generally based on the
revenues recorded by our licensees which are subject to significant
fluctuation from period to period based on our licensees business
activities and related varying rates of growth, and we are unable to
estimate or predict the impact of these factors on estimated future
license fees that we may generate from our existing licensees.
25
o In February 2003, Acacia Media Technologies initiated DMT patent
infringement litigation in the Federal District Court for the Central
District of California against approximately 39 defendants who provide
adult oriented digital content over the Internet. As of December 31,
2003, nine of the original 39 defendants remain in the initial
litigation. In December 2003, Acacia Media Technologies added an
additional eight defendants to its pending patent infringement
litigation, and is seeking to create a defendant class for all adult
entertainment companies that infringe Acacia Media Technologies' DMT
patents.
o The Acacia Technologies group's patent on the V-chip technology expired
in July 2003. To date, the Acacia Technologies group has out-licensed
its V-chip technology to 13 television manufacturers representing
approximately 75% of the industry. Depending on the outcome of ongoing
licensing efforts and related infringement actions, the Acacia
Technologies group may, however, continue to collect license fees on
televisions sold in the United States during the patent term,
subsequent to the July 2003 patent expiration date.
o In November 2003, Acacia Media Technologies Corporation initiated a
patent infringement lawsuit in the Federal District Court for the
Central District of California against On Command Corporation, provider
of interactive in-room entertainment, information and business services
to the lodging industry, regarding Acacia Media Technologies' DMT
technology.
During 2002, the Acacia Technologies group's operating activities were
highlighted by the continued building of its executive management team,
including the hiring of key media technology and intellectual property industry
experts that are responsible for the development, licensing and protection of
the Acacia Technologies group's intellectual property and proprietary
technologies, as well as the pursuit of additional licensing and strategic
business alliances with leading companies in the growing intellectual property
licensing industry. In addition, in 2002, the Acacia Technologies group
increased legal and third-party consulting activities related to its ongoing DMT
patent marketing and commercialization efforts, including patent claims
construction, patent prosecution and related research and engineering costs.
In 2001, the Acacia Technologies group's operating and financing
activities were highlighted by the receipt of $25.6 million in payments from the
licensing of the Acacia Technologies group's television V-chip technology,
Acacia Research Corporation's completion of a private equity financing raising
gross proceeds of $19.0 million which was allocated to the Acacia Technologies
group and Acacia Research Corporation's acquisition of the minority interests in
Soundview Technologies in June 2001 and Acacia Media Technologies Corporation in
November 2001.
26
EFFECT OF VARIOUS ACCOUNTING METHODS ON RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements and the separate group financial
statements are prepared in conformity with accounting principles generally
accepted in the United States of America. In preparing these statements, we are
required to use estimates and assumptions. While we believe we have considered
all available information, actual results could affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements, and the reported amounts of revenues and
expenses during the reporting periods. We believe that, of the significant
accounting policies discussed in Note 2 to our consolidated and separate group
financial statements, the following accounting policies require our most
difficult, subjective or complex judgments:
o revenue recognition;
o research and development expenses;
o accounting for income taxes;
o valuation of long-lived and intangible assets and goodwill;
o accounting for business combinations;
o basis of presentation of separate group financial statements; and
o management and allocation policies relating to AR-Acacia Technologies
stock and AR-CombiMatrix stock.
REVENUE RECOGNITION
As described below, significant management judgments must be made and
used in connection with the revenue recognized in any accounting period.
Material differences may result in the amount and timing of revenue recognized
or deferred for any period if management made different judgments.
Revenue is recognized 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.
ACACIA TECHNOLOGIES GROUP
Under the terms of our DMT license agreements, the Acacia Technologies
group grants an annual non-exclusive license for the use of its patented DMT
technology. In most instances, our license agreements provide for recurring
royalty payments for each year that the license agreements are in effect through
the expiration of the patents. Pursuant to the terms of our DMT license
agreements, once executed, the Acacia Technologies group has no further
obligations with respect to the grant of the annual license each year. License
fees paid to and recognized as revenue by the Acacia Technologies group are
non-refundable.
PER UNIT ROYALTIES: Revenue generated from license agreements that
provide for the calculation of royalties on a per-unit basis are accrued and
recognized as revenue in the period earned, provided that amounts are fixed or
determinable and collectibility is reasonably assured.
PERCENTAGE OF LICENSEE SALES ROYALTIES: Certain license agreements
provide for the calculation of license fees based on a licensee's actual
quarterly sales applied to a contractual royalty rate. Licensees that pay
license fees on a quarterly basis generally report actual quarterly sales
information and related quarterly license fees due to the Acacia Technologies
group within 30 to 45 days after the end of the quarter in which such activity
takes place. Consequently, the Acacia Technologies group recognizes revenue from
these licensing agreements on a three-month lag basis, in the quarter following
the quarter of sales, provided amounts are fixed or determinable and
collectibility is reasonably assured. The lag method described above allows for
the receipt of licensee royalty reports prior to the recognition of revenue.
MINIMUM UPFRONT ANNUAL ROYALTIES: Certain license agreements provide
for the calculation and payment of a minimum upfront annual license fee, based
upon a licensee's expected annual sales during each annual license term. These
license fee payments are deferred and amortized to revenue on a straight-line
basis over the annual license term. To the extent actual annual royalties
reported at the conclusion of each annual license term exceed the amount
prepaid, the additional royalties are recognized in revenue in the quarter
following the annual license term, provided that amounts are fixed or
determinable and collectibility is reasonably assured.
27
License fee payments received by the Acacia Technologies group that do
not meet the revenue recognition criteria described above are deferred until the
revenue recognition criteria are met. The Acacia Technologies group assesses
collection of accrued license fees based on a number of factors, including past
transaction history and credit-worthiness. If it is determined that collection
is not reasonably assured, the fee is recognized when collectibility becomes
reasonably assured, assuming all other revenue recognition criteria have been
met, which is generally upon receipt of cash.
The Acacia Technologies group's V-chip technology settlement and/or
license agreements provide for the payment of contractually determined license
fees to us in consideration for the grant to the television manufacturer of a
non-exclusive, retroactive and future license to manufacture and/or sell
products covered by Soundview Technologies' V-chip patent through July 2003, the
expiration date of the V-chip patent. Certain of the V-chip license agreements
also provide for future royalties or additional required payments based on
future television sales or the outcome of future litigation and settlement
activities.
The Acacia Technologies group is responsible for the licensing and
protection of its intellectual property and proprietary technologies and pursues
third parties that are utilizing its intellectual property without a license or
who have under-reported the amount of royalties owed under a license agreement
with the Acacia Technologies group. As a result of these activities, from time
to time, we may recognize royalty revenues that relate to infringements by our
licensees that occurred in prior periods. These royalty recoveries may cause
revenues to be higher than expected during a particular reporting period and may
not occur in subsequent periods. Differences between amounts initially
recognized and amounts subsequently audited or reported as an adjustment to
those amounts, will be recognized in the period such adjustment is determined as
a change in accounting estimate.
COMBIMATRIX GROUP
The CombiMatrix group derives revenues primarily from three sources:
(i) government grants and contract revenues and (ii) multiple-element
arrangements with strategic partners and licensees and (iii) product sales.
GOVERNMENT GRANTS: Revenues from government grants and contracts are
recognized as the related services are performed, when the services have been
accepted by the grantor and collectibility is reasonably assured. Amounts
recognized are limited to amounts due from the grantor based upon the contract
or grant terms.
REVENUES UNDER MULTIPLE-ELEMENT ARRANGEMENTS WITH STRATEGIC PARTNERS
AND LICENSEES: The CombiMatrix group accounts for revenues under
multiple-element arrangements in accordance with Staff Accounting Bulletin No.
104, "Revenue Recognition," or SAB No. 104 and Emerging Issues Task Force, or
EITF, Issue 00-21, "Revenue Arrangements with Multiple Deliverables," and
related pronouncements. Arrangements with multiple elements or deliverables must
be segmented into individual units of accounting based on the separate
deliverables only if there is objective and verifiable evidence of fair value to
allocate the consideration received to the deliverables. Accordingly, revenues
from multiple-element arrangements involving license fees, up-front payments and
milestone payments, which are received and/or billable in connection with other
rights and services that represent continuing obligations of the CombiMatrix
group, are deferred until all of the multiple elements have been delivered or
until objective and verifiable evidence of the fair value of the undelivered
elements has been established. Upon establishing objective and verifiable
evidence of the fair value of the elements in multiple-element arrangements, the
fair value is allocated to each element of the arrangement, such as license fees
or research and development projects, based on the relative fair values of the
elements. The CombiMatrix group determines the fair value of each element in
multiple-element arrangements based on objective and verifiable evidence of fair
value, which is determined for each element based on the price charged when the
same element is sold separately to a third party. If objective and verifiable
evidence of fair value of all undelivered elements exists but objective and
verifiable evidence of fair value does not exist for one or more delivered
elements, then revenue is recognized using the residual method. Under the
residual method, the revenues from delivered elements are not recognized until
the fair value of the undelivered element(s) have been determined.
For the years ended December 31, 2003 and 2002, the CombiMatrix group
received cash consideration from Roche of $9.8 million and $11.5 million,
respectively. In 2003, the CombiMatrix group also received an up-front payment
of $1.0 million and subsequent milestone payments of $1.4 million pursuant to
its agreement with Toppan. All payments received to date from Roche and Toppan
have been classified as deferred revenue in the CombiMatrix group's December 31,
2003 and 2002 consolidated balance sheets due to the determination that
objective and verifiable evidence of fair value does not currently exist for the
remaining undelivered elements. Pursuant to EITF 00-21, SAB No. 104 and related
guidance, the elements associated with the amounts received to date and
additional milestone payments will be treated as one accounting unit. The
up-front fees and cash payments received upon the accomplishment of the
contractual milestones will be deferred. Revenue will be recognized when all of
the related elements, for which objective and reliable evidence does not exist,
have been delivered and there is objective and reliable evidence to support the
fair value for all of the undelivered elements.
28
In connection with the step acquisition described below, and the
application of purchase accounting, Acacia Research Corporation was required to
record CombiMatrix Corporation's assets and liabilities at fair value, including
deferred revenue. As a result, deferred revenue, primarily consisting of
milestone payments and other cash receipts from Roche and NASA, was reduced by
$8.4 million to reflect the fair value of the continuing obligation related to
the 52% interest acquired by Acacia Research Corporation.
PRODUCT SALES. In general, revenues from the sale of products and/or
services are recognized when delivery has occurred or services have been
rendered.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses relate solely to the CombiMatrix
group. The CombiMatrix group has been and continues to be engaged in a number of
research and development initiatives to improve and expand its array system,
including increasing the number of test sites on each array from their current
density of 1,024 sites per square centimeter to over 10,000 sites per square
centimeter and by developing additional applications of CombiMatrix group's
technology for national and homeland defense and drug discovery.
Except for the amortization of non-cash deferred stock compensation
discussed below, research and development expenses have been the CombiMatrix
group's largest expense category to date and consist of costs to develop a
semiconductor-based, array system. These costs include salaries, benefits,
recruiting and relocation expenses attributed to the CombiMatrix group's
research and development personnel, costs incurred in the development of
prototype products, contract engineering and development with third parties, the
consumption of laboratory materials and supplies and facilities costs. The
CombiMatrix group expects to continue to incur significant expenses for research
and development in order to commercialize its array platform. Once
commercialization for this platform technology has been achieved, the related
research and development spending will decrease. The CombiMatrix group expects
that new research and development efforts in collaboration with other strategic
partners will supplant existing collaboration efforts as they are completed. As
a result, the CombiMatrix group expects that the group's research and
development expenses will be volatile and could increase in the near term.
The CombiMatrix group accounts for research and development expenses
pursuant to Statement of Financial Accounting Standards, or SFAS, No. 2,
"Accounting for Research and Development Costs," which requires that all
research and development costs be charged to expense as incurred. These would
include the costs described above as well as costs incurred to acquire
technologies, which are utilized in research and development and which have no
alternative future use. Also, costs related to filing and pursuing patent
applications are expensed as incurred, as recoverability of such expenditures is
uncertain. Research and development refers to a plan or design for a new product
or process or for a significant improvement to an existing product or process
whether intended for sale or use. Significant management estimates are required
with respect to the determination of which costs relate to plans or designs for
a new product or process or for a significant improvement to an existing
product. Had the CombiMatrix group determined that certain costs incurred were
not related to research and development activities, different accounting
treatment for such costs may have been required.
The costs of software developed or obtained for internal use is
expensed as incurred until certain capitalization criteria have been met, at
which time such costs are capitalized and reported as a component of property
and equipment. To date, these costs have been classified as research and
development expenses. Significant management estimates are required with respect
to the determination of when certain capitalization criteria have been met.
Typically this occurs upon completion of a prototype and design phase and a
functioning model exists. Thereafter, all software program costs are required to
be capitalized and amortized over the remaining estimated useful life of the
software. Had management made differing judgments regarding the capitalization
criteria, different accounting treatment of costs of software developed for
internal use may have been required.
For the year ended December 31, 2002, Acacia Research Corporation
recorded a charge for acquired in-process research and development of $17.2
million, in connection with our December 2002 step acquisition of the
outstanding ownership interests in CombiMatrix Corporation. The value assigned
to acquired in-process technology was determined by identifying those acquired
specific in-process research and development projects that would be continued
and for which (a) technological feasibility had not been established at the
acquisition date, (b) there was no alternative future use and (c) the fair value
was estimable with reasonable reliability.
ACCOUNTING FOR INCOME TAXES
As part of the process of preparing our consolidated financial
statements, we are required to estimate our income taxes in each of the
jurisdictions in which we operate. This process involves the estimating of our
actual current tax exposure together with assessing temporary differences
resulting from differing treatment of items, such as deferred revenue,
amortization of intangibles and asset depreciation for tax and accounting
purposes. These differences result in deferred tax assets and liabilities, which
29
are included within our consolidated balance sheet. We must then assess the
likelihood that our deferred tax assets will be recovered from future taxable
income and to the extent we believe that recovery is not likely, we must
establish a valuation allowance. To the extent we establish a valuation
allowance or increase this allowance in a period, we must include an expense
within the tax provision in the consolidated statement of operations and
comprehensive loss.
Significant management judgment is required in determining our
provision for income taxes, our deferred tax assets and liabilities and our
valuation allowance. We have recorded a full valuation allowance against our
deferred tax assets of $90.6 million as of December 31, 2003, due to
uncertainties related to our ability to utilize our deferred tax assets,
primarily consisting of certain net operating losses carried forward, before
they expire. In assessing the need for a valuation allowance, we have considered
our estimates of future taxable income, the period over which our deferred tax
assets may be recoverable, our history of losses and our assessment of the
probability of continuing losses in the foreseeable future. In management's
estimate, any positive indicators, including forecasts of potential future
profitability of our businesses, are outweighed by the uncertainties surrounding
our estimates and judgments of potential future taxable income. In the event
that actual results differ from these estimates or we adjust these estimates
should we believe we would be able to realize these deferred tax assets in the
future, an adjustment to the valuation allowance would increase income in the
period such determination was made. Any changes in the valuation allowance could
materially impact our financial position and results of operations.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL
We review long-lived assets and intangible assets for potential
impairment annually and when events or changes in circumstances indicate the
carrying amount of an asset may not be recoverable. Factors we consider
important, which could trigger an impairment review include the following:
o significant underperformance relative to expected historical or
projected future operating results;
o significant changes in the manner of our use of the acquired assets or
the strategy for our overall business;
o significant negative industry or economic trends;
o significant adverse changes in legal factors or in the business
climate, including adverse regulatory actions or assessments; and
o significant decline in our stock price for a sustained period.
In the event the sum of the expected undiscounted future cash flows
resulting from the use of the asset is less than the carrying amount of the
asset, an impairment loss equal to the excess of the asset's carrying value over
its fair value is recorded. If an asset is determined to be impaired, the loss
is measured based on quoted market prices in active markets, if available. If
quoted market prices are not available, the estimate of fair value is based on
various valuation techniques, including a discounted value of estimated future
cash flows.
In September 2002 and 2003, the U.S. District Court - Connecticut
granted certain motions for summary judgment filed by the defendants in
Soundview Technologies federal patent infringement and antitrust lawsuits as
described at Item 3. "Legal Proceedings." Significant assumptions used in
connection with our impairment testing of the Acacia Technologies group's
goodwill and intangibles consider the impact of the rulings referenced above.
Near term potential for the recording of impairment charges exists related to
V-chip related intangibles totaling $1.7 million at December 31, 2003, in the
event that we experience any additional adverse rulings related to our pending
antitrust and/or infringement actions.
Goodwill is evaluated for impairment in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets," or 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 $4.6 million. We performed a transitional
goodwill impairment assessment in 2002 and a year-end goodwill impairment
assessment in 2002 and 2003 and determined that there was no impairment of
goodwill. The fair values of our reporting units were estimated using a
discounted cash flow analysis. The carrying value of goodwill not subject to
amortization at December 31, 2003 totaled $21.2 million. To date, goodwill has
not been impaired. In assessing the recoverability of goodwill and other
intangible assets, market values and projections regarding estimated future cash
flows and other factors are used to determine the fair value of the respective
assets. If these estimates or related projections change in future periods,
future goodwill impairment tests may result in a charge to earnings.
30
ACCOUNTING FOR BUSINESS COMBINATIONS
On December 13, 2002, Acacia Research Corporation increased its
consolidated ownership interest in CombiMatrix Corporation from 48% to 100% by
acquiring from existing stockholders of CombiMatrix Corporation 11,987,052
shares of CombiMatrix Corporation common stock in exchange for 11,987,052 shares
of AR-CombiMatrix stock with a fair value of $46.0 million. The transaction was
accounted for as a step acquisition using the purchase method of accounting. The
fair value of the AR-CombiMatrix stock issued in the transaction was based on
the quoted market price of AR-CombiMatrix stock averaged over a five-day period
(from December 16, 2002, the first day of trading for the AR-CombiMatrix stock
through December 20, 2002). The total purchase price of $46.8 million, including
acquisition costs of $0.8 million, was allocated to the fair value of assets
acquired and liabilities assumed, including acquired in-process research and
development, or IPR&D. The amount attributable to CombiMatrix Corporation's core
technology and related patents was $5.3 million, which is being amortized using
the straight-line method over the estimated economic useful life of 7 years. The
amount attributable to IPR&D of $17.2 million was charged to expense and is
included in the consolidated statement of operations and comprehensive loss for
the year ended December 31, 2002. The amount attributable to goodwill was $16.0
million. Amounts allocated to patents, IPR&D and goodwill have been attributed
to the CombiMatrix group.
As described above, $17.2 million of the purchase price was allocated
to IPR&D projects that had not yet reached technological feasibility and had no
alternative future use. Accordingly, this amount was immediately expensed in the
2002 consolidated statement of operations and comprehensive loss as of the
acquisition date. The amounts attributed to acquired IPR&D were based on an
independent appraisal and were developed using an income approach. The
in-process technologies were valued using a discounted cash flow model on a
project-by-project basis, which estimated the cash flows expected to result from
each project once it has reached technological feasibility. A discount rate
consistent with the risks of each project was used to estimate the present value
of future cash flows. In estimating future cash flows, management considered the
contribution of its core technology (for which a United States patent was
obtained in July 2000) that would be required for successful exploitation of
purchased in-process technology, in order to value the core and in-process
technologies discretely. As a result, future cash flows relating to each
purchased IPR&D project were reduced in order to reflect the contribution of
core technology to each IPR&D project. The cash flows from these projects
attributable to core technology were then separately valued to determine the
intangible asset value of purchased core technology. In determining the
contribution of core technology to in-process projects, management used a profit
split approach which considered the estimated profit split between a licensor
and licensee of the core technology and management's assessment of how critical
the core technology was to the IPR&D projects.
The nature of the efforts to develop the purchased IPR&D into
commercially viable products principally relates to the completion and/or
acceleration of existing development programs. These efforts include testing
current and alternative materials used in array design, testing of existing and
alternative methods for array synthesis, developing prototype machinery
(including operating software) to synthesize, hybridize and read individual
arrays, and to perform numerous experiments, or assays, with actual target
samples in order to determine customer protocols and procedures for using the
CombiMatrix group's array system. The costs of these efforts have been included
in the CombiMatrix group's projections to successfully launch the purchased
IPR&D projects. The resulting net cash flows from such projects are based on
management's estimates of revenues, cost of sales, research and development
expenses, sales and marketing expenses, general and administrative expenses, the
anticipated effect of income taxes, and required returns on working capital,
fixed assets and other assets necessary to support the generation of these cash
flows.
The discounting of net cash flows relating to core technology to their
present value is based on CombiMatrix Corporation's weighted average cost of
capital, or WACC. The WACC calculation produces the average required rate of
return of an investment in an operating enterprise, based on various required
rates of return from investments in various areas of that enterprise. The WACC
for CombiMatrix Corporation was approximately 20% at the time of the merger and
is the rate used in discounting the net cash flows attributable to purchased
core technology. Due to the additional inherent risks associated with the
purchased IPR&D projects, including if and when the technologies will ultimately
become commercially viable, market acceptance risks, and threats from competing
technologies, higher discount rates were used to value the projects. The
discount rates used for each project are described below.
The forecast data employed in the valuation analyses was based upon
product level forecast information obtained by Acacia Research Corporation from
numerous internal and external resources. These resources included publicly
available databases, external market research consultants, company-sponsored
focus groups and internal market experts. Management reviewed and challenged the
forecast data and related assumptions and utilized the information in analyzing
IPR&D. The forecast data and assumptions are inherently uncertain and
unpredictable. However, based upon the information available at this time,
Acacia Research Corporation management believes the forecast data and
31
assumptions to be reasonable. These assumptions may be incomplete or inaccurate
and no assurance can be given that unanticipated events and circumstances will
not occur. Accordingly, actual results may vary from the forecasted results. Any
such variance may result in a material adverse effect on Acacia Research
Corporation's financial condition and results of operations.
In the allocation of purchase price to the IPR&D, the concept of
alternative future use was specifically considered for each of the programs
under development. The acquired IPR&D consists of CombiMatrix Corporation's work
to complete each of the identified programs. The programs are very specific to
research market for which they are intended. There are no alternative uses for
the in-process programs in the event that the programs fail in their continued
development or are otherwise not feasible. The development effort for the
acquired IPR&D does not possess an alternative future use for Acacia Research
Corporation as defined by generally accepted accounting principles. Following is
a brief description of each IPR&D project.
GENOMICS BIOLOGICAL ARRAY SYSTEM: CombiMatrix Corporation's genomics
biological array processor system is being developed to discretely immobilize
sequences of DNA or RNA within individual test sites on a modified semiconductor
chip coated with a three-dimensional layer of porous material. The system also
includes proprietary hardware units and related software applications to be able
to synthesize materials onto the chips, apply target samples of genetic
materials and interpret the results. The application of this system will be in
gene expression profiling and SNP genotyping, which could lead to the better
understanding of gene function and ultimately therapeutic discovery to fight
disease. CombiMatrix Corporation's projected cash flow models from
commercializing this system include servicing CombiMatrix Corporation's existing
relationship with Roche as well as other strategic partners, including
pharmaceutical, biotech and academic institutions. Although ongoing research and
development efforts in commercializing this system have been positive, there can
be no assurance that the system will be successfully launched and broadly
accepted by the pharmaceutical, biotech and academic research fields. The value
assigned to the genomics biological array system IPR&D project was $14.0
million. A risk-adjusted discount rate of 32% was applied to the project's
estimated cash flows.
PROTEOMICS BIOLOGICAL ARRAY SYSTEM: CombiMatrix Corporation's
proteomics biological array processor system is being developed to discretely
immobilize proteins and other small molecules within individual test sites on a
modified semiconductor chip in a similar fashion as described above for the
genomics biological array system. However, the porous reaction layer coating
used in synthesis and manner in which the software used to design probes for
protein immobilization are significantly different from what is currently being
developed for the genomics application. Further, the proteomics biological array
system primarily uses electrochemical methods for detection of assay results,
which contrasts with the optical means that are the primary method used with the
CombiMatrix Corporation's genomics products. These differences arise largely due
to the inherent biological differences between DNA molecules and protein
molecules and how they interact with the CombiMatrix group's proprietary
technology. The proteomics biological array system is used for detection and
identification of bio-threat agents in CombiMatrix Corporation's biological and
chemical threat agent detector development programs that are currently in
process. Although ongoing research and development efforts in commercializing
this system have been positive, there can be no assurance that the system will
be successfully launched and accepted by the government, pharmaceutical, biotech
and academic research fields. The value assigned to the proteomics biological
array system IPR&D project was $3.2 million. A risk- adjusted discount rate of
60% was applied to the project's estimated cash flows.
BASIS OF PRESENTATION OF SEPARATE GROUP FINANCIAL STATEMENTS
The CombiMatrix group and Acacia Technologies group financial
statements have been prepared in accordance with generally accepted accounting
principles and, taken together, comprise all the accounts included in the
corresponding consolidated financial statements of Acacia Research Corporation.
The financial statements of the CombiMatrix group and the Acacia Technologies
group reflect the financial condition, results of operations and cash flows of
the businesses included therein. The financial statements of each group include
the accounts or assets of Acacia Research Corporation specifically attributed to
the respective groups and give effect to the applicable accounting policies. The
group financial statements have been prepared on a basis that management
believes to be reasonable and appropriate and reflect the financial position,
results of operations and cash flows of businesses that comprise the separate
groups and all other corporate assets, liabilities and related transactions of
Acacia Research Corporation attributed to the respective groups, including
allocated portions of Acacia Research Corporation's general and administrative
costs. Intergroup transactions between the CombiMatrix group and the Acacia
Technologies group have not been eliminated in the separate group's financial
statements.
The preparation of the divisional financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting periods. Actual results could differ from those estimates.
Significant management estimates and judgments are required related to the
implementation of the management and allocation policies applicable to the
preparation of the divisional financial statements of the CombiMatrix group and
the Acacia Technologies group. Individual group results may be significantly
impacted based on management's estimates and judgments.
32
MANAGEMENT AND ALLOCATION POLICIES RELATING TO AR-ACACIA TECHNOLOGIES STOCK AND
AR-COMBIMATRIX STOCK
The management and allocation policies applicable to the preparation of
the divisional financial statements of the CombiMatrix group and the Acacia
Technologies group (collectively, "the groups") may be modified or rescinded, or
additional policies may be adopted, at the sole discretion of the Acacia
Research Corporation board of directors at any time without approval of the
stockholders. The group divisional financial statements reflect the application
of the management and allocation policies adopted by the Acacia Research
Corporation board of directors to various corporate activities, as described
below. The group's divisional financial statements should be read in conjunction
with Acacia Research Corporation's consolidated financial statements and related
notes.
TREASURY AND CASH MANAGEMENT POLICIES
Acacia Research Corporation manages most treasury and cash management
activities on a de-centralized basis, with each group separately managing its
own treasury activities. Pursuant to treasury and cash management policies
adopted by the Acacia Research Corporation board of directors, the following
policies apply:
o Acacia Research Corporation attributes each issuance of AR-Acacia
Technologies stock (and the proceeds thereof) to the Acacia
Technologies group and attributes each issuance of AR-CombiMatrix stock
(and the proceeds thereof) to the CombiMatrix group;
o Acacia Research Corporation attributes each future incurrence or
issuance of external debt or preferred stock (and the proceeds thereof)
between the Acacia Technologies group and the CombiMatrix group or
entirely to one group as determined by the Acacia Research Corporation
board of directors, based on the extent to which Acacia Research
Corporation incurs or issues the debt or preferred stock for the
benefit of the CombiMatrix group and the Acacia Technologies group;
o Dividends, if any, on AR-Acacia Technologies stock will be charged
against the Acacia Technologies group, and dividends, if any, on
AR-CombiMatrix stock will be charged against the CombiMatrix group;
o Repurchases of AR-Acacia Technologies stock will be charged against the
Acacia Technologies group and repurchases of AR-CombiMatrix stock will
be charged against the CombiMatrix group;
o Acacia Research Corporation will account for any cash transfers from
Acacia Research Corporation to or for the account of a group, from a
group to or for the account of Acacia Research Corporation, or from one
group to or for the account of the other group (other than transfers in
return for assets or services rendered) as short-term loans unless (A)
the Acacia Research Corporation board of directors determines that a
given transfer (or type of transfer) should be accounted for as a
long-term loan, (B) the Acacia Research Corporation board of directors
determines that a given transfer (or type of transfer) should be
accounted for as a capital contribution or (C) the Acacia Research
Corporation board of directors determines that a given transfer (or
type of transfer) should be accounted for as a return of capital. There
are no specific criteria to determine when Acacia Research Corporation
will account for a cash transfer as a long-term loan, a capital
contribution or a return of capital rather than an inter-group
revolving credit advance; provided, however, that cash advances from
Acacia Research Corporation to the Acacia Technologies group or to the
CombiMatrix group up to $25.0 million on a cumulative basis shall be
accounted for as short-term or long-term loans at interest rates at
which Acacia Research Corporation could borrow such funds and shall not
be accounted for as a capital contribution. The Acacia Research
Corporation board of directors will make such a determination in the
exercise of its business judgment at the time of such transfer based
upon all relevant circumstances. Factors the Acacia Research
Corporation board of directors may consider include, without
limitation: the current and projected capital structure of each group;
the financing needs and objectives of the recipient group; the
availability, cost and time associated with alternative financing
sources; and prevailing interest rates and general economic conditions;
and
o Any cash transfers accounted for as short-term loans will bear interest
at the rate at which Acacia Research Corporation could borrow such
funds. In addition, any cash transfers accounted for as a long-term
loan will have interest rates, amortization, maturity, redemption and
other terms that reflect the then-prevailing terms on which Acacia
Research Corporation could borrow such funds.
33
CORPORATE GENERAL AND ADMINISTRATIVE SERVICES AND FACILITIES
Acacia Research Corporation allocates the cost of corporate general and
administrative services and facilities between the groups generally based upon
utilization. Where determinations based on utilization alone are impracticable,
Acacia Research Corporation uses other methods and criteria that management
believes to be equitable and to provide a reasonable estimate of the cost
attributable to each group. Except as otherwise determined by management, the
allocated costs of providing such services and facilities include, without
limitation, all costs and expenses of personnel employed in connection with such
services and facilities, including, without limitation, all direct costs of such
personnel, such as payroll, payroll taxes and fringe benefit costs (calculated
at the appropriate annual composite rate therefor) and all overhead costs and
expenses directly related to such personnel and the services or facilities
provided by them. In addition, allocated costs include all materials used in
connection with such services or facilities, billed at their net cost to the
provider of the services or facilities plus all overhead costs and expenses
related to such materials.
Except as may otherwise be specifically provided pursuant to the terms
of any agreements among Acacia Research Corporation and the groups or any
resolutions of the Acacia Research Corporation board of directors, the corporate
general and administrative services and facilities allocated between the groups
include, without limitation, legal services, accounting services (tax and
financial), insurance and deductibles payable in connection therewith, employee
benefit plans and administration thereof, investor relations, stockholder
services and services relating to the Acacia Research Corporation board of
directors.
ALLOCATION OF FEDERAL AND STATE INCOME TAXES
Acacia Research Corporation determines its federal income taxes and the
federal income taxes of its subsidiaries that own assets allocated between the
groups on a consolidated basis. Acacia Research Corporation allocates
consolidated federal income tax provisions and related tax payments or refunds
between the groups based principally on the taxable income and tax credits
directly attributable to each group. Such allocations reflect each group's
contribution, whether positive or negative, to Acacia Research Corporation's
consolidated federal taxable income and consolidated federal tax liability and
tax credit position. Acacia Research Corporation credits tax benefits that
cannot be used by the group generating those benefits but can be used on a
consolidated basis to the group that generated such benefits. Inter-group
transactions will be treated as taxed on a separate return basis.
Had the groups filed separate tax returns, the provision (benefit) for
income taxes and net income (loss) for each group would not have differed from
the amounts reported in the groups' statements of operations for the years ended
December 31, 2003, 2002, and 2001.
Depending on the tax laws of the respective jurisdictions, state and
local income taxes are calculated on either a consolidated or combined basis
between the groups based on their respective contribution to such consolidated
or combined state taxable incomes. State and local income tax provisions and
related tax payments or refunds which are determined on a separate corporation
basis are allocated between the groups in a manner designed to reflect the
respective contributions of the groups to Acacia Research Corporation, separate
or local taxable income.
34
ACACIA RESEARCH CORPORATION CONSOLIDATED
RESULTS OF OPERATIONS
REVENUES (IN THOUSANDS)
2003 2002 2001
-------- -------- --------
License fee income .............. $ 692 $ 43 $24,180
Product revenue ................. 407 306 --
Grant and contract revenue ...... 49 533 456
Cost of sales ................... (99) (263) --
LICENSE FEE INCOME. 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 our
DMT license agreements, the Acacia Technologies group grants an annual
non-exclusive license for the use of its patented DMT technology. In most
instances, our license agreements provide for recurring royalty payments for
each year that the license agreements are in effect through the expiration of
the patents. Refer to "Critical Accounting Policies - Revenue Recognition" for a
description of our license fee revenue recognition policies. In 2002 and 2001,
license fee income recognized represents one-time V-chip license fee payments
received from television manufacturers with whom we executed separate settlement
and/or license agreements. The Acacia Technologies group has executed V-chip
license agreements with 13 television manufacturers representing approximately
75% of the televisions sold in the United States.
PRODUCT REVENUES AND COST OF SALES. In 2003, product revenues and cost
of sales were recognized by CombiMatrix K.K. from sales of genomics array
synthesizers and related array products and services, primarily to Japanese
research institutions in the first and third quarters of 2003. In 2002, product
revenue and cost of sales relate to the sale of an array synthesizer, an array
reader and arrays to a Japanese government institution by CombiMatrix K.K. in
the second and third quarters of 2002.
GRANT AND CONTRACT REVENUE. Contract revenues in 2003 and 2002 relate
to ongoing contract maintenance and service revenues earned by CombiMatrix K.K.,
which were $49,000 and $20,000, respectively. During 2002, grant revenues
included amounts earned from CombiMatrix Corporation's performance under its
Phase I 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. Grant revenue for
2001 related to CombiMatrix Corporation's continued performance under its Phase
II SBIR contract.
RESEARCH AND DEVELOPMENT EXPENSES (IN THOUSANDS)
2003 2002 2001
-------- -------- --------
Research and development expenses .......... $ 8,098 $18,187 $11,656
Charge for acquired in-process
research and development ................. -- 17,237 --
RESEARCH AND DEVELOPMENT EXPENSES. During 2003, 2002 and 2001, the
CombiMatrix group's research and development activities continued 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 arrays 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 2002
and 2001. 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.
CHARGE FOR ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. Operating
expenses in 2002 include a non-cash charge for acquired in-process research and
development of $17.2 million, related to Acacia Research Corporation's purchase
of the stockholder interests in CombiMatrix Corporation that we did not already
own. See "Critical Accounting Policies - Accounting for Business Combinations"
for a discussion of the allocation of the purchase price and the accounting for
acquired in-process research and development.
35
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES AND LEGAL SETTLEMENT CHARGES
(IN THOUSANDS)
2003 2002 2001
-------- -------- --------
Marketing, general and administrative expenses... $14,917 $18,632 $32,664
Legal settlement charges ........................ 144 18,471 --
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. The decrease in 2003,
as compared to 2002, was due primarily to a decrease in the CombiMatrix group's
corporate legal expenses primarily as a result of settling the litigation with
Nanogen, 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. This 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, enforcement and the identification of additional potential licensees of
our DMT technology. DMT related legal fees to outside attorneys are charged
based on actual time and out-of-pocket expenses incurred by external counsel and
are not incurred on a contingent fee basis.
The decrease in 2002, as compared to 2001, was primarily due to a
decrease in V-chip license fee revenues and related contingent legal fees
expense in 2002. Legal fees related to the V-chip license fee agreements
executed with television manufacturers are generally incurred on a contingency
basis, based on license fee payments received. V-chip related legal fees
incurred were not material in 2002, as compared to $11.0 million in 2001. The
decrease was also due to reductions in the CombiMatrix group's sales and
marketing staff and related expenses, decreased recruitment and relocation
expenses and reduced corporate legal fees incurred during 2002, as compared to
2001, primarily as a result of settling the litigation with Nanogen. This
decrease was partially offset by an increase in personnel, legal and consulting
fees incurred in connection with ongoing DMT patent marketing and
commercialization efforts, including patent claims construction, patent
prosecution and related research and engineering costs, an increase in
professional fees incurred in connection with the December 2002 recapitalization
and merger transactions discussed elsewhere herein, and an increase in
CombiMatrix Corporation's rent and utilities expenses as a result of an increase
in occupancy of its headquarters in Mukilteo, Washington.
LEGAL SETTLEMENT CHARGES. In connection with the September 2002
settlement agreement between CombiMatrix Corporation, Dr. Donald Montgomery, and
Nanogen (see Note 14 to the Acacia Research Corporation consolidated financial
statements included elsewhere herein) CombiMatrix Corporation expensed a $1.0
million payment to Nanogen ($500,000 paid in 2002 and $500,000 paid in 2003) and
recorded a non-cash charge in the amount of $17.5 million related to the fair
value of CombiMatrix Corporation common shares issued to Nanogen.
NON-CASH STOCK COMPENSATION EXPENSE (IN THOUSANDS)
2003 2002 2001
-------- -------- --------
Non-cash stock compensation expense
- research and development ................. $ 466 $ 1,868 $ 7,183
Non-cash stock compensation expense
- marketing, general and administrative .... 1,189 4,559 13,636
The decrease in non-cash stock compensation charges is primarily due to
forfeitures of certain unvested options in 2003, 2002 and 2001 related to
employee turnover at CombiMatrix Corporation 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 remaining amount of
deferred stock compensation expense of $766,000 as of December 31, 2003, all
related to the CombiMatrix group, is expected to be fully amortized by the end
of 2004.
AMORTIZATION OF PATENTS AND GOODWILL (IN THOUSANDS)
2003 2002 2001
------- ------- -------
Amortization of patents and goodwill ........ $1,597 $1,990 $2,695
The decrease in 2003, as compared to 2002, was due to a reduction in
patent amortization expense related to V-chip technology related patent costs
and other intangibles that were fully amortized during 2002. The decrease was
partially offset by an increase in amortization expense related to the December
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.
36
The decrease in 2002, as compared to 2001, was due to the adoption of
SFAS No. 142, effective January 1, 2002, which requires goodwill to be tested
for impairment at least annually and written off when determined to be impaired,
rather than being amortized as previous standards required. Amortization expense
in 2001 includes $1.1 million of goodwill amortization. The reduction in 2002
goodwill amortization was partially offset by an increase in 2002 patent
amortization related to the increase in our ownership interest in Acacia Media
Technologies Corporation from 33% to 100% in November 2001, which resulted in an
increase in patent related intangibles that are being amortized over the
economic useful life of approximately 10 years.
OTHER INCOME (EXPENSES), NET (IN THOUSANDS)
The significant components of other income (expense), net were as
follows:
2003 2002 2001
-------- -------- --------
Impairment of cost method investment ........ $ (207) $(2,748) $ --
Interest income ............................. 735 1,209 3,762
Realized gains (losses) on
short-term investments ................... 94 (1,184) 350
Unrealized (losses) gains on
short-term investments ................... -- (249) 237
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. The decrease in 2003 and 2002 is primarily due to
decreases in average cash balances during the respective periods related to net
operating cash outflows for the CombiMatrix group and the Acacia Technologies
group and the continuing impact of declining interest rates and other external
economic factors negatively impacting rates of return on short-term investments
occurring during 2001, 2002 and continuing in 2003.
REALIZED AND UNREALIZED GAINS/LOSSES ON SHORT-TERM INVESTMENTS. The
decrease is due to no investments classified as trading securities held during
2003 and the sale of the balance of our trading securities during 2002.
