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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005
COMMISSION FILE NUMBER 0-26068
ACACIA RESEARCH CORPORATION
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(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 95-4405754
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
500 NEWPORT CENTER DRIVE, NEWPORT BEACH, CA 92660
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (949) 480-8300
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Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
As of August 3, 2005, 27,282,185 shares of Acacia Research-Acacia
Technologies common stock were issued and outstanding. As of August 3, 2005,
32,606,495 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 June 30, 2005, and
December 31, 2004 (Unaudited)....................................................... 1
Consolidated Statements of Operations and Comprehensive Income (Loss) for the
Three Months and Six Months Ended June 30, 2005 and 2004 (Unaudited)................ 2
Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2005 and 2004 (Unaudited).................................................. 3
Notes to Consolidated Financial Statements (Unaudited).............................. 4
*CombiMatrix Group Financial Statements
Balance Sheets as of June 30, 2005, and December 31, 2004 (Unaudited)............... 22
Statements of Operations for the Three Months and Six Months Ended
June 30, 2005 and 2004 (Unaudited).................................................. 23
Statements of Cash Flows for the Six Months Ended
June 30, 2005 and 2004 (Unaudited).................................................. 24
Notes to Financial Statements (Unaudited)........................................... 25
*Acacia Technologies Group Financial Statements
Balance Sheets as of June 30, 2005, and December 31, 2004 (Unaudited)............... 29
Statements of Operations for the Three Months and Six Months Ended
June 30, 2005 and 2004 (Unaudited).................................................. 30
Statements of Cash Flows for the Six Months Ended
June 30, 2005 and 2004 (Unaudited).................................................. 31
Notes to Financial Statements (Unaudited)........................................... 32
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................................... 39
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................... 58
Item 4. Controls and Procedures............................................................. 58
i
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................... 59
Item 5. Other Information................................................................... 59
Item 6. Exhibits............................................................................ 60
SIGNATURES.............................................................................................. 61
EXHIBIT INDEX .......................................................................................... 62
*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)
JUNE 30, DECEMBER 31,
2005 2004
---------------- ----------------
ASSETS
Current assets:
Cash and cash equivalents .................................................. $ 19,639 $ 18,735
Short-term investments ..................................................... 35,692 33,623
Accounts receivable ........................................................ 2,195 536
Prepaid expenses, inventory, and other assets .............................. 1,567 983
---------------- ----------------
Total current assets .................................................. 59,093 53,877
Property and equipment, net of accumulated depreciation ......................... 2,404 2,434
Patents, net of accumulated amortization of $7,558 (2005) and $4,758 (2004) ..... 34,816 12,063
Goodwill ........................................................................ 19,545 19,545
Other assets .................................................................... 899 408
---------------- ----------------
$ 116,757 $ 88,327
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued expenses and other ............................... $ 4,003 $ 4,139
Royalties and legal fees payable ........................................... 447 --
Current portion of deferred revenues ....................................... 582 494
---------------- ----------------
Total current liabilities ............................................. 5,032 4,633
Deferred income taxes ........................................................... 2,841 2,981
Deferred revenues, net of current portion ....................................... 3,934 3,893
Other liabilities ............................................................... 407 406
---------------- ----------------
Total liabilities ..................................................... 12,214 11,913
---------------- ----------------
Minority interests .............................................................. 482 778
---------------- ----------------
Commitments and contingencies (Note 9)
Redeemable stockholders' equity:
Preferred stock
Acacia Research Corporation, par value $0.001 per share;
10,000,000 shares authorized; no shares issued or outstanding ...... -- --
Common stock
Acacia Research - Acacia Technologies stock, par value $0.001
per share; 50,000,000 shares authorized; 27,273,019 and
19,811,524 shares issued and outstanding as of June 30, 2005
and December 31, 2004, respectively ................................ 27 20
Acacia Research - CombiMatrix stock, par value $0.001 per share;
50,000,000 shares authorized; 31,206,051 and 31,200,496 shares
issued and outstanding as of June 30, 2005 and December 31,
2004, respectively ................................................. 31 31
Additional paid-in capital ................................................. 302,656 263,900
Accumulated comprehensive income ........................................... (48) (77)
Accumulated deficit ........................................................ (198,605) (188,238)
---------------- ----------------
Total stockholders' equity .......................................... 104,061 75,636
---------------- ----------------
$ 116,757 $ 88,327
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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 FOR THE SIX MONTHS ENDED
---------------------------------- ----------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
--------------- --------------- --------------- ---------------
Revenues:
Research and development contract ................. $ -- $ -- $ -- $ 17,302
License fees ...................................... 2,682 666 4,545 1,265
Government contract ............................... 1,281 701 2,012 918
Products and services ............................. 576 49 914 146
--------------- --------------- --------------- ---------------
Total revenues ............................... 4,539 1,416 7,471 19,631
--------------- --------------- --------------- ---------------
Operating expenses:
Cost of government contract revenues .............. 1,209 653 1,900 858
Cost of product sales ............................. 190 36 353 40
Research and development expenses ................. 1,415 1,409 2,555 2,792
Non-cash stock compensation amortization
- research and development ..................... -- 32 -- 101
Marketing, general and administrative expenses .... 4,261 3,388 8,150 6,672
Legal expenses - patents .......................... 536 576 1,097 1,178
Contingent legal fees and inventor royalties
expense - patents .............................. 1,120 -- 1,767 --
Non-cash stock compensation amortization
- marketing, general and administrative ........ 15 143 (111) 477
Amortization of patents ........................... 1,610 399 2,800 798
Legal settlement charges (credits) ................ (16) (391) (195) 866
--------------- --------------- --------------- ---------------
Total operating expenses ..................... 10,340 6,245 18,316 13,782
--------------- --------------- --------------- ---------------
Operating income (loss) ...................... (5,801) (4,829) (10,845) 5,849
--------------- --------------- --------------- ---------------
Other income (expense):
Interest income ................................... 382 192 655 350
Other expense ..................................... (62) -- (101) --
--------------- --------------- --------------- ---------------
Total other income ........................... 320 192 554 350
--------------- --------------- --------------- ---------------
Income (loss) from continuing operations before
income taxes and minority interests ................. (5,481) (4,637) (10,291) 6,199
Benefit for income taxes ............................... 64 69 134 136
--------------- --------------- --------------- ---------------
Income (loss) from continuing operations before
minority interests .................................. (5,417) (4,568) (10,157) 6,335
Minority interests ..................................... -- 3 -- 3
--------------- --------------- --------------- ---------------
Income (loss) from continuing operations ............... (5,417) (4,565) (10,157) 6,338
--------------- --------------- --------------- ---------------
Discontinued operations:
Estimated loss on disposal of discontinued
operations ..................................... -- (104) (210) (104)
--------------- --------------- --------------- ---------------
Net income (loss) ...................................... (5,417) (4,669) (10,367) 6,234
--------------- --------------- --------------- ---------------
Unrealized gains (losses) on short-term
investments .................................... (7) (80) 7 (78)
Unrealized gains (losses) on foreign currency
translation .................................... 14 (13) 22 (7)
--------------- --------------- --------------- ---------------
Comprehensive income (loss) ............................ $ (5,410) $ (4,762) $ (10,338) $ 6,149
=============== =============== =============== ===============
Earnings (loss) per common share:
Attributable to the Acacia Technologies group:
Net loss .......................................... $ (1,760) $ (1,153) $ (3,634) $ (2,142)
Basic and diluted loss per share ............. (0.06) (0.06) (0.14) (0.11)
Attributable to the CombiMatrix group:
Basic
Net income (loss) ................................. $ (3,657) $ (3,516) $ (6,733) $ 8,376
Basic earnings (loss) per share .............. (0.12) (0.12) (0.22) 0.29
Diluted
Net income (loss) ................................. $ (3,657) $ (3,516) $ (6,733) $ 8,376
Diluted earnings (loss) per share ............ (0.12) (0.12) (0.22) 0.28
Weighted average shares:
Acacia Research - Acacia Technologies stock:
Basic and diluted ............................ 27,271,416 19,787,466 25,922,412 19,769,901
=============== =============== =============== ===============
Acacia Research - CombiMatrix stock:
Basic ............................................. 31,200,984 30,459,576 31,200,742 28,867,101
=============== =============== =============== ===============
Diluted ........................................... 31,200,984 30,459,576 31,200,742 30,385,512
=============== =============== =============== ===============
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 SIX MONTHS ENDED
------------------------------------
JUNE 30, 2005 JUNE 30, 2004
--------------- ---------------
Cash flows from operating activities:
Net income (loss) from continuing operations .................................. $ (10,157) $ 6,338
Adjustments to reconcile net income (loss) from continuing operations
to net cash used in operating activities:
Depreciation and amortization ............................................. 3,358 1,403
Non-cash stock compensation ............................................... (111) 578
Deferred tax benefit ...................................................... (140) (140)
Non-cash legal settlement charge (credit) ................................. (195) 866
Other ..................................................................... 46 (55)
Changes in assets and liabilities, excluding effect of business acquisition:
Accounts receivable ....................................................... (1,659) (438)
Prepaid expenses, inventory and other assets .............................. (625) (204)
Accounts payable, accrued expenses and other .............................. (384) 1,263
Royalties and legal fees payable .......................................... 447 --
Deferred revenues ......................................................... 129 (17,209)
--------------- ---------------
Net cash used in operating activities from continuing operations .......... (9,291) (7,598)
Net cash used in operating activities from discontinued operations ........ (433) (311)
--------------- ---------------
Net cash used in operating activities ..................................... (9,724) (7,909)
--------------- ---------------
Cash flows from investing activities:
Purchase of property and equipment ........................................ (512) (315)
Purchase of available-for-sale investments ................................ (38,248) (37,681)
Sale of available-for-sale investments .................................... 36,282 21,860
Business acquisition ...................................................... (5,796) --
Purchase of additional interests in equity method investee ................ (600) --
Patent acquisition costs .................................................. (325) --
Other ..................................................................... -- (5)
--------------- ---------------
Net cash used in investing activities from continued operations ........... (9,199) (16,141)
Net cash used in investing activities from discontinued operations ........ -- (198)
--------------- ---------------
Net cash used in investing activities ..................................... (9,199) (16,339)
--------------- ---------------
Cash flows from financing activities:
Proceeds from sale of common stock, net of issuance costs ................. 19,753 13,715
Proceeds from the exercise of stock options and warrants .................. 53 4,691
--------------- ---------------
Net cash provided by financing activities ................................. 19,806 18,406
--------------- ---------------
Effect of exchange rate on cash ................................................. 21 (6)
--------------- ---------------
Increase (decrease) in cash and cash equivalents ................................ 904 (5,848)
Cash and cash equivalents, beginning ............................................ 18,735 24,199
--------------- ---------------
Cash and cash equivalents, ending ............................................... $ 19,639 $ 18,351
=============== ===============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
3
ACACIA RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
DESCRIPTION OF BUSINESS. Acacia Research Corporation ("we," "us" and
"our") is comprised of two operating groups: the CombiMatrix group and the
Acacia Technologies group.
Our life sciences business, referred to as the "CombiMatrix group," a
division of Acacia Research Corporation, is comprised of our wholly owned
subsidiary, CombiMatrix Corporation and CombiMatrix Corporation's wholly owned
subsidiaries, CombiMatrix Molecular Diagnostics, Inc. and CombiMatrix K.K. and
includes all corporate assets, liabilities and transactions related to Acacia
Research Corporation's life sciences business.
The CombiMatrix group is seeking to become a broadly diversified
biotechnology business, through the development of proprietary technologies and
products in the areas of drug development, genetic analysis, molecular
diagnostics, nanotechnology research, defense and homeland security markets, as
well as other potential markets where its products could be utilized. Among the
technologies being developed by the CombiMatrix group is 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. This 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.
Other technologies include proprietary molecular synthesis and screening methods
for the discovery of potential new drugs. CombiMatrix Molecular Diagnostics,
Inc., a wholly owned subsidiary located in Irvine, California, is exploring
opportunities for the CombiMatrix group's arrays in the field of clinical
diagnostics. CombiMatrix K.K., a wholly owned Japanese corporation located in
Tokyo, Japan, is exploring opportunities for CombiMatrix Corporation's array
system with pharmaceutical and biotechnology companies in the Asian market.
Our intellectual property licensing and enforcement business, referred
to as the "Acacia Technologies group," a division of Acacia Research
Corporation, is currently comprised of certain of Acacia Research Corporation's
wholly owned subsidiaries and limited liability companies including: Acacia
Global Acquisition Corporation, Acacia Media Technologies Corporation, Acacia
Patent Acquisition Corporation, Acacia Technologies Services Corporation, AV
Technologies LLC, Broadcast Innovation LLC, Computer Cache Coherency
Corporation, Computer Docking Station Corporation, Data Encryption Corporation,
Data Innovation LLC, Financial Services Innovation LLC, Information Technology
Innovation LLC, InternetAd LLC, IP Innovation LLC, KY Data Systems LLC,
Microprocessor Enhancement Corporation, New Medium LLC, TechSearch LLC, VData
LLC, Soundview Technologies, Inc. and Spreadsheet Automation Corporation, and
also includes all corporate assets, liabilities, and related transactions of
Acacia Research Corporation attributed to Acacia Research Corporation's
intellectual property licensing and enforcement business. See Note 8 for
information on our recent business acquisition.
The Acacia Technologies group develops, acquires, licenses and enforces
patented technologies. The Acacia Technologies group controls 31 patent
portfolios, which include over 120 U.S. patents, and certain foreign
counterparts, covering technologies used in a wide variety of industries
including Audio/Video Enhancement & Synchronization, Broadcast Data Retrieval,
Compact Disk, Computer Memory Cache Coherency, Credit Card Fraud Protection,
Data Encryption & Product Activation, Digital Media Transmission ("DMT(R)"),
Digital Video Production, Dynamic Manufacturing Modeling, Enhanced Internet
Navigation, Hearing Aid ECM, Image Resolution Enhancement, Interactive Data
Sharing, Interactive Television, Interstitial Internet Advertising, Laptop
Docking Station Connectivity, Microprocessor Enhancement, Multi-dimensional Bar
Codes, Network Data Storage, Resource Scheduling, Rotational Video Imaging and
Spreadsheet Automation.
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 common stock ("AR-CombiMatrix stock") and Acacia
Research-Acacia Technologies common 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.
4
BASIS OF PRESENTATION. The accompanying unaudited 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 accompanying 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 ("SEC"). These interim consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto for the year ended December 31, 2004, 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 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 statement of our financial position as of
June 30, 2005, and results of operations and cash flows for the interim periods
presented. The results of operations for the three months and six months ended
June 30, 2005, are not necessarily indicative of the results to be expected for
the entire year.
SEPARATE GROUP PRESENTATION. AR-CombiMatrix stock and AR-Acacia
Technologies stock are intended to reflect the separate performance of the
respective divisions of Acacia Research Corporation. The CombiMatrix group and
the Acacia Technologies group are not separate legal entities. Holders of
AR-CombiMatrix stock and AR-Acacia Technologies stock are stockholders of Acacia
Research Corporation. As a result, holders of AR-CombiMatrix stock and AR-Acacia
Technologies stock continue to be subject to all of the risks of an investment
in Acacia Research Corporation and all of its businesses, assets and
liabilities. The assets Acacia Research Corporation attributes to one of the
groups could be subject to the liabilities of the other group. The group
financial statements have been prepared in accordance with generally accepted
accounting principles in the United States of America, and taken together,
comprise all the accounts included in the corresponding consolidated financial
statements of Acacia Research Corporation. The financial statements of the
groups reflect the financial condition, results of operations, and cash flows of
the businesses included therein. The financial statements of the groups include
the accounts or assets of Acacia Research Corporation specifically attributed to
the groups and were prepared using amounts included in Acacia Research
Corporation's consolidated financial statements.
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
REVISION IN THE CLASSIFICATION OF CERTAIN SECURITIES. In connection
with the preparation of our annual Report on Form 10-K for the year ended
December 31, 2004, we concluded that it was appropriate to classify our auction
rate municipal bonds and variable rate municipal demand notes as current
investments. Previously, such investments had been classified as cash and cash
equivalents. Accordingly, we have revised our prior classification to report
these securities as current investments in our Consolidated Balance Sheet as of
June 30, 2004. We have also made corresponding adjustments to our Consolidated
Statement of Cash Flows for the six months ended June 30, 2004, to reflect the
gross purchases and sales of these securities as investing activities rather
than as a component of cash and cash equivalents. This change in classification
does not affect previously reported cash flows from operations or from financing
activities in our previously reported Consolidated Statements of Cash Flows, or
our previously reported Consolidated Statements of Income for any period.
As of June 30, 2004, and December 31, 2003, before this revision in
classification, $12,750,000 and $7,750,000, respectively, of these current
investments were classified as cash and cash equivalents on our Consolidated
Balance Sheets. For the six months ended June 30, 2004, before this revision in
classification, net cash used in investing activities related to these current
investments of $5,000,000 were included in cash and cash equivalents in our
Consolidated Statement of Cash Flows.
5
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, including shipping and
handling fees, are recognized when delivery has occurred or services have been
rendered.
Deferred revenues arise from payments received in advance of the
culmination of the earnings process. Deferred revenues expected to be recognized
within the next twelve months are classified within current liabilities.
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 license agreements, the Acacia Technologies
group grants non-exclusive licenses for the use of its patented technologies. In
general, pursuant to the terms of our agreements with our licensees, upon the
grant of the licenses, the Acacia Technologies group has no further obligations
with respect to the licenses granted. License fees paid to and recognized as
revenue by the Acacia Technologies group are non-refundable.
Revenues generated from license agreements are generally accrued and
recognized as revenue in the period earned, provided that amounts are fixed or
determinable and collectibility is reasonably assured.
Certain license agreements provide for the calculation of license fees
based on a licensee's actual quarterly sales or actual per unit activity,
applied to a contractual royalty rate. Licensees that pay license fees on a
quarterly basis generally report actual quarterly sales or actual per unit
activity 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 sales or 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 or per unit activity, 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.
Certain license agreements provide for the payment of a minimum upfront
annual license fee at the inception of each annual license term. Minimum upfront
annual license fees are generally determined based on a licensee's estimated
annual sales or a licensee's base level of per unit activity. These minimum
upfront annual 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, determined and reported in accordance with the terms of the
respective agreements, exceed the minimum upfront annual license fees paid, the
additional royalties are recognized in revenue in the quarter following the
6
quarter in which the base per unit activity was exceeded or the quarter
following the annual license term, depending on the terms of the respective
agreement, provided that amounts are fixed or determinable and collectibility is
reasonably assured.
Certain license agreements provide for the payment of contractually
determined paid-up license fees to us in consideration for the grant of a
non-exclusive, retroactive and future license to manufacture and/or sell
products covered by our patented technologies. Certain of the agreements also
provide for future royalties or additional required payments based on future
activities. The execution of these license agreements may also result in the
dismissal of any pending litigation. Pursuant to the terms of these agreements,
the Acacia Technologies group has no further obligation with respect to the
grant of the non-exclusive retroactive and future license, including no express
or implied obligation on the Acacia Technologies group's part to maintain or
upgrade the technology, or provide future support or services. Generally, the
agreements provide for the grant of the license upon execution of the agreement.
As such, the earnings process is generally complete upon the execution of the
agreement, and revenue is recognized upon execution of the agreement, when
collectibility is reasonably assured, and all other revenue recognition criteria
have been met.
