SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 __________________________________ FORM 10-K/A __________________________________ [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934] For the fiscal year ended December 31, 1996. OR [ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from N/A to N/A ----- ----- COMMISSION FILE NUMBER 0-26068 ACACIA RESEARCH CORPORATION ________________________________________________________________________________ (Exact name of registrant as specified in its charter) California 95-4405754 _____________________________________________ ___________________ (State or other jurisdiction of (I.R.S. Employer incorporation organization) Identification No.) 12 South Raymond Avenue, Pasadena CA 91105 _____________________________________________ ___________________ (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (818) 449-6431 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, NO PAR VALUE 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. |X| The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the average bid and asked prices of such stock, as of March 27, 1997 was approximately $12,140,563. (All officers and directors of the registrant are considered affiliates.) At March 27, 1997 the registrant had 2,078,172 shares of Common Stock, and no shares of Preferred Stock, all no par value, issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement for its Annual Meeting of Shareholders to be filed with the Commission within 120 days after the close of the registrant's fiscal year are incorporated by reference into Part III. The Registrant submits its second amendment to its Form 10-K for the year ended December 31, 1996 to restate its consolidated financial statements to include the accounts of CombiMatrix Corporation on a consolidated basis. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS. RECENT MARKET PRICES The Company's Common Stock began trading under the symbol ACRI on the Nasdaq National Market System on July 8, 1996. Prior to the Company's listing on the Nasdaq National Market System and subsequent to June 15, 1995 when the Company's Registration Statement on Form SB-2 became effective under the Securities Act of 1933, as amended (the "Securities Act"), the Company's Common Stock traded under the same symbol in the over-the-counter market. Preceding June 15, 1995, there had been no public market for the Company's Common Stock. The markets for securities such as the Company's Common Stock historically have experienced extreme price and volume fluctuations during certain periods. These broad market fluctuations and other factors, such as new product developments and trends in the Company's industry and the investment markets generally, as well as economic conditions and quarterly variations in the Company's results of operations, may adversely affect the market price of the Company's Common Stock. The high and low bid prices for the Common Stock as reported by the National Quotation Bureau, Inc. for the period of June 15, 1995 through July 5, 1996 and the Nasdaq Stock Market for the period July 8, 1996 through December 31, 1996 are as follows. Such prices are interdealer prices without retail markups, markdowns or commissions, and may not necessarily represent actual transactions. Fiscal Year 1996 High Low Fiscal Year 1995 High Low ---------------- ---- --- ---------------- ---- --- First Quarter $8-3/4 $5-1/4 First Quarter N/A N/A Second Quarter $13-3/4 $7 Second Quarter N/A N/A Third Quarter $12-3/4 $6-5/8 Third Quarter $10 $5-1/2 Fourth Quarter $11 $7-1/8 Fourth Quarter $8 $5-1/4 On March 27, 1997, the closing bid and asked quotations for the Common Stock were $7-1/4 and $8, respectively, per share. On March 27, 1997, there were approximately 425 owners of record of the Company's Common Stock. The majority of the outstanding shares of the Common Stock are held by a nominee holder on behalf of an indeterminable number of ultimate beneficial owners. SALE OF UNREGISTERED SECURITIES In December 1996, the Company issued 8,500 warrants convertible into an equal number of shares of the Company's Common Stock in connection with financial consulting services, which transaction was exempt from registration under Section 4(2) of the Securities Act of 1933. DESCRIPTION OF SECURITIES The Company is authorized to issue up to 10,000,000 shares of Common Stock, without par value, of which 2,078,172 shares of Common Stock have been issued and are outstanding as of March 27, 1997. Holders of the Common Stock are entitled to one vote per share on all matters to be voted on by the shareholders, and to cumulate votes in the election of directors. Holders 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 therefor. Upon the liquidation, dissolution, or winding up of the Company, the holders of Common Stock are entitled to share ratably in all assets of the Company which are legally available for distribution, after payment of all debts and other liabilities. Holders of Common Stock have no preemptive, subscription, redemption or conversion rights. The outstanding shares of the Common Stock are, when issued and delivered, validly issued, fully paid, and nonassessable. 2 TRANSFER AGENT AND REGISTRAR U.S. Stock Transfer Corporation, 1745 Gardena Avenue, Glendale, California 91204-2991, is the Transfer Agent and Registrar for the Company's Common Stock. DIVIDEND POLICY To date, the Company has not declared or paid any cash dividends with respect to its capital stock and the current policy of the Board of Directors is to retain earnings, if any, to provide for the growth of the Company. Consequently, no cash dividends are expected to be paid in the foreseeable future. Further, there can be no assurance that the proposed operations of the Company will generate revenues and cash flow needed to declare a cash dividend or that the Company will have legally available funds to pay dividends. ITEM 6. SELECTED FINANCIAL DATA The selected financial data set forth below as of December 31, 1995 and 1996, and for the period January 25, 1993 (inception) through December 31, 1993 and the years ended December 31, 1994, 1995 and 1996, has been derived from the Company's audited consolidated financial statements included elsewhere herein, and should be read in conjunction with those financial statements (including the notes thereto). Marketing, general and administrative expense incurred in 1996 includes a write-down of $559,250 relating to two promissory notes held by the Company, which are secured by Whitewing stock. The notes, which are currently past due, have been written down to the market value price of the collateral held by the Company as of December 31, 1996. The Company intends to collect on these notes and will take such action deemed by the Company to be necessary and appropriate to ensure that these notes do not remain outstanding for an extended period of time. Financial statement for 1996 have been restated to include the accounts of CombiMatrix in the Company's consolidated financial statements. The Company previously accounted for its interest in CombiMatrix using the equity method of accounting. Financial statements for 1995 and 1996 were restated to reflect the Company's auditors determination that the appropriate accounting for the Company's nonstatutory stock options and the reporting of deferred tax benefits for the difference between market value and option price require the establishment of deferred tax assets related to nonstatutory stock options only for those options for which the Company has recorded compensation expense for financial statement purposes. Prior to this determination, the Company reported the deferred tax benefit for all nonstatutory options. On the advice of its auditors, the Company has historically taken the position that all nonstatutory options created a deferred tax benefit. However, in accordance with current interpretations of generally accepted accounting principles, the Company's auditors have now determined that deferred tax benefits should only be recorded for those nonstatutory stock options that the Company has or will record book expense. Generally accepted accounting principles allow deferred tax assets to be recorded only on temporary differences. For the most of the Company's nonstatutory stock options, a book expense will not be recorded. Therefore, these differences are permanent differences rather than temporary and do not give rise to deferred tax benefits. Based on this interpretation, the Company has restated its financial position to reflect the tax savings in the year that the options are exercised, and the entry will be reported as in increase to common stock and a reduction of income taxes payable. The amount of this entry may vary depending on the details of the option and when it is exercised. 