INCOME TAXES (IN THOUSANDS)
2003 2002 2001
------ ------ ------
Benefit (provision) for income taxes .......... $ 273 $ 857 $(780)
The 2003 and 2002 income tax benefits reflect the impact of the
reversal of deferred tax liabilities related to the amortization of identifiable
intangible assets related to certain of Acacia Research Corporation's step
acquisitions during 2001 and 2000. The 2002 income tax benefit also reflects the
impact of differences between the 2001 income tax provision and Acacia Research
Corporation's final 2001 consolidated tax return filed in September 2002, and is
the result of additional deductions against Soundview Technologies taxable
income. In 2001, Acacia Research Corporation recorded taxable income relating
principally to V-chip license fee income generated by Soundview Technologies.
MINORITY INTERESTS (IN THOUSANDS)
2003 2002 2001
-------- -------- --------
Minority interests ................ $ 47 $23,806 $17,540
The decrease is due to Acacia Research Corporation's acquisition of the
remaining ownership interests in Soundview and Acacia Media Technologies in
2001, CombiMatrix Corporation in December 2002, and CombiMatrix K.K. in July
2003 and approximately 99% of the remaining ownership interests in Advanced
Material Sciences in July 2003.
INFLATION
Inflation has not had a significant impact on Acacia Research
Corporation in the current or prior periods.
37
LIQUIDITY AND CAPITAL RESOURCES
Acacia Research Corporation's consolidated cash and cash equivalents
along with short-term investments totaled $50.5 million at December 31, 2003,
compared to $54.7 million at December 31, 2002. Working capital at December 31,
2003 was $30.7 million, compared to $41.0 million at December 31, 2002. At
December 31, 2003 and 2002 working capital included $18.1 million and $10.7
million in deferred revenues, respectively, primarily related to the CombiMatrix
group's agreements with Roche and Toppan, which are not subject to any refund or
repayment obligations and do not represent payment obligations of the
CombiMatrix group. See "Critical Accounting Policies - "Revenue Recognition" in
this section, for a description of deferred revenue and related revenue
recognition policies.
To date, we and our subsidiaries have relied primarily upon selling
equity securities and payments from our strategic partners and licensees to
generate the funds needed to finance the operations of our business groups.
Net cash used in continuing operating activities in 2003 was $9.2
million, compared to $19.7 million in 2002. The decrease was primarily
attributable to a reduction in research and development expenses incurred by the
CombiMatrix group and a decrease in consolidated marketing, general and
administrative expenses in 2003 (before the impact of changes in working
capital) as compared to 2002. The change was also due to a net increase in
working capital during 2003, primarily related to cash payments received by
CombiMatrix Corporation totaling $12.8 million, consisting primarily of $9.8
million related to the completion of certain milestones and delivery of
prototype products and services pursuant to its agreements with Roche and an
up-front payment of $1.0 million and a $1.4 million milestone payment pursuant
to its agreement with Toppan. The Roche and Toppan cash payments received have
been recorded as deferred revenues at December 31, 2003. In 2002, the increase
in deferred revenues related to cash receipts, primarily from Roche, totaling
$11.5 million.
Net cash flows used in continuing investing activities was $7.1 million
in 2003, compared to net cash provided by investing activities of $7.0 million
in 2002. The change was primarily due to an increase in short-term investments
purchased during 2003 in connection with ongoing short-term cash management
activities, offset by a decrease in fixed asset purchases by CombiMatrix
Corporation and the absence of acquisition costs in 2003, as compared to 2002.
Net cash provided by financing activities was $6.0 million in 2003,
compared to net cash used in financing activities of $2.9 million in 2002. In
May 2003, Acacia Research Corporation completed a private equity financing
raising net proceeds of $4.9 million and received proceeds from the exercise of
options and warrants totaling $1.1 million. Cash used in financing activities in
2002 was comprised primarily of payments on CombiMatrix Corporation's capital
lease obligation totaling $2.8 million (the capital lease obligation was paid in
full in November 2002) and net capital distributions to minority shareholders of
subsidiaries of $318,000, which were partially offset by proceeds from stock
option exercises of $242,000.
At December 31, 2001, Acacia Research Corporation's consolidated cash
and cash equivalents and short-term investments totaled $84.6 million and
working capital totaled $72.4 million. During 2001, net cash used in continuing
operations of $10.4 million included $6.4 million in payments received from
Roche and NASA by the CombiMatrix group and $25.6 million in gross V-chip
license fee payments received and recognized as revenues by the Acacia
Technologies group. Net cash outflows from operations were offset by proceeds
from the issuance of our common stock of $18.3 million, capital from minority
shareholders in our subsidiaries, CombiMatrix Corporation and Advanced Material
Sciences, totaling $3.3 million, proceeds from stock option and warrant
exercises of $1.8 million, and net sales of available-for-sale securities of
$19.6 million, partially offset by cash out flows related to the acquisition of
the outstanding ownership interests in Acacia Media Technologies and the
purchase of the outstanding interests in Soundview Technologies.
We have sustained losses since our inception contributing to an
accumulated deficit of $183.4 million on a consolidated basis, which includes
net losses of $24.4 million, $59.0 million and $22.3 million in 2003, 2002 and
2001, respectively. Net losses include significant non-cash acquired in-process
research and development, litigation and stock compensation charges reflected in
the accompanying Acacia Research Corporation consolidated results of operations
data for 2003, 2002 and 2001. The consolidated accumulated deficit includes a
non-cash increase related to a reclassification of accumulated deficit in the
amount of $21.7 million to permanent capital representing the fair value of the
ten percent (10%) stock dividend distributed to stockholders in 2001.
There can be no assurance that we will become profitable. If we do, we
may never be able to sustain profitability. We expect to incur significant
losses for the foreseeable future. We are making efforts to reduce expenses and
may take steps to raise additional capital.
38
Management believes that our cash and cash equivalent balances,
anticipated cash flow from operations and other external sources of available
credit will be sufficient to meet our cash requirements through at least the
next twelve months. 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. If we fail
to obtain additional funding when needed, we may not be able to execute our
business plans and our business may suffer.
OFF-BALANCE SHEET ARRANGEMENTS
We have not entered into off-balance sheet financing arrangements,
other than operating leases. We have no significant commitments for capital
expenditures in 2004. We have no committed lines of credit or other committed
funding or long-term debt. The following table lists Acacia Research
Corporation's material known future cash commitments:
PAYMENTS DUE BY PERIOD (IN THOUSANDS)
-----------------------------------------------------------------------
2008 AND
CONTRACTUAL OBLIGATIONS 2004 2005 2006 2007 THEREAFTER
----------- ----------- ----------- ----------- -----------
Operating Leases $ 2,159 $ 2,221 $ 2,148 $ 1,976 $ 1,615
Minimum Royalty Payments(1) 138 100 100 100 1,100
----------- ----------- ----------- ----------- -----------
Total Contractual Cash Obligations $ 2,297 $ 2,321 $ 2,248 $ 2,076 $ 2,715
=========== =========== =========== =========== ===========
- ------------------------
(1) Refer to Note 14 to the Acacia Research Corporation consolidated financial
statements for a description of the September 30, 2002 settlement agreement
between CombiMatrix Corporation and Dr. Donald Montgomery and Nanogen.
In connection with the purchase of the outstanding ownership interests
in Acacia Media Technologies in November 2001, Acacia Media Technologies also
executed related assignment agreements which granted to the former owners of
Acacia Media Technologies' current patent portfolio the right to receive a
royalty of 15% of future net revenues, as defined in the agreements, generated
by Acacia Media Technologies' current patent portfolio, which includes its DMT
patents. No royalty obligation has been incurred as of December 31, 2003. Any
royalties paid pursuant to the agreements will be expensed in the consolidated
statement of operations.
As of December 31, 2003, CombiMatrix Corporation had a one-year
commitment with a third-party vendor to purchase $1.1 million of semiconductor
wafers contingent upon successfully developing a next-generation array. This
agreement was terminated effective January 31, 2004 thereby relieving
CombiMatrix Corporation of this future commitment.
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 2 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.
39
DISCUSSION OF SEGMENTS' OPERATIONS, FINANCIAL RESOURCES AND LIQUIDITY
COMBIMATRIX GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS
(A DIVISION OF ACACIA RESEARCH CORPORATION)
YOU SHOULD READ THIS DISCUSSION IN CONJUNCTION WITH THE COMBIMATRIX
GROUP, A DIVISION OF ACACIA RESEARCH CORPORATION, FINANCIAL STATEMENTS AND
RELATED NOTES AND THE ACACIA RESEARCH CORPORATION CONSOLIDATED FINANCIAL
STATEMENTS AND RELATED NOTES, BOTH INCLUDED ELSEWHERE HEREIN. HISTORICAL RESULTS
AND PERCENTAGE RELATIONSHIPS ARE NOT NECESSARILY INDICATIVE OF OPERATING RESULTS
FOR ANY FUTURE PERIODS.
GENERAL
The CombiMatrix group, a division of Acacia Research Corporation, is
comprised of CombiMatrix Corporation and its 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. The CombiMatrix group is a life sciences technology business
that is developing a platform technology to rapidly produce customizable arrays,
which are semiconductor-based tools for use in identifying and determining the
roles of genes, gene mutations and proteins. The CombiMatrix group's technology
has a wide range of potential applications in the areas of genomics, proteomics,
biosensors, drug discovery, drug development, diagnostics, combinatorial
chemistry, material sciences and nanotechnology.
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.
During 2003, the CombiMatrix group received significant payments from
its strategic partners and licensees. By continuing the CombiMatrix group's
efforts with these partners and by identifying new strategic relationships, the
CombiMatrix group intends to maximize the opportunities in the life sciences
sector that will be created by commercializing its array system.
Since inception, the CombiMatrix group has incurred significant net losses.
During the years ended December 31, 2003, 2002 and 2001, the CombiMatrix group
incurred net losses of approximately $19.0 million, $46.2 million and $28.0
million, respectively. At December 31, 2003 and 2002, the CombiMatrix group's
accumulated deficit was approximately $112.9 million and $94.0 million,
respectively. The losses have resulted principally from costs incurred in
research and development and from marketing, general and administrative costs
associated with the CombiMatrix group's operations. Operating expenses including
non-cash stock-based compensation expense increased to $19.8 million for the
year ended December 31, 2003 from $71.3 million for 2002 and $49.5 million for
2001. Operating expenses for 2002 include one-time charges of $17.2 million and
$18.5 million relating to acquired in-process research and development and
litigation settlement charges, respectively. There were no similar significant
charges in 2003 or 2001. The CombiMatrix group expects to continue to incur net
losses and negative cash flow from operations for the foreseeable future due to
significant increases in research and development and marketing, general and
administrative expenses that will be necessary to further develop CombiMatrix
group's technologies towards commercialization.
40
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
RESULTS OF OPERATIONS
REVENUES (IN THOUSANDS)
2003 2002 2001
-------- -------- --------
Product revenue ................. 407 306 --
Grant and contract revenue ...... 49 533 456
Cost of sales ................... (99) (263) --
PRODUCT REVENUE AND COST OF SALES. In 2003, product revenues and cost
of sales were recognized by CombiMatrix K.K. from sales of genomics array
synthesizers and related array products and services to Japanese research
institutions in the first and third quarters of 2003. In 2002, product revenue
and cost of sales relate to the sale of an array synthesizer, an array reader
and arrays to a Japanese government institution by CombiMatrix K.K. in the
second and third quarters of 2002.
GRANT AND CONTRACT REVENUE. Contract revenues in 2003 and 2002 relate
to ongoing contract maintenance and service revenues earned by CombiMatrix K.K.,
which were $49,000 and $20,000, respectively. During 2002, grant revenues
included amounts earned from CombiMatrix Corporation's performance under its
Phase I 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. Grant revenue for
2001 related to CombiMatrix Corporation's continued performance under its Phase
II SBIR contract.
RESEARCH AND DEVELOPMENT EXPENSES (IN THOUSANDS)
2003 2002 2001
-------- -------- --------
Research and development expenses .......... $ 8,098 $18,187 $11,656
Charge for acquired in-process
research and development ................. -- 17,237 --
RESEARCH AND DEVELOPMENT EXPENSES. In 2003, 2002 and 2001, 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 arrays 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 array instrumentation
and hardware, improved array synthesis techniques, development of higher density
arrays and the development of a robust manufacturing process for its array
platform.
CHARGE FOR ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. Operating
expenses in 2002 include a non-cash charge for acquired in-process research and
development of $17.2 million, related to Acacia Research Corporation's purchase
of the stockholder interests in CombiMatrix Corporation that it did not already
own. See "Critical Accounting Policies - Accounting for Business Combinations"
for a discussion of the allocation of the purchase price and the accounting for
acquired in-process research and development.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES AND LEGAL SETTLEMENT CHARGES
(IN THOUSANDS)
2003 2002 2001
-------- -------- --------
Marketing, general and administrative expenses... $ 8,714 $10,334 $16,690
Legal settlement charges ........................ 144 18,471 --
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. The decrease in 2003,
as compared to 2002, 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.
41
The decrease in 2002, as compared to 2001, was due primarily to
reductions in the CombiMatrix group's sales and marketing staff and related
expenses, decreased recruitment and relocation expenses and reduced legal fees
incurred during 2002, as compared to 2001, primarily as a result of settling the
litigation with Nanogen. This overall decrease in general and administrative
expenses was partially offset by an increase in CombiMatrix Corporation's rent
and utilities expenses as a result of the increase in occupancy of its
headquarters in Mukilteo, Washington.
Included in marketing, general and administrative expenses are
allocated corporate charges of $637,000 in 2003, $1.2 million in 2002 and $1.4
million in 2001. See "Critical Accounting Policies" for a description of the
management allocation policies implemented.
LEGAL SETTLEMENT CHARGES. In connection with the September 2002
settlement between CombiMatrix Corporation, Dr. Donald Montgomery, and Nanogen
(see Note 14 to the Acacia Research Corporation consolidated financial
statements included elsewhere herein) CombiMatrix Corporation expensed a $1.0
million payment to Nanogen ($500,000 paid in 2002 and $500,000 paid in 2003) and
recorded a non-cash charge in the amount of $17.5 million related to the fair
value of CombiMatrix Corporation common shares issued to Nanogen pursuant to the
settlement agreement.
NON-CASH STOCK COMPENSATION EXPENSE (IN THOUSANDS)
2003 2002 2001
-------- -------- --------
Non-cash stock compensation expense
- research and development ................. $ 466 $ 1,868 $ 7,183
Non-cash stock compensation expense
- marketing, general and administrative .... 1,189 4,540 12,780
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 related to employee turnover at
CombiMatrix Corporation 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 of the awards. The CombiMatrix group's
remaining amount of deferred stock compensation expense of $766,000 as of
December 31, 2003 is expected to be fully amortized by the end of 2004.
AMORTIZATION OF PATENTS AND GOODWILL (IN THOUSANDS)
2003 2002 2001
------- ------- -------
Amortization of patents and goodwill ........ $1,095 $ 399 $1,203
The increase in 2003, as compared to 2002, is due to the December 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. Amortization
expense relating to patents and goodwill in 2001 includes $862,000 of goodwill
amortization expense. Effective January 1, 2002, pursuant to SFAS No. 142,
goodwill is required to be tested for impairment at least annually and written
off when determined to be impaired, rather than being amortized as previous
standards required.
OTHER INCOME (IN THOUSANDS)
2003 2002 2001
-------- -------- --------
Interest income ............................. $ 214 $ 589 $ 2,120
The decrease is due primarily to lower average cash and cash
equivalents balances and short-term investments during 2003 and 2002, as
compared to 2001, as well as lower market interest rates earned on the
CombiMatrix group's cash and investments.
MINORITY INTERESTS (IN THOUSANDS)
2003 2002 2001
-------- -------- --------
Minority interests .......................... $ 30 $23,702 $18,817
The decrease in 2003, as compared to 2002, was primarily due to Acacia
Research Corporation's acquisition of the remaining ownership interests in
CombiMatrix Corporation in December 2002 and CombiMatrix K.K. in July 2003 and
approximately 99% of the remaining ownership interests in Advanced Material
Sciences in July 2003. Acacia Research Corporation's interests in Advanced
Material Sciences and CombiMatrix K.K. have been attributed to the CombiMatrix
group.
42
INFLATION
Inflation has not had a significant impact on the CombiMatrix group in
the current or prior periods.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2003, cash and cash equivalents and short-term
investments totaled $17.3 million, compared to $14.9 million at December 31,
2002. The CombiMatrix group had a working capital deficit at December 31, 2003
of $2.0 million, compared to a working capital surplus of $4.3 million at
December 31, 2002. At December 31, 2003 and 2002 working capital included $18.0
million and $9.2 million in deferred revenues, respectively, primarily related
to the CombiMatrix group's agreements with Roche and Toppan, which are not
subject to any refund or repayment obligations and do not represent payment
obligations of the CombiMatrix group. See "Critical Accounting Policies -
"Revenue Recognition" in this section, for a description of deferred revenue and
related accounting policies.
To date, the CombiMatrix group has relied primarily upon selling equity
securities, as well as payments from strategic partners to generate the funds
needed to finance the implementation of the CombiMatrix group's business
strategies. The CombiMatrix group cannot assure that it will not encounter
unforeseen difficulties that may deplete capital resources more rapidly than
anticipated. Any efforts to seek additional funds could be made through equity,
debt or other external financings; however, the CombiMatrix group cannot assure
that additional funding will be available on favorable terms, if at all. If the
CombiMatrix group fails to obtain additional funding when needed, the
CombiMatrix group may not be able to execute its business strategies and its
business may suffer.
Net cash used in operations was $3.9 million in 2003, compared to $16.1
million in 2002. The decrease was primarily due to a reduction in research and
development and marketing, general and administrative expenses in 2003 (before
the impact of changes in working capital) as compared to 2002. The change was
also due to an increase in working capital related to cash payments received by
the CombiMatrix group totaling $12.8 million, consisting primarily of $9.8
million related to the completion of certain milestones and delivery of
prototype products and services pursuant to its agreements with Roche and an
up-front payment of $1.0 million and a milestone payment of $1.4 million
pursuant to its agreement with Toppan. The Roche and Toppan cash payments
received have been recorded as deferred revenues at December 31, 2003. In 2002,
the increase in deferred revenues related to cash payments received, primarily
from Roche, totaling $11.5 million. In September 2003, the CombiMatrix group
paid 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.
Net cash flows used in investing activities was $2.0 million in 2003,
compared to net cash provided by investing activities of $7.6 million in 2002.
The change was primarily due to an increase in short-term investments purchased
during 2003 in connection with the CombiMatrix group's ongoing short term cash
management activities, partially offset by a decrease in the amount of fixed
assets purchased by the CombiMatrix group and the absence of acquisition costs
in 2003, as compared to 2002.
Net cash inflows (outflows) attributed to the CombiMatrix group from
financing activities was $6.4 million in 2003, compared to ($818,000) in 2002.
The change 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 $953,000, all
of which were attributed to the CombiMatrix group and corporate costs allocated
to the CombiMatrix group totaling $620,000. Net cash outflows attributed to the
CombiMatrix group from financing activities in 2002 was comprised primarily of
payments on CombiMatrix Corporation's capital lease obligation totaling $2.8
million (the capital lease obligation was paid in full in November 2002), which
were partially offset by acquisition and other corporate costs allocated to the
CombiMatrix group totaling $1.8 million and proceeds from stock option exercises
of $106,000.
At December 31, 2001, the CombiMatrix group's cash and cash equivalents
and short-term investments totaled $33.3 million and working capital totaled
$24.8 million. In 2001, net cash used in continuing operations was $17.2 million
and included $6.4 million in milestone payments received under the CombiMatrix
group's agreements with Roche and NASA. Net cash used in investing activities
was $18.8 million primarily related to net purchases of short-term investments.
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;
43
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, including acquisition of
additional inventories and capital equipment; and
o other factors that may not be within the CombiMatrix group's control.
The CombiMatrix group believes that its cash and cash equivalent and
short-term investment balances, anticipated cash flow from operations and other
external sources of available credit will be sufficient to meet its cash
requirements through at least the next twelve months. 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.
OFF-BALANCE SHEET ARRANGEMENTS
The CombiMatrix group has not entered into off-balance sheet financing
arrangements, other than operating leases. The CombiMatrix group has no
significant commitments for capital expenditures in 2004. The CombiMatrix group
has no committed lines of credit or other committed funding or long-term debt.
The following table lists the CombiMatrix group's material known future cash
commitments:
PAYMENTS DUE BY PERIOD (IN THOUSANDS)
-----------------------------------------------------------------------
2008 AND
CONTRACTUAL OBLIGATIONS 2004 2005 2006 2007 THEREAFTER
----------- ----------- ----------- ----------- -----------
Operating Leases (2) $ 1,864 $ 1,918 $ 1,836 $ 1,937 $ 1,615
Minimum Royalty Payments(1) 138 100 100 100 1,100
----------- ----------- ----------- ----------- -----------
Total Contractual Cash Obligations $ 2,002 $ 2,018 $ 1,936 $ 2,037 $ 2,715
=========== =========== =========== =========== ===========
- ---------------------
(1) Refer to Note 14 to the Acacia Research Corporation consolidated financial
statements for a description of the September 30, 2002 settlement agreement
between CombiMatrix Corporation and Dr. Donald Montgomery and Nanogen.
(2) Excludes any allocated rent expense.
As of December 31, 2003, CombiMatrix Corporation had a one-year
commitment with a third-party vendor to purchase $1.1 million of semiconductor
wafers contingent upon successfully developing a next-generation array. This
agreement was terminated effective January 31, 2004 thereby relieving
CombiMatrix Corporation of this future commitment.
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 2 to the Acacia Research Corporation consolidated
financial statements included elsewhere herein.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The CombiMatrix group's exposure to market risk is limited to interest
income sensitivity, which is affected by changes in the general level of United
States interest rates, particularly because the majority of the group's
investments are in short-term debt securities issued by the U.S. treasury and by
U.S. corporations. The primary objective of the group's investment activities is
to preserve principal while at the same time maximizing the income the
CombiMatrix group receives without significantly increasing risk. To minimize
risk, the CombiMatrix group maintains its portfolio of cash, cash equivalents
and short-term investments in a variety of investment-grade securities and with
a variety of issuers, including corporate notes, commercial paper, government
securities and money market funds. Due to the nature of its short-term
investments, the CombiMatrix group believes that it is not subject to any
material market risk exposure.
At December 31, 2003, 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.
44
ACACIA TECHNOLOGIES GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS
(A DIVISION OF ACACIA RESEARCH CORPORATION)
YOU SHOULD READ THIS DISCUSSION IN CONJUNCTION WITH THE ACACIA
TECHNOLOGIES GROUP, A DIVISION OF ACACIA RESEARCH CORPORATION, FINANCIAL
STATEMENTS AND RELATED NOTES AND THE ACACIA RESEARCH CORPORATION CONSOLIDATED
FINANCIAL STATEMENTS AND RELATED NOTES, BOTH INCLUDED ELSEWHERE HEREIN.
HISTORICAL RESULTS AND PERCENTAGE RELATIONSHIPS ARE NOT NECESSARILY INDICATIVE
OF OPERATING RESULTS FOR ANY FUTURE PERIODS.
GENERAL
The Acacia Technologies group, a division of Acacia Research
Corporation, is comprised primarily of Acacia Research Corporation's wholly
owned intellectual property licensing subsidiaries, Acacia Media Technologies
and Soundview Technologies, and also includes all other related corporate assets
and liabilities and related transactions of Acacia Research Corporation that are
attributed to its intellectual property licensing business.
The Acacia Technologies group is responsible for the development,
acquisition, licensing and protection of intellectual property and proprietary
technologies and is pursuing licensing and strategic business alliances with
leading companies in the rapidly growing intellectual property licensing
industry.
The Acacia Technologies group owns and out-licenses a portfolio of
pioneering U.S. and foreign patents covering digital audio and video
transmission and receiving systems, commonly known as audio-on-demand,
video-on-demand, and audio/video streaming. The Acacia Technologies group's
patented proprietary DMT technology, enables the digitization, encryption,
storage, transmission, receipt and playback of digital content via several means
including the Internet, cable, satellite and wireless systems. The Acacia
Technologies group believes that its DMT technology is utilized by a variety of
companies in activities including digital ad insertion, cable programming,
satellite programming, hotel in-room entertainment services, distance learning,
and other Internet programming involving digital audio/video content. The Acacia
Technologies group's DMT technology is protected by five U.S. and 31 foreign
patents. The Acacia Technologies group also owns and has out-licensed to
consumer electronics manufacturers, patented technology known as the V-chip. The
V-chip technology was protected by U.S. Patent No. 4,554,584, which expired in
July 2003. The V-chip was adopted by manufacturers of televisions sold in the
Untied States to provide blocking of certain programming based upon its content
rating code, in compliance with the Telecommunications Act of 1996.
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'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. See Item 3 "Legal
Proceedings," for a description of current legal actions related to the V-chip
patent. 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 United States and in 2012
in foreign 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.
45
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
RESULTS OF OPERATIONS
REVENUES (IN THOUSANDS)
2003 2002 2001
-------- -------- --------
License fee income .............. $ 692 $ 43 $24,180
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 our DMT license agreements, the
Acacia Technologies group grants an annual non-exclusive license for the use of
its patented DMT technology. In most instances, our license agreements provide
for recurring royalty payments for each year that the license agreements are in
effect through the expiration of the patents. Refer to "Critical Accounting
Policies - Revenue Recognition" for a description of our license fee revenue
recognition policies. In 2002 and 2001, license fee income recognized represents
one-time V-chip license fee payments received from television manufacturers with
whom we executed separate settlement and/or license agreements. The Acacia
Technologies group has executed V-chip license agreements with 13 television
manufacturers representing approximately 75% of the televisions sold in the
United States.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSE (IN THOUSANDS)
2003 2002 2001
-------- -------- --------
Marketing, general and administrative expenses... $ 4,317 $ 6,883 $ 4,853
Legal expenses - patents ........................ 1,886 1,415 11,121
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSE. The decrease in 2003, as
compared to 2002, 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 business
development costs related to the identification of additional potential
licensees of the Acacia Technologies group's DMT technology.
The increase in 2002, as compared to 2001, was primarily due to
increased legal and accounting related expenses related to Acacia Research
Corporation's recapitalization and merger transactions discussed above, and
increased costs related to Acacia Technologies group's ongoing DMT patent
marketing and commercialization efforts, including increased personnel costs
relating to the hiring of key executives and increased patent related research
and engineering costs.
LEGAL EXPENSES - PATENTS. During 2003 and 2002, expenses related to
ongoing DMT patent commercialization and enforcement efforts, including legal
and engineering costs related to new patent claims, enforcement and the
identification of additional potential licensees of the Acacia Technologies
group's DMT technology. The Acacia Technologies group expects patent related
legal expenses to continue to be significant as we continue to develop,
strengthen and license our existing patent portfolios and acquire and seek to
develop and commercialize additional patent portfolios. DMT related legal fees
to outside attorneys are charged based on actual time and out-of-pocket expenses
incurred by external counsel and are not incurred on a contingent fee basis.
The decrease in 2002, as compared to 2001, was primarily due to a
decrease in legal expenses related to Soundview Technologies' V-chip patent
licensing program and related infringement settlements. V-chip related legal
expenses totaled approximately $11.0 million in 2001 and were not material in
2002. Legal fees related to the V-chip license fee agreements executed are
generally incurred on a contingency basis, based on license fee payments
received. The decrease in V-chip related legal fees was partially offset by $1.0
million in legal fees incurred in connection with the inception of the Acacia
Technologies group's DMT patent commercialization efforts, including patent
claims construction, patent prosecution and related research costs.
46
AMORTIZATION OF PATENTS AND GOODWILL (IN THOUSANDS)
2003 2002 2001
------- ------- -------
Amortization of patents and goodwill ........ $ 502 $1,591 $1,492
The decrease in 2003, as compared to 2002, was 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. The decrease in
amortization expense in 2002, as compared to 2001, was due to the adoption of
SFAS No. 142, effective January 1, 2002, which requires goodwill to be tested
for impairment at least annually and written-off when determined to be impaired,
rather than being amortized as previous standards required. Amortization expense
in 2001 includes $216,000 of goodwill amortization expense. The reduction in
2002 goodwill amortization expense was offset by an increase in 2002 patent
amortization related to the increase in our ownership interest in Acacia Media
Technologies Corporation from 33% to 100% in November 2001, which resulted in an
increase in patent related intangibles that are being amortized over the
economic useful life of approximately 10 years.
OTHER INCOME (EXPENSES), NET (IN THOUSANDS)
2003 2002 2001
-------- -------- --------
Impairment of cost method investment ........ $ (207) $(2,748) $ --
Interest income ............................. 521 620 1,642
Realized gains (losses) on
short-term investments ................... 94 (1,184) 350
Unrealized (losses) gains on
short-term investments ................... -- (249) 237
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. The decrease in 2003 and 2002 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 (LOSSES) GAINS ON SHORT-TERM INVESTMENTS. The
decrease is due to no investments classified as trading securities held during
2003 and the sale of the balance of the Acacia Technologies group's trading
securities during 2002.
INCOME TAXES (IN THOUSANDS)
2003 2002 2001
------ ------ ------
Benefit (provision) for income taxes .......... $ 137 $ 710 $(935)
The 2003 benefit relates primarily to the scheduled reversal of
deferred tax liabilities related to the amortization of identifiable intangible
assets related to Acacia Research Corporation's acquisition of 100% of Acacia
Media Technologies in 2001. The 2002 income tax benefit relates principally to
differences between the 2001 provision and Acacia Research Corporation's final
2001 return filed in September 2002, and is the result of additional deductions
against Soundview Technologies' 2001 taxable income and the reversal of deferred
tax liabilities discussed above. In 2001, the Acacia Technologies group had
taxable income relating principally to V-chip license fee income generated by
Soundview Technologies.
MINORITY INTERESTS (IN THOUSANDS)
2003 2002 2001
-------- -------- --------
Minority interests ................ $ 17 $ 104 $(1,277)
The decrease in minority interests is due to Acacia Research
Corporation's acquisition of the remaining ownership interests in Soundview and
Acacia Media Technologies in 2001. Minority interests in the net income of
consolidated subsidiaries in 2001 was comprised primarily of $1.3 million of
minority interests in the net income of Soundview Technologies recorded prior to
the increase in Acacia Research Corporation's ownership interest in Soundview
Technologies to 100% in June 2001.
47
INFLATION
Inflation has not had a significant impact on the Acacia Technologies
group in the current or previous periods.
LIQUIDITY AND CAPITAL RESOURCES
The Acacia Technologies group's cash and cash equivalents and
short-term investments totaled $33.2 million at December 31, 2003, compared to
$39.8 million at December 31, 2002. Working capital at December 31, 2003 was
$32.7 million, compared to $36.5 million at December 31, 2002.
To date, the Acacia Technologies group has relied primarily upon
selling of Acacia Research Corporation equity securities and payments from our
V-chip licensees, primarily in 2001, to generate the funds needed to finance the
operations of the Acacia Technologies group. The V-chip patent 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 United States before the expiration date. In 2003, the Acacia Technologies
group began to commercially license its DMT technology recognizing $692,000 in
DMT license fee revenues, and intends to acquire and develop additional
intellectual property. However, there can be no assurance that the Acacia
Technologies group will be able to implement its future plans. Failure by
management to achieve its plans would have a material adverse effect on the
Acacia Technologies group and on Acacia Research Corporation's ability to
achieve its intended business objectives. The Acacia Technologies group's
success also depends on its ability to protect its intellectual property.
The timing of the receipt of revenues by the Acacia Technologies
group's business operations are subject to certain risks and uncertainties,
including:
o market acceptance of products and services;
o technological advances that may make our products and services obsolete
or less competitive;
o increases in operating costs, including costs for legal services,
engineering and research and personnel;
o the availability and cost of capital;
o general economic conditions; and
o governmental regulation that may restrict the Acacia Technologies
group's business.
The Acacia Technologies group believes that its cash and cash
equivalent balances, anticipated cash flow from operations and other external
sources of available credit will be sufficient to meet its cash requirements
through at least the next twelve months.
Net cash used in continuing operating activities in 2003 was $5.3
million, compared to $7.6 million (excluding net sales of trading securities of
$4.1 million) in 2002. Net cash used in continuing operating activities in 2003
includes $692,000 in DMT revenues recognized during the period and $101,000 in
deferred DMT license fee revenues.
Net cash flows used in continuing investing activities was $5.1 million
in 2003, compared to $592,000 in 2002. The change was primarily due to an
increase in short-term investments purchased during 2003 in connection with the
Acacia Technologies group's ongoing short term cash management activities.
Net cash outflows attributed to the Acacia Technologies group from
financing activities was $417,000 in 2003, compared to $2.0 million in 2002. Net
cash outflows attributed to the Acacia Technologies group in 2003 relate
primarily to stock option exercise proceeds of $190,000 offset by allocated
corporate charges of $620,000. Net cash outflows attributed to the Acacia
Technologies group in 2002 primarily related to $1.8 million in corporate and
acquisition costs allocated to the CombiMatrix group.
At December 31, 2001, the Acacia Technologies group's cash and cash
equivalents and short-term investments totaled $51.2 million and working capital
totaled $47.6 million. During 2001, net cash inflows included cash provided by
continuing operations of $6.8 million resulting primarily from gross V-chip
related license fee revenues of $25.6 million, and $20.9 million in proceeds
from the sale of Acacia Research Corporation securities allocated to the Acacia
Technologies group, which were partially offset by net cash outflows from
investing activities related to the acquisition of the outstanding ownership
interests in Acacia Media Technologies and the acquisition of the outstanding
interests in Soundview Technologies.
48
OFF-BALANCE SHEET ARRANGEMENTS
The Acacia Technologies group has not entered into off-balance sheet
financing arrangements, other than operating leases. The Acacia Technologies
group has no significant commitments for capital expenditures in 2004. The
Acacia Technologies group has no committed lines of credit or other committed
funding or long-term debt. The following table lists the Acacia Technologies
group's material known future cash commitments:
PAYMENTS DUE BY PERIOD (IN THOUSANDS)
-----------------------------------------------------------------------
2008 AND
CONTRACTUAL OBLIGATIONS 2004 2005 2006 2007 THEREAFTER
----------- ----------- ----------- ----------- -----------
Operating Leases (1) $ 295 $ 303 $ 312 $ 39 $ --
----------- ----------- ----------- ----------- -----------
Total Contractual Cash Obligations $ 295 $ 303 $ 312 $ 39 $ --
=========== =========== =========== =========== ===========
- ------------------------
(1) Excludes any allocated rent expense.
In connection with the purchase of the outstanding ownership interests
in Acacia Media Technologies in November 2001, Acacia Media Technologies also
executed related assignment agreements which granted to the former owners of
Acacia Media Technologies' current patent portfolio the right to receive a
royalty of 15% of future net revenues, as defined in the agreements, generated
by Acacia Media Technologies' current patent portfolio, which includes its DMT
patents. No royalty obligation has been incurred as of December 31, 2003. Any
royalties paid pursuant to the agreements will be expensed in the statement of
operations.
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 2 to the Acacia Research Corporation consolidated
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.
49
RISK FACTORS
AN INVESTMENT IN OUR STOCK INVOLVES A NUMBER OF RISKS. BEFORE MAKING A
DECISION TO PURCHASE OUR SECURITIES, YOU SHOULD CAREFULLY CONSIDER ALL OF THE
RISKS DESCRIBED IN THIS ANNUAL REPORT. IF ANY OF THE RISKS DISCUSSED IN THIS
ANNUAL REPORT ACTUALLY OCCUR, OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF
OPERATIONS COULD BE MATERIALLY ADVERSELY AFFECTED. IF THIS WERE TO OCCUR, THE
TRADING PRICE OF OUR SECURITIES COULD DECLINE SIGNIFICANTLY AND YOU MAY LOSE ALL
OR PART OF YOUR INVESTMENT.
GENERAL RISKS
THE CONTINUING WORLDWIDE ECONOMIC SLOWDOWN AND RELATED UNCERTAINTIES MAY
CONTINUE TO ADVERSELY IMPACT OUR REVENUES AND OPERATING RESULTS.
Slower economic activity, concerns about inflation, decreased consumer
confidence, reduced corporate profits and capital spending, adverse business
conditions and liquidity concerns in the technology and biotechnology and
related industries, 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 December 31, 2003, of $183.4 million 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.
OUR STOCK PRICES MAY BE VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL LOSSES FOR
INVESTORS IN OUR SECURITIES.
The stock markets in general, and the markets for technology stocks in
particular, have experienced extreme volatility that has often been unrelated to
the operating performance of particular companies. These broad market
fluctuations may adversely affect the trading prices of our two classes of
common stock.
50
The market prices of our securities may also fluctuate significantly in
response to the following factors, some of which are beyond our control:
o variations in our quarterly operating results;
o changes in management's or securities analysts' estimates of our
financial performance;
o changes in market valuations of similar companies;
o announcements by us or our competitors of significant contracts,
acquisitions, strategic partnerships, joint ventures, capital
commitments, new products or product enhancements;
o failure to complete significant transactions; and
o additions or departures of key personnel.
BECAUSE CERTAIN OF OUR SUBSIDIARY COMPANIES MAY NOT GENERATE ANY SIGNIFICANT
REVENUES, AND OPERATING RESULTS FROM OUR SUBSIDIARY COMPANIES MAY FLUCTUATE
SIGNIFICANTLY, OUR OWN OPERATING RESULTS MAY BE NEGATIVELY AFFECTED.
Our operating results may be materially impacted by the operating
results of our subsidiary companies. We cannot assure that these companies will
be able to meet their anticipated working capital needs to develop their
products and services. If they fail to properly develop these products and
services, they will be unable to generate meaningful product sales. We
anticipate that our operating results are likely to vary significantly as a
result of a number of factors, including:
o the timing of new product introductions by each subsidiary company;
o the stage of development of the business of each subsidiary company;
o the technical feasibility of each subsidiary company's technologies and
techniques;
o the novelty of the technology owned by our subsidiary companies;
o the accuracy, effectiveness and reliability of products developed by
our subsidiary companies;
o the level of product acceptance;
o the strength of each subsidiary company's intellectual property rights;
o the ability of each subsidiary company to avoid infringing the
intellectual property rights of others;
o each subsidiary company's ability to exploit and commercialize its
technology;
o the volume and timing of orders received and product line maturation;
o the impact of price competition; and
o each subsidiary company's ability to access distribution channels.
Many of these factors are beyond our subsidiary companies' control. We
cannot provide any assurance that any subsidiary company will experience growth
in the future or be profitable on an operating basis in any future period.
IF WE, OR OUR SUBSIDIARIES, ENCOUNTER UNFORESEEN DIFFICULTIES AND CANNOT OBTAIN
ADDITIONAL FUNDING ON FAVORABLE TERMS, OUR BUSINESS MAY SUFFER.
As of December 31, 2003, we had cash and short-term investments of
$50.5 million on our consolidated financial statements.
51
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
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.
BECAUSE WE HAVE A LIMITED OPERATING HISTORY, WE CANNOT ASSURE THAT OUR
OPERATIONS WILL BE PROFITABLE.
We commenced operations in 1993 and, accordingly, have a limited
operating history. In addition, certain of our subsidiary companies are in the
early stages of development and/or operations and have limited operating
histories. You should consider our prospects in light of the risks, expenses and
difficulties frequently encountered by companies with such limited operating
histories. Since we have a limited operating history, we cannot assure you that
our operations will be profitable or that we will generate sufficient revenues
to meet our expenditures and support our activities.
During the fiscal years ended December 31, 2003 and 2002, we had
operating losses of approximately $25.4 million and $80.3 million, respectively,
and net losses of approximately $24.4 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.
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.
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 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.
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
52
issue securities convertible into our common stock. Any of these events may
dilute your ownership interest in us and have an adverse impact on the price of
our common stock.
In addition, sales of a substantial amount of our common stock in the
public market, or the perception that these sales may occur, could reduce the
market price of our common stock. This could also impair our ability to raise
additional capital through the sale of our securities.
