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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_____________
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
COMMISSION FILE NUMBER 0-26068
ACACIA RESEARCH CORPORATION
---------------------------
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 95-4405754
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
500 NEWPORT CENTER DRIVE, NEWPORT BEACH, CA 92660
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (949) 480-8300
--------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
As of April 30, 2004, 19,781,693 shares of Acacia Research-Acacia
Technologies common stock were issued and outstanding. As of April 30, 2004,
30,871,566 shares of Acacia Research-CombiMatrix common stock were issued and
outstanding.
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ACACIA RESEARCH CORPORATION
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Acacia Research Corporation Consolidated Financial Statements
Consolidated Balance Sheets as of March 31, 2004 and
December 31, 2003 (Unaudited)....................................................... 1
Consolidated Statements of Operations and Comprehensive Loss for the
Three Months Ended March 31, 2004 and 2003 (Unaudited).............................. 2
Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2004 and 2003 (Unaudited)................................................. 3
Notes to Consolidated Financial Statements (Unaudited).............................. 4
*CombiMatrix Group Financial Statements
Balance Sheets as of March 31, 2004 and December 31, 2003 (Unaudited)............... 15
Statements of Operations for the Three Months Ended
March 31, 2004 and 2003 (Unaudited)................................................. 16
Statements of Cash Flows for the Three Months Ended
March 31, 2004 and 2003 (Unaudited)................................................. 17
Notes to Financial Statements (Unaudited)........................................... 18
*Acacia Technologies Group Financial Statements
Balance Sheets as of March 31, 2004 and December 31, 2003 (Unaudited)............... 22
Statements of Operations for the Three Months Ended
March 31, 2004 and 2003 (Unaudited)................................................. 23
Statements of Cash Flows for the Three Months Ended
March 31, 2004 and 2003 (Unaudited)................................................. 24
Notes to Financial Statements (Unaudited)........................................... 25
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................................... 29
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................... 63
Item 4. Controls and Procedures............................................................. 63
i
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................... 64
Item 6. Exhibits and Reports on Form 8-K.................................................... 65
SIGNATURES................................................................................................ 66
EXHIBIT INDEX ............................................................................................ 67
*NOTE: We are presenting the Acacia Research Corporation consolidated unaudited
interim financial statements and the separate unaudited interim financial
statements for the CombiMatrix group and the Acacia Technologies group. The
separate financial statements and accompanying notes of the two groups are being
provided as additional disclosure regarding the financial performance of the two
divisions and to provide investors with information regarding the potential
value and operating results of the respective businesses, which may affect the
respective share values. The separate financial statements should be reviewed in
conjunction with Acacia Research Corporation's consolidated financial statements
and accompanying notes. The presentation of separate financial statements is not
intended to indicate that we have changed the title to any of our assets or
changed the responsibility for any of our liabilities, nor is it intended to
indicate that the rights of our creditors have been changed. Acacia Research
Corporation, and not the individual groups, is the issuer of the securities.
Holders of the two securities are stockholders of Acacia Research Corporation
and do not have a separate and exclusive interest in the respective groups.
ii
ACACIA RESEARCH CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION)
(UNAUDITED)
MARCH 31, DECEMBER 31,
2004 2003
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents .................................................. $ 32,982 $ 31,949
Short-term investments ..................................................... 17,962 18,551
Accounts receivable, net of allowance for doubtful accounts
of $0 (2004) and $145 (2003) ............................................ 339 323
Prepaid expenses, inventory, and other assets .............................. 1,522 1,180
------------- -------------
Total current assets ............................................... 52,805 52,003
Property and equipment, net of accumulated depreciation .......................... 2,552 2,823
Patents, net of accumulated amortization of $9,610 (2004) and $9,210 (2003)....... 13,284 13,683
Goodwill ......................................................................... 21,200 21,200
Other assets ..................................................................... 332 331
------------- -------------
$ 90,173 $ 90,040
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued expenses and other ............................... $ 3,797 $ 3,244
Current portion of deferred revenues ....................................... 647 18,108
------------- -------------
Total current liabilities .......................................... 4,444 21,352
Deferred income taxes ............................................................ 3,190 3,260
Deferred revenues, net of current portion ........................................ 3,920 3,901
Other liabilities ................................................................ 1,257 --
------------- -------------
Total liabilities ........................................................ 12,811 28,513
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Minority interests ............................................................... 1,127 1,127
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Commitments and contingencies (Note 8)
Redeemable Stockholders' equity:
Preferred stock
Acacia Research Corporation, par value $0001 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; 19,781,693 and
19,739,984 shares issued and outstanding as of March 31, 2004
and December 31, 2003, respectively .................................. 20 20
Acacia Research - CombiMatrix stock, par value $0.001 per share;
50,000,000 shares authorized; 27,766,703 and 26,328,122 shares
issued and outstanding as of March 31, 2004 and December 31, 2003,
respectively ......................................................... 28 26
Additional paid-in capital ................................................. 249,195 244,517
Deferred stock compensation ................................................ (521) (766)
Accumulated comprehensive income ........................................... 15 8
Accumulated deficit ........................................................ (172,502) (183,405)
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Total stockholders' equity ......................................... 76,235 60,400
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$ 90,173 $ 90,040
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THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
1
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION)
(UNAUDITED)
FOR THE THREE MONTHS ENDED
--------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Revenues:
Research and development contract .................................... $ 17,302 $ --
License fees ......................................................... 599 6
Government contract .................................................. 217 --
Service contracts .................................................... 81 7
Products ............................................................. 16 209
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Total revenues ........................................... 18,215 222
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Operating expenses:
Cost of product sales ................................................ 4 77
Research and development expenses .................................... 1,588 2,335
Non-cash stock compensation amortization - research and development .. 69 2
Marketing, general and administrative expenses ....................... 3,886 4,255
Non-cash stock compensation amortization - marketing,
general and administrative ........................................ 334 138
Amortization of patents .............................................. 399 400
Legal settlement charges ............................................. 1,257 --
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Total operating expenses ................................. 7,537 7,207
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Operating income (loss) .................................. 10,678 (6,985)
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Other income:
Interest income ...................................................... 158 215
Realized gains on short-term investments ............................. -- 37
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Total other income ....................................... 158 252
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Income (loss) from operations before income taxes and minority interests.... 10,836 (6,733)
Benefit for income taxes ................................................... 67 60
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Income (loss) from operations before minority interests .................... 10,903 (6,673)
Minority interests ......................................................... -- 6
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Net income (loss) .......................................................... 10,903 (6,667)
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Unrealized gains (losses) on short-term investments .................. 2 (8)
Unrealized gains (losses) on foreign currency translation ............ 6 (7)
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Comprehensive income (loss) ................................................ $ 10,911 $ (6,682)
============= =============
Earnings (loss) per common share:
Attributable to the Acacia Technologies group:
Net income (loss) ....................................................... $ (989) $ (1,494)
Basic and diluted loss per share ........................................ (0.05) (0.08)
Attributable to the CombiMatrix group:
Basic
Net income (loss) ....................................................... $ 11,892 $ (5,173)
Basic net income (loss) per share ....................................... 0.44 (0.23)
Diluted
Net income (loss) ....................................................... $ 11,892 $ (5,173)
Diluted net income (loss) per share ..................................... 0.41 (0.23)
Weighted average shares:
Acacia Research - Acacia Technologies stock:
Basic and diluted ................................................... 19,752,335 19,640,808
============= =============
Acacia Research - CombiMatrix stock:
Basic ............................................................... 27,274,627 22,983,278
============= =============
Diluted ............................................................. 29,233,817 22,983,278
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THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
2
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
FOR THE THREE MONTHS ENDED
---------------------------------------
MARCH 31, 2004 MARCH 31, 2003
----------------- -----------------
Cash flows from operating activities:
Net income (loss) from operations ........................................... $ 10,903 $ (6,667)
Adjustments to reconcile net income (loss) from operations
to net cash used in operating activities:
Depreciation and amortization .......................................... 712 767
Minority interests ..................................................... -- (6)
Non-cash stock compensation amortization ............................... 403 140
Deferred tax benefit ................................................... (70) (70)
Non-cash legal settlement charge ....................................... 1,257 --
Other .................................................................. (27) 121
Changes in assets and liabilities:
Accounts receivable .................................................... (16) 301
Prepaid expenses, inventory and other assets ........................... (221) (397)
Accounts payable, accrued expenses and other ........................... 671 (250)
Deferred revenues ...................................................... (17,442) 1,508
----------------- -----------------
Net cash used in operating activities from continuing operations ....... (3,830) (4,553)
Net cash used in operating activities from discontinued operations ..... (87) (86)
----------------- -----------------
Net cash used in operating activities .................................. (3,917) (4,639)
----------------- -----------------
Cash flows from investing activities:
Purchase of property and equipment, net ................................ (97) (24)
Purchase of available-for-sale investments ............................. (13,605) (469)
Sale of available-for-sale investments ................................. 14,196 2,462
----------------- -----------------
Net cash provided by investing activities from continuing operations ... 494 1,969
Net cash used in investing activities from discontinued operations ..... -- (344)
----------------- -----------------
Net cash provided by investing activities .............................. 494 1,625
----------------- -----------------
Cash flows from financing activities:
Proceeds from the exercise of stock options and warrants ............... 4,450 --
----------------- -----------------
Net cash provided by financing activities .............................. 4,450 --
----------------- -----------------
Effect of exchange rate on cash ............................................... 6 (7)
----------------- -----------------
Increase (decrease) in cash and cash equivalents .............................. 1,033 (3,021)
Cash and cash equivalents, beginning .......................................... 31,949 43,083
----------------- -----------------
Cash and cash equivalents, ending ............................................. $ 32,982 $ 40,062
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THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
3
ACACIA RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS
BASIS OF PRESENTATION. The accompanying unaudited consolidated
financial statements have been prepared in accordance with generally accepted
accounting principles for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain
information and footnotes required by generally accepted accounting principles
in annual financial statements have been omitted or condensed in accordance with
quarterly reporting requirements of the Securities and Exchange Commission.
These interim consolidated financial statements should be read in conjunction
with the consolidated financial statements and notes thereto for the year ended
December 31, 2003, as reported by us in our Annual Report on Form 10-K. The
year-end consolidated balance sheet data was derived from audited financial
statements but does not include all disclosures required by accounting
principles generally accepted in the United States of America.
The accompanying consolidated financial statements include the accounts
of Acacia Research Corporation and its wholly owned and majority-owned
subsidiaries. Material intercompany transactions and balances have been
eliminated in consolidation.
The consolidated financial statements of Acacia Research Corporation
include all adjustments of a normal recurring nature which, in the opinion of
management, are necessary for a fair presentation of our financial position as
of March 31, 2004 and results of operations and cash flows for the interim
periods presented. The results of operations for the three months ended March
31, 2004 are not necessarily indicative of the results to be expected for the
entire year.
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 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. CombiMatrix K.K.,
a 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.
RECAPITALIZATION TRANSACTION
On December 11, 2002, our stockholders voted in favor of a
recapitalization transaction, which became effective on December 13, 2002,
whereby we created two new classes of common stock called Acacia
Research-CombiMatrix stock ("AR-CombiMatrix stock") and Acacia Research-Acacia
Technologies stock ("AR-Acacia Technologies stock"), and divided our existing
Acacia Research Corporation common stock into shares of the two new classes of
common stock. AR-CombiMatrix stock is intended to reflect separately the
performance of Acacia Research Corporation's CombiMatrix group. AR-Acacia
Technologies stock is intended to reflect separately the performance of Acacia
Research Corporation's Acacia Technologies group. Although the AR-CombiMatrix
stock and the AR-Acacia Technologies stock are intended to reflect the
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.
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
4
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.
Financial effects arising from one group that affect Acacia Research
Corporation's results of operations or financial condition could, if
significant, affect the results of operations or financial condition of the
other group and the market price of the class of common stock relating to the
other group. Any division net losses of the CombiMatrix group or of the Acacia
Technologies group, and dividends or distributions on, or repurchases of,
AR-CombiMatrix stock or AR-Acacia Technologies stock, will reduce the assets of
Acacia Research Corporation legally available for payment of dividends on
AR-CombiMatrix stock or AR-Acacia Technologies stock.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION. We recognize revenue in accordance with Staff
Accounting Bulletin No. 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.
COMBIMATRIX GROUP
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.