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, we may recognize royalty revenues that relate to prior
period activities of our licensees. Differences between amounts initially
recognized and amounts subsequently audited or reported as an adjustment to
those amounts are 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. In May 2005,
CombiMatrix Molecular Diagnostics, Inc. adopted the CombiMatrix Molecular
Diagnostics 2005 Stock Award Plan. Compensation cost related to stock options
issued to employees is accounted for in accordance with Accounting Principles
Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB
No. 25") and related interpretations. Compensation cost attributable to such
options is recognized based on the difference, if any, between the closing
market price of the stock on the date of grant and the exercise price of the
option. Compensation cost is generally deferred and amortized on an accelerated
basis over the vesting period of the individual option awards using the
amortization method prescribed in Financial Accounting Standards Board ("FASB")
Interpretation No. 28, "Accounting for Stock Appreciation Rights and Other
Variable Stock Option or Award Plans" ("FIN No. 28"). We have adopted the
disclosure only requirements of SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"), as amended by SFAS No. 148 "Accounting for
Stock-Based Compensation--Transition and Disclosure--an amendment of SFAS No.
123" ("SFAS No. 148"), with respect to options issued to employees. Compensation
cost of stock options and warrants issued to non-employee service providers is
accounted for under the fair value method required by SFAS No. 123 and related
interpretations.
The following table illustrates the effect on net income (loss) and
earnings (loss) per share if Acacia Research Corporation had applied the fair
value recognition provisions of SFAS No. 123 (in thousands, except per share
data):
7
AR-ACACIA TECHNOLOGIES STOCK AR-COMBIMATRIX STOCK
-------------------------------- --------------------------------
THREE MONTHS ENDED THREE MONTHS ENDED
-------------------------------- --------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
------------- ------------- ------------- -------------
Income (loss) from operations as reported .............. $ (1,760) $ (1,153) $ (3,657) $ (3,516)
Add: Stock-based compensation, intrinsic
value method reported in net loss, net of tax ....... -- -- -- 188
Deduct: Pro forma stock-based compensation
fair value method, net of tax ....................... (371) (551) (672) (1,845)
------------- ------------- ------------- -------------
Income (loss) from operations, pro forma ............... $ (2,131) $ (1,704) $ (4,329) $ (5,173)
============= ============= ============= =============
Basic earnings (loss) per share from operations
as reported ......................................... $ (0.06) $ (0.06) $ (0.12) $ (0.12)
Basic earnings (loss) per share from operations,
pro forma ........................................... $ (0.08) $ (0.09) $ (0.14) $ (0.17)
Diluted earnings (loss) per share from operations
as reported ......................................... $ (0.06) $ (0.06) $ (0.12) $ (0.12)
Diluted earnings (loss) per share from operations,
pro forma ........................................... $ (0.08) $ (0.09) $ (0.14) $ (0.17)
Weighted Average Assumptions used (1):
Risk free interest rate ................................ 3.90% 3.42% 3.83% 3.63%
Volatility ............................................. 94% 104% 88% 104%
Expected term .......................................... 5 years 5 years 5 years 5 years
AR-ACACIA TECHNOLOGIES STOCK AR-COMBIMATRIX STOCK
-------------------------------- --------------------------------
SIX MONTHS ENDED SIX MONTHS ENDED
-------------------------------- --------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
------------- ------------- ------------- -------------
Income (loss) from operations as reported .............. $ (3,634) $ (2,142) $ (6,733) $ 8,376
Add: Stock-based compensation, intrinsic
value method reported in net loss, net of tax ....... -- -- -- 426
Deduct: Pro forma stock-based compensation
fair value method, net of tax ....................... (717) (1,113) (1,691) (3,617)
------------- ------------- ------------- -------------
Income (loss) from operations, pro forma ............... $ (4,351) $ (3,255) $ (8,424) $ 5,185
============= ============= ============= =============
Basic earnings (loss) per share from operations
as reported ......................................... $ (0.14) $ (0.11) $ (0.22) $ 0.29
Basic earnings (loss) per share from operations,
pro forma ........................................... $ (0.17) $ (0.16) $ (0.27) $ 0.18
Diluted earnings (loss) per share from operations
as reported ......................................... $ (0.14) $ (0.11) $ (0.22) $ 0.28
Diluted earnings (loss) per share from operations,
pro forma ........................................... $ (0.17) $ (0.16) $ (0.27) $ 0.17
Weighted Average Assumptions used (1):
Risk free interest rate ................................ 3.71% 3.32% 3.82% 3.13%
Volatility ............................................. 94% 104% 88% 104%
Expected term .......................................... 5 years 5 years 5 years 5 years
- --------------------
(1) The fair value of stock options was determined using the Black-Scholes
option-pricing model. The fair value calculations assume no expected
dividends.
PATENTS AND GOODWILL. Goodwill and identifiable intangibles, including
patents, are recorded when the consideration paid for acquisitions exceeds the
fair value of the net tangible assets acquired. Patents, once issued or
purchased, are amortized on the straight-line method over their remaining
economic useful lives. Goodwill is not amortized.
IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL. We review long-lived
assets and intangible assets for potential impairment annually and when events
or changes in circumstances indicate the carrying amount of an asset may not be
recoverable. In the event the sum of the expected undiscounted future cash flows
resulting from the use of the asset is less than the carrying amount of the
asset, an impairment loss equal to the excess of the asset's carrying value over
its fair value is recorded. If an asset is determined to be impaired, the loss
is measured based on quoted market prices in active markets, if available. If
quoted market prices are not available, the estimate of fair value is based on
various valuation techniques, including a discounted value of estimated future
cash flows.
Goodwill is evaluated for impairment in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets" ("SFAS No. 142") and is subject to a
periodic review for potential impairment at a reporting unit level. Reviews for
potential impairment must occur at least annually and may be performed earlier,
if circumstances indicate that an impairment may have occurred. Acacia Research
Corporation has elected to perform its annual tests for indications of goodwill
impairment as of December 31 of each year. Goodwill is allocated between two of
our reporting units at June 30, 2005: 1) the Acacia Technologies group and 2)
the CombiMatrix group. The fair values of our reporting units are estimated
using a discounted cash flow analysis and by reference to quoted market prices
of Acacia Research Corporation's classes of stock.
8
SFAS No. 142 requires us to compare the fair value of our reporting
units to their carrying amounts on an annual basis to determine if there is
potential goodwill impairment. If the fair value of a reporting unit is less
than its carrying value, an impairment loss is recorded to the extent that the
fair value of the goodwill within the reporting unit is less than its carrying
value. There can be no assurance that future goodwill impairment tests will not
result in a charge to earnings.
BUSINESS ACQUISITIONS. The cost of an acquired business is assigned to
the tangible and identifiable intangible assets acquired and liabilities assumed
on the basis of their fair values at the date of acquisition. We assess fair
value using a variety of methods, including the use of present value models,
independent appraisers, and estimation of current selling prices and replacement
values. Amounts recorded as intangible assets are based on assumptions and
estimates regarding the amount and timing of projected revenues and costs,
appropriate risk-adjusted discount rates, as well as assessing the economic
useful lives of our technologies, the impact of competition and other market
factors. Actual results may vary from projected results.
USE OF ESTIMATES. The preparation of financial statements in conformity
with generally accepted accounting principles in the United States of America
requires management to make estimates and assumptions that affect the reported
amount of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from these estimates.
3. EARNINGS PER SHARE
Earnings per share for each class of common stock is computed by
dividing the earnings or loss 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 earnings or loss
allocated to each class of common stock by the weighted average number of
outstanding shares of that class of common stock including the dilutive effect
of common stock equivalents. Potentially dilutive common stock equivalents
primarily consist of employee stock options and warrants.
The earnings or losses allocated to each class of common stock are
determined by Acacia Research Corporation's board of directors. This
determination is generally based on the net income or loss amounts of the
corresponding group determined in accordance with accounting principles
generally accepted in the United States of America, consistently applied. Acacia
Research Corporation believes this method of allocation is systematic and
reasonable. The Acacia Research Corporation board of directors can, at its
discretion, change the method of allocating earnings or losses to each class of
common stock at any time. Management currently has no plans to change allocation
methods.
The following table presents a reconciliation of basic and diluted
income (loss) per share:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
------------------------------- -------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
-------------- -------------- -------------- --------------
ACACIA RESEARCH - ACACIA TECHNOLOGIES STOCK
- -------------------------------------------
Basic and diluted weighted average number of common
shares outstanding .......................................... 27,271,416 19,787,466 25,922,412 19,769,901
============== ============== ============== ==============
Potential AR-Acacia Technologies stock common shares
excluded from the per share calculation because
the effect of their inclusion would be anti-dilutive ........ 1,309,481 1,376,010 1,355,879 1,405,370
============== ============== ============== ==============
ACACIA RESEARCH - COMBIMATRIX STOCK
- -----------------------------------
Basic weighted average number of common shares outstanding ..... 31,200,984 30,459,576 31,200,742 28,867,101
Dilutive effect of outstanding stock options and warrants ...... -- -- -- 1,518,411
-------------- -------------- -------------- --------------
Diluted weighted average number of common and potential
common shares outstanding ................................... 31,200,984 30,459,576 31,200,742 30,385,512
============== ============== ============== ==============
Potential AR-CombiMatrix stock common shares excluded from
the per share calculation because the effect of their
inclusion would be anti-dilutive ............................ 297,108 1,160,408 398,212 --
============== ============== ============== ==============
4. GOODWILL AND INTANGIBLES
The Acacia Technologies group had $121,000 of goodwill at June 30,
2005, and December 31, 2004. The CombiMatrix group had $19,424,000 of goodwill
at June 30, 2005, and December 31, 2004.
Acacia Research Corporation's only identifiable intangible assets at
June 30, 2005, and December 31, 2004, are patents and patent rights. The gross
carrying amounts and accumulated amortization as of June 30, 2005, and December
31, 2004, related to patents, by segment, are as follows (in thousands):
9
ACACIA TECHNOLOGIES GROUP COMBIMATRIX GROUP
------------------------------ ------------------------------
JUNE 30, DECEMBER 31, JUNE 30, DECEMBER 31,
2005 2004 2005 2004
------------ ------------ ------------ ------------
Gross carrying amount - patents ..... $ 30,279 $ 4,726 $ 12,095 $ 12,095
Accumulated amortization ............ (3,936) (1,684) (3,622) (3,074)
------------ ------------ ------------ ------------
Patents, net ........................ $ 26,343 $ 3,042 $ 8,473 $ 9,021
============ ============ ============ ============
The Acacia Technologies group and the CombiMatrix group's patents have
remaining estimated economic useful lives up to 2012 and 2020, respectively. The
weighted average remaining estimated economic useful life of the Acacia
Technologies group's patents is 6 years. Annual aggregate amortization expense
for each of the five fiscal years through December 31, 2009 is estimated to be
$4,914,000 in 2005, $5,324,000 in 2006, $5,272,000 in 2007, $3,951,000 in 2008
and $3,504,000 in 2009 for the Acacia Technologies group and $1,095,000 per year
for the CombiMatrix group. At June 30, 2005, and December 31, 2004, all of our
acquired intangible assets other than goodwill were subject to amortization.
See Note 8 for additions to patent related intangibles during the six
months ended June 30, 2005.
5. EQUITY FINANCING
In February 2005, Acacia Research Corporation raised gross proceeds of
$19,600,000 through the sale of 3,500,000 shares of AR-Acacia Technologies stock
at a price of $5.60 per share in a registered direct offering. Net proceeds
raised of approximately $19,530,000, which are net of related issuance costs,
were attributed to the Acacia Technologies group and will be used for general
working capital purposes. The shares of AR-Acacia Technologies stock were
offered pursuant to an effective registration statement previously filed with
the Securities and Exchange Commission.
6. RESEARCH AND DEVELOPMENT CONTRACTS
In August 2004, the CombiMatrix group received a $1,000,000 upfront
payment from Furuno Electric Co., LTD ("Furuno") as part of a multi-year
collaboration agreement to develop a bench-top array synthesizer for commercial
applications. In 2003, the CombiMatrix group received upfront and milestone
payments from Toppan Printing Co., LTD ("Toppan") totaling $2,400,000, pursuant
to a multi-year collaboration and supply agreement to develop and manufacture
arrays using the CombiMatrix group's proprietary electrochemical detection
approach. The payments received from Furuno and Toppan are included in deferred
revenues at June 30, 2005, and December 31, 2004, in accordance with the
CombiMatrix group's revenue recognition policies for multiple-element
arrangements.
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.
7. RECENT ACCOUNTING PRONOUNCEMENTS
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections." This statement applies to all voluntary changes in
accounting principle and requires retrospective application to prior periods'
financial statements of changes in accounting principle, unless this would be
impracticable. This statement also makes a distinction between "retrospective
application" of an accounting principle and the "restatement" of financial
statements to reflect the correction of an error. This statement is effective
for accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. We are evaluating the effect the adoption of this
interpretation will have on its financial position, cash flows and results of
operations.
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payments," ("SFAS No. 123(R)") that addresses the accounting for
share-based payment transactions in which an enterprise receives employee
services in exchange for (a) equity instruments of the enterprise or (b)
10
liabilities that are based on the fair value of the enterprise's equity
instruments or that may be settled by the issuance of such equity instruments.
SFAS No. 123(R) will require Acacia Research Corporation to measure all employee
stock-based compensation awards using a fair-value method and record such
expense in its consolidated and separate group financial statements. The
adoption of SFAS No. 123(R) will require additional accounting related to the
income tax effects and additional disclosure regarding the cash flow effects
resulting from share-based payment arrangements. SFAS No. 123(R) was to be
effective beginning in the quarter ending September 30, 2005. On April 14, 2005,
the SEC announced a deferral of the effective date of SFAS No. 123(R) for
calendar year companies until the beginning of 2006. In March 2005, the SEC
issued Staff Accounting Bulletin No. 107 ("SAB 107") regarding the SEC Staff's
interpretation of SFAS No. 123(R) and provides the Staff's views regarding
interactions between SFAS No. 123(R) and certain SEC rules and regulations and
provides interpretations of the valuation of share-based payments for public
companies. The effect of the adoption of SFAS No. 123(R) is expected to be
comparable to the effect disclosed on a pro forma basis resulting from the
application of the current fair-value recognition provisions of SFAS No. 123, as
shown in Note 2 above.
8. ACQUISITION
On January 28, 2005, Acacia Global Acquisition Corporation, a wholly
owned subsidiary of Acacia Research Corporation, acquired substantially all of
the assets of Global Patent Holdings, LLC, a privately held patent holding
company based in Northbrook, Illinois, which owned 11 patent licensing
companies. The acquisition provided the Acacia Technologies group 100% ownership
of companies that control 27 patent portfolios, which include 120 U.S. patents
and certain foreign counterparts, and cover technologies used in a wide variety
of industries. As a result of the acquisition, we have expanded and diversified
the Acacia Technologies group's revenue generating opportunities and accelerated
the execution of the Acacia Technologies group's business strategy of acquiring,
developing and licensing patented technologies.
The acquisition was accounted for using the purchase method of
accounting. Under the purchase method of accounting, the purchase consideration
is allocated to the assets acquired, including tangible assets, patents and
other identifiable intangibles and liabilities assumed, based on their estimated
fair market values at the date of acquisition. The consolidated statement of
operations includes the results of the acquired companies beginning on January
28, 2005, the date of acquisition. The aggregate purchase consideration was
approximately $25,089,000, including $5.0 million of cash, the issuance of
3,938,832 shares of AR-Acacia Technologies stock valued at $19,293,000 (net of
estimated common stock registration costs of $212,000) and acquisition costs,
including registration costs, of $796,000. The value of the common shares issued
was determined based on the average market price of AR-Acacia Technologies
stock, as reported on NASDAQ, over the 5-day period (December 13 - December 17,
2004) before and after the terms of the acquisition were agreed to and
announced.
The following table summarizes the total purchase consideration and the
allocation of the consideration paid to the estimated fair value of the assets
acquired and liabilities assumed (in thousands):
Purchase Consideration:
Cash paid.................................................................. $ 5,000
Fair value of AR-Acacia Technologies stock issued (1)...................... 19,293
Acquisition and registration costs......................................... 796
--------------
Total purchase consideration.................................................... $ 25,089
==============
Purchase Price Allocation:
Estimated fair value of net tangible assets acquired at January 28, 2005 ... $ (49)
Intangible assets acquired - patents and patent rights (1).................. 25,138
--------------
Total........................................................................ $ 25,089
==============
--------------------
(1) Reflects non-cash investing activity.
Management was primarily responsible for determining the fair value of
the tangible and identifiable intangible assets acquired and liabilities assumed
at the date of acquisition. Management considered a number of factors, including
reference to an independent valuation. The patents and patent rights acquired
were valued using a discounted cash flow model on a patent portfolio by
portfolio basis, which estimated the future net cash flows expected to result
from the licensing of each portfolio, taking into account potential infringers
of the patents, usage of the underlying technologies, estimated license fee
revenues, contingent legal fee arrangements, inventor royalties due to former
patent holders, other estimated costs, tax implications and other factors. A
discount rate consistent with the risks associated with achieving the estimated
11
net cash flows was used to estimate the present value of future estimated net
cash flows. Management's valuation resulted in an estimated fair value of patent
related assets acquired of approximately $27,000,000, resulting in approximately
$1,900,000 of excess fair value over the cost of net assets acquired, which has
been allocated as a pro rata reduction to the amounts that otherwise would have
been assigned to the assets acquired, in accordance with the purchase method of
accounting.
Amounts attributable to patents and patent rights acquired are
amortized using the straight-line method over the estimated economic useful
lives of the underlying patents which range from two to seven years. The
estimated weighted average useful life of amortizable patent related intangibles
acquired is approximately 6 years.
In connection with the acquisition described above, Acacia Global
Acquisition Corporation entered into a consulting agreement with the former CEO
of Global Patent Holdings, LLC who, as a result of the acquisition transaction,
is also a shareholder of Acacia Research Corporation. The agreement requires the
payment of $2,000,000 in consulting fees over a two-year period, and certain
reimbursable consulting related expenses, commencing on the date of acquisition.
Marketing, general and administrative expenses for the three and six months
ended June 30, 2005, include $271,000 and $466,000, respectively, in expenses
related to the consulting agreement. Consulting services to be performed consist
primarily of consultation on intellectual property matters associated with the
patents and patent rights acquired in the transaction. The consulting fees will
be expensed in the consolidated statement of operations as the consulting
services are rendered during the two-year term of the consulting agreement.
Acacia Global Acquisition Corporation may terminate the consulting agreement for
cause as provided for in the agreement. The consulting agreement also contains
certain automatic termination provisions, including; the failure by Acacia
Global Acquisition Corporation to make timely consulting payments in accordance
with the agreement; a significant decrease in working capital of Acacia Research
Corporation, as defined in the agreement; material breach of the agreement by
Acacia Global Acquisition Corporation; and the death of the consultant. Any
occurrence of these conditions may require the payment of all remaining
consulting fees outstanding under the agreement within thirty days of the
occurrence of the termination event. Acacia Research Corporation also executed
an agreement guaranteeing Acacia Global Acquisition Corporation's performance of
its obligations under the consulting agreement.
The acquisition will be treated for tax purposes as a taxable asset
acquisition and, as such, Acacia Research Corporation does not expect any
book/tax basis differences and thus, no deferred income taxes were recorded in
connection with the application of the purchase method of accounting.
The following unaudited pro forma combined results of operations for
the interim period presented are provided for illustrative purposes only and
assume the acquisition occurred as of January 1, 2005, and 2004. The unaudited
pro forma combined financial results do not purport to be indicative of the
results of operations for future periods or the results that actually would have
been realized had the entities been a single entity during these periods. The
unaudited pro forma combined results are presented in thousands, except share
and per share information.