DELAWARE LAW AND OUR CHARTER DOCUMENTS CONTAIN PROVISIONS THAT COULD DISCOURAGE
OR PREVENT A POTENTIAL TAKEOVER OF ACACIA RESEARCH CORPORATION THAT MIGHT
OTHERWISE RESULT IN OUR STOCKHOLDERS RECEIVING A PREMIUM OVER THE MARKET PRICE
OF THEIR SHARES.
Provisions of Delaware law and our certificate of incorporation and
bylaws could make more difficult the acquisition of Acacia Research Corporation
by means of a tender offer, proxy contest or otherwise, and the removal of
incumbent officers and directors. These provisions include:
o Section 203 of the Delaware General Corporation Law, which prohibits a
merger with a 15%-or-greater stockholder, such as a party that has
completed a successful tender offer, until three years after that party
became a 15%-or-greater stockholder;
o amendment of our bylaws by the stockholders requires a two-thirds
approval of the outstanding shares;
o the authorization in our certificate of incorporation of undesignated
preferred stock, which could be issued without stockholder approval in
a manner designed to prevent or discourage a takeover;
o provisions in our bylaws eliminating stockholders' rights to call a
special meeting of stockholders, which could make it more difficult for
stockholders to wage a proxy contest for control of our board of
directors or to vote to repeal any of the anti-takeover provisions
contained in our certificate of incorporation and bylaws; and
o the division of our board of directors into three classes with
staggered terms for each class, which could make it more difficult for
an outsider to gain control of our board of directors.
Such potential obstacles to a takeover could adversely affect the
ability of our stockholders to receive a premium price for their stock in the
event another company wants to acquire us.
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 also 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 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.
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
55
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:
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;
56
o the willingness and ability of customers to adopt new technologies
requiring capital investments or the reluctance of customers to change
technologies in which they have made a significant investment; and
o the willingness of customers to transmit test data and permit the
CombiMatrix group to transmit test results over the Internet, which
will be a necessary component of its product and services packages
unless customers purchase or license its equipment for use in their own
facilities.
IF THE MARKET FOR ANALYSIS OF GENOMIC INFORMATION DOES NOT DEVELOP OR IF GENOMIC
INFORMATION IS NOT AVAILABLE TO THE COMBIMATRIX GROUP'S POTENTIAL CUSTOMERS, ITS
BUSINESS WILL NOT SUCCEED.
The CombiMatrix group is designing its technology primarily for
applications in the biotechnology, pharmaceutical and academic communities. The
usefulness of the CombiMatrix group's technology depends in part upon the
availability of genomic data. The CombiMatrix group is initially focusing on
markets for analysis of genetic variation and function, namely SNP genotyping
and gene expression profiling. These markets are new and emerging, and they may
not develop as the CombiMatrix group anticipates, or at all. Also, researchers
may not seek or be able to convert raw genomic data into medically valuable
information through the analysis of genetic variation and function. If genomic
data is not available for use by the CombiMatrix group's customers or if its
target markets do not emerge in a timely manner, or at all, demand for its
products will not develop as it expects, and it may never become profitable.
THE COMBIMATRIX GROUP'S FUTURE SUCCESS DEPENDS ON THE CONTINUED SERVICE OF ITS
ENGINEERING, TECHNICAL AND KEY MANAGEMENT PERSONNEL AND ITS ABILITY TO IDENTIFY,
HIRE AND RETAIN ADDITIONAL ENGINEERING, TECHNICAL AND KEY MANAGEMENT PERSONNEL.
There is intense competition for qualified personnel in the CombiMatrix
group's industry, particularly for engineers and senior level management. Loss
of the services of, or failure to recruit, engineers or other technical and key
management personnel could be significantly detrimental to the group and could
adversely affect its business and operating results. The CombiMatrix group may
not be able to continue to attract and retain engineers or other qualified
personnel necessary for the development of its products and business or to
replace engineers or other qualified personnel who may leave the group in the
future. The CombiMatrix group's anticipated growth is expected to place
increased demands on its resources and likely will require the addition of new
management personnel.
THE EXPANSION OF THE COMBIMATRIX GROUP'S PRODUCT LINES MAY SUBJECT IT TO
REGULATION BY THE UNITED STATES FOOD AND DRUG ADMINISTRATION AND FOREIGN
REGULATORY AUTHORITIES, WHICH COULD PREVENT OR DELAY ITS INTRODUCTION OF NEW
PRODUCTS.
If the CombiMatrix group manufactures, markets or sells any products
for any regulated clinical or diagnostic applications, those products will be
subject to extensive governmental regulation as medical devices in the United
States by the FDA and in other countries by corresponding foreign regulatory
authorities. The process of obtaining and maintaining required regulatory
clearances and approvals is lengthy, expensive and uncertain. Products that
CombiMatrix Corporation manufactures, markets or sells for research purposes
only are not subject to governmental regulations as medical devices or as
analyte specific reagents to aid in disease diagnosis. We believe that the
CombiMatrix group's success will depend upon commercial sales of improved
versions of products, certain of which cannot be marketed in the United States
and other regulated markets unless and until the CombiMatrix group obtains
clearance or approval from the FDA and its foreign counterparts, as the case may
be. Delays or failures in receiving these approvals may limit our ability to
benefit from new CombiMatrix group products.
AS THE COMBIMATRIX GROUP'S OPERATIONS EXPAND, ITS COSTS TO COMPLY WITH
ENVIRONMENTAL LAWS AND REGULATIONS WILL INCREASE, AND FAILURE TO COMPLY WITH
THESE LAWS AND REGULATIONS COULD HARM ITS FINANCIAL RESULTS.
The CombiMatrix group's operations involve the use, transportation,
storage and disposal of hazardous substances, and as a result it is subject to
environmental and health and safety laws and regulations. As the CombiMatrix
group expands its operations, its use of hazardous substances will increase and
lead to additional and more stringent requirements. The cost to comply with
these and any future environmental and health and safety regulations could be
substantial. In addition, the CombiMatrix group's failure to comply with laws
and regulations, and any releases of hazardous substances into the environment
or at its disposal sites, could expose the CombiMatrix group to substantial
liability in the form of fines, penalties, remediation costs and other damages,
or could lead to a curtailment or shut down of its operations. These types of
events, if they occur, would adversely impact the group's financial results.
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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 four
patents issued in the United States, one patent issued in Europe and 46 patent
applications pending in the United States, Europe and elsewhere. The patent
application process before the United States Patent and Trademark Office and
other similar agencies in other countries is initially confidential in nature.
Patents that are filed outside the United States, however, are published
approximately eighteen months after filing. The CombiMatrix group cannot
determine in a timely manner whether patent applications covering technology
that competes with its technology have been filed in the United States or other
foreign countries or which, if any, will ultimately issue or be granted as
enforceable patents. Some of the CombiMatrix group's patent applications may
claim compositions, methods or uses that may also be claimed in patent
applications filed by others. In some or all of these applications, a
determination of priority of inventorship may need to be decided in a proceeding
before the United States Patent and Trademark Office or a foreign regulatory
body or a court. If the CombiMatrix group is unsuccessful in these proceedings,
it could be blocked from further developing, commercializing or selling
products. Regardless of the ultimate outcome, this process is time-consuming and
expensive.
ANY INABILITY TO ADEQUATELY PROTECT THE COMBIMATRIX GROUP'S PROPRIETARY
TECHNOLOGIES COULD MATERIALLY HARM THE COMBIMATRIX GROUP'S COMPETITIVE POSITION
AND FINANCIAL RESULTS.
If the CombiMatrix group does not protect its intellectual property
adequately, competitors may be able to use its technologies and erode any
competitive advantage that it may have. The laws of some foreign countries do
not protect proprietary rights to the same extent as the laws of the United
States, and many companies have encountered significant problems in protecting
their proprietary rights abroad. These problems can be caused by the absence of
rules and methods for defending intellectual property rights.
The patent positions of companies developing tools for the
biotechnology, pharmaceutical and academic communities, including the
CombiMatrix group's patent position, generally are uncertain and involve complex
legal and factual questions. The CombiMatrix group will be able to protect its
proprietary rights from unauthorized use by third parties only to the extent
that its proprietary technologies are covered by valid and enforceable patents
or are effectively maintained as trade secrets. The CombiMatrix group's existing
patents and any future issued or granted patents it obtains may not be
sufficiently broad in scope to prevent others from practicing its technologies
or from developing competing products. There also is a risk that others may
independently develop similar or alternative technologies or designs around the
CombiMatrix group's patented technologies. In addition, others may oppose or
invalidate its patents, or its patents may fail to provide it with any
competitive advantage. Enforcing the CombiMatrix group's intellectual property
rights may be difficult, costly and time-consuming and ultimately may not be
successful.
The CombiMatrix group also relies upon trade secret protection for its
confidential and proprietary information. While it has taken security measures
to protect its proprietary information, these measures may not provide adequate
protection for its trade secrets or other proprietary information. The
CombiMatrix group seeks to protect its proprietary information by entering into
confidentiality and invention disclosure and transfer agreements with employees,
collaborators and consultants. Nevertheless, employees, collaborators or
consultants may still disclose its proprietary information, and the CombiMatrix
group may not be able to meaningfully protect its trade secrets. In addition,
others may independently develop substantially equivalent proprietary
information or techniques or otherwise gain access to its trade secrets.
ANY LITIGATION TO PROTECT THE COMBIMATRIX GROUP'S INTELLECTUAL PROPERTY, OR ANY
THIRD-PARTY CLAIMS OF INFRINGEMENT, COULD DIVERT SUBSTANTIAL TIME AND MONEY FROM
THE COMBIMATRIX GROUP'S BUSINESS AND COULD SHUT DOWN SOME OF ITS OPERATIONS.
The CombiMatrix group's commercial success depends in part on its
non-infringement of the patents or proprietary rights of third parties. Many
companies developing tools for the biotechnology and pharmaceutical industries
use litigation aggressively as a strategy to protect and expand the scope of
their intellectual property rights. Accordingly, third parties may assert that
the CombiMatrix group is employing their proprietary technology without
authorization. In addition, third parties may claim that use of the CombiMatrix
group's technologies infringes their current or future patents. The CombiMatrix
group could incur substantial costs and the attention of its management and
technical personnel could be diverted while defending ourselves against any of
these claims. The CombiMatrix group may incur the same liabilities in enforcing
its patents against others. The CombiMatrix group has not made any provision in
its financial plans for potential intellectual property related litigation, and
it may not be able to pursue litigation as aggressively as competitors with
substantially greater financial resources.
58
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, 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 United States before that
date. The Acacia Technologies group is beginning to market its digital media
transmission technology and is developing other technologies and products. The
eventual licensing and sale of these technologies is intended to replace the
revenue currently being generated by licensing its V-chip technology. If the
Acacia Technologies group does not succeed in developing such technologies or is
unable to commercially license its existing and future technologies, its
financial condition will be adversely impacted.
THE ACACIA TECHNOLOGIES GROUP MAY FAIL TO MEET MARKET EXPECTATIONS BECAUSE OF
FLUCTUATIONS IN ITS QUARTERLY OPERATING RESULTS, WHICH COULD CAUSE THE PRICE OF
AR-ACACIA TECHNOLOGIES STOCK TO DECLINE.
The Acacia Technologies group'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.
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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.
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.
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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.
RISKS RELATING TO OUR CAPITAL STRUCTURE
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.
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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).
o We will not hold separate stockholder meetings for holders of
AR-CombiMatrix stock and AR-Acacia Technologies stock.
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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
would be a defense to any challenge to such determination made by or on behalf
of the holders of either class of common stock.
63
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
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
64
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.
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
65
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.
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
66
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.
67
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Refer to the caption "Quantitative and Qualitative Disclosures About
Market Risk" for Acacia Research Corporation, the CombiMatrix group and the
Acacia Technologies group under Item 7. "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
The primary objective of our investment activities is to preserve
principal while concurrently maximizing the income we receive from our
investments without significantly increasing risk. Some of the securities that
we may invest in may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate. For example, if we hold a security that was issued with a fixed
interest rate at the then-prevailing rate and the prevailing interest rate later
rises, the current value of the principal amount of our investment will decline.
To minimize this risk in the future, we intend to maintain our portfolio of cash
equivalents and short-term investments in a variety of securities, including
commercial paper, money market funds, high-grade corporate bonds, government and
non-government debt securities and certificates of deposit. In general, money
market funds are not subject to market risk because the interest paid on such
funds fluctuates with the prevailing interest rate. As of December 31, 2003, all
of our investments were in money market funds, high-grade corporate bonds,
certificates of deposit 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 December 31, 2003. See
Note 3 to the Consolidated Financial Statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and related financial information required to
be filed hereunder are indexed under Item 15 of this report and are incorporated
herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH AUDITORS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
(a) As of the end of the period covered by this Annual Report on Form
10-K, the effectiveness of our disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of
1934) was evaluated by our management, with the participation of our Chief
Executive Officer and our Chief Financial Officer. We have concluded that our
disclosure controls and procedures are effective, as of the end of the period
covered by this Report, to help ensure that information we are required to
disclose in reports that we file with the SEC is accumulated and communicated to
management and recorded, processed, summarized and reported within the time
periods prescribed by the SEC.
(b) There were no changes in our internal control over financial
reporting that occurred during our last fiscal quarter (the quarter ended
December 31, 2003) that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
68
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Except as provided below, the information required by this Item is
incorporated by reference from the information under the captions entitled
"Election of Directors-Nominees," "Executive Officers" and "Section 16(a)
Beneficial Ownership Reporting Compliance" in our definitive proxy statement to
be filed with the SEC no later than April 29, 2004.
CODE OF CONDUCT.
Acacia Research Corporation has adopted a Code of Conduct that applies
to all of its employees, including its chief executive officer, chief financial
and accounting officer, president and any persons performing similar functions.
Our Code of Conduct is provided on our internet website at
www.acaciaresearch.com.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference from
the information under the caption entitled "Executive Officer Compensation and
Other Information" in our definitive proxy statement to be filed with the SEC no
later than April 29, 2004.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference from
the information under the caption entitled "Security Ownership of Certain
Beneficial Owners and Management" in our definitive proxy statement to be filed
with the SEC no later than April 29, 2004.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference from
the information under the caption entitled "Certain Transactions" in our
definitive proxy statement to be filed with the SEC no later than April 29,
2004.
ITEM 14. PRINICPAL ACCOUNTING FEES AND SERVICES
The information required by this Item is incorporated by reference from
the information under the caption entitled "Audit Committee Report" in our
definitive proxy statement to be filed with the SEC no later than April 29,
2004.
69
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report.
(1) Financial Statements
Acacia Research Corporation Consolidated Financial Statements PAGE
----
Report of Independent Auditors..................................................F-1
Consolidated Balance Sheets as of December 31, 2003 and 2002....................F-2
Consolidated Statements of Operations and Comprehensive Loss
for the Years Ended December 31, 2003, 2002 and 2001..........................F-3
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 2003, 2002 and 2001........................................F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2003, 2002 and 2001..............................................F-6
Notes to Consolidated Financial Statements......................................F-7
*CombiMatrix Group Financial Statements PAGE
(A Division of Acacia Research Corporation) ----
Report of Independent Auditors..................................................F-41
Balance Sheets as of December 31, 2003 and 2002.................................F-42
Statements of Operations
for the Years Ended December 31, 2003, 2002 and 2001..........................F-43
Statements of Allocated Net Worth for the Years
Ended December 31, 2003, 2002 and 2001........................................F-44
Statements of Cash Flows for the Years Ended
December 31, 2003, 2002 and 2001..............................................F-45
Notes to Financial Statements...................................................F-46
*Acacia Technologies Group Financial Statements PAGE
(A Division of Acacia Research Corporation) ----
Report of Independent Auditors..................................................F-61
Balance Sheets as of December 31, 2003 and 2002.................................F-62
Statements of Operations
for the Years Ended December 31, 2003, 2002 and 2001..........................F-63
Statements of Allocated Net Worth for the Years
Ended December 31, 2003, 2002 and 2001........................................F-64
Statements of Cash Flows for the Years Ended
December 31, 2003, 2002 and 2001..............................................F-65
Notes to Financial Statements...................................................F-66
*NOTE: We are presenting, the Acacia Research Corporation consolidated financial
statements and the separate financial statements for the CombiMatrix group and
the Acacia Technologies group. The separate financial statements and
accompanying notes of the two groups are being provided as additional disclosure
regarding the financial performance of the two divisions and to provide
investors with information regarding the potential value and operating results
of the respective businesses, which may affect the respective share values. The
separate financial statements should be reviewed in conjunction with Acacia
Research Corporation's consolidated financial statements and accompanying notes.
The presentation of separate financial statements is not intended to indicate
that we have changed the title to any of our assets or changed the
responsibility for any of our liabilities, nor is it intended to indicate that
the rights of our creditors have been changed. Acacia Research Corporation, and
not the individual groups, is the issuer of the securities. Holders of the two
securities are stockholders of Acacia Research Corporation and do not have a
separate and exclusive interest in the respective groups.
70
(2) Financial Statement Schedules
Financial statement schedules are omitted because they are not applicable
or the required information is shown in the Financial Statements or the
Notes thereto.
(3) Exhibits. The following exhibits are either filed herewith or incorporated
herein by reference:
EXHIBIT
NUMBER DESCRIPTION
------ -----------
2.1 Agreement and Plan of Merger of Acacia Research Corporation, a
California corporation, and Acacia Research Corporation, a Delaware
corporation, dated as of December 23, 1999 (1)
2.2 Agreement and Plan of Reorganization by and among Acacia Research
Corporation, Combi Acquisition Corp. and CombiMatrix Corporation
dated as of March 20, 2002 (attached as Annex A to the
Prospectus/Proxy Statement included in this Registration Statement)
3.1 Restated Certificate of Incorporation (2)
3.2 Amended and Restated Bylaws (3)
4.1 Form of Specimen Certificate of Acacia's Common Stock (4)
10.1 Acacia Research Corporation1993 Stock Option Plan (5)
10.2 Form of Stock Option Agreement for Acacia Research Corporation1993
Stock Option Plan (5)
10.3 Acacia Research Corporation1996 Stock Option Plan, as amended (6)
10.4 Form of Option Agreement constituting the Acacia Research
Corporation1996 Executive Stock Bonus Plan (7)
10.5 CombiMatrix Corporation 1995 Stock Option Plan (8)
10.6 CombiMatrix Corporation 1998 Stock Option Plan (8)
10.7 CombiMatrix Corporation 2000 Stock Awards Plan (8)
10.8 2002 CombiMatrix Stock Incentive Plan (9)
10.9 2002 Acacia Technologies Stock Incentive Plan (10)
10.10 Agreement between Acacia Research Corporation and Paul Ryan (11)
10.11 Lease Agreement dated April 30, 1998, between Acacia Research
Corporation and EOP-Pasadena Towers, L.L.C., a Delaware limited
liability company doing business as EOP-Pasadena, LLC (12)
10.12 Lease Agreement between Soundbreak.com Incorporated and 8730 Sunset
Towers and related Guaranty (13)
10.13 First Amendment dated June 26, 2000, to Lease Agreement between
Acacia Research Corporation and Pasadena Towers, L.L.C. (14)
10.14 Sublease dated November 30, 2001, between Acacia Research
Corporation and Jenkens & Gilchrist (14)
10.15 Lease Agreement dated January 28, 2002, between Acacia Research
Corporation and The Irvine Company (14)
10.16 Settlement Agreement dated September 30, 2002, by and among Acacia
Research Corporation, CombiMatrix Corporation, Donald D. Montgomery,
Ph.D. and Nanogen, Inc.(8)
10.17+ Research & Development Agreement dated September 25, 2002, between
CombiMatrix Corporation and Roche Diagnostics GmbH(8)
10.18+ License Agreement dated September 25, 2002 between CombiMatrix
Corporation and Roche Diagnostics GmbH(8)
10.19 Form of Indemnification Agreement
21.1 List of Subsidiaries
23.1 Consent of PricewaterhouseCoopers LLP (relating to the financial
statements of Acacia Research Corporation)
23.2 Consent of PricewaterhouseCoopers LLP (relating to the financial
statements of CombiMatrix Corporation)
23.3 Consent of PricewaterhouseCoopers LLP (relating to the financial
statements of the Acacia Technologies group and the CombiMatrix
group)
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
32.1 Certification 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 Certification 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
- ----------------------------
71
+ Portions of this exhibit have been omitted pursuant to a request for
confidential treatment and have been filed separately with the United
States Securities and Exchange Commission.
(1) Incorporated by reference from Acacia Research Corporation's Report on Form
8-K filed on December 30, 1999 (SEC File No. 000-26068).
(2) Incorporated by reference as Appendix B to the Proxy Statement/Prospectus
which formed part of Acacia Research Corporation's Registration Statement
on Form S-4 (SEC File No. 333-87654) which became effective on November 8,
2002.
(3) Incorporated by reference from Acacia Research Corporation's Quarterly
Report on Form 10-Q filed on August 10, 2001 (SEC File No. 000-26068).
(4) Incorporated by reference from Amendment No. 2 on Form 8-A/A filed on
December 30, 1999 (SEC File No. 000-26068).
(5) Incorporated by reference from Acacia Research Corporation's Registration
Statement on Form SB-2 (33-87368-L.A.), which became effective under the
Securities Act of 1933, as amended, on June 15, 1995.
(6) Incorporated by reference as Appendix A to the Definitive Proxy Statement
on Schedule 14A filed on April 10, 2000 (SEC File No. 000-26068).
(7) Incorporated by reference from Acacia Research Corporation's Definitive
Proxy as Appendix A Statement on Schedule 14A filed on April 26, 1996 (SEC
File No. 000-26068).
(8) Incorporated by reference to Acacia Research Corporation's Registration
Statement on Form S-4 (SEC File No. 333-87654) which became effective on
November 8, 2002.
(9) Incorporated by reference as Appendix D to the Proxy Statement/Prospectus
which formed part of Acacia Research Corporation's Registration Statement
on Form S-4 (SEC File No. 333-87654) which became effective on November 8,
2002.
(10) Incorporated by reference as Appendix E to the Proxy Statement/Prospectus
which formed part of Acacia Research Corporation's Registration Statement
on Form S-4 (SEC File No. 333-87654) which became effective on November 8,
2002.
(11) Incorporated by reference from Acacia Research Corporation's Annual Report
on Form 10-K for the year ended December 31, 1997, filed on March 30, 1998
(SEC File No. 000-26068).
(12) Incorporated by reference to Acacia Research Corporation's Quarterly Report
on Form 10-Q filed on August 14, 1998 (SEC File No. 000-26068).
(13) Incorporated by reference to Acacia Research Corporation's Quarterly Report
on Form 10-Q filed on November 15, 1999 (SEC File No. 000-26068).
(14) Incorporated by reference from Acacia Research Corporation's Annual Report
on Form 10-K for the year ended December 31, 2001 filed on March 27, 2002
(SEC File No. 000-26068). (b) Reports on Form 8-K filed during the quarter
ended December 31, 2002.
(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 December 31, 2003. The report,
dated October 22, 2003, contained Acacia Research Corporation's press release
announcing its earnings for the third quarter of 2003.
72
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DATED: March 3, 2004 ACACIA RESEARCH CORPORATION
/s/ Paul R. Ryan
---------------------------
Paul R. Ryan
CHAIRMAN OF THE BOARD
AND CHIEF EXECUTIVE OFFICER
(AUTHORIZED SIGNATORY)
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Paul R. Ryan Chairman of the Board and March 3, 2004
- ----------------------------------- Chief Executive Officer
Paul R. Ryan (Principal Chief Executive)
/s/ Robert L. Harris, II Director and President March 3, 2004
- -----------------------------------
Robert L. Harris, II
/s/ Clayton J. Haynes Chief Financial Officer March 3, 2004
- ----------------------------------- (Principal Financial Officer)
Clayton J. Haynes
/s/ Thomas B. Akin Director March 3, 2004
- -----------------------------------
Thomas B. Akin
/s/ Fred A. de Boom Director March 3, 2004
- -----------------------------------
Fred A. de Boom
/s/ Edward W. Frykman Director March 3, 2004
- -----------------------------------
Edward W. Frykman
/s/ G. Louis Graziadio, III Director March 3, 2004
- -----------------------------------
G. Louis Graziadio, III
/s/ Amit Kumar, Ph.D. Director March 3, 2004
- -----------------------------------
Amit Kumar, Ph.D.
/s/ Rigdon Currie Director March 3, 2004
- -----------------------------------
Rigdon Currie
73
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and
Stockholders of Acacia Research Corporation
In our opinion, the consolidated financial statements listed in the
index appearing under Item 15(a)(1) on page 70 present fairly, in all material
respects, the financial position of Acacia Research Corporation and its
subsidiaries at December 31, 2003 and 2002, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 2003, in conformity with accounting principles generally accepted in the
United States of America. These financial statements are the responsibility of
Acacia Research Corporation's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Los Angeles, California
February 27, 2004
F-1
ACACIA RESEARCH CORPORATION
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2003 AND 2002
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION)
2003 2002
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents ......................................................... $ 31,949 $ 43,083
Short-term investments ............................................................ 18,551 11,605
Accounts receivable, net of allowance for doubtful accounts of $145 (2003)
and $0 (2002) .................................................................. 323 578
Prepaid expenses, inventory, and other assets ..................................... 1,180 1,221
------------- -------------
Total current assets ......................................................... 52,003 56,487
Property and equipment, net of accumulated depreciation ............................... 2,823 4,075
Patents, net of accumulated amortization of $9,210 (2003) and $7,613 (2002) .......... 13,683 15,280
Goodwill .............................................................................. 21,200 20,693
Other assets .......................................................................... 331 536
------------- -------------
$ 90,040 $ 97,071
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued expenses and other ...................................... $ 3,244 $ 4,826
Current portion of deferred revenues .............................................. 18,108 10,675
------------- -------------
Total current liabilities .................................................... 21,352 15,501
Deferred income taxes ................................................................. 3,260 3,540
Deferred revenues, net of current portion ............................................. 3,901 --
------------- -------------
Total liabilities ............................................................ 28,513 19,041
------------- -------------
Minority interests .................................................................... 1,127 2,171
------------- -------------
Commitments and contingencies (Note 14)
Redeemable 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; 19,739,984 and 19,640,808 shares issued
and outstanding as of
December 31, 2003 and December 31, 2002, respectively ......................... 20 20
Acacia Research - CombiMatrix stock, par value $0.001 per share; 50,000,000
shares authorized; 26,328,122 and 22,964,779 shares issued and outstanding
as of December 31, 2003 and December 31, 2002, respectively ................... 26 23
Additional paid-in capital ........................................................ 244,517 238,826
Deferred stock compensation ....................................................... (766) (4,023)
Accumulated comprehensive loss .................................................... 8 (2)
Accumulated deficit ............................................................... (183,405) (158,985)
------------- -------------
Total stockholders' equity ................................................... 60,400 75,859
------------- -------------
$ 90,040 $ 97,071
============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
F-2
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION)
2003 2002 2001
---------- ---------- ----------
Revenues:
License fee income .................................................... $ 692 $ 43 $ 24,180
Product revenue ....................................................... 407 306 --
Grant and contract revenue ............................................ 49 533 456
---------- ---------- ----------
Total revenues ........................................................ 1,148 882 24,636
---------- ---------- ----------
Operating expenses:
Cost of sales ............................................................. 99 263 --
Research and development expenses ......................................... 8,098 18,187 11,656
Charge for acquired in-process research and development ................... -- 17,237 --
Non-cash stock compensation expense - research and development ............ 466 1,868 7,183
Marketing, general and administrative expenses ............................ 14,917 18,632 32,664
Non-cash stock compensation expense - marketing,
general and administrative .............................................. 1,189 4,559 13,636
Amortization of patents and goodwill ...................................... 1,597 1,990 2,695
Legal settlement charges .................................................. 144 18,471 --
---------- ---------- ----------
Total operating expenses ............................................. 26,510 81,207 67,834
---------- ---------- ----------
Operating loss ....................................................... (25,362) (80,325) (43,198)
---------- ---------- ----------
Other income (expense) :
Impairment of cost method investment ...................................... (207) (2,748) --
Interest income ........................................................... 735 1,209 3,762
Realized gains (losses) on short-term investments ......................... 94 (1,184) 350
Unrealized (losses) gains on short-term investments ....................... -- (249) 237
Interest expense .......................................................... -- (203) (65)
Equity in losses of affiliate ............................................. -- -- (195)
Other income .............................................................. -- 64 77
---------- ---------- ----------
Total other income (expenses) ........................................ 622 (3,111) 4,166
---------- ---------- ----------
Loss from continuing operations before income taxes and minority interests .... (24,740) (83,436) (39,032)
Benefit (provision) for income taxes .......................................... 273 857 (780)
---------- ---------- ----------
Loss from continuing operations before minority interests ..................... (24,467) (82,579) (39,812)
Minority interests ............................................................ 47 23,806 17,540
---------- ---------- ----------
Loss from continuing operations ............................................... (24,420) (58,773) (22,272)
Discontinued operations:
Estimated loss on disposal of Soundbreak.com .............................. -- (200) --
---------- ---------- ----------
Net loss ...................................................................... (24,420) (58,973) (22,272)
Unrealized losses on short-term investments ............................... (25) (38) (9)
Unrealized gains (losses) on foreign currency translation ................. 35 40 (72)
---------- ---------- ----------
Comprehensive loss ............................................................ $ (24,410) $ (58,971) $ (22,353)
========== ========== ==========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
F-3
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION)
2003 2002 2001
------------- ------------- -------------
Loss per common share:
Attributable to the Acacia Technologies group:
Loss from continuing operations ................ $ (5,451) $ (12,554) $ --
Basic and diluted per share .................. (0.28) (0.64) --
Loss from discontinued operations .............. -- (200) --
Basic and diluted per share .................. -- (0.01) --
Net loss ....................................... (5,451) (12,754) --
Basic and diluted per share .................. (0.28) (0.65) --
Attributable to the CombiMatrix group:
Net loss ....................................... $ (18,969) $ (46,219) $ --
Basic and diluted per share .................. (0.76) (2.01) --
Acacia Research Corporation:
Net loss ....................................... $ -- $ -- $ (22,272)
Basic and diluted per share .................. -- -- (1.16)
Weighted average shares - basic and diluted:
Acacia Research - Acacia Technologies stock .... 19,661,655 19,640,808 --
============= ============= =============
Acacia Research - CombiMatrix stock ............ 24,827,819 22,950,746 --
============= ============= =============
Acacia Research Corporation .................... -- -- 19,259,256
============= ============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
F-4
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
Acacia AR-Acacia AR-Combi- Acacia AR-Acacia AR-Combi-
Research Technologies Matrix Research Technologies Matrix
Corporation Redeemable Redeemable Corporation Redeemable Redeemable
Common Shares Common Common Common Stock Common Common
(Predecessor) Shares Shares (Predecessor) Stock Stock
------------- ------------ ------------ ------------ ------------ ------------
2001
Balance at December 31, 2000 ...................... 16,090,587 -- -- $ 16 $ -- $ --
Net loss .......................................... -- -- -- -- -- --
Units issued in private placement, net ............ 1,127,274 -- -- 1 -- --
Stock options exercised ........................... 596,888 -- -- 1 -- --
Increase in capital due to issuance of stock
by subsidiaries ................................. -- -- -- -- -- --
Compensation expense relating to stock
options and warrants ............................ -- -- -- -- -- --
Stock dividend (Note 1 and 8) ..................... 1,777,710 -- -- 2 -- --
Unrealized loss on short-term investments ......... -- -- -- -- -- --
Unrealized loss on foreign currency translation ... -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 2001 ...................... 19,592,459 -- -- 20 -- --
2002
Net loss .......................................... -- -- -- -- -- --
Stock options exercised ........................... 48,349 -- -- -- -- --
Decrease in capital due to issuance of stock
by subsidiaries ................................. -- -- -- -- -- --
Compensation expense relating to stock options .... -- -- -- -- -- --
Unrealized loss on short-term investments ......... -- -- -- -- -- --
Unrealized gain on foreign currency translation ... -- -- -- -- -- --
Dividends paid by subsidiary ...................... -- -- -- -- -- --
Stock cancellation due to recapitalization ........ (19,640,808) -- -- (20) -- --
Stock issuance due to recapitalization ............ -- 19,640,808 10,963,499 -- 20 11
Stock issuance related to acquisition of
additional CombiMatrix Corporation shares ....... -- -- 11,987,052 -- -- 12
Stock options exercised ........................... -- -- 14,228 -- -- --
Compensation expense relating to stock options .... -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 2002 ...................... -- 19,640,808 22,964,779 -- 20 23
2003
Net loss .......................................... -- -- -- -- -- --
Stock options exercised ........................... -- 99,176 253,036 -- -- --
Warrants exercised ................................ -- -- 163,637 -- -- --
Employee stock grant .............................. -- -- 18,000 -- -- --
Units issued in private placement, net ............ -- -- 2,416,502 -- -- 2
Deferred stock compensation ....................... -- -- -- -- -- --
Compensation expense relating to stock options .... -- -- -- -- -- --
Stock option cancellations ........................ -- -- -- -- -- --
Unrealized loss on short-term investments ......... -- -- -- -- -- --
Unrealized gain on foreign currency translation ... -- -- -- -- -- --
Legal settlement (see Note 14) .................... -- -- 16,378 -- -- --
Stock issuance related to acquisitions (see Note 8) -- -- 495,790 -- -- 1
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 2003 ...................... -- 19,739,984 26,328,122 $ -- $ 20 $ 26
============ ============ ============ ============ ============ ============
(CONTINUED ON NEXT PAGE)
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
Additional Deferred
Paid-in Stock Accumulated Comprehensive
Capital Compensation Deficit Income (Loss) Total
------------ ------------ ------------ ------------ ------------
2001
Balance at December 31, 2000 ...................... $ 116,103 $ -- $ (56,052) $ 77 $ 60,144
Net loss .......................................... -- -- (22,272) -- (22,272)
Units issued in private placement, net ............ 18,360 -- -- -- 18,361
Stock options exercised ........................... 1,251 -- -- -- 1,252
Increase in capital due to issuance of stock
by subsidiaries ................................. 1,283 -- -- -- 1,283
Compensation expense relating to stock
options and warrants ............................ 47 -- -- -- 47
Stock dividend (Note 1 and 8) ..................... 21,684 -- (21,688) -- (2)
Unrealized loss on short-term investments ......... -- -- -- (9) (9)
Unrealized loss on foreign currency translation ... -- -- -- (72) (72)
------------ ------------ ------------ ------------ ------------
Balance at December 31, 2001 ...................... 158,728 -- (100,012) (4) 58,732
2002
Net loss .......................................... -- -- (58,973) -- (58,973)
Stock options exercised ........................... 136 -- -- -- 136
Decrease in capital due to issuance of stock
by subsidiaries ................................. (550) -- -- -- (550)
Compensation expense relating to stock options .... 19 -- -- -- 19
Unrealized loss on short-term investments ......... -- -- -- (38) (38)
Unrealized gain on foreign currency translation ... -- -- -- 40 40
Dividends paid by subsidiary ...................... (11) -- -- -- (11)
Stock cancellation due to recapitalization ........ 20 -- -- -- --
Stock issuance due to recapitalization ............ (31) -- -- -- --
Stock issuance related to acquisition of
additional CombiMatrix Corporation shares ....... 80,370 (4,207) -- -- 76,175
Stock options exercised ........................... 29 -- -- -- 29
Compensation expense relating to stock options .... 116 184 -- -- 300
------------ ------------ ------------ ------------ ------------
Balance at December 31, 2002 ...................... 238,826 (4,023) (158,985) (2) 75,859
2003
Net loss .......................................... -- -- (24,420) -- (24,420)
Stock options exercised ........................... 692 -- -- -- 692
Warrants exercised ................................ 450 -- -- -- 450
Employee stock grant .............................. 60 -- -- -- 60
Units issued in private placement, net ............ 4,860 -- -- -- 4,862
Deferred stock compensation ....................... 11 (11) -- -- --
Compensation expense relating to stock options .... 24 1,825 -- -- 1,849
Stock option cancellations ........................ (1,699) 1,443 -- -- (256)
Unrealized loss on short-term investments ......... -- -- -- (25) (25)
Unrealized gain on foreign currency translation ... -- -- -- 35 35
Legal settlement (see Note 14) .................... 75 -- -- -- 75
Stock issuance related to acquisitions (see Note 8) 1,218 -- -- -- 1,219
------------ ------------ ------------ ------------ ------------
Balance at December 31, 2003 ...................... $ 244,517 $ (766) $ (183,405) $ 8 $ 60,400
============ ============ ============ ============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
F-5
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(IN THOUSANDS)
2003 2002 2001
------------ ------------ ------------
Cash flows from operating activities:
Net loss from continuing operations ............................................ $ (24,420) $ (58,773) $ (22,272)
Adjustments to reconcile net loss from continuing operations
to net cash used in operating activities:
Depreciation and amortization ........................................... 3,025 3,533 3,869
Equity in losses of affiliate ........................................... -- -- 195
Minority interests ...................................................... (47) (23,806) (17,540)
Non-cash stock compensation expense ..................................... 1,655 6,427 20,819
Charge for acquired in-process research and development ................. -- 17,237 --
Deferred tax benefit .................................................... (280) (289) (182)
Write-off of other assets ............................................... -- -- 918
Net sales (purchases) of trading securities ............................. -- 4,124 (4,135)
Unrealized losses (gains) on short-term investments ..................... -- 249 (237)
Issuance of common stock by subsidiary - legal settlement charge ........ -- 17,471 --
Impairment of cost method investment .................................... 207 2,748 --
Other ................................................................... 29 99 354
Changes in assets and liabilities:
Accounts receivable ..................................................... 255 (435) (143)
Prepaid expenses, inventory and other assets ............................ 124 257 (570)
Accounts payable, accrued expenses and other ............................ (1,056) (143) 1,085
Deferred revenues ....................................................... 11,334 11,640 7,460
------------ ------------ ------------
Net cash used in operating activities from continuing operations ........ (9,174) (19,661) (10,379)
Net cash used in operating activities from discontinued operations ...... (551) (905) (2,182)
------------ ------------ ------------
Net cash used in operating activities ................................... (9,725) (20,566) (12,561)
------------ ------------ ------------
Cash flows from investing activities:
Purchase of additional equity in consolidated subsidiaries .............. -- (200) (3,304)
Purchase of property and equipment, net ................................. (86) (1,080) (3,775)
Sale of property and equipment .......................................... -- 361 --
Proceeds from sale and leaseback arrangement ............................ -- -- 3,000
Purchase of available-for-sale investments .............................. (37,773) (11,338) (56,686)
Sale of available-for-sale investments .................................. 30,801 20,383 76,275
Purchase of common stock from minority stockholders of subsidiaries ..... -- (217) (2,550)
Acquisition costs ....................................................... -- (834) --
Other ................................................................... -- (100) --
------------ ------------ ------------
Net cash (used in) provided by investing activities from continuing
operations ........................................................... (7,058) 6,975 12,960
Net cash used in investing activities from discontinued operations ...... (356) (3) (145)
------------ ------------ ------------
Net cash (used in) provided by investing activities ..................... (7,414) 6,972 12,815
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from sale of common stock, net of issuance costs ............... 4,862 -- 18,349
Proceeds from the exercise of stock options and warrants ................ 1,142 242 1,774
Capital contributions from minority shareholders of subsidiaries,
net of issuance costs ................................................ -- 300 3,257
Capital distributions to minority shareholders of subsidiaries,
net of issuance costs ................................................ -- (618) --
Repayment of capital lease obligation ................................... -- (2,779) (221)
Other ................................................................... 14 (11) --
------------ ------------ ------------
Net cash provided by (used in) financing activities ..................... 6,018 (2,866) 23,159
------------ ------------ ------------
Effect of exchange rate on cash .................................................. (13) 92 (125)
------------ ------------ ------------
(Decrease) increase in cash and cash equivalents ................................. (11,134) (16,368) 23,288
Cash and cash equivalents, beginning ............................................. 43,083 59,451 36,163
------------ ------------ ------------
Cash and cash equivalents, ending ................................................ $ 31,949 $ 43,083 $ 59,451
============ ============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
F-6
ACACIA RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Acacia Research Corporation ("we," "us" and "our") is comprised of two
operating groups.