Revenues from government grants and contracts are recognized in
accordance with Accounting Research Bulletin ("ARB") No. 43, "Government
Contracts," and related pronouncements. Accordingly, revenues are recognized
under the percentage-of-completion method of accounting, using the cost-to-cost
approach to measure completeness at each reporting period. Under the
percentage-of-completion method of accounting, contract revenues and expenses
are recognized in the period that work is performed based on the percentage of
actual incurred costs to estimated total contract costs. Actual contract costs
and cost estimates include direct charges for labor and materials and indirect
charges for labor, overhead and certain general and administrative charges.
Contract change orders and claims are included when they can be reliably
estimated and are considered probable. For contracts that extend over a one-year
period, revisions in contract cost estimates, if they occur, have the effect of
adjusting current period earnings applicable to performance in prior periods.
Should current contract estimates indicate an overall future loss to be
incurred, a provision is made for the total anticipated loss in the current
period.
Revenue from the sale of products and services is recognized when
delivery has occurred or services have been rendered.
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 current. Deferred revenues will
be recognized as revenue in future periods when the applicable revenue
recognition criteria as described above are met.
ACACIA TECHNOLOGIES GROUP
Under the terms of our digital media transmission ("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.
5
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 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.
INVENTORY. Inventory, which consists primarily of raw materials to be
used in the production of the CombiMatrix group's array products, is stated at
the lower of cost or market using the first-in, first-out method.
STOCK-BASED COMPENSATION. Acacia Research Corporation has two
stock-based employee compensation plans, the 2002 CombiMatrix Stock Incentive
Plan and the 2002 Acacia Technologies Stock Incentive Plan. 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.
6
The following table illustrates the effect on net income (loss) and
income (loss) per share if Acacia Research Corporation had applied the fair
value recognition provisions of SFAS No. 123 (in thousands, except per share
data):
AR-ACACIA TECHNOLOGIES STOCK AR-COMBIMATRIX STOCK
THREE MONTHS ENDED THREE MONTHS ENDED
------------------------------- -------------------------------
MARCH 31, 2004 MARCH 31, 2003 MARCH 31, 2004 MARCH 31, 2003
-------------- -------------- -------------- --------------
Income (loss) from operations as reported .................... $ (989) $ (1,494) $ 11,892 $ (5,173)
Add: Stock-based compensation, intrinsic value method
reported in net income, net of tax and minority
interests ................................................. -- -- 238 69
Deduct: Pro forma stock-based compensation fair value
method, net of tax and minority interests ................. (562) (1,078) (1,772) (2,782)
Income (loss) from operations, pro forma ..................... (1,551) (2,572) 10,358 (7,886)
Basic income (loss) per share from operations as reported .... (0.05) (0.08) 0.44 (0.23)
Basic income (loss) per share from operations, pro forma ..... (0.08) (0.13) 0.38 (0.34)
Diluted income (loss) per share from operations as
reported .................................................. (0.05) (0.08) 0.41 (0.23)
Diluted income (loss) per share from operations, pro forma ... (0.08) (0.13) 0.35 (0.34)
The fair value of AR-Acacia Technologies stock options and
AR-CombiMatrix stock options was determined using the Black-Scholes
option-pricing model, assuming volatility of approximately 100%, with expected
lives of approximately five years and no expected dividends.
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 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. The
fair values of our reporting units are 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.
3. EARNINGS PER SHARE
EARNINGS PER SHARE. Earnings per share for each class of common stock
is computed by dividing the earnings allocated to each class of common stock by
the weighted average number of outstanding shares of that class of common stock.
Diluted earnings per share is computed by dividing the loss allocated to each
class of common stock by the weighted average number of outstanding shares of
that class of common stock including the dilutive effect of common stock
equivalents. Potentially dilutive common stock equivalents primarily consist of
employee stock options and warrants.
The earnings or losses allocated to each class of common stock are
determined by Acacia Research Corporation's board of directors. This
determination is generally based on the net income or loss amounts of the
corresponding group determined in accordance with accounting principles
generally accepted in the United States of America, consistently applied. Acacia
Research Corporation believes this method of allocation is systematic and
reasonable. The Acacia Research Corporation board of directors can, at its
discretion, change the method of allocating earnings or losses to each class of
common stock at any time. Management currently has no plans to change allocation
methods.
7
The following table presents a reconciliation of basic and diluted loss per share:
FOR THE THREE MONTHS ENDED
----------------------------------
MARCH 31, 2004 MARCH 31, 2003
--------------- ---------------
ACACIA RESEARCH - ACACIA TECHNOLOGIES STOCK
- -------------------------------------------
Basic weighted average number of common shares outstanding ....................... 19,752,335 19,640,808
Dilutive effect of outstanding stock options and warrants ........................ -- --
--------------- ---------------
Diluted weighted average number of common and
potential common shares outstanding .............................................. 19,752,335 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.... 1,436,257 786
=============== ===============
ACACIA RESEARCH - COMBIMATRIX STOCK
- -----------------------------------
Basic weighted average number of common shares outstanding ....................... 27,274,627 22,983,278
Dilutive effect of outstanding stock options and warrants(1) ..................... 1,959,190 --
--------------- ---------------
Diluted weighted average number of common and
potential common shares outstanding .............................................. 29,233,817 22,983,278
=============== ===============
Potential AR-CombiMatrix stock common shares excluded from the per
share calculation because the effect of their inclusion would be anti-dilutive ... -- 441,750
=============== ===============
- ---------------
(1) Includes 84,299 shares of potentially dilutive AR-CombiMatrix stock
issuable as of March 31, 2004 related to certain anti-dilution provisions
of the September 2002 settlement agreement between CombiMatrix Corporation,
Dr. Donald Montgomery, and Nanogen, Inc.
4. GOODWILL AND INTANGIBLES
The Acacia Technologies group had $1,776,000 of goodwill at March 31,
2004 and December 31, 2003. The CombiMatrix group had $19,424,000 of goodwill at
March 31, 2004 and December 31, 2003.
Acacia Research Corporation's only identifiable intangible assets at
March 31, 2004 and December 31, 2003 are patents. The gross carrying amounts and
accumulated amortization as of March 31, 2004 and December 31, 2003, related to
patents, by segment, are as follows (in thousands):
ACACIA TECHNOLOGIES GROUP COMBIMATRIX GROUP
------------------------------- -------------------------------
MARCH 31, DECEMBER 31, MARCH 31, DECEMBER 31,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Gross carrying amount - patents.... $ 10,798 $ 10,798 $ 12,095 $ 12,095
Accumulated amortization .......... (7,357) (7,232) (2,252) (1,978)
------------- ------------- ------------- -------------
Patents, net ...................... $ 3,441 $ 3,566 $ 9,843 $ 10,117
============= ============= ============= =============
See Note 10 for patent amortization expense by segment for the three
months ended March 31, 2004 and 2003.
Annual aggregate amortization expense for each of the next five years
through December 31, 2008 is estimated to be $1,595,000 per year ($500,000 for
the Acacia Technologies group and $1,095,000 for the CombiMatrix group).
At March 31, 2004 and December 31, 2003, all of our acquired intangible
assets other than goodwill were subject to amortization.
5. REVENUES
In March 2004, the CombiMatrix group completed all phases of its
research and development agreement with Roche Diagnostics, GmbH ("Roche"). As a
result of completing all of its obligations under this agreement and in
accordance with the CombiMatrix group's revenue recognition policies for
multiple-element arrangements, the CombiMatrix group recognized all previously
deferred Roche related contract revenues totaling $17,302,000 during the first
quarter of 2004.
8
6. INCOME TAXES
We estimate that there will be sufficient losses from operations in the
current fiscal year to offset any taxable income related to the Roche deferred
contract revenues totaling $17,302,000 recognized during the three months ended
March 31, 2004, resulting in no significant tax liability or expense in the
current period or for the year ending December 31, 2004. Additionally, there was
a deferred tax asset that was previously recognized for income tax purposes that
was offset by a valuation allowance; as a result of the deferred revenue
recognition, the associated deferred tax asset and related valuation allowance
were reduced in the current period by approximately $3.5 million.
7. RECENT ACCOUNTING PRONOUNCEMENTS
In March 2004, the Emerging Issues Task Force ("EITF") issued EITF
Issue No. 03-6, "Participating Securities and the Two-Class Method under FASB
Statement No. 128, Earnings Per Share," ("EITF 03-6") which addresses questions
regarding the computation of earnings per share ("EPS") by companies that have
issued securities other than common stock that contractually entitle the holder
to participate in dividends and earnings of the company when, and if, it
declares dividends on its common stock. The issue also provides further guidance
in applying the two-class method of calculating EPS and clarifies what
constitutes a participating security and how to apply the two-class method of
computing EPS once it is determined that a security is participating, including
how to allocate undistributed earnings to such a security. EITF 03-6 defines
participation rights based solely on whether the holder would be entitled to
receive any dividends if the entity declared them during the period and requires
the use of the two-class method for computing basic EPS when participating
convertible securities exist. In addition, EITF 03-6 expands the use of the
two-class method to encompass other forms of participating securities, including
options, warrants, forwards, and other contracts to issue an entity's common
stock. The provisions of EITF 03-6 are effective for fiscal periods beginning
after March 31, 2004. We do not expect the adoption of EITF 03-6 to have a
material impact on the Acacia Research Corporation's, the CombiMatrix group's or
the Acacia Technologies group's financial position, results of operations or
cash flows.
8. COMMITMENTS AND CONTIGENCIES
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. During the three months ended March 31,
2004, we recorded a non-cash charge totaling $1,257,000 in connection with
certain anti-dilution provisions of that agreement. The non-cash charge reflects
management's estimate of the fair value of AR-CombiMatrix stock that will be
issued to Nanogen, Inc. as a result of certain options and warrants exercised
during the quarter and the fair value of AR-CombiMatrix stock potentially
issuable to Nanogen, Inc. as of the balance sheet date. The liability is
adjusted at each balance date for changes in the market value of the
AR-CombiMatrix stock and is reflected as long-term until settled in equity. The
anti-dilution provisions of the settlement agreement expire in September 2005.
In addition to other terms of the settlement agreement, CombiMatrix
Corporation is also required to make quarterly payments to Nanogen, Inc. 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.
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 March 31, 2004. Any
royalties paid pursuant to the agreements will be expensed in the consolidated
statement of operations.
LITIGATION
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.
9
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
March 31, 2004, 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.
9. SUBSEQUENT EVENTS
In April 2004, Acacia Research Corporation raised gross proceeds of
$15,000,000 through the sale of 3,000,000 shares of Acacia Research -
CombiMatrix common stock at a price of $5.00 per share in a registered direct
offering. Net proceeds raised of approximately $13,600,000, which are net of
related issuance costs, were attributed to the CombiMatrix group.
10
10. 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 Chief
Executive Officer ("CEO"). The CEO reviews and evaluates financial information
presented on a group basis as described below. Management evaluates performance
based on the profit or loss from continuing operations and financial position of
its segments. Acacia Research Corporation has two reportable segments as
described earlier in Note 1.
Material intercompany transactions and transfers have been eliminated
in consolidation. The accounting policies of the segments are the same as those
described in the summary of significant accounting policies.
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.