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
-------------------------- --------------------------------------------
JUNE 30, 2004 (3) JUNE 30, 2005 (1) JUNE 30, 2004
-------------------------- ------------------- -------------------
Total revenues ................................ $ 4,482 $ 7,471 $ 27,937
-------------------------- ------------------- -------------------
Total operating expenses ...................... 10,311 18,793 23,138
-------------------------- ------------------- -------------------
Operating income (loss) ....................... (5,829) (11,322) 4,799
-------------------------- ------------------- -------------------
Total other income ............................ 439 554 595
-------------------------- ------------------- -------------------
Income (loss) from continuing operations
before income taxes ........................ (5,390) (10,768) 5,394
Benefit for income taxes ...................... 69 134 128
Estimated loss on discontinued operations ..... (104) (210) (104)
-------------------------- ------------------- -------------------
Net income (loss) ............................. $ (5,425) $ (10,844) $ 5,418
========================== =================== ===================
Pro forma earnings (loss) per common share:
Attributable to the Acacia Technologies group:
Net loss ...................................... $ (1,909) $ (4,111) $ (2,958)
Basic and diluted loss per share ......... (0.08) (0.16) (0.12)
Weighted average shares (2):
Acacia Research - Acacia Technologies stock:
Basic and diluted ........................ 23,726,298 26,509,973 23,708,733
========================== =================== ===================
- --------------------
(1) Results of operations for Global Patent Holdings, LLC were not material for
the period January 1, 2005, through January 28, 2005. Pro forma adjustments
reflect the impact of the acquisition for the 28-day period from January 1,
2005 to January 28, 2005.
(2) There is no pro forma impact on earnings (loss) per share attributable to
the CombiMatrix group as presented in the accompany statements of
operations for the six months ended June 30, 2005, and 2004 and the three
months ending June 30, 2004.
(3) There is no pro forma impact on the three months ended June 30, 2005.
12
9. COMMITMENTS AND CONTINGENCIES
COMBIMATRIX GROUP
In October 2004, the CombiMatrix group entered into an agreement to
acquire up to a one-third ownership interest in Leuchemix, Inc. ("Leuchemix"), a
private drug development firm, which is developing several compounds for the
treatment of leukemia and other cancers. In accordance with the terms of the
purchase agreement, the CombiMatrix group will purchase 3,137,500 shares of
Series A Preferred Stock of Leuchemix for a total purchase price of $4,000,000.
The ownership interest will be acquired and paid for quarterly over the two-year
period commencing with the fourth quarter of 2004. In accordance with the terms
of the purchase agreement, the CombiMatrix group made scheduled investments
totaling $600,000 during the six months ended June 30, 2005, resulting in an
ownership interest of approximately 9.6% as of June 30, 2005. The CombiMatrix
group will make additional investments in Leuchemix of $1,000,000 in 2005 and
$2,150,000 in 2006, in accordance with the terms of the agreement. The
CombiMatrix group's investment is being accounted for under the equity method as
the CombiMatrix group has the ability to exercise significant influence over
Leuchemix, primarily due to CombiMatrix Corporation's representation on
Leuchemix's board of directors.
In March 2004, the CombiMatrix group was awarded a two-year, $5.9
million contract with the Department of Defense to further the development of
the CombiMatrix group's array technology for the detection of biological threat
agents. Under the terms of the contract, the CombiMatrix group will perform
research and development activities, as described under the contract, and 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. As of June 30, 2005, the
biological threat detection contract with the Department of Defense was
approximately 68% complete and had approximately $1.4 million of costs remaining
to be incurred on the existing contract.
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 six months ended June 30,
2005, and 2004, we recorded a net non-cash credit totaling $195,000 and a net
non-cash charge totaling $866,000, respectively, in connection with certain
anti-dilution provisions of the settlement agreement. The related liability
reflects management's estimate, as of each balance sheet date, of the fair value
of AR-CombiMatrix stock to be issued to Nanogen, Inc. as a result of certain
options and warrants exercised during the period, if any, and the fair value of
AR-CombiMatrix stock potentially issuable to Nanogen, Inc. as of each balance
sheet date pursuant to the anti-dilution terms of the agreement. The liability
is adjusted at each balance sheet 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 are $25,000 per
quarter until the patents expire in 2018. Royalties incurred under the agreement
during the six months ended June 30, 2005, and 2004, were $53,000 and $75,000,
respectively.
ACACIA TECHNOLOGIES GROUP
In connection with the acquisition of certain patents and patent
rights, certain companies included in the Acacia Technologies group executed
related agreements which grant to the former owners of the respective patents or
patent rights, the right to receive inventor royalties based on future net
license fee revenues (as defined in the respective agreements) generated by the
Acacia Technologies group as a result of licensing the respective patents or
patent portfolios. Inventor royalties paid pursuant to the agreements are
expensed in the consolidated statement of operations in the period that the
related license fee revenues are recognized.
In connection with the Acacia Technologies group's licensing and
enforcement activities, the Acacia Technologies group may retain the services of
law firms that specialize in intellectual property licensing and enforcement and
patent law. These law firms may be retained on a contingent fee basis in which
the law firms are paid on a scaled percentage of any negotiated license fees,
settlements or judgments awarded based on how and when the license fees,
settlements or judgments are obtained by the Acacia Technologies group. In
instances where the Acacia Technologies group does not recover license fees from
potential infringers, no contingent legal fees are paid; however, the Acacia
Technologies group may be liable for certain out of pocket legal costs incurred
pursuant to the underlying legal services agreement. Legal fees advanced by
13
contingent law firms that are required to be paid in the event that no license
recoveries are obtained by the Acacia Technologies group are included in
long-term liabilities in the statement of financial condition.
LITIGATION
Acacia Research Corporation is subject to 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. As additional information becomes available, we will
assess the potential liability related to our pending litigation and may revise
our estimates accordingly. Such revisions in our estimates of the potential
liability could materially impact our results of operations and financial
position.
PATENT ENFORCEMENT LITIGATION
From time to time, companies comprising the Acacia Technologies group
engage in litigation to enforce their patents and patent rights. In the
litigation listed below, certain companies comprising the Acacia Technologies
group are parties to ongoing litigation alleging infringement of certain of our
patented technologies by the companies listed. Current patent enforcement
litigation, by related patented technology, is as follows:
AUDIO/VIDEO ENHANCEMENT AND SYNCHRONIZATION TECHNOLOGY
IMAGE RESOLUTION ENHANCEMENT TECHNOLOGY
IP Innovation, LLC and Technology Licensing Corporation v. Lexmark
International, Inc. United States District Court for the Northern District of
Illinois. Filed 10/23/02. Case No. 1:02-cv-07611.
IP Innovation, LLC and Technology Licensing Corporation v. Dell
Computer Corporation. United States District Court for the Northern District of
Illinois. Filed 5/15/03. Case No. 1:03-cv-03245.
IP Innovation, LLC, Technology Licensing Corporation, New Medium
Technologies, LLC, and AV Technologies LLC v. Sony Electronics, Inc. United
States District Court for the Northern District of Illinois. Filed 10/4/04. Case
No. 1:04-cv-06388.
IP Innovation, LLC, Technology Licensing Corporation, New
Medium Technologies, LLC and AV Technologies, LLC v. Matsushita Electric
Industrial Co., Ltd. and Panasonic Corporation of North America. United States
District Court for the Northern District of Illinois. Filed 2/14/05. Case No.
1:05-cv-00902.
Technology Licensing Corporation and AV Technologies, LLC v. Thomson,
Inc. United States District Court for the Eastern District of California. Filed
6/20/03. Case No. 2:03-cv-01329.
COMPUTER MEMORY CACHE COHERENCY TECHNOLOGY
Computer Cache Coherency Corporation v. VIA Technologies, Inc. and Via
Technologies, Inc. (USA). United States District Court for the Northern District
of California. Filed 12/2/04. Case No. 5:05-cv-01668.
Computer Cache Coherency Corporation v. Advanced Micro Devices, Inc.
United States District Court for the Northern District of California. Filed
4/28/05. Case No. 5:05-cv-01767.
Computer Cache Coherency Corporation v. Intel Corporation. United
States District Court for the Northern District of California. Filed 4/28/05.
Case No. 5:05-cv-01766.
CREDIT CARD FRAUD PROTECTION TECHNOLOGY
Financial Systems Innovation, LLC and Paul N. Ware v. Gap, Inc.,
Racetrac Petroleum, Inc. and The Kroger Company. United States District Court
for the Northern District of Georgia. Filed 3/3/04. Case No. 4:04-cv-00065.
Financial Systems Innovation, LLC and Paul N. Ware v. Williams-Sonoma,
Inc., Linens N Things, Inc. and Costco Wholesale Corporation. United States
District Court for the Northern District of Texas. Filed 6/30/04. Case No.
4:04-cv-00479.
14
DIGITAL MEDIA TRANSMISSION TECHNOLOGY
In accordance with the Transfer Order issued February 24, 2005, by the
Judicial Panel on Multidistrict Litigation, all of the following Digital Media
Transmission Technology cases have been transferred to the Northern District of
California. The lead case number is 5:05-cv-01114.
Acacia Media Technologies Corporation v. Comcast Cable Communications,
LLC Charter Communications, Inc., The DirectTV Group, Inc., Echostar
Communications Corporation, Cox Communications, Inc., Hospitality Network, Inc.
(a wholly owned subsidiary of Cox that supplies hotel on-demand TV services),
Mediacom, LLC, Armstrong Group, Arvig Communication Systems, Block
Communications, Inc., Cable America Corporation, Cable One, Inc., Cannon Valley
Communications, Inc., East Cleveland Cable TV and Communications, LLC, Loretel
Cablevision, Massillon Cable TV, Inc., Mid-Continent Media, Inc., NPG Cable,
Inc., Savage Communications, Inc., Sjoberg's Cablevision, Inc., US Cable
Holdings LP, and Wide Open West, LLC, Time Warner Cable, Cablevision Systems
Corporation, Insight Communications Company, Cebridge Communications and Bresnan
Communications.
Acacia Media Technologies Corporation v. New Destiny Internet Group,
Inc., Audio Communications Inc., VS Media Inc., Ademia Multimedia, LLC,
International Web Innovations, Inc., Offendale Commercial BV, Ltd., Adult
Entertainment Broadcast Network, Cybertrend, Inc., Lightspeed Media Corporation,
Adult Revenue Services, Innovative Ideas International, AskCS.com, Game Link,
Inc., Club Jenna, Inc., Cybernet Ventures, Inc., ACMP, LLC, Global AVS, Inc.
d/b/a DrewNet, ICS, Inc. / AP Net Marketing, Inc., and National A-1 Advertising.
DYNAMIC MANUFACTURING MODELING TECHNOLOGY
Information Technology Innovation, LLC v. Motorola, Inc. and Freescale
Semiconductor, Inc. United States District Court for the Northern District of
Illinois. Filed 11/3/04. Case No. 1:04-cv-07121.
Intel Corporation v. Information Technology Innovation, LLC. United
States District Court for the Northern District of Illinois. Filed 7/7/05. Case
No. 1:05-cv-03951. See Note 11.
INTERACTIVE TELEVISION TECHNOLOGY
Broadcast Innovation, LLC and IO Research, Ltd v. Charter
Communications, Inc. and Comcast Corporation. United States District Court for
the District of Colorado, on appeal to the U.S. Court of Appeals for the Federal
Court. Notice of Appeal Filed 9/28/04. Lower Court Case No. 1:03-cv-02223.
Broadcast Innovation, LLC v. Echostar Communications Corporation.
United States District Court for the District of Colorado. Filed 11/9/01. Case
No. 1:01-cv-02201.
INTERSTITIAL INTERNET ADVERTISING
InternetAd Systems, LLC v. British Airways PLC, Continental Airlines
Inc., Priceline.com Incorporated. United States District Court for the Northern
District of Texas. Filed 3/28/05. Case No. 3:05-cv-00604.
MICROPROCESSOR ENHANCEMENT TECHNOLOGY
Microprocessor Enhancement Corporation and Michael H. Branigin v. Texas
Instruments, Incorporated and Intel Corporation. United States District Court
for the Central District of California. Filed 4/7/05. Case No. 8:05-cv-00323.
MULTI-DIMENSIONAL BAR CODE TECHNOLOGY
VCode Holdings, Inc. and VData, LLC v. Adidas America, Inc., Advanced
Micro Devices, Inc., Boston Scientific Corporation, Stamps.com, Inc., and
Hitachi Global Storage Technologies (Thailand), Ltd. United States District
Court for the District of Minnesota. Filed 10/25/04. Case No. 0:04-cv-04583.
SPREADSHEET AUTOMATION
Spreadsheet Automation Corporation v. Microsoft Corporation. United
States District Court for the Eastern District of Texas. Filed 3/28/05. Case No.
2:05-cv-00127. See Note 11.
15
V-CHIP TECHNOLOGY
The remaining Non-Soundview, Inc. parties in the Acacia Technologies
group's V-chip patent infringement lawsuit, which concluded in August 2004,
filed a motion before the United States District Court for the District of
Connecticut seeking reimbursement of certain attorney's fees. On July 13, 2005,
the Court entered an Order denying the motion in part, and granting the motion
in part. The motion was denied with respect to Soundview Inc.'s patent
infringement allegations, which the Court ruled were not asserted in bad faith.
The motion was granted with respect to certain anti-trust allegations asserted
subsequent to the Court's ruling of non-infringement in August 2004. 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.
OTHER
IP Innovation, LLC v. Digital Think, Inc., Docent, Inc., eCollege.Com.
United States District Court for the Southern District of Texas. On appeal to
the U.S. Court of Appeals for the Federal Circuit. Notice of Appeal Filed
12/10/04. Lower Court Case No. 4:02-cv-02031.
10. DISCONTINUED OPERATIONS
Results for the six months ended June 30, 2005 and June 30, 2004,
include a $210,000 and $104,000 charge, net of minority interests, related to
estimated additional costs to be incurred in connection with the discontinued
operations of Soundbreak.com (originally ceased operations in February 2001),
related primarily to certain noncancellable lease obligations and a reduction in
estimated amounts recoverable from existing sublease arrangements. The related
lease obligations, which are guaranteed by Acacia Research Corporation, expire
in August 2005.
11. SUBSEQUENT EVENTS
In July 2005, Intel Corporation filed a Complaint in the District Court
for the Northern District of Illinois against Information Technology LLC, a
wholly owned subsidiary that is part of the Acacia Technologies group, seeking a
Declaratory Judgment of non-infringement of a patent relating to Information
Technology's Dynamic Manufacturing Modeling technology.
In July 2005, Spreadsheet Automation Corporation, a wholly owned
subsidiary that is part of the Acacia Technologies group, commenced a patent
infringement lawsuit in the District Court for the Eastern District of Texas
against Microsoft Corporation. The suit alleges the unauthorized use by certain
Microsoft products, including without limitation certain versions of Microsoft
Access and Microsoft Excel, of our Spreadsheet Automation technology.
In June 2005, Acacia Research Corporation obtained commitments to
purchase approximately $3.2 million of its AR-CombiMatrix stock in a registered
direct offering, which closed on July 5, 2005. Under the terms of the
transaction, 1,400,444 shares of AR-CombiMatrix stock were sold at $2.25 per
share to a select group of institutional investors. The net proceeds, totaling
approximately $3.1 million, which are net of offering costs, were allocated to
the CombiMatrix group and are expected to be used for general working capital
purposes. All of the shares of AR-CombiMatrix stock were offered by Acacia
Research Corporation pursuant to an effective registration statement previously
filed with the Securities and Exchange Commission.
12. 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.
16
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.
17
CONSOLIDATING BALANCE SHEETS
(IN THOUSANDS)
AT JUNE 30, 2005 AT DECEMBER 31, 2004
-------------------------------------------- --------------------------------------------
ACACIA ACACIA
TECHNO- COMBI- TECHNO- COMBI-
LOGIES MATRIX ELIMI- CONSOL- LOGIES MATRIX ELIMI- CONSOL-
GROUP GROUP NATIONS IDATED GROUP GROUP NATIONS IDATED
--------- --------- --------- --------- --------- --------- --------- ---------
ASSETS
Current assets:
Cash and cash equivalents ......... $ 12,141 $ 7,498 $ -- $ 19,639 $ 15,750 $ 2,985 $ -- $ 18,735
Short-term investments ............ 27,017 8,675 -- 35,692 12,896 20,727 -- 33,623
Accounts receivable ............... 650 1,545 -- 2,195 193 343 -- 536
Prepaid expenses, inventory
and other assets ............... 1,083 484 -- 1,567 754 229 -- 983
Receivable from CombiMatrix
group .......................... 87 -- (87) -- 119 -- (119) --
--------- --------- --------- --------- --------- --------- --------- ---------
Total current assets .......... 40,978 18,202 (87) 59,093 29,712 24,284 (119) 53,877
Property and equipment, net of
accumulated depreciation ............ 137 2,267 -- 2,404 104 2,330 -- 2,434
Patents, net of accumulated
amortization ........................ 26,343 8,473 -- 34,816 3,042 9,021 -- 12,063
Goodwill ............................... 121 19,424 -- 19,545 121 19,424 -- 19,545
Other assets ........................... 79 820 -- 899 79 329 -- 408
--------- --------- --------- --------- --------- --------- --------- ---------
$ 67,658 $ 49,186 $ (87) $ 116,757 $ 33,058 $ 55,388 $ (119) $ 88,327
========= ========= ========= ========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued
expenses and other ............. $ 1,232 $ 2,771 $ -- $ 4,003 $ 2,175 $ 1,964 $ -- $ 4,139
Royalties and legal fees
payable ........................ 447 -- -- 447 -- -- -- --
Current portion of deferred
revenues ....................... 438 144 -- 582 428 66 -- 494
Payable to Acacia
Technologies group ............. -- 87 (87) -- -- 119 (119) --
--------- --------- --------- --------- --------- --------- --------- ---------
Total current liabilities ..... 2,117 3,002 (87) 5,032 2,603 2,149 (119) 4,633
Deferred income taxes .................. 798 2,043 -- 2,841 869 2,112 -- 2,981
Deferred revenues, net of
current portion ..................... 143 3,791 -- 3,934 -- 3,893 -- 3,893
Other liabilities ...................... 196 211 -- 407 -- 406 -- 406
--------- --------- --------- --------- --------- --------- --------- ---------
Total liabilities ............. 3,254 9,047 (87) 12,214 3,472 8,560 (119) 11,913
--------- --------- --------- --------- --------- --------- --------- ---------
Minority interests ..................... 482 -- -- 482 778 -- -- 778
--------- --------- --------- --------- --------- --------- --------- ---------
Redeemable stockholders' equity:
AR - Acacia Technologies stock .... 63,922 -- -- 63,922 28,808 -- -- 28,808
AR - CombiMatrix stock ............ -- 40,139 -- 40,139 -- 46,828 -- 46,828
--------- --------- --------- --------- --------- --------- --------- ---------
Total stockholders' equity .... 63,922 40,139 -- 104,061 28,808 46,828 -- 75,636
--------- --------- --------- --------- --------- --------- --------- ---------
$ 67,658 $ 49,186 $ (87) $ 116,757 $ 33,058 $ 55,388 $ (119) $ 88,327
========= ========= ========= ========= ========= ========= ========= =========
- --------------------
NOTE: Segment information for the Acacia Technologies group includes discontinued operations related to Soundbreak.com. Total assets
related to discontinued operations totaled $837,000 and $1,443,000 at June 30, 2005, and December 31, 2004, respectively. Total
liabilities related to discontinued operations totaled $175,000 and $275,000 at June 30, 2005, and December 31, 2004, respectively.