Our life sciences business, referred to as the "CombiMatrix group," is
comprised of our wholly owned subsidiary, CombiMatrix Corporation and
CombiMatrix Corporation's majority-owned subsidiary, Advanced Material Sciences,
Inc. ("Advanced Material Sciences") and wholly owned subsidiary, CombiMatrix
K.K. CombiMatrix Corporation is a life sciences technology company with a
proprietary system for rapid, cost competitive creation of DNA and other
compounds on a programmable semiconductor chip. This proprietary technology has
applications in the areas of genomics, proteomics, biosensors, drug discovery,
drug development, diagnostics, combinatorial chemistry, material sciences and
nanotechnology. 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., a wholly
owned Japanese corporation located in Tokyo, is exploring opportunities for
CombiMatrix Corporation's active array system with pharmaceutical and
biotechnology companies in the Asian market.
Our intellectual property licensing business, referred to as the
"Acacia Technologies group," acquires, develops and licenses intellectual
property, and is comprised primarily of Acacia Research Corporation's wholly
owned subsidiaries, Acacia Media Technologies Corporation ("Acacia Media
Technologies") and Soundview Technologies, Inc. ("Soundview Technologies"). The
Acacia Technologies group is responsible for the development, acquisition,
licensing and protection of intellectual property and proprietary technologies
and is pursuing additional licensing and strategic business alliances with
leading companies in the rapidly growing intellectual property licensing
industry.
The Acacia Technologies group owns and out-licenses a portfolio of
pioneering U.S. and foreign patents covering digital audio and video
transmission and receiving systems, commonly known as audio-on-demand,
video-on-demand, and audio/video streaming. The Acacia Technologies group's
patented proprietary digital media transmission ("DMT") technology, enables the
digitization, encryption, storage, transmission, receipt and playback of digital
content via several means including the Internet, cable, satellite and wireless
systems. We believe our DMT technology is utilized by a variety of companies in
activities including digital ad insertion, cable programming, satellite
programming, hotel in-room entertainment services, distance learning, and other
Internet programming involving digital audio/video content. Our DMT technology
is protected by five U.S. patents which expire in 2011 and 31 foreign patents
which expire in 2012. The Acacia Technologies group also owns and has
out-licensed to consumer electronics manufacturers, patented technology known as
the V-chip. The V-chip technology was protected by U.S. Patent No. 4,554,584,
which expired in July 2003. 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.
We were incorporated on January 25, 1993 under the laws of the State of
California. In December 1999, we changed our state of incorporation from
California to Delaware.
LIQUIDITY AND RISKS
To date, we and our subsidiaries have relied primarily upon selling
equity securities and payments from our strategic partners and licensees to
generate the funds needed to finance the implementation of our plans of
operation for our subsidiaries. Management believes that our cash and cash
equivalent balances, anticipated cash flow from operations and other external
sources of available credit will be sufficient to meet our cash requirements
through at least the next twelve months. We may be required to obtain additional
financing. We cannot assure that additional funding will be available on
favorable terms, if at all. If we fail to obtain additional funding when needed,
we may not be able to execute our business plans and our businesses may suffer.
Our business operations are also subject to certain risks and uncertainties,
including:
F-7
o market acceptance of products and services;
o technological advances that may make our products and services obsolete
or less competitive;
o increases in operating costs, including costs for supplies, personnel
and equipment;
o the availability and cost of capital;
o general economic conditions; and
o governmental regulation that may restrict our subsidiaries businesses.
The CombiMatrix group is deploying unproven technologies and continues
to develop its commercial products. The CombiMatrix group has historically been
substantially dependent on its arrangements with strategic partners including
Roche Diagnostics GmbH ("Roche"), and has relied upon payments by Roche and
other partners for a majority of its future revenues. The CombiMatrix group
expends a majority of its resources toward fulfilling its contractual
obligations under the Roche agreements. Roche's primary service to the
CombiMatrix group is to distribute and proliferate its technology platform. The
CombiMatrix group will need to enter into additional strategic partnerships to
develop and commercialize future products. However, there can be no assurance
that the CombiMatrix group will be able to implement its future plans. Failure
by management to achieve its plans would have a material adverse effect on the
CombiMatrix group's and Acacia Research Corporation's ability to achieve its
intended business objectives. The CombiMatrix group's success also depends on
its ability to protect its intellectual property.
Until 2003, the Acacia Technologies group generated substantially all
of its revenues from licensing the Acacia Technologies group's patented V-chip
technology to television manufacturers. The V-chip patent 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 the
patent, but it may still collect revenues from the sale of such televisions in
the United States before the expiration date. The Acacia Technologies group is
marketing and commercially licensing its DMT technology and is currently
developing additional technologies. However, there can be no assurance that the
Acacia Technologies group will be able to implement its future plans. Failure by
management to achieve its plans would have a material adverse effect on the
Acacia Technologies group and on Acacia Research Corporation's ability to
achieve its intended business objectives. The Acacia Technologies group's
success also depends on its ability to enforce and protect its intellectual
property.
RECAPITALIZATION AND MERGER TRANSACTIONS
On December 11, 2002, our stockholders voted in favor of a
recapitalization transaction, which became effective on December 13, 2002,
whereby we created two new classes of common stock called Acacia
Research-CombiMatrix stock ("AR-CombiMatrix stock") and Acacia Research-Acacia
Technologies stock ("AR-Acacia Technologies stock"), and divided our existing
Acacia Research Corporation common stock into shares of the two new classes of
common stock. AR-CombiMatrix stock is intended to reflect separately the
performance of Acacia Research Corporation's CombiMatrix group. AR-Acacia
Technologies stock is intended to reflect separately the performance of Acacia
Research Corporation's Acacia Technologies group. Although the AR-CombiMatrix
stock and the AR-Acacia Technologies stock are intended to reflect the
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.
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.
All share and per share information in the consolidated financial
statements and accompanying notes to the consolidated financial statements,
unless otherwise noted, give effect to the recapitalization as of January 1,
2002. Share and per share information is excluded for the AR-CombiMatrix stock
and the AR-Acacia Technologies stock for all periods prior to 2002 as the Acacia
Research-Acacia Technologies stock and Acacia Research-CombiMatrix stock were
not part of Acacia Research Corporation's capital structure prior to 2002.
F-8
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ACCOUNTING PRINCIPLES AND FISCAL YEAR END. The consolidated financial
statements and accompanying notes are prepared on the accrual basis of
accounting in accordance with generally accepted accounting principles in the
United States of America. We have a December 31 year end.
PRINCIPLES OF CONSOLIDATION. The accompanying consolidated financial
statements include the accounts of Acacia Research Corporation and its wholly
owned and majority-owned subsidiaries. Investments for which Acacia Research
Corporation possesses the power to direct or cause the direction of the
management and policies, either through majority ownership or other means, are
accounted for under the consolidation method. Material intercompany transactions
and balances have been eliminated in consolidation. Investments in companies in
which we maintain an ownership interest of 20% to 50% or exercise significant
influence over operating and financial policies are accounted for under the
equity method. The cost method is used where we maintain ownership interests of
less than 20% and do not exercise significant influence over the investee.
REVENUE RECOGNITION. We recognize revenue in accordance with Staff
Accounting Bulletin No. 104, "Revenue Recognition" ("SAB No. 104") and related
authoritative pronouncements. Revenues from multiple-element arrangements are
accounted for in accordance with Emerging Issues Task Force ("EITF") Issue
00-21, "Revenue Arrangements with Multiple Deliverables." Revenue is recognized
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.
ACACIA TECHNOLOGIES GROUP
Under the terms of our DMT license agreements, the Acacia Technologies
group grants an annual non-exclusive license for the use of its patented DMT
technology. In most instances, our license agreements provide for recurring
royalty payments for each year that the license agreements are in effect through
the expiration of the patents. Pursuant to the terms of our DMT license
agreements, once executed, the Acacia Technologies group has no further
obligations with respect to the grant of the annual license each year. License
fees paid to and recognized as revenue by the Acacia Technologies group are
non-refundable.
PER UNIT ROYALTIES. Revenue generated from license agreements that
provide for the calculation of royalties on a per-unit basis are accrued and
recognized as revenue in the period earned, provided that amounts are fixed or
determinable and collectibility is reasonably assured.
PERCENTAGE OF LICENSEE SALES ROYALTIES. Certain license agreements
provide for the calculation of license fees based on a licensee's actual
quarterly sales applied to a contractual royalty rate. Licensees that pay
license fees on a quarterly basis generally report actual quarterly sales
information and related quarterly license fees due to the Acacia Technologies
group within 30 to 45 days after the end of the quarter in which such activity
takes place. Consequently, the Acacia Technologies group recognizes revenue from
these licensing agreements on a three-month lag basis, in the quarter following
the quarter of sales, provided amounts are fixed or determinable and
collectibility is reasonably assured. The lag method described above allows for
the receipt of licensee royalty reports prior to the recognition of revenue.
MINIMUM UPFRONT ANNUAL ROYALTIES. Certain license agreements provide
for the calculation and payment of a minimum upfront annual license fee, based
upon a licensee's expected annual sales during each annual license term. These
license fee payments are deferred and amortized to revenue on a straight-line
basis over the annual license term. To the extent actual annual royalties
reported at the conclusion of each annual license term exceed the amount
prepaid, the additional royalties are recognized in revenue in the quarter
following the annual license term provided that amounts are fixed or
determinable and collectibility is reasonably assured.
License fee payments received by the Acacia Technologies group that do
not meet the revenue recognition criteria described above are deferred until the
revenue recognition criteria are met. The Acacia Technologies group assesses
collection of accrued license fees based on a number of factors, including past
transaction history and credit-worthiness. If it is determined that collection
F-9
is not reasonably assured, the fee is recognized when collectibility becomes
reasonably assured, assuming all other revenue recognition criteria have been
met, which is generally upon receipt of cash.
As a result of our licensing and any related intellectual property
enforcement activities that we choose to conduct, we may recognize royalty
revenues that relate to prior period infringements by licensees. Differences
between amounts initially recognized and amounts subsequently audited or
reported as an adjustment to those amounts will be recognized in the period the
adjustment is determined as a change in accounting estimate.
COMBIMATRIX GROUP
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
delivery has occurred or services have been rendered.
Revenues from multiple-element arrangements involving license fees,
up-front payments and milestone payments, which are received and/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 will be recognized as revenue in future periods when the applicable
revenue recognition criteria as described above are met.
CASH AND CASH EQUIVALENTS. We consider all highly liquid, short-term
investments with original maturities of three months or less when purchased to
be cash equivalents.
SHORT-TERM INVESTMENTS. Our short-term investments are held in a
variety of interest bearing instruments including high-grade corporate bonds,
commercial paper and other marketable securities. Investments in securities with
original maturities of greater than three months and less than one year are
classified as short-term investments. Investments are classified into categories
in accordance with the provisions of Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS No. 115"). At December 31, 2003 and 2002, all of our
investments are classified as available-for-sale, which are reported at fair
value with related unrealized gains and losses in the value of such securities
recorded as a separate component of comprehensive income (loss) in stockholders'
equity until realized. During 2002 and 2001, certain of our investments were
classified as trading securities. Realized and unrealized gains and losses in
the value of trading securities are included in net loss in the consolidated
statements of operations and comprehensive loss.
The fair value of our investments is determined by quoted market
prices. Realized and unrealized gains and losses are recorded based on the
specific identification method. For investments classified as
available-for-sale, unrealized losses that are other than temporary are
recognized in net loss.
The cost of debt securities is adjusted for amortization of premiums
and accretion of discounts to maturity. Such amortization is included in
interest income (expense). Interest and dividends on all securities are included
in interest income.
CONCENTRATION OF CREDIT RISKS. Cash and cash equivalents are invested
in deposits with certain financial institutions and may, at times, exceed
federally insured limits. We have not experienced any losses on our deposits of
cash and cash equivalents.
One licensee accounted for approximately 28% of Acacia Research
Corporation's license fee revenues recognized during the year ended December 31,
2003, and also represents approximately 31% of accounts receivable at
F-10
December 31, 2003. Acacia Research Corporation performs regular credit
evaluations of its significant licensees and has not experienced any significant
credit losses.
PROPERTY AND EQUIPMENT. Property and equipment are recorded at cost.
Major additions and improvements that materially extend useful lives of property
and equipment are capitalized. Maintenance and repairs are charged against the
results of operations as incurred. When these assets are sold or otherwise
disposed of, the asset and related depreciation are relieved, and any gain or
loss is included in the statement of operations and comprehensive loss for the
period of sale or disposal. Depreciation is computed on a straight-line basis
over the following estimated useful lives of the assets:
Machine shop and laboratory equipment........ 5 years
Furniture and fixtures....................... 3 to 7 years
Computer hardware and software............... 3 to 5 years
Leasehold improvements....................... Lesser of lease term or
useful life of improvement
Construction in progress includes direct costs incurred related to
internally constructed assets which are depreciated once the asset is placed
into service.
PREPAID PUBLIC OFFERING COSTS. As of September 30, 2001, CombiMatrix
Corporation capitalized $1,353,000 of costs incurred in connection with the
filing of a registration statement with the SEC in November 2000. In the fourth
quarter of 2001, all of these deferred costs were charged to operations.
ORGANIZATION COSTS. Costs of start-up activities, including
organization costs, are expensed as incurred.
PATENTS AND GOODWILL. Goodwill and identifiable intangibles, including
patents, are recorded when the consideration paid for acquisitions exceeds the
fair value of the net tangible assets acquired. Patents, once issued or
purchased, are amortized on the straight-line method over their remaining
economic useful lives, ranging from three to twenty years. Goodwill is not
amortized.
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL. We review long-lived
assets and intangible assets for potential impairment annually and when events
or changes in circumstances indicate the carrying amount of an asset may not be
recoverable. In the event the sum of the expected undiscounted future cash flows
resulting from the use of the asset is less than the carrying amount of the
asset, an impairment loss equal to the excess of the asset's carrying value over
its fair value is recorded. If an asset is determined to be impaired, the loss
is measured based on quoted market prices in active markets, if available. If
quoted market prices are not available, the estimate of fair value is based on
various valuation techniques, including a discounted value of estimated future
cash flows.
Goodwill is evaluated for impairment in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets" ("SFAS No. 142") and 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 three 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. We performed a
transitional goodwill impairment assessment in 2002 and a year-end goodwill
impairment assessment in 2002 and 2003 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.
FAIR VALUE OF FINANCIAL INSTRUMENTS. The carrying value of cash and
cash equivalents, accounts receivables, accounts payable and accrued expenses
approximate fair value due to their short-term maturity.
FOREIGN CURRENCY TRANSLATION. The functional currency of our foreign
entity is the local currency (Japanese Yen). Foreign currency translation is
reported pursuant to SFAS No. 52, "Foreign Currency Translation" ("SFAS No.
F-11
52"). Assets and liabilities recorded in foreign currencies are translated at
the exchange rate on the balance sheet date. Translation adjustments resulting
from this process are charged or credited to other comprehensive income. Revenue
and expenses are translated at average rates of exchange prevailing during the
year.
STOCK-BASED COMPENSATION. At December 31, 2003, Acacia Research
Corporation has two stock-based employee compensation plans, which are described
more fully in Note 12. Compensation cost of stock options issued to employees is
accounted for in accordance with Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB No. 25") and related
interpretations. Compensation cost attributable to such options is recognized
based on the difference, if any, between the closing market price of the stock
on the date of grant and the exercise price of the option. Compensation cost is
generally deferred and amortized on an accelerated basis over the vesting period
of the individual option awards using the amortization method prescribed in
Financial Accounting Standards Board ("FASB") Interpretation No. 28, "Accounting
for Stock Appreciation Rights and Other Variable Stock Option or Award Plans"
("FIN No. 28"). We have adopted the disclosure only requirements of SFAS No.
123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"), as amended by
SFAS No. 148 "Accounting for Stock-Based Compensation--Transition and
Disclosure--an amendment of SFAS No. 123" ("SFAS No. 148"), with respect to
options issued to employees. Compensation cost of stock options and warrants
issued to non-employee service providers is accounted for under the fair value
method required by SFAS No. 123 and related interpretations.
The following table illustrates the effect on net loss and loss per
share if Acacia Research Corporation had applied the fair value recognition
provisions of SFAS No. 123 (in thousands, except per share data):
AR-ACACIA AR- AR-ACACIA AR- ACACIA
TECHNOLOGIES COMBIMATRIX TECHNOLOGIES COMBIMATRIX RESEARCH
STOCK STOCK STOCK STOCK CORPORATION
2003 2003 2002 2002 2001
------------ ------------ ------------ ------------ ------------
Loss from continuing operations as
reported ................................. $ (5,451) $ (18,969) $ (12,554) $ (46,219) $ (22,272)
Stock-based compensation, intrinsic
value method, net of tax .............. -- 1,475 19 3,660 12,335
Pro forma stock based compensation
fair value method, net of tax ......... (3,273) (9,029) (5,034) (7,198) (4,907)
Loss from continuing operations, pro
forma .................................... (8,724) (26,523) (17,569) (49,757) (14,844)
Basic and diluted loss per share from
continuing operations as reported ..... (0.28) (0.76) (0.64) (2.01) (1.16)
Basic and diluted loss per share from
continuing operations, pro forma ...... (0.44) (1.07) (0.89) (2.17) (0.77)
- ------------------------
Note: The stock-based compensation information above gives effect to the
recapitalization as of January 1, 2002. As a result, stock-based compensation
information related to Acacia Research Corporation common stock in 2002 has been
omitted from the table above. Further, stock-based compensation information
related to the AR-Acacia Technologies stock and the AR-CombiMatrix stock has
been omitted for all periods prior to 2002 as the Acacia Research-Acacia
Technologies stock and Acacia Research-CombiMatrix stock were not part of Acacia
Research Corporation's capital structure prior to 2002.
The fair value of Acacia Research Corporation stock options was
determined using the Black-Scholes option-pricing model, assuming weighted
average risk free annual interest of 4.52% in 2001, volatility of approximately
75%, with expected lives of approximately four years and no expected dividends.
The fair value of AR-Acacia Technologies stock options was determined
using the Black-Scholes option-pricing model, assuming weighted average risk
free annual interest rate of 2.97% and 3.43% in 2003 and 2002, respectively,
volatility of approximately 100%, with expected lives of approximately five
years, and no expected dividends.
The fair value of AR-CombiMatrix stock options was determined using the
Black-Scholes option-pricing model, assuming weighted average risk free annual
interest rate of 2.89% and 4.38% in 2003 and 2002, respectively, volatility of
approximately 100%, with expected lives of approximately five years, and no
expected dividends.
F-12
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
consist of costs incurred for direct and overhead-related research expenses and
are expensed as incurred. Costs to acquire technologies, which are utilized in
research and development and which have no alternative future use are expensed
when incurred. Costs related to filing and pursuing patent applications are
expensed as incurred, as recoverability of such expenditures is uncertain.
Software developed for use in our products is expensed as incurred until both
(i) technological feasibility for the software has been established and (ii) all
research and development activities for the other components of the system have
been completed. We believe these criteria are met after we have received
evaluations from third-party test sites and completed any resulting
modifications to the products. Expenditures to date have been classified as
research and development expense.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. The value assigned to
acquired in-process research and development ("IPR&D") is determined by
identifying acquired specific in-process research and development projects that
would be continued and for which (a) technological feasibility has not been
established at the acquisition date, (b) there is no alternative future use and
(c) the fair value is estimable with reasonable reliability, upon consummation
of a business combination.
INCOME TAXES. Income taxes are accounted for using an asset and
liability approach that requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that have been
recognized in Acacia Research Corporation's financial statements or tax returns.
A valuation allowance is established to reduce deferred tax assets if all, or
some portion, of such assets will more than likely not be realized.
ACCOUNTING FOR SALES OF STOCK BY A SUBSIDIARY. Gains or losses
resulting from a subsidiary's sale of stock to third parties at a price per
share in excess of or below Acacia Research Corporation's average carrying
amount per share are generally reflected in stockholders' equity as a direct
increase or decrease to capital in excess of par or stated value.
COMPREHENSIVE (LOSS) INCOME. Comprehensive (loss) income is the change
in equity from transactions and other events and circumstances other than those
resulting from investments by owners and distributions to owners.
SEGMENT REPORTING. We use the management approach, which designates the
internal organization that is used by management for making operating decisions
and assessing performance as the basis of Acacia Research Corporation's
reportable segments. At December 31, 2002, our reporting segments were modified
for all periods presented 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.
USE OF ESTIMATES. The preparation of financial statements in conformity
with generally accepted accounting principles in the United States of America
requires management to make estimates and assumptions that affect the reported
amount of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from these estimates.
LOSS PER SHARE. Basic loss per share for each class of common stock is
computed by dividing the loss allocated to each class of common stock by the
weighted average number of outstanding shares of that class of common stock.
Diluted loss 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 common stock purchase 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.
F-13
The following table presents a reconciliation of basic and diluted loss
per share:
FOR THE YEAR FOR THE YEAR FOR THE YEAR
ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2003 2002 2001
----------- ----------- -----------
ACACIA RESEARCH - ACACIA TECHNOLOGIES STOCK
- -------------------------------------------
Basic weighted average number of common shares outstanding ........................... 19,661,655 19,640,808 --
Dilutive effect of outstanding stock options and warrants ............................ -- -- --
----------- ----------- -----------
Diluted weighted average number of common and
potential common shares outstanding ............................................... 19,661,655 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 .... 424,571 46,857 --
=========== =========== ===========
ACACIA RESEARCH - COMBIMATRIX STOCK
- -----------------------------------
Basic weighted average number of common shares outstanding ........................... 24,827,819 22,950,746 --
Dilutive effect of outstanding stock options and warrants ............................ -- -- --
----------- ----------- -----------
Diluted weighted average number of common and
potential common shares outstanding ............................................... 24,827,819 22,950,746 --
=========== =========== ===========
Potential AR-CombiMatrix stock common shares excluded from the per share
calculation because the effect of their inclusion would be anti-dilutive .......... 779,238 305,256 --
=========== =========== ===========
ACACIA RESEARCH CORPORATION COMMON STOCK
- ----------------------------------------
Basic weighted average number of common shares outstanding ........................... -- -- 19,259,256
Dilutive effect of outstanding stock options and warrants ............................ -- -- --
----------- ----------- -----------
Diluted weighted average number of common and
potential common shares outstanding ............................................... -- -- 19,259,256
=========== =========== ===========
Potential AR-CombiMatrix stock common shares excluded from the per share
calculation because the effect of their inclusion would be anti-dilutive .......... -- -- 719,471
=========== =========== ===========
SEPARATE GROUP 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 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.
F-14
MANAGEMENT ALLOCATION POLICIES. The management and allocation policies
applicable to the preparation of the financial statements of the CombiMatrix
group and the Acacia Technologies group may be modified or rescinded, or
additional policies may be adopted, at the sole discretion of the Acacia
Research Corporation board of directors at any time without approval of the
stockholders. The group's financial statements reflect the application of the
management and allocation policies adopted by the Acacia Research Corporation
board of directors to various corporate activities, as described below.
Management has no plans to change allocation methods or the composition of the
groups. The group financial statements should be read in conjunction with the
Acacia Research Corporation consolidated financial statements and related notes.
TREASURY AND CASH MANAGEMENT POLICIES. Cash and cash equivalents and
short-term investments are attributed to the groups based on the respective cash
and cash equivalents and short term investments balances of the entities
comprising each group. Acacia Research Corporation's cash and the cash held by
its intellectual property licensing businesses, including all cash raised
through Acacia Research Corporation's previous offerings, have been attributed
to the Acacia Technologies group as these funds are intended to support the
intellectual property licensing businesses of Acacia Research Corporation. All
cash raised by CombiMatrix Corporation and Advanced Material Sciences have been
attributed to the CombiMatrix group. Acacia Research Corporation manages most
treasury and cash management activities on a decentralized basis, with each
group separately managing its own treasury activities. Pursuant to treasury and
cash management policies adopted by the Acacia Research Corporation board of
directors, the following applies:
o Acacia Research Corporation will attribute each future issuance of
AR-Acacia Technologies stock (and the proceeds thereof) to the Acacia
Technologies group and will attribute each future issuance of
AR-CombiMatrix stock (and the proceeds thereof) to the CombiMatrix
group;
o Acacia Research Corporation will attribute each future incurrence or
issuance of external debt or preferred stock (and the proceeds
thereof), if any, between the groups or entirely to one group as
determined by the Acacia Research Corporation board of directors, based
on the extent to which Acacia Research Corporation incurs or issues the
debt or preferred stock for the benefit of the CombiMatrix group or the
Acacia Technologies group;
o Dividends, if any, on AR-Acacia Technologies stock will be charged
against the Acacia Technologies group, and dividends, if any on
AR-CombiMatrix stock will be charged against the CombiMatrix group;
o Repurchases of AR-Acacia Technologies stock will be charged against the
Acacia Technologies group and repurchases of AR-CombiMatrix stock will
be charged against the CombiMatrix group;
o Acacia Research Corporation accounts for any cash transfers from Acacia
Research Corporation to or for the account of a group, from a group to
or for the account of Acacia Research Corporation, or from one group to
or for the account of the other group (other than transfers in return
for assets or services rendered) as short-term loans unless (A) the
Acacia Research Corporation board of directors determines that a given
transfer (or type of transfer) should be accounted for as a long-term
loan, (B) the Acacia Research Corporation board of directors determines
that a given transfer (or type of transfer) should be accounted for as
a capital contribution or (iii) the Acacia Research Corporation board
of directors determines that a given transfer (or type of transfer)
should be accounted for as a return of capital. There are no specific
criteria to determine when Acacia Research Corporation will account for
a cash transfer as a long-term loan, a capital contribution or a return
of capital rather than an inter-group revolving credit advance;
provided, however, that cash advances from Acacia Research Corporation
to the Acacia Technologies group or to the CombiMatrix group up to
$25.0 million on a cumulative basis shall be accounted for as
short-term or long-term loans at interest rates at which Acacia
Research Corporation could borrow such funds and shall not be accounted
for as a capital contribution. The Acacia Research Corporation board of
directors will make such a determination in the exercise of its
business judgment at the time of such transfer based upon all relevant
circumstances. Factors the Acacia Research Corporation board of
directors may consider include, without limitation, the current and
projected capital structure of each group; the financing needs and
objectives of the recipient group; the availability, cost and time
F-15
associated with alternative financing sources; and prevailing interest
rates and general economic conditions; and
o Any cash transfers accounted for as short-term loans will bear interest
at the rate at which Acacia Research Corporation could borrow such
funds. In addition, any cash transfers accounted for as a long-term
loan will have interest rates, amortization, maturity, redemption and
other terms that reflect the then-prevailing terms on which Acacia
Research Corporation could borrow such funds.
ASSETS AND LIABILITIES. Acacia Research Corporation's assets and
liabilities have been attributed to the Acacia Technologies group and the
CombiMatrix group based on the respective asset and liabilities of the business
comprising each group. Net intangible assets recorded at the Acacia Research
Corporation level, primarily consisting of acquired patents and goodwill
balances, have been attributed to the respective businesses comprising each
group to which the intangibles and goodwill relate.
CORPORATE GENERAL AND ADMINISTRATIVE SERVICES AND FACILITIES. Acacia
Research Corporation allocates the cost of corporate general and administrative
services and facilities between the groups generally based upon utilization.
Where determinations based on utilization alone are impracticable, Acacia
Research Corporation utilizes other methods and criteria that management
believes to be equitable and to provide a reasonable estimate of the cost
attributable to each group. Except as otherwise determined by management, the
allocated costs of providing such services and facilities include, without
limitation, all costs and expenses of personnel employed in connection with such
services and facilities, including, without limitation, all direct costs of such
personnel, such as payroll, payroll taxes and fringe benefit costs (calculated
at the appropriate annual composite rate therefor) and all overhead costs and
expenses directly related to such personnel and the services or facilities
provided by them. In addition, allocated costs include all materials used in
connection with such services or facilities, billed at their net cost to the
provider of the services or facilities plus all overhead costs and expenses
related to such materials. Except as may otherwise be specifically provided
pursuant to the terms of any agreements among Acacia Research Corporation and
the groups or any resolutions of the Acacia Research Corporation board of
directors, the corporate general and administrative services and facilities to
be allocated between the groups include, without limitation, legal services,
accounting services (tax and financial), insurance and deductibles payable in
connection therewith, employee benefit plans and administration thereof,
investor relations, stockholder services, and services relating to the board of
directors.
Direct salaries, payroll taxes and fringe benefits are allocated to the
groups based on the percentage of actual time incurred by specific employees to
total annual time available and direct costs including, postage, insurance,
legal fees, accounting and tax and other are allocated to the groups based on
specific identification of costs incurred on behalf of each group. Other direct
costs, including direct depreciation expense, computer costs, general office
supplies and rent are allocated to the groups based on the ratio of direct
salaries to total salaries. Indirect costs, including indirect salaries and
benefits, investor relations, rent, general office supplies and indirect
depreciation are allocated to the groups based on the ratio of direct salaries
for each group to total direct salaries. Included in marketing, general and
administrative expenses of the Acacia Technologies group are allocated corporate
charges of $2,864,000, $4,906,000 and $4,591,000 relating to the periods ending
December 31, 2003, 2002 and 2001, respectively. Included in marketing, general
and administrative expenses of the CombiMatrix group are allocated corporate
charges of $637,000, $1,161,000 and $1,361,000 relating to the periods ending
December 31, 2003, 2002 and 2001, respectively.
Management believes that the methods and criteria used to allocate
costs are equitable and provide a reasonable estimate of the cost attributable
to the groups. Based on the allocation methods used, Acacia Research Corporation
believes that the allocation of expenses as presented in the accompanying
consolidating financial information reflects a reasonable estimation of expenses
that would be recognized if the groups were separate stand alone registrants.
ALLOCATION OF FEDERAL AND STATE INCOME TAXES. Acacia Research
Corporation determines its federal income taxes and the federal income taxes of
its subsidiaries that own assets allocated between the groups on a consolidated
basis. Acacia Research Corporation allocates consolidated federal income tax
provisions and related tax payments or refunds between the Acacia Technologies'
group and CombiMatrix group based principally on the taxable income and tax
credits directly attributable to each group. Such allocations reflect each
F-16
group's contribution, whether positive or negative, to Acacia Research
Corporation's consolidated federal taxable income and consolidated federal tax
liability and tax credit position. Acacia Research Corporation will credit tax
benefits that cannot be used by the group generating those benefits but can be
used on a consolidated tax return basis to the group that generated such
benefits.
Inter-group transactions are treated as taxed as if each group was a
stand-alone company. Depending on the tax laws of the respective jurisdictions,
state and local income taxes are calculated on either a consolidated or combined
basis between the groups based on their respective contribution to such
consolidated or combined state taxable incomes. State and local income tax
provisions and related tax payments or refunds which are determined on a
separate corporation basis are allocated between the groups in a manner designed
to reflect the respective contributions of the groups to Acacia Research
Corporation's separate or local taxable income.
RECLASSIFICATIONS. Certain immaterial reclassifications of prior year
amounts have been made to conform to the 2003 presentation.
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 No. 46") as superseded in December 2003 by
FASB issued Interpretation No. 46R, "Consolidation of Variable Interest Entities
- -- an interpretation of ARB 51 ("FIN No. 46R"). FIN No. 46R requires the primary
beneficiary of a variable interest entity ("VIE") to consolidate the entity and
also requires majority and significant variable interest investors to provide
certain disclosures. A VIE is an entity in which the equity investors do not
have a controlling interest, equity investors participate in losses or residual
interests of the entity on a basis that differs from its ownership interest, or
the equity investment at risk is insufficient to finance the entity's activities
without receiving additional subordinated financial support from the other
parties. FIN No. 46R is applicable for Acacia Research Corporation starting
January 1, 2004. We do not expect the adoption of FIN No. 46R 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. The adoption of SFAS No. 149 did not 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. The adoption of SFAS No. 150 did not 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.
F-17
3. SHORT-TERM INVESTMENTS
Short-term investments consists of the following at December 31, 2003
and 2002 (in thousands):
2003 AMORTIZED FAIR
COST VALUE
--------- ---------
Available-for-sale securities:
Corporate bonds and notes ..................... $ 10,986 $ 10,990
U.S. government securities .................... 6,558 6,561
Certificates of deposit ....................... 1,000 1,000
--------- ---------
$ 18,544 $ 18,551
========= =========
2002 AMORTIZED FAIR
COST VALUE
--------- ---------
Available-for-sale securities:
Corporate bonds and notes ..................... $ 5,718 $ 5,808
U.S. government securities .................... 5,698 5,797
-------- --------
$ 11,416 $ 11,605
========= =========
Gross unrealized gains and losses related to available-for-sale
securities were not material for 2003 and 2002.
Contractual maturities for investments in debt securities classified as
available-for-sale as of December 31, 2003 are as follows (in
thousands):
FAIR
COST VALUE
--------- ---------
Due within one year ................................ $ 18,222 $ 18,229
Due after one year through two years ............... 322 322
--------- ---------
$ 18,544 $ 18,551
========= =========
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31, 2003
and 2002 (in thousands):
2003 2002
--------- ---------
Machine shop and laboratory equipment .............. $ 3,687 $ 3,272
Furniture and fixtures ............................. 352 345
Computer hardware and software ..................... 1,406 1,444
Leasehold improvements ............................. 1,208 1,200
Construction in progress ........................... 84 352
--------- ---------
6,737 6,613
Less: accumulated depreciation and amortization .... (3,914) (2,538)
--------- ---------
$ 2,823 $ 4,075
========= =========
Depreciation expense was $1,428,000, $1,573,000 and $1,174,000 for the
years ended December 31, 2003, 2002 and 2001, respectively. Amortization of
assets held under capital lease included in depreciation expense was $590,000
for the year ended December 31, 2002.
F-18
5. BALANCE SHEET COMPONENTS
Accounts payable, accrued expenses and other consists of the following
at December 31, 2003 and 2002 (in thousands):
2003 2002
--------- ---------
Accounts payable .................................. $ 776 $ 559
Payroll, vacation and other employee benefits ..... 938 1,348
Accrued liabilities of discontinued operations .... 388 915
Accrued legal expenses ............................ 495 1,307
Deferred rent ..................................... 284 131
Other accrued liabilities ......................... 363 566
--------- ---------
$ 3,244 $ 4,826
========= =========
Deferred revenues consist of the following at December 31, 2003 and
2002 (in thousands):
2003 2002
--------- ---------
Milestone and up-front payments ................... $ 20,405 $ 9,172
License fee payments .............................. 1,604 1,503
--------- ---------
22,009 10,675
Less: current portion ............................ (18,108) (10,675)
--------- ---------
$ 3,901 $ --
========= =========
6. INVESTMENTS
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 in Advanced Data Exchange ("ADX").
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 $2,748,000 for an
other-than-temporary decline in the fair value of ADX. Impairment indicators
included recurring losses, a decline in working capital and the completion of a
recent equity transaction with a shareholder at an amount below our carrying
value. The fair value of our investment in ADX was determined by reference to
available financial and market information.
On April 25, 2002, CombiMatrix Corporation purchased our interest in
Advanced Material Sciences. CombiMatrix Corporation issued 180,982 shares of its
common stock in exchange for our 58% interest in Advanced Material Sciences. As
a result of the sale of our interest in Advanced Material Sciences, as of
December 31, 2002 CombiMatrix Corporation owned 87% of Advanced Material
Sciences and the remaining interests are owned by unaffiliated entities. The
purchase was accounted for pursuant to APB Opinion No. 16, "Business
Combinations," and related interpretations and EITF 90-5, "Exchanges of
Ownership Interests between Entities under Common Control." Accordingly, the
transaction was accounted for using Acacia Research Corporation's basis in the
net assets of Advanced Material Sciences and as a result, Acacia Research
Corporation's 2002 consolidated financial statements reflect the assets and
liabilities of Advanced Material Sciences at historical cost.
F-19
7. INTANGIBLES AND GOODWILL
The Acacia Technologies group had $1,776,000 and $1,834,000 of goodwill
at December 31, 2003 and December 31, 2002, respectively. The CombiMatrix group
had $19,424,000 and $18,859,000 of goodwill at December 31, 2003 and December
31, 2002, respectively.
We adopted SFAS No. 142 effective January 1, 2002 and ceased amortizing
goodwill on that date. Our net loss and loss per share, adjusted to exclude
goodwill amortization expense for 2001 was as follows (in thousands, except loss
per share amounts):
REPORTED GOODWILL ADJUSTED
NET INCOME(LOSS) AMORTIZATION NET INCOME(LOSS)
-------- ------------ --------
FOR THE YEAR ENDED DECEMBER 31, 2001
Acacia Research Corporation
Actual ................................. $(22,272) $ 1,078 $(21,194)
Loss per share (basic and diluted) ..... (1.16) 0.06 (1.10)
Acacia Technologies group
Actual ................................. 5,757 216 5,973
Loss per share (basic and diluted) ..... -- -- --
CombiMatrix group
Actual ................................. (28,029) 862 (27,167)
Loss per share (basic and diluted) ..... -- -- --
Acacia Research Corporation's only identifiable intangible assets at
December 31, 2003 and 2002 are patents. The gross carrying amounts and
accumulated amortization as of December 31, 2003 and 2002 and amortization
expense for 2003, 2002 and 2001, related to patents, by segment, are as follows
(in thousands):
ACACIA TECHNOLOGIES GROUP COMBIMATRIX GROUP
------------------------- -----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Gross carrying amount - patents .... $ 10,798 $ 10,798 $ 12,095 $ 12,095
Accumulated amortization ........... (7,232) (6,730) (1,978) (883)
--------- --------- --------- ---------
Patents, net ....................... $ 3,566 $ 4,068 $ 10,117 $ 11,212
========= ========= ========= =========
ACACIA TECHNOLOGIES GROUP COMBIMATRIX GROUP
----------------------------- -----------------------------
2003 2002 2001 2003 2002 2001
------- ------- ------- ------- ------- -------
Patent Amortization Expense ....... $ 502 $1,591 $1,277 $1,095 $ 399 $ 341
======= ======= ======= ======= ======= =======
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).
Refer to Note 8, "Step Acquisitions," for additions to goodwill during
2003 and 2002.
At December 31, 2003 and 2002, all of our acquired intangible assets
other than goodwill were subject to amortization.
F-20
8. STEP ACQUISITIONS
On July 11, 2003, Acacia Research Corporation purchased the outstanding
minority interests in its consolidated subsidiary 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
interests (120 shares) 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.
On July 2, 2003, Acacia Research Corporation increased its consolidated
ownership interest in Advanced Material Sciences from 87% 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.
Acacia Research Corporation's interests in Advanced Material Sciences
and CombiMatrix K.K. have been attributed to the CombiMatrix group.
On December 13, 2002, Acacia Research Corporation increased its
consolidated ownership interest in CombiMatrix Corporation from 48% to 100% by
acquiring from existing stockholders of CombiMatrix Corporation 11,987,274
shares of CombiMatrix Corporation common stock in exchange for 11,987,274 shares
of AR-CombiMatrix stock with a fair value of $46,007,000. The merger was
designed to consolidate our ownership of CombiMatrix Corporation and permit us
to effectuate the recapitalization transaction described elsewhere herein, by
creating the CombiMatrix group.
The transaction was accounted for as a step acquisition using the
purchase method of accounting. The fair value of the AR-CombiMatrix stock issued
in the transaction was based on the quoted market price of AR-CombiMatrix stock
averaged over a five-day period (from December 16, 2002, the first day of
trading for the AR-CombiMatrix stock, through December 20, 2002).