11
CONSOLIDATING BALANCE SHEETS (IN THOUSANDS)
AT MARCH 31, 2004 AT DECEMBER 31, 2003
----------------------------------------- ----------------------------------------
ACACIA ACACIA
TECHNO- COMBI- TECHNO- COMBI-
LOGIES MATRIX ELIMI- CONSOLI- LOGIES MATRIX ELIMI- CONSOLI-
GROUP GROUP NATIONS DATED GROUP GROUP NATIONS DATED
--------- --------- --------- --------- --------- --------- --------- ---------
ASSETS
Current assets:
Cash and cash equivalents ................. $ 29,500 $ 3,482 $ -- $ 32,982 $ 28,142 $ 3,807 $ -- $ 31,949
Short-term investments .................... 3,029 14,933 -- 17,962 5,059 13,492 -- 18,551
Accounts receivable ....................... 121 218 -- 339 124 199 -- 323
Prepaid expenses, inventory and other
assets .................................. 1,063 459 -- 1,522 903 277 -- 1,180
Receivable from CombiMatrix group ......... 212 -- (212) -- 99 -- (99) --
--------- --------- --------- --------- --------- --------- --------- ---------
Total current assets .............. 33,925 19,092 (212) 52,805 34,327 17,775 (99) 52,003
Property and equipment, net of accumulated
depreciation ................................. 97 2,455 -- 2,552 71 2,752 -- 2,823
Patents, net of accumulated amortization ....... 3,441 9,843 -- 13,284 3,566 10,117 -- 13,683
Goodwill ....................................... 1,776 19,424 -- 21,200 1,776 19,424 -- 21,200
Other assets ................................... 238 94 -- 332 238 93 -- 331
--------- --------- --------- --------- --------- --------- --------- ---------
$ 39,477 $ 50,908 $ (212) $ 90,173 $ 39,978 $ 50,161 $ (99) $ 90,040
========= ========= ========= ========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses...... $ 2,139 $ 1,658 $ -- $ 3,797 $ 1,572 $ 1,672 $ -- $ 3,244
Current portion of deferred revenues ...... 130 517 -- 647 104 18,004 -- 18,108
Payable to Acacia Technologies group ...... -- 212 (212) -- -- 99 (99) --
--------- --------- --------- --------- --------- --------- --------- ---------
Total current liabilities ......... 2,269 2,387 (212) 4,444 1,676 19,775 (99) 21,352
Deferred income taxes .......................... 976 2,214 -- 3,190 1,012 2,248 -- 3,260
Deferred revenues, net of current portion ...... 1,500 2,420 -- 3,920 1,500 2,401 -- 3,901
Other liabilities .............................. -- 1,257 -- 1,257 -- -- -- --
--------- --------- --------- --------- --------- --------- --------- ---------
Total liabilities ................. 4,745 8,278 (212) 12,811 4,188 24,424 (99) 28,513
--------- --------- --------- --------- --------- --------- --------- ---------
Minority interests ............................. 1,127 -- -- 1,127 1,127 -- -- 1,127
--------- --------- --------- --------- --------- --------- --------- ---------
Redeemable Stockholders' equity:
AR - Acacia Technologies stock ............ 33,605 -- -- 33,605 34,663 -- -- 34,663
AR - CombiMatrix stock .................... -- 42,630 -- 42,630 -- 25,737 -- 25,737
--------- --------- --------- --------- --------- --------- --------- ---------
Total stockholders' equity ........ 33,605 42,630 -- 76,235 34,663 25,737 -- 60,400
--------- --------- --------- --------- --------- --------- --------- ---------
$ 39,477 $ 50,908 $ (212) $ 90,173 $ 39,978 $ 50,161 $ (99) $ 90,040
========= ========= ========= ========= ========= ========= ========= =========
- ---------------
NOTE: Segment information for the Acacia Technologies group includes discontinued operations related to Soundbreak.com. Total assets
related to discontinued operations totaled $2,104,000 and $2,150,000 at March 31, 2004 and December 31, 2003, respectively. Total
liabilities related to discontinued operations totaled $349,000 and $395,000 at March 31, 2004 and December 31, 2003, respectively.
12
CONSOLIDATING STATEMENTS OF OPERATIONS (IN THOUSANDS)
FOR THE THREE MONTHS ENDED FOR THE THREE MONTHS ENDED
MARCH 31, 2004 MARCH 31, 2003
----------------------------------------- ------------------------------------------
ACACIA ELIMI- ACACIA ELIMI-
TECHNO- COMBI- NATIONS/ TECHNO- COMBI- NATIONS/
LOGIES MATRIX RECLASSI- CONSOLI- LOGIES MATRIX RECLASSI- CONSOLI-
GROUP GROUP FICATIONS DATED GROUP GROUP FICATIONS DATED
--------- --------- --------- --------- --------- --------- --------- ---------
Revenues:
Research and development, government
and service contracts .................. $ -- $ 17,600 $ -- $ 17,600 $ -- $ 7 $ -- $ 7
License fees .............................. 599 -- -- 599 6 -- -- 6
Products .................................. -- 16 -- 16 -- 209 -- 209
--------- --------- --------- --------- --------- --------- --------- ---------
Total revenues ............................ 599 17,616 -- 18,215 6 216 -- 222
--------- --------- --------- --------- --------- --------- --------- ---------
Operating expenses:
Cost of product sales ..................... -- 4 -- 4 -- 77 -- 77
Research and development expenses ......... -- 1,588 -- 1,588 -- 2,335 -- 2,335
Non-cash stock compensation
amortization - research and
development ............................. -- 69 -- 69 -- 2 -- 2
Marketing, general and
administrative expenses ................. 1,006 2,278 602 3,886 1,323 2,670 262 4,255
Non-cash stock compensation
amortization - marketing, general
and administrative ...................... -- 334 -- 334 -- 138 -- 138
Legal expenses - patents .................. 602 -- (602) -- 262 -- (262) --
Amortization of patents ................... 125 274 -- 399 126 274 -- 400
Legal settlement charges .................. -- 1,257 -- 1,257 -- -- -- --
--------- --------- --------- --------- --------- --------- --------- ---------
Total operating expenses ............ 1,733 5,804 -- 7,537 1,711 5,496 -- 7,207
--------- --------- --------- --------- --------- --------- --------- ---------
Operating income (loss) ............. (1,134) 11,812 -- 10,678 (1,705) (5,280) -- (6,985)
--------- --------- --------- --------- --------- --------- --------- ---------
Other income:
Interest income ........................... 112 46 -- 158 148 67 -- 215
Realized gains on short-term
investments ............................. -- -- -- -- 37 -- -- 37
--------- --------- --------- --------- --------- --------- --------- ---------
Total other income .................. 112 46 -- 158 185 67 -- 252
--------- --------- --------- --------- --------- --------- --------- ---------
Income (loss) from continuing
operations before income taxes and
minority interests ......................... (1,022) 11,858 -- 10,836 (1,520) (5,213) -- (6,733)
Benefit for income taxes ..................... 33 34 -- 67 26 34 -- 60
--------- --------- --------- --------- --------- --------- --------- ---------
Income (loss) from continuing
operations before minority interests ....... (989) 11,892 -- 10,903 (1,494) (5,179) -- (6,673)
Minority interests ........................... -- -- -- -- -- 6 -- 6
--------- --------- --------- --------- --------- --------- --------- ---------
Net income (loss) ............................ $ (989) $ 11,892 $ -- $ 10,903 $ (1,494) $ (5,173) $ -- $ (6,667)
========= ========= ========= ========= ========= ========= ========= =========
13
CONSOLIDATING STATEMENTS OF CASH FLOWS (IN THOUSANDS)
FOR THE THREE MONTHS ENDED FOR THE THREE MONTHS ENDED
MARCH 31, 2004 MARCH 31, 2003
------------------------------------------ ----------------------------------------
ACACIA ACACIA
TECHNO- COMBI- TECHNO- COMBI-
LOGIES MATRIX ELIMI- CONSOLI- LOGIES MATRIX ELIMI- CONSOLI-
GROUP GROUP NATIONS DATED GROUP GROUP NATIONS DATED
--------- --------- --------- --------- --------- --------- -------- ---------
Cash flows from operating activities:
Net income (loss) from operations .......... $ (989) $ 11,892 $ -- $ 10,903 $ (1,494) $ (5,173) $ -- $ (6,667)
Adjustments to reconcile net income
(loss) from operations to net cash
used in operating activities:
Depreciation and amortization ............ 136 576 -- 712 161 606 -- 767
Minority interests ....................... -- -- -- -- -- (6) -- (6)
Non-cash stock compensation
amortization ........................... -- 403 -- 403 -- 140 -- 140
Deferred tax benefit ..................... (36) (34) -- (70) (36) (34) -- (70)
Non-cash legal settlement charge ......... -- 1,257 -- 1,257 -- -- -- --
Other .................................... -- (27) -- (27) (3) 124 -- 121
Changes in assets and liabilities:
Accounts receivable ...................... 3 (19) -- (16) (11) 312 -- 301
Prepaid expenses, other receivables
and other assets ....................... (234) (101) 114 (221) (218) (179) -- (397)
Accounts payable, accrued expenses
and other liabilities .................. 615 170 (114) 671 (420) 170 -- (250)
Deferred revenues ........................ 26 (17,468) -- (17,442) 33 1,475 -- 1,508
--------- --------- --------- --------- --------- --------- -------- ---------
Net cash used in operating
activities from continuing
operations ............................. (479) (3,351) -- (3,830) (1,988) (2,565) -- (4,553)
Net cash used in operating
activities from discontinued
operations ............................. (87) -- -- (87) (86) -- -- (86)
--------- --------- --------- --------- --------- --------- -------- ---------
Net cash used in operating
activities ............................. (566) (3,351) -- (3,917) (2,074) (2,565) -- (4,639)
--------- --------- --------- --------- --------- --------- -------- ---------
Cash flows from investing activities:
Purchase of property and equipment,
net .................................... (36) (61) -- (97) (2) (22) -- (24)
Purchase of available-for-sale
investments ............................ -- (13,605) -- (13,605) -- (469) -- (469)
Sale of available-for-sale
investments ............................ 2,030 12,166 -- 14,196 -- 2,462 -- 2,462
--------- --------- --------- --------- --------- --------- -------- ---------
Net cash provided by (used in)
investing activities from
continuing operations .................. 1,994 (1,500) -- 494 (2) 1,971 -- 1,969
Net cash used in investing
activities from discontinued
operations ............................. -- -- -- -- (344) -- -- (344)
--------- --------- --------- --------- --------- --------- -------- ---------
Net cash provided by (used in)
investing activities ................... 1,994 (1,500) -- 494 (346) 1,971 -- 1,625
--------- --------- --------- --------- --------- --------- -------- ---------
Cash flows from financing activities:
Net cash attributed to the Acacia
Technologies group ..................... (70) -- -- (70) (275) -- -- (275)
Net cash attributed to the
CombiMatrix group ...................... -- 4,520 -- 4,520 -- 275 -- 275
--------- --------- --------- --------- --------- --------- -------- ---------
Net cash provided by (used in)
financing activities ................... (70) 4,520 -- 4,450 (275) 275 -- --
--------- --------- --------- --------- --------- --------- -------- ---------
Effect of exchange rate on cash .......... -- 6 -- 6 -- (7) -- (7)
--------- --------- --------- --------- --------- --------- -------- ---------
Increase (decrease) in cash and
cash equivalents ....................... 1,358 (325) -- 1,033 (2,695) (326) -- (3,021)
Cash and cash equivalents, beginning ..... 28,142 3,807 -- 31,949 39,792 3,291 -- 43,083
--------- --------- --------- --------- --------- --------- -------- ---------
Cash and cash equivalents, ending ........ $ 29,500 $ 3,482 $ -- $ 32,982 $ 37,097 $ 2,965 $ -- $ 40,062
========= ========= ========= ========= ========= ========= ======== =========
14
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
MARCH 31, DECEMBER 31,
2004 2003
-------------- --------------
ASSETS
Current assets:
Cash and cash equivalents .................................................. $ 3,482 $ 3,807
Available-for-sale investments ............................................. 14,933 13,492
Accounts receivable, net of allowance for doubtful accounts
of $0 (2004) and $145 (2003) ............................................. 218 199
Inventory, prepaid expenses and other assets ............................... 459 277
-------------- --------------
Total current assets ................................................. 19,092 17,775
Property and equipment, net of accumulated depreciation and amortization ...... 2,455 2,752
Patents, net of accumulated amortization of $2,252 (2004) and $1,978 (2003).... 9,843 10,117
Goodwill ...................................................................... 19,424 19,424
Other assets .................................................................. 94 93
-------------- --------------
$ 50,908 $ 50,161
============== ==============
LIABILITIES AND ALLOCATED NET WORTH
Current liabilities:
Accounts payable and accrued expenses ...................................... $ 1,658 $ 1,672
Current portion of deferred revenues ....................................... 517 18,004
Payable to Acacia Technologies group ....................................... 212 99
-------------- --------------
Total current liabilities ............................................ 2,387 19,775
Deferred income taxes ......................................................... 2,214 2,248
Deferred revenues, net of current portion ..................................... 2,420 2,401
Other liabilities ............................................................. 1,257 --
-------------- --------------
Total liabilities .................................................... 8,278 24,424
-------------- --------------
Commitments and contingencies (Note 7)
Allocated net worth:
Funds allocated by Acacia Research Corporation ............................. 143,676 138,675
Accumulated net losses ..................................................... (101,046) (112,938)
-------------- --------------
Total allocated net worth ............................................ 42,630 25,737
-------------- --------------
$ 50,908 $ 50,161
============== ==============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
15
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF OPERATION
(IN THOUSANDS)
(UNAUDITED)
FOR THE THREE MONTHS ENDED
-------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Revenues:
Research and development contract ..................................... $ 17,302 $ --
Government contract ................................................... 217 --
Service contracts ..................................................... 81 7
Products .............................................................. 16 209
------------- -------------
Total revenues ..................................................... 17,616 216
------------- -------------
Operating expenses:
Cost of product sales ................................................. 4 77
Research and development expenses ..................................... 1,588 2,335
Non-cash stock compensation amortization - research and development ... 69 2
Marketing, general and administrative expenses ........................ 2,278 2,670
Non-cash stock compensation amortization - marketing, general
and administrative .................................................. 334 138
Amortization of patents ............................................... 274 274
Legal settlement charges .............................................. 1,257 --
------------- -------------
Total operating expenses ........................................... 5,804 5,496
------------- -------------
Operating income (loss) ............................................ 11,812 (5,280)
------------- -------------
Other income:
Interest income ....................................................... 46 67
------------- -------------
Total other income ................................................. 46 67
------------- -------------
Income (loss) from operations before income taxes
and minority interests ................................................. 11,858 (5,213)
Benefit for income taxes ................................................. 34 34
------------- -------------
Income (loss) from operations before minority interests .................. 11,892 (5,179)
Minority interests ....................................................... -- 6
------------- -------------
Division net income (loss) ............................................... $ 11,892 $ (5,173)
============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
16
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
FOR THE THREE MONTHS ENDED
--------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Cash flows from operating activities:
Division net income (loss) from operations ............................ $ 11,892 $ (5,173)
Adjustments to reconcile division net income (loss) from operations
to net cash used in operating activities:
Depreciation and amortization .................................... 576 606
Minority interests ............................................... -- (6)
Non-cash stock compensation amortization ......................... 403 140
Deferred tax benefit ............................................. (34) (34)
Non-cash legal settlement charge ................................. 1,257 --
Other ............................................................ (27) 124
Changes in assets and liabilities:
Accounts receivable .............................................. (19) 312
Inventory, prepaid expenses and other assets ..................... (101) (179)
Accounts payable, accrued expenses and other ..................... 170 170
Deferred revenues ................................................ (17,468) 1,475
------------- -------------
Net cash used in operating activities ............................ (3,351) (2,565)
------------- -------------
Cash flows from investing activities:
Purchase of property and equipment, net .......................... (61) (22)
Purchase of available-for-sale investments ....................... (13,605) (469)
Sale of available-for-sale investments ........................... 12,166 2,462
------------- -------------
Net cash provided by (used in) investing activities .............. (1,500) 1,971
------------- -------------
Cash flows from financing activities:
Net cash flows attributed to the CombiMatrix group ............... 4,520 275
------------- -------------
Effect of exchange rate on cash ......................................... 6 (7)
------------- -------------
Increase (decrease) in cash and cash equivalents ........................ (325) (326)
Cash and cash equivalents, beginning .................................... 3,807 3,291
------------- -------------
Cash and cash equivalents, ending ....................................... $ 3,482 $ 2,965
============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
17
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
DESCRIPTION OF BUSINESS. Acacia Research Corporation is comprised of
two separate divisions: the CombiMatrix group and the Acacia Technologies group.