18
CONSOLIDATING STATEMENTS OF OPERATIONS
(IN THOUSANDS)
FOR THE THREE MONTHS ENDED JUNE 30, 2005 FOR THE SIX MONTHS ENDED JUNE 30, 2005
--------------------------------------------- ---------------------------------------------
ACACIA ELIMI- ACACIA ELIMI-
TECHNO- COMBI- NATIONS/ TECHNO- COMBI- NATIONS/
LOGIES MATRIX RECLASSI- CONSOL- LOGIES MATRIX RECLASSI- CONSOL-
GROUP GROUP FICATIONS IDATED GROUP GROUP FICATIONS IDATED
--------- --------- ---------- --------- --------- --------- ---------- ---------
Revenues:
Research and development and
government contracts ....... $ -- $ 1,281 $ -- $ 1,281 $ -- $ 2,012 $ -- $ 2,012
License fees .................. 2,682 -- -- 2,682 4,545 -- -- 4,545
Products and services ......... -- 576 -- 576 -- 914 -- 914
--------- --------- ---------- --------- --------- --------- ---------- ---------
Total revenues ........... 2,682 1,857 -- 4,539 4,545 2,926 -- 7,471
--------- --------- ---------- --------- --------- --------- ---------- ---------
Operating expenses:
Cost of government contract
revenues ................... -- 1,209 -- 1,209 -- 1,900 -- 1,900
Cost of product sales ......... -- 190 -- 190 -- 353 -- 353
Research and development
expenses ................... -- 1,415 -- 1,415 -- 2,555 -- 2,555
Marketing, general and
administrative expenses .... 1,759 2,502 -- 4,261 3,369 4,781 -- 8,150
Legal expenses - patents ...... 536 -- -- 536 1,097 -- -- 1,097
Contingent legal fees and
inventor royalties expense
- patents .................. 1,120 -- -- 1,120 1,767 -- -- 1,767
Non-cash stock compensation
amortization - marketing,
general and administrative.. -- 15 -- 15 -- (111) -- (111)
Amortization of patents ....... 1,336 274 -- 1,610 2,252 548 -- 2,800
Legal settlement charges
(credits) .................. -- (16) -- (16) -- (195) -- (195)
--------- --------- ---------- --------- --------- --------- ---------- ---------
Total operating expenses.. 4,751 5,589 -- 10,340 8,485 9,831 -- 18,316
--------- --------- ---------- --------- --------- --------- ---------- ---------
Operating income (loss)... (2,069) (3,732) -- (5,801) (3,940) (6,905) -- (10,845)
--------- --------- ---------- --------- --------- --------- ---------- ---------
Other income (expense):
Interest income ............... 278 104 -- 382 449 206 -- 655
Other income (expense) ........ 1 (63) -- (62) 1 (102) -- (101)
--------- --------- ---------- --------- --------- --------- ---------- ---------
Total other income ....... 279 41 -- 320 450 104 -- 554
--------- --------- ---------- --------- --------- --------- ---------- ---------
Income (loss) from continuing
operations before income taxes .. (1,790) (3,691) -- (5,481) (3,490) (6,801) -- (10,291)
Benefit for income taxes ........... 30 34 -- 64 66 68 -- 134
--------- --------- ---------- --------- --------- --------- ---------- ---------
Loss from continuing operations .... (1,760) (3,657) -- (5,417) (3,424) (6,733) -- (10,157)
Discontinued operations:
Estimated loss on disposal of
discontinued operations .... -- -- -- -- (210) -- -- (210)
--------- --------- ---------- --------- --------- --------- ---------- ---------
Net income (loss) .................. $ (1,760) $ (3,657) $ -- $ (5,417) $ (3,634) $ (6,733) $ -- $ (10,367)
========= ========= ========== ========= ========= ========= ========== =========
19
CONSOLIDATING STATEMENTS OF OPERATIONS (CONTINUED)
(IN THOUSANDS)
FOR THE THREE MONTHS ENDED JUNE 30, 2004 FOR THE SIX MONTHS ENDED JUNE 30, 2004
--------------------------------------------- ---------------------------------------------
ACACIA ELIMI- ACACIA ELIMI-
TECHNO- COMBI- NATIONS/ TECHNO- COMBI- NATIONS/
LOGIES MATRIX RECLASSI- CONSOL- LOGIES MATRIX RECLASSI- CONSOL-
GROUP GROUP FICATIONS IDATED GROUP GROUP FICATIONS IDATED
--------- --------- ---------- --------- --------- --------- ---------- ---------
Revenues:
Research and development and
government contracts ....... $ -- $ 701 $ -- $ 701 $ -- $ 18,220 $ -- $ 18,220
License fees .................. 666 -- -- 666 1,265 -- -- 1,265
Products and services ......... -- 49 -- 49 -- 146 -- 146
--------- --------- ---------- --------- --------- --------- ---------- ---------
Total revenues ........... 666 750 -- 1,416 1,265 18,366 -- 19,631
--------- --------- ---------- --------- --------- --------- ---------- ---------
Operating expenses:
Cost of government contract
revenues ................... -- 653 -- 653 -- 858 -- 858
Cost of product sales ......... -- 36 -- 36 -- 40 -- 40
Research and development
expenses ................... -- 1,409 -- 1,409 -- 2,792 -- 2,792
Non-cash stock compensation
amortization - research and
development ................ -- 32 -- 32 -- 101 -- 101
Marketing, general and
administrative expenses .... 1,160 2,228 -- 3,388 2,166 4,506 -- 6,672
Non-cash stock compensation
amortization - marketing,
general and administrative.. -- 143 -- 143 -- 477 -- 477
Legal expenses - patents ...... 576 -- -- 576 1,178 -- -- 1,178
Amortization of patents ....... 125 274 -- 399 250 548 -- 798
Legal settlement charges
(credits) .................. -- (391) -- (391) -- 866 -- 866
--------- --------- ---------- --------- --------- --------- ---------- ---------
Total operating expenses.. 1,861 4,384 -- 6,245 3,594 10,188 -- 13,782
--------- --------- ---------- --------- --------- --------- ---------- ---------
Operating income (loss)... (1,195) (3,634) -- (4,829) (2,329) 8,178 -- 5,849
--------- --------- ---------- --------- --------- --------- ---------- ---------
Other income:
Interest income ............... 108 84 -- 192 220 130 -- 350
--------- --------- ---------- --------- --------- --------- ---------- ---------
Total other income ...... 108 84 -- 192 220 130 -- 350
--------- --------- ---------- --------- --------- --------- ---------- ---------
Income (loss) from continuing
operations before income taxes
and minority interests .......... (1,087) (3,550) -- (4,637) (2,109) 8,308 -- 6,199
Benefit for income taxes ........... 35 34 -- 69 68 68 -- 136
--------- --------- ---------- --------- --------- --------- ---------- ---------
Income (loss) from continuing
operations before minority
interests ....................... (1,052) (3,516) -- (4,568) (2,041) 8,376 -- 6,335
Minority interests ................. 3 -- -- 3 3 -- -- 3
--------- --------- ---------- --------- --------- --------- ---------- ---------
Loss from continuing operations .... (1,049) (3,516) -- (4,565) (2,038) 8,376 -- 6,338
Discontinued operations:
Estimated loss on disposal of
discontinued operations .... (104) -- -- (104) (104) -- -- (104)
--------- --------- ---------- --------- --------- --------- ---------- ---------
Net income (loss) .................. $ (1,153) $ (3,516) $ -- $ (4,669) $ (2,142) $ 8,376 $ -- $ 6,234
========= ========= ========== ========= ========= ========= ========== =========
20
CONSOLIDATING STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE SIX MONTHS ENDED JUNE 30, 2005 FOR THE SIX MONTHS ENDED JUNE 30, 2004
--------------------------------------------- ---------------------------------------------
ACACIA ACACIA
TECHNO- COMBI- TECHNO- COMBI-
LOGIES MATRIX ELIMI- CONSOL- LOGIES MATRIX ELIMI- CONSOL-
GROUP GROUP NATIONS IDATED GROUP GROUP NATIONS IDATED
--------- --------- ---------- --------- --------- --------- ---------- ---------
Cash flows from operating activities:
Net income (loss) from continuing
operations ....................... $ (3,424) $ (6,733) $ -- $ (10,157) $ (2,038) $ 8,376 $ -- $ 6,338
Adjustments to reconcile net
income (loss) from continuing
operations to net cash used
in operating activities:
Depreciation and amortization .. 2,279 1,079 -- 3,358 275 1,128 -- 1,403
Non-cash stock compensation .... -- (111) -- (111) -- 578 -- 578
Deferred tax benefit ........... (71) (69) -- (140) (72) (68) -- (140)
Non-cash legal settlement
charges (credits) ........... -- (195) -- (195) -- 866 -- 866
Other .......................... -- 46 -- 46 -- (55) -- (55)
Changes in assets and liabilities,
excluding effect of business
acquisition:
Accounts receivable ............ (457) (1,202) -- (1,659) (26) (412) -- (438)
Prepaid expenses, inventory and
other assets ................ (387) (206) (32) (625) (440) (31) 267 (204)
Accounts payable, accrued
expenses and other .......... (869) 453 32 (384) 994 536 (267) 1,263
Royalties and legal fees payable 447 -- -- 447 -- -- -- --
Deferred revenues .............. 153 (24) -- 129 309 (17,518) -- (17,209)
--------- --------- --------- --------- --------- --------- --------- ---------
Net cash used in operating
activities from continuing
operations .................. (2,329) (6,962) -- (9,291) (998) (6,600) -- (7,598)
Net cash used in operating
activities from discontinued
operations .................. (433) -- -- (433) (311) -- -- (311)
--------- --------- --------- --------- --------- --------- --------- ---------
Net cash used in operating
activities .................. (2,762) (6,962) -- (9,724) (1,309) (6,600) -- (7,909)
--------- --------- --------- --------- --------- --------- --------- ---------
Cash flows from investing activities:
Purchase of property and
equipment ................... (59) (453) -- (512) (53) (262) -- (315)
Purchase of available-for-sale
investments ................. (26,296) (11,952) -- (38,248) (5,948) (31,733) -- (37,681)
Sale of available-for-sale
investments ................. 12,150 24,132 -- 36,282 3,000 18,860 -- 21,860
Business acquisition ........... (5,796) -- -- (5,796) -- -- -- --
Purchase of additional interests
in equity method investee ... -- (600) -- (600) -- -- -- --
Patent acquisition costs ....... (325) -- -- (325) -- -- -- --
Other .......................... -- -- -- -- (5) -- -- (5)
--------- --------- --------- --------- --------- --------- --------- ---------
Net cash provided by (used in)
investing activities from
continued operations ........ (20,326) 11,127 -- (9,199) (3,006) (13,135) -- (16,141)
Net cash used in investing
activities from discontinued
operations .................. -- -- -- -- (198) -- -- (198)
--------- --------- --------- --------- --------- --------- --------- ---------
Net cash provided by (used in)
investing activities ........ (20,326) 11,127 -- (9,199) (3,204) (13,135) -- (16,339)
--------- --------- --------- --------- --------- --------- --------- ---------
Cash flows from financing activities:
Net cash attributed to the
Acacia Technologies group ... 19,479 -- -- 19,479 (155) -- -- (155)
Net cash attributed to the
CombiMatrix group ........... -- 327 -- 327 -- 18,561 -- 18,561
--------- --------- --------- --------- --------- --------- --------- ---------
Net cash provided by (used in)
financing activities ........ 19,479 327 -- 19,806 (155) 18,561 -- 18,406
--------- --------- --------- --------- --------- --------- --------- ---------
Effect of exchange rate on
cash ................... -- 21 -- 21 -- (6) -- (6)
--------- --------- --------- --------- --------- --------- --------- ---------
Increase (decrease) in cash
and cash equivalents ... (3,609) 4,513 -- 904 (4,668) (1,180) -- (5,848)
Cash and cash equivalents,
beginning .............. 15,750 2,985 -- 18,735 20,392 3,807 -- 24,199
--------- --------- --------- --------- --------- --------- --------- ---------
Cash and cash equivalents,
ending ................. $ 12,141 $ 7,498 $ -- $ 19,639 $ 15,724 $ 2,627 $ -- $ 18,351
========= ========= ========= ========= ========= ========= ========= =========
21
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
JUNE 30, DECEMBER 31,
2005 2004
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents .................................................. $ 7,498 $ 2,985
Available-for-sale investments ............................................. 8,675 20,727
Accounts receivable ........................................................ 1,545 343
Inventory, prepaid expenses and other assets ............................... 484 229
------------ ------------
Total current assets .................................................. 18,202 24,284
Property and equipment, net of accumulated depreciation ......................... 2,267 2,330
Patents, net of accumulated amortization of $3,622 (2005) and $3,074 (2004) ..... 8,473 9,021
Goodwill ........................................................................ 19,424 19,424
Other assets .................................................................... 820 329
------------ ------------
$ 49,186 $ 55,388
============ ============
LIABILITIES AND ALLOCATED NET WORTH
Current liabilities:
Accounts payable, accrued expenses and other ............................... $ 2,771 $ 1,964
Current portion of deferred revenues ....................................... 144 66
Payable to Acacia Technologies group ....................................... 87 119
------------ ------------
Total current liabilities ............................................. 3,002 2,149
Deferred income taxes ........................................................... 2,043 2,112
Deferred revenues, net of current portion ....................................... 3,791 3,893
Other liabilities ............................................................... 211 406
------------ ------------
Total liabilities ..................................................... 9,047 8,560
------------ ------------
Commitments and contingencies (Note 6)
Allocated net worth:
Funds allocated by Acacia Research Corporation ............................. 159,100 159,056
Accumulated net losses ..................................................... (118,961) (112,228)
------------ ------------
Total allocated net worth ............................................. 40,139 46,828
------------ ------------
$ 49,186 $ 55,388
============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
22
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
(UNAUDITED)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
--------------------------------- ---------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
--------------- --------------- --------------- ---------------
Revenues:
Research and development contract ..................... $ -- $ -- $ -- $ 17,302
Government contract ................................... 1,281 701 2,012 918
Products and services ................................. 576 49 914 146
--------------- --------------- --------------- ---------------
Total revenues ................................... 1,857 750 2,926 18,366
--------------- --------------- --------------- ---------------
Operating expenses:
Cost of government contract revenues .................. 1,209 653 1,900 858
Cost of product sales ................................. 190 36 353 40
Research and development expenses ..................... 1,415 1,409 2,555 2,792
Non-cash stock compensation amortization
- research and development ......................... -- 32 -- 101
Marketing, general and administrative expenses ........ 2,502 2,228 4,781 4,506
Non-cash stock compensation amortization - marketing,
general and administrative ......................... 15 143 (111) 477
Amortization of patents ............................... 274 274 548 548
Legal settlement charges (credits) .................... (16) (391) (195) 866
--------------- --------------- --------------- ---------------
Total operating expenses ......................... 5,589 4,384 9,831 10,188
--------------- --------------- --------------- ---------------
Operating income (loss) .......................... (3,732) (3,634) (6,905) 8,178
--------------- --------------- --------------- ---------------
Other income (expense):
Interest income ....................................... 104 84 206 130
Other expense ......................................... (63) -- (102) --
--------------- --------------- --------------- ---------------
Total other income ............................... 41 84 104 130
--------------- --------------- --------------- ---------------
Income (loss) from operations before income taxes .......... (3,691) (3,550) (6,801) 8,308
Benefit for income taxes ................................... 34 34 68 68
--------------- --------------- --------------- ---------------
Division net income (loss) ................................. $ (3,657) $ (3,516) $ (6,733) $ 8,376
=============== =============== =============== ===============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
23
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
FOR THE SIX MONTHS ENDED
------------------------------------
JUNE 30, 2005 JUNE 30, 2004
--------------- ---------------
Cash flows from operating activities:
Division net income (loss) from operations ......................... $ (6,733) $ 8,376
Adjustments to reconcile division net income (loss) from
operations to net cash used in operating activities:
Depreciation and amortization .................................. 1,079 1,128
Non-cash stock compensation .................................... (111) 578
Deferred tax benefit ........................................... (69) (68)
Non-cash legal settlement charges (credits) .................... (195) 866
Other .......................................................... 46 (55)
Changes in assets and liabilities:
Accounts receivable ............................................ (1,202) (412)
Inventory, prepaid expenses and other assets ................... (206) (31)
Accounts payable, accrued expenses and other ................... 453 536
Deferred revenues .............................................. (24) (17,518)
--------------- ---------------
Net cash used in operating activities .......................... (6,962) (6,600)
--------------- ---------------
Cash flows from investing activities:
Purchase of property and equipment ............................. (453) (262)
Purchase of available-for-sale investments ..................... (11,952) (31,733)
Sale of available-for-sale investments ......................... 24,132 18,860
Purchase of additional interests in equity method investee ..... (600) --
--------------- ---------------
Net cash provided by (used in) investing activities ............ 11,127 (13,135)
--------------- ---------------
Cash flows from financing activities:
Net cash flows attributed to the CombiMatrix group ............. 327 18,561
--------------- ---------------
Effect of exchange rate on cash ...................................... 21 (6)
--------------- ---------------
Increase (decrease) in cash and cash equivalents ..................... 4,513 (1,180)
Cash and cash equivalents, beginning ................................. 2,985 3,807
--------------- ---------------
Cash and cash equivalents, ending .................................... $ 7,498 $ 2,627
=============== ===============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
24
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," a
division of Acacia Research Corporation, is comprised of our wholly owned
subsidiary, CombiMatrix Corporation and CombiMatrix Corporation's wholly owned
subsidiaries, CombiMatrix Molecular Diagnostics, Inc. and CombiMatrix K.K. and
includes all corporate assets, liabilities and transactions related to Acacia
Research Corporation's life sciences business.
The CombiMatrix group is seeking to become a broadly diversified
biotechnology business, through the development of proprietary technologies and
products in the areas of drug development, genetic analysis, molecular
diagnostics, nanotechnology research, defense and homeland security markets, as
well as other potential markets where its products could be utilized. Among the
technologies being developed by the CombiMatrix group is 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. This 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.
Other technologies include proprietary molecular synthesis and screening methods
for the discovery of potential new drugs. CombiMatrix Molecular Diagnostics,
Inc., a wholly owned subsidiary located in Irvine, California, is exploring
opportunities for the CombiMatrix group's arrays in the field of clinical
diagnostics. CombiMatrix K.K., a wholly owned Japanese corporation located in
Tokyo, Japan, is exploring opportunities for CombiMatrix Corporation's array
system with pharmaceutical and biotechnology companies in the Asian market.
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 common stock ("AR-CombiMatrix stock")
and Acacia Research-Acacia Technologies common 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 June 30, 2005, 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, 2004. 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 statement of its financial position as of June 30, 2005, and the results of
its operations and its cash flows for the interim periods presented. The results
of operations for the three and six months ended June 30, 2005, 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 of the accounts
included in the corresponding consolidated financial statements of Acacia
25
Research Corporation. The financial statements of the CombiMatrix group reflect
the financial condition, results of operations, and cash flows of the businesses
included therein. The financial statements of the CombiMatrix group include the
accounts or assets of Acacia Research Corporation specifically attributed to the
CombiMatrix group and were prepared using amounts included in Acacia Research
Corporation's consolidated financial statements.
Financial effects arising from one group that affect Acacia Research
Corporation's results of operations or financial condition could, if
significant, affect the results of operations or financial condition of the
other group and the market price of the class of common stock relating to the
other group. Any division net losses of the CombiMatrix group or the Acacia
Technologies group and dividends or distributions on, or repurchases of,
AR-CombiMatrix stock or AR-Acacia Technologies stock or repurchases of preferred
stock of Acacia Research Corporation will reduce the assets of Acacia Research
Corporation legally available for payment of dividends on AR-CombiMatrix stock
or AR-Acacia Technologies stock.
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. 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.