The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed and the allocation of the purchase price at the
date of acquisition (in thousands):
Acquisition costs:
Exchange of AR-CombiMatrix stock for CombiMatrix Corporation
common stock ............................................... $46,007
Acquisition expenses ........................................... 834
--------
Total acquisition cost ......................................... $46,841
========
Purchase price allocation:
Fair value of 52% of CombiMatrix
Corporation net tangible assets at December 13, 2002 ....... $ 8,313
Intangible assets acquired:
Core technology/patent ..................................... 5,283
Acquired in-process research and development ............... 17,237
Goodwill (non-deductible for tax purposes) ................. 16,008
--------
Total .......................................................... $46,841
========
The total purchase price of $46,841,000 was allocated to the fair value
of assets acquired and liabilities assumed, including acquired IPR&D. The amount
attributable to CombiMatrix Corporation's core technology and related patents
was $5,283,000, which is being amortized using the straight-line method over the
F-21
estimated economic useful life of 7 years. The amount attributable to goodwill
was $16,008,000. Amounts allocated to patents, IPR&D and goodwill have been
attributed to the CombiMatrix group.
The amount attributable to IPR&D projects (comprised of two projects:
Genomics and Proteomics biological array systems) that had not yet reached
technological feasibility and had no alternative future use of $17,237,000 was
charged to expense on the acquisition date and is included in the consolidated
statement of operations and comprehensive loss for the year ended December 31,
2002. Following is a brief description of the two IPR&D projects identified.
Genomics Biological Array System: CombiMatrix Corporation's genomics
biological array processor system is being developed to discretely immobilize
sequences of DNA or RNA within individual test sites on a modified semiconductor
chip coated with a three-dimensional layer of porous material. The system also
includes proprietary hardware units and related software applications to be able
to synthesize materials onto the chips, apply target samples of genetic
materials and interpret the results. The value assigned to the genomics
biological array system IPR&D project was $13,978,000. A risk-adjusted discount
rate of 32% was applied to the project's estimated cash flows.
Proteomics Biological Array System: CombiMatrix Corporation's
proteomics biological array processor system is being developed to discretely
immobilize proteins and other small molecules within individual test sites on a
modified semiconductor chip in a similar fashion as described above for the
genomics biological array system. The proteomics biological array system is used
for detection and identification of bio-threat agents in CombiMatrix
Corporation's biological and chemical threat agent detector development programs
that are currently in process. The value assigned to the proteomics biological
array system IPR&D project was $3,259,000. A risk-adjusted discount rate of 60%
was applied to the project's estimated cash flows.
DEFERRED REVENUE PURCHASE ACCOUNTING ADJUSTMENT
In connection with the December 2002 step acquisition of CombiMatrix
Corporation described above, and the application of purchase accounting pursuant
to SFAS No. 142, Acacia Research Corporation was required to adjust CombiMatrix
Corporation's assets and liabilities, including deferred revenue, to fair value.
As a result, deferred revenue, primarily consisting of milestone payments and
other cash receipts from Roche and NASA, was reduced by $8,425,000 to reflect
the fair value of the continuing obligation related to the 52% interest in
CombiMatrix Corporation acquired by Acacia Research Corporation. A
reconciliation of 2002 activity related CombiMatrix Corporation's deferred
revenue balances including the impact of the fair value adjustment is as follows
(in thousands):
CombiMatrix Corporation deferred revenue balance at December 31, 2001 .... $ 5,960
Cash payments and accruals recorded as deferred revenues during 2002 ..... 11,637
Less: purchase accounting adjustment .................................... (8,425)
---------
CombiMatrix Corporation deferred revenue balance at December 31, 2002 .... $ 9,172
=========
9. STOCKHOLDERS' EQUITY
REDEEMABLE CAPITAL STOCK
The authorized capital stock of Acacia Research Corporation consists of
110,000,000 shares, of which 50,000,000 shares is a class of common stock
designated as "AR-CombiMatrix stock," having a par value of $0.001 per share,
50,000,000 shares is a class of common stock designated as "AR-Acacia
Technologies stock," having a par value of $0.001 per share, and 10,000,000 is a
class of preferred stock having a par value of $0.001 per share (the "Preferred
Stock") and issuable in one or more series as determined by the board of
directors pursuant to Acacia Research Corporation's restated certificate of
incorporation. Holders of AR-CombiMatrix stock and AR-Acacia Technologies stock
vote together as a single class (except in certain limited circumstances). Each
share of AR-CombiMatrix stock entitles the holder to one vote. Each share of
F-22
AR-Acacia Technologies stock entitles the holder, for any particular vote, to a
number of votes equal to the average market value of a share of AR-Acacia
Technologies stock divided by the average market value of a share of
AR-CombiMatrix stock over a specified 20-trading day period ending on the tenth
trading day prior to the record date for determining the stockholders entitled
to vote.
Holders of each class of common stock are entitled to receive ratably
such dividends, if any, as may be declared by the board of directors out of
funds legally available therefore.
Under our restated certificate of incorporation, in the event of our
dissolution, liquidation or winding up, after payment or provision for payment
of the debts and other liabilities and full preferential amounts to which
holders of any preferred stock are entitled, regardless of the group to which
such shares of preferred stock were attributed, the holders of AR-CombiMatrix
stock and AR-Acacia Technologies stock will be entitled to receive our assets
remaining for distribution to holders of common stock on a per share basis in
proportion to the liquidation units per share of such class. Each share of
AR-CombiMatrix stock will have one liquidation unit. Each share of AR-Acacia
Technologies stock will have a number of liquidation units equal to the quotient
of the average market value of a share of AR-Acacia Technologies stock over the
20-trading day period ending on the 40th trading day after the effective date of
the recapitalization, divided by the average market value of a share of
AR-CombiMatrix stock over the same period.
Holders of each class of common stock have no preemptive, subscription,
redemption or conversion rights. Management, at its discretion may, at any time,
convert each share of AR-CombiMatrix stock into a number of shares of AR-Acacia
Technologies stock at a 10% premium over the average market price.
Each class of stock is designed to reflect the financial performance of
the respective group, rather than the performance of Acacia Research Corporation
as a whole. The chief mechanisms intended to cause the AR-CombiMatrix stock and
the AR-Acacia Technologies stock to reflect the financial performance of the
respective group are provisions in Acacia Research Corporation's restated
certificate of incorporation governing dividends and distributions. Under these
provisions, Acacia Research Corporation will:
o factor the assets and liabilities and income or losses attributable to
the respective group into the determination of the amount available to
pay dividends on the shares issued for the respective group; and
o require Acacia Research Corporation to exchange, redeem or distribute a
dividend on the stock of a group if all or substantially all of the
assets allocated to the respective group are sold to a third party.
Management of Acacia Research Corporation cannot assure the holders of
AR-CombiMatrix stock or AR-Acacia Technologies stock that the market values of
the two share classes will in fact reflect the separate performance of each
class of stock. Holders of AR-CombiMatrix stock and AR-Acacia Technologies stock
are stockholders of Acacia Research Corporation and as a result, are subject to
all of the risks of an investment in Acacia Research Corporation and all of its
businesses, assets and liabilities. Financial effects from one group that affect
Acacia Research Corporation's consolidated results of operations or financial
condition could, if significant, affect the results of operations or financial
condition of the other group.
Acacia Research Corporation's board of directors, subject to state laws
and limits in our restated certificate of incorporation, including those
discussed above, will be able to declare dividends on AR-CombiMatrix stock and
AR-Acacia Technologies stock in its discretion. To date, Acacia Research
Corporation has never paid or declared cash dividends on shares of our stock,
nor do we anticipate paying cash dividends on either of the two classes of stock
in the foreseeable future.
The allocation of corporate expenses is generally based on utilization
and is in accordance with Acacia Research Corporation's restated certificate of
incorporation, for the purpose of measuring earnings available to stockholders
of AR-CombiMatrix stock and AR-Acacia Technologies stock and does not
necessarily reflect the financial condition, cash flows and operating results of
each division as if it were a stand-alone entity. The management and allocation
policies applicable to the determination of the assets and liabilities and
income or losses attributable to the respective group may be modified or
rescinded, or additional policies may be adopted, at the sole discretion of
F-23
Acacia Research Corporation's board of directors at any time without approval of
the stockholders. Acacia Research Corporation's management and board of
directors have the ability to: transfer funds between the groups at the
discretion of management and the board of directors; allocate financing costs
between groups that may not reflect the separate borrowing costs of the groups;
and charge a greater or lesser portion of the total corporate tax liability to
the groups than that which would have been charged if the groups were
stand-alone entities. Acacia Research Corporation's management and board of
directors do not presently intend to modify or rescind the methodologies and
assumptions underlying the allocations in the pro forma financial statements.
See Note 2 for a description of applicable management allocation policies.
OTHER
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 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.
In September 2002, CombiMatrix Corporation issued 4,016,346 shares of
its common stock to Nanogen, Inc. ("Nanogen") in settlement of all outstanding
litigation between the parties (see Note 14). As a result of the transaction,
our equity ownership in CombiMatrix Corporation decreased from 58% to 48%. A
loss totaling $550,000, resulting from CombiMatrix Corporation's issuance of
stock to a third party at a value per share below our carrying amount per share
has been reflected as a direct reduction to additional paid-in capital in
consolidated stockholders' equity.
On October 22, 2001, our board of directors declared a ten percent
(10%) stock dividend. The stock dividend totaling 1,777,710 shares of our common
stock was distributed on December 5, 2001 to stockholders of record as of
November 21, 2001. The fair value of the stock dividend paid, based on the
market value of our common stock on the date of declaration, as adjusted for the
dilutive effect of the stock dividend declared, is reflected as a
reclassification of accumulated deficit in the amount of $21,688,000, to
permanent capital, represented by our common stock and additional paid-in
capital accounts. All references to the number of shares (other than common
stock issued or outstanding on the 2001 consolidated statements of stockholders'
equity), per share amounts and any other reference to shares in the consolidated
financial statements and accompanying notes to the consolidated financial
statements, unless otherwise noted, have been adjusted to reflect the stock
dividend on a retroactive basis.
In May 2001, Advanced Material Sciences completed a private equity
financing raising gross proceeds of $2.0 million through the issuance of
2,000,000 shares of common stock. As a result of the transaction, our equity
ownership in Advanced Material Sciences decreased from 66.7% to 58.1%.
Additionally, in October 2001, a subsidiary of CombiMatrix Corporation sold 10%
of its voting common stock to a joint venture partner in Japan. The gain,
totaling $1,283,000, resulting from our subsidiaries sale of stock to
third-parties at a price per share in excess of our carrying amount per share
has been reflected as a direct increase to additional paid-in capital in
consolidated stockholders' equity.
In January 2001, we completed an institutional private equity financing
raising gross proceeds of $19.0 million ($17.9 million, net of issuance costs)
through the issuance of 1,107,274 units. Each unit consists of one share of our
common stock and one three-year callable common stock purchase warrant. Each
common stock purchase warrant entitles the holder to purchase a share of
AR-Acacia Technologies stock and a fraction of a share of AR-CombiMatrix stock
at a price of $13.23 and $10.50 per share, respectively. The separate warrants
F-24
are callable by us once the closing bid price of our AR-Acacia Technologies
stock averages $16.53 and our AR-CombiMatrix stock averages $13.13, or above for
20 or more consecutive trading days on the Nasdaq Stock Market. These warrants
expired unexercised in January 2004. We issued an additional 20,000 units in
lieu of cash payments for finders' fees in conjunction with the private
placement. Proceeds from this equity financing were attributed to the Acacia
Technologies group.
10. INCOME TAXES
(Benefit) provision for income taxes consists of the following (in
thousands):
2003 2002 2001
----------- ---------- ----------
Current:
U.S. Federal tax ....... $ (2) $ (572) $ 776
State taxes ............ 9 4 186
----------- ---------- ----------
7 (568) 962
----------- ---------- ----------
Deferred:
U.S. Federal tax ....... (280) (289) (182)
State taxes ............ -- -- --
----------- ---------- ----------
(280) (289) (182)
----------- ---------- ----------
$ (273) $ (857) $ 780
========== ========== ==========
The tax effects of temporary differences and carryforwards that give
rise to significant portions of deferred assets and liabilities consist of the
following at December 31, 2003 and 2002 (in thousands):
2003 2002
--------- ---------
Deferred tax assets:
Basis of investments in affiliates ................................... $ 26,159 $ 18,265
Depreciation ......................................................... (55) (95)
Deferred revenue ..................................................... 3,456 3,116
Stock compensation ................................................... 8,749 8,656
Accrued liabilities and other ........................................ 2,022 1,358
Write-off of investments ............................................. 1,282 1,200
Net operating loss and capital loss carryforwards and credits ........ 49,018 39,237
--------- ---------
Total deferred tax assets ............................................ 90,631 71,737
Less: valuation allowance ........................................... (90,631) (71,737)
--------- ---------
Deferred tax assets, net of valuation allowance ...................... -- --
--------- ---------
Deferred tax liabilities:
Intangibles .......................................................... (3,260) (3,540)
--------- ---------
Net deferred tax liability ........................................... $ (3,260) $ (3,540)
========= =========
F-25
A reconciliation of the federal statutory income tax rate and the
effective income tax rate is as follows:
2003 2002 2001
------- ------- -------
Statutory federal tax rate .................... (34%) (34%) (34%)
State income taxes, net of federal benefit .... -- -- (3%)
Amortization of intangible assets ............. -- 1% 2%
Stock compensation ............................ -- 1% 7%
Non deductible permanent items ................ -- 9% --
Intangibles ................................... 1% 3% --
Valuation allowance and other credits ......... 32% 21% 30%
------- ------- -------
(1%) 1% 2%
======= ======= ========
At December 31, 2003, Acacia Research Corporation has deferred tax
assets totaling approximately $90,631,000, which are fully offset by a valuation
allowance due to management's determination that the criteria for recognition
have not been met.
In December 2002, Acacia Research Corporation increased its ownership
interest in CombiMatrix Corporation from 48% to 100%. As a result of the
increase in ownership, Acacia Research Corporation files a consolidated federal
income tax returns that includes the Acacia Technologies group (excluding
discontinued operations) and the CombiMatrix group.
At December 31, 2003, consolidated U.S. Federal and state income tax
net operating loss carry forwards ("NOLs"), excluding NOLs related to
subsidiaries for which we do not file a consolidated tax return, were
approximately $128,385,000 and $32,485,000, expiring between 2004 and 2023. In
addition, we had consolidated tax credit carryforwards of approximately
$2,532,000. The amount of the CombiMatrix Corporation NOLs and tax credits
acquired, totaling approximately $66,360,000 (expiring between 2010 and 2023)
and $1,989,000, respectively, that can be utilized annually to offset future
taxable income or tax liability has been limited under the Internal Revenue Code
due to the ownership change resulting from our December 2002 increase in
ownership interest in CombiMatrix Corporation to 100%.
As of December 31, 2003, the aggregate tax NOLs at other subsidiaries
for which we do not file a consolidated tax return are approximately $19,598,000
and $10,782,000 for federal and state income tax purposes, respectively,
expiring between 2004 and 2023. However, the use of these NOLs are limited to
the separate earnings of the respective subsidiaries. In addition, ownership
changes may also restrict the use of NOLs and tax credits.
Had the Acacia Technologies group and the CombiMatrix group each filed
separate tax returns, the provision (benefit) for income taxes and division net
income (loss) would not have differed from the amounts reported in Acacia
Research Corporation's statement of operations for the years ended December 31,
2003, 2002, and 2001.
As of December 31, 2003, approximately $9,662,000 of the valuation
allowance related to the tax benefits of stock option deductions included in
Acacia Research Corporation's NOLs. At such time as the valuation allowance is
released, the benefit will be credited to additional paid-in capital.
11. DISCONTINUED OPERATIONS
In September 2002, we accrued an additional $480,000 ($200,000 net of
minority interests) in estimated costs to be incurred in connection with the
discontinued operations of Soundbreak.com (originally ceased operations in
February 2001). The additional accrual relates primarily to certain
noncancellable lease obligations and the inability to sublease the related
office space at rates commensurate with our existing obligations.
Discontinued operations did not have an impact on the December 31, 2003
or 2001 consolidated statement of operations and comprehensive loss.
F-26
The assets and liabilities of the discontinued operations at December
31, 2003 and 2002 consist primarily of $1,953,000 and $3,109,000 of cash and
cash equivalents and $388,000 and $918,000 of accounts payable and accrued
expenses, respectively.
12. STOCK OPTIONS AND WARRANTS
The 2002 Acacia Technologies Stock Incentive Plan (the "AR-Acacia
Technologies Group Plan") and the 2002 CombiMatrix Stock Incentive Plan (the
"AR-CombiMatrix Group Plan") were approved by the stockholders of Acacia
Research Corporation in December 2002 (see Note 1). The AR-Acacia Technologies
Group Plan authorizes grants of stock options, stock awards and performance
shares with respect to AR-Acacia Technologies stock. The AR-CombiMatrix Group
Plan authorizes grants of stock options, stock awards and performance shares
with respect to AR-CombiMatrix stock. Directors and certain officers and key
employees with responsibilities involving both the Acacia Technologies group and
the CombiMatrix group may be granted awards under both incentive plans in a
manner which reflects their responsibilities. The board of directors believes
that granting participants awards tied to performance of the group in which the
participants work and, in certain cases the other group, is in the best interest
of the Acacia Research Corporation and its stockholders.
As a result of the recapitalization of Acacia Research Corporation in
December 2002 (see Note 1), each outstanding option and warrant to acquire a
share of Acacia Research Corporation common stock under the existing stock
option plans or warrants was converted into separately exercisable options or
warrants, as the case may be, to acquire 0.5582 of a share of AR-CombiMatrix
stock and one share of AR-Acacia Technologies stock. The conversion ratio for
shares of AR-CombiMatrix stock is equal to the quotient obtained by dividing (a)
the number of shares of CombiMatrix Corporation common stock owned by Acacia
Research Corporation immediately prior to the effective time of the merger by
(b) the total number of shares of Acacia Research Corporation common stock
issued and outstanding immediately prior to the effective time. The exercise
price for the resulting AR-Acacia Technologies stock options and warrants and
AR-CombiMatrix stock options and warrants was calculated by multiplying the
exercise price under such existing stock option or warrant by a fraction, the
numerator of which is the result obtained by multiplying the opening price of
the applicable class of common stock underlying such option on the first date
such stocks are traded after the recapitalization times the applicable
conversion ratio and the denominator of which is the sum of such amounts for the
AR-CombiMatrix stock and the AR-Acacia Technologies stock. However, the
aggregate intrinsic value of the options was not increased, and the ratio of the
exercise price per option to the market value per share was not reduced. The
converted options continue to be governed by the terms and conditions of the
original option plans.
As a result of the merger transaction with CombiMatrix Corporation, in
December 2002 (see Note 1), each outstanding option to purchase shares of
CombiMatrix Corporation common stock under CombiMatrix Corporation's 1995 Stock
Option Plan, 1998 Stock Option Plan and 2000 Stock Awards Plan, whether or not
exercisable, was assumed by Acacia Research Corporation. Each assumed option
continues to be governed by the same terms and conditions that governed it under
the applicable CombiMatrix Corporation plan immediately before the effective
time of the merger except that the option is exercisable for shares of
AR-CombiMatrix stock rather than CombiMatrix Corporation common stock. The
number of shares of AR-CombiMatrix stock issuable upon exercise of the assumed
option, as well as the exercise price, is the same as the number of shares of
CombiMatrix Corporation common stock issuable and exercise price prior to the
merger. The exchange of AR-CombiMatrix stock options for CombiMatrix Corporation
common stock options is considered a modification (or settlement) of a
stock-based compensation arrangement resulting in a new measurement date for the
respective awards. The new measurement date for the award modifications was
December 13, 2002, the effective date of the merger, and resulted in additional
stock-based compensation of $116,000, which was allocated to the CombiMatrix
group.
STOCK OPTION PLANS
The terms of the AR-Acacia Technologies Group Plan and the
AR-CombiMatrix Group Plan are identical except that AR-Acacia Technologies stock
may be issued only under the AR-Acacia Technologies Group Plan and
AR-CombiMatrix stock may be issued only under the AR-CombiMatrix Group Plan.
F-27
Acacia Research Corporation's compensation committee administers the
discretionary option grant and stock issuance programs. This committee
determines which eligible individuals are to receive option grants or stock
issuances under those programs, the time or times when the grants or issuances
are to be made, the number of shares subject to each grant or issuance, the
status of any granted option as either an incentive stock option or a
non-statutory stock option under the federal tax laws, the vesting schedule to
be in effect for the option grant or stock issuance and the maximum term for
which any granted option is to remain outstanding.
PROGRAMS
Each of the incentive plans has four separate programs:
o DISCRETIONARY OPTION GRANT PROGRAM. Under the discretionary option
grant program, our compensation committee may grant (1) non-statutory
options to purchase shares of AR-Acacia Technologies stock and
AR-CombiMatrix stock, as applicable, to eligible individuals in the
employ or service of Acacia Research Corporation or our subsidiaries
(including employees, non-employee board members and consultants) at an
exercise price not less than 85% of the fair market value of those
shares on the grant date and (2) incentive stock options to purchase
shares of AR-Acacia Technologies stock and AR-CombiMatrix stock, as
applicable, to eligible employees at an exercise price not less than
100% of the fair market value of those shares on the grant date (not
less than 110% of fair market value if such employee actually or
constructively owns more than 10% of our voting stock or the voting
stock of any of our subsidiaries).
o STOCK ISSUANCE PROGRAM. Under the stock issuance program, eligible
individuals may be issued shares of AR-Acacia Technologies stock and
AR-CombiMatrix stock, as applicable, directly, upon the attainment of
performance milestones or the completion of a specified period of
service or as a bonus for past services. Under this program, the
purchase price for the shares shall not be less than 100% of the fair
market value of the shares on the date of issuance, and payment may be
in the form of cash or past services rendered.
o AUTOMATIC OPTION GRANT PROGRAM. Under the automatic option grant
program, option grants will automatically be made at periodic intervals
to eligible non-employee members of our board of directors to purchase
shares of AR-Acacia Technologies stock and AR-CombiMatrix stock, as
applicable, at an exercise price equal to 100% of the fair market value
of those shares on the grant date. Each individual who first becomes a
non-employee board member at any time after the date of the adoption of
the incentive plans by our board of directors will automatically
receive an option to purchase 20,000 shares of AR-Acacia Technologies
stock and 20,000 shares of AR-CombiMatrix stock on the date the
individual joins the board of directors. In addition, on the first
business day in each calendar year following the adoption of the
incentive plans by our board of directors, each non-employee board
member then in office, including each of our current non-employee board
members who is then in office, will automatically be granted an option
to purchase 15,000 shares of AR-Acacia Technologies stock and 15,000
shares of AR-CombiMatrix stock, provided that the individual has served
on the board of directors for at least six months.
o DIRECTOR FEE OPTION GRANT PROGRAM. If this program is put into effect
in the future, it will allow non-employee members of our board of
directors the opportunity to apply a portion of any retainer fee
otherwise payable to them in cash each year to the acquisition of
special below-market option grants.
Limited stock appreciation rights will automatically be included as
part of each grant made under the automatic and director fee option grant
programs, and these rights may also be granted to one or more of our officers as
part of their option grants under the discretionary option grant program.
The AR-Acacia Technologies Group Plan and the AR-CombiMatrix Group Plan
do not segregate the number of securities remaining available for future
issuance among stock options and other awards. The shares authorized for future
issuance represents the total number of shares available through any combination
of stock options or other awards.
F-28
Our board of directors may amend or modify the incentive plans at any
time, subject to any required stockholder approval. The incentive plans will
terminate no later than the tenth anniversary of the approval of the incentive
plans by our stockholders.
Options are generally exercisable six months to one year after grant
and expire five years after grant for directors or up to ten years after grant
for key employees. The authorized number of shares of common stock subject to
the AR-Acacia Technologies Group Plan is 5,609,000 shares. The authorized number
of shares of common stock subject to the AR-CombiMatrix Group Plan is 8,825,000
shares. At December 31, 2003, shares available for grant are 470,000 and
2,208,000 under the AR-Acacia Technologies Group Plan and the AR-CombiMatrix
Group Plan, respectively.
The following is a summary of common stock option activities:
ACACIA RESEARCH CORPORATION COMMON STOCK (THROUGH DECEMBER 13, 2002):
EXERCISE WEIGHTED
SHARES PRICES AVERAGE PRICE
-------------- -------------------- -----------------
Balance at December 31, 2000........................... 3,625,000 $ 2.77 - $50.28 $20.51
Options Granted........................................ 1,390,000 $ 5.65 - $16.08 $ 7.14
Options Exercised...................................... (790,000) $ 2.77 - $14.55 $ 3.48
Options Cancelled...................................... (743,000) $ 3.18 - $48.69 $30.48
------------
Balance at December 31, 2001........................... 3,482,000 $ 3.47 - $50.28 $16.94
Options Granted........................................ 441,000 $ 6.68 - $11.67 $ 8.48
Options Exercised...................................... (56,000) $ 3.47 - $ 7.16 $ 3.63
Options Cancelled...................................... (370,000) $ 3.52 - $43.18 $16.94
------------
Balance at December 13, 2002 (pre-recapitalization).... 3,497,000 $ 3.59 - $50.28 $16.09
Exchange in recapitalization transaction............... (3,497,000) $ 3.59 - $50.28 $16.09
Balance at December 13, 2002 (post-recapitalization)... - - -
============
Exercisable at December 31, 2001....................... 1,315,000 $ 3.47 - $50.28 $18.47
Exercisable at December 13, 2002
(pre-recapitalization)............................ 2,088,000 $ 3.59 - $50.28 $17.17
AR-ACACIA TECHNOLOGIES STOCK (FROM DECEMBER 13, 2002):
EXERCISE WEIGHTED
SHARES PRICES AVERAGE PRICE
-------------- --------------------- ---------------
Balance at December 13, 2002.......................... 3,497,000 $ 2.49 - $34.84 $11.14
Options Granted....................................... 822,000 $ 1.85 - $ 1.85 $ 1.85
Options Exercised..................................... - - -
Options Cancelled..................................... (24,000) $ 9.45 - $15.31 $12.65
-----------
Balance at December 31, 2002.......................... 4,295,000 $ 1.85 - $34.84 $ 9.36
Options Granted....................................... 1,059,000 $ 1.37 - $ 5.17 $ 3.35
Options Exercised..................................... (99,000) $ 1.85 - $ 2.70 $ 1.91
Options Cancelled..................................... (116,000) $ 1.85 - $18.98 $ 8.07
-----------
Balance at December 31, 2003.......................... 5,139,000 $ 1.37 - $34.84 $ 8.29
===========
Exercisable at December 31, 2003...................... 3,367,000 $ 1.85 - $34.84 $10.60
F-29
AR-COMBIMATRIX STOCK (FROM DECEMBER 13, 2002):
EXERCISE WEIGHTED
SHARES PRICES AVERAGE PRICE
-------------- -------------------- ---------------
Balance at December 13, 2002.......................... 5,648,000 $ 1.50 - $27.67 $ 9.22
Options Granted....................................... - - -
Options Exercised..................................... (14,000) $ 1.98 - $ 2.00 $ 2.00
Options Cancelled..................................... (14,000) $ 7.50 - $12.16 $10.04
-----------
Balance at December 31, 2002.......................... 5,620,000 $ 1.50 - $27.67 $ 9.24
Options Granted....................................... 2,014,000 $ 0.00 - $ 4.49 $ 2.05
Options Exercised..................................... (271,000) $ 0.00 - $ 2.14 $ 1.86
Options Cancelled..................................... (746,000) $ 1.95 - $24.00 $ 9.89
-----------
Balance at December 31, 2003.......................... 6,617,000 $ 1.50 - $27.67 $ 7.28
===========
Exercisable at December 31, 2003...................... 4,930,000 $ 1.50 - $27.67 $ 7.74
Options outstanding at December 31, 2003 are summarized as follows:
AR-ACACIA TECHNOLOGIES STOCK:
WEIGHTED OUTSTANDING EXERCISABLE
NUMBER OF AVERAGE WEIGHTED WEIGHTED
RANGE OF OUTSTANDING REMAINING AVERAGE NUMBER AVERAGE
EXERCISE PRICES OPTIONS CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
-------------------------- -------------- ------------------ ----------------- --------------- ----------------
$ 0.00 - $ 3.48.......... 1,278,000 9.1 $ 1.87 231,000 $ 1.93
$ 3.49 - $ 6.97.......... 2,048,000 7.7 $ 4.61 1,449,000 $ 4.41
$ 6.98 - $10.45.......... 140,000 7.8 $ 7.68 107,000 $ 7.84
$10.46 - $13.94.......... 169,000 6.6 $11.81 160,000 $11.86
$13.95 - $17.42.......... 659,000 6.3 $15.18 659,000 $15.18
$17.43 - $20.90.......... 535,000 6.0 $19.11 451,000 $19.12
$20.91 - $24.39.......... 193,000 5.4 $20.90 193,000 $20.90
$27.88 - $31.36.......... 110,000 6.2 $29.09 110,000 $29.09
$31.37 - $34.84.......... 7,000 0.2 $34.84 7,000 $34.84
------------ -----------
5,139,000 7.5 $ 8.29 3,367,000 $10.60
============ ===========
AR-COMBIMATRIX STOCK:
WEIGHTED OUTSTANDING EXERCISABLE
NUMBER OF AVERAGE WEIGHTED WEIGHTED
RANGE OF OUTSTANDING REMAINING AVERAGE NUMBER AVERAGE
EXERCISE PRICES OPTIONS CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
-------------------------- -------------- ------------------ ----------------- --------------- ----------------
$ 0.00 - $ 2.77.......... 1,915,000 8.5 $ 1.96 951,000 $ 1.95
$ 2.78 - $ 5.53.......... 1,916,000 6.5 $ 4.25 1,757,000 $ 4.27
$ 5.54 - $ 8.30.......... 83,000 7.7 $ 6.12 64,000 $ 6.24
$ 8.31 - $11.07.......... 714,000 6.7 $ 9.05 649,000 $ 9.06
$11.08 - $13.83.......... 1,106,000 7.4 $12.02 803,000 $12.03
$13.84 - $16.60.......... 388,000 6.6 $15.14 287,000 $15.16
$16.61 - $19.37.......... 257,000 6.3 $17.42 227,000 $17.34
$22.14 - $24.90.......... 234,000 5.9 $23.76 188,000 $23.71
$24.91 - $27.67.......... 4,000 0.2 $27.67 4,000 $27.67
------------ -----------
6,617,000 7.2 $ 7.28 4,930,000 $ 7.74
============ ===========
At December 31, 2003, there were 1,045,000 warrants outstanding, issued
in connection with the May 2003 equity financing discussed elsewhere herein,
representing rights to purchase AR-CombiMatrix common stock at a per share
exercise price of $2.75, which are exercisable through May 2008.
F-30
At December 31, 2003, there were 1,240,000 warrants outstanding
representing rights to purchase AR-Acacia Technologies common stock at a per
share exercise price of $13.23 and 692,000 warrants outstanding representing
rights to purchase AR-CombiMatrix common stock at a per share exercise price of
$10.50. These warrants expired unexercised in January 2004.
We have adopted the disclosure only requirements of SFAS No. 123 with
respect to options issued to employees. The weighted average fair value of
options granted during 2003, 2002 and 2001 are as follows:
OPTIONS GRANTED WEIGHTED AVERAGE FAIR VALUE OF OPTIONS
- --------------- --------------------------------------
2003 2002 2001
---- ---- ----
Acacia Research Corporation stock options
(January 1, 2002 - December 13, 2002).......................... $ -- $ -- $ 4.19
AR-Acacia Technologies stock options................................ $ 2.44 $ 5.43
AR-CombiMatrix stock options........................................ $ 1.59 $ 1.16
There were 380,000 AR-Acacia Technologies stock options and 108,000
AR-CombiMatrix stock options granted during 2003 with exercise prices greater
than the market value on the date of grant. There were 18,000 AR-CombiMatrix
stock options granted during 2003 with exercise prices less than the market
value on the date of grant. There were no options granted during 2002 or 2001
with exercise prices less than the market value on the date of grant.
13. DEFERRED NON-CASH STOCK COMPENSATION CHARGES
During the year ended December 31, 2000, CombiMatrix Corporation
recorded deferred non-cash stock compensation charges aggregating approximately
$53,773,000 in connection with the granting of stock options. Pursuant to Acacia
Research Corporation's policy, the stock options were originally granted by
CombiMatrix Corporation at exercise prices equal to the fair value of the
underlying CombiMatrix Corporation stock on the date of grant as determined by
its board of directors. However, such exercise prices were subsequently
determined to have been granted at exercise prices below fair value due to a
substantial step-up in the fair value of CombiMatrix Corporation pursuant to a
valuation provided by an investment banker in contemplation of a potential
CombiMatrix Corporation initial public offering in 2000. In connection with the
proposed CombiMatrix Corporation initial public offering and pursuant to SEC
rules and guidelines, we were required to reassess the value of stock options
issued during the one-year period preceding the potential initial public
offering and utilize the stepped-up fair value provided by the investment banker
for purposes of determining whether such stock option issuances were
compensatory, resulting in the calculation of the $53,773,000 in deferred
non-cash stock compensation charges in 2000. Deferred non-cash stock
compensation charges are being amortized over the respective option grant
vesting periods, which range from one to four years. Non-cash stock compensation
charged to income during 2003, 2002 and 2001 totaled $1,655,000, $6,408,000 and
$19,963,000, respectively. Pursuant to the vesting terms of CombiMatrix
Corporation's stock options outstanding at December 31, 2003, we will record
non-cash stock compensation amortization expenses of approximately $766,000 in
2004.
During 2003, 2002 and 2001, certain CombiMatrix Corporation unvested
stock options were forfeited. Pursuant to the provisions of APB Opinion No. 25
and related interpretations, the reversal of previously recognized non-cash
stock compensation expense on forfeited unvested stock options in the amount of
$1,199,000, $1,204,000 and $4,698,000 has been reflected in the 2003, 2002 and
2001 consolidated statements of operations and comprehensive loss, respectively,
as reductions in non-cash stock compensation expense. The forfeiture of unvested
options during 2003, 2002 and 2001 results in a reduction of the remaining
deferred non-cash stock compensation expense scheduled to be amortized in future
periods.
Amounts to be amortized in future periods reflected above may be
impacted by certain subsequent stock option transactions including modification
of terms, cancellations, forfeitures and other activity.
F-31
14. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
We lease certain office furniture and equipment and laboratory and
office space under various operating lease agreements expiring over the next 7
years. Minimum annual rental commitments on operating leases of continuing
operations having initial or remaining non-cancelable lease terms in excess of
one year are as follows (in thousands):
YEAR
----
2004................................................. $ 2,159
2005................................................. 2,221
2006................................................. 2,148
2007................................................. 1,976
2008................................................. 1,615
Thereafter........................................... --
---------
Total minimum lease payments......................... $ 10,119
=========
Rent expense in 2003, 2002 and 2001 approximated $2,473,000, $2,063,000
and $1,979,000, respectively.
LITIGATION
CombiMatrix Corporation
On November 28, 2000, Nanogen filed a complaint in the United States
District Court for the Southern District of California against CombiMatrix
Corporation and Donald D. Montgomery, Ph.D., an officer, director and
stockholder of CombiMatrix Corporation. Dr. Montgomery was employed by Nanogen
as a senior research scientist between May 1994 and August 1995. The Nanogen
complaint alleged, among other things, breach of contract, trade secret
misappropriation and that U.S. Patent No. 6,093,302 and other proprietary
information belonging to CombiMatrix Corporation are instead the property of
Nanogen. The complaint sought, among other things, correction of inventorship on
the patent, the assignment of rights in the patent and pending patent
applications to Nanogen, an injunction preventing disclosure of trade secrets,
damages for trade secret misappropriation and the imposition of a constructive
trust.
On September 30, 2002, CombiMatrix Corporation and Dr. Donald
Montgomery entered into a settlement agreement with Nanogen to settle all
pending litigation between the parties. Pursuant to the terms of the settlement
agreement, Nanogen dismissed with prejudice its lawsuit against CombiMatrix
Corporation and Dr. Montgomery. In return, CombiMatrix Corporation agreed to pay
Nanogen $500,000 within 30 days of the settlement and an additional $500,000,
which was paid in September 2003. CombiMatrix Corporation also agreed to make
quarterly payments to Nanogen equal to 12.5% of payments to CombiMatrix
Corporation from sales of products developed by CombiMatrix Corporation and its
affiliates and based on the patents that had been in dispute in the litigation,
up to an annual maximum of $1,500,000. The minimum quarterly payments under the
settlement agreement will be $37,500 per quarter for the period from October 1,
2003 through October 1, 2004, and $25,000 per quarter thereafter until the
patents expire in 2018. Also, pursuant to the settlement agreement, CombiMatrix
Corporation issued to Nanogen 4,016,346 shares, or 17.5% of its outstanding
shares post-issuance, subject to an anti-dilution provision related to the
exercise of CombiMatrix Corporation options and warrants that were outstanding
on the effective date of the agreement, for a period of up to three years.
The issuance of the CombiMatrix Corporation common shares in settlement
of the litigation with Nanogen was accounted for as a nonmonetary transaction.
Accordingly, CombiMatrix Corporation recorded a non-cash litigation settlement
charge in the consolidated statements of operations for the year ended December
31, 2002 of approximately $17,471,000, which was based on the fair value of the
CombiMatrix Corporation common shares issued to Nanogen. The fair value of the
common shares issued and the related litigation charge was based on an
independent third-party valuation of CombiMatrix Corporation as of September 30,
2002.
F-32
Total legal settlement charges recorded in the consolidated statements
of operations for the year ended December 31, 2002 include the fair value of the
common shares issued to Nanogen in the amount of $17,471,000 and a charge in the
amount of $1,000,000 related to the cash payments due to Nanogen discussed
above.
SOUNDVIEW TECHNOLOGIES
In September 2002, the United States District Court for the District of
Connecticut granted a motion for summary judgment filed by the defendants in
Soundview Technologies pending patent infringement and antitrust lawsuit against
Sony Corporation of America, Philips Electronics North America Corporation, the
Consumer Electronics Manufacturers Association and the Electronics Industries
Alliance d/b/a Consumer Electronics Association in the United States District
Court for the Eastern District of Virginia (filed on April 5, 2000), alleging
that television sets utilizing certain content blocking technology (commonly
known as the "V-chip") and sold in the United States infringe Soundview
Technologies' U.S. Patent No. 4,554,584. In granting the motion, the court ruled
that the defendants have not infringed on Soundview Technologies' patent.
In September 2003, a motion for summary judgment filed by the remaining
defendants was granted by the United States District Court for the District of
Connecticut on Soundview Technologies' anti-trust claims due to the Court's
previous ruling of non-infringement as described above.
The decisions are currently being appealed to the U.S. Court of Appeals
for the Federal Circuit. While we are currently appealing the two summary
judgment rulings, litigation is inherently uncertain and we can give no
assurance that we will be successful in any such appeals.
The rulings have no impact on the revenues that we have recognized to
date from licensees of our patented V-chip technology. Further, none of the
revenues that we have recognized to date are contingent upon any court rulings
or the future outcome of any litigation with unlicensed television
manufacturers.
ACACIA MEDIA TECHNOLOGIES CORPORATION
In February 2003, Acacia Media Technologies initiated DMT patent
infringement litigation in the Federal District Court for the Central District
of California against approximately 39 defendants who provide adult oriented
digital content over the Internet. All of the defendants were previously
notified of our belief that their conduct infringes on our patent rights. As of
December 31, 2003, nine of the original 39 defendants remain in the initial
litigation.
In December 2003, Acacia Media Technologies added an additional eight
defendants to its pending patent infringement litigation described above. The
new complaints, filed with the Court, seek to create a defendant class for all
adult entertainment companies that infringe Acacia Media Technologies' DMT
patents by transmitting pre-recorded, digital audio and audio/video adult
content via any electronic communication channel into or from the Central
District of California, or that operate at least one interactive website where a
user located in Central District of California can exchange information with a
host computer. Defendant class action status, which must be approved by the
court, would permit the court's rulings on certain key issues to legally bind
all members of the class, whether or not they have been specifically named as
defendants in the litigation.