3 Financial statements for 1994 and 1995 were restated to reflect a change in accounting for the Company's investment in Whitewing to the equity method due to the Company's reduced ownership interest in Whitewing. The Company also accounts for its investments in Soundview Technologies and Greenwich Information Technologies as well as the two private investment partnerships of which the Company is a general partner on the equity method. However, financial statements for the years ended December 31, 1995 and December 31, 1996 reflect consolidation with MerkWerks, and financial statements for the year ended December 31, 1996 reflect consolidation with CombiMatrix. Financial statements for periods prior to the period ending December 31, 1995 were originally consolidated to include the accounts of the Company and Whitewing. These prior statements included operating revenue earned by the Company from the sale of health care products by Whitewing. Prior to this restatement, sales for the Company were reported as $455,359 in 1994, as compared to no revenues from this source reported in 1994 in the restated financial statements. STATEMENT OF OPERATIONS DATA: For the years ended December 31, 1996, 1995, and 1994 and the period ended 1993 1996 1995 1994 1993 ------------------------------------------------------ Revenues Gains on sales of securities, net $ 876,499 $3,194,241 $ 0 $ 0 Unrealized gain attributable to issuance of common stock 1,066,408 0 0 0 Equity in earnings of investments (175,689) 271,023 (137,782) (276,465) Management fees 1,458,078 2,880 0 0 Interest income 113,049 49,567 37,502 8,215 ---------- ---------- --------- ---------- Total revenue 3,338,345 3,517,711 (100,280) (268,250) Marketing, general and administrative 2,640,504 1,399,042 724,156 597,848 ---------- ---------- --------- ---------- Income (loss) before minority interest and taxes 697,841 2,118,669 (824,436) (866,098) Minority interest in net loss of consolidated subsidiary (201,309) (459) 0 0 ---------- ---------- --------- ---------- Income (loss) before provision for taxes 899,150 2,119,128 (824,436) (866,098) Provision for Income Taxes 606,141 287,817 3,541 1,486 ---------- ---------- --------- ---------- Net Income (Loss) $ 293,009 $1,831,311 $(827,977) $(867,584) ---------- ---------- --------- ---------- ---------- ---------- --------- ---------- Earnings (loss) per common share Fully diluted $0.11 $0.72 ($0.35) ($0.44) Weighted average shares outstanding Fully diluted 2,680,433 2,558,647 2,357,050 1,991,000 BALANCE SHEET DATA: December 31, 1996 and 1995 1996 1995 ------------------------- Total assets $5,638,932 $3,843,954 Total liabilities $ 836,602 $ 357,979 Minority interest $ 380,329 $ 10,796 Stockholders' equity $4,422,001 $3,475,179 4 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION GENERAL The Company's financial condition and results of operations can only be understood with reference to the Company's business and ongoing activities. The Company engages in two main lines of business: investment advisory services, which includes the Company acting as an investment advisor to domestic and offshore private investment funds, and investing in and developing start-up business ventures. Although the Company has relied upon the sale of equity securities to generate the capital needed to finance the implementation of its plan of operations, the Company's strategy is to retain the majority of its interests in its current holdings, and possibly acquire additional interests in such holdings. The Company is currently focussed on the development of its various business enterprises to establish operations and promote growth and cash flow in each enterprise. In the following discussion and analysis, the period to period comparisons must be viewed in light of the impact that the Company's acquisition and disposition of securities of its various business interests has had on the Company's financial condition and results of operations. In fiscal 1995, the Company's financial condition and results of operations were dominated by the Company's activities relating primarily to the sale of a portion of its holdings in Whitewing, and to a lesser extent the formation of and sale of shares in MerkWerks. In fiscal 1996, the Company's financial condition and results of operations were dominated primarily by the Company's activities relating to the acquisition of CombiMatrix, Soundview Technologies, and Greenwich Information Technologies as well as the impact of the initial public offering of Whitewing, and to a lesser extent the sale of a portion of the Company's interests in these acquisitions. In addition, in fiscal 1996, the Company expended significant resources developing and expanding its investment advisory services. As a result of the impact of each of these activities that the Company has undertaken and will continue to undertake, the Company's results of operations are volatile and do not fall into repeatable patterns. Consequently, past performance is not necessarily indicative of future performance. RESULTS OF OPERATIONS During fiscal year 1996, the Company expanded its assets by securing significant positions in CombiMatrix, Soundview Technologies, and Greenwich Information Technologies LLC as well as becoming the investment advisor to an additional private investment partnership and two offshore private investment corporations. The Company is currently concentrating on establishing operations in each of these new enterprises as well as the further development of its existing holdings, which include MerkWerks, Whitewing, its other private investment partnership, and its investment advisory services in general. REVENUES 1996 compared to 1995 The Company reported revenues of $3,338,345 for the year ended December 31, 1996, a decrease of $179,366, over revenues of $3,517,711 for the year ended December 31, 1995. During 1995, the Company generated significant operating revenue by selling part of its stake in two of its holdings, Whitewing and MerkWerks. During 1996, the Company sold a smaller portion of its assets, focusing instead on the development of its various business interests. During 1995, the Company sold a larger portion of its holdings primarily to raise the capital necessary to acquire interests in new companies, thereby increasing and diversifying its holdings, as well as providing working capital for ongoing operations. Until the Company generates sufficient revenue from operations of its various business concerns, the Company, from time to time, may sell a portion of its equity interests when that interest has appreciated to a value that management believes is prudent and market conditions are favorable. However, the Company intends to retain significant interests in its current and future holdings. The Company intends to continue to concentrate on development of its existing holdings in the foreseeable future while preserving, and possibly increasing, its positions in such holdings. GAINS ON SALES OF SECURITIES, NET. During the year ended December 31, 1996, the Company increased its asset base by acquiring interests in three new companies, CombiMatrix, Soundview Technologies, and Greenwich Information Technologies. Although the Company sold a limited amount of its interests in these companies, the Company continues to maintain significant equity positions in each. Net gains on sales of securities decreased from 5 $3,194,241 for the year ended December 31, 1995 to $876,499 for the year ended December 31, 1996, which represents a decrease of $2,317,742 or 72.6%. Such gain for the year ended December 31, 1996 is comprised primarily of gains on sales of shares of CombiMatrix of $618,758, and, to a lesser extent, of gains on sales of shares of MerkWerks of $119,551, losses on sales of shares of Soundview Technologies of $10,000, and gains in sales of membership interests in Greenwich Information Technologies of $148,190. The year earlier gain of $3,194,241 represented a gain of $2,716,216 from sales of approximately 51% of the Company's holding in Whitewing and a gain of $478,025 from the sale of approximately 25% of the Company's holding in MerkWerks. Following Whitewing's initial public offering, the Company was prohibited from selling shares of Whitewing without the consent of the managing underwriter, Cohig & Associates, Inc. Furthermore, the timing and extent of any sales of securities are subject to substantial fluctuation from quarter to quarter. UNREALIZED GAIN ATTRIBUTABLE ON ISSUANCE OF COMMON STOCK BY AFFILIATE. In February 1996, shares of Whitewing were sold in an initial public offering. This initial public offering of shares reduced the Company's ownership interest in Whitewing from 38.3% to 18.4%. As a result of this offering, under generally accepted accounting principles, the Company reported an unrealized gain of $1,066,408, representing an increase in the book value of the shares of Whitewing that the Company retained following the initial public offering. Consequently, the Company currently accounts for its investment in Whitewing under the equity method of accounting. Management does not anticipate recognizing any similar gain in relation to shares of Whitewing, however, the Company does anticipate future gains of this nature with respect to other subsidiaries should they become publicly offered entities. EQUITY IN EARNINGS OF INVESTMENTS. The Company reported losses attributable to equity in earnings of investments of $175,689 for the year ended December 31, 1996, compared to revenues of $271,023 for the year-earlier period. Such losses for the year ended December 31, 1996 are comprised of a gain of $182,980 on the Company's capital investments as a general partner in two private investment partnerships offset by a loss