Revenues from multiple-element arrangements involving license fees,
up-front payments and milestone payments, which are received and/or billable by
the CombiMatrix group in connection with other rights and services that
represent continuing obligations of 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, including shipping and
handling fees, are recognized when delivery has occurred or services have been
rendered.
Deferred revenues arise from payments received in advance of the
culmination of the earnings process. Deferred revenues expected to be recognized
within the next twelve months are classified within current liabilities.
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
26
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.
PATENTS AND GOODWILL AND IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL.
Refer to Note 2 to the Acacia Research Corporation consolidated financial
statements included elsewhere herein.
USE OF ESTIMATES. The preparation of financial statements in conformity
with generally accepted accounting principles in the United States of America
requires management to make estimates and assumptions that affect the reported
amount of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from these estimates.
3. RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 7 to the Acacia Research Corporation consolidated
financial statements included elsewhere herein.
4. INTANGIBLE ASSETS
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 five fiscal years through December 31, 2009
is estimated to be $1,095,000 per year. At June 30, 2005, and December 31, 2004,
all of the CombiMatrix group's acquired intangible assets other than goodwill
were subject to amortization.
5. RESEARCH AND DEVELOPMENT CONTRACT REVENUES
In August 2004, the CombiMatrix group received a $1,000,000 upfront
payment from Furuno Electric Co., LTD ("Furuno") as part of a multi-year
collaboration agreement to develop a bench-top array synthesizer for commercial
applications. In 2003, the CombiMatrix group received upfront and milestone
payments from Toppan Printing Co., LTD. ("Toppan") totaling $2,400,000, pursuant
to a multi-year collaboration and supply agreement to develop and manufacture
arrays using the CombiMatrix group's proprietary electrochemical detection
approach. The payments received from Furuno and Toppan are included in deferred
revenues at June 30, 2005, and December 31, 2004, in accordance with the
CombiMatrix group's revenue recognition policies for multiple-element
arrangements.
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. COMMITMENTS AND CONTINGENCIES
In October 2004, the CombiMatrix group entered into an agreement to
acquire up to a one-third ownership interest in Leuchemix, Inc. ("Leuchemix"), a
private drug development firm, which is developing several compounds for the
treatment of leukemia and other cancers. In accordance with the terms of the
purchase agreement, the CombiMatrix group will purchase 3,137,500 shares of
Series A Preferred Stock of Leuchemix for a total purchase price of $4,000,000.
The ownership interest will be acquired and paid for quarterly over the two-year
period commencing with the fourth quarter of 2004. In accordance with the terms
of the purchase agreement, the CombiMatrix group made scheduled investments
totaling $600,000 during the six months ended June 30, 2005, resulting in an
ownership interest of approximately 9.6% as of June 30, 2005. The CombiMatrix
group will make additional investments in Leuchemix of $1,000,000 in 2005 and
$2,150,000 in 2006, in accordance with the terms of the agreement. The
27
CombiMatrix group's investment is being accounted for under the equity method as
the CombiMatrix group has the ability to exercise significant influence over
Leuchemix, primarily due to CombiMatrix Corporation's representation on
Leuchemix's board of directors.
In March 2004, the CombiMatrix group was awarded a two-year, $5.9
million contract with the Department of Defense to further the development of
the CombiMatrix group's array technology for the detection of biological threat
agents. Under the terms of the contract, the CombiMatrix group will perform
research and development activities, as described under the contract, and 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. As of June 30, 2005, the
biological threat detection contract with the Department of Defense was
approximately 68% complete and had approximately $1.4 million of costs remaining
to be incurred on the existing contract.
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 six months ended June 30,
2005, and 2004, the CombiMatrix group recorded a net non-cash credit totaling
$195,000 and a net non-cash charge totaling $866,000, respectively, in
connection with certain anti-dilution provisions of the settlement agreement.
The related liability reflects management's estimate, as of each balance sheet
date, of the fair value of AR-CombiMatrix stock to be issued to Nanogen, Inc. as
a result of certain options and warrants exercised during the period, if any,
and the fair value of AR-CombiMatrix stock potentially issuable to Nanogen, Inc.
as of each balance sheet date pursuant to the anti-dilution terms of the
agreement. The liability is adjusted at each balance sheet 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 are $25,000 per
quarter until the patents expire in 2018. Royalties incurred under the agreement
during the six months ended June 30, 2005, and 2004, were $53,000 and $75,000,
respectively.
The CombiMatrix group is subject to 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 the CombiMatrix group's financial position, results of
operations or cash flows.
7. SUBSEQUENT EVENT
In June 2005, Acacia Research Corporation obtained commitments to
purchase approximately $3.2 million of its AR-CombiMatrix stock in a registered
direct offering, which closed on July 5, 2005. Under the terms of the
transaction, 1,400,444 shares of AR-CombiMatrix stock were sold at $2.25 per
share to a select group of institutional investors. The net proceeds, totaling
approximately $3.1 million, which are net of offering costs, were allocated to
the CombiMatrix group and are expected to be used for general working capital
purposes. All of the shares of AR-CombiMatrix stock were offered by Acacia
Research Corporation pursuant to an effective registration statement previously
filed with the Securities and Exchange Commission.
28
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
JUNE 30, DECEMBER 31,
2005 2004
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents .................................................. $ 12,141 $ 15,750
Short-term investments ..................................................... 27,017 12,896
Accounts receivable ........................................................ 650 193
Prepaid expenses and other assets .......................................... 1,083 754
Receivable from CombiMatrix group .......................................... 87 119
------------ ------------
Total current assets .................................................. 40,978 29,712
Property and equipment, net of accumulated depreciation ......................... 137 104
Patents, net of accumulated amortization of $3,936 (2005) and $1,684 (2004) 26,343 3,042
Goodwill ........................................................................ 121 121
Other assets .................................................................... 79 79
------------ ------------
$ 67,658 $ 33,058
============ ============
LIABILITIES AND ALLOCATED NET WORTH
Current liabilities:
Accounts payable and accrued expenses ...................................... $ 1,232 $ 2,175
Royalties and legal fees payable ........................................... 447 --
Current portion of deferred revenues ....................................... 438 428
------------ ------------
Total current liabilities ............................................. 2,117 2,603
Deferred income taxes ........................................................... 798 869
Deferred revenues, net of current portion ....................................... 143 --
Other liabilities ............................................................... 196 --
------------ ------------
Total liabilities ..................................................... 3,254 3,472
------------ ------------
Minority interests .............................................................. 482 778
------------ ------------
Commitments and contingencies (Note 7)
Allocated net worth:
Funds allocated by Acacia Research Corporation ............................. 143,565 104,817
Accumulated net losses ..................................................... (79,643) (76,009)
------------ ------------
Total allocated net worth ............................................. 63,922 28,808
------------ ------------
$ 67,658 $ 33,058
============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
29
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
(UNAUDITED)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
---------------------------------- ----------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
--------------- --------------- --------------- ---------------
Revenues:
License fees ...................................... $ 2,682 $ 666 $ 4,545 $ 1,265
--------------- --------------- --------------- ---------------
Total revenues ............................... 2,682 666 4,545 1,265
--------------- --------------- --------------- ---------------
Operating expenses:
Marketing, general and administrative expenses .... 1,759 1,160 3,369 2,166
Legal expenses - patents .......................... 536 576 1,097 1,178
Contingent legal fees and inventor royalties
expense - patents .............................. 1,120 -- 1,767 --
Amortization of patents ........................... 1,336 125 2,252 250
--------------- --------------- --------------- ---------------
Total operating expenses ..................... 4,751 1,861 8,485 3,594
--------------- --------------- --------------- ---------------
Operating loss ............................... (2,069) (1,195) (3,940) (2,329)
--------------- --------------- --------------- ---------------
Other income:
Interest income ................................... 278 108 449 220
Other income ...................................... 1 -- 1 --
--------------- --------------- --------------- ---------------
Total other income ........................... 279 108 450 220
--------------- --------------- --------------- ---------------
Loss from continuing operations before
income taxes and minority interests ................. (1,790) (1,087) (3,490) (2,109)
Benefit for income taxes ............................... 30 35 66 68
--------------- --------------- --------------- ---------------
Loss from continuing operations before
minority interests .................................. (1,760) (1,052) (3,424) (2,041)
Minority interests ..................................... -- 3 -- 3
--------------- --------------- --------------- ---------------
Loss from continuing operations ........................ (1,760) (1,049) (3,424) (2,038)
Discontinued operations:
Estimated loss on disposal of discontinued
operations ..................................... -- (104) (210) (104)
--------------- --------------- --------------- ---------------
Division net loss ...................................... $ (1,760) $ (1,153) $ (3,634) $ (2,142)
=============== =============== =============== ===============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
30
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
FOR THE SIX MONTHS ENDED
-------------------------------------
JUNE 30, 2005 JUNE 30, 2004
--------------- ---------------
Cash flows from operating activities:
Division net loss from continuing operations ........................... $ (3,424) $ (2,038)
Adjustments to reconcile division net loss from continuing
operations to net cash used in operating activities:
Depreciation and amortization .......................................... 2,279 275
Deferred tax benefit ................................................... (71) (72)
Changes in assets and liabilities, excluding effect of business
acquisitions:
Accounts receivable .................................................... (457) (26)
Prepaid expenses and other assets ...................................... (387) (440)
Accounts payable and accrued expenses .................................. (869) 994
Royalties and legal fees payable ....................................... 447 --
Deferred revenues ...................................................... 153 309
--------------- ---------------
Net cash used in operating activities from continuing operations ....... (2,329) (998)
Net cash used in operating activities from discontinued operations ..... (433) (311)
--------------- ---------------
Net cash used in operating activities .................................. (2,762) (1,309)
--------------- ---------------
Cash flows from investing activities:
Purchase of property and equipment ..................................... (59) (53)
Purchase of available-for-sale investments ............................. (26,296) (5,948)
Sale of available-for-sale investments ................................. 12,150 3,000
Business acquisition ................................................... (5,796) --
Patent acquisition costs ............................................... (325) --
Other .................................................................. -- (5)
--------------- ---------------
Net cash used in investing activities from continued operations ........ (20,326) (3,006)
Net cash used in investing activities from discontinued operations ..... -- (198)
--------------- ---------------
Net cash used in investing activities .................................. (20,326) (3,204)
--------------- ---------------
Cash flows from financing activities:
Net cash flows attributed to the Acacia Technologies group ............. 19,479 (155)
--------------- ---------------
Decrease in cash and cash equivalents ....................................... (3,609) (4,668)
Cash and cash equivalents, beginning ........................................ 15,750 20,392
--------------- ---------------
Cash and cash equivalents, ending ........................................... $ 12,141 $ 15,724
=============== ===============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
31
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.
Our intellectual property licensing and enforcement business, referred
to as the "Acacia Technologies group," a division of Acacia Research
Corporation, is currently comprised of certain of Acacia Research Corporation's
wholly owned subsidiaries and limited liability companies including: Acacia
Global Acquisition Corporation, Acacia Media Technologies Corporation, Acacia
Patent Acquisition Corporation, Acacia Technologies Services Corporation, AV
Technologies LLC, Broadcast Innovation LLC, Computer Cache Coherency
Corporation, Computer Docking Station Corporation, Data Encryption Corporation,
Data Innovation LLC, Financial Services Innovation LLC, Information Technology
Innovation LLC, InternetAd LLC, IP Innovation LLC, KY Data Systems LLC,
Microprocessor Enhancement Corporation, New Medium LLC, TechSearch LLC, VData
LLC, Soundview Technologies, Inc. and Spreadsheet Automation 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 and enforcement business. See Note 6 for
information on Acacia Global Acquisition Corporation's recent business
acquisition.
The Acacia Technologies group develops, acquires, licenses and enforces
patented technologies. The Acacia Technologies group controls 31 patent
portfolios, which include over 120 U.S. patents, and certain foreign
counterparts, covering technologies used in a wide variety of industries
including Audio/Video Enhancement & Synchronization, Broadcast Data Retrieval,
Compact Disk, Computer Memory Cache Coherency, Credit Card Fraud Protection,
Data Encryption & Product Activation, Digital Media Transmission ("DMT(R)"),
Digital Video Production, Dynamic Manufacturing Modeling, Enhanced Internet
Navigation, Hearing Aid ECM, Image Resolution Enhancement, Interactive Data
Sharing, Interactive Television, Interstitial Internet Advertising, Laptop
Docking Station Connectivity, Microprocessor Enhancement, Multi-dimensional Bar
Codes, Network Data Storage, Resource Scheduling, Rotational Video Imaging and
Spreadsheet Automation.
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 common stock ("AR-CombiMatrix stock")
and Acacia Research-Acacia Technologies common 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 June 30, 2005, 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, 2004. 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 statement of its financial position as of June 30,
2005, and the results of its operations and its cash flows for the interim
periods presented. The results of operations for the three and six months ended
June 30, 2005, are not necessarily indicative of the results to be expected for
the entire year.
32
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 group 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 of the accounts
included in the corresponding consolidated financial statements of Acacia
Research Corporation. The financial statements of Acacia Technologies group
reflect the financial condition, results of operations, and cash flows of the
businesses included therein. The financial statements of the Acacia Technologies
group include the accounts or assets of Acacia Research Corporation specifically
attributed to the Acacia Technologies group and were prepared using amounts
included in Acacia Research Corporation's consolidated financial statements.
Financial effects arising from one group that affect Acacia Research
Corporation's results of operations or financial condition could, if
significant, affect the results of operations or financial condition of the
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
REVISION IN THE CLASSIFICATION OF CERTAIN SECURITIES. In connection
with the preparation of Acacia Research Corporation's Annual Report on Form 10-K
for the year ended December 31, 2004, we concluded that it was appropriate to
classify the Acacia Technologies group's auction rate municipal bonds and
variable rate municipal demand notes as current investments. Previously, such
investments had been classified as cash and cash equivalents. Accordingly, the
Acacia Technologies group has revised its prior classification to report these
securities as current investments in its Consolidated Balance Sheet as of June
30, 2004. The Acacia Technologies group has also made corresponding adjustments
to its Consolidated Statement of Cash Flows for the six months ended June 30,
2004, to reflect the gross purchases and sales of these securities as investing
activities rather than as a component of cash and cash equivalents. This change
in classification does not affect previously reported cash flows from operations
or from financing activities in the Acacia Technologies group's previously
reported Consolidated Statements of Cash Flows, or previously reported
Consolidated Statements of Income for any period.
As of June 30, 2004, and December 31, 2003, before this revision in
classification, $12,750,000 and $7,750,000, respectively, of these current
investments were classified as cash and cash equivalents on the Acacia
Technologies group's Consolidated Balance Sheets. For the six months ended June
30, 2004, before this revision in classification, net cash used in investing
activities related to these current investments of $5,000,000 were included in
cash and cash equivalents in the Acacia Technologies group's Consolidated
Statement of Cash Flows.
REVENUE RECOGNITION. Under the terms of its license agreements, the
Acacia Technologies group grants non-exclusive licenses for the use of its
patented technologies. In general, pursuant to the terms of the Acacia
Technologies group's agreements with its licensees, upon the grant of the
licenses, the Acacia Technologies group has no further obligations with respect
to the licenses granted. License fees paid to and recognized as revenue by the
Acacia Technologies group are non-refundable.
Revenues generated from license agreements are generally accrued and
recognized as revenue in the period earned, provided that amounts are fixed or
determinable and collectibility is reasonably assured.
Certain license agreements provide for the calculation of license fees
based on a licensee's actual quarterly sales or actual per unit activity,
applied to a contractual royalty rate. Licensees that pay license fees on a
quarterly basis generally report actual quarterly sales or actual per unit
activity 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 sales or 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 or per unit activity, provided
33
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.
Certain license agreements provide for the payment of a minimum upfront
annual license fee at the inception of each annual license term. Minimum upfront
annual license fees are generally determined based on a licensee's estimated
annual sales or a licensee's base level of per unit activity. These minimum
upfront annual 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, determined and reported in accordance with the terms of the
respective agreements, exceed the minimum upfront annual license fees paid, the
additional royalties are recognized in revenue in the quarter following the
quarter in which the base per unit activity was exceeded or the quarter
following the annual license term, depending on the terms of the respective
agreement, provided that amounts are fixed or determinable and collectibility is
reasonably assured.
Certain license agreements provide for the payment of contractually
determined paid-up license fees in consideration for the grant of a
non-exclusive, retroactive and future license to manufacture and/or sell
products covered by the Acacia Technologies group's patented technologies.
Certain of these agreements also provide for future royalties or additional
required payments based on future activities. The execution of these license
agreements may also result in the dismissal of any pending litigation. Pursuant
to the terms of these agreements, the Acacia Technologies group has no further
obligation with respect to the grant of the non-exclusive retroactive and future
license, including no express or implied obligation on the Acacia Technologies
group's part to maintain or upgrade the technology, or provide future support or
services. Generally, the agreements provide for the grant of the license upon
execution of the agreement. As such, the earnings process is generally complete
upon the execution of the agreement, and revenue is recognized upon execution of
the agreement, when collectibility is reasonably assured, and all other revenue
recognition criteria have been met.
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, the Acacia Technologies
group may recognize royalty revenues that relate to prior period activities of
our licensees. Differences between amounts initially recognized and amounts
subsequently audited or reported as an adjustment to those amounts are
recognized in the period the adjustment is determined as a change in accounting
estimate.
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.
PATENTS AND GOODWILL, IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL AND
BUSINESS ACQUISITIONS. Refer to Note 2 to the Acacia Research Corporation
consolidated financial statements included elsewhere herein.
USE OF ESTIMATES. The preparation of financial statements in conformity
with generally accepted accounting principles in the United States of America
requires management to make estimates and assumptions that affect the reported
amount of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from these estimates.
34
3. RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 7 to the Acacia Research Corporation consolidated
financial statements included elsewhere herein.
4. INTANGIBLE ASSETS
The Acacia Technologies group's only identifiable intangible assets are
patents and patent rights which have remaining economic useful lives of between
2 and 7 years. The weighted average remaining economic useful life of the Acacia
Technologies group's patents is approximately 6 years. Annual aggregate
amortization expense for each of the five fiscal years through December 31, 2009
is estimated to be $4,914,000 in 2005, $5,324,000 in 2006, $5,272,000 in 2007,
$3,951,000 in 2008 and $3,504,000 in 2009. At June 30, 2005, and December 31,
2004, all of the Acacia Technologies group's acquired intangible assets other
than goodwill were subject to amortization.
See Note 8 for additions to patent related intangibles during the six
months ended June 30, 2005.
5. EQUITY FINANCING
In February 2005, Acacia Research Corporation raised gross proceeds of
$19,600,000 through the sale of 3,500,000 shares of AR-Acacia Technologies stock
at a price of $5.60 per share in a registered direct offering. Net proceeds
raised of approximately $19,530,000, which are net of related issuance costs,
were attributed to the Acacia Technologies group and will be used for general
working capital purposes. The shares of AR-Acacia Technologies stock were
offered pursuant to an effective registration statement previously filed with
the Securities and Exchange Commission.
6. ACQUISITION
On January 28, 2005, Acacia Global Acquisition Corporation, a wholly
owned subsidiary of Acacia Research Corporation, acquired substantially all of
the assets of Global Patent Holdings, LLC, a privately held patent holding
company based in Northbrook, Illinois, which owned 11 patent licensing
companies. The acquisition provided the Acacia Technologies group 100% ownership
of companies that control 27 patent portfolios, which include 120 U.S. patents
and certain foreign counterparts, and cover technologies used in a wide variety
of industries. As a result of the acquisition, we have expanded and diversified
the Acacia Technologies group's revenue generating opportunities and accelerated
the execution of the Acacia Technologies group's business strategy of acquiring,
developing and licensing patented technologies.