In November 2003, Acacia Media Technologies initiated a patent
infringement lawsuit in the Federal District Court for the Central District of
California against On Command Corporation, provider of interactive in-room
entertainment, information and business services to the lodging industry,
regarding Acacia Media Technologies' DMT technology.
Acacia Research Corporation is subject to other claims, counterclaims
and legal actions that arise in the ordinary course of business. Management
believes that the ultimate liability with respect to these claims and legal
actions, if any, will not have a material effect on our financial position,
results of operations or cash flows.
F-33
SALE AND LEASEBACK ARRANGEMENT
In September 2001, CombiMatrix Corporation entered into a sale and
leaseback arrangement with a bank, providing up to $7,000,000 in financing for
equipment and other capital purchases. Pursuant to the terms of the agreement,
certain equipment and leasehold improvements, totaling $2,557,000 in net book
value were sold to the bank at a purchase price of $3,000,000, resulting in a
deferred gain on the sale of assets of $443,000. The deferred gain is being
amortized over 4 years, the life of the related property and equipment. In
addition, CombiMatrix Corporation entered into a capital lease arrangement to
lease the fixed assets from the bank.
In October 2002, CombiMatrix Corporation was in non-compliance with one of its
covenants under its capital lease obligation with a commercial bank. CombiMatrix
Corporation repaid the entire remaining balance of the obligation in the amount
of $2,116,000 on November 1, 2002.
GUARANTEES AND INDEMNIFICATIONS
Acacia Research Corporation has made guarantees and indemnities under
which it may be required to make payments to a guaranteed or indemnified party,
in relation to certain transactions, including revenue transactions in the
ordinary course of business. In connection with certain facility leases Acacia
Research Corporation has indemnified its lessors for certain claims arising from
the facility or the lease. Acacia Research Corporation indemnifies its directors
and officers to the maximum extent permitted under the laws of the State of
Delaware. However, Acacia Research Corporation has a directors and officers
insurance policy that may reduce its exposure in certain circumstances and may
enable it to recover a portion of future amounts that may be payable, if any.
The duration of the guarantees and indemnities varies and, in many cases is
indefinite but subject to statute of limitations. The majority of guarantees and
indemnities do not provide any limitations of the maximum potential future
payments Acacia Research Corporation could be obligated to make. To date, we
have made no payments related to these guarantees and indemnities. Acacia
Research Corporation estimates the fair value of its indemnification obligations
as insignificant based on this history and insurance coverage and has therefore,
not recorded any liability for these guarantees and indemnities in the
accompanying consolidated balance sheets.
OTHER
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
array. This agreement was terminated effective January 31, 2004 thereby
relieving CombiMatrix Corporation of this future commitment.
In connection with the purchase of the outstanding ownership interests
in Acacia Media Technologies in November 2001, Acacia Media Technologies also
executed related assignment agreements which granted to the former owners of
Acacia Media Technologies' current patent portfolio the right to receive a
royalty of 15% of future net revenues, as defined in the agreements, generated
by Acacia Media Technologies' current patent portfolio, which includes its DMT
patents. No royalty obligation has been incurred as of December 31, 2003. Any
royalties paid pursuant to the agreements will be expensed in the consolidated
statement of operations.
15. 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 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.
F-34
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.
Consolidating Balance Sheets (In thousands)
AT DECEMBER 31, 2003
----------------------------------------------------
ACACIA COMBI-
TECHNOLOGIES MATRIX ELIMI- CONSOLI-
GROUP GROUP NATIONS DATED
---------- ---------- ---------- ----------
ASSETS
Current assets:
Cash and cash equivalents ...................... $ 28,142 $ 3,807 $ -- $ 31,949
Short-term investments ......................... 5,059 13,492 -- 18,551
Accounts receivable ............................ 124 199 -- 323
Prepaid expenses, inventory and other assets ... 903 277 -- 1,180
Receivable from CombiMatrix group .............. 99 -- (99) --
---------- ---------- ---------- ----------
Total current assets ..................... 34,327 17,775 (99) 52,003
Property and equipment, net of accumulated
depreciation ................................... 71 2,752 -- 2,823
Patents, net of accumulated amortization .......... 3,566 10,117 -- 13,683
Goodwill, net of accumulated amortization ......... 1,776 19,424 -- 21,200
Other assets ...................................... 238 93 -- 331
---------- ---------- ---------- ----------
$ 39,978 $ 50,161 $ (99) $ 90,040
========== ========== ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued expenses and other ... $ 1,572 $ 1,672 $ -- $ 3,244
Current portion of deferred revenues ........... 104 18,004 -- 18,108
Current portion of capital lease obligation .... -- -- -- --
Payable to Acacia Technologies group ........... -- 99 (99) --
---------- ---------- ---------- ----------
Total current liabilities ................ 1,676 19,775 (99) 21,352
Deferred income taxes ............................. 1,012 2,248 -- 3,260
Deferred revenues, net of current portion ......... 1,500 2,401 -- 3,901
Capital lease obligation, net of current portion .. -- -- -- --
---------- ---------- ---------- ----------
Total liabilities ........................ 4,188 24,424 (99) 28,513
---------- ---------- ---------- ----------
Minority interests ................................ 1,127 -- -- 1,127
---------- ---------- ---------- ----------
Redeemable Stockholders' equity:
AR - Acacia Technologies stock ................. 34,663 -- -- 34,663
AR - CombiMatrix stock ......................... -- 25,737 -- 25,737
---------- ---------- ---------- ----------
Total stockholders' equity ............... 34,663 25,737 -- 60,400
---------- ---------- ---------- ----------
$ 39,978 $ 50,161 $ (99) $ 90,040
========== ========== ========== ==========
(CONTINUED ON NEXT PAGE)
F-35a
Consolidating Balance Sheets (In thousands) (CONTINUED)
AT DECEMBER 31, 2002
--------------------------------------------------
ACACIA COMBI-
TECHNOLOGIES MATRIX ELIMI- CONSOLI-
GROUP GROUP NATIONS DATED
---------- ---------- ---------- ----------
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
Current portion of capital lease obligation .... -- -- -- --
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 ......... -- -- -- --
Capital lease obligation, net of current portion .. -- -- -- --
---------- ---------- ---------- ----------
Total liabilities ........................ 5,183 13,972 (114) 19,041
---------- ---------- ---------- ----------
Minority interests ................................ 1,487 684 -- 2,171
---------- ---------- ---------- ----------
Redeemable 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
========== ========== ========== ==========
F-35b
Consolidating Balance Sheets (In thousands) (CONTINUED)
AT DECEMBER 31, 2001
---------------------------------------------------
ACACIA COMBI-
TECHNOLOGIES MATRIX ELIMI- CONSOLI-
GROUP GROUP NATIONS DATED
---------- ---------- ---------- ----------
ASSETS
Current assets:
Cash and cash equivalents ...................... $ 46,859 $ 12,592 $ -- $ 59,451
Short-term investments ......................... 4,372 20,738 -- 25,110
Accounts receivable ............................ -- 143 -- 143
Prepaid expenses, inventory and other assets ... 800 670 -- 1,470
Receivable from CombiMatrix group .............. 30 -- (30) --
---------- ---------- ---------- ----------
Total current assets ..................... 52,061 34,143 (30) 86,174
Property and equipment, net of accumulated
depreciation ................................... 358 4,548 -- 4,906
Patents, net of accumulated amortization .......... 5,554 6,301 -- 11,855
Goodwill, net of accumulated amortization ......... 1,776 2,851 -- 4,627
Other assets ...................................... 3,177 120 -- 3,297
---------- ---------- ---------- ----------
$ 62,926 $ 47,963 $ (30) $ 110,859
========== ========== ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued expenses and other ... $ 2,925 $ 2,831 $ -- $ 5,756
Current portion of deferred revenues ........... 1,500 5,588 -- 7,088
Current portion of capital lease obligation .... -- 934 -- 934
Payable to Acacia Technologies group ........... -- 30 (30) --
---------- ---------- ---------- ----------
Total current liabilities ................ 4,425 9,383 (30) 13,778
Deferred income taxes ............................. 1,298 2,531 -- 3,829
Deferred revenues, net of current portion ......... -- 372 -- 372
Capital lease obligation, net of current portion .. -- 1,845 -- 1,845
---------- ---------- ---------- ----------
Total liabilities ........................ 5,723 14,131 (30) 19,824
---------- ---------- ---------- ----------
Minority interests ................................ 2,194 30,109 -- 32,303
---------- ---------- ---------- ----------
Redeemable Stockholders' equity:
AR - Acacia Technologies stock ................. 55,009 -- -- 55,009
AR - CombiMatrix stock ......................... -- 3,723 -- 3,723
---------- ---------- ---------- ----------
Total stockholders' equity ............... 55,009 3,723 -- 58,732
---------- ---------- ---------- ----------
$ 62,926 $ 47,963 $ (30) $ 110,859
========== ========== ========== ==========
NOTE: Segment information for the Acacia Technologies group includes discontinued operations related to
Soundbreak.com. Total assets related to discontinued operations totaled $2,150,000 and $3,282,000 at
December 31, 2003 and December 31, 2002, respectively. Total liabilities related to discontinued
operations totaled $395,000 and $918,000 at December 31, 2003 and December 31, 2002, respectively.
F-35c
CONSOLIDATING STATEMENT OF OPERATIONS (IN THOUSANDS)
2003 2002
--------------------------------------------- ---------------------------------------------
ACACIA COMBI- ELIMINATIONS/ ACACIA COMBI- ELIMINATIONS/
TECHNOLOGIES MATRIX RECLASS- CONSOL- TECHNOLOGIES MATRIX RECLASS- CONSOL-
GROUP GROUP IFICATIONS IDATED GROUP GROUP IFICATIONS IDATED
--------- --------- --------- --------- --------- --------- --------- ---------
Revenues:
License fee income ............... $ 692 $ -- $ -- $ 692 $ 43 $ -- $ -- $ 43
Product revenue .................. -- 407 -- 407 -- 306 -- 306
Grant and contract revenue ....... -- 49 -- 49 -- 533 -- 533
--------- --------- --------- --------- --------- --------- --------- ---------
Total revenues ................ 692 456 -- 1,148 43 839 -- 882
--------- --------- --------- --------- --------- --------- --------- ---------
Operating expenses:
Cost of sales .................... -- 99 -- 99 -- 263 -- 263
Research and development
expenses ...................... -- 8,098 -- 8,098 -- 18,187 -- 18,187
Charge for acquired in-process
research and development ...... -- -- -- -- -- 17,237 -- 17,237
Non-cash stock compensation
expense - research and
development ................... -- 466 -- 466 -- 1,868 -- 1,868
Marketing, general and
administrative expenses ....... 4,317 8,714 1,886 14,917 6,883 10,334 1,415 18,632
Non-cash stock compensation
expense - marketing, general
and administrative ............ -- 1,189 -- 1,189 19 4,540 -- 4,559
Legal expenses - patents ......... 1,886 -- (1,886) -- 1,415 -- (1,415) --
Amortization of patents and
goodwill ...................... 502 1,095 -- 1,597 1,591 399 -- 1,990
Legal settlement charges ......... -- 144 -- 144 -- 18,471 -- 18,471
--------- --------- --------- --------- --------- --------- --------- ---------
Total operating expenses ...... 6,705 19,805 -- 26,510 9,908 71,299 -- 81,207
--------- --------- --------- --------- --------- --------- --------- ---------
Operating (loss) income ....... (6,013) (19,349) -- (25,362) (9,865) (70,460) -- (80,325)
--------- --------- --------- --------- --------- --------- --------- ---------
Other income (expense):
Impairment of cost method
investment .................... (207) -- -- (207) (2,748) -- -- (2,748)
Interest income .................. 521 214 -- 735 620 589 -- 1,209
Realized gains (losses) on
short-term investments ........ 94 -- -- 94 (1,184) -- -- (1,184)
Unrealized (losses) gains on
short-term investments ........ -- -- -- -- (249) -- -- (249)
Interest expense ................. -- -- -- -- (6) (197) -- (203)
Equity in losses of affiliates ... -- -- -- -- -- -- -- --
Other income ..................... -- -- -- -- 64 -- -- 64
--------- --------- --------- --------- --------- --------- --------- ---------
Total other income (expense) .. 408 214 -- 622 (3,503) 392 -- (3,111)
--------- --------- --------- --------- --------- --------- --------- ---------
(Loss) income from continuing
operations before income
taxes and minority
interests ....................... (5,605) (19,135) -- (24,740) (13,368) (70,068) -- (83,436)
Benefit (provision) for income
taxes ........................... 137 136 -- 273 710 147 -- 857
--------- --------- --------- --------- --------- --------- --------- ---------
(Loss) income from continuing
operations before minority
interests ....................... (5,468) (18,999) -- (24,467) (12,658) (69,921) -- (82,579)
Minority interests ................. 17 30 -- 47 104 23,702 -- 23,806
--------- --------- --------- --------- --------- --------- --------- ---------
(Loss) income from continuing
operations ...................... (5,451) (18,969) -- (24,420) (12,554) (46,219) -- (58,773)
Discontinued operations:
Estimated loss on disposal of
Soundbreak.com ................ -- -- -- -- (200) -- -- (200)
--------- --------- --------- --------- --------- --------- --------- ---------
Net (loss) income .................. $ (5,451) $(18,969) $ -- $(24,420) $(12,754) $(46,219) $ -- $(58,973)
========= ========= ========= ========= ========= ========= ========= =========
continued below: F-36a
continued from above:
2001
----------------------------------------------
ACACIA COMBI- ELIMINATIONS/
TECHNOLOGIES MATRIX RECLASS- CONSOL-
GROUP GROUP IFICATIONS IDATED
--------- --------- --------- ---------
Revenues:
License fee income ............... $ 24,180 $ -- $ -- $ 24,180
Product revenue .................. -- -- -- --
Grant and contract revenue ....... -- 456 -- 456
--------- --------- --------- ---------
Total revenues ................ 24,180 456 -- 24,636
--------- --------- --------- ---------
Operating expenses:
Cost of sales .................... -- -- -- --
Research and development
expenses ...................... -- 11,656 -- 11,656
Charge for acquired in-process
research and development ...... -- -- -- --
Non-cash stock compensation
expense - research and
development ................... -- 7,183 -- 7,183
Marketing, general and
administrative expenses ....... 4,853 16,690 11,121 32,664
Non-cash stock compensation
expense - marketing, general
and administrative ............ 856 12,780 -- 13,636
Legal expenses - patents ......... 11,121 -- (11,121) --
Amortization of patents and
goodwill ...................... 1,492 1,203 -- 2,695
Legal settlement charges ......... -- -- -- --
--------- --------- --------- ---------
Total operating expenses ...... 18,322 49,512 -- 67,834
--------- --------- --------- ---------
Operating (loss) income ....... 5,858 (49,056) -- (43,198)
--------- --------- --------- ---------
Other income (expense):
Impairment of cost method
investment .................... -- -- -- --
Interest income .................. 1,642 2,120 -- 3,762
Realized gains (losses) on
short-term investments ........ 350 -- -- 350
Unrealized (losses) gains on
short-term investments ........ 237 -- -- 237
Interest expense ................. -- (65) -- (65)
Equity in losses of affiliates ... (195) -- -- (195)
Other income ..................... 77 -- -- 77
--------- --------- --------- ---------
Total other income (expense) .. 2,111 2,055 -- 4,166
--------- --------- --------- ---------
(Loss) income from continuing
operations before income
taxes and minority
interests ....................... 7,969 (47,001) -- (39,032)
Benefit (provision) for income
taxes ........................... (935) 155 -- (780)
--------- --------- --------- ---------
(Loss) income from continuing
operations before minority
interests ....................... 7,034 (46,846) -- (39,812)
Minority interests ................. (1,277) 18,817 -- 17,540
--------- --------- --------- ---------
(Loss) income from continuing
operations ...................... 5,757 (28,029) -- (22,272)
Discontinued operations:
Estimated loss on disposal of
Soundbreak.com ................ -- -- -- --
--------- --------- --------- ---------
Net (loss) income .................. $ 5,757 $(28,029) $ -- $(22,272)
========= ========= ========= =========
F-36b
CONSOLIDATING STATEMENT OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, 2003 YEAR ENDED DECEMBER 31, 2002
------------------------------------------ --------------------------------------------
ACACIA COMBI- ELIMINATIONS/ ACACIA COMBI- ELIMINATIONS/
TECHNOLOGIES MATRIX RECLASS- CONSOL- TECHNOLOGIES MATRIX RECLASS- CONSOL-
GROUP GROUP IFICATIONS IDATED GROUP GROUP IFICATIONS IDATED
--------- --------- --------- --------- --------- --------- --------- ---------
Cash flows from operating activities:
Net (loss) income from continuing
operations ............................ $ (5,451) $(18,969) $ -- $(24,420) $(12,554) $(46,219) $ -- $(58,773)
Adjustments to reconcile net (loss)
income from continuing operations to
net cash used in operating activities:
Depreciation and amortization ... 616 2,409 -- 3,025 1,797 1,736 -- 3,533
Equity in losses of affiliate ... -- -- -- -- -- -- -- --
Minority interests .............. (17) (30) -- (47) (104) (23,702) -- (23,806)
Non-cash stock compensation
expense ....................... -- 1,655 -- 1,655 19 6,408 -- 6,427
Charge for acquired in-process
research and development ...... -- -- -- -- -- 17,237 -- 17,237
Deferred tax benefit ............ (144) (136) -- (280) (142) (147) -- (289)
Write-off of other assets ....... -- -- -- -- -- -- -- --
Net sales (purchases) of
trading securities ............ -- -- -- -- 4,124 -- -- 4,124
Unrealized losses (gains) on
short-term investments ........ -- -- -- -- 249 -- -- 249
Issuance of common stock by
subsidiary - legal
settlement charge ............. -- -- -- -- -- 17,471 -- 17,471
Impairment of cost method
investment .................... 207 -- -- 207 2,748 -- -- 2,748
Other ........................... 4 25 -- 29 (30) 129 -- 99
Changes in assets and liabilities:
Accounts receivable ............. (124) 379 -- 255 -- (435) -- (435)
Prepaid expenses, other
receivables and other assets .. (45) 169 -- 124 (1) 258 -- 257
Accounts payable, accrued
expenses and other ............ (411) (645) -- (1,056) 372 (515) -- (143)
Deferred revenues ............... 101 11,233 -- 11,334 3 11,637 -- 11,640
--------- --------- --------- --------- --------- --------- --------- ---------
Net cash (used in) provided
by operating activities from
continuing operations ........... (5,264) (3,910) -- (9,174) (3,519) (16,142) -- (19,661)
Net cash used in operating
activities from
discontinued operations ......... (551) -- -- (551) (905) -- -- (905)
--------- --------- --------- --------- --------- --------- --------- ---------
Net cash used in operating
activities .................... (5,815) (3,910) -- (9,725) (4,424) (16,142) -- (20,566)
--------- --------- --------- --------- --------- --------- --------- ---------
Cash flows from investing activities:
Purchase of additional equity
in consolidated subsidiaries .. -- -- -- -- (200) -- -- (200)
Purchase of property and
equipment, net ................ (3) (83) -- (86) (78) (1,002) -- (1,080)
Sale of property and equipment .. -- -- -- -- 3 358 -- 361
Proceeds from sale and
leaseback arrangement ......... -- -- -- -- -- -- -- --
Purchase of available-for-sale
investments ................... (5,059) (32,714) -- (37,773) -- (11,338) -- (11,338)
Sale of available-for-sale
investments ................... -- 30,801 -- 30,801 -- 20,383 -- 20,383
Purchase of common stock from
minority stockholders of
subsidiaries .................. -- -- -- -- (217) -- -- (217)
Acquisition costs ............... -- -- -- -- -- (834) -- (834)
Other ........................... -- -- -- -- (100) -- -- (100)
--------- --------- --------- --------- --------- --------- --------- ---------
Net cash (used in) provided by
investing activities from
continuing operations ........... (5,062) (1,996) -- (7,058) (592) 7,567 -- 6,975
Net cash used in investing
activities from
discontinued operations ......... (356) -- -- (356) (3) -- -- (3)
--------- --------- --------- --------- --------- --------- --------- ---------
Net cash (used in) provided by
investing activities .......... (5,418) (1,996) -- (7,414) (595) 7,567 -- 6,972
--------- --------- --------- --------- --------- --------- --------- ---------
Cash flows from financing activities:
Net cash attributed to the
Acacia Technologies group ..... (417) -- -- (417) (2,048) -- -- (2,048)
Net cash attributed to the
CombiMatrix group ............. -- 6,435 -- 6,435 -- (818) -- (818)
--------- --------- --------- --------- --------- --------- --------- ---------
Net cash (used in) provided
by financing activities ....... (417) 6,435 -- 6,018 (2,048) (818) -- (2,866)
--------- --------- --------- --------- --------- --------- --------- ---------
Effect of exchange rate on cash ......... -- (13) -- (13) -- 92 -- 92
--------- --------- --------- --------- --------- --------- --------- ---------
(Decrease) increase in cash and
cash equivalents .............. (11,650) 516 -- (11,134) (7,067) (9,301) -- (16,368)
Cash and cash equivalents, beginning .... 39,792 3,291 -- 43,083 46,859 12,592 -- 59,451
--------- --------- --------- --------- --------- --------- --------- ---------
Cash and cash equivalents, ending ....... $ 28,142 $ 3,807 $ -- $ 31,949 $ 39,792 $ 3,291 $ -- $ 43,083
========= ========= ========= ========= ========= ========= ========= =========
continued below: F-37a
continued from above:
YEAR ENDED DECEMBER 31, 2001
--------------------------------------------
ACACIA COMBI- ELIMINATIONS/
TECHNOLOGIES MATRIX RECLASS- CONSOL-
GROUP GROUP IFICATIONS IDATED
--------- --------- --------- ---------
Cash flows from operating activities:
Net (loss) income from continuing
operations ............................ $ 5,757 $(28,029) $ -- $(22,272)
Adjustments to reconcile net (loss)
income from continuing operations to
net cash used in operating activities:
Depreciation and amortization ... 1,710 2,159 -- 3,869
Equity in losses of affiliate ... 195 -- -- 195
Minority interests .............. 1,277 (18,817) -- (17,540)
Non-cash stock compensation
expense ....................... 856 19,963 -- 20,819
Charge for acquired in-process
research and development ...... -- -- -- --
Deferred tax benefit ............ (27) (155) -- (182)
Write-off of other assets ....... -- 918 -- 918
Net sales (purchases) of
trading securities ............ (4,135) -- -- (4,135)
Unrealized losses (gains) on
short-term investments ........ (237) -- -- (237)
Issuance of common stock by
subsidiary - legal
settlement charge ............. -- -- -- --
Impairment of cost method
investment .................... -- -- -- --
Other ........................... 40 314 -- 354
Changes in assets and liabilities:
Accounts receivable ............. -- (143) (77) (220)
Prepaid expenses, other
receivables and other assets .. (378) (115) -- (493)
Accounts payable, accrued
expenses and other ............ 233 775 77 1,085
Deferred revenues ............... 1,500 5,960 -- 7,460
--------- --------- --------- ---------
Net cash (used in) provided
by operating activities from
continuing operations ........... 6,791 (17,170) -- (10,379)
Net cash used in operating
activities from
discontinued operations ......... (2,182) -- -- (2,182)
--------- --------- --------- ---------
Net cash used in operating
activities .................... 4,609 (17,170) -- (12,561)
--------- --------- --------- ---------
Cash flows from investing activities:
Purchase of additional equity
in consolidated subsidiaries .. (3,304) -- -- (3,304)
Purchase of property and
equipment, net ................ (19) (3,756) -- (3,775)
Sale of property and equipment .. -- -- -- --
Proceeds from sale and
leaseback arrangement ......... -- 3,000 -- 3,000
Purchase of available-for-sale
investments ................... (25,921) (30,765) -- (56,686)
Sale of available-for-sale
investments ................... 25,921 50,354 -- 76,275
Purchase of common stock from
minority stockholders of
subsidiaries .................. (2,550) -- -- (2,550)
Acquisition costs ............... -- -- -- --
Other ........................... -- -- -- --
--------- --------- --------- ---------
Net cash (used in) provided by
investing activities from
continuing operations ........... (5,873) 18,833 -- 12,960
Net cash used in investing
activities from
discontinued operations ......... (145) -- -- (145)
--------- --------- --------- ---------
Net cash (used in) provided by
investing activities .......... (6,018) 18,833 -- 12,815
--------- --------- --------- ---------
Cash flows from financing activities:
Net cash attributed to the
Acacia Technologies group ..... 18,663 -- -- 18,663
Net cash attributed to the
CombiMatrix group ............. -- 4,496 -- 4,496
--------- --------- --------- ---------
Net cash (used in) provided
by financing activities ....... 18,663 4,496 -- 23,159
--------- --------- --------- ---------
Effect of exchange rate on cash ......... -- (125) -- (125)
--------- --------- --------- ---------
(Decrease) increase in cash and
cash equivalents .............. 17,254 6,034 -- 23,288
Cash and cash equivalents, beginning .... 29,605 6,558 -- 36,163
--------- --------- --------- ---------
Cash and cash equivalents, ending ....... $ 46,859 $ 12,592 $ -- $ 59,451
========= ========= ========= =========
F-37b
16. SUPPLEMENTAL CASH FLOW INFORMATION (IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------
2003 2002 2001
----------- ----------- -----------
Supplemental disclosures of cash flow information:
Cash paid for interest ...................................... $ -- $ 192 $ 42
Cash paid for income taxes .................................. 9 -- 597
Supplemental schedule of non-cash operating, investing and
financing activities:
Issuance of common stock for additional
equity in consolidated subsidiary ........................ 1,219 (46,007) --
Purchase price allocated to goodwill - step acquisitions .... 565 16,008 --
Purchase price allocated to patents - step acquisitions ..... -- 5,283 --
Liabilities assumed in acquisition of minority
ownership interest in subsidiary ......................... -- -- 200
Fixed assets purchased with accounts payable ................ -- 70 --
Purchase of equipment under capital lease agreement ......... -- -- (3,000)
Capital lease obligation incurred ........................... -- -- 3,000
Accrued payments for purchase of common stock
from minority stockholders of subsidiary ................. -- 58 217
Loss from discontinued operations of Soundbreak.com ......... -- 480 --
Deferred revenue purchase accounting adjustment ............. -- 8,425 --
F-38
17. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth unaudited consolidated statement of
operations data for the eight quarters in the period ended December 31, 2003.
This information has been derived from our unaudited condensed consolidated
financial statements that have been prepared on the same basis as the audited
consolidated financial statements and, in the opinion of management, include all
adjustments, consisting of normal recurring adjustments, necessary for a fair
presentation of the information when read in conjunction with the audited
consolidated financial statements and related notes thereto. Our quarterly
results have been in the past and may in the future be subject to significant
fluctuations. As a result, we believe that results of operations for interim
periods should not be relied upon as any indication of the results to be
expected in any future periods.
F-39
17. QUARTERLY FINANCIAL DATA (UNAUDITED)
QUARTER ENDED
-------------------------------------------------------------
MAR. 31, JUN. 30, SEP. 30, DEC. 31,
2003 2003 2003 2003
------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION)
Revenues:
License fee income ........................... $ 6 $ 19 $ 186 $ 481
Product revenue .............................. 209 -- 171 27
Grant and contract revenue ................... 7 6 10 26
------------- ------------- ------------- -------------
Total revenues ............................... 222 25 367 534
Operating expenses ................................ 7,207 6,885 6,481 5,937
------------- ------------- ------------- -------------
Operating loss .................................... (6,985) (6,860) (6,114) (5,403)
Other income (expenses) ........................... 252 (4) 212 162
------------- ------------- ------------- -------------
Loss from continuing operations before
income taxes and minority interests .......... (6,733) (6,864) (5,902) (5,241)
Benefit for income taxes .......................... 60 66 70 77
------------- ------------- ------------- -------------
Loss from continuing operations before
minority interests ........................... (6,673) (6,798) (5,832) (5,164)
Minority interests ................................ 6 24 -- 17
------------- ------------- ------------- -------------
Loss from continuing operations ................... (6,667) (6,774) (5,832) (5,147)
Loss from discontinued operations ................. -- -- -- --
------------- ------------- ------------- -------------
Net loss .......................................... $ (6,667) $ (6,774) $ (5,832) $ (5,147)
============= ============= ============= =============
Loss per common share basic and diluted:
Attributable to the Acacia Technologies group:
Loss from continuing operations ................. $ (0.08) $ (0.08) $ (0.07) $ (0.05)
Loss from discontinued operations ............... $ -- $ -- $ -- $ --
------------- ------------- ------------- -------------
Net loss .......................................... $ (0.08) $ (0.08) $ (0.07) $ (0.05)
============= ============= ============= =============
Attributable to the CombiMatrix group:
Loss from continuing operations ................. $ (0.23) $ (0.21) $ (0.18) $ (0.16)
Loss from discontinued operations ............... $ -- $ -- $ -- $ --
------------- ------------- ------------- -------------
Net loss .......................................... $ (0.23) $ (0.21) $ (0.18) $ (0.16)
============= ============= ============= =============
Weighted average shares - basic and diluted:
Acacia Research - Acacia Technologies stock ..... 19,640,808 19,640,808 19,645,949 19,718,377
Acacia Research - CombiMatrix stock ............. 22,983,278 24,183,340 25,890,408 26,207,146
Market price per share - Acacia Technologies stock:
High ......................................... $ 2.40 $ 1.75 $ 6.73 $ 8.58
Low .......................................... $ 0.96 $ 0.99 $ 1.25 $ 4.71
Market price per share - CombiMatrix stock:
High ......................................... $ 3.65 $ 2.83 $ 5.07 $ 5.05
Low .......................................... $ 1.50 $ 1.71 $ 2.25 $ 2.90
continued below: F-40a
continued from above:
QUARTER ENDED
--------------------------------------------------------------
MAR. 31, JUN. 30, SEP. 30, DEC. 31,
2002 2002 2002 2002
------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION)
Revenues:
License fee income ........................... $ -- $ -- $ 43 $ --
Product revenue .............................. -- 274 23 9
Grant and contract revenue ................... 249 164 113 7
------------- ------------- ------------- -------------
Total revenues ............................... 249 438 179 16
Operating expenses ................................ 8,694 13,473 32,219 26,820
------------- ------------- ------------- -------------
Operating loss .................................... (8,445) (13,035) (32,040) (26,804)
Other income (expenses) ........................... (486) (845) (2,749) 968
------------- ------------- ------------- -------------
Loss from continuing operations before
income taxes and minority interests .......... (8,931) (13,880) (34,789) (25,836)
Benefit for income taxes .......................... 69 75 287 426
------------- ------------- ------------- -------------
Loss from continuing operations before
minority interests ........................... (8,862) (13,805) (34,502) (25,410)
Minority interests ................................ 2,435 4,104 14,080 3,187
------------- ------------- ------------- -------------
Loss from continuing operations ................... (6,427) (9,701) (20,422) (22,223)
Loss from discontinued operations ................. -- -- (200) --
------------- ------------- ------------- -------------
Net loss .......................................... $ (6,427) $ (9,701) $ (20,622) $ (22,223)
============= ============= ============= =============
Loss per common share basic and diluted:
Attributable to the Acacia Technologies group:
Loss from continuing operations ................. $ (0.14) $ (0.19) $ (0.26) $ (0.04)
Loss from discontinued operations ............... $ -- $ -- $ (0.01) $ --
------------- ------------- ------------- -------------
Net loss .......................................... $ (0.14) $ (0.19) $ (0.27) $ (0.04)
============= ============= ============= =============
Attributable to the CombiMatrix group:
Loss from continuing operations ................. $ (0.16) $ (0.26) $ (0.67) $ (0.93)
Loss from discontinued operations ............... $ -- $ -- $ -- $ --
------------- ------------- ------------- -------------
Net loss .......................................... $ (0.16) $ (0.26) $ (0.67) $ (0.93)
============= ============= ============= =============
Weighted average shares - basic and diluted:
Acacia Research - Acacia Technologies stock ..... 19,640,808 19,640,808 19,640,808 19,640,808
Acacia Research - CombiMatrix stock ............. 22,950,551 22,950,551 22,950,551 22,951,324
Market price per share - Acacia Technologies stock:
High ......................................... $ -- $ -- $ -- $ 3.40
Low .......................................... $ -- $ -- $ -- $ 1.65
Market price per share - CombiMatrix stock:
High ......................................... $ -- $ -- $ -- $ 4.98
Low .......................................... $ -- $ -- $ -- $ 2.70
F-40b
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and
Stockholders of Acacia Research Corporation
In our opinion, the financial statements listed in the index appearing
under Item 15(a)(1) on page 70 present fairly, in all material respects, the
financial position of CombiMatrix Group (a division of Acacia Research
Corporation as described in Note 1) at December 31, 2003 and December 31, 2002,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of Acacia Research Corporation's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As more fully described in Note 1 to the financial statements,
CombiMatrix Group is a division of Acacia Research Corporation; accordingly, the
financial statements of Acacia Technologies group should be read in conjunction
with the consolidated financial statements of Acacia Research Corporation.
/s/ PricewaterhouseCoopers LLP
Los Angeles, California
February 27, 2004
F-41
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31, DECEMBER 31,
2003 2002
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents ................................................................ $ 3,807 $ 3,291
Available-for-sale investments ........................................................... 13,492 11,605
Accounts receivable, net of allowance for doubtful accounts of $145 (2003) $0 (2002) ..... 199 578
Inventory, prepaid expenses and other assets ............................................. 277 446
------------ ------------
Total current assets ............................................................. 17,775 15,920
Property and equipment, net of accumulated depreciation and amortization ................. 2,752 3,895
Patents, net of accumulated amortization of $1,978 (2003) and $883 (2002) ................ 10,117 11,212
Goodwill ................................................................................. 19,424 18,859
Other assets ............................................................................. 93 87
------------ ------------
$ 50,161 $ 49,973
============ ============
LIABILITIES AND ALLOCATED NET WORTH
Current liabilities:
Accounts payable, accrued expenses and other ............................................. $ 1,672 $ 2,302
Current portion of deferred revenues ..................................................... 18,004 9,172
Payable to Acacia Technologies group ..................................................... 99 114
------------ ------------
Total current liabilities ........................................................ 19,775 11,588
Deferred income taxes ...................................................................... 2,248 2,384
Deferred revenues, net of current portion .................................................. 2,401 --
------------ ------------
Total liabilities ................................................................ 24,424 13,972
------------ ------------
Minority interests ......................................................................... -- 684
------------ ------------
Commitments and contingencies (Note 9)
Allocated net worth:
Funds allocated by Acacia Research Corporation ........................................... 138,675 129,286
Accumulated net losses ................................................................... (112,938) (93,969)
------------ ------------
Total allocated net worth ........................................................ 25,737 35,317
------------ ------------
$ 50,161 $ 49,973
============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-42
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
Revenues:
Product revenue ................................................... $ 407 $ 306 $ --
Grant and contract revenue ........................................ 49 533 456
--------- --------- ---------
Total revenues ................................................. 456 839 456
--------- --------- ---------
Operating expenses:
Cost of sales ..................................................... 99 263 --
Research and development expenses ................................. 8,098 18,187 11,656
Charge for acquired in-process research and development ........... -- 17,237 --
Non-cash stock compensation expense - research and development .... 466 1,868 7,183
Marketing, general and administrative expenses .................... 8,714 10,334 16,690
Non-cash stock compensation expense - marketing, general
and administrative .............................................. 1,189 4,540 12,780
Amortization of patents and goodwill .............................. 1,095 399 1,203
Legal settlement charges .......................................... 144 18,471 --
--------- --------- ---------
Total operating expenses ....................................... 19,805 71,299 49,512
--------- --------- ---------
Operating loss ................................................. (19,349) (70,460) (49,056)
--------- --------- ---------
Other income (expense):
Interest income ................................................... 214 589 2,120
Interest expense .................................................. -- (197) (65)
--------- --------- ---------
Total other income ............................................. 214 392 2,055
--------- --------- ---------
Loss from operations before income taxes
and minority interests ............................................ (19,135) (70,068) (47,001)
Benefit for income taxes ............................................ 136 147 155
--------- --------- ---------
Loss from operations before minority interests ...................... (18,999) (69,921) (46,846)
Minority interests .................................................. 30 23,702 18,817
--------- --------- ---------
Division net loss ................................................... $(18,969) $(46,219) $(28,029)
========= ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-43
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF ALLOCATED NET WORTH
(IN THOUSANDS)
Balance at December 31, 2000 ................................... $ 30,169
Net assets attributed to the CombiMatrix group ................. 1,583
Division net loss .............................................. (28,029)
---------
Balance at December 31, 2001 ................................... 3,723
Net assets attributed to the CombiMatrix group ................. 77,813
Division net loss .............................................. (46,219)
---------
Balance at December 31, 2002 ................................... 35,317
Net assets attributed to the CombiMatrix group ................. 9,389
Division net loss .............................................. (18,969)
---------
Balance at December 31, 2003 ................................... $ 25,737
=========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-44
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
Cash flows from operating activities:
Division net loss from operations ....................................... $(18,969) $(46,219) $(28,029)
Adjustments to reconcile division net loss from operations
to net cash used in operating activities:
Depreciation and amortization ....................................... 2,409 1,736 2,159
Minority interests .................................................. (30) (23,702) (18,817)
Non-cash stock compensation expense ................................. 1,655 6,408 19,963
Charge for acquired in-process research and development ............. -- 17,237 --
Deferred tax benefit ................................................ (136) (147) (155)
Write-off of other assets ........................................... -- -- 918
Issuance of common stock by subsidiary - legal settlement charge .... -- 17,471 --
Other ............................................................... 25 129 314
Changes in assets and liabilities:
Accounts receivable ................................................. 379 (435) (143)
Inventory, prepaid expenses and other assets ........................ 169 258 (115)
Accounts payable, accrued expenses and other ........................ (645) (515) 775
Deferred revenues ................................................... 11,233 11,637 5,960
--------- --------- ---------
Net cash used in operating activities ............................... (3,910) (16,142) (17,170)
--------- --------- ---------
Cash flows from investing activities:
Purchase of property and equipment, net ............................. (83) (1,002) (3,756)
Sale of property and equipment ...................................... -- 358 --
Proceeds from sale and leaseback arrangement ........................ -- -- 3,000
Purchase of available-for-sale investments .......................... (32,714) (11,338) (30,765)
Sale of available-for-sale investments .............................. 30,801 20,383 50,354
Acquisition costs ................................................... -- (834) --
--------- --------- ---------
Net cash (used in) provided by investing activities ................. (1,996) 7,567 18,833
--------- --------- ---------
Cash flows from financing activities:
Net cash flows attributed to the CombiMatrix group .................. 6,435 (818) 4,496
--------- --------- ---------
Effect of exchange rate on cash ....................................... (13) 92 (125)
--------- --------- ---------
Increase (decrease) in cash and cash equivalents ...................... 516 (9,301) 6,034
Cash and cash equivalents, beginning .................................. 3,291 12,592 6,558
--------- --------- ---------
Cash and cash equivalents, ending ..................................... $ 3,807 $ 3,291 $ 12,592
========= ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-45
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Acacia Research Corporation is comprised of two separate divisions: the
CombiMatrix group and the Acacia Technologies group (the "groups").
Our life sciences business, referred to as the "CombiMatrix group," is
comprised of our wholly owned subsidiary, CombiMatrix Corporation and
CombiMatrix Corporation's majority-owned subsidiary, Advanced Material Sciences,
Inc. ("Advanced Material Sciences") and wholly owned subsidiary, CombiMatrix
K.K. CombiMatrix Corporation is a life sciences technology company with a
proprietary system for rapid, cost competitive creation of DNA and other
compounds on a programmable semiconductor chip, also referred to as an array.