from the Company's share of net losses in Greenwich Information Technologies of $46,120, and a loss of $312,240 from the Company's investment in Whitewing, as determined by the equity method of accounting. MANAGEMENT FEES. For the year ended December 31, 1996, management fee income increased to $1,458,078 over management fee income of $2,880 generated during the year ended in 1995. Of the total of $1,458,078 in management fees earned for fiscal year 1996, $1,400,000 was paid to the Company by Soundview Technologies through the issuance of 1,400,000 shares of Soundview Technologies' common stock to the Company for providing management and consulting services, including assisting Soundview Technologies in raising $1,000,000 through the sale of Soundview Technologies' common stock at $1.00 per share. At December 31, 1996, the Company retained 1,233,000 of these shares. The balance of approximately $58,000 of management and performance fee income recorded during the year ended December 31, 1996 was derived from four investment funds managed by the Company. While the Company is entitled to receive quarterly management fees based on the amount of assets under management in each of these funds, the Company does not receive performance fees until a particular fund has been in operation for a twelve month period. In the case of the private investment partnerships, performance fees are not earned until the first anniversary of each limited partner's initial investment date. After such anniversary date, performance fees are earned at the end of each fiscal year. Two of the funds to which the Company is the investment advisor have been managed by the Company during the full twelve month period in 1996. The third and fourth funds were formed in April 1996 and June 1996, respectively and, therefore, have generated limited management fees and no performance fees during the year ended December 31, 1996. The Company may share management fees or direct a certain amount of brokerage to a broker in return for the broker's referral of prospective clients in relation to its investment advisory business. The Company may also employ consultants to whom it will pay cash or a portion of the advisory fees paid by clients referred to the Company by such consultant. The Company entered into a distribution agreement with an international group during the fiscal year 1996. As part of this agreement, the Company will retain all management fees, but will share performance fees earned in those funds managed by the Company to which the group provides its services. 6 1995 COMPARED TO 1994 The Company reported revenues of $3,517,711 in the year ended December 31, 1995 as compared to reported negative total revenues of $100,280 in the year ended December 31, 1994. The Company's sole asset in fiscal year 1994 was its holdings in Whitewing. During 1995, the Company became a general partner in its first private investment partnership as well as formed and capitalized MerkWerks. GAINS ON SALES OF SECURITIES, NET. Net gains on sales of securities increased from no revenue for the year ended December 31, 1994 to $3,194,241 for the year ended December 31, 1995. Such gain for the year ended December 31, 1995 is comprised primarily of gains on sales of shares of Whitewing, and, to a lesser extent, of gains on sales of shares of MerkWerks. EQUITY IN EARNINGS OF INVESTMENTS. The Company reported gains attributable to equity in earnings of investments of $271,023 for the year ended December 31, 1995, compared to a loss of $137,782 for the year-earlier period. Such gains for the period ended December 31, 1995 are comprised of a gain of $71,023 on the Company's capital investment as a general partner in its private investment partnership as well as a gain of $200,000 for the Company's investment in Whitewing Labs, as determined by the equity method of accounting. Such losses for the period ended December 31, 1994 are comprised of a loss of the Company's share of net losses in Whitewing, as determined by the equity method of accounting. MANAGEMENT FEES. For the year ended December 31, 1996, management fee income increased to $2,880 over no such revenue reported for the year ended December 31, 1994. The Company derived management fees in the year ended December 31, 1995 from the single investment fund managed by the Company at that time. As this fund was established in early 1995 and had not operated for the required twelve months for the Company to earn performance fees, no such fees were earned in 1995. EXPENSES 1996 COMPARED TO 1995 Marketing, general and administrative expenses increased from $1,399,042 for the year ended December 31, 1995 to $2,640,504 for the year ended December 31, 1996. Expenses incurred in 1996 include a write-down of $559,250 relating to two promissory notes held by the Company, which are secured by Whitewing stock. The notes, which are currently past due, have been written down to the market value price of the collateral held by the Company as of December 31, 1996. The Company intends to collect on these notes and will take such action deemed by the Company to be necessary and appropriate to ensure that these notes do not remain outstanding for an extended period of time. Expenses in 1996 also include the consolidation of the accounts of CombiMatrix of $420,887, which were not present in 1995 as CombiMatrix commenced operations in 1996. Actual marketing, general and administrative expenses incurred in 1996, less the write down and expenses related to CombiMatrix, were $1,660,367, which represents an increase over 1995 expenses of 18.7%. This increase is primarily due to increased costs of operating a public company as well as those costs incurred in the acquisition of additional business ventures and the further development of the Company's investment advisory services, including additional accounting, legal, printing, and other professional costs, which were not incurred in 1995. Salary expenses increased approximately $95,000 in 1996 primarily due to increases in two officers' salaries and an increase in personnel. Although, in general, the Company has experienced increased costs since becoming a public company, the Company did not incur certain expenses associated with the raising of capital, which has occurred in previous years. 1995 COMPARED TO 1994 Marketing, general and administrative expenses increased from $724,156 for the year ended December 31, 1994 to $1,399,042 for the year ended December 31, 1995. This increase is primarily due to increased costs of operating a public company including additional accounting, legal, printing and other professional costs which were not incurred in 1994. 7 PROVISION FOR INCOME TAXES AND NET INCOME In reviewing the appropriate accounting for the Company's nonstatutory stock options and the reporting of deferred tax benefits for the difference between market value and option price, the Company's auditors have determined that generally accepted accounting principles require the establishment of deferred tax assets related to nonstatutory stock options only for those options for which the Company has recorded compensation expense for financial statement purposes. Prior to this determination, the Company reported the deferred tax benefit for all nonstatutory options. On the advice of its auditors, the Company has historically taken the position that all nonstatutory options created a deferred tax benefit. However, in accordance with current interpretations of generally accepted accounting principles, the Company's auditors have now determined that deferred tax benefits should only be recorded for those nonstatutory stock options that the Company has or will record book expense. Generally accepted accounting principles allow deferred tax assets to be recorded only on temporary differences. For most of the Company's nonstatutory stock options, a book expense will not be recorded. Therefore, these differences are permanent differences rather than temporary and do not give rise to deferred tax benefits. Based on this interpretation, the Company has restated its financial position to reflect the tax savings in the year that the options are exercised, and the entry will be reported as an increase to common stock and a reduction of income taxes payable. The amount of this entry may vary depending on the details of the option and when it is exercised. 1996 COMPARED TO 1995 For the year ended December 31, 1996, the Company recorded an income tax provision of $606,141, as compared to an income tax provision of $287,817 for the same period in fiscal 1995. This increase is primarily due to the deferred tax liability associated with the unrealized gain on the issuance of Whitewing stock and amounts currently payable that are associated with the management fee earned by the Company for its management and consulting services to Soundview Technologies. Prior to the restatement, the Company reported an income tax provision of $55,756 for the 1995 fiscal year. Net income for 1996 was $293,009, compared to $1,831,311 in 1995. This decrease is primarily attributable to the Company's decision to limit the sale of securities held in its emerging companies. Net income for fiscal year 1995 was reported as $2,063,372 prior to the restatement. 