The acquisition was accounted for using the purchase method of
accounting. Under the purchase method of accounting, the purchase consideration
is allocated to the assets acquired, including tangible assets, patents and
other identifiable intangibles and liabilities assumed, based on their estimated
fair market values at the date of acquisition. The consolidated statement of
operations includes the results of the acquired companies beginning on January
28, 2005, the date of acquisition. The aggregate purchase consideration was
approximately $25,089,000, including $5.0 million of cash, the issuance of
3,938,832 shares of AR-Acacia Technologies stock valued at $19,293,000 (net of
estimated common stock registration costs of $212,000) and acquisition costs,
including registration costs, of $796,000. The value of the common shares issued
was determined based on the average market price of AR-Acacia Technologies
stock, as reported on NASDAQ, over the 5-day period (December 13 - December 17,
2004) before and after the terms of the acquisition were agreed to and
announced.
The following table summarizes the total purchase consideration and the
allocation of the consideration paid to the estimated fair value of the assets
acquired and liabilities assumed (in thousands):
35
Purchase Consideration:
Cash paid ................................................................... $ 5,000
Fair value of AR-Acacia Technologies stock issued (1) ....................... 19,293
Acquisition and registration costs ......................................... 796
-----------
Total purchase consideration ..................................................... $ 25,089
===========
Purchase Price Allocation:
Estimated fair value of net tangible assets acquired at January 28, 2005 ..... $ (49)
Intangible assets acquired - patents and patent rights (1) ................... 25,138
-----------
Total ........................................................................... $ 25,089
===========
--------------------
(1) Reflects non-cash investing activity.
Management was primarily responsible for determining the fair value of
the tangible and identifiable intangible assets acquired and liabilities assumed
at the date of acquisition. Management considered a number of factors, including
reference to an independent valuation. The patents and patent rights acquired
were valued using a discounted cash flow model on a patent portfolio by
portfolio basis, which estimated the future net cash flows expected to result
from the licensing of each portfolio, taking into account potential infringers
of the patents, usage of the underlying technologies, estimated license fee
revenues, contingent legal fee arrangements, inventor royalties due to former
patent holders, other estimated costs, tax implications and other factors. A
discount rate consistent with the risks associated with achieving the estimated
net cash flows was used to estimate the present value of future estimated net
cash flows. Management's valuation resulted in an estimated fair value of patent
related assets acquired of approximately $27,000,000, resulting in approximately
$1,900,000 of excess fair value over the cost of net assets acquired, which has
been allocated as a pro rata reduction to the amounts that otherwise would have
been assigned to the assets acquired, in accordance with the purchase method of
accounting.
Amounts attributable to patents and patent rights acquired are
amortized using the straight-line method over the estimated economic useful
lives of the underlying patents which range from two to seven years. The
estimated weighted average useful life of amortizable patent related intangibles
acquired is approximately 6 years.
In connection with the acquisition described above, Acacia Global
Acquisition Corporation entered into a consulting agreement with the former CEO
of Global Patent Holdings, LLC who, as a result of the acquisition transaction,
is also a shareholder of Acacia Research Corporation. The agreement requires the
payment of $2,000,000 in consulting fees over a two-year period, and certain
reimbursable consulting related expenses, commencing on the date of acquisition.
Marketing, general and administrative expenses for the three and six months
ended June 30, 2005, include $271,000 and $466,000, respectively, in expenses
related to the consulting agreement. Consulting services to be performed consist
primarily of consultation on intellectual property matters associated with the
patents and patent rights acquired in the transaction. The consulting fees will
be expensed in the consolidated statement of operations as the consulting
services are rendered during the two-year term of the consulting agreement.
Acacia Global Acquisition Corporation may terminate the consulting agreement for
cause as provided for in the agreement. The consulting agreement also contains
certain automatic termination provisions, including; the failure by Acacia
Global Acquisition Corporation to make timely consulting payments in accordance
with the agreement; a significant decrease in working capital of Acacia Research
Corporation, as defined in the agreement; material breach of the agreement by
Acacia Global Acquisition Corporation; and the death of the consultant. Any
occurrence of these conditions may require the payment of all remaining
consulting fees outstanding under the agreement within thirty days of the
occurrence of the termination event. Acacia Research Corporation also executed
an agreement guaranteeing Acacia Global Acquisition Corporation's performance of
its obligations under the consulting agreement.
The acquisition will be treated for tax purposes as a taxable asset
acquisition and, as such, Acacia Research Corporation does not expect any
book/tax basis differences and thus, no deferred income taxes were recorded in
connection with the application of the purchase method of accounting.
See Note 8 to the Acacia Research Corporation consolidated financial
statements for the unaudited pro forma combined results of operations related to
the acquisition for the interim periods presented.
36
7. COMMITMENTS AND CONTINGENCIES
In connection with the acquisition of certain patents and patent
rights, certain companies included in the Acacia Technologies group executed
related agreements which grant to the former owners of the respective patents or
patent rights, the right to receive inventor royalties based on future net
license fee revenues (as defined in the respective agreements) generated by the
Acacia Technologies group as a result of licensing the respective patents or
patent portfolios. Inventor royalties paid pursuant to the agreements are
expensed in the consolidated statement of operations in the period that the
related license fee revenues are recognized.
In connection with the Acacia Technologies group's licensing and
enforcement activities, the Acacia Technologies group may retain the services of
law firms that specialize in intellectual property licensing and enforcement and
patent law. These law firms may be retained on a contingent fee basis in which
the law firms are paid on a scaled percentage of any negotiated license fees,
settlements or judgments awarded based on how and when the license fees,
settlements or judgments are obtained by the Acacia Technologies group. In
instances where the Acacia Technologies group does not recover license fees from
potential infringers, no contingent legal fees are paid; however, the Acacia
Technologies group may be liable for certain out of pocket legal costs incurred
pursuant to the underlying legal services agreement. Legal fees advanced by
contingent law firms that are required to be paid in the event that no license
recoveries are obtained by the Acacia Technologies group are included in
long-term liabilities in the statement of financial condition.
LITIGATION
The Acacia Technologies group is subject to 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. From time to time,
companies comprising the Acacia Technologies group engage in litigation to
enforce their patents and patent rights. Refer to Note 9 to the Acacia Research
Corporation consolidated financial statements contained elsewhere herein for a
summary of current patent enforcement litigation.
The remaining Non-Soundview, Inc. parties in the Acacia Technologies
group's V-chip patent infringement lawsuit, which concluded in August 2004,
filed a motion before the United States District Court for the District of
Connecticut seeking reimbursement of certain attorney's fees. On July 13, 2005,
the Court entered an Order denying the motion in part, and granting the motion
in part. The motion was denied with respect to Soundview Inc.'s patent
infringement allegations, which the Court ruled were not asserted in bad faith.
The motion was granted with respect to certain anti-trust allegations asserted
subsequent to the Court's ruling of non-infringement in August 2004. 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.
8. DISCONTINUED OPERATIONS
Results for the six months ended June 30, 2005 and June 30, 2004,
include a $210,000 and $104,000 charge, net of minority interests, related to
estimated additional costs to be incurred in connection with the discontinued
operations of Soundbreak.com (originally ceased operations in February 2001),
related primarily to certain noncancellable lease obligations and a reduction in
estimated amounts recoverable from existing sublease arrangements. The related
lease obligations, which are guaranteed by Acacia Research Corporation, expire
in August 2005.
9. SUBSEQUENT EVENTS
In July 2005, Intel Corporation filed a Complaint in the District Court
for the Northern District of Illinois against Information Technology LLC, a
wholly owned subsidiary that is part of the Acacia Technologies group, seeking a
Declaratory Judgment of non-infringement of a patent relating to Information
Technology's Dynamic Manufacturing Modeling technology.
37
In July 2005, Spreadsheet Automation Corporation, a wholly owned
subsidiary that is part of the Acacia Technologies group, commenced a patent
infringement lawsuit in the District Court for the Eastern District of Texas
against Microsoft Corporation. The suit alleges the unauthorized use by certain
Microsoft products, including without limitation certain versions of Microsoft
Access and Microsoft Excel, of our Spreadsheet Automation technology.
38
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, or SEC,
including our Annual Report on Form 10-K for the year ended December 31, 2004,
filed with the Securities and Exchange Commission on March 15, 2005, and our
Registration Statement on Form S-3 filed with the Securities and Exchange
Commission on February 1, 2005, 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,
results of litigation 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 and in the section titled "Risk Factors" below.
BUSINESSES
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 June 30, 2005, and on our unaudited
consolidated statement of operations for the period from January 1, 2005, to
June 30, 2005. The discussion compares the activities for the three and six
months ended June 30, 2005, to the activities for the three and six months ended
June 30, 2004. This information should be read in conjunction with the
accompanying unaudited consolidated financial statements and notes thereto. This
information should also be read in conjunction with the "Risk Factors"
incorporated by reference elsewhere in this section.
Acacia Research Corporation is comprised of two operating groups, the
CombiMatrix group and the Acacia Technologies group.
COMBIMATRIX GROUP
Our life sciences business, referred to as the "CombiMatrix group," a
division of Acacia Research Corporation, is comprised of our wholly owned
subsidiary, CombiMatrix Corporation and CombiMatrix Corporation's wholly owned
subsidiaries, CombiMatrix Molecular Diagnostics, Inc. and CombiMatrix K.K. and
includes all corporate assets, liabilities and transactions related to Acacia
Research Corporation's life sciences business.
39
The CombiMatrix group is seeking to become a broadly diversified
biotechnology business, through the development of proprietary technologies and
products in the areas of drug development, genetic analysis, molecular
diagnostics, nanotechnology research, defense and homeland security markets, as
well as other potential markets where its products could be utilized. Among the
technologies being developed by the CombiMatrix group is 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. This 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.
Other technologies include proprietary molecular synthesis and screening methods
for the discovery of potential new drugs. CombiMatrix Molecular Diagnostics,
Inc., a wholly owned subsidiary located in Irvine, California, is exploring
opportunities for the CombiMatrix group's arrays in the field of clinical
diagnostics. CombiMatrix K.K., a wholly owned Japanese corporation located in
Tokyo, Japan, is exploring opportunities for CombiMatrix Corporation's array
system with pharmaceutical and biotechnology companies in the Asian market.
ACACIA TECHNOLOGIES GROUP
Our intellectual property licensing and enforcement business, referred
to as the "Acacia Technologies group," a division of Acacia Research
Corporation, is currently comprised of certain of Acacia Research Corporation's
wholly owned subsidiaries and limited liability companies including: Acacia
Global Acquisition Corporation, Acacia Media Technologies Corporation, Acacia
Patent Acquisition Corporation, Acacia Technologies Services Corporation, AV
Technologies LLC, Broadcast Innovation LLC, Computer Cache Coherency
Corporation, Computer Docking Station Corporation, Data Encryption Corporation,
Data Innovation LLC, Financial Services Innovation LLC, Information Technology
Innovation LLC, InternetAd LLC, IP Innovation LLC, KY Data Systems LLC,
Microprocessor Enhancement Corporation, New Medium LLC, TechSearch LLC, VData
LLC, Soundview Technologies, Inc., and Spreadsheet Automation 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 and enforcement business.
The Acacia Technologies group develops, acquires, licenses and enforces
patented technologies. The Acacia Technologies group controls 31 patent
portfolios, which include over 120 U.S. patents, and certain foreign
counterparts, covering technologies used in a wide variety of industries
including Audio/Video Enhancement & Synchronization, Broadcast Data Retrieval,
Compact Disk, Computer Memory Cache Coherency, Credit Card Fraud Protection,
Data Encryption & Product Activation, Digital Media Transmission, or DMT(R),
Digital Video Production, Dynamic Manufacturing Modeling, Enhanced Internet
Navigation, Hearing Aid ECM, Image Resolution Enhancement, Interactive Data
Sharing, Interactive Television, Interstitial Internet Advertising, Laptop
Docking Station Connectivity, Microprocessor Enhancement, Multi-dimensional Bar
Codes, Network Data Storage, Resource Scheduling, Rotational Video Imaging and
Spreadsheet Automation.
ACQUISITION
On January 28, 2005, Acacia Global Acquisition Corporation acquired
substantially all of the assets of Global Patent Holdings, LLC, a privately held
patent holding company based in Northbrook, Illinois, which owned 11 patent
licensing companies, or GPH Acquisition. The acquisition provided the Acacia
Technologies group 100% ownership of companies that control 27 patent
portfolios, which included 120 U.S. patents and certain foreign counterparts,
and cover technologies used in a wide variety of industries.
The acquisition was accounted for using the purchase method of
accounting. Under the purchase method of accounting, the purchase consideration
is allocated to the assets acquired, including tangible assets, patents and
other identifiable intangibles and liabilities assumed, based on their estimated
fair market values at the date of acquisition. The consolidated statement of
operations includes the results of the acquired companies beginning on January
28, 2005, the date of acquisition. The aggregate purchase consideration was
approximately $25.1 million, including $5.0 million of cash, the issuance of
3,938,832 shares of Acacia Research-Acacia Technologies common stock, or
AR-Acacia Technologies stock, valued at $19.3 million (net of estimated common
stock registration costs of $212,000) and acquisition costs, including
registration costs, of $796,000. The value of the common shares issued was
determined based on the average market price of AR-Acacia Technologies stock, as
reported on NASDAQ, over the 5-day period (December 13 - December 17, 2004)
before and after the terms of the acquisition were agreed to and announced. Net
tangible assets acquired were not material. $25.1 million of the purchase price
40
was allocated to patent related intangible assets acquired, which are being
amortized on a straight-line basis over a weighted average estimated economic
useful life of 6 years.
OVERVIEW
COMBIMATRIX GROUP
During the three and six months ended June 30, 2005, the CombiMatrix
group's operating activities included the recognition of $1.9 million and $2.9
million in revenues, including $1.3 million and $2.0 million in government
contract revenues under its two-year, $5.9 million contract with the Department
of Defense to further the development of the CombiMatrix group's array
technology for the detection of biological threat agents, and $576,000 and
$914,000 in CustomArray(TM) product, capital equipment and service revenues,
respectively. CustomArray(TM) product, capital equipment and service revenues
increased 70% over the prior quarter and have increased each quarter since the
launch of CustomArray(TM) in March of 2004, signaling continued growth of the
CombiMatrix's business and acceptance of its products and services in the
marketplace. Research and development expenses, excluding government contract
costs, increased from the previous quarter due to ongoing internal research and
development efforts to improve and expand the CombiMatrix group's technology and
product offerings.
During the second quarter of 2005, CombiMatrix Corporation formed a
wholly owned subsidiary, CombiMatrix Molecular Diagnostics, Inc., or CMD, for
the purpose of exploiting the opportunities in the clinical diagnostics market
for the CombiMatrix group's microarray technology. CMD is a California
corporation located in Irvine. As of June 30, 2005, CMD had 8 employees,
including several former executives of US Labs and other laboratory diagnostic
companies. This experienced management team will lead the CombiMatrix group's
efforts in developing and selling array-based products and services to the
diagnostics marketplace. CMD currently leases approximately 3,500 square feet of
lab space in Irvine, California and is in the process of applying for it's
Clinical Laboratory Improvement Amendment, or CLIA, certification necessary to
perform laboratory operations for customers.
The CombiMatrix group established additional strategic alliances during
the three months ended June 30, 2005, as follows:
o In May 2005 the CombiMatrix group entered into a non-exclusive
distribution agreement with Inter Medical to distribute
CustomArray(TM) microarray products in Japan. Under the
agreement, Inter Medical will market, sell and service the
CustomArray(TM) products in the Japanese marketplace.
o In June 2005, the CombiMatrix group entered into a
co-development agreement with STMicroelectronics, or ST, a
global leader in the development and manufacturing of
semiconductor products. The co-development is to add the
CombiMatrix group's proprietary electro-chemical detection
technology to ST's In-Check(TM) lab-on-chip platform and to
evaluate the combined system. ST's In-Check platform is
designed to address research and point-of-care diagnostics
markets. Under the terms of the agreement, ST will financially
support the CombiMatrix group in this work.
The CombiMatrix group established additional strategic alliances during
the three months ended March 31, 2005, as follows:
o In January 2005, the CombiMatrix group entered into a
distribution agreement with InBio to distribute the
CombiMatrix group's CustomArray(TM) products for the
Australian and New Zealand marketplaces. InBio's sales and
marketing organization will market, sell, and service the
CustomArray(TM) products in these regions.
o In February 2005, the CombiMatrix group entered into a broad
cross-licensing and collaboration agreement with Benitec,
Ltd., or Benitec, a leading RNAi therapeutics company. The
CombiMatrix group has non-exclusively licensed to Benitec
intellectual property related to the use of cocktails, or
pools of siRNAs, as therapeutic agents against viral diseases.
In addition, Benitec will also receive a co-exclusive
sublicense to two specific sequences targeting key genes of
HIV that the CombiMatrix group previously exclusively licensed
from its partner irsiCaixa.
In return, Benitec has non-exclusively licensed its portfolio
of 10 issued and 60 pending patents to the CombiMatrix group
for the development of RNAi therapeutics for the treatment or
41
prevention of injuries or diseases in humans resulting from
the exposure to biological, chemical, radioactive and other
weapons.
In addition to this cross-license agreement, the CombiMatrix
group and Benitec plan to collaborate in a number of other
areas including the use of CustomArrays(TM) to study possible
off-target effects of RNAi therapeutics.
During the three and six months ended June 30, 2005, the CombiMatrix
group made progress in several facets of its business including sales growth,
advancement of its drug development programs, entrance into the molecular
diagnostics market, advances in programs with its existing alliance partners,
establishment of additional strategic alliances, and continued progress with its
government contract work and in other general business initiatives.
In June 2005, Acacia Research Corporation obtained commitments to
purchase approximately $3.2 million of its Acacia Research-CombiMatrix common
stock, or AR-CombiMatrix stock, in a registered direct offering, which closed on
July 5, 2005. Under the terms of the transaction, 1,400,444 shares of
AR-CombiMatrix stock were sold at $2.25 per share to a select group of
institutional investors. The net proceeds, totaling approximately $3.1 million,
which are net of offering costs, were allocated to the CombiMatrix group. The
proceeds from this offering will be used for general working capital purposes.
ACACIA TECHNOLOGIES GROUP
Revenues for the three and six months ended June 30, 2005, were $2.7
million and $4.5 million, respectively, representing increases of approximately
300% and 259% over the respective comparable 2004 periods. Revenues increased
44% over revenues for the first quarter of 2005. Revenues for the three and six
months ended June 30, 2005 were comprised of recurring license fee revenues of
$832,000 and $1.6 million, and paid-up license fee revenues of $1.9 million and
$2.9 million, respectively. License fee revenues included licensing revenues
from our DMT(R) technology and from our credit card fraud protection, computer
simulation, digital video production, high capacity compact disk, interactive
television and multi-dimensional bar code technologies, which were acquired in
the GPH Acquisition transaction.
The Acacia Technologies group's operating activities for the six months
ended June 30, 2005, were principally focused on the continued development,
commercialization and enforcement of its patent portfolios, including the
pursuit of several licensing programs and execution of licensing agreements
associated with the newly acquired patents and patent rights in connection with
the GPH Acquisition.
As of July 2005, the Acacia Technologies group is pursuing 18 licensing
and enforcement programs which include its audio/video enhancement and
synchronization, broadcast data retrieval, computer memory cache coherency,
credit card fraud protection, data encryption and product activation, digital
media transmission, digital video production, dynamic manufacturing modeling,
image resolution enhancement, interactive television, interstitial Internet
advertising, high capacity compact disks, laptop connectivity, microprocessor
enhancement, multi-dimensional bar codes, network data storage, spreadsheet
automation, and resource scheduling technologies. As of July 2005, the Acacia
Technologies group has executed license agreements and recognized revenues from
seven of its ongoing licensing and enforcement programs.