This proprietary technology has applications in the areas of genomics,
proteomics, biosensors, drug discovery, drug development, diagnostics,
combinatorial chemistry, material sciences and nanotechnology. 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., a wholly owned Japanese
corporation located in Tokyo, is exploring opportunities for CombiMatrix
Corporation's active array system with pharmaceutical and biotechnology
companies in the Asian market.
During 2002, the CombiMatrix group emerged from the development stage
as it began commencement of its planned principal operations and from which it
generated revenues.
LIQUIDITY AND RISKS
The CombiMatrix group is deploying new and unproven technologies and
continues to develop its commercial products. The CombiMatrix group has several
ongoing long-term development projects that involve experimental technology and
may require several years and substantial expenditures to complete. Management
believes that existing cash and cash equivalents and short-term investments are
adequate to fund operations through at least the next twelve months. However,
the ability to meet business objectives is dependent upon the CombiMatrix
group's ability to raise additional financing, substantiate its technology and
ultimately to fund itself from continuing operations. There can be no assurance
that such funding will be available at acceptable terms or at all.
The CombiMatrix group's business operations are also subject to certain
risks and uncertainties, including:
o market acceptance of products and services;
o technological advances that may make our products and services obsolete
or less competitive;
o increases in operating costs, including costs for supplies, personnel
and equipment;
o the availability and cost of capital;
o general economic conditions; and
o governmental regulation that may restrict our subsidiary companies'
businesses.
The CombiMatrix group has historically been substantially dependent on
its existing arrangements with strategic partners including Roche Diagnostics
GmbH ("Roche"), and has relied upon payments by Roche and other partners for a
majority of its future revenues. The CombiMatrix group expends a majority of its
resources toward fulfilling its contractual obligations under the Roche
agreements. Roche's primary service to the CombiMatrix group is to distribute
and proliferate its technology platform. The CombiMatrix group will need to
enter into additional strategic partnerships to develop and commercialize future
products. However, there can be no assurance that the CombiMatrix group will be
able to implement its future plans. Failure by management to achieve its plans
would have a material adverse effect on the CombiMatrix group's ability to
achieve its intended business objectives. The CombiMatrix group's success also
depends on its ability to protect its intellectual property.
F-46
RECAPITALIZATION AND MERGER TRANSACTIONS
On December 11, 2002, our stockholders voted in favor of a
recapitalization transaction, which became effective on December 13, 2002,
whereby we created two new classes of common stock called Acacia
Research-CombiMatrix stock ("AR-CombiMatrix stock") and Acacia Research-Acacia
Technologies stock ("AR-Acacia Technologies stock"), and divided our existing
Acacia Research Corporation common stock into shares of the two new classes of
common stock. AR-CombiMatrix stock is intended to reflect separately the
performance of Acacia Research Corporation's CombiMatrix group. AR-Acacia
Technologies stock is intended to reflect separately the performance of Acacia
Research Corporation's Acacia Technologies group. Although the AR-CombiMatrix
stock and the AR-Acacia Technologies stock are intended to reflect the
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.
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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. AR-CombiMatrix stock is intended to reflect the
separate performance of the respective division of Acacia Research Corporation.
The CombiMatrix group is not a separate legal entity. Holders of AR-CombiMatrix
stock are stockholders of Acacia Research Corporation. As a result, holders of
AR-CombiMatrix stock are subject to all of the risks of an investment in Acacia
Research Corporation and all of its businesses, assets and liabilities. The
assets Acacia Research Corporation attributes to the CombiMatrix group could be
subject to the liabilities of the Acacia Technologies group.
The CombiMatrix group financial statements have been prepared in
accordance with generally accepted accounting principles in the United States of
America, and taken together with the Acacia Technologies group financial
statements, comprise all the accounts included in the corresponding consolidated
financial statements of Acacia Research Corporation. The financial statements of
CombiMatrix group reflect the financial condition, results of operations, and
cash flows of the businesses included therein. The financial statements of the
CombiMatrix group include the accounts or assets of Acacia Research Corporation
specifically attributed to the CombiMatrix group and were prepared using amounts
included in Acacia Research Corporation's consolidated financial statements.
Minority interests represent participation of other stockholders in the
allocated net assets and in the division earnings and losses of the CombiMatrix
group and are reflected in the caption "Minority interests" in CombiMatrix
group's financial statements. Minority interests adjust CombiMatrix group's net
results of operations to reflect only CombiMatrix group's share of the division
earnings or losses of non wholly owned investees of Acacia Research Corporation
that have been attributed to the CombiMatrix group (see Note 12).
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.
Refer to Note 2 to the Acacia Research Corporation consolidated
financial statements included elsewhere herein for the management allocation
policies, treasury and cash management policies, asset and liability attribution
policies, corporate, general and administrative services and facilities
allocation policies and federal and state income tax allocation policies,
utilized in the preparation of the separate CombiMatrix group financial
statements.
F-47
REVENUE RECOGNITION. The CombiMatrix group recognizes revenue in
accordance with Staff Accounting Bulletin No. 104, "Revenue Recognition" ("SAB
No. 104") and related authoritative pronouncements. Revenues from
multiple-element arrangements are accounted for in accordance with Emerging
Issues Task Force ("EITF") Issue 00-21, "Revenue Arrangements with Multiple
Deliverables." Revenue 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.
Revenue from government grant and contract activities are recognized as
the related services are performed and when the services have been approved by
the grantor and collectibility is reasonably assured. Amounts recognized are
limited to amounts due from customers based on contract or grant terms.
Revenue from the sale of products and services is recognized when
delivery has occurred or services have been rendered.
Multiple-element arrangements typically include license fees, up-front
payments and milestone payments that are received and/or billable by the
CombiMatrix group in connection with other rights and services that represent
continuing obligations of the CombiMatrix group. Payments received or billable
by the CombiMatrix group 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. Deferred
revenues will be recognized as revenue in future periods when the applicable
revenue recognition criteria as described above are met.
CASH AND CASH EQUIVALENTS. The CombiMatrix group considers all highly
liquid, short-term investments with original maturities of three months or less
when purchased to be cash equivalents.
SHORT-TERM INVESTMENTS. The CombiMatrix group's short-term investments
are held in a variety of interest bearing instruments including high-grade
corporate bonds, money market accounts and other high-credit quality marketable
securities. Investments in securities with original maturities of greater than
three months and less than one year are classified as short-term investments.
Investments are classified in accordance with the provisions of Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities" ("SFAS No. 115"). Investments are classified as
available-for-sale, which are reported at fair value with related unrealized
gains and losses in the value of such securities recorded as a component of
allocated net worth until realized.
The fair value of the CombiMatrix group's investments is determined by
quoted market prices. Realized and unrealized gains and losses are recorded
based on the specific identification method. For investments classified as
available-for-sale, unrealized losses that are other than temporary are
recognized in division net loss.
The cost of debt securities is adjusted for amortization of premiums
and accretion of discounts to maturity. Such amortization is included in
interest income (expense). Interest and dividends on all securities are included
in interest income.
CONCENTRATION OF CREDIT RISKS. Cash and cash equivalents are invested
in deposits with certain financial institutions and may, at times, exceed
federally insured limits. The CombiMatrix group has not experienced any
significant losses on its deposits of cash and cash equivalents.
INVENTORY. Inventory, which consists primarily of raw materials to be
used in the production of our array products, is stated at the lower of cost or
market using the first-in, first-out method.
PROPERTY AND EQUIPMENT. Property and equipment is recorded at cost.
Additions and improvements that increase the value or extend the life of an
asset are capitalized. Maintenance and repairs are expensed as incurred.
Disposals are removed at cost less accumulated depreciation or amortization and
any gain or loss from disposition is reflected in the statement of operations in
the period of disposition. Depreciation is computed on a straight-line basis
over the following estimated useful lives of the assets:
F-48
Machine shop and laboratory equipment....... 5 years
Furniture and fixtures...................... 5 to 7 years
Computer hardware and software.............. 3 years
Leasehold improvements...................... Lesser of lease term or
useful life of improvement
Construction in progress includes direct costs incurred related to
internally constructed assets which are depreciated once the asset is placed
into service. Certain leasehold improvements, furniture and equipment held under
capital leases are classified as property and equipment and are amortized over
their useful lives using the straight-line method. Lease amortization is
included in depreciation expense.
PREPAID PUBLIC OFFERING COSTS. During 2000 and 2001, CombiMatrix
Corporation capitalized $1,353,000 of costs incurred in connection with the
filing of a registration statement with the Securities and Exchange Commission
in November 2000. During 2001, all of these deferred costs were charged to
operations and are included as a component of marketing, general and
administrative expense in the accompanying statements of operations.
ORGANIZATION COSTS. Costs of start-up activities, including
organization costs, are expensed as incurred.
PATENTS AND GOODWILL. Goodwill and identifiable intangibles, including
patents, are recorded when the consideration paid for acquisitions exceeds the
fair value of the net tangible assets acquired. Patents, once issued or
purchased, are amortized on the straight-line method over their economic
remaining useful lives, ranging from three to twenty years. Goodwill is not
amortized.
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL. Long-lived assets and
intangible assets are reviewed for potential impairment when events or changes
in circumstances indicate the carrying amount of an asset may not be
recoverable. In the event the sum of the expected undiscounted future cash flows
resulting from the use of the asset is less than the carrying amount of the
asset, an impairment loss equal to the excess of the asset's carrying value over
its fair value is recorded. If an asset is determined to be impaired, the loss
is measured based on quoted market prices in active markets, if available. If
quoted market prices are not available, the estimate of fair value is based on
various valuation techniques, including a discounted value of estimated future
cash flows.
Goodwill is evaluated for impairment in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets" ("SFAS No. 142") and 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. The
CombiMatrix group performed a transitional goodwill impairment assessment in
2002 and a year-end goodwill impairment assessment in 2002 and 2003 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.
FAIR VALUE OF FINANCIAL INSTRUMENTS. The carrying value of cash and
cash equivalents, accounts receivables, accounts payable and accrued expenses
approximate fair value due to their short-term maturity. The carrying value of
the capital lease obligation approximates its fair value based on the current
interest rate for similar type of instruments.
FOREIGN CURRENCY TRANSLATION. The functional currency of CombiMatrix
K.K. is the local currency (Japanese Yen). Foreign currency translation is
reported pursuant to SFAS No. 52, "Foreign Currency Translation" ("SFAS No.
52"). Assets and liabilities recorded in foreign currencies are translated at
the exchange rate on the balance sheet date. Translation adjustments resulting
from this process are charged or credited to allocated net worth. Revenue and
expenses are translated at average rates of exchange prevailing during the year.
Foreign currency transactions gains and losses were insignificant for the years
ended December 31, 2003, 2002 and 2001.
F-49
STOCK-BASED COMPENSATION. Refer to Note 2 to the Acacia Research
Corporation consolidated financial statements included elsewhere herein. In 2001
and earlier periods, stock compensation expense recorded related to the
CombiMatrix group employees has been allocated to the CombiMatrix group. As a
result of the recapitalization transaction discussed earlier, in future periods,
stock compensation expense, if any, resulting from the issuance of
AR-CombiMatrix stock will generally be allocated to the CombiMatrix group.
Stock option and related option plan information is omitted from the
CombiMatrix group footnotes because AR- CombiMatrix stock is part of the capital
structure of Acacia Research Corporation. The CombiMatrix group is not a
separate legal entity. Holders of AR-CombiMatrix stock continue to be
stockholders of Acacia Research Corporation. This presentation reflects the fact
that the CombiMatrix group does not have legally issued common or preferred
stock, nor are warrant issuances or employee stock transactions legal
transactions of the CombiMatrix group. Refer to the Acacia Research Corporation
consolidated financial statements for disclosures regarding Acacia Research
Corporation's stock option plans.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
consist of costs incurred for direct and overhead-related research expenses and
are expensed as incurred. Costs to acquire technologies which are utilized in
research and development and which have no alternative future use are expensed
when incurred. Costs related to filing and pursuing patent applications are
expensed as incurred, as recoverability of such expenditures is uncertain.
Software developed for use in our products is expensed as incurred until both
(i) technological feasibility for the software has been established and (ii) all
research and development activities for the other components of the system have
been completed. Management believes these criteria are met after the CombiMatrix
group has received evaluations from third-party test sites and completed any
resulting modifications to the products. Expenditures to date have been
classified as research and development expense.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. The value assigned to
acquired in-process research and development ("IPR&D") is determined by
identifying acquired specific in-process research and development projects that
would be continued and for which (a) technological feasibility has not been
established at the acquisition date, (b) there is no alternative future use and
(c) the fair value is estimable with reasonable reliability, upon consummation
of a business combination.
SEGMENTS. The CombiMatrix group follows SFAS No. 131, "Disclosure about
Segments of an Enterprise and Related Information" ("SFAS No. 131"), which
establishes annual and interim reporting standards for an enterprise's operating
segments and related disclosures about its products, services, geographic areas
and major customers. Management has determined that the CombiMatrix group
operates in one segment.
USE OF ESTIMATES. The preparation of financial statements in conformity
with generally accepted accounting principles in the United States of America
requires management to make estimates and assumptions that affect the reported
amount of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the combined financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from these estimates.
LOSS PER SHARE. Loss per share information is omitted from the
CombiMatrix group statements of operations because AR-CombiMatrix stock is part
of the capital structure of Acacia Research Corporation. The CombiMatrix group
is not a separate legal entity. Holders of AR-CombiMatrix stock continue to be
stockholders of Acacia Research Corporation. This presentation reflects the fact
that the CombiMatrix group does not have legally issued common or preferred
stock, nor are warrant issuances or employee stock transactions legal
transactions of the CombiMatrix group. Refer to the Acacia Research Corporation
consolidated financial statements for loss 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."
CERTAIN RISKS AND UNCERTAINTIES. The CombiMatrix group's products and
services will be concentrated in a highly competitive market that is
characterized by rapid technological advances, frequent changes in customer
requirements and evolving regulatory requirements and industry standards.
Failure to anticipate or respond adequately to technological advances, changes
in customer requirements, changes in regulatory requirements or industry
standards, or any significant delays in the development or introduction of
planned products or services, could have a material adverse effect on the
CombiMatrix group's business and operating results.
F-50
RECENT ACCOUNTING PRONOUNCEMENTS. Refer to Note 2 to the Acacia
Research Corporation consolidated financial statements included elsewhere
herein.
3. SHORT-TERM INVESTMENTS
Short-term investments consists of the following at December 31, 2003
and 2002 (in thousands):
AMORTIZED FAIR
2003 COST VALUE
----------- -----------
Available-for-sale securities:
Corporate bonds and notes................ $ 6,930 $ 6,931
U.S. government securities............... 6,558 6,561
----------- -----------
$ 13,488 $ 13,492
=========== ===========
AMORTIZED FAIR
2002 COST VALUE
----------- -----------
Available-for-sale securities:
Corporate bonds and notes................ $ 5,718 $ 5,808
U.S. government securities............... 5,698 5,797
----------- -----------
$ 11,416 $ 11,605
=========== ===========
Gross unrealized gains and losses related to available-for-sale
securities were not material for 2003 and 2002.
Contractual maturities for investments in debt securities classified as
available-for-sale as of December 31, 2003 are as follows (in thousands):
FAIR
COST VALUE
----------- -----------
Due within one year.......................... $ 13,166 $ 13,170
Due after one year through two years......... 322 322
----------- -----------
$ 13,488 $ 13,492
=========== ===========
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31, 2003
and 2002 (in thousands):
2003 2002
----------- -----------
Machine shop and laboratory equipment........ $ 3,687 $ 3,272
Furniture and fixtures....................... 160 156
Computer hardware and software............... 1,163 1,157
Leasehold improvements....................... 999 992
Construction in progress..................... 84 352
----------- -----------
6,093 5,929
Less: accumulated depreciation and
amortization............................... (3,341) (2,034)
----------- -----------
$ 2,752 $ 3,895
=========== ===========
F-51
Depreciation and amortization expense was $1,314,000, $1,364,000 and
$955,000 for the years ended December 31, 2003, 2002 and 2001. Amortization of
assets held under capital lease included in depreciation and amortization
expense was $590,000 and $161,000 for the years ended December 31, 2002 and
2001, respectively.
During 2001, CombiMatrix Corporation entered into a sale and leaseback
transaction with a commercial bank. Approximately $3,000,000 of property and
equipment was financed, resulting in a deferred gain of approximately $443,000.
In November 2002, the lease obligation was repaid and title to the assets
previously under capital lease was transferred back to the CombiMatrix group.
5. INVESTMENTS IN AFFILIATES
In April 2002, CombiMatrix Corporation purchased Acacia Research
Corporation's majority interest in Advanced Material Sciences. CombiMatrix
Corporation issued 180,982 shares of its common stock to Acacia Research
Corporation in exchange for Acacia Research Corporation's 58% interest in
Advanced Material Sciences. As a result of this transaction, CombiMatrix
Corporation owned 87% of Advanced Material Sciences as of December 31, 2002,
with the remaining interests owned by unaffiliated parties. CombiMatrix
Corporation's ownership interest was increased during 2003 as described in Note
12 below. The April 2002 transaction was accounted for using Acacia Research
Corporation's basis in the net assets of Advanced Material Sciences and as a
result, the CombiMatrix group's 2002 financial statements reflect the assets and
liabilities of Advanced Material Sciences at historical cost.
6. INTANGIBLES
The CombiMatrix group has $19,424,000 and $18,859,000 of goodwill
at December 31, 2003 and 2002. The CombiMatrix group adopted SFAS No. 142
effective January 1, 2002 and ceased amortizing goodwill on that date. Division
net loss for the year ended December 31, 2001, adjusted to exclude goodwill
amortization expense of $862,000, was $27,167,000.
The CombiMatrix group's only identifiable intangible assets are
patents. The gross carrying amounts and accumulated amortization related to
acquired intangible assets, all related to patents, as of December 31, 2003 and
2002, are as follows (in thousands):
2003 2002
----------- -----------
Gross carrying amount - patents.............. $ 12,095 $ 12,095
Accumulated amortization..................... (1,978) (883)
----------- -----------
Patents, net................................. $ 10,117 $ 11,212
=========== ===========
Aggregate patent amortization expense was $1,095,000, $399,000 and
$341,000 in 2003, 2002 and 2001, respectively. Annual aggregate amortization
expense for each of the next five years through December 31, 2008 is estimated
to be $1,095,000 per year.
Refer to Note 12, "Step Acquisitions Allocated to the CombiMatrix
Group," for additions to goodwill during 2003 and 2002.
At December 31, 2003, all of the CombiMatrix group's acquired
intangible assets other than goodwill were subject to amortization.
F-52
7. BALANCE SHEET COMPONENTS
Accounts payable, accrued expenses and other consists of the following
at December 31, 2003 and December 31, 2002 (in thousands):
2003 2002
----------- -----------
Accounts payable............................. $ 547 $ 325
Payroll and other employee benefits.......... 304 481
Accrued vacation............................. 287 412
Legal settlement (see Note 9)................ -- 500
Deferred rent................................ 284 131
Other accrued liabilities.................... 250 453
----------- -----------
$ 1,672 $ 2,302
=========== ===========
8. INCOME TAXES
CombiMatrix group's allocated benefit for income taxes consists of the
following (in thousands):
2003 2002 2001
----------- ----------- -----------
Current:
U.S. Federal tax.................. $ -- $ -- $ --
State taxes....................... -- -- 3
----------- ----------- -----------
-- -- 3
----------- ----------- -----------
Deferred:
U.S. Federal tax.................. (136) (147) (158)
State taxes....................... -- -- --
----------- ----------- -----------
(136) (147) (158)
----------- ----------- -----------
$ (136) $ (147) $ (155)
=========== =========== ===========
The tax effects of temporary differences and carryforwards that give
rise to significant portions of deferred assets and liabilities consist of the
following at December 31, 2003 and 2002 (in thousands):
2003 2002
----------- -----------
Deferred tax assets:
Depreciation and amortization................... $ (117) $ (128)
Deferred revenues............................... 3,456 3,116
Stock compensation.............................. 8,009 7,686
Accrued liabilities and other................... 213 286
Net operating loss carryforwards and credits.... 28,947 22,666
----------- -----------
Total deferred tax assets...................... 40,508 33,626
Less: valuation allowance..................... (40,508) (33,626)
----------- -----------
Deferred tax assets, net of valuation allowance -- --
----------- -----------
Deferred tax liabilities:
Intangibles.................................... (2,248) (2,384)
----------- -----------
Net deferred tax liability..................... $ (2,248) $ (2,384)
=========== ===========
F-53
A reconciliation of the federal statutory income tax rate and the
effective income tax rate is as follows:
2003 2002 2001
----------- ----------- -----------
Statutory federal tax rate.......... (34%) (34%) (34%)
Amortization of intangible assets... -- 3% --
Stock compensation.................. 1% 1% 6%
Non deductible permanent items...... -- 13% (1%)
Valuation allowance................. 36% 19% 29%
Other (4%) (2%) --
----------- ----------- -----------
(1%) -- --
=========== =========== ===========
At December 31, 2003, the CombiMatrix group has deferred tax assets
totaling approximately $40,508,000, which are fully offset by a valuation
allowance due to management's determination that the criteria for recognition
have not been met.
In December 2002, Acacia Research Corporation increased its ownership
interest in CombiMatrix Corporation from 48% to 100%. As a result of the
increase in ownership, Acacia Research Corporation files a consolidated federal
income tax returns that includes the Acacia Technologies group (excluding
discontinued operations) and the CombiMatrix group.
At December 31, 2003, the CombiMatrix group had federal net operating
loss carryforwards of approximately $82,126,000, which will begin to expire in
2011 through 2023. In addition, the CombiMatrix group has tax credit
carryforwards of approximately $2,470,000. Utilization of net operating loss
carryforwards and tax credit carryforwards are subject to the "change of
ownership" provisions under Section 382 of the Internal Revenue Code. The amount
of such limitations has not been determined.
Had the CombiMatrix group filed separate tax returns, the benefit for
income taxes and division net loss would not have differed from the amounts
reported in the CombiMatrix group's statements of operations for the years ended
December 31, 2003, 2002, and 2001.
9. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
In October 2000, CombiMatrix Corporation entered into a non-cancelable
operating lease for office space. A security deposit in the form of a $783,000
letter of credit was issued November 1, 2000, which was increased to $1,200,000
during 2001 and to $1,500,000 during 2002. Future minimum operating lease
payments as of December 31, 2003 are as follows (in thousands):
YEAR
-----------
2004................................................... $ 1,864
2005................................................... 1,918
2006................................................... 1,836
2007................................................... 1,937
2008................................................... 1,615
Thereafter............................................. --
-----------
Total minimum lease payments........................... $ 9,170
===========
Rent expense for the years ended December 31, 2003, 2002 and 2001 was
$2,006,000, $1,618,000, and $1,450,000, respectively.
F-54
COLLABORATIVE AND RESEARCH AGREEMENTS
In July 2001, CombiMatrix Corporation entered into a non-exclusive
worldwide license, supply, research and development agreement with Roche. Under
the terms of the agreement, Roche will purchase, use and resell CombiMatrix
Corporation's array and related technologies for rapid production of
customizable arrays. Additionally, CombiMatrix Corporation and Roche will
develop a platform technology, providing a range of standardized arrays for use
in research applications. The agreement has a 15-year term and provides for
minimum payments by Roche to CombiMatrix Corporation over the first three years,
including payments upon the achievement of certain milestone and payments for
products, royalties and research and development projects. This agreement was
amended in September 2002 in order to grant Roche additional manufacturing
rights in exchange for greater cash compensation to CombiMatrix Corporation,
among other changes and modifications. For the years ended December 31, 2003 and
2002, CombiMatrix Corporation received $9,811,000 and $11,435,000 in milestone
payments, respectively, which have been classified as deferred revenue in the
CombiMatrix group balance sheets.
RESEARCH AND DEVELOPMENT
In January 2001, CombiMatrix Corporation entered into a design
commitment to develop a next generation array. If the design project was
successful pursuant to the terms of the agreement, CombiMatrix Corporation would
have been obligated to a one-year commitment to purchase a specific number of
semiconductor wafers at a total cost of $1,100,000. This agreement was
terminated effective January 31, 2004 thereby relieving CombiMatrix Corporation
of this future commitment.
HUMAN RESOURCES
In October 2001, CombiMatrix Corporation's board of directors amended
its existing general severance plan for executive officers, which provides that
if CombiMatrix Corporation terminates an executive who is a vice president or
higher for other than cause, death or disability, the executive will receive
payments equal to three months' base salary and target bonus and other benefits
on a bi-weekly basis over a three-month period. If termination occurs as a
result of a change in control transaction, these benefits will be extended by
three months.
CombiMatrix Corporation also offers a general severance plan providing
all employees with certain benefits upon their termination of employment due to
lack of work. Under this plan, terminated employees will be provided with either
four-weeks notice or four-weeks' salary in lieu of notice, and paid a lump-sum
amount based on the employee's length of service, plus accrued benefits. The
terminated employees will also be provided continuing medical and dental
benefits, as well as continuation of life insurance, for a period ranging from
two to 26 weeks subsequent to the date of termination, depending upon the
employee's length of service.
LITIGATION
On November 28, 2000, Nanogen, Inc. ("Nanogen") filed suit against
CombiMatrix Corporation and Dr. Donald Montgomery, an officer, director and
stockholder of CombiMatrix Corporation. The Nanogen suit alleged, among other
things, that CombiMatrix Corporation's issued patent and certain pending patent
applications, trade secrets and related technologies that were inappropriately
obtained by CombiMatrix Corporation and that Nanogen was the legal owner of the
patents, trade secrets and related technologies. The suit sought, among other
things, correction of inventorship on CombiMatrix Corporation's issued patent,
the assignment of rights in the issued patent and pending patent applications to
Nanogen, an injunction preventing disclosure of trade secrets, damages for trade
secret misappropriation and the imposition of a constructive trust.
F-55
On September 30, 2002, CombiMatrix Corporation and Dr. Donald
Montgomery entered into a settlement agreement with Nanogen, Inc. to settle all
pending litigation between the parties. Pursuant to the terms of the settlement
agreement, CombiMatrix Corporation agreed to pay Nanogen $500,000 within 30 days
of the settlement, which was paid, and an additional $500,000 within one year of
the settlement (paid in September 2003). CombiMatrix Corporation also agreed to
make quarterly payments to Nanogen equal to 12.5% of total sales of products
developed by CombiMatrix Corporation and its affiliates and based on the patents
that had been in dispute in the litigation, up to an annual maximum of
$1,500,000. The minimum quarterly payments under the settlement agreement will
be $37,500 per quarter for the period from October 1, 2003 through October 1,
2004, and $25,000 per quarter thereafter until the patents expire. Also,
pursuant to the settlement agreement, CombiMatrix Corporation issued to Nanogen
4,016,346 shares, or 17.5% of its outstanding shares post-issuance, subject to
an antidilution provision related to the exercise of CombiMatrix Corporation
options and warrants that were outstanding on the effective date of the
agreement, for a period of up to three years.
CombiMatrix Corporation accounted for the issuance of the CombiMatrix
Corporation common shares in settlement of the litigation with Nanogen as a
nonmonetary transaction. Accordingly, in the third quarter of 2002, CombiMatrix
Corporation recorded a litigation settlement charge in its statement of
operations of approximately $17,471,000, which was based on the fair value of
the CombiMatrix Corporation common shares issued to Nanogen. The fair value of
the common shares issued and the related litigation charge was based on a
third-party valuation of CombiMatrix Corporation. Including the $1,000,000 cash
settlement stipulated in the agreement, the CombiMatrix group has recognized
$18,471,000 of litigation settlement charges in its December 31, 2002 statement
of operations.
The CombiMatrix group is subject to other claims and legal actions that
arise in the ordinary course of business. Management believes that the ultimate
liability with respect to these claims and legal actions, if any, will not have
a material effect on CombiMatrix group's financial position, results of
operations or cash flows.
10. RETIREMENT SAVINGS PLAN
CombiMatrix Corporation has an employee savings and retirement plan
under section 401(k) of the Internal Revenue Code (the "Plan"). The Plan is a
defined contribution plan in which eligible employees may elect to have a
percentage of their compensation contributed to the Plan, subject to certain
guidelines issued by the Internal Revenue Service. CombiMatrix Corporation may
contribute to the Plan at the discretion of the board of directors. There were
no contributions made by the CombiMatrix group during the years ended December
31, 2003, 2002 and 2001.
11. ALLOCATED NET WORTH
The CombiMatrix group statement of allocated net worth presents the
equity transactions of Acacia Research Corporation, which are attributed to the
CombiMatrix group as "Net assets attributed to the CombiMatrix group." This
presentation reflects the fact that the CombiMatrix group does not have legally
issued common or preferred stock, nor are warrant issuances or employee stock
transactions legal transactions of the CombiMatrix group. Presented below is a
detail of the equity transactions of Acacia Research Corporation which relate to
the businesses of the CombiMatrix group and which therefore comprise the
balances reflected in the group's net assets attributed to CombiMatrix group (in
thousands):
COMBIMATRIX
GROUP
-----------
2001
Allocated corporate charges...................................... $ 1,118
Change in capital due to issuance of stock by subsidiaries....... 546
Unrealized loss on short-term investments........................ (9)
Unrealized loss on foreign currency translation.................. (72)
-----------
Net assets attributed to the CombiMatrix group - 2001............ $ 1,583
===========
F-56
2002
Allocated corporate charges...................................... $ 1,032
Stock options exercised.......................................... 29
Change in capital due to issuance of stock by subsidiaries....... (550)
Compensation expense relating to stock options and warrants...... 300
Unrealized gain on short-term investments........................ (38)
Unrealized loss on foreign currency translation.................. 40
Dividends paid................................................... (11)
Stock issuance related to acquisition of additional
CombiMatrix shares............................................. 76,175
Acquisition costs allocated...................................... 834
Other............................................................ 2
-----------
Net assets attributed to the CombiMatrix group - 2002............ $ 77,813
===========
2003
Units issued in private placement, net........................... $ 4,862
Allocated corporate charges...................................... 637
Stock options and warrants exercised............................. 953
Employee stock grant............................................. 60
Stock option cancellations....................................... (256)
Compensation expense relating to stock options and warrants...... 1,849
Unrealized gain on short-term investments........................ (27)
Unrealized loss on foreign currency translation.................. 35
Shares issued to Nanogen pursuant to September 2002
settlement agreement (see Note 9).............................. 74
Stock issuance related to acquisition of minority interests
in Advanced Material Sciences and CombiMatrix K.K.............. 1,219
Other............................................................ (17)
-----------
Net assets attributed to the CombiMatrix group - 2003............ $ 9,389
===========
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.
During October 2001, CombiMatrix K.K. issued 10% of its common stock to
Marubeni Corporation ("Marubeni"), an unrelated company for $1,108,000. The
per-share price paid for these shares exceeded the price per share paid by
CombiMatrix Corporation to capitalize CombiMatrix K.K. As a result, the
CombiMatrix group recognized a change of interest gain of approximately
$951,000. The gain, net of minority interests, has been recorded as an increase
to allocated net worth.
WARRANTS
In September 2003, proceeds of $450,000 were received from the issuance
of 164,000 shares of AR-CombiMatrix 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.
F-57
Pursuant to the issuance of convertible promissory notes in March 1998,
CombiMatrix Corporation issued warrants to purchase 145,000 shares of its common
stock at a price of $2.00 per share. These warrants were exercised in 2000 and
2001, resulting in proceeds to the CombiMatrix group of $33,000 and $257,000,
respectively, which were allocated to the CombiMatrix group.
12. STEP ACQUISITIONS ALLOCATED TO THE COMBIMATRIX GROUP
On July 11, 2003, Acacia Research Corporation purchased the outstanding
minority interests in its consolidated subsidiary CombiMatrix K.K. from
Marubeni. Acacia Research Corporation issued 200,000 shares of its
AR-CombiMatrix stock to Marubeni in exchange for Marubeni's 10% minority
interests (120 shares) 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.
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.
Acacia Research Corporation's interests in Advanced Material Sciences
and CombiMatrix K.K. have been attributed to the CombiMatrix group.
On December 13, 2002, Acacia Research Corporation increased its
consolidated ownership interest in CombiMatrix Corporation from 48% to 100% by
acquiring from existing stockholders of CombiMatrix Corporation 11,987,052
shares of CombiMatrix Corporation common stock in exchange for 11,987,052 shares
of AR-CombiMatrix stock with a fair value of $46,007,000. The merger was
designed to consolidate Acacia Research Corporation's ownership of CombiMatrix
Corporation and permit Acacia Research Corporation to effectuate the
recapitalization transaction described elsewhere herein, by creating the
CombiMatrix group.
The transaction was accounted for as a step acquisition using the
purchase method of accounting. The fair value of the AR-CombiMatrix stock issued
in the transaction was based on the quoted market price of AR-CombiMatrix stock
averaged over a five-day period (from December 16, 2002, the first day of
trading for the AR-CombiMatrix stock, through December 20, 2002).
The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed and the allocation of the purchase price at the
date of acquisition (in thousands):
Acquisition costs:
Exchange of AR-CombiMatrix stock for CombiMatrix
Corporation common stock......................... $ 46,007
Acquisition expenses................................ 834
-----------
Total acquisition cost.............................. $ 46,841
===========
Purchase price allocation:
Fair value of 52% of CombiMatrix Corporation
net tangible assets at December 13, 2002......... $ 8,313
Intangible assets acquired:
Core technology/patent.......................... 5,283
Acquired in-process research and development.... 17,237
Goodwill (non-deductible for tax purposes)...... 16,008
-----------
Total.............................................. $ 46,841
===========
F-58
The total purchase price of $46,841,000 was allocated to the fair value
of assets acquired and liabilities assumed, including acquired IPR&D. The amount
attributable to CombiMatrix Corporation's core technology and related patents
was $5,283,000, which is being amortized using the straight-line method over the
estimated economic useful life of 7 years. The amount attributable to goodwill
was $16,008,000. Amounts allocated to patents, IPR&D and goodwill have been
attributed to the CombiMatrix group.
The amount attributable to IPR&D projects (comprised of two projects:
Genomics and Proteomics biological array systems) that had not yet reached
technological feasibility and had no alternative future use of $17,237,000 was
charged to expense on the acquisition date and is included in the accompanying
statement of operations for the year ended December 31, 2002.
The nature of the efforts to develop the purchased IPR&D into
commercially viable products principally relates to the completion and/or
acceleration of existing development programs. These efforts include testing
current and alternative materials used in array design, testing of existing and
alternative methods for array synthesis, developing prototype machinery
(including operating software) to synthesize, hybridize and read individual
arrays, and to perform numerous experiments, or assays, with actual target
samples in order to determine customer protocols and procedures for using the
CombiMatrix group's array system. Following is a brief description of the two
IPR&D projects identified.
Genomics Biological Array System: CombiMatrix Corporation's genomics
biological array processor system is being developed to discretely immobilize
sequences of DNA or RNA within individual test sites on a modified semiconductor
chip coated with a three-dimensional layer of porous material. The system also
includes proprietary hardware units and related software applications to be able
to synthesize materials onto the chips, apply target samples of genetic
materials and interpret the results. The value assigned to the genomics
biological array system IPR&D project was $13,978,000. A risk-adjusted discount
rate of 32% was applied to the project's estimated cash flows.
Proteomics Biological Array System: CombiMatrix Corporation's
proteomics biological array processor system is being developed to discretely
immobilize proteins and other small molecules within individual test sites on a
modified semiconductor chip in a similar fashion as described above for the
genomics biological array system. The proteomics biological array system is used
for detection and identification of bio-threat agents in CombiMatrix
Corporation's biological and chemical threat agent detector development programs
that are currently in process. The value assigned to the proteomics biological
array system IPR&D project was $3,259,000. A risk-adjusted discount rate of 60%
was applied to the project's estimated cash flows.
DEFERRED REVENUE PURCHASE ACCOUNTING ADJUSTMENT
In connection with the December 2002 step acquisition described
above, and the application of purchase accounting pursuant to SFAS No. 142,
Acacia Research Corporation was required to adjust CombiMatrix Corporation's
assets and liabilities, including deferred revenues attributed to the
CombiMatrix group to fair value. As a result, deferred revenue, primarily
consisting of milestone payments and other cash receipts from Roche and the
National Aeronautics and Space Administration, was reduced by $8,425,000 to
reflect the fair value of the continuing obligation related to the 52% interest
in CombiMatrix Corporation acquired by Acacia Research Corporation. A
reconciliation of 2002 activity related to the CombiMatrix group's deferred
revenue balances including the impact of the fair value adjustment is as follows
(in thousands):
Deferred revenue balance at December 31, 2001.............. $ 5,960
Cash payments and accruals recorded as deferred revenues
during 2002............................................. 11,637
Less: purchase accounting adjustment...................... (8,425)
-----------
Deferred revenue balance at December 31, 2002.............. $ 9,172
===========
F-59
13. SUPPLEMENTAL CASH FLOW INFORMATION (IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
2003 2002 2001
--------- --------- ---------
Supplemental disclosures of cash flow information:
Cash paid for interest ..................................... $ -- $ 192 $ 42
Supplemental schedule of non-cash operating, investing and financing
activities:
Intangibles attributed to the CombiMatrix group ............ 1,219 (46,007) --
Purchase price allocated to goodwill - step acquisitions ... 565 16,008 --
Purchase price allocated to patents - step acquisitions .... -- 5,283 --
Fixed assets purchased with accounts payable ............... -- 70 --
Purchase of equipment under capital lease agreement ........ -- -- (3,000)
Capital lease obligation incurred .......................... -- -- 3,000
Deferred revenue purchase accounting adjustment ............ -- 8,425 --
F-60
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and
Stockholders of Acacia Research Corporation
In our opinion, the financial statements listed in the index appearing
under Item 15(a)(1) on page 70 present fairly, in all material respects, the
financial position of Acacia Technologies Group (a division of Acacia Research
Corporation as described in Note 1) at December 31, 2003 and December 31, 2002,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of Acacia Research Corporation's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As more fully described in Note 1 to the financial statements, Acacia
Technologies Group is a division of Acacia Research Corporation; accordingly,
the financial statements of Acacia Technologies group should be read in
conjunction with the consolidated financial statements of Acacia Research
Corporation.