Our life sciences business, referred to as the "CombiMatrix group," is
primarily comprised of our wholly owned subsidiary, CombiMatrix Corporation and
CombiMatrix Corporation's 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. CombiMatrix K.K., a Japanese corporation located in
Tokyo, is exploring opportunities for CombiMatrix Corporation's active array
system with pharmaceutical and biotechnology companies in the Asian market.
RECAPITALIZATION TRANSACTION
On December 11, 2002, Acacia Research Corporation's stockholders voted
in favor of a recapitalization transaction, which became effective on December
13, 2002, whereby Acacia Research Corporation created two new classes of common
stock called Acacia Research-CombiMatrix stock ("AR-CombiMatrix stock") and
Acacia Research-Acacia Technologies stock ("AR-Acacia Technologies stock"), and
divided Acacia Research Corporation's existing Acacia Research Corporation
common stock into shares of the two new classes of common stock.
BASIS OF PRESENTATION. The unaudited interim CombiMatrix group
financial statements as of March 31, 2004, and for the interim periods
presented, have been prepared in accordance with generally accepted accounting
principles for interim financial information. These interim financial statements
should be read in conjunction with the CombiMatrix group financial statements
and Acacia Research Corporation's consolidated financial statements and notes
thereto for the year ended December 31, 2003. The year-end balance sheet data
was derived from audited financial statements but does not include all
disclosures required by accounting principles generally accepted in the United
States of America.
The CombiMatrix group financial statements include all adjustments of a
normal recurring nature which, in the opinion of management, are necessary for a
fair presentation of its financial position as of March 31, 2004, and the
results of its operations and its cash flows for the interim periods presented.
The results of operations for the three months ended March 31, 2004 are not
necessarily indicative of the results to be expected for the entire year.
AR-CombiMatrix stock is intended to reflect the separate performance of
the CombiMatrix group, a division of Acacia Research Corporation. The
CombiMatrix group is not a separate legal entity. Holders of AR-CombiMatrix
stock are stockholders of Acacia Research Corporation. As a result, holders of
AR-CombiMatrix stock are subject to all of the risks of an investment in Acacia
Research Corporation and all of its businesses, assets and liabilities. The
assets that Acacia Research Corporation attributes to the CombiMatrix group
could be subject to the liabilities of the Acacia Technologies group.
The CombiMatrix group financial statements taken together with the
Acacia Technologies group financial statements, comprise all the accounts
included in the corresponding consolidated financial statements of Acacia
Research Corporation. The financial statements of the CombiMatrix group reflect
the financial condition, results of operations, and cash flows of the businesses
included therein. The financial statements of the CombiMatrix group include the
accounts or assets of Acacia Research Corporation specifically attributed to the
CombiMatrix group and were prepared using amounts included in Acacia Research
Corporation's consolidated financial statements.
Financial effects arising from one group that affect Acacia Research
Corporation's results of operations or financial condition could, if
significant, affect the results of operations or financial condition of the
other group and the market price of the class of common stock relating to the
other group. Any division net losses of the CombiMatrix group or the Acacia
Technologies group and dividends or distributions on, or repurchases of,
18
AR-CombiMatrix stock or AR-Acacia Technologies stock or repurchases of preferred
stock of Acacia Research Corporation will reduce the assets of Acacia Research
Corporation legally available for payment of dividends on AR-CombiMatrix stock
or AR-Acacia Technologies stock.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION. The CombiMatrix group recognizes revenue in
accordance with Staff Accounting Bulletin No. 104, "Revenue Recognition" ("SAB
No. 104") and related authoritative pronouncements. 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.
Revenues from multiple-element arrangements are accounted for in
accordance with Emerging Issues Task Force ("EITF") Issue 00-21, "Revenue
Arrangements with Multiple Deliverables." 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.
Revenues from government grants and contracts are recognized in
accordance with Accounting Research Bulletin ("ARB") No. 43, "Government
Contracts," and related pronouncements. Accordingly, revenues are recognized
under the percentage-of-completion method of accounting, using the cost-to-cost
approach to measure completeness at each reporting period. Under the
percentage-of-completion method of accounting, contract revenues and expenses
are recognized in the period that work is performed based on the percentage of
actual incurred costs to estimated total contract costs. Actual contract costs
and cost estimates include direct charges for labor and materials and indirect
charges for labor, overhead and certain general and administrative charges.
Contract change orders and claims are included when they can be reliably
estimated and are considered probable. For contracts that extend over a one-year
period, revisions in contract cost estimates, if they occur, have the effect of
adjusting current period earnings applicable to performance in prior periods.
Should current contract estimates indicate an overall future loss to be
incurred, a provision is made for the total anticipated loss in the current
period.
Revenue from the sale of products and services is recognized when
delivery has occurred or services have been rendered.
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 current. Deferred revenues will
be recognized as revenue in future periods when the applicable revenue
recognition criteria as described above are met.
INVENTORY. Inventory, which consists primarily of raw materials to be
used in the production of the CombiMatrix group's array products, is stated at
the lower of cost or market using the first-in, first-out method.
STOCK-BASED COMPENSATION. Refer to Note 2 to the Acacia Research
Corporation consolidated financial statements included elsewhere herein.
EARNINGS PER SHARE INFORMATION AND STOCK OPTION AND RELATED OPTION PLAN
INFORMATION. Earnings per share and stock option and related option plan
information is omitted from the CombiMatrix group footnotes because
AR-CombiMatrix stock is part of the capital structure of Acacia Research
Corporation. The CombiMatrix group is not a separate legal entity. Holders of
AR-CombiMatrix stock are stockholders of Acacia Research Corporation. This
presentation reflects the fact that the CombiMatrix group does not have legally
issued common or preferred stock and AR-CombiMatrix stock transactions are not
legal transactions of the CombiMatrix group. Refer to the Acacia Research
Corporation consolidated financial statements for earnings per share information
for Acacia Research Corporation's classes of stock, computed using the two-class
method in accordance with SFAS No. 128, "Earnings per Share." Refer to the
Acacia Research Corporation consolidated financial statements for disclosures
regarding Acacia Research Corporation's stock option plans.
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL. Refer to Note 2 to the
Acacia Research Corporation consolidated financial statements included elsewhere
herein.
19
3. RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 7 to the Acacia Research Corporation consolidated
financial statements included elsewhere herein.
4. GOODWILL AND INTANGIBLES
The CombiMatrix group's only identifiable intangible assets are
patents, which have remaining economic useful lives up to 2020. Annual aggregate
amortization expense for each of the next five years through December 31, 2008
is estimated to be $1,095,000 per year. At March 31, 2004 and December 31, 2003,
all of the CombiMatrix group's acquired intangible assets other than goodwill
were subject to amortization.
5. REVENUES
In March 2004, the CombiMatrix group completed all phases of its
research and development agreement with Roche Diagnostics, GmbH ("Roche"). As a
result of completing all of its obligations under this agreement and in
accordance with the CombiMatrix group's revenue recognition policies for
multiple-element arrangements, the CombiMatrix group recognized all previously
deferred Roche related contract revenues totaling $17,302,000 during the first
quarter of 2004.
6. INCOME TAXES
The CombiMatrix group estimates that there will be sufficient losses
from operations in the current fiscal year to offset any taxable income related
to the Roche deferred contract revenues totaling $17,302,000 recognized during
the three months ended March 31, 2004, resulting in no significant tax liability
or expense in the current period or for the year ending December 31, 2004.
Additionally, there was a deferred tax asset that was previously recognized for
income tax purposes that was offset by a valuation allowance; as a result of the
deferred revenue recognition, the associated deferred tax asset and related
valuation allowance were reduced in the current period by approximately $3.5
million.
7. COMMITMENTS AND CONTINGENCIES
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. During the three months ended March 31,
2004, we recorded a non-cash charge totaling $1,257,000 in connection with
certain anti-dilution provisions of that agreement. The non-cash charge reflects
management's estimate of the fair value of AR-CombiMatrix stock that will be
issued to Nanogen, Inc. as a result of certain options and warrants exercised
during the quarter and the fair value of AR-CombiMatrix stock potentially
issuable to Nanogen, Inc. as of the balance sheet date. The liability is
adjusted at each balance date for changes in the market value of the
AR-CombiMatrix stock and is reflected as long-term until settled in equity. The
anti-dilution provisions of the settlement agreement expire in September 2005.
In addition to other terms of the settlement agreement, CombiMatrix
Corporation is also required to make quarterly payments to Nanogen, Inc. 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.
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.
20
8. SUBSEQUENT EVENTS
In April 2004, Acacia Research Corporation raised gross proceeds of
$15,000,000 through the sale of 3,000,000 shares of Acacia Research -
CombiMatrix common stock at a price of $5.00 per share in a registered direct
offering. Net proceeds raised of approximately $13,600,000, which are net of
related issuance costs, were attributed to the CombiMatrix group.