Marketing, general and administrative expenses increased during the
three and six months ended June 30, 2005, as compared to the same periods in
2004, due primarily to the hiring of additional patent licensing and business
development personnel as we expanded our licensing and enforcement business and
an increase in general and administrative expenses in connection with ongoing
operations, including GPH Acquisition related consulting fees. Patent related
legal expenses decreased during the three and six months ended June 30, 2005, as
compared to the same period in 2004, due to a decrease in DMT(R) technology
patent prosecution and patent enforcement activity in the quarter. The decrease
in patent related legal expenses was partially offset by additional patent
related legal expenses associated with ongoing patent prosecution and
enforcement activities of several of the companies acquired in the GPH
Acquisition.
During the three and six months ended June 30, 2005, the Acacia
Technologies group continued to execute its business strategy in the area of
patent portfolio acquisitions, including consummation of the GPH Acquisition and
the acquisition of our Laptop Connectivity patent, which relates to a commonly
used technology to connect laptop computers to peripheral devices via docking
stations. In July 2005, the Acacia Technologies group acquired several patents,
42
related to a letter of intent executed in February 2005, covering
electromagnetic compatibility shielding, or ECS, technology commonly
incorporated into hearing aids. During the six months ended June 30, 2005, the
Acacia Technologies group also executed several additional letters of intent
with third party patent holders regarding additional potential patent portfolio
purchases. These acquisitions will continue to expand and diversify the Acacia
Technologies group's revenue generating opportunities and accelerate the
execution of the Acacia Technologies group's business strategy of acquiring,
developing and licensing patented technologies.
In February 2005, Acacia Research Corporation raised gross proceeds of
$19.6 million through the sale of 3,500,000 shares of AR-Acacia Technologies
common stock at a price of $5.60 per share in a registered direct offering. Net
proceeds raised of approximately $19.5 million, which are net of related
issuance costs, were attributed to the Acacia Technologies group and will be
used for general working capital purposes. The shares of AR-Acacia Technologies
common stock were offered pursuant to an effective registration statement
previously filed with the Securities and Exchange Commission.
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 2004 Annual Report on Form 10-K, filed with the SEC on March
15, 2005, 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 AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004
NET INCOME (LOSS) (IN THOUSANDS)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
------------------------------------ ------------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
--------------- --------------- --------------- ---------------
Net income (loss) .......................... $ (5,417) $ (4,669) $ (10,367) $ 6,234
The changes in net income (loss) were primarily due to operating
results and activities as discussed below.
REVENUES AND COST OF REVENUES (IN THOUSANDS)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
------------------------------------ ------------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
--------------- --------------- --------------- ---------------
Research and development contract .......... $ -- $ -- $ -- $ 17,302
License fees
Recurring license fees ................ 832 666 1,620 1,265
Paid-up license fees .................. 1,850 -- 2,925 --
Government contract ........................ 1,281 701 2,012 918
Cost of government contract revenues ....... (1,209) (653) (1,900) (858)
Products and services ...................... 576 49 914 146
Cost of product sales ...................... (190) (36) (353) (40)
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 obligations under this agreement and in accordance with
the CombiMatrix group's revenue recognition policies for multiple-element
arrangements, the CombiMatrix group recognized $17.3 million of research and
development contract revenues during the first quarter of 2004, all of which
were previously deferred. The majority of research and development efforts under
the Roche agreement were incurred prior to 2004.
LICENSE FEES. Recurring license fee revenues are recognized from Acacia
Technologies group licensees that make recurring quarterly or annual license fee
payments, in accordance with the terms of their respective license agreements.
Paid-up license fee revenues are recognized from Acacia Technologies group
43
licensees that made paid-up license fee payments for past infringement and
future use of certain of our patented technologies, in accordance with the terms
of their respective license agreements.
Second quarter 2005 license fee revenues included fees from the
licensing of our DMT(R) technology, and from our credit card fraud protection
technology, multi-dimensional bar code technology, computer simulation
technology, high capacity compact disk technology and interactive television
technology, which were acquired in connection with the GPH Acquisition.
Recurring license fee revenues in the comparable 2004 periods all relate to our
DMT(R) technology.
The increase in license fee revenues is due primarily to the growth in
the number of DMT(R) technology license agreements executed since the end of the
2004 comparable periods, organic growth within our recurring licensee category
and the timing of the execution of paid-up license agreements. License fee
revenues will fluctuate from period to period based on the types of agreements
executed each period (i.e. recurring payments over the license term or fully
paid-up license agreements for past infringement and future use of our patented
technologies), an 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. Costs incurred in connection with the Acacia Technologies group's
ongoing licensing activities are included in marketing, general and
administrative expenses.
GOVERNMENT CONTRACT AND COST OF GOVERNMENT CONTRACT REVENUES. The
increase in government contract revenues for the three and six months ended June
30, 2005, as compared to the same periods in 2004, was due to increased
development efforts under the CombiMatrix group's two-year, $5.9 million
research and development contract with the Department of Defense to further the
development of the CombiMatrix group's array technology for the detection of
biological threat agents, which was executed in March 2004. Under the terms of
the contract, the CombiMatrix group is reimbursed on a periodic basis for actual
costs incurred to perform its obligations, plus a fixed fee. 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. Cost of government contract revenues reflect research and development
expenses incurred in connection with the CombiMatrix group's commitments under
this contract. As of June 30, 2005, the contract was approximately 68% complete
and the CombiMatrix group had approximately $1.4 million of costs remaining to
be incurred on the existing contract. The CombiMatrix group is negotiating
additional contracts with the government, which if successful will extend the
amount of revenues to be earned beyond what is currently obligated under its
existing Department of Defense contract.
PRODUCT REVENUES AND COST OF PRODUCT SALES. Product revenues and costs
of product sales relate to domestic and international sales of the CombiMatrix
group's array products and equipment. The CombiMatrix group launched its
CustomArray(TM) 902 DNA array platform in March 2004, its CustomArray(TM) 12K
DNA expression array in July 2004 and began selling its DNA array synthesizer
during the second quarter of 2005. The increase in sales and cost of sales is
due primarily to continued growth and acceptance of its array products,
equipment and services in the marketplace since launch in 2004, as well as two
full quarter's worth of array sales for the six months ended June 30, 2005, as
compared to only four months of sales in the comparable 2004 period.
RESEARCH AND DEVELOPMENT EXPENSES
(IN THOUSANDS)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
------------------------------------ ------------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
--------------- --------------- --------------- ---------------
Research and development expenses .......... $ 1,415 $ 1,409 $ 2,555 $ 2,792
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses,
comprised solely of costs incurred by the CombiMatrix group, were relatively
flat during the three and six months ended June 30, 2005 and 2004. Several
array-related research and development projects undertaken prior to launch of
the CustomArray(TM) platform in March 2004 were concluded upon launch, thereby
contributing to the slight decrease in research and development expenses during
the six months ended June 30, 2005, as compared to the six months ended June 30,
2004. Since the launch of CustomArray(TM), the CombiMatrix group has continued
internal research and development efforts to improve and expand the CombiMatrix
group's technology and product offerings.
Future research and development expenses will continue to be incurred
in connection with the CombiMatrix group's commitments under its collaboration
and supply agreements with various strategic partners including Furuno and
Toppan, as well as ongoing internal research and development efforts in the
44
areas of genomics, diagnostics, drug discovery and development and material
sciences. The CombiMatrix group expects its research and development expenses to
continue to fluctuate and such expenses could increase in future periods as
additional contract and/or internal research and development agreements are
undertaken.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES AND LEGAL SETTLEMENT CHARGES (CREDITS)
(IN THOUSANDS)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
------------------------------------ ------------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
--------------- --------------- --------------- ---------------
Marketing, general and administrative
expenses ................................ $ 4,261 $ 3,388 $ 8,150 $ 6,672
Legal expenses - patents ................... 536 576 1,097 1,178
Contingent legal fees and inventor
royalties expense - patents ............. 1,120 -- 1,767 --
Legal settlement charges (credits) ......... (16) (391) (195) 866
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. The increase in
marketing, general and administrative expenses was due to an increase in
personnel costs primarily related to the addition of patent licensing and
business development personnel for the Acacia Technologies group, an increase in
the Acacia Technologies group's consulting expenses primarily related to a
consulting agreement executed with the former CEO of Global Patent Holdings, LLC
in connection with the GPH Acquisition and an increase in the Acacia
Technologies group's general and administrative expenses primarily related to
certain of the companies acquired in the GPH Acquisition.
The increase also reflects an increase in marketing and sales costs
related to the CombiMatrix group's CustomArray(TM) platform, which were driven
primarily by increases in the CombiMatrix group's sales force as well as
expanded marketing and advertising efforts. The increase was partially offset by
a decrease in the CombiMatrix group's general and administrative costs related
to ongoing operations for the six months ended June 30, 2005.
A summary of the main drivers of the change in marketing, general and
administrative expenses for the periods presented is as follows (in thousands):
THREE MONTHS SIX MONTHS
--------------- ---------------
JUNE 30, 2005 JUNE 30, 2005
--------------- ---------------
CombiMatrix group:
Increase in marketing and sales
expenses ................................ $ 179 $ 417
Increase (decrease) in general and
administrative expenses ................. 95 (142)
Acacia Technologies group:
Increase in personnel expenses ............. 229 460
Increase in consulting expenses ............ 271 466
Increase in general and
administrative expenses ................. 99 277
LEGAL EXPENSE - PATENTS (ACACIA TECHNOLOGIES GROUP ONLY). Patent
related legal expenses for the three and six months ended June 30, 2005,
included $278,000 and $429,000, respectively, in patent related prosecution and
enforcement costs incurred by certain of the companies acquired in the GPH
Acquisition. Excluding the impact of the GPH Acquisition, patent related legal
expenses decreased to $258,000 and $668,000 for the three and six months ended
June 30, 2005, respectively, due to a decrease in costs incurred in connection
with the Acacia Technologies group's ongoing DMT(R) patent commercialization and
enforcement programs, including decreased legal costs related to new patent
claims and a decrease in patent enforcement costs related to ongoing DMT(R)
patent related litigation. DMT(R) related legal fees paid to outside attorneys
are incurred based on actual time and out-of-pocket expenses incurred by
external counsel and fluctuate from period to period based on patent enforcement
and prosecution activity in each period. We expect patent related legal expenses
to continue to fluctuate based on actual outside patent counsel fees and
expenses incurred in connection with the Acacia Technologies group's ongoing
patent commercialization and enforcement programs.
Although most litigation with respect to the patent portfolios acquired
in connection with the GPH Acquisition is handled on a contingency basis, where
attorneys fees are paid out of license fee revenues collected based on a
contractual percentage, certain other costs and expenses in connection with our
maintenance, licensing, and enforcement of patents are likely to increase as a
result of the acquisition, including patent filing fees, patent development
costs, travel costs, expert and consulting fees, and other third-party expenses.
In addition, under the various contingency agreements with outside patent law
firms, the Acacia Technologies group is required to pay out-of-pocket expenses
incurred by these firms in connection with the ongoing litigation, on a monthly
basis. We also expect these expenses to fluctuate from quarter to quarter based
on the level of enforcement activity each period.
45
CONTINGENT LEGAL FEES AND INVENTOR ROYALTIES EXPENSE. During the three
and six months ended June 30, 2005, the Acacia Technologies group incurred
contingent legal fee expenses totaling $592,000 and $957,000 and inventor
royalties expenses totaling $528,000 and $810,000, respectively, in connection
with the recognition of paid-up license fee revenues summarized above. The
majority of patent and patent rights agreements associated with the patent
portfolios acquired in the GPH Acquisition are subject to contingent legal fee
arrangements with outside attorneys and also are subject to agreements with
inventors that contain provisions granting to the original patent owners the
right to receive inventor royalties based on future net revenues, as defined in
the respective agreements. As such, contingent legal fees and inventor royalties
expenses in future periods will fluctuate in accordance with the timing and
amount of related revenues recognized by the Acacia Technologies group from
these patent portfolios.
LEGAL SETTLEMENT CHARGES (CREDITS). Legal settlement charges (credits)
relate to Acacia Research - CombiMatrix common stock, or AR-CombiMatrix stock,
issuable and or potentially issuable in connection with certain anti-dilution
provisions of the September 2002 settlement agreement between CombiMatrix
Corporation, Dr. Donald Montgomery, and Nanogen, Inc. The related liability
reflects management's estimate, as of each balance sheet date, of the fair value
of AR-CombiMatrix stock to be issued to Nanogen, Inc. as a result of certain
options and warrants exercised during the period, if any, and the fair value of
AR-CombiMatrix stock potentially issuable to Nanogen, Inc. as of each balance
sheet date, pursuant to the anti-dilution terms of the agreement. The liability
is adjusted at each balance sheet 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.
AMORTIZATION OF PATENTS (IN THOUSANDS)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
------------------------------------ ------------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
--------------- --------------- --------------- ---------------
Amortization of patents .................... $ 1,610 $ 399 $ 2,800 $ 798
AMORTIZATION OF PATENTS. Non-cash patent amortization charges increased
due to the amortization of patent related intangibles acquired in connection
with the January 28, 2005 GPH Acquisition. Approximately $25.1 million of the
purchase consideration paid in the GPH Acquisition was allocated to amortizable
patents and related patent rights acquired. Amortization of the newly acquired
patents and patent rights for the three and six months ended June 30, 2005,
totaled $1.2 million and $2.0 million, respectively. Patent amortization charges
will continue to be significant in future periods as the Acacia Technologies
group continues to amortize the acquired patent related costs over a weighted
average economic useful life of approximately 6 years.
OTHER
Results for the six months ended June 30, 2005 and 2004, include
charges, net of minority interests, of $210,000 and $104,000, respectively,
related to estimated additional costs to be incurred in connection with the
discontinued operations of Soundbreak.com (originally ceased operations in
February 2001), related primarily to certain noncancellable lease obligations
and a reduction in estimated amounts recoverable from existing sublease
arrangements. The related lease obligations, which are guaranteed by Acacia
Research Corporation, expire in August 2005.
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 $55.3 million at June 30, 2005, compared to
$52.4 million at December 31, 2004. Working capital at June 30, 2005, was
$54.1million, compared to $49.2 million at December 31, 2004.
46
The net increase (decrease) in cash and cash equivalents for the three
and six months ended June 30, 2005, and 2004, was comprised of the following (in
thousands):
FOR THE SIX MONTHS ENDED JUNE 30, 2005 FOR THE SIX MONTHS ENDED JUNE 30, 2004
--------------------------------------- ---------------------------------------
ACACIA ACACIA
TECHNO- COMBI- TECHNO- COMBI-
LOGIES MATRIX CONSOL- LOGIES MATRIX CONSOL-
GROUP GROUP IDATED GROUP GROUP IDATED
--------- --------- --------- --------- --------- ---------
Net cash provided by (used in)
continuing operations:
Operating activities ........... $ (2,329) $ (6,962) $ (9,291) $ (998) $ (6,600) $ (7,598)
Investing activities ........... (20,326) 11,127 (9,199) (3,006) (13,135) (16,141)
Financing activities ........... 19,479 327 19,806 (155) 18,561 18,406
Effect of exchange rate on cash ..... -- 21 21 -- (6) (6)
Net cash used in discontinued
operations ....................... (433) -- (433) (509) -- (509)
--------- --------- --------- --------- --------- ---------
Increase (decrease) in cash and
cash equivalents ................. $ (3,609) $ 4,513 $ 904 $ (4,668) $ (1,180) $ (5,848)
========= ========= ========= ========= ========= =========
Cash receipts from customers for the CombiMatrix group for the six
months ended June 30, 2005, were $1.8 million, comprised of $1.3 million, in
biological threat detection contract payments received from the Department of
Defense and $498,000 from the sale of array products and related services. Cash
receipts in the comparable 2004 period totaled $462,000, comprised of $339,000
in biological threat detection contract payments received from the Department of
Defense and $123,000 from the sale of array products and related services. Cash
outflows from operations for the CombiMatrix group increased to $8.8 million, as
compared to $7.1 million in the same period in 2004, due to an increase in
research and development expenses primarily related to its biological threat
detection contract with the Department of Defense, an increase in sales and
marketing expenses related to the launch and ongoing sales activities associated
with its CustomArray(TM) products and services, which were partially offset by a
decrease in general and administrative expenses and the impact of the timing of
vendor payments and related accruals.
Cash receipts from licensees for the Acacia Technologies group for the
six months ended June 30, 2005, increased to $4.3 million, as compared to $1.6
million in the same period in 2004. Cash outflows from operations for the Acacia
Technologies group increased to $6.6 million, as compared to $2.6 million in the
same period in 2004, due to increases in personnel costs, GPH Acquisition
related consulting expenses, contingent legal fees and inventor royalty
expenses, general and administrative expenses and the impact of the timing of
vendor payments and related accruals.
The change in net cash flows from continuing investing activities was
due to net changes in short term investments in available-for-sale securities by
both groups, in connection with ongoing short-term cash management activities.
Short term investments represent capital available to fund current operations
and fund capital expenditures. Net cash outflows from investing activities also
reflects the cash consideration and related acquisition and registration costs,
totaling $5.8 million, paid by the Acacia Technologies group in connection with
the GPH Acquisition in the first quarter of 2005. Investing activities also
included capital purchases totaling $512,000 and $315,000, for the six months
ended June 30, 2005 and 2004, respectively, primarily related to the CombiMatrix
group.
Cash flows provided by financing activities for the six months ended
June 30, 2005 included net proceeds of approximately $19.5 million, related to
the sale of 3.5 million shares of AR-Acacia Technologies stock in February 2005.
Cash flows provided by financing activities for the six months ended June 30,
2004 included net proceeds of approximately $13.7 million, related to the sale
of AR-CombiMatrix stock in April 2004, and proceeds primarily from the exercise
of AR-CombiMatrix stock warrants and stock options, totaling $4.6 million.
In June 2005, Acacia Research Corporation obtained commitments to
purchase approximately $3.2 million of its AR-CombiMatrix stock in a registered
direct offering, which closed on July 5, 2005. Under the terms of the
transaction, 1,400,444 shares of AR-CombiMatrix stock were sold at $2.25 per
share to a select group of institutional investors. The net proceeds, totaling
approximately $3.1 million, which are net of offering costs, were allocated to
the CombiMatrix group, and are expected to be used for general working capital
purposes.
Management believes that our cash and cash equivalent balances,
anticipated cash flow from operations, availability under our shelf registration
statement and other external sources of available credit, will be sufficient to
meet our cash requirements through at least the next twelve months. Total
maximum proceeds of the shelf registration were $50.0 million, of which $12.2
million remains available subsequent to the July 5, 2005 direct offering
described above. We may however encounter unforeseen difficulties that may
deplete our capital resources more rapidly than anticipated, including those set
forth in our Risk Factors on pages 5, 6, 8, 9, 12 and 13 of our amended
registration statement on Form S-3/A filed with the SEC on May 6, 2005,
47
incorporated by reference herein. Any efforts to seek additional funding could
be made through equity, debt or other external financing and there can be no
assurance that additional funding will be available on favorable terms, if at
all. If we fail to obtain additional funding when needed, we may not be able to
execute our business plans and our business may suffer.