/s/ PricewaterhouseCoopers LLP
Los Angeles, California
February 27, 2004
F-61
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31, DECEMBER 31,
2003 2002
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents .................................................... $ 28,142 $ 39,792
Short-term investments ....................................................... 5,059 --
Accounts receivable .......................................................... 124 --
Prepaid expenses and other assets ............................................ 903 775
Receivable from CombiMatrix group ............................................ 99 114
------------- -------------
Total current assets ................................................. 34,327 40,681
Property and equipment, net of accumulated depreciation ........................ 71 180
Patents, net of accumulated amortization of $7,232 (2003) and $6,730 (2002) .... 3,566 4,068
Goodwill ....................................................................... 1,776 1,834
Other assets ................................................................... 238 449
------------- -------------
$ 39,978 $ 47,212
============= =============
LIABILITIES AND ALLOCATED NET WORTH
Current liabilities:
Accounts payable, accrued expenses and other ................................. $ 1,572 $ 2,524
Deferred revenues ............................................................ 104 1,503
------------- -------------
Total current liabilities ............................................ 1,676 4,027
Deferred income taxes .......................................................... 1,012 1,156
Deferred revenues, net of current portion ...................................... 1,500 --
------------- -------------
Total liabilities .................................................... 4,188 5,183
------------- -------------
Minority interests ............................................................. 1,127 1,487
------------- -------------
Commitments and contingencies (Note 10)
Allocated net worth:
Funds allocated by Acacia Research Corporation ............................... 105,129 105,557
Accumulated net losses ....................................................... (70,466) (65,015)
------------- -------------
Total allocated net worth ............................................ 34,663 40,542
------------- -------------
$ 39,978 $ 47,212
============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-62
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
Revenues:
License fee income ..................................... $ 692 $ 43 $ 24,180
--------- --------- ---------
Total revenues ...................................... 692 43 24,180
--------- --------- ---------
Operating expenses:
Marketing, general and administrative expenses ......... 4,317 6,883 4,853
Non-cash stock compensation expense - marketing,
general and administrative ........................... -- 19 856
Legal expenses - patents ............................... 1,886 1,415 11,121
Amortization of patents and goodwill ................... 502 1,591 1,492
--------- --------- ---------
Total operating expenses ............................ 6,705 9,908 18,322
--------- --------- ---------
Operating (loss) income ............................. (6,013) (9,865) 5,858
--------- --------- ---------
Other income (expense):
Impairment of cost method investment ................... (207) (2,748) --
Interest income ........................................ 521 620 1,642
Realized gains (losses) on short-term investments ...... 94 (1,184) 350
Unrealized (losses) gains on short-term investments .... -- (249) 237
Interest expense ....................................... -- (6) --
Equity in losses of affiliate .......................... -- -- (195)
Other income ........................................... -- 64 77
--------- --------- ---------
Total other income (expenses) ....................... 408 (3,503) 2,111
--------- --------- ---------
(Loss) income from continuing operations before
income taxes and minority interests .................... (5,605) (13,368) 7,969
Benefit (provision) for income taxes ..................... 137 710 (935)
--------- --------- ---------
(Loss) income from continuing operations before
minority interests ..................................... (5,468) (12,658) 7,034
Minority interests ....................................... 17 104 (1,277)
--------- --------- ---------
(Loss) income from continuing operations ................. (5,451) (12,554) 5,757
Discontinued operations:
Estimated loss on disposal of Soundbreak.com ........... -- (200) --
--------- --------- ---------
Division net (loss) income ............................... $ (5,451) $(12,754) $ 5,757
========= ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-63
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF ALLOCATED NET WORTH
(IN THOUSANDS)
Balance at December 31, 2000.................................... $ 29,975
Net assets attributed to the Acacia Technologies group.......... 19,277
Division net income............................................. 5,757
-----------
Balance at December 31, 2001.................................... 55,009
Net assets attributed to the Acacia Technologies group.......... (1,713)
Division net loss............................................... (12,754)
-----------
Balance at December 31, 2002.................................... 40,542
Net assets attributed to the Acacia Technologies group.......... (428)
Division net loss............................................... (5,451)
-----------
Balance at December 31, 2003.................................... $ 34,663
===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-64
ACACIA TECHNOLOGIES GROUP
(A Division of Acacia Research Corporation)
STATEMENTS OF CASH FLOWS
(In thousands)
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
Cash flows from operating activities:
Division net (loss) income from continuing operations ........................ $ (5,451) $(12,554) $ 5,757
Adjustments to reconcile division net (loss) income from continuing operations
to net cash (used in) provided by operating activities:
Depreciation and amortization ....................................... 616 1,797 1,710
Equity in losses of affiliate ....................................... -- -- 195
Minority interests .................................................. (17) (104) 1,277
Non-cash stock compensation expense ................................. -- 19 856
Deferred tax benefit ................................................ (144) (142) (27)
Net sales (purchases) of trading securities ......................... -- 4,124 (4,135)
Unrealized losses (gains) on short-term investments ................. -- 249 (237)
Impairment of cost method investment ................................ 207 2,748 --
Other ............................................................... 4 (30) 40
Changes in assets and liabilities:
Accounts receivable ................................................. (124) -- --
Prepaid expenses, other receivables and other assets ................ (45) (1) (455)
Accounts payable, accrued expenses and other ........................ (411) 372 310
Deferred revenues ................................................... 101 3 1,500
--------- --------- ---------
Net cash (used in) provided by operating activities from
continuing operations ............................................. (5,264) (3,519) 6,791
Net cash used in operating activities from discontinued operations .. (551) (905) (2,182)
--------- --------- ---------
Net cash (used in) provided by operating activities ................. (5,815) (4,424) 4,609
--------- --------- ---------
Cash flows from investing activities:
Purchase of additional equity in consolidated subsidiaries .......... -- (200) (3,304)
Purchase of property and equipment, net ............................. (3) (78) (19)
Purchase of common stock from minority stockholders of subsidiaries . -- (217) (2,550)
Purchase of available-for-sale investments .......................... (5,059) -- --
Other ............................................................... -- (97) --
--------- --------- ---------
Net cash used in investing activities from continuing operations .... (5,062) (592) (5,873)
Net cash used in investing activities from discontinued operations .. (356) (3) (145)
--------- --------- ---------
Net cash used in investing activities ............................... (5,418) (595) (6,018)
--------- --------- ---------
Cash flows from financing activities:
Net cash flows attributed to the Acacia Technologies group .......... (417) (2,048) 18,663
--------- --------- ---------
(Decrease) increase in cash and cash equivalents ........................... (11,650) (7,067) 17,254
Cash and cash equivalents, beginning ....................................... 39,792 46,859 29,605
--------- --------- ---------
Cash and cash equivalents, ending .......................................... $ 28,142 $ 39,792 $ 46,859
========= ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-65
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Acacia Research Corporation's continuing operations are comprised of
two separate divisions: the Acacia Technologies group and the CombiMatrix group
(the "groups").
The Acacia Technologies group, a division of Acacia Research
Corporation, is primarily comprised of Acacia Research Corporation's interests
in two wholly owned subsidiaries: (1) Acacia Media Technologies Corporation,
("Acacia Media Technologies") a Delaware corporation and (2) Soundview
Technologies, Inc., ("Soundview Technologies") a Delaware corporation, and also
includes all corporate assets, liabilities, and related transactions of Acacia
Research Corporation attributed to the Acacia Research Corporation's
intellectual property licensing business.
The Acacia Technologies group is responsible for the development,
acquisition, licensing and protection of intellectual property and proprietary
technologies and is pursuing additional licensing and strategic business
alliances with leading companies in the rapidly growing intellectual property
licensing industry.
The Acacia Technologies group owns and out-licenses a portfolio of
pioneering U.S. and foreign patents covering digital audio and video
transmission and receiving systems, commonly known as audio-on-demand,
video-on-demand, and audio/video streaming. The Acacia Technologies group's
patented proprietary digital media transmission ("DMT"), technology, enables the
digitization, encryption, storage, transmission, receipt and playback of digital
content via several means including the Internet, cable, satellite and wireless
systems. The Acacia Technologies group believes its DMT technology is utilized
by a variety of companies in activities including digital ad insertion, cable
programming, satellite programming, hotel in-room entertainment services,
distance learning, and other Internet programming involving digital audio/video
content. The DMT technology is protected by five U.S. and 31 foreign patents.
The Acacia Technologies group also owns and has out-licensed to consumer
electronics manufacturers, patented technology known as the V-chip. The V-chip
technology was protected by U.S. Patent No. 4,554,584, which expired in July
2003. 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.
LIQUIDITY AND RISKS
The Acacia Technologies group believes that its cash and cash
equivalent and short term investment balances, anticipated cash flow from
operations and other external sources of available credit will be sufficient to
meet its cash requirements through at least the next twelve months.
Until 2003, the Acacia Technologies group generated substantially all
of its revenues from licensing the Acacia Technologies group's patented V-chip
technology to television manufacturers. The V-chip patent 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 the
patent, but it may still collect revenues from the sale of such televisions in
the United States before the expiration date. The Acacia Technologies group is
marketing and commercially licensing its DMT technology and is currently
developing additional technologies. However, there can be no assurance that the
Acacia Technologies group will be able to implement its future plans. Failure by
management to achieve its plans would have a material adverse effect on the
Acacia Technologies group and on Acacia Research Corporation's ability to
achieve its intended business objectives. The Acacia Technologies group's
success also depends on its ability to enforce and protect its intellectual
property.
F-66
The Acacia Technologies group's business operations are subject to
certain risks and uncertainties, including:
o market acceptance of products and services;
o technological advances that may make our products and services
obsolete or less competitive;
o increases in operating costs, including costs for supplies,
personnel and equipment;
o the availability and cost of capital;
o general economic conditions; and
o governmental regulation that may restrict our subsidiary
companies' businesses.
RECAPITALIZATION AND MERGER TRANSACTIONS
On December 11, 2002, our stockholders voted in favor of a
recapitalization transaction, which became effective on December 13, 2002,
whereby we created two new classes of common stock called Acacia
Research-CombiMatrix stock ("AR-CombiMatrix stock") and Acacia Research-Acacia
Technologies stock ("AR-Acacia Technologies stock"), and divided our existing
Acacia Research Corporation common stock into shares of the two new classes of
common stock. AR-CombiMatrix stock is intended to reflect separately the
performance of Acacia Research Corporation's CombiMatrix group. AR-Acacia
Technologies stock is intended to reflect separately the performance of Acacia
Research Corporation's Acacia Technologies group. Although the AR-CombiMatrix
stock and the AR-Acacia Technologies stock are intended to reflect the
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.
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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. AR-Acacia Technologies stock is intended to
reflect the separate performance of the respective division of Acacia Research
Corporation. The Acacia Technologies group is not a separate legal entity.
Holders of AR-Acacia Technologies stock are stockholders of Acacia Research
Corporation. As a result, holders of AR-Acacia Technologies stock are subject to
all of the risks of an investment in Acacia Research Corporation and all of its
businesses, assets and liabilities. The assets Acacia Research Corporation
attributes to Acacia Technologies could be subject to the liabilities of the
CombiMatrix group.
The Acacia Technologies group financial statements have been prepared
in accordance with generally accepted accounting principles in the United States
of America, and taken together with the CombiMatrix group financial statements,
comprise all the accounts included in the corresponding consolidated financial
statements of Acacia Research Corporation. The financial statements of Acacia
Technologies group reflect the financial condition, results of operations, and
cash flows of the businesses included therein. The financial statements of the
Acacia Technologies group include the accounts or assets of Acacia Research
Corporation specifically attributed to the Acacia Technologies group and were
prepared using amounts included in Acacia Research Corporation's consolidated
financial statements.
Minority interests represents participation of other stockholders in
the allocated net assets and in the division earnings and losses of the Acacia
Technologies group and is reflected in the caption "Minority interests" in the
Acacia Technologies group financial statements. Minority interests adjust the
Acacia Technologies group's share of the division's earnings or loss of
non-wholly owned subsidiaries of Acacia Research Corporation that have been
attributed to the Acacia Technologies group.
F-67
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.
Refer to Note 2 to the Acacia Research Corporation consolidated
financial statements included elsewhere herein for the management allocation
policies, treasury and cash management policies, asset and liability attribution
policies, corporate, general and administrative services and facilities
allocation policies and federal and state income tax allocation policies,
utilized in the preparation of the separate Acacia Technologies group financial
statements.
REVENUE RECOGNITION. The Acacia Technologies group recognizes revenue
in accordance with Staff Accounting Bulletin No. 104, "Revenue Recognition"
("SAB No. 104") 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.
Under the terms of the Acacia Technologies group's DMT license
agreements, the Acacia Technologies group grants an annual non-exclusive license
for the use of its patented DMT technology. In most instances, our license
agreements provide for recurring royalty payments for each year that the license
agreements are in effect through the expiration of the patents. Pursuant to the
terms of the DMT license agreements, once executed, the Acacia Technologies
group has no further obligations with respect to the grant of the annual license
each year. License fees paid to and recognized as revenue by the Acacia
Technologies group are non-refundable.
PER UNIT ROYALTIES: Revenue generated from license agreements that
provide for the calculation of royalties on a per-unit basis are accrued and
recognized as revenue in the period earned, provided that amounts are fixed or
determinable and collectibility is reasonably assured.
PERCENTAGE OF LICENSEE SALES ROYALTIES: Certain license agreements
provide for the calculation of license fees based on a licensee's actual
quarterly sales applied to a contractual royalty rate. Licensees that pay
license fees on a quarterly basis generally report actual quarterly sales
information and related quarterly license fees due to the Acacia Technologies
group within 30 to 45 days after the end of the quarter in which such activity
takes place. Consequently, the Acacia Technologies group recognizes revenue from
these licensing agreements on a three-month lag basis, in the quarter following
the quarter of sales, provided amounts are fixed or determinable and
collectibility is reasonably assured. The lag method described above allows for
the receipt of licensee royalty reports prior to the recognition of revenue.
MINIMUM UPFRONT ANNUAL ROYALTIES: Certain license agreements provide
for the calculation and payment of a minimum upfront annual license fee, based
upon a licensee's expected annual sales during each annual license term. These
license fee payments are deferred and amortized to revenue on a straight-line
basis over the annual license term. To the extent actual annual royalties
reported at the conclusion of each annual license term exceed the amount
prepaid, the additional royalties are recognized in revenue in the quarter
following the annual license term provided that amounts are fixed or
determinable and collectibility is reasonably assured.
License fee payments received by the Acacia Technologies group that do
not meet the revenue recognition criteria described above are deferred until the
revenue recognition criteria are met. The Acacia Technologies group assesses
collection of accrued license fees based on a number of factors, including past
transaction history and credit-worthiness. If it is determined that collection
is not reasonably assured, the fee is recognized when collectibility becomes
reasonably assured, assuming all other revenue recognition criteria have been
met, which is generally upon receipt of cash.
As a result of the Acacia Technologies group's licensing and any
related intellectual property enforcement activities that we choose to conduct,
we may recognize royalty revenues that relate to prior period infringements by
licensees. Differences between amounts initially recognized and amounts
subsequently audited or reported as an adjustment to those amounts will be
recognized in the period the adjustment is determined as a change in accounting
estimate.
F-68
Deferred revenue arises from payments received in advance of the
culmination of the earnings process. Deferred revenue expected to be recognized
within the next twelve months is classified as a current liability. At December
31, 2003 and 2002, the Acacia Technologies group balance sheets include deferred
revenues related to payments received in advance of the culmination of the
earnings process, which will be recognized as revenue in future periods when the
applicable revenue recognition criteria, as described above, are met.
CASH AND CASH EQUIVALENTS. The Acacia Technologies group considers all
highly liquid, short-term investments with original maturities of three months
or less when purchased to be cash equivalents.
SHORT-TERM INVESTMENTS. The Acacia Technologies group's short-term
investments are held in a variety of interest bearing instruments including
high-grade corporate bonds, commercial paper, money market accounts,
certificates of deposit and other high-credit quality marketable securities.
Investments in securities with original maturities of greater than three months
and less than one year are classified as short-term investments. Investments are
classified into categories in accordance with the provisions of Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities" ("SFAS No. 115"). At December 31, 2003 and 2002, all
of the Acacia Technologies group's investments are classified as
available-for-sale, which are reported at fair value with related unrealized
gains and losses in the value of such securities recorded as a component of
allocated net worth until realized. During 2002 and 2001, certain of the Acacia
Technologies group's investments were classified as trading securities. Realized
and unrealized gains and losses in the value of trading securities are included
in net income (loss) in the consolidated statements of operations and
comprehensive loss.
The fair value of the Acacia Technologies group's investments is
primarily determined by quoted market prices. Realized and unrealized gains and
losses are recorded based on the specific identification method. For investments
classified as available-for-sale, unrealized losses that are other than
temporary are recognized in division net income (loss).
The cost of debt securities is adjusted for amortization of premiums
and accretion of discounts to maturity. Such amortization is included in
interest income (expense). Interest and dividends on all securities are included
in interest income.
CONCENTRATION OF CREDIT RISKS. Cash and cash equivalents are invested
in deposits with certain financial institutions and may, at times, exceed
federally insured limits. The Acacia Technologies group has not experienced any
losses on its deposits of cash and cash equivalents. One licensee accounted for
approximately 28% of the Acacia Technologies group's license fee revenues
recognized during the year ended December 31, 2003, and also represents
approximately 31% of accounts receivable at December 31, 2003. The Acacia
Technologies group performs regular credit evaluations of its significant
licensees and has not experienced any significant credit losses.
PROPERTY AND EQUIPMENT. Property and equipment are recorded at cost.
Major additions and improvements that materially extend useful lives of property
and equipment are capitalized. Maintenance and repairs are charged against the
results of operations as incurred. When these assets are sold or otherwise
disposed of, the asset and related depreciation are relieved, and any gain or
loss is included in the statement of operations for the period of sale or
disposal. Depreciation is computed on a straight-line basis over the following
estimated useful lives of the assets:
Furniture and fixtures....................... 3 to 5 years
Computer hardware and software............... 3 to 5 years
Leasehold improvements....................... Lesser of lease term or
useful life of
improvement
ORGANIZATION COSTS. Costs of start-up activities, including
organization costs, are expensed as incurred.
PATENTS AND GOODWILL. Goodwill and identifiable intangibles, including
patents, are recorded when the consideration paid for acquisitions exceeds the
fair value of the net tangible assets acquired. Patents, once issued or
purchased, are amortized on the straight-line method over their economic
remaining useful lives, ranging from three to twenty years. Goodwill is not
amortized.
F-69
IMPAIRMENT OF LONG-LIVED ASSETS GOODWILL. Long-lived assets and
intangible assets are reviewed for potential impairment when events or changes
in circumstances indicate the carrying amount of an asset may not be
recoverable. In the event the sum of the expected undiscounted future cash flows
resulting from the use of the asset is less than the carrying amount of the
asset, an impairment loss equal to the excess of the asset's carrying value over
its fair value is recorded. If an asset is determined to be impaired, the loss
is measured based on quoted market prices in active markets, if available. If
quoted market prices are not available, the estimate of fair value is based on
various valuation techniques, including a discounted value of estimated future
cash flows.
Goodwill is evaluated for impairment in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets" ("SFAS No. 142") and 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. The Acacia Technologies group performed a transitional goodwill
impairment assessment in 2002 and a year end goodwill impairment assessment in
2002 and 2003 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.
FAIR VALUE OF FINANCIAL INSTRUMENTS. The carrying value of cash and
cash equivalents, other receivables, accounts payable and accrued expenses
approximate fair value due to their short-term maturity.
STOCK-BASED COMPENSATION. Refer to Note 2 to the Acacia Research
Corporation consolidated financial statements included elsewhere herein. In 2001
and earlier periods, stock compensation expense recorded related to Acacia
Research Corporation employees was allocated to the Acacia Technologies group.
As a result of the recapitalization transaction discussed earlier, in future
periods, stock compensation expense, if any, resulting from the issuance of
AR-Acacia Technologies stock will generally be allocated to the Acacia
Technologies group.
Stock option and related option plan information is omitted from the
Acacia Technologies group footnotes because AR-Acacia Technologies stock is part
of the capital structure of Acacia Research Corporation. The Acacia Technologies
group is not a separate legal entity. Holders of AR-Acacia Technologies stock
continue to be stockholders of Acacia Research Corporation. This presentation
reflects the fact that the Acacia Technologies group does not have legally
issued common or preferred stock, nor are warrant issuances or employee stock
transactions legal transactions of the Acacia Technologies group. Refer to the
Acacia Research Corporation consolidated financial statements for disclosures
regarding Acacia Research Corporation's stock option plans.
SEGMENTS. The Acacia Technologies group follows SFAS No. 131,
"Disclosure about Segments of an Enterprise and Related Information," which
establishes annual and interim reporting standards for an enterprise's operating
segments and related disclosures about its products, services, geographic areas
and major customers. Management has determined that the Acacia Technologies
group operates in one segment.
USE OF ESTIMATES. The preparation of financial statements in conformity
with generally accepted accounting principles in the United States of America
requires management to make estimates and assumptions that affect the reported
amount of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from these estimates.
EARNINGS (LOSS) PER SHARE. Earnings (loss) per share information is
omitted from the Acacia Technologies group statements of operations because
AR-Acacia Technologies stock is part of the capital structure of Acacia Research
Corporation. The Acacia Technologies group is not a separate legal entity.
Holders of AR-Acacia Technologies stock continue to be stockholders of Acacia
Research Corporation. This presentation reflects the fact that the Acacia
Technologies group does not have legally issued common or preferred stock, nor
are warrant issuances or employee stock transactions legal transactions of the
Acacia Technologies group. Refer to the Acacia Research Corporation consolidated
financial statements for earnings(loss) per share information for Acacia
Research Corporation's classes of stock, computed using the two-class method in
accordance with SFAS No. 128 "Earnings per Share."
RECENT ACCOUNTING PRONOUNCEMENTS. Refer to Note 2 to the Acacia
Research Corporation consolidated financial statements included elsewhere
herein.
F-70
3. SHORT-TERM INVESTMENTS
Short-term investments consists of the following at December 31, 2003
(in thousands):
AMORTIZED FAIR
2003 COST VALUE
----------- -----------
Available-for-sale securities:
Corporate bonds and notes................ $ 4,056 $ 4,059
U.S. government securities............... 1,000 1,000
----------- -----------
$ 5,056 $ 5,059
=========== ===========
There were no short-term investments as of December 31, 2002. Gross
unrealized gains and losses related to available-for-sale securities were not
material for 2003. All investments in debt securities classified as
available-for-sale as of December 31, 2003 are due within one year.
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31, 2003
and 2002 (in thousands):
2003 2002
----------- -----------
Furniture and fixtures....................... $ 192 $ 189
Computer hardware and software............... 243 287
Leasehold improvements....................... 209 208
----------- -----------
644 684
Less: accumulated depreciation.............. (573) (504)
----------- -----------
$ 71 $ 180
=========== ===========
Depreciation expense was $114,000, $209,000 and $218,000 for the years
ended December 31, 2003, 2002 and 2001, respectively.
5. BALANCE SHEET COMPONENTS
Accounts payable, accrued expenses and other consists of the following
at December 31, 2003 and December 31, 2002 (in thousands):
2003 2002
----------- -----------
Accounts payable............................. $ 229 $ 234
Payroll, vacation and other employee
benefits................................... 347 455
Accrued liabilities of discontinued
operations................................. 388 915
Accrued legal expenses....................... 495 626
Other accrued liabilities.................... 113 294
----------- -----------
$ 1,572 $ 2,524
=========== ===========
F-71
6. INVESTMENTS IN AFFILIATES
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 Acacia Research Corporation's investment in Advanced Data Exchange
("ADX"). 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 $2,748,000 for an other-than-temporary decline in the fair
value of ADX. Impairment indicators included recurring losses, a decline in
working capital and the completion of a recent equity transaction with a
shareholder at an amount below Acacia Research Corporation's carrying value. The
fair value of the investment in ADX was determined by reference to available
financial and market information. The investment in ADX is accounted for under
the cost method.
In 2002, the Acacia Technologies group conducted a portion of its
investing activity through a limited partnership, of which a wholly owned
subsidiary of Acacia Research Corporation is the general partner. The limited
partnership ceased trading activity in May 2002. As a result of the significant
control that Acacia Research Corporation exercised over the limited partnership,
the assets and liabilities and results of operations have been consolidated by
Acacia Research Corporation during 2002. As of December 31, 2002, the limited
partnership had distributed all limited partner capital account balances and as
a result has no net assets as of December 31, 2002. Prior to cessation of
operations, the net assets, liabilities and results of operations of the limited
partnership, which included certain health sciences securities, were attributed
to the Acacia Technologies group.
7. INTANGIBLES AND GOODWILL
At December 31, 2003 and 2002, the Acacia Technologies group had
$1,776,000 and $1,834,000 of goodwill, primarily related to the Soundview
Technologies reporting unit. The Acacia Technologies group adopted SFAS No. 142
effective January 1, 2002 and ceased amortizing goodwill on that date. Division
net income for the year ended December 31, 2001, adjusted to exclude goodwill
amortization expense of $216,000, was $5,973,000.
The Acacia Technologies group's only identifiable intangible assets are
patents. The gross carrying amounts and accumulated amortization related to
acquired intangible assets as of December 31, 2003 and 2002 are as follows (in
thousands):
2003 2002
----------- -----------
Gross carrying amount - patents.............. $ 10,798 $ 10,798
Accumulated amortization..................... (7,232) (6,730)
----------- -----------
Patents, net................................. $ 3,566 $ 4,068
=========== ===========
Aggregate patent amortization expense was $502,000, $1,591,000 and
$1,277,000 in 2003, 2002 and 2001, respectively. Annual aggregate amortization
expense for each of the next five years through December 31, 2008 is estimated
to be $500,000 per year.
At December 31, 2003 and 2002, all of the Acacia Technologies group's
acquired intangible assets other than goodwill were subject to amortization.
F-72
8. INCOME TAXES
Acacia Technologies group's allocated provision (benefit) for income
taxes consists of the following (in thousands):
2003 2002 2001
----------- ----------- -----------
Current:
U.S. Federal tax............ $ (2) $ (572) $ 776
State taxes................. 9 4 183
----------- ----------- -----------
7 (568) 959
----------- ----------- -----------
Deferred:
U.S. Federal tax............ (144) (142) (24)
State taxes................. -- -- --
----------- ----------- -----------
(144) (142) (24)
----------- ----------- -----------
$ (137) $ (710) $ 935
=========== =========== ===========
The tax effects of temporary differences and carryforwards that give
rise to significant portions of deferred assets and liabilities consist of the
following at December 31, 2003 and 2002 (in thousands):
2003 2002
----------- -----------
Deferred tax assets:
Basis of investments in affiliates................. $ 26,159 $ 18,265
Depreciation and amortization...................... 62 4
Stock compensation................................. 740 740
Accrued liabilities and other...................... 1,809 1,374
Write-off of investments........................... 1,282 1,200
Net operating loss and capital loss carryforwards
and credits...................................... 20,071 16,529
----------- -----------
Total deferred tax assets......................... 50,123 38,112
Less: valuation allowance........................ (50,123) (38,112)
----------- -----------
Deferred tax assets, net of valuation allowance... -- --
----------- -----------
Deferred tax liabilities:
Intangibles....................................... (1,012) (1,156)
----------- -----------
Net deferred tax liability....................... $ (1,012) $ (1,156)
=========== ===========
A reconciliation of the federal statutory income tax rate and the
effective income tax rate is as follows:
2003 2002 2001
--------- --------- ---------
Statutory federal tax rate.................. (34%) (34%) (34%)
State income taxes, net of federal benefit.. -- -- (2%)
Amortization of intangible assets........... 1% 5% (13%)
Non deductible permanent items.............. -- (4%) --
Valuation allowance......................... 32% 28% 37%
--------- --------- ---------
(1%) (5%) (12%)
========= ========= =========
At December 31, 2003, the Acacia Technologies group has deferred tax
assets totaling approximately $50,122,000, which are fully offset by a valuation
allowance due to management's determination that the criteria for recognition
have not been met.
F-73
At December 31, 2003, the Acacia Technologies group had U.S. Federal
and state income tax net operating loss carry forwards ("NOLs"), excluding NOLs
related to subsidiaries for which we do not file a consolidated return, were
approximately $46,259,000 and $32,485,000, expiring between 2004 and 2023. In
addition, the Acacia Technologies group had tax credit carryforwards of
approximately $62,000.
As of December 31, 2003, the aggregate tax NOLs at subsidiaries not
consolidated for tax purposes are $19,598,000 and $10,782,000 for federal and
state income tax purposes, respectively, expiring between 2004 and 2023.
However, the use of these NOLs are limited to the separate earnings of the
respective subsidiaries. In addition, ownership changes may also restrict the
use of NOLs.
Had the Acacia Technologies group filed separate tax returns, the
provision (benefit) for income taxes and division net income (loss) would not
have differed from the amounts reported in the Acacia Technologies group's
statements of operations for the years ended December 31, 2003, 2002, and 2001.
As of December 31, 2003, approximately $9,662,000 of the valuation
allowance related to the tax benefits of stock option deductions included in
Acacia Research Corporation's NOLs. At such time as the valuation allowance is
released, the benefit will be credited to additional paid-in capital.
9. DISCONTINUED OPERATIONS
The Acacia Technologies group includes the assets and liabilities of
Soundbreak.com, a 66.9% held subsidiary of Acacia Research Corporation, which
ceased operations as of February 15, 2001. In September 2002, the Acacia
Technologies group accrued an additional $480,000 ($200,000 net of minority
interests) in estimated costs to be incurred in connection with the discontinued
operations of Soundbreak.com. The additional accrual relates primarily to
certain noncancellable lease obligations and the inability to sublease the
related office space at rates commensurate with our existing obligations.
Discontinued operations did not have an impact on the December 31, 2003
or 2001 Acacia Technologies group statement of operations.
The assets and liabilities of the discontinued operations at December
31, 2003 and 2002 consist primarily of $1,953,000 and $3,109,000 of cash and
cash equivalents and $388,000 and $918,000 of accounts payable and accrued
expenses, respectively.
10. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
Acacia Technologies group leases certain office furniture and equipment
and office space under various operating lease agreements expiring over the next
5 years. Minimum annual rental commitments for Acacia Technologies group
operating leases of continuing operations having initial or remaining
noncancellable lease terms in excess of one year are as follows (in thousands):
YEAR
2004................................................. $ 295
2005................................................. 303
2006................................................. 312
2007................................................. 39
-----------
Total minimum lease payments......................... $ 949
===========
Rent expense of continuing operations for the years ended December 31,
2003, 2002 and 2001 approximated $467,000, $445,000 and $529,000, respectively.
F-74
LITIGATION
SOUNDVIEW TECHNOLOGIES
In September 2002, the United States District Court for the District of
Connecticut granted a motion for summary judgment filed by the defendants in
Soundview Technologies pending patent infringement and antitrust lawsuit against
Sony Corporation of America, Philips Electronics North America Corporation, the
Consumer Electronics Manufacturers Association and the Electronics Industries
Alliance d/b/a Consumer Electronics Association in the United States District
Court for the Eastern District of Virginia (filed on April 5, 2000), alleging
that television sets utilizing certain content blocking technology (commonly
known as the "V-chip") and sold in the United States infringe Soundview
Technologies' U.S. Patent No. 4,554,584. In granting the motion, the court ruled
that the defendants have not infringed on Soundview Technologies' patent.
In September 2003, a motion for summary judgment filed by the remaining
defendants was granted by the United States District Court for the District of
Connecticut on Soundview Technologies' anti-trust claims due to the Court's
previous ruling of non-infringement as described above.
The decisions are currently being appealed to the U.S. Court of Appeals
for the Federal Circuit. While we are currently appealing the two summary
judgment rulings, litigation is inherently uncertain and we can give no
assurance that we will be successful in any such appeals.
The rulings have no impact on the revenues that the Acacia Technologies
group has recognized to date from licensees of its patented V-chip technology.
Further, none of the revenues recognized are contingent upon any court rulings
or the future outcome of any litigation with unlicensed television
manufacturers.
ACACIA MEDIA TECHNOLOGIES
In February 2003, Acacia Media Technologies initiated DMT patent
infringement litigation in the Federal District Court for the Central District
of California against approximately 39 defendants who provide adult oriented
digital content over the Internet. All of the defendants were previously
notified of our belief that their conduct infringes on our patent rights. As of
December 31, 2003, nine of the original 39 defendants remain in the initial
litigation.
In December 2003, Acacia Media Technologies added an additional eight
defendants to its pending patent infringement litigation described above. The
new complaints, filed with the Court, seek to create a defendant class for all
adult entertainment companies that infringe Acacia Media Technologies' DMT
patents by transmitting pre-recorded, digital audio and audio/video adult
content via any electronic communication channel into or from the Central
District of California, or that operate at least one interactive website where a
user located in Central District of California can exchange information with a
host computer. Defendant class action status, which must be approved by the
court, would permit the court's rulings on certain key issues to legally bind
all members of the class, whether or not they have been specifically named as
defendants in the litigation.
In November 2003, Acacia Media Technologies initiated a patent
infringement lawsuit in the Federal District Court for the Central District of
California against On Command Corporation, provider of interactive in-room
entertainment, information and business services to the lodging industry,
regarding Acacia Media Technologies' DMT technology.
Acacia Technologies group is subject to other claims, counterclaims and
legal actions that arise in the ordinary course of business. Management believes
that the ultimate liability with respect to these claims and legal actions, if
any, will not have a material effect on the Acacia Technologies group's
financial position, results of operations or cash flows. However, the Acacia
Technologies group could be subject to claims and legal actions relating to the
CombiMatrix group.
OTHER
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,
as defined in the agreements, generated by Acacia Media Technologies
Corporation's current patent portfolio, which includes its DMT patents. No
royalty obligation has been incurred as of December 31, 2003. Any royalties paid
pursuant to the agreements will be expensed in the statement of operations.
F-75
11. ALLOCATED NET WORTH
The Acacia Technologies group statement of allocated net worth presents
the equity transactions of Acacia Research Corporation, which are attributed to
the Acacia Technologies group as "Net assets attributed to the Acacia
Technologies group." This presentation reflects the fact that the Acacia
Technologies group does not have legally issued common or preferred stock, nor
are warrant issuances or employee stock transactions legal transactions of the
Acacia Technologies group. Presented below is a detail of the equity
transactions of Acacia Research Corporation which relate to the businesses of
the Acacia Technologies group and which therefore comprise the balances
reflected in the group's net assets attributed to Acacia Technologies group (in
thousands):
ACACIA
TECHNOLOGIES
GROUP
-----------
2001
Allocated corporate charges......................................... $ (1,118)
Units issued in private placement, net.............................. 18,361
Stock options exercised............................................. 1,252
Change in capital due to issuance of stock by subsidiaries.......... 737
Compensation expense relating to stock options and warrants......... 47
Stock dividend...................................................... (2)
-----------
Net assets attributed to the Acacia Technologies group - 2001....... $ 19,277
===========
2002
Allocated corporate charges......................................... $ (1,032)
Stock options exercised............................................. 136
Compensation expense relating to stock options and warrants......... 19
Acquisition costs allocated to the CombiMatrix group................ (834)
Other............................................................... (2)
-----------
Net assets attributed to the Acacia Technologies group - 2002....... $ (1,713)
===========
2003
Allocated corporate charges......................................... $ (637)
Stock options exercised............................................. 190
Unrealized gain on short-term investments........................... 2
Other............................................................... 17
-----------
Net assets attributed to the Acacia Technologies group - 2003....... $ (428)
===========
In January 2001, Acacia Research Corporation completed an institutional
private equity financing raising gross proceeds of $19.0 million ($17.9 million,
net of issuance costs) through the issuance of 1,107,274 units. Proceeds from
this equity financing were attributed to the Acacia Technologies group.
F-76
12. SUPPLEMENTAL CASH FLOW INFORMATION (IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
2003 2002 2001
---------- ---------- ----------
Supplemental disclosures of cash flow information:
Cash paid for income taxes ........................... $ 9 $ -- $ 597
Supplemental schedule of non-cash operating, investing
and financing activities:
Liabilities assumed in acquisition of minority
ownership interest in subsidiary.................... -- -- 200
Accrued payments for purchase of common stock from
former minority stockholders of subsidiary.......... -- 58 217
Loss from discontinued operations of Soundbreak.com.. -- 480 --
F-77
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
2.1 Agreement and Plan of Merger of Acacia Research Corporation, a
California corporation, and Acacia Research Corporation, a Delaware
corporation, dated as of December 23, 1999 (1)
2.2 Agreement and Plan of Reorganization by and among Acacia Research
Corporation, Combi Acquisition Corp. and CombiMatrix Corporation
dated as of March 20, 2002 (attached as Annex A to the
Prospectus/Proxy Statement included in this Registration Statement)
3.1 Restated Certificate of Incorporation (2)
3.2 Amended and Restated Bylaws (3)
4.1 Form of Specimen Certificate of Acacia's Common Stock (4)
10.1 Acacia 1993 Stock Option Plan (5)
10.2 Form of Stock Option Agreement for Acacia 1993 Stock Option Plan (5)
10.3 Acacia 1996 Stock Option Plan, as amended (6)
10.4 Form of Option Agreement constituting the Acacia 1996 Executive
Stock Bonus Plan (7)
10.5 CombiMatrix Corporation 1995 Stock Option Plan (8)
10.6 CombiMatrix Corporation 1998 Stock Option Plan (8)
10.7 CombiMatrix Corporation 2000 Stock Awards Plan (8)
10.8 2002 CombiMatrix Stock Incentive Plan (9)
10.9 2002 Acacia Technologies Stock Incentive Plan (10)
10.10 Agreement between Acacia Research and Paul Ryan (11)
10.11 Lease Agreement dated April 30, 1998, between Acacia and
EOP-Pasadena Towers, L.L.C., a Delaware limited liability company
doing business as EOP-Pasadena, LLC (12)
10.12 Lease Agreement between Soundbreak.com Incorporated and 8730 Sunset
Towers and related Guaranty (13)
10.13 First Amendment dated June 26, 2000, to Lease Agreement between
Acacia and Pasadena Towers, L.L.C. (14)
10.14 Sublease dated November 30, 2001, between Acacia and Jenkens &
Gilchrist (14)
10.15 Lease Agreement dated January 28, 2002, between Acacia and The
Irvine Company (14)
10.16 Settlement Agreement dated September 30, 2002, by and among Acacia,
CombiMatrix Corporation, Donald D. Montgomery, Ph.D. and Nanogen,
Inc.(8)
10.17+ Research & Development Agreement dated September 25, 2002, between
CombiMatrix Corporation and Roche Diagnostics GmbH(8)
10.18+ License Agreement dated September 25, 2002 between CombiMatrix
Corporation and Roche Diagnostics GmbH(8)
10.19 Form of Indemnification Agreement
21.1 List of Subsidiaries
23.1 Consent of PricewaterhouseCoopers LLP (relating to the financial
statements of Acacia Research Corporation)
23.2 Consent of PricewaterhouseCoopers LLP (relating to the financial
statements of CombiMatrix Corporation)
23.3 Consent of PricewaterhouseCoopers LLP (relating to the financial
statements of the Acacia Technologies group and the CombiMatrix
group)
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
32.1 Certification 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 Certification of the Chief Financial Officer provided pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
- -------------------
+ Portions of this exhibit have been omitted pursuant to a request for
confidential treatment and have been filed separately with the United
States Securities and Exchange Commission.
(1) Incorporated by reference from Acacia's Report on Form 8-K filed on
December 30, 1999 (SEC File No. 000-26068).
(2) Incorporated by reference as Appendix B to the Proxy
Statement/Prospectus which formed part of Acacia's Registration
Statement on Form S-4 (SEC File No. 333-87654) which became effective on
November 8, 2002.
(3) Incorporated by reference from Acacia's Quarterly Report on Form 10-Q
filed on August 10, 2001 (SEC File No. 000-26068).
(4) Incorporated by reference from Amendment No. 2 on Form 8-A/A filed on
December 30, 1999 (SEC File No. 000-26068).
(5) Incorporated by reference from Acacia's Registration Statement on Form
SB-2 (33-87368-L.A.), which became effective under the Securities Act of
1933, as amended, on June 15, 1995.
(6) Incorporated by reference as Appendix A to the Definitive Proxy
Statement on Schedule 14A filed on April 10, 2000 (SEC File No.
000-26068).
(7) Incorporated by reference from Acacia's Definitive Proxy as Appendix A
Statement on Schedule 14A filed on April 26, 1996 (SEC File No.
000-26068).
(8) Incorporated by reference to Acacia's Registration Statement on Form S-4
(SEC File No. 333-87654) which became effective on November 8, 2002.
(9) Incorporated by reference as Appendix D to the Proxy
Statement/Prospectus which formed part of Acacia's Registration
Statement on Form S-4 (SEC File No. 333-87654) which became effective on
November 8, 2002.
(10) Incorporated by reference as Appendix E to the Proxy
Statement/Prospectus which formed part of Acacia's Registration
Statement on Form S-4 (SEC File No. 333-87654) which became effective on
November 8, 2002.
(11) Incorporated by reference from Acacia's Annual Report on Form 10-K for
the year ended December 31, 1997, filed on March 30, 1998 (SEC File No.
000-26068).
(12) Incorporated by reference to Acacia's Quarterly Report on Form 10-Q
filed on August 14, 1998 (SEC File No. 000-26068).
(13) Incorporated by reference to Acacia's Quarterly Report on Form 10-Q
filed on November 15, 1999 (SEC File No. 000-26068).
(14) Incorporated by reference from Acacia's Annual Report on Form 10-K for
the year ended December 31, 2001 filed on March 27, 2002 (SEC File No.
000-26068).