1995 COMPARED TO 1994 For the year ended December 31, 1994, the Company recorded an income tax provision of $3,541 as compared to an income tax provision of $287,817 for the same period in fiscal 1995. The difference is attributable to the lack of revenue during the year ended December 31, 1994 versus revenue generated during the year ended December 31, 1995. Net income in 1995 was $1,831,311, compared to a net loss of $827,977 in 1994. This difference is again attributable to the lack of revenue during 1994. The reported provision for income tax and net income reported in 1994 were unaffected by the restatement. INFLATION Inflation has not had a significant impact on the Company. LIQUIDITY AND CAPITAL RESOURCES Net cash used by operating activities in 1996 was $1,913,829, compared with $1,496,657 in 1995, and $695,590 in 1994. Growth in working capital requirements in all three years reflected the Company's increased business activities. During 1996, the Company's emphasis was on the acquisition and development of new business enterprises. The Company invested a total of $3,000,000 in 1996 in three additional start-up ventures as well as purchased an interest in a new private investment partnership of which the Company is a general partner. During 1995, the Company invested a total of $750,000 in the acquisition of one start-up venture and became the general partner of its first private investment partnership in which it purchased an interest. Activities related to the disposition of securities decreased from proceeds of $3,205,496 from such sales 8 in 1995 to proceeds of $2,049,051 in 1996. Overall net cash used by investing activities was $446,821 in 1996, compared to net cash provided by investing activities of $707,328 in 1995 and $19,477 in 1994. As of December 31, 1996, the Company had cash and cash equivalents of $292,701, $116,450 of which was cash held by CombiMatrix. In addition, the Company had working capital of $1,437,271, and a ratio of current assets to current liabilities of 3.1 to 1. As of December 31, 1996, the Company had issued a short-term non-interest bearing note with a balance of $552,500 in connection with the investment by the Company in Greenwich Information Technologies LLC. Subsequent to a payment in the amount of $27,500 by the Company to Greenwich, the Company issued a Promissory Note in the principal amount of $525,000, whereby the Company will make payments to Greenwich Information Technologies of a minimum of $25,000 each month from February 1, 1997 through July 1, 1997; $50,000 each month from August 1, 1997 to December 1, 1997; and pay the outstanding principal plus any accrued and unpaid interest by December 31, 1997. The Note bears a simple interest rate of 6.5% per annum. The Company also executed a Pledge Agreement in connection with the Promissory Note whereby the Company pledged a portion of its membership interest in Greenwich Information Technologies, while retaining voting and distribution rights to such membership interest, in order to secure the Company's obligations under the Promissory Note. Should the Company default on the Promissory Note, the Company could lose a substantial portion of its membership interest. As of March 28, 1997, the Company has paid $75,000 towards the note and has a principal balance owing of $450,000. The Company invested a total of $950,000 in the two private investment partnerships of which it is a general partner during 1995 and 1996. The Company withdrew a total of $600,000 from these partnerships in 1996. As of December 31, 1996, subsequent to these withdrawals, the value of the Company's partnership interests is approximately $625,000. The Company anticipates that although revenues from operations, together with working capital reserves may provide necessary funds for its operating expenses in the foreseeable future, the Company may also seek additional financing to fund these expenses as well as new business opportunities. In addition, there can be no assurance that the Company will not encounter unforeseen difficulties that may deplete its capital resources more rapidly than anticipated. Any efforts to seek additional funds could be made through equity, debt, or other external financing and there can be no assurance that additional funding, if necessary, will be available on favorable terms, if at all. Moreover, the development and expansion of the Company's business could place significant demands on the Company's infrastructure, and may require the Company to hire additional personnel, to implement additional operating and financial controls, install additional reporting and management information systems, and otherwise improve and expand the Company's business. The Company's future operating results will depend on management's ability to manage future growth, and there can be no assurance that efforts to manage future growth will be successful. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION The financial statements and related financial information required to be filed hereunder are indexed on page F-1 of this report and are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item is incorporated by reference from the registrant's definitive proxy statement to be filed with the Commission not later than April 22, 1997. 9 ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated by reference from the registrant's definitive proxy statement to be filed with the Commission not later than April 22, 1997. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated by reference from the registrant's definitive proxy statement to be filed with the Commission not later than April 22, 1997. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated by reference from the registrant's definitive proxy statement to be filed with the Commission not later than April 22, 1997. ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) 1,2 FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE PAGE ---- Independent Auditor's Report. . . . . . . . . . . . . . . F-1 Consolidated Balance Sheets as of December 31, 1996 and 1995. . . . . . . . . . . . . . . . . . . . . . . . F-2 Consolidated Statements of Operations for the Years Ended December 31, 1996, 1995, and 1994 . . . . . F-3 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1996, 1995, and 1994 . . . F-4 Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995, and 1994 . . . . . . . . F-5 Notes to Consolidated Financial Statements. . . . . . . . F-6 3. EXHIBITS. The following exhibits are either filed herewith or incorporated herein by reference: 3.1 Articles of Incorporation, as amended* 3.2 Amended and Restated Bylaws** 10.1 Lease of Company's Executive Offices at 12 South Raymond Avenue, Pasadena, California 91105* 10.2 Company's 1993 Stock Option Plan* 10.3 Form of Stock Option Agreement* 10.4 Company's 1996 Stock Option Plan*** 10.5 Letter Agreement between Company and Greenwich Information Technologies regarding attached Promissory Note and Pledge Agreement. 21 Subsidiaries 27 Financial Data Schedule * Incorporated by reference from the Company'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. ** Incorporated by reference from the Company's Quarterly Report on Form 10-Q filed on August 14, 1996. *** Incorporated by reference from the Company's Registration Statement on Form S-8 filed on February 21, 1997. (b) REPORTS ON FORM 8-K. None 10 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: August 13, 1997 __________________ /s/ PAUL R. RYAN ----------------------- Paul R. Ryan Chief Executive Officer and President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. SIGNATURE TITLE DATE /s/ R. BRUCE STEWART - --------------------- Chairman of the Board of August 13, 1997 R. Bruce Stewart Directors, Chief Financial Officer (Principal Financial and Accounting Officer) /s/ PAUL R. RYAN - ------------------------ Chief Executive Officer and August 13, 1997 Paul R. Ryan President (Principal Executive Officer) /s/ KATHRYN KING-VAN-WIE - ------------------------ Chief Operating Officer and August 13, 1997 Kathryn King-Van-Wie Secretary /s/ BROOKE P. ANDERSON - ----------------------- Director August 13, 1997 Brooke P. Anderson /s/ FRED A. DE BOOM - ------------------------ Director August 13, 1997 Fred A. de Boom /s/ EDWARD W. FRYKMAN - ------------------------ Director August 13, 1997 Edward W. Frykman 11 FINOCCHIARO & CO. 150 East Colorado Boulevard, Suite 201 Pasadena, California 91105 Telephone (818)449-6300 Fax (818)449-6299 INDEPENDENT AUDITOR'S REPORT To the Stockholders and the Board of Directors Acacia Research Corporation We have audited the accompanying consolidated balance sheets of Acacia Research Corporation as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years ended December 31, 1996. 