21
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
MARCH 31, DECEMBER 31,
2004 2003
----------------- -----------------
ASSETS
Current assets:
Cash and cash equivalents .................................................. $ 29,500 $ 28,142
Short-term investments ..................................................... 3,029 5,059
Accounts receivable ........................................................ 121 124
Prepaid expenses and other assets .......................................... 1,063 903
Receivable from CombiMatrix group .......................................... 212 99
----------------- -----------------
Total current assets ................................................. 33,925 34,327
Property and equipment, net of accumulated depreciation ....................... 97 71
Patents, net of accumulated amortization of $7,358 (2003) and $7,232 (2003) ... 3,441 3,566
Goodwill ...................................................................... 1,776 1,776
Other assets .................................................................. 238 238
----------------- -----------------
$ 39,477 $ 39,978
================= =================
LIABILITIES AND ALLOCATED NET WORTH
Current liabilities:
Accounts payable and accrued expenses ...................................... $ 2,139 $ 1,572
Deferred revenues .......................................................... 130 104
----------------- -----------------
Total current liabilities ............................................ 2,269 1,676
Deferred income taxes ......................................................... 976 1,012
Deferred revenues, net of current portion ..................................... 1,500 1,500
----------------- -----------------
Total liabilities .................................................... 4,745 4,188
----------------- -----------------
Minority interests ............................................................ 1,127 1,127
----------------- -----------------
Commitments and contingencies (Note 5)
Allocated net worth:
Funds allocated by Acacia Research Corporation ............................. 105,060 105,129
Accumulated net losses ..................................................... (71,455) (70,466)
----------------- -----------------
Total allocated net worth ............................................ 33,605 34,663
----------------- -----------------
$ 39,477 $ 39,978
================= =================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
22
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
(UNAUDITED)
FOR THE THREE MONTHS ENDED
---------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Revenues:
License fees ....................................... $ 599 $ 6
-------------- --------------
Total revenues .................................. 599 6
-------------- --------------
Operating expenses:
Marketing, general and administrative expenses ..... 1,006 1,323
Legal expenses - patents ........................... 602 262
Amortization of patents ............................ 125 126
-------------- --------------
Total operating expenses ........................ 1,733 1,711
-------------- --------------
Operating loss .................................. (1,134) (1,705)
-------------- --------------
Other income:
Interest income .................................... 112 148
Realized gains on short-term investments ........... -- 37
-------------- --------------
Total other income .............................. 112 185
-------------- --------------
Loss from continuing operations before income taxes ... (1,022) (1,520)
Benefit for income taxes .............................. 33 26
-------------- --------------
Division net loss ..................................... (989) (1,494)
============== ==============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
23
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
FOR THE THREE MONTHS ENDED
---------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Cash flows from operating activities:
Division net loss from operations ................................................... $ (989) $ (1,494)
Adjustments to reconcile division net loss from operations
to net cash used in operating activities:
Depreciation and amortization .................................................... 136 161
Deferred tax benefit ............................................................. (36) (36)
Other ............................................................................ -- (3)
Changes in assets and liabilities:
Accounts receivable .............................................................. 3 (11)
Prepaid expenses, other receivables and other assets ............................. (234) (218)
Accounts payable, accrued expenses ............................................... 615 (420)
Deferred revenues ................................................................ 26 33
-------------- --------------
Net cash used in operating activities from continuing operations ................. (479) (1,988)
Net cash used in operating activities from discontinued operations ............... (87) (86)
-------------- --------------
Net cash used in operating activities ............................................ (566) (2,074)
-------------- --------------
Cash flows from investing activities:
Purchase of property and equipment, net .......................................... (36) (2)
Sale of available-for-sale investments ........................................... 2,030 --
-------------- --------------
Net cash provided by (used in) investing activities from continuing operations ... 1,994 (2)
Net cash used in investing activities from discontinued operations ............... -- (344)
-------------- --------------
Net cash provided by (used in) investing activities .............................. 1,994 (346)
-------------- --------------
Cash flows from financing activities:
Net cash flows attributed to the Acacia Technologies group ....................... (70) (275)
-------------- --------------
Increase (decrease) in cash and cash equivalents ...................................... 1,358 (2,695)
Cash and cash equivalents, beginning .................................................. 28,142 39,792
-------------- --------------
Cash and cash equivalents, ending ..................................................... $ 29,500 $ 37,097
============== ==============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
24
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
DESCRIPTION OF BUSINESS. Acacia Research Corporation's continuing
operations are comprised of two separate divisions: the Acacia Technologies
group and the CombiMatrix group.
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.
RECAPITALIZATION TRANSACTION
On December 11, 2002, Acacia Research Corporation's stockholders voted
in favor of a recapitalization transaction, which became effective on December
13, 2002, whereby Acacia Research Corporation created two new classes of common
stock called Acacia Research-CombiMatrix stock ("AR-CombiMatrix stock") and
Acacia Research-Acacia Technologies stock ("AR-Acacia Technologies stock"), and
divided Acacia Research Corporation's existing Acacia Research Corporation
common stock into shares of the two new classes of common stock.
BASIS OF PRESENTATION. The unaudited interim Acacia Technologies group
financial statements as of March 31, 2004, and for the interim periods
presented, have been prepared in accordance with generally accepted accounting
principles for interim financial information. These interim financial statements
should be read in conjunction with the Acacia Technologies group financial
statements and Acacia Research Corporation's consolidated financial statements
and notes thereto for the year ended December 31, 2003. The year-end balance
sheet data was derived from audited financial statements but does not include
all disclosures required by accounting principles generally accepted in the
United States of America.
The Acacia Technologies group financial statements include all
adjustments of a normal recurring nature which, in the opinion of management,
are necessary for a fair presentation of its financial position as of March 31,
2004, and the results of its operations and its cash flows for the interim
periods presented. The results of operations for the three months ended March
31, 2004 are not necessarily indicative of the results to be expected for the
entire year.
AR-Acacia Technologies stock is intended to reflect the separate
performance of the Acacia Technologies group, a division of Acacia Research
Corporation. The Acacia Technologies group is not a separate legal entity.
Holders of AR-Acacia Technologies stock are stockholders of Acacia Research
Corporation. As a result, holders of AR-Acacia Technologies stock are subject to
all of the risks of an investment in Acacia Research Corporation and all of its
businesses, assets and liabilities. The assets Acacia Research Corporation
attributes to Acacia Technologies could be subject to the liabilities of the
CombiMatrix group.
The Acacia Technologies group financial statements 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.
25
Financial effects arising from one group that affect Acacia Research
Corporation's results of operations or financial condition could, if
significant, affect the results of operations or financial condition of the
other group and the market price of the class of common stock relating to the
other group. Any division net losses of the CombiMatrix group or the Acacia
Technologies group and dividends or distributions on, or repurchases of,
AR-CombiMatrix stock or AR-Acacia Technologies stock or repurchases of preferred
stock of Acacia Research Corporation will reduce the assets of Acacia Research
Corporation legally available for payment of dividends on AR-CombiMatrix stock
or AR-Acacia Technologies stock.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION. The Acacia Technologies group recognizes revenue
in accordance with Staff Accounting Bulletin No. 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 digital media
transmission ("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 the Acacia
Technologies group may conduct, the Acacia Technologies group 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.
26
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 current. 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.
STOCK-BASED COMPENSATION. Refer to Note 2 to the Acacia Research
Corporation consolidated financial statements included elsewhere herein.
EARNINGS PER SHARE INFORMATION AND STOCK OPTION AND RELATED OPTION PLAN
INFORMATION. Earnings per share and stock option and related option plan
information is omitted from the Acacia Technologies group footnotes because
AR-Acacia Technologies stock is part of the capital structure of Acacia Research
Corporation. The Acacia Technologies group is not a separate legal entity.
Holders of AR-Acacia Technologies stock are stockholders of Acacia Research
Corporation. This presentation reflects the fact that the Acacia Technologies
group does not have legally issued common or preferred stock and AR-Acacia
Technologies stock transactions are not legal transactions of the Acacia
Technologies group. Refer to the Acacia Research Corporation consolidated
financial statements for earnings per share information for Acacia Research
Corporation's classes of stock, computed using the two-class method in
accordance with SFAS No. 128, "Earnings per Share." Refer to the Acacia Research
Corporation consolidated financial statements for disclosures regarding Acacia
Research Corporation's stock option plans.
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL. Refer to Note 2 to the
Acacia Research Corporation consolidated financial statements included elsewhere
herein.
3. RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 7 to the Acacia Research Corporation consolidated
financial statements included elsewhere herein.
4. GOODWILL AND INTANGIBLES
The Acacia Technologies group's only identifiable intangible assets
are patents. Annual aggregate amortization expense for each of the next five
years through December 31, 2008 is estimated to be $500,000 per year. At March
31, 2004 and December 31, 2003, all of the Acacia Technologies group's acquired
intangible assets other than goodwill were subject to amortization.
5. COMMITMENTS AND CONTIGENCIES
In connection with the purchase of the outstanding ownership interests
in Acacia Media Technologies 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 March 31, 2004. Any
royalties paid pursuant to the agreements will be expensed in the statement of
operations.
LITIGATION
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.
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
27
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 the Acacia Technologies group is currently
appealing the two summary judgment rulings, litigation is inherently uncertain
and the Acacia Technologies group can give no assurance that it 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
March 31, 2004, 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.
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CAUTIONARY STATEMENT
You should read the following discussion and analysis in conjunction
with the consolidated financial statements and related notes thereto contained
elsewhere in this report. The information contained in this Quarterly Report on
Form 10-Q is not a complete description of our businesses or the risks
associated with an investment in our common stock. We urge you to carefully
review and consider the various disclosures made by us in this report and in our
other reports filed with the Securities and Exchange Commission, including our
Annual Report on Form 10-K for the year ended December 31, 2003 and our
Registration Statement on Form S-4 filed with the Securities and Exchange
Commission on May 7, 2002, as amended, that discuss our businesses in greater
detail.
This report contains forward-looking statements within the meaning of
the "safe harbor" provisions of the Private Securities Litigation Reform Act of
1995. Reference is made in particular to the description of our plans and
objectives for future operations, assumptions underlying such plans and
objectives, and other forward-looking statements included in this report. Such
statements may be identified by the use of forward-looking terminology such as
"may," "will," "expect," "believe," "estimate," "anticipate," "intend,"
"continue," or similar terms, variations of such terms or the negative of such
terms. Such statements are based on management's current expectations and are
subject to a number of factors and uncertainties, which could cause actual
results to differ materially from those described in the forward-looking
statements. Such statements address future events and conditions concerning
product development, capital expenditures, earnings, litigation, regulatory
matters, markets for products and services, liquidity and capital resources and
accounting matters. Actual results in each case could differ materially from
those anticipated in such statements by reason of factors such as future
economic conditions, changes in consumer demand, legislative, regulatory and
competitive developments in markets in which we and our subsidiaries operate,
and other circumstances affecting anticipated revenues and costs. We expressly
disclaim any obligation or undertaking to release publicly any updates or
revisions to any forward-looking statements contained herein to reflect any
change in our expectations with regard thereto or any change in events,
conditions or circumstances on which any such statement is based. Additional
factors that could cause such results to differ materially from those described
in the forward-looking statements are set forth in connection with the
forward-looking statements.
OVERVIEW
As used in this Form 10-Q, "we," "us" and "our" refer to Acacia
Research Corporation and its subsidiary companies.
Acacia Research Corporation, a Delaware corporation, was originally
incorporated in California in January 1993 and reincorporated in Delaware in
December 1999.
The following discussion is based primarily on our unaudited
consolidated balance sheet as of March 31, 2004 and on our unaudited
consolidated statement of operations for the period from January 1, 2004 to
March 31, 2004. The discussion compares the activities for the three months
ended March 31, 2004 to the activities for the three months ended March 31,
2003. This information should be read in conjunction with the accompanying
unaudited consolidated financial statements and notes thereto.
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.
29
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.