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 in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Acacia Research Corporation as of December 31, 1996 and 1995, and the consolidated results of operations and cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. As discussed in Note 2 to the financial statements, and as required by generally accepted accounting principles, Acacia Research Corporation has restated its financial statements for the years ended December 31, 1995 and 1994, to reflect a change in its accounting for deferred tax benefits and its investment in Whitewing Labs, Inc. to the equity method and its financial statements for the year ended December 31, 1996 to reflect a change in its accounting for its investment in CombiMatrix Corporation to the consolidated method. /s/ FINOCCHIARO & CO. Pasadena, California July 31, 1997 ACACIA RESEARCH CORPORATION CONSOLIDATED BALANCE SHEETS December 31, 1996 and 1995 December 31, 1996 December 31, 1995 ----------------- ----------------- ASSETS Current assets Cash and cash equivalents $ 292,701 $ 788,611 Distributions receivable 400,000 0 Notes receivable 820,500 1,846,000 Receivables from affiliates 52,592 176,885 Other receivables 295,546 74,994 Prepaid expenses 219,027 12,948 Deferred tax benefit 272 15,820 ---------- ---------- Total current assets 2,080,638 2,915,258 Equipment, furniture, and fixtures 202,049 63,569 Other assets Equity in unconsolidated subsidiaries, at equity 1,494,671 0 Investment in unconsolidated subsidary, at cost 1,233,000 0 Partnership interests, at equity 625,405 821,023 Deferred tax benefit 0 40,463 Organization costs, net of accumulated amortization of $3,367 and $2,045 3,169 3,641 ---------- ---------- Total assets $5,638,932 $3,843,954 ---------- ---------- ---------- ---------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Accounts payable and accrued expenses $ 90,599 $ 129,066 Deficit interest in unconsolidated subsidiary, at equity 0 114,247 Income taxes payable 0 110,471 Note payable 552,500 0 ---------- ---------- Total current liabilities 643,099 353,784 Deferred tax liability 193,503 4,195 ---------- ---------- Total liabilities 836,602 357,979 Commitments and contingencies Minority interest 380,329 10,796 Stockholders' equity Common stock, no par value, 10,000,000 shares authorized, 1,970,672 shares in 1996 and 1,862,672 shares in 1995 issued and outstanding 4,081,993 3,547,680 Retained earnings 428,760 135,751 Less stock subscription receivable (88,752) (208,252) ---------- ---------- Total stockholders' equity 4,422,001 3,475,179 ---------- ---------- Total liabilities and stockholders' equity $5,638,932 $3,843,954 ---------- ---------- ---------- ---------- THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. F-2 ACACIA RESEARCH CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended December 31, 1996, 1995 and 1994 1996 1995 1994 ---------- ---------- ---------- Revenues Gains on sales of securities, net $ 876,499 $3,194,241 $ 0 Gain on issuance of stock by equity investee 1,066,408 0 0 Equity in earnings of investments (175,689) 271,023 (137,782) Management fees 1,458,078 2,880 0 Interest income 113,049 49,567 37,502 ---------- ---------- ---------- Total revenues 3,338,345 3,517,711 (100,280) Marketing, general, and administrative 2,640,504 1,399,042 724,156 ---------- ---------- ---------- Income (loss) before minority interest and 697,841 2,118,669 (824,436) taxes Minority interest in net loss of consolidated subsidiary (201,309) (459) 0 ---------- ---------- ---------- Income (loss) before provision for income taxes 899,150 2,119,128 (824,436) Provision (benefit) for income taxes 606,141 287,817 3,541 ---------- ---------- ---------- Net income (loss) $ 293,009 $1,831,311 $ (827,977) ---------- ---------- ---------- ---------- ---------- ---------- Earnings per common share Primary $0.11 $0.72 ($0.35) Fully diluted $0.11 $0.72 ($0.35) Weighted average shares outstanding Primary 2,680,433 2,558,647 2,357,050 Fully diluted 2,680,433 2,558,647 2,357,050 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. F-3 ACACIA RESEARCH CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the Years Ended December 31, 1996, 1995 and 1994 Common Common Retained Stock Shares Stock Earnings (Deficit) Subscriptions Total ------ ------ ------------------ ------------- ----- 1994 Stockholders' equity at December 31, 1993 1,441,000 $1,647,608 $ (867,584) $ $ 780,024 Net loss (827,977) (827,977) Common stock issued 136,825 547,300 547,300 Issuance costs (97,399) (97,399) Common stock issued for stock subscriptions 25,000 50,000 (50,000) 0 Compensation expense relating to stock options 25,000 25,000 --------- ---------- ----------- --------- ---------- Stockholders' equity at December 31, 1994 1,602,825 2,172,509 (1,695,561) (50,000) 426,948 1995 Net income 1,831,312 1,831,312 Common stock issued 136,180 817,082 817,082 Issuance costs (167,974) (167,974) Stock options exercised 74,500 183,375 183,375 Common stock issued for stock subscriptions 16,167 97,002 (97,002) 0 Stock options exercised for stock subscriptions 33,000 61,250 (61,250) 0 Tax benefit from nonstatutory stock options 232,061 232,061 Compensation expense relating to stock options 142,375 142,375 Stock warrants issued 10,000 10,000 --------- ---------- ----------- --------- ---------- Stockholders' equity at December 31, 1995 1,862,672 3,547,680 135,751 (208,252) 3,475,179 1996 Net income 293,009 293,009 Stock options exercised 108,000 215,500 215,500 Cash received for stock subscriptions 119,500 119,500 Tax benefit from nonstatutory stock options 318,813 318,813 --------- ---------- ----------- --------- ---------- Stockholders' equity at December 31, 1996 1,970,672 $4,081,993 $ 428,760 $ (88,752) $4,422,001 --------- ---------- ----------- --------- ---------- --------- ---------- ----------- --------- ---------- THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. F-4 ACACIA RESEARCH CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1996, 1995 and 1994 1996 1995 1994 ----------- ----------- --------- Cash flows from operating activities: Net income (loss) $ 293,009 $ 1,831,311 $(827,977) Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 31,151 9,681 6,517 Deferred taxes 245,319 (54,715) 1,941 Undistributed (earnings) loss of affiliate 175,689 (271,023) 137,782 Gain on sales of securities (876,499) (3,194,241) 0 Minority interest in net loss (201,309) (459) 0 Gain on issuance of stock by equity investee (1,066,408) 0 0 Unrealized gain on trading securities 0 0 (1,505) Changes in operating assets and liabilities: (Increase) decrease in accounts receivable, prepaid expenses, and other assets (358,962) (14,782) (33,397) Increase (decrease) in accounts payable, accrued expenses, income taxes payable, and other liabilities (155,819) 197,571 21,049 ----------- ----------- --------- Net cash used by operating activities (1,913,829) (1,496,657) (695,590) Cash flows from investing activities: Purchase of equity investments (3,000,000) (750,000) 0 Proceeds from sales of securities 2,049,051 3,205,496 0 Payment received on advances to affiliate 414,156 200,000 0 Advances to affiliates (369,597) (62,638) (40,000) Payment for acquisition of patent (53,637) Payment for other receivables (51,604) Collection of other receivables 94,336 Advance to officers 0 0 73,447 Distributions receivable (400,000) 0 0 Notes receivable 0 (1,846,000) 0 Payments received and write-off on notes receivable 1,025,500 0 0 Capitalized expenditures (155,026) (39,530) (13,970) ----------- ----------- --------- Net cash provided (used) by investing activities (446,821) 707,328 19,477 Cash flows from financing activities: Proceeds from note payable 800,000 0 0 Payments on note payable (248,143) 0 0 Proceeds from line of credit 0 2,000,000 0 Payments of line of credit 0 (2,000,000) 0 Tax benefit from nonstatutory stock options 318,813 232,061 0 Compensation from stock options 0 142,375 25,000 Issuance costs (34,650) (167,974) (97,399) Proceeds from issuance of common stock 693,720 Proceeds from sale of common stock 335,000 1,010,457 672,300 ----------- ----------- --------- Net cash provided by financing activities 1,864,740 1,216,919 599,901 ----------- ----------- --------- Increase (decrease) in cash and cash equivalents (495,910) 427,590 (76,212) Cash and cash equivalents, beginning 788,611 361,021 437,233 ----------- ----------- --------- Cash and cash equivalents, ending $ 292,701 $ 788,611 $ 361,021 ----------- ----------- --------- ----------- ----------- --------- THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. F-5 ACACIA RESEARCH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. DESCRIPTION OF BUSINESS Acacia Research Corporation (the "Company") was incorporated on January 25, 1993 under the laws of state of California. The Company provides investment advisory services, and also provides management services to, and makes direct investments in, new emerging corporations. The Company has significant economic interests in five companies that it has formed and takes an active role in each company's growth and advancement. These companies are: Whitewing Labs, Inc., MerkWerks Corporation, CombiMatrix Corporation, Soundview Technologies Incorporated, and Greenwich Information Technologies LLC. In addition, as a registered investment advisor, the Company is a general partner in two private investment partnerships and is an investment advisor to two offshore investment corporations. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION - The accompanying consolidated financial statements for the year ended December 31, 1996 and 1995 include the accounts of the Company, MerkWerks Corporation, a 69% owned subsidiary developed by the Company and CombiMatrix Corporation, a 52% owned subsidiary acquired by the Company. Material intercompany transactions and balances have been eliminated in consolidation. Investments in companies in which the Company maintains an ownership interest of 20% to 50%, or exercises significant influence over operating and financial policies, are accounted for under the equity method. The cost method is used where the Company maintains ownership interest of greater than 5% and less than 20%, and does not exercise significant influence over the investee. CASH AND CASH EQUIVALENTS - The Company considers all highly liquid investments with original maturities of ninety days or less when purchased to be cash equivalents. The Company invests excess cash in money market accounts. EQUIPMENT, FURNITURE, AND FIXTURES - Equipment, furniture, and fixtures are recorded at cost. Major additions and improvements are capitalized. When equipment, furniture, and fixtures are sold or otherwise disposed of, the assets account and related depreciation account are relieved, and any gain or loss is included in income for the period of sale or disposal. Depreciation is computed on the straight-line basis. ORGANIZATION COSTS - Organization costs are recorded at cost and are amortized on a straight-line basis over a period of five years. NET INCOME (LOSS) PER SHARE - Earnings (loss) per share has been computed based upon the weighted average number of shares actually outstanding plus the shares that would be outstanding assuming conversion of common stock options and warrants, which are considered to be common stock equivalents using the treasury stock method. Weighted average shares outstanding for all years presented include those shares and options considered to be "cheap stock" pursuant to SEC rules. USE OF ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles 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. PRESENTATION - For financial statement reporting purposes certain reclassifications of prior years' balances have been made to conform to the 1996 presentation. F-6 ACACIA RESEARCH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES (continued) RESTATEMENT OF PRIOR PERIODS - Financial statements for the period ended December 31, 1994 were restated to reflect the change in accounting for the Company's investment in Whitewing Labs, Inc. to the equity method of accounting. The Company's ownership interest was reduced, through sales of the Company's holdings in the investment and additional stock issued by Whitewing Labs, Inc. during 1995, from 100% of common equity to 38% while maintaining an overall voting interest of 55% as of December 31, 1995. Whitewing Labs, Inc. completed a public offering of common stock in February of 1996 further reducing the Company's control of its affiliate. As a result of these transactions, the Company has restated the prior period financial statements to reflect the accounting for its investment in Whitewing Labs, Inc. on the equity method in accordance with generally accepted accounting principles. This restatement reduced the net loss per common share for the year ended December 31, 1994 from $0.39 per share to $0.35 per share. The December 31, 1995 financial statements reflect a restatement for the accounting for the tax benefits of nonstatutory stock options. As a result of these changes, net income for 1995 decreased by $232,061 and decreased earnings per share from $0.81 to $0.72. RESTATEMENT OF 1996 - The Company's December 31, 1996 consolidated financial statements have been restated to include the accounts of CombiMatrix Corporation on a consolidated basis. The Company's ownership interest in CombiMatrix Corporation exceeded 50% as of December 31, 1996, but was expected to decline below 50% based on planned offering's of common stock by CombiMatrix Corporation and, therefore, was previously reported under the equity method. However, the Securities and Exchange Commission believes that the exception for temporary control is applicable only, if control is likely to be lost in the near term as a result of the probable occurence of events that lie outside the Company's control. As a result of these changes, net income for 1996 decreased by $133,411 and earnings per share earnings decreased from $0.16 to $0.11. Total assets as of December 31, 1996 increased by $261,162 to $5,638,932. 3. EQUIPMENT, FURNITURE, AND FIXTURES Equipment, furniture, and fixtures consist of the following at December 31, 1996 and December 31, 1995: 1996 1995 -------- -------- Computer equipment $106,371 $ 45,730 Furniture and fixtures 89,172 34,260 Laboratory equipment 40,050 - Leasehold improvements 11,892 - -------- -------- 247,485 79,990 Accumulated depreciation (45,436) (16,421) -------- -------- Total Equipment, Furniture, and Fixtures $202,049 $ 63,569 -------- -------- -------- -------- Depreciation expense for the years ended December 31, 1996 and 1995 was $29,888 and 8,887, respectively. 4. COMMITMENTS AND CONTINGENCIES LEASE OBLIGATIONS - As of December 31, 1996, the equipment, furniture and fixtures account included assets in the amount of $9,531 financed by capital lease agreements which will expire in 1999 and 2000. Accumulated depreciation includes approximately $1,900 of amortization related to assets financed by capital lease agreements. The amortization of assets under capital lease has been included in depreciation expense. The Company leases office facilities under operating leases through December 1998, with options to renew the leases at a rate determined by the Consumer Price Index at the time of renewal. The Company's current minimum monthly lease payment is $3,006. Rent expense for the years ended December 31, 1996 and 1995 was approximately $38,300 and $29,000, respectively. F-7 ACACIA RESEARCH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4. COMMITMENTS AND CONTINGENCIES (continued) At December 31, 1996, the future minimum lease payments for capital and operating leases equaled the following: Capital Operating ------- --------- 1997 $ 3,415 $36,072 1998 3,415 36,072 1999 3,023 - 2000 793 - ------- --------- Totals 10,646 72,144 Less interest portion (2,653) - ------- --------- Minimum lease payments $ 7,993 $72,144 ------- --------- ------- --------- LITIGATION - The Company has been named in a lawsuit filed by a former director and employee for alleged breach of contract. The suit asks for damages totalling $950,000. The Company's management cannot predict with certainty the outcome of this litigation, however, the impact of an adverse outcome on the Company's financial position or results of operations may be material. 5. STOCK OPTIONS AND WARRANTS During 1993, the Company adopted a stock option plan (the "1993 Plan") which authorizes the granting of both options intended to qualify as "incentive stock options" under Section 422A of the Internal Revenue Code of 1986 ("Incentive Stock Options") and stock options which are not intended to so qualify ("Nonstatutory Options") to officers, directors, employees, consultants, and others expected to provide significant services to the Company or its subsidiaries. The 1993 Plan, which covers an aggregate of 1,000,000 shares of common stock, was approved by the Board of Directors in October, 1993. The Company has reserved 1,000,000 shares of common stock in connection with the 1993 Plan. Under the terms of the 1993 Plan, options may be exercised upon terms approved by the Board of Directors of the Company, and expire at a maximum of ten years from the date of grant.Incentive Stock Options are granted at prices equal to or greater than fair market value at the date of grant. Nonstatutory Stock Options are generally granted at prices equal to or greater than 85% of the fair market value at the date of grant. At December 31, 1996 all shares available for grant under the 1993 Plan had been granted, and at December 31, 1995, there were 1,775 shares reserved for future grants of common stock options. In March of 1996, the Board of Directors adopted the 1996 Executive Stock Bonus Plan (the "Bonus Plan"), which was approved by a vote of the shareholders in May of 1996. The Bonus Plan grants one-time options to purchase an aggregate of 360,000 shares of common stock of the Company to directors, officers and other key employees performing services for the Company and its affiliates. Under each option agreement of the Bonus Plan, 25% of the options become exercisable on each of the first four anniversaries of the grant date. The options granted under the Bonus Plan expire in March 2001. During April of 1996, the Board of Directors adopted the Acacia 1996 Stock Option Plan (the "1996 Plan"), which was approved by the shareholders in May of 1996. The Company has reserved 250,000 shares of common stock for issuance under the 1996 Plan. The 1996 Plan provides for the grant of Nonqualified Stock Options and Incentive Stock Options to key employees including officers of the Company and its subsidiaries and certain other individuals. The 1996 Plan also provides for the automatic grant of Nonqualified Stock Options to non-employee directors upon initial election to the Board of Directors and thereafter on an annual basis under the Non- Employee Director Program. These 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. At December 31, 1996, options to purchase 35,000 shares of common stock had been issued under the 1996 Plan