Operating activities for the first quarter of 2004 include the following:
COMBIMATRIX GROUP:
o In January 2004, the CombiMatrix group made the first
commercially available microarray designed for the H5N1
influenza A virus ("bird flu"). The World Health Organization
appealed on January 27, 2004 for technical assistance and
expert advice to help stop the threat to humans and
agriculture posed by bird flu virus. The CombiMatrix group
utilized its proprietary probe-design software and ability to
rapidly synthesize novel DNA microarrays to respond within two
days.
o In March 2004, the CombiMatrix group announced the launch of
its CustomArray(TM) DNA Microarray platform, offering
researchers the ability to order fully customizable arrays on
demand.
o In March 2004, the CombiMatrix group executed a two-year, $5.9
million contract with the Department of Defense to further the
development of the CombiMatrix group's microarray technology
for the detection of biological threat agents.
o On March 12, 2004, Acacia Research Corporation's Acacia
Research - CombiMatrix common stock began trading on the
NASDAQ National Market system. The stock had previously traded
on the NASDAQ SmallCap Market.
o During the first quarter of 2004, the CombiMatrix group
entered into the following collaborations:
Nanotechnology
--------------
- a collaboration, funded by the National Science
Foundation, with Washington University in St. Louis
to develop a system for the synthesis of libraries of
diverse, non-nucleic acid molecules. These libraries
will be synthesized using CombiMatrix's semiconductor
based microarrays and electrochemical synthetic
methods. CombiMatrix NanoArrays(TM) will be used for
the diverse chemical synthesis.
- a collaboration with Cyrano Sciences on the
development of chemical sensors which merge
CombiMatrix's microarray technology with Cyrano's
electronic nose technology.
Express Tracksm
---------------
- an expanded collaboration with Professor Bonaventura
Clotet, M.D., Ph.D., of the Retrovirology Laboratory
irsiCaixa, to conduct the initial efficacy screening
of pooled siRNA compounds against the hepatitis C
virus.
Diagnostics
-----------
- a collaboration with Dr. Ulrich Melcher, Department
of Biochemistry and Molecular Biology and Dr.
Alexander C. Lai, Department of Microbiology and
Molecular Genetics, from Oklahoma State University,
to utilize CombiMatrix's `Bird Flu' CustomArray(TM)
devices to characterize Bird flu viruses at the
genomic level.
- a collaboration with St. Jude Children's Research
Hospital to study the genetic variation in the H9
variant of Bird Flu.
30
- a collaboration with Case Western Reserve University
for work in developing a novel diagnostic for
Alzheimer's disease using the CustomArray(TM)
platform.
ACACIA TECHNOLOGIES GROUP:
o As of May 2004, the Acacia Technologies group has entered into
120 DMT technology licensing agreements, including agreements
with CinemaNow, Inc., Disney Enterprises, Inc., General
Dynamics Interactive Corporation, Grupo Pegaso, LodgeNet
Entertainment Corporation, NXTV, Inc., Oral Roberts
University, T. Rowe Price, 24/7 University, Inc. and Virgin
Radio. We have executed license agreements with companies in
the hotel in-room entertainment, online music, movie, adult
entertainment, e-learning, corporate and sports, news and
information industries. The Acacia Technologies group
continues to pursue additional licensing and strategic
business alliances with leading companies in the rapidly
growing intellectual property licensing industry.
o In January 2004, the Acacia Technologies group was issued an
additional European patent covering 14 countries for its DMT
technology. The new patent provides additional coverage in
Great Britain, Germany, France, Italy, Spain, Switzerland,
Sweden, Denmark, Austria, Belgium, Netherlands, Monaco,
Luxembourg and Greece.
CRITICAL ACCOUNTING POLICIES
Our unaudited interim financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America. Preparation of these statements requires management to make judgments
and estimates. Some accounting policies have a significant impact on amounts
reported in these financial statements. A summary of significant accounting
policies and a description of accounting policies that are considered critical
may be found in our 2003 Annual Report on Form 10-K, filed on March 3, 2004, in
the Notes to the Consolidated Financial Statements and the Critical Accounting
Policies section. In addition, refer to Note 2 to the consolidated interim
financial statements included elsewhere herein.
ACACIA RESEARCH CORPORATION CONSOLIDATED
COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31,
2004 AND 2003
NET INCOME (LOSS) (IN THOUSANDS)
FOR THE THREE MONTHS ENDED
-------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Net income (loss) ......................... $ 10,903 $ (6,667)
The change in net income (loss) for the three months ended March 31,
2004 is primarily due to $17.3 million in previously deferred Roche Diagnostics
GmbH ("Roche") related contract revenues recognized during the first quarter of
2004 as discussed below. We estimate that there will be sufficient losses from
operations in the current fiscal year to offset any taxable income related to
the Roche deferred contract revenues recognized during the three months ended
March 31, 2004, resulting in no significant tax liability or expense in the
current period or for the year ended December 31, 2004.
REVENUES (IN THOUSANDS)
FOR THE THREE MONTHS ENDED
---------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Research and development contract ......... $ 17,302 $ --
License fees .............................. 599 6
Government contract ....................... 217 --
Service contracts ......................... 81 7
Products .................................. 16 209
Cost of product sales ..................... (4) (77)
31
RESEARCH AND DEVELOPMENT CONTRACT. In March 2004, the CombiMatrix group
completed all phases of its research and development agreement with Roche. As a
result of completing all of its obligations under this agreement and in
accordance with the CombiMatrix group's revenue recognition policies for
multiple-element arrangements, the CombiMatrix group recognized all previously
deferred Roche related contract revenues during the first quarter of 2004.
LICENSE FEES. License fee revenues are comprised of DMT technology
license fees recognized by the Acacia Technologies group which increased
primarily due to the significant growth in the number of DMT technology license
agreements executed since March 31, 2003. License fee revenues will fluctuate
from period to period based on the increase in license agreements executed,
fluctuations in the sales results or other royalty per unit activities of our
licensees that impact the calculation of license fees due, the timing of the
receipt of periodic license fee payments from licensees, and other factors.
Periodic license fee revenues may include amounts that relate to prior license
periods or prior periods of infringement, which are recognized as revenues in
the period received.
GOVERNMENT CONTRACTS. In March 2004, the CombiMatrix group executed a
two-year research and development contract with the Department of Defense to
further the development of the CombiMatrix group's microarray technology for the
detection of biological threat agents. Under the terms of the contract, the
CombiMatrix group will be reimbursed on a periodic basis for actual costs
incurred to perform its obligations, plus a fixed fee, of up to $5.9 million.
Revenues are recognized under the percentage-of-completion method of accounting,
using the cost-to-cost approach to measure completeness at the end of each
reporting period.
SERVICE CONTRACTS. The increase is due to $70,000 in service contract
revenues recognized by CombiMatrix K.K. during the three months ended March 31,
2004.
PRODUCTS AND COST OF PRODUCT SALES. Product revenues and costs of sales
during the three months ended March 31, 2004 related to sales of microarrays
primarily by CombiMatrix K.K. Product revenues and costs of product sales during
the three months ended March 31, 2003 were recognized exclusively by CombiMatrix
K.K. from the sale of a genomics microarray synthesizer and related microarray
products and services to Japanese research institutions.
RESEARCH AND DEVELOPMENT EXPENSES (IN THOUSANDS)
FOR THE THREE MONTHS ENDED
---------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Research and development expenses ..................... $ 1,588 $ 2,335
RESEARCH AND DEVELOPMENT EXPENSES. The decrease was primarily due to
the CombiMatrix group's completion of several Roche related research and
development projects during the third and fourth quarters of 2003, and final
completion of the research and development agreement with Roche in the first
quarter of 2004. During the past three years, the CombiMatrix group's research
and development activities were primarily driven by ongoing performance
obligations under the product commercialization phase of the CombiMatrix group's
license, research and development agreements with Roche. With the completion of
the research and development agreement with Roche, future research and
development expenses will be incurred in connection with the CombiMatrix group's
commitments to the Department of Defense, Toppan Corporation Printing Co. and
other internal research and development efforts in the areas of genomics, drug
discovery and development and material sciences. The CombiMatrix group expects
its research and development expenses to continue to be volatile and such
expenses could increase in future periods as additional contract research and
development agreements are undertaken.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES AND LEGAL SETTLEMENT CHARGES
(IN THOUSANDS)
FOR THE THREE MONTHS ENDED
---------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Marketing, general and administrative expenses ........ $ 3,886 $ 4,255
Legal settlement charges .............................. 1,257 --
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. The decrease was due
primarily to a decrease in corporate legal expenses and a general reduction in
personnel related overhead expenses. This decrease was partially offset by an
32
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.
LEGAL SETTLEMENT CHARGES. In connection with the September 2002
settlement agreement between CombiMatrix Corporation, Dr. Donald Montgomery, and
Nanogen, Inc., we recorded a non-cash charge totaling $1.3 million in the first
quarter of 2004, which reflects the fair value of AR-CombiMatrix common stock
issuable to Nanogen, Inc. in connection with certain anti-dilution provisions of
the settlement agreement. Periodic charges and the related liability are
estimated based on the number of shares potentially issuable and the
AR-CombiMatrix stock price at the end of the respective reporting period. The
increase is due primarily to the increase in AR-CombiMatrix stock price during
the three months ended March 31, 2004, as compared to the same period in 2003.
The anti-dilution provisions of the settlement agreement expire in September
2005.
NON-CASH STOCK COMPENSATION AMORTIZATION (IN THOUSANDS)
FOR THE THREE MONTHS ENDED
---------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Non-cash stock compensation amortization
- research and development .......................... $ 69 $ 2
Non-cash stock compensation amortization
- marketing, general and administrative ............. 334 138
The increase is due to the recognition of $743,000 in stock
compensation expense reversals related to the forfeiture of certain unvested
stock options during the three months ended March 31, 2003. Excluding the impact
of stock compensation expense reversals during the three months ended March 31,
2003, non-cash stock compensation expense decreased during the three months
ended March 31, 2004, as compared to the same period in 2003, primarily due to
the accelerated method of amortization utilized pursuant to Financial Accounting
Standards Board Interpretation No. 28, "Accounting for Stock Appreciation Rights
and Other Variable Stock Option or Award Plans," 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 $521,000 as of March 31, 2004,
all related to the CombiMatrix group, is expected to be fully amortized by the
end of 2004.
INFLATION
Inflation has not had a significant impact on Acacia Research
Corporation.
LIQUIDITY AND CAPITAL RESOURCES
Acacia Research Corporation's consolidated cash and cash equivalents
and short-term investments totaled $50.9 million at March 31, 2004 compared to
$50.5 million at December 31, 2003. Working capital at March 31, 2004 was $48.4
million, compared to $30.7 million at December 31, 2003. Working capital
increased due primarily to the recognition of $17.3 million in deferred contract
revenues during the three months ended March 31, 2004.
Net cash used in continuing operating activities for the three months
ended March 31, 2004 was $3.8 million, compared to $4.6 million in the same
period in 2003. Net cash outflows from operations for the three months ended
March 31, 2004 were comprised of $3.4 million in net cash outflows from
operations for the CombiMatrix group, compared to $2.6 million in the same
period in 2003 and $479,000 in net cash outflows from operations for the Acacia
Technologies group, compared to $2.0 million in the same period in 2003. The
change is primarily due to a decrease in the CombiMatrix group's research and
development and marketing, general and administrative expenses, partially offset
by $1.7 million in Roche related milestone payments and $271,000 related to the
sale of a genomic microarray synthesizer system (all of which were included in
deferred revenue at March 31, 2003) received by the CombiMatrix group during the
three months ended March 31, 2003, compared to zero in the same period in 2004
and the impact of the timing of accruals and related vendor payments for both
operating groups.
Net cash flows provided by continuing investing activities was $494,000
for the three months ended March 31, 2004, compared to $2.0 million for the same
period in 2003. The change is primarily due to a decrease in short-term
investments sold during the three months ended March 31, 2004 in connection with
Acacia Research Corporation's ongoing cash management activities.
Net cash provided by financing activities was $4.4 million for the
three months ended March 31, 2004, compared to zero in the same period in 2003.
The increase was comprised of $4.4 million in proceeds received primarily from
33
the exercise of AR-CombiMatrix common stock options and warrants during the
three months ended March 31, 2004.
In April 2004, Acacia Research Corporation raised gross proceeds of
$15,000,000 through the sale of 3,000,000 shares of Acacia Research -
CombiMatrix common stock at a price of $5.00 per share in a registered direct
offering. Net proceeds raised of approximately $13,600,000, which are net of
related issuance costs, were attributed to the CombiMatrix group.
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. See the CombiMatrix group and the
Acacia Technologies group discussion and analysis for additional factors
impacting the adequacy of our available funds.
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)
-----------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS REMAINING 2008 AND
2004 2005 2006 2007 THEREAFTER
----------- ----------- ----------- ----------- -----------
Operating Leases ................. $ 1,620 $ 2,221 $ 2,148 $ 1,976 $ 1,615
Minimum Royalty Payments(1) ...... 100 100 100 100 1,100
----------- ----------- ----------- ----------- -----------
Total Contractual Cash Obligations $ 1,720 $ 2,321 $ 2,248 $ 2,076 $ 2,715
========== ========== ========== ========== ==========
- ---------------
(1) In accordance with the September 30, 2002 settlement agreement entered into
between CombiMatrix Corporation, Dr. Don Montgomery and Nanogen, Inc.,
CombiMatrix Corporation is required to pay 12.5% of certain revenues,
subject to minimum and maximum amounts not to exceed $1.5 million per year,
beginning in the fourth quarter of 2003, for the remaining life of the
CombiMatrix group's core patents.
In 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 March 31, 2004. Any
royalties paid pursuant to the agreements will be expensed in the consolidated
statement of operations.
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 7 to the Acacia Research Corporation consolidated
financial statements included elsewhere herein.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk is limited primarily to interest income
sensitivity, which is affected by changes in the general level of United States
interest rates, particularly because a significant portion of our investments
are in short-term debt securities issued by the U.S. government, U.S.
corporations, institutional money market funds and other money market
instruments. The primary objective of our investment activities is to preserve
principal while at the same time maximizing the income received without
significantly increasing risk. To minimize risk, we maintain a portfolio of
cash, cash equivalents and short-term investments in a variety of
investment-grade securities and with a variety of issuers, including corporate
notes, commercial paper and money market instruments. Due to the nature of our
short-term investments, we believe that we are not subject to any material
market risk exposure. We do not have any derivative financial instruments.
34
DISCUSSION OF SEGMENTS' OPERATIONS, FINANCIAL RESOURCES AND LIQUIDITY
COMBIMATRIX GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS
(A DIVISION OF ACACIA RESEARCH CORPORATION)
YOU SHOULD READ THIS DISCUSSION IN CONJUNCTION WITH THE COMBIMATRIX
GROUP FINANCIAL STATEMENTS AND RELATED NOTES AND THE ACACIA RESEARCH CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES, BOTH INCLUDED ELSEWHERE
HEREIN. HISTORICAL RESULTS AND PERCENTAGE RELATIONSHIPS ARE NOT NECESSARILY
INDICATIVE OF OPERATING RESULTS FOR ANY FUTURE PERIODS.
GENERAL
The CombiMatrix group, a division of Acacia Research Corporation, is
primarily comprised of CombiMatrix Corporation and its wholly owned subsidiary,
CombiMatrix K.K. 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.
35
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31,
2004 AND 2003
NET INCOME (LOSS) (IN THOUSANDS)
FOR THE THREE MONTHS ENDED
---------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Division net income (loss) ............................. $ 11,892 $ (5,173)
The change in net income (loss) for the three months ended March 31,
2004 is primarily due to $17.3 million in previously deferred Roche related
contract revenues recognized during the first quarter of 2004 as discussed
below. The CombiMatrix group estimates that there will be sufficient losses from
operations in the current fiscal year to offset any taxable income related to
the Roche deferred contract revenues recognized during the three months ended
March 31, 2004, resulting in no significant tax liability or expense in the
current period or for the year ended December 31, 2004.
REVENUES (IN THOUSANDS)
FOR THE THREE MONTHS ENDED
---------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Research and development contract ................ $ 17,302 $ --
Government contract .............................. 217 --
Service contracts ................................ 81 7
Products ......................................... 16 209
Cost of product sales ............................ (4) (77)
RESEARCH AND DEVELOPMENT CONTRACT. In March 2004, the CombiMatrix group
completed all phases of its research and development agreement with Roche. As a
result of completing all of its obligations under this agreement and in
accordance with the CombiMatrix group's revenue recognition policies for
multiple-element arrangements, the CombiMatrix group recognized all previously
deferred Roche related contract revenues totaling $17.3 million during the first
quarter of 2004.
GOVERNMENT CONTRACT. In March 2004, the CombiMatrix group executed a
two-year research and development contract with the Department of Defense to
further the development of the CombiMatrix group's microarray technology for the
detection of biological threat agents. Under the terms of the contract, the
CombiMatrix group will be reimbursed on a periodic basis for actual costs
incurred to perform its obligations, plus a fixed fee, of up to $5.9 million.
Revenues are recognized under the percentage-of-completion method of accounting,
using the cost-to-cost approach to measure completeness at the end of each
reporting period.
SERVICE CONTRACTS. The increase is due to $70,000 in service contract
revenues recognized by CombiMatrix K.K. during the three months ended March 31,
2004.
PRODUCTS AND COST OF PRODUCT SALES. Product revenues and costs of sales
during the three months ended March 31, 2004 related to sales of microarrays
primarily by CombiMatrix K.K. Product revenues and costs of product sales during
the three months ended March 31, 2003 were recognized exclusively by CombiMatrix
K.K. from the sale of a genomics microarray synthesizer and related microarray
products and services to Japanese research institutions.
RESEARCH AND DEVELOPMENT EXPENSES (IN THOUSANDS)
FOR THE THREE MONTHS ENDED
---------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Research and development expenses ................ $ 1,588 $ 2,335
RESEARCH AND DEVELOPMENT EXPENSES. The decrease was primarily due to
the CombiMatrix group's completion of several Roche related research and
development projects during the third and fourth quarters of 2003, and final
completion of the research and development agreement with Roche in the first
quarter of 2004. During the past three years, the CombiMatrix group's research
and development activities were primarily driven by ongoing performance
36
obligations under the product commercialization phase of the CombiMatrix group's
license, research and development agreements with Roche. With the completion of
the research and development agreement with Roche, future research and
development expenses will be incurred in connection with the CombiMatrix group's
commitments to the Department of Defense, Toppan Corporation Printing Co. and
other internal research and development efforts in the areas of genomics, drug
discovery and development and material sciences. The CombiMatrix group expects
its research and development expenses to be volatile and such expenses could
increase in future periods as additional contract research and development
agreements are undertaken.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES AND LEGAL SETTLEMENT CHARGES
(IN THOUSANDS)
FOR THE THREE MONTHS ENDED
---------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Marketing, general and administrative expenses ... $ 2,278 $ 2,670
Legal settlement charges ......................... 1,257 --
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. The change was due
primarily to a decrease in corporate legal expenses during the three months
ended March 31, 2004, as compared to the same period in 2003. In addition, the
CombiMatrix group incurred certain severance and personnel-reduction costs that
were not incurred during the three months ended March 31, 2004, contributing to
the overall decrease in marketing, general and administrative expenses for the
comparable periods.
LEGAL SETTLEMENT CHARGES. In connection with the September 2002
settlement agreement between CombiMatrix Corporation, Dr. Donald Montgomery, and
Nanogen, Inc., the CombiMatrix group recorded a non-cash charge totaling $1.3
million during the first quarter of 2004, which reflects the fair value of
AR-CombiMatrix common stock issuable to Nanogen, Inc. in connection with certain
anti-dilution provisions of the settlement agreement. Periodic charges and the
related liability are estimated based on the number of shares potentially
issuable and the AR-CombiMatrix stock price at the end of the respective
reporting period. The increase is due primarily to the increase in
AR-CombiMatrix stock price during the three months ended March 31, 2004, as
compared to the same period in 2003. The anti-dilution provisions of the
settlement agreement expire in September 2005.
NON-CASH STOCK COMPENSATION AMORTIZATION (IN THOUSANDS)
FOR THE THREE MONTHS ENDED
---------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Non-cash stock compensation amortization
- research and development ..................... $ 69 $ 2
Non-cash stock compensation amortization
- marketing, general and administrative ........ 334 138
The increase is due to the recognition of $743,000 in stock
compensation expense reversals related to the forfeiture of certain unvested
stock options during the three months ended March 31, 2003. Excluding the impact
of stock compensation expense reversals during the three months ended March 31,
2003, non-cash stock compensation expense decreased during the three months
ended March 31, 2004, as compared to the same period in 2003, primarily due to
the accelerated method of amortization utilized pursuant to FIN No. 28, which
results in higher amounts of amortization in the early vesting periods. The
remaining amount of deferred stock compensation expense of $521,000 as of March
31, 2004 is expected to be fully amortized by the end of 2004.
INFLATION
Inflation has not had a significant impact on the CombiMatrix group in
the current or prior periods.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2004, cash and cash equivalents and short-term investments
totaled $18.4 million, compared to $17.3 million at December 31, 2003. Working
capital at March 31, 2004 was $16.7 million, compared to a working capital
deficit of $2.0 million at December 31, 2003. Working capital increased due
primarily to the recognition of $17.3 million in deferred contract revenues
during the three months ended March 31, 2004.
Net cash used in operations was $3.4 million during the three months
ended March 31, 2004, compared to $2.6 million in same period in 2003. The
change is primarily due to a decrease in the CombiMatrix group's research and
37
development and marketing, general and administrative expenses, partially offset
by $1.7 million in Roche related milestone payments and $271,000 related to the
sale of a genomic microarray synthesizer system (all of which were included in
deferred revenue at March 31, 2003) received by the CombiMatrix group during the
three months ended March 31, 2003, compared to zero in the same period in 2004
and the impact of the timing of accruals and related vendor payments.
Net cash flows used in investing activities was $1.5 million during the
three months ended March 31, 2004, compared to net cash provided by investing
activities of $2.0 million in the same period in 2003. The change was primarily
due to an increase in short term investments in connection with the CombiMatrix
group's ongoing short term cash management activities.
Net cash inflows attributed to the CombiMatrix group from financing
activities was $4.5 million during the three months ended March 31, 2004,
compared to $275,000 in the same period in 2003, primarily due to the receipt of
$4.4 million in proceeds from the exercise of AR-CombiMatrix stock options and
warrants during the three months ended March 31, 2004.
In April 2004, Acacia Research Corporation raised gross proceeds of
$15,000,000 through the sale of 3,000,000 shares of Acacia Research -
CombiMatrix common stock at a price of $5.00 per share in a registered direct
offering. Net proceeds raised of approximately $13,600,000, which are net of
related issuance costs, were attributed to the CombiMatrix group.
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.
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.
The CombiMatrix group's long-term capital requirements will be
substantial and the adequacy of our available funds will depend upon many
factors, including:
o the CombiMatrix group's continued progress in research and
development programs;
o the costs involved in filing, prosecuting, enforcing and
defending any patents claims, should they arise;
o the CombiMatrix group's ability to license technology;
o competing technological developments;
o the creation and formation of strategic partnerships;
o the costs associated with leasing and improving our
headquarters in Mukilteo, Washington;
o the costs of commercialization activities, including
acquisition of additional inventories and capital equipment;
and
o other factors that may not be within the CombiMatrix group's
control.
38
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)
-----------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS REMAINING 2008 AND
2004 2005 2006 2007 THEREAFTER
----------- ----------- ----------- ----------- -----------
Operating Leases (2) ............. $ 1,398 $ 1,918 $ 1,836 $ 1,937 $ 1,615
Minimum Royalty Payments(1) ...... 100 100 100 100 1,100
----------- ----------- ----------- ----------- -----------
Total Contractual Cash Obligations $ 1,498 $ 2,018 $ 1,936 $ 2,037 $ 2,715
=========== =========== =========== =========== ===========
- ---------------
(1) In accordance with the September 30, 2002 settlement agreement entered into
between CombiMatrix Corporation, Dr. Don Montgomery and Nanogen, Inc.,
CombiMatrix Corporation is required to pay 12.5% of certain revenues,
subject to minimum and maximum amounts not to exceed $1.5 million per year,
beginning in the fourth quarter of 2003, for the remaining life of the
CombiMatrix group's core patents.
(2) Excludes any allocated rent expense in connection with Acacia Research
Corporation's management allocation policies.
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 7 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 March 31, 2004, the CombiMatrix group had certain assets and
liabilities denominated in Japanese Yen as a result of forming CombiMatrix K.K.
However, due to the relative insignificance of those amounts, the CombiMatrix
group does not believe that it has significant exposure to foreign currency
exchange rate risks. The CombiMatrix group currently does not use derivative
financial instruments to mitigate this exposure. The CombiMatrix group continues
to review this and may begin hedging certain foreign exchange risks through the
use of currency forwards or options in future periods.