with 215,000 shares reserved for further grants of options. F-8 ACACIA RESEARCH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. STOCK OPTIONS AND WARRANTS (continued) During 1996 the Company also granted 20,000 options at $5.38 per share that were granted outside the 1993 and 1996 Plans. These options expire in March 2001. As of December 31, 1996 and 1995, there were 215,000 and 1,775 shares reserved for grants of common stock options. The following is a summary of common stock options: Weighted Shares Prices Average ---------------------------------------------------------------------- 1994 Balance at December 31, 1993 550,000 $1.50-$2.00 $1.59 Options granted 259,225 $1.50-$4.40 $2.05 ---------------------------------------------------------------------- 1995 Balance at December 31, 1994 809,225 $1.50-$4.40 $1.74 Options granted 294,000 $1.50-$5.25 $4.80 Options exercised (107,500) $1.50-$5.25 $2.28 Options canceled (105,000) $2.00 $2.00 ---------------------------------------------------------------------- 1996 Balance at December 31, 1995 890,725 $1.50-$5.25 $2.66 Options granted 421,775 $5.38-$10.50 $6.28 Options exercised (108,000) $1.50-$5.25 $2.00 Options canceled (10,000) $5.00 $5.00 ---------------------------------------------------------------------- Balance at December 31, 1996 1,194,500 $1.50-$10.50 $3.98 ---------------------------------------------------------------------- ---------------------------------------------------------------------- Exercisable at December 31, 1996 712,500 $1.50-$5.75 $2.50 ---------------------------------------------------------------------- ---------------------------------------------------------------------- In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, Accounting for Stock-Based Compensation. This pronouncement establishes the accounting and reporting requirements using a fair value method of accounting for stock-based compensation plans. Under the new standard, the Company may either adopt the new fair value-based measurement method or continue to use the intrinsic value-based measurement method for stock-based compensation and provide pro forma disclosures of net income and earnings per share as if the measurement provisions of the pronouncement had been adopted. The Company has adopted only the disclosure requirements of SFAS No. 123; therefore, the adoption will have no effect on the Company's consolidated net earnings or cash flows. Had compensation expense related to stock options been reported in accordance with SFAS No. 123 the Company's net income and earnings per share would have been reduced to the pro forma amounts below: 1996 1995 -------- ---------- Net Income, as reported $426,240 $1,831,311 Net Income, Pro Forma 402,104 1,656,051 Primary earnings per share, as reported $0.16 $0.72 Primary earnings per share, Pro Forma $0.15 $0.65 Fully diluted earnings per share, as reported $0.16 $0.72 Fully diluted earnings per share, Pro Forma $0.15 $0.65 The fair values of options were determined using the Black-Scholes model, and assumed option lives of five years, risk free interest of 7%, and volatility of approximately 80%. During 1996, the Company issued 8,500 warrants with an exercise price of $6.75 per share. As of December 31, 1996, the Company had 108,500 warrants outstanding. The warrants are exercisable at $2.00-$6.75 per share, and expire in January 2000 and November 2001. F-9 ACACIA RESEARCH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. NOTES RECEIVABLE As of December 31, 1996 and 1995, the Company held promissory notes from individuals related to the sale of common stock owned by the Company in Whitewing Labs, Inc. and MerkWerks Corporation. These notes generally bear interest at 5% per annum and are generally secured by the common stock sold. As of December 31, 1996, two promissory notes which are secured by Whitewing Labs, Inc. common stock have been written down to the market value price of the collateral held by the Company as of the balance sheet date. The amount of the write down was $559,250, and has been reported in the statement of operations as part of marketing, selling and administrative expenses. The following is a summary of notes receivable at December 31, 1996 and 1995: 1996 1995 -------- ---------- Notes receivable due from stockholders, secured $480,000 $ 530,000 Notes receivable, secured 319,500 1,245,000 Notes receivable, unsecured 21,000 71,000 -------- ---------- Total Notes Receivable $820,500 $1,846,000 -------- ---------- -------- ---------- Subsequent to the balance sheet date the Company has collected $49,508 on the notes receivable outstanding as of December 31, 1996. Interest receivable on these notes amounted to approximately $85,500, and $13,200, as of December 31, 1996 and 1995, respectively. 7. INVESTMENTS, AT EQUITY Investments carried at equity, and the Company's ownership in each consist of the following at December 31, 1996 and 1995: 1996 1995 ---- ---- Whitewing Labs, Inc. 18% 38% Acacia Capital Partners, L.P. 36% 60% Acacia Growth Fund, L.P. 29% 0% Greenwich Information Technologies, LLC 30% 0% The investment in Whitewing Labs, Inc. is reported using the equity method. The Company maintains an ownership percentage of 18.4% as of December 31, 1996, and officers of the Company hold significant positions on the board of directors of Whitewing Labs, Inc. The investment in Whitewing Labs, Inc. is carried on the financial statements at a value of $640,101 at December 31, 1996, and $0 as of December 31, 1995. The market value of the Company's investment in Whitewing Labs, Inc. is approximately $1,064,918 based upon the closing market price of $2.00 per share as of December 31, 1996. The net losses attributable to the Company as equity owner of Whitewing Labs, Inc. exceeded the carrying value of the investment on the Company's financial statement by approximately $57,000 in 1995. Whitewing Labs, Inc. had total assets of $3,720,256 in 1996 and $5,901,956 in 1995, and net losses of $2,428,062, $69,554, and $336,544 in 1996, 1995, and 1994, respectively. In September of 1996 the Company acquired an equity interest in Greenwich Information Technologies, LLC, a Delaware Limited Liability Company. As of December 31, 1996, the Company maintains a 30% ownership interest in the entity. The investment is carried on the balance sheet of the Company as of December 31, 1996 at a cost of $854,570. The Company records its investment in Acacia Capital Partners, L.P. at equity in accordance with authoritative pronouncements regarding investments in partnerships. The Company's carrying value with respect to Acacia Capital Partners, L.P. is $361,427 and $821,023, as of December 31, 1996 and 1995, respectively. Acacia Capital Partners, L.P. is a California limited partnership that invests primarily in large-cap U.S. equity securities. On April 1, 1996 the Company acquired an equity interest in Acacia Growth Fund, L.P. The Company's investment at December 31, 1996 is carried on these financial statements at $263,978. Acacia Growth Fund, L.P. is a California limited partnership that invests primarily in large-cap U.S. equity securities. F-10 ACACIA RESEARCH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. INVESTMENTS, AT COST In March 1996, the Company entered into an agreement with Soundview Technologies Incorporated. Under the terms of the agreement the Company would receive up to a 32% interest in the common stock of Soundview Technologies in exchange for the Company's raising capital and offering management assistance to Soundview Technologies. The Company received a management fee of $1,400,000 in the form of common stock for these services. As of December 31, 1996, the Company carries its investment in Soundview Technologies at $1,233,000, which represents a 16.4% ownership interest. 9. NOTE PAYABLE As of December 31, 1996, the Company has a note payable to Greenwich Information Technologies LLC, which is in connection with the purchase of an equity interest in that entity. This note has a balance of $552,500 as of December 31, 1996. In February 1997, the Company signed a new note payable to Greenwich Information Technologies, which replaced the original note. The new note bears interest at 6.5%, and calls for monthly principal payments of $25,000 to $50,000 per month, with the final payment due in December 1997. The Company has pledged a portion of its membership interest in Greenwich Information Technologies as security for this note. 10. PROVISION FOR INCOME TAXES Provision for income taxes consists of the following: FEDERAL STATE TOTAL -------------------------------------- 1996 Current $277,565 $83,257 $360,822 Deferred 195,968 49,351 245,319 1995 Current $245,360 $97,172 $342,532 Deferred (46,360) (8,355) (54,715) 1994 Current $ - $ 1,600 $ 1,600 Deferred 1,524 417 1,941 A reconciliation of the Federal statutory tax rate and the effective tax rate is as follows: 1996 1995 1994 -------------------------- Statutory Federal tax rate 34.0% 34.0% 0.0% State income taxes-net of federal benefit 8.4 2.8 0.2 Net operating loss carryforwards 0.0 (20.0) 0.0 Tax benefit from nonstatutory options 24.1 3.7 0.0 Other, net (7.9) (7.0) 0.2 -------------------------- Effective income tax rates 58.6% 13.5% 0.4% -------------------------- -------------------------- The