39
ACACIA TECHNOLOGIES GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS
(A DIVISION OF ACACIA RESEARCH CORPORATION)
YOU SHOULD READ THIS DISCUSSION IN CONJUNCTION WITH THE ACACIA
TECHNOLOGIES GROUP FINANCIAL STATEMENTS AND RELATED NOTES AND THE ACACIA
RESEARCH CORPORATION CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES, BOTH
INCLUDED ELSEWHERE HEREIN. HISTORICAL RESULTS AND PERCENTAGE RELATIONSHIPS ARE
NOT NECESSARILY INDICATIVE OF OPERATING RESULTS FOR ANY FUTURE PERIODS.
GENERAL
The Acacia Technologies group, a division of Acacia Research
Corporation, is comprised primarily of Acacia Research Corporation's wholly
owned media technology subsidiaries, Acacia Media Technologies Corporation and
Soundview Technologies, Inc., or Soundview Technologies, and also includes all
other related corporate assets and liabilities and related transactions of
Acacia Research Corporation that are attributed to its media technology
businesses.
Although the AR-Acacia Technologies stock is intended to reflect the
separate performance of the Acacia Technologies group, rather than the
performance of Acacia Research Corporation as a whole, the Acacia Technologies
group is not a separate legal entity. Holders of the AR-Acacia Technologies
stock are stockholders of Acacia Research Corporation. As a result, they
continue to be subject to all of the risks of an investment in Acacia Research
Corporation and all of Acacia Research Corporation's businesses, assets and
liabilities. The assets Acacia Research Corporation attributes to the Acacia
Technologies group could be subject to the liabilities of the CombiMatrix group.
The Acacia Technologies group owns and is developing a portfolio of
U.S. and international pioneering patents covering the transmission and receipt
of digital content. These transmission and receiving systems are commonly
referred to as audio-on-demand, video-on-demand, and audio/video streaming. The
Acacia Technologies group's patented proprietary digital media transmission
technology is referred to as "DMT" technology. The Acacia Technologies group
also owns a patent for a system that screens television content by content
rating code, commonly referred to as V-chip technology. The system, which uses
the audio and video blanking interval in conjunction with rating codes which are
transmitted with television programming, was approved by the Federal
Communication Commission or FCC and adopted by television manufacturers as the
industry standard in response to the U.S. Telecommunications Act of 1996. The
Acacia Technologies group is responsible for the development, licensing and
protection of its intellectual property and proprietary technologies. The Acacia
Technologies group continues to pursue both licensing and strategic business
alliances with leading companies in the rapidly growing media technologies
industry.
The Acacia Technologies group's patent on the V-chip technology expired
in July 2003. However, depending on the outcome of ongoing licensing efforts and
related infringement actions, the Acacia Technologies group may continue to
collect license fees on televisions sold in the United States during the patent
term, subsequent to the July 2003 patent expiration date. The Acacia
Technologies group is marketing its DMT technology and is looking to acquire
other technologies. Acacia Technologies group's digital media transmission
patent portfolio expires in 2011 in the U.S. and in 2012 in international
markets. If we do not succeed in acquiring such technologies or are unable to
successfully commercially license our existing and future technologies, our
financial condition may be adversely impacted.
40
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31,
2004 AND 2003
NET LOSS (IN THOUSANDS)
FOR THE THREE MONTHS ENDED
---------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Net loss ......................................... $ (989) $ (1,494)
The change in net loss is due primarily to an increase in DMT
technology license fee revenues recognized by the Acacia Technologies group
during the three months ended March 31, 2004, as compared to the same period in
2003, as discussed below.
REVENUES (IN THOUSANDS)
FOR THE THREE MONTHS ENDED
---------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
License fees ..................................... $ 599 $ 6
LICENSE FEES. License fee revenues are comprised of DMT technology
license fees recognized by the Acacia Technologies group which increased
primarily due to the significant growth in the number of DMT technology license
agreements executed since March 31, 2003. License fee revenues will fluctuate
from period to period based on the increase in license agreements executed,
fluctuations in the sales results or other royalty per unit activities of our
licensees that impact the calculation of license fees due, the timing of the
receipt of periodic license fee payments from licensees, and other factors.
Periodic license fee revenues may include amounts that relate to prior license
periods or prior periods of infringement, which are recognized as revenues in
the period received.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSE (IN THOUSANDS)
FOR THE THREE MONTHS ENDED
---------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------
Marketing, general and administrative expenses ... $ 1,006 $ 1,323
Legal expenses - patents ......................... 602 262
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. The decrease was due
primarily to a decrease in corporate legal expenses and a general reduction in
personnel related overhead expenses. This decrease was partially offset by 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.
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 $32.5 million at March 31, 2004, compared to
$33.2 million at December 31, 2003. Working capital at March 31, 2004 was $31.7
million, compared to $32.7 million at December 31, 2003.
Net cash used in continuing operating activities for the three months
ended March 31, 2004 was $479,000, compared to $2.0 million in the same period
in 2003. The change is due primarily to an increase in DMT license fee payments
received during the three months ended March 31, 2004 and the impact of the
timing of accruals and related vendor payments.
41
Net cash flows provided by investing activities was $2.0 million during
the three months ended March 31, 2004 related to the sale of short term
investments in connection with the Acacia Technologies group's ongoing short
term cash management activities. Net cash flows from investing activities were
not material in the comparable 2003 period.
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.
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 $1.3 million
in DMT license fee revenues to date, 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 our technologies and services;
o business activities and financial results of our licensees;
o technological advances that may make our technologies 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.
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)
--------------------------------------------------------------
CONTRACTUAL OBLIGATIONS REMAINING 2008 AND
2004 2005 2006 2007 THEREAFTER
--------- --------- --------- --------- ----------
Operating Leases (1) ............. $ 222 $ 303 $ 312 $ 39 $ --
--------- --------- --------- --------- ---------
Total Contractual Cash Obligations $ 222 $ 303 $ 312 $ 39 $ --
========= ========= ========= ========= =========
- ----------------
(1) Excludes any allocated rent expense in connection with Acacia Research
Corporation's management allocation policies.
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.
42
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 7 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.
43
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 QUARTERLY REPORT. IF ANY OF THE RISKS DISCUSSED IN THIS
QUARTERLY REPORT ACTUALLY OCCUR, OUR BUSINESS, FINANCIAL CONDITION AND RESULTS
OF OPERATIONS COULD BE MATERIALLY 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 March 31, 2004, of $172.5 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.
44
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.
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.
45
Many of these factors are beyond our subsidiary companies' control. We
cannot provide any assurance that any subsidiary company will experience growth
in the future or be profitable on an operating basis in any future period.
IF WE, OR OUR SUBSIDIARIES, ENCOUNTER UNFORESEEN DIFFICULTIES AND CANNOT OBTAIN
ADDITIONAL FUNDING ON FAVORABLE TERMS, OUR BUSINESS MAY SUFFER.
As of March 31, 2004, we had cash and short-term investments of $50.9
million on our consolidated financial statements.
To date, our subsidiary companies have relied primarily upon selling
equity securities, including sales to and loans from us, to generate the funds
needed to finance implementing their plans of operations. Our subsidiary
companies may be required to obtain additional financing through bank
borrowings, debt or equity financings or otherwise, which would require us to
make additional investments or face a dilution of our equity interests.
We cannot assure that we will not encounter unforeseen difficulties
that may deplete our capital resources more rapidly than anticipated. Any
efforts to seek additional funds could be made through equity, debt or other
external financings. Nevertheless, we cannot assure that additional funding will
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.
Despite net operating income of $10.7 million and net income of $10.9
million for the three months ended March 31, 2004, we have sustained substantial
losses since our inception resulting in an accumulated deficit as of March 31,
2004, of $172.5 million on a consolidated basis. If we continue to incur
operating losses in future periods, 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.
46
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
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.
FUTURE CHANGES IN ACCOUNTING STANDARDS OR PRACTICES MAY CAUSE ADVERSE OR
UNEXPECTED FLUCTUATIONS IN OUR REPORTED RESULTS OF OPERATIONS.
For example, any changes requiring that we record compensation expense
in the statement of operations for employee stock options using the fair value
method or changes in existing taxation rules related to stock options could have
a significant negative impact on our reported results. Several agencies and
entities are considering and the Financial Accounting Standards Board (the
"FASB") has announced, proposals to change generally accept accounting
principals in the United States that, if implemented, would require us to record
charges to earnings for employee stock option grants. This pending requirement
47
would negatively impact our earnings. In addition the FASB has proposed a choice
of valuation models to estimate the fair value of employee stock options. These
models, including the Black-Scholes option pricing model, use varying methods
and inputs and may yield significantly different results. If another party
asserts that the fair values of our employee stock options are misstated,
securities class action litigation could be brought against us and/or the market
price of our common stock could decline.
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
48
o it cannot be sure as to the timing of receipt of payment for
its products.
As a result, the CombiMatrix group's revenues may vary significantly
from quarter to quarter, which could make its business difficult to manage and
cause its quarterly results to be below market expectations. If this happens,
the price of the CombiMatrix group's common stock may decline significantly.
TECHNOLOGY COMPANY STOCK PRICES ARE ESPECIALLY VOLATILE, AND THIS VOLATILITY MAY
DEPRESS THE PRICE OF 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.
49
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
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
50
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;
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
51
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.
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
52
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.
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
53
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.
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
54
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.
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
55
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.
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.
56
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.
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
57
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.
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.
58
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
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.
59
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
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.
60
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
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.
61
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.
62
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Refer to Item 2. "Management's Discussion and Analysis of Financial
Condition and Results of Operations" under the caption "Quantitative and
Qualitative Disclosures About Market Risk" for Acacia Research Corporation, the
CombiMatrix group and the Acacia Technologies group.
The primary objective of our investment activities is to preserve
principal while concurrently maximizing the income we receive from our
investments without significantly increasing risk. Some of the securities that
we may invest in may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate. For example, if we hold a security that was issued with a fixed
interest rate at the then-prevailing rate and the prevailing interest rate later
rises, the current value of the principal amount of our investment will decline.
To minimize this risk in the future, we intend to maintain our portfolio of cash
equivalents and short-term investments in a variety of securities, including
commercial paper, money market funds, high-grade corporate bonds, government and
non-government debt securities and certificates of deposit. In general, money
market funds are not subject to market risk because the interest paid on such
funds fluctuates with the prevailing interest rate. As of March 31, 2004, all of
our investments were in money market funds, high-grade corporate bonds, and U.S.
government debt securities. A hypothetical 100 basis point increase in interest
rates would not have a material impact on the fair value of our
available-for-sale securities as of March 31, 2004.
ITEM 4. CONTROLS AND PROCEDURES
(a) As of the end of the period covered by this Quarterly Report on
Form 10-Q, 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 March
31, 2004) that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
63
PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
SOUNDVIEW TECHNOLOGIES
On April 5, 2000, Soundview Technologies filed a federal patent
infringement and antitrust lawsuit against Sony Corporation of America, Philips
Electronics North America Corporation, the Consumer Electronics Manufacturers
Association and the Electronics Industries Alliance d/b/a Consumer Electronics
Association in the United States District Court for the Eastern District of
Virginia, alleging that television sets utilizing certain content blocking
technology (commonly known as the "V-chip") and sold in the United States
infringe Soundview Technologies' U.S. Patent No. 4,554,584.
In September 2002, the 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 March 31, 2004, 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.
64
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31.1 Certifications of the Chief Executive Officer provided pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certifications of the Chief Financial Officer provided pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certifications of the Chief Executive Officer provided pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certifications of the Chief Financial Officer provided pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
On February 19, 2004, Acacia Research Corporation furnished, but did
not file, a Current Report on Form 8-K containing the Company's press release
announcing its earnings for the fourth quarter and fiscal year ended December
31, 2003.
On March 11, 2004, Acacia Research Corporation filed a Current Report
on Form 8-K which contained Acacia Research Corporation's press release
announcing that its Acacia Research - CombiMatrix common stock will begin
trading on the NASDAQ National Market system on March 12, 2004.
65
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ACACIA RESEARCH CORPORATION
By: /S/ Paul R. Ryan
----------------------------------
Paul R. Ryan
Chief Executive Officer
(Authorized Signatory)
By: /S/ Clayton J. Haynes
----------------------------------
Clayton J. Haynes
Chief Financial Officer /Treasurer
(Principal Financial Officer)
Date: May 4, 2004
66
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT
- ------ -------
31.1 Certifications of the Chief Executive Officer provided pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certifications of the Chief Financial Officer provided pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certifications of the Chief Executive Officer provided pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certifications of the Chief Financial Officer provided pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
67