Company utilized net operating loss carryforwards of $1,249,223 and $954,547 to offset taxable income for the year ended December 31, 1995 for federal and state of California purposes, respectively. F-11 ACACIA RESEARCH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10. PROVISION FOR INCOME TAXES (continued) The tax effects of temporary differences and carryforwards that give rise to significant portions of deferred assets and liabilities consist of the following: 1996 1995 --------------------- DEFERRED TAX ASSETS: Tax basis of investments at equity $ 0 $40,463 State income tax deductions 272 15,820 --------------------- Deferred tax assets $ 272 $56,283 --------------------- --------------------- DEFERRED TAX LIABILITIES: Tax basis of investments at equity $184,762 $ 0 Equipment, furniture & fixtures 8,741 4,195 --------------------- Deferred tax liabilities $193,503 $ 4,195 --------------------- --------------------- Deferred tax assets for 1995 have been restated to reflect the change in accounting of the tax benefits related to nonstatutory stock options. The restatement reduced deferred tax assets for 1995 by $619,353. The Company's income taxes currently payable for federal and state purposes have been reduced by the benefit derived from nonstatutory stock options by $232,061 in 1995, and $318,813 in 1996. The Company believes that all deferred tax assets as of December 31, 1996 are more likely than not to be realizable, therefore a valuation allowance has not been recorded. 11. COMMON STOCK SUBSCRIPTIONS Common stock subscriptions as of December 31, 1996 and 1995 consist of promissory notes due from individuals on the purchase of common stock and the exercise of stock options. These notes generally bear interest at 4% to 5% per annum. The notes are due in full in 1997. As of December 31, 1996 and 1995 the outstanding balances due on these notes were $88,752 and $208,252, respectively. Other receivables include interest receivable of $5,700 for 1996, and $1,400 for 1995 on these notes. Subsequent to December 31, 1996, the Company has collected $28,752 on these notes. 12. RECEIVABLES FROM AFFILIATES Receivables from affiliates generally represent advances to the Company's investments carried at equity and carried at cost. As of December 31, 1996, receivables from affiliates include advances for the benefit of Whitewing Labs, Inc. of approximately $37,000 and Soundview Technologies Incorporated of approximately $15,000. Subsequent to December 31, 1996 the Company has collected $26,587 from these balances. Receivables from affiliates includes advances for the benefit of CombiMatrix Corporation of approximately $62,000 and a promissory note with a balance of $114,247 at December 31, 1995 bearing interest at 8% per annum from Whitewing Labs, Inc. At December 31, 1995 other receivables included approximately $43,000 of interest receivable on the note from Whitewing Labs, Inc. These balances were paid in full in 1996. 13. GAIN ON ISSUANCE OF STOCK BY EQUITY INVESTEE In February 1996, Whitewing Labs, Inc. issued approximately, 1.1 million shares of common stock as part of a public offering of its common stock. The issuance of stock reduced the Company's ownership interest from approximately 38% to approximately 18%. This transaction resulted in a noncash pretax gain of approximately $1.1 million for the Company. The Company will continue to account for this investment under the equity method as described in Note 7. F-12 ACACIA RESEARCH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. SUPPLEMENTAL CASH FLOW INFORMATION As disclosed in Note 4, the Company incurred a capital lease obligation of $2,922 in 1996, $6,609 in 1995, and $2,052 in 1994. Cash paid for the years ended December 31, 1996, 1995 and 1994 for interest was $1,511, $23,492 and $306, respectively. The Company paid cash for income taxes in the amount of $814 in 1994 and $251,885 in 1996. 15. CONCENTRATION OF CREDIT RISK Notes receivable at December 31, 1996 and 1995 subject the Company to concentration on credit risk due to notes being due from two individuals. These notes are collateralized by common stock. The Company has determined that due to the fact that these notes are past due they should be reported on the balance sheet at the value of their collateral. As described in Note 6, the Company has charged income for $559,250 relative to these notes. The Company maintains its cash balances with financial and brokerage institutions located in Southern California. On December 31, 1996 the Company had no accounts which exceeded the insured amounts. As of December 31, 1995 the Company maintained balances of $669,405 in excess of insured amounts with these institutions. 16. SEGMENT INFORMATION The results for the year ended December 31, 1996 and 1995 include the consolidated balances of MerkWerks Corporation. MerkWerks Corporations is engaged in the business of software development. As of December 31, 1996, there have been no sales related to those operations. These financial statements do include $86,285 in 1996 and $64,013 in 1995 of administrative expenses that were incurred by Merkwerks Corporation. The total assets of MerkWerks Corporation at December 31, 1996 and 1995 are $51,876 and $106,623. Assets of the subsidiary consist of cash, equipment, and organization costs, net of depreciation and amortization. The results for the year ended December 31, 1996 include the consolidated balances of CombiMatrix Corporation. CombiMatrix Corporation is engaged in the business of developing new technologies in the field of drug discovery. These financial statements include revenues of $10,715 and operating expenses of $420,887 from CombiMatrix Corporation. The total assets of CombiMatrix Corporation at December 31, 1996 were $261,162 and consisted of cash, prepaid expenses, patent, equipment and organization costs, net of depreciation and amortization. The revenues reported for the year ended December 31, 1996 consisted of transactions between several investors and the Company. Included in those revenues were sales to Dr. Robert Ching in the amount of $600,000. The revenues reported for the year ended December 31, 1995 consisted of transactions between several investors and the Company. Included in those revenues were sales to Wilfred Desrosiers in the amount of $1,125,000, sales to Dr. Robert Ching in the amount of $580,000, and sales to Mark Rosen in the amount of $510,000. 17. 1996 QUARTERLY INFORMATION (UNAUDITED) The following is selected unaudited quarterly information that reflects the inclusion of the accounts of CombiMatrix Corporation on a consolidated basis (See Note 2). Quarter Ended Quarter Ended Quarter Ended March 31, 1996 June 30, 1996 September 30, 1996 --------------- ------------- ------------------ Total Revenue $1,827,681 $1,439,708 $ 134,336 Net Income $ 879,790 $ 552,105 (161,033) Earnings Per Share $ 0.34 $ 0.20 ($0.08) F-13 ACACIA RESEARCH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SCHEDULE I. MARKETABLE SECURITIES, OTHER INVESTMENTS - --------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------- Name Principal Cost Basis Market Value Book Value of Issuer Amount/Shares of Issue of Issue of Issue - --------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------- Whitewing Labs, Inc., common (1) 532,459 $ 48,796 $1,064,918 $ 640,101 Acacia Capital Partners, L.P. 361,427 361,427 361,427 361,427 CombiMatrix Corporation, common 3,965,000 83,269 3,965,000 0 Acacia Growth Fund, L.P 263,978 263,978 263,978 263,978 Greenwich Information Technologies LLC 854,570 854,570 903,090 854,570 Soundview Technologies Incorporated 1,233,000 1,233,000 1,233,000 1,233,000 ---------- ---------- ---------- Totals $2,845,040 $7,791,413 $3,353,076 ---------- ---------- ---------- ---------- ---------- ---------- (1) Total shares adjusted for 3 for 2 stock split, effective February 9, 1996. F-14 ACACIA RESEARCH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SCHEDULE II. AMOUNTS RECEIVABLE FROM RELATED PARTIES - ---------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------- Balance at beginning of Balance at Name of debtor period Additions Deductions end of period - ---------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------- 1996 Whitewing Labs $114,247 $ - $114,247 $ - Mark Rosen (a) 520,000 - 10,000 510,000 William R. Tipton 50,000 - 50,000 - Dr. Robert Ching (b) - 100,000 - 100,000 -------- -------- -------- -------- $684,247 $100,000 $174,247 $610,000 -------- -------- -------- -------- -------- -------- -------- -------- 1995 Whitewing Labs $314,247 $ - $200,000 $114,247 Mark Rosen - 520,000 - 520,000 William R. Tipton - 100,000 50,000 50,000 -------- -------- -------- -------- $314,247 $620,000 $250,000 $684,247 -------- -------- -------- -------- -------- -------- -------- -------- 1994 Whitewing Labs $274,247 $ 40,000 $ - $314,247 -------- -------- -------- -------- -------- -------- -------- -------- (a) Note receivable, secured by common stock in Whitewing Labs and Acacia Research Corporation, bearing interest at 5% per annum in the face amount of $520,000. The note is due on demand. Subsequent to December 31, 1996, the Company received $28,508 in connection with this note. (b) This receivable was paid in full subsequent to December 31, 1996. F-15