OFF-BALANCE SHEET ARRANGEMENTS
We have not entered into off-balance sheet financing arrangements,
other than operating leases. We have no significant commitments for capital
expenditures in 2005. Other than as set forth below, we have no committed lines
of credit or other committed funding or long-term debt. The following table
lists our material known future cash commitments as of June 30, 2005:
PAYMENTS DUE BY PERIOD (IN THOUSANDS)
-----------------------------------------------------------------------
REMAINING 2009 AND
CONTRACTUAL OBLIGATIONS 2005 2006 2007 2008 THEREAFTER
---------- ---------- ---------- ---------- ----------
Operating Leases .............................. $ 1,171 $ 2,351 $ 2,002 $ 1,615 $ --
Minimum Royalty Payments (1) .................. 50 100 100 100 975
irsiCaixa Foundation research, development,
and licensing agreement (3) ................ 75 175 100 -- --
Leuchemix equity purchases (2) ................ 1,000 2,150 -- -- --
Consulting contract(4) ........................ 519 1,074 99 -- --
---------- ---------- ---------- ---------- ----------
Total Contractual Cash Obligations ............ $ 2,815 $ 5,850 $ 2,301 $ 1,715 $ 975
========== ========== ========== ========== ==========
- --------------------
(1) Refer to Note 9 to the Acacia Research Corporation consolidated
financial statements for a description of the September 30, 2002
settlement agreement between CombiMatrix Corporation and Dr. Donald
Montgomery and Nanogen.
(2) See Note 9 to the Acacia Research Corporation consolidated financial
statements included elsewhere herein for additional information
regarding the October 2004 Leuchemix transaction.
(3) Excludes any potential future payments contingent upon the completion
of certain milestones in accordance with the agreement.
(4) Reflects $2.0 million consulting contract commitment, including
estimated reimbursable expenses, to be paid over two years in
connection with the Acacia Technologies group's GPH Acquisition, as
described above.
In connection with the acquisition of certain patents and patent
rights, certain companies included in the Acacia Technologies group executed
related agreements which grant to the former owners of the respective patents or
patent rights, the right to receive inventor royalties based on future net
license fee revenues (as defined in the respective agreements) generated by the
Acacia Technologies group as a result of licensing the respective patents or
patent portfolios. Inventor royalties paid pursuant to the agreements are
expensed in the consolidated statement of operations in the period that the
related license fee revenues are recognized.
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.
48
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
See Item 2. "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Overview," for a general overview of the
CombiMatrix group's business.
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. Please see Note 1 to our consolidated financial statements included
elsewhere herein for details regarding our separate group presentation and our
classes of common stock.
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004
DIVISION NET INCOME (LOSS) (IN THOUSANDS)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
----------------------------------- -----------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
--------------- --------------- --------------- ---------------
Division net income (loss) ......................... $ (3,657) $ (3,516) $ (6,733) $ 8,376
The changes in net income (loss) were primarily due to operating
results and activities as discussed below.
REVENUES AND COST OF REVENUES (IN THOUSANDS)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
----------------------------------- -----------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
--------------- --------------- --------------- ---------------
Research and development contract .................. $ -- $ -- $ -- $ 17,302
Government contract ................................ 1,281 701 2,012 918
Cost of government contract revenues ............... (1,209) (653) (1,900) (858)
Products and services .............................. 576 49 914 146
Cost of product sales .............................. (190) (36) (353) (40)
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 obligations under this agreement and in accordance with
the CombiMatrix group's revenue recognition policies for multiple-element
arrangements, the CombiMatrix group recognized $17.3 million of research and
development contract revenues during the first quarter of 2004, all of which
were previously deferred. The majority of research and development efforts under
the Roche agreement were incurred prior to 2004.
GOVERNMENT CONTRACT AND COST OF GOVERNMENT CONTRACT REVENUES. The
increase in government contract revenues for the three and six months ended June
30, 2005, as compared to the same periods in 2004, was due to increased
development efforts under the CombiMatrix group's two-year, $5.9 million
research and development contract with the Department of Defense, which was
49
executed in March 2004. Under the terms of the contract, the CombiMatrix group
is reimbursed on a periodic basis for actual costs incurred to perform its
obligations, plus a fixed fee. 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. Cost of government
contract revenues reflect research and development expenses incurred in
connection with the CombiMatrix group's commitments under this contract. As of
June 30, 2005, the contract was approximately 68% complete and the CombiMatrix
group had approximately $1.4 million of costs remaining to be incurred on the
existing contract. The CombiMatrix group is negotiating additional contracts
with the government, which if successful will extend the amount of revenues to
be earned beyond what is currently obligated under its existing Department of
Defense contract.
PRODUCT REVENUES AND COST OF PRODUCT SALES. Product revenues and costs
of product sales relate to domestic and international sales of the CombiMatrix
group's array products and equipment. The CombiMatrix group launched its
CustomArray(TM) 902 DNA array platform in March 2004, its CustomArray(TM) 12K
DNA expression array in July 2004 and began selling its DNA array synthesizer
during the second quarter of 2005. The increase in sales and cost of sales is
due primarily to continued growth and acceptance of its array products,
equipment and services in the marketplace since launch in 2004, as well as two
full quarter's worth of array sales for the six months ended June 30, 2005, as
compared to only four months of sales in the comparable 2004 period.
RESEARCH AND DEVELOPMENT EXPENSES (IN THOUSANDS)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
----------------------------------- -----------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
--------------- --------------- --------------- ---------------
Research and development expenses .................. $ 1,415 $ 1,409 $ 2,555 $ 2,792
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
were relatively flat during the three and six months ended June 30, 2005 and
2004. Several array-related research and development projects undertaken prior
to launch of the CustomArray(TM) platform in March 2004 were concluded upon
launch, thereby contributing to the slight decrease in research and development
expenses during the six months ended June 30, 2005, as compared to the six
months ended June 30, 2004. Since the launch of CustomArray(TM), the CombiMatrix
group has continued internal research and development efforts to improve and
expand the CombiMatrix group's technology and product offerings.
Future research and development expenses will continue to be incurred
in connection with the CombiMatrix group's commitments under its collaboration
and supply agreements with various strategic partners including Furuno and
Toppan, as well as ongoing internal research and development efforts in the
areas of genomics, diagnostics, drug discovery and development and material
sciences. The CombiMatrix group expects its research and development expenses to
continue to fluctuate and such expenses could increase in future periods as
additional contract and/or internal research and development agreements are
undertaken.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES AND LEGAL SETTLEMENT CHARGES (CREDITS) (IN THOUSANDS)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
----------------------------------- -----------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
--------------- --------------- --------------- ---------------
Marketing, general and administrative expenses ..... $ 2,502 $ 2,228 $ 4,781 $ 4,506
Legal settlement charges (credits) ................. (16) (391) (195) 866
The increase in marketing, general and administrative expenses for the
three and six months ended June 30, 2005 as compared to the same periods in
2004, was due primarily to increases in marketing and sales costs of $178,000
and $416,000, respectively, related to the CustomArray(TM) platform, which are
driven primarily by increases in our sales force as well as expanded marketing
and advertising efforts.
LEGAL SETTLEMENT CHARGES (CREDITS). Legal settlement charges (credits)
relate to AR-CombiMatrix stock issuable and or potentially issuable in
connection with certain anti-dilution provisions of the September 2002
settlement agreement between CombiMatrix Corporation, Dr. Donald Montgomery, and
Nanogen, Inc. The related liability reflects management's estimate, as of each
balance sheet date, of the fair value of AR-CombiMatrix stock to be issued to
Nanogen, Inc. as a result of certain options and warrants exercised during the
period, if any, and the fair value of AR-CombiMatrix stock potentially issuable
to Nanogen, Inc. as of each balance sheet date, pursuant to the anti-dilution
terms of the agreement. The liability is adjusted at each balance sheet 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.
50
INFLATION
Inflation has not had a significant impact on the CombiMatrix group in
the current or prior periods.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2005, cash and cash equivalents and short-term investments
totaled $16.2 million, compared to $23.7 million at December 31, 2004.
The net increase (decrease) in cash and cash equivalents for the six
months ended June 30, 2005, and 2004, was comprised of the following (in
thousands):
FOR THE SIX MONTHS ENDED
--------------------------------------
JUNE 30, 2005 JUNE 30, 2004
---------------- ----------------
Net cash provided by (used in):
Operating activities ............................ $ (6,962) $ (6,600)
Investing activities ............................ 11,127 (13,135)
Financing activities ............................ 327 18,561
Effect of exchange rate on cash ...................... 21 (6)
---------------- ----------------
Increase (decrease) in cash and cash equivalents ..... $ 4,513 $ (1,180)
================ ================
Cash receipts from customers for the CombiMatrix group for the six
months ended June 30, 2005, were $1.8 million, comprised of $1.3 million, in
biological threat detection contract payments received from the Department of
Defense and $498,000 from the sale of array products and related services. Cash
receipts in the comparable 2004 period totaled $462,000, comprised of $339,000
in biological threat detection contract payments received from the Department of
Defense and $123,000 from the sale of array products and related services. Cash
outflows from operations increased to $8.8 million, as compared to $7.1 million
in the same period in 2004, due to an increase in research and development
expenses primarily related to its biological threat detection contract with the
Department of Defense, an increase in sales and marketing expenses related to
the launch and ongoing sales activities associated with its CustomArray(TM)
products and services, which were partially offset by a decrease in general and
administrative expenses and the impact of the timing of vendor payments and
related accruals.
The change in net cash flows from continuing investing activities was
due to net purchases and sales of available-for-sale investments by the
CombiMatrix group in connection with ongoing short-term cash management
activities.
Net cash flows provided by financing activities for the six months
ended June 30, 2005 included $225,000 related to the July 2005 AR-CombiMatrix
stock equity financing described below. Cash flows provided by financing
activities for the six months ended June 30, 2004 included net proceeds of
approximately $13.7 million, related to the sale of AR-CombiMatrix stock in
April 2004, and also included proceeds, primarily from the exercise of
AR-CombiMatrix stock warrants and stock options, totaling $4.6 million.
In June 2005, Acacia Research Corporation obtained commitments to
purchase approximately $3.2 million of its AR-CombiMatrix stock in a registered
direct offering, which closed on July 5, 2005. Under the terms of the
transaction, 1,400,444 shares of AR-CombiMatrix stock were sold at $2.25 per
share to a select group of institutional investors. The net proceeds, totaling
approximately $3.1 million, which are net of offering costs, were allocated to
the CombiMatrix group, and are expected to be used for general working capital
purposes.
Customer receivables at June 30, 2005 increased to $1.5 million,
compared to $343,000 at December 31, 2004, due to an increase in receivables
from the Department of Defense in connection with the increase in activity under
the CombiMatrix group's biological threat detection contract and an increase in
customer receivables related to CustomArray(TM) product and equipment sales in
June 2005.
We believe that the CombiMatrix group's cash and cash equivalent
balances, anticipated cash flow from operations, availability under Acacia
Research Corporation's shelf registration statement and other external sources
of available credit, will be sufficient to meet its cash requirements through at
least the next twelve months. Total maximum proceeds under Acacia Research
Corporation's shelf registration were $50.0 million, of which $12.2 million
remains available subsequent to the July 5, 2005 direct offering described
51
above. The CombiMatrix group may however encounter unforeseen difficulties that
may deplete its capital resources more rapidly than anticipated, including those
set forth in Acacia Research Corporation's Risk Factors on pages 5, 6, 8, 9, 12
and 13 of Acacia Research Corporation's amended registration statement on Form
S-3/A filed with the SEC on May 6, 2005, incorporated by reference herein. 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 the CombiMatrix group fails to
obtain additional funding when needed, it may not be able to execute its
business plans and its business may suffer.
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 2005. Other than as set
forth below, 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 as of June 30, 2005:
PAYMENTS DUE BY PERIOD (IN THOUSANDS)
----------------------------------------------------------------------
REMAINING 2009 AND
CONTRACTUAL OBLIGATIONS 2005 2006 2007 2008 THEREAFTER
---------- ---------- ---------- ---------- ----------
Operating Leases (2) ............................ $ 962 $ 1,836 $ 1,937 $ 1,615 $ --
Minimum Royalty Payments (1) .................... 50 100 100 100 975
irsiCaixa Foundation research, development,
and licensing agreement (4) ................... 75 175 100 -- --
Leuchemix equity purchases (3) .................. 1,000 2,150 -- -- --
---------- ---------- ---------- ---------- ----------
Total Contractual Cash Obligations .............. $ 2,087 $ 4,261 $ 2,137 $ 1,715 $ 975
========== ========== ========== ========== ==========
--------------------
(1) Refer to Note 9 to the Acacia Research Corporation consolidated
financial statements for a description of the September 30, 2002
settlement agreement between CombiMatrix Corporation and Dr. Donald
Montgomery and Nanogen.
(2) Excludes any allocated rent expense in connection with Acacia Research
Corporation's management allocation policies.
(3) See Note 9 to the CombiMatrix group financial statements for
additional information regarding the October 2004 Leuchemix
transaction.
(4) Excludes any potential future payments contingent upon the completion
of certain milestones in accordance with the agreement.
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, we believe that the CombiMatrix group is not subject to any
material market risk exposure.
At June 30, 2005, 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, we do not believe
that the CombiMatrix group 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.
52
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
See Item 2. "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Overview," for a general overview of the
Acacia Technologies group's business.
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.
Please see Note 1 to our consolidated financial statements included elsewhere
herein for details regarding our separate group presentation and our classes of
common stock.
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004
DIVISION NET LOSS (IN THOUSANDS)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
----------------------------------- -----------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
--------------- --------------- --------------- ---------------
Division net loss .................................. $ (1,760) $ (1,153) $ (3,634) $ (2,142)
The changes in net loss were primarily due to operating results and
activities as discussed below.
REVENUES (IN THOUSANDS)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
----------------------------------- -----------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
--------------- --------------- --------------- ---------------
Recurring license fees ............................. $ 832 $ 666 $ 1,620 $ 1,265
Paid-up license fees ............................... 1,850 -- 2,925 --
--------------- --------------- --------------- ---------------
Total license fees ............................ $ 2,682 $ 666 $ 4,545 $ 1,265
=============== =============== =============== ===============
LICENSE FEES. Recurring license fee revenues are recognized from Acacia
Technologies group licensees that make recurring quarterly or annual license fee
payments, in accordance with the terms of their respective license agreements.
Paid-up license fee revenues are recognized from Acacia Technologies group
licensees that made paid-up license fee payments for past infringement and
future use of certain of our patented technologies, in accordance with the terms
of their respective license agreements.
Second quarter 2005 license fee revenues included fees from the
licensing of our DMT(R) technology, and from our credit card fraud protection
technology, multi-dimensional bar code technology, computer simulation
technology, high capacity compact disk technology and interactive television
technology, which were acquired in connection with the GPH Acquisition.
Recurring license fee revenues in the comparable 2004 periods all relate to our
DMT(R) technology.
The increase in license fee revenues is due primarily to the growth in
the number of DMT(R) technology license agreements executed since the end of the
2004 comparable periods, organic growth within our recurring licensee category
and the timing of the execution of paid-up license agreements. License fee
revenues will fluctuate from period to period based on the types of agreements
executed each period (i.e. recurring payments over the license term or fully
53
paid-up license agreements for past infringement and future use of our patented
technologies), an 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. Costs incurred in connection with the Acacia Technologies group's
ongoing licensing activities are included in marketing, general and
administrative expenses.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES (IN THOUSANDS):
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
----------------------------------- -----------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
--------------- --------------- --------------- ---------------
Marketing, general and administrative expenses ..... $ 1,759 $ 1,160 $ 3,369 $ 2,166
Legal expenses - patents ........................... 536 576 1,097 1,178
Contingent legal fees and inventor royalties
expense - patents ............................... 1,120 -- 1,767 --
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. The increase in
marketing, general and administrative expenses was due to an increase in
personnel costs related primarily to the addition of patent licensing and
business development personnel for the Acacia Technologies group, an increase in
the Acacia Technologies group's consulting expenses primarily related to a
consulting agreement executed with the former CEO of Global Patent Holdings, LLC
in connection with the GPH Acquisition and an increase in the Acacia
Technologies group's general and administrative expenses primarily related to
certain of the companies acquired in the GPH Acquisition.
A summary of the main drivers of the change in marketing, general and
administrative expenses for the periods presented is as follows (in thousands):
THREE MONTHS SIX MONTHS
--------------- ---------------
JUNE 30, 2005 JUNE 30, 2005
--------------- ---------------
Increase in personnel expenses ..................... $ 229 $ 460
Increase in consulting expenses .................... 271 466
Increase in general and administrative expenses .... 99 277
LEGAL EXPENSE - PATENTS. Patent related legal expenses for the three
and six months ended June 30, 2005, included $278,000 and $429,000,
respectively, in patent related prosecution and enforcement costs incurred by
certain of the companies acquired in the GPH Acquisition. Excluding the impact
of the GPH Acquisition, patent related legal expenses decreased to $258,000 and
$668,000 for the three and six months ended June 30, 2005, respectively, due to
a decrease in costs incurred in connection with the Acacia Technologies group's
ongoing DMT(R) patent commercialization and enforcement programs, including
decreased legal costs related to new patent claims and a decrease in patent
enforcement costs related to ongoing DMT(R) patent related litigation. DMT(R)
related legal fees paid to outside attorneys are incurred based on actual time
and out-of-pocket expenses incurred by external counsel and fluctuate from
period to period based on patent enforcement and prosecution activity in each
period. We expect patent related legal expenses to continue to fluctuate based
on actual outside patent counsel fees and expenses incurred in connection with
the Acacia Technologies group's ongoing patent commercialization and enforcement
programs.
Although most litigation with respect to the patent portfolios acquired
in connection with the GPH Acquisition is handled on a contingency basis, where
attorneys fees are paid out of license fee revenues collected based on a
contractual percentage, certain other costs and expenses in connection with our
maintenance, licensing, and enforcement of patents are likely to increase as a
result of the acquisition, including patent filing fees, patent development
costs, travel costs, expert and consulting fees, and other third-party expenses.
In addition, under the various contingency agreements with outside patent law
firms, the Acacia Technologies group is required to pay out-of-pocket expenses
incurred by these firms in connection with the ongoing litigation, on a monthly
basis. We also expect these expenses to fluctuate from quarter to quarter based
on the level of enforcement activity each period.
CONTINGENT LEGAL FEES AND INVENTOR ROYALTIES EXPENSE. During the three
and six months ended June 30, 2005, the Acacia Technologies group incurred
contingent legal fee expenses totaling $592,000 and $957,000 and inventor
royalties expenses totaling $528,000 and $810,000, respectively, in connection
with the recognition of paid-up license fee revenues summarized above. The
majority of patent and patent rights agreements associated with the patent
portfolios acquired in the GPH Acquisition are subject to contingent legal fee
54
arrangements with outside attorneys and also are subject to agreements with
inventors that contain provisions granting to the original patent owners the
right to receive inventor royalties based on future net revenues, as defined in
the respective agreements. As such, contingent legal fees and inventor royalties
expenses in future periods will fluctuate in accordance with the timing and
amount of related revenues recognized by the Acacia Technologies group from
these patent portfolios.
AMORTIZATION OF PATENTS (IN THOUSANDS)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
----------------------------------- -----------------------------------
JUNE 30, 2005 JUNE 30, 2004 JUNE 30, 2005 JUNE 30, 2004
--------------- --------------- --------------- ---------------
Amortization of patents ............................ $ 1,336 $ 125 $ 2,252 $ 250
AMORTIZATION OF PATENTS. Non-cash patent amortization charges increased
due to the amortization of patent related intangibles acquired in connection
with the January 28, 2005 GPH Acquisition. Approximately $25.1 million of the
purchase consideration paid in the GPH Acquisition was allocated to amortizable
patents and related patent rights acquired. Amortization of the newly acquired
patents and patent rights for the three and six months ended June 30, 2005,
totaled $1.2 million and $2.0 million, respectively. Patent amortization charges
will continue to be significant in future periods as the Acacia Technologies
group continues to amortize the acquired patent related costs over a weighted
average economic useful life of approximately 6 years.
OTHER
Results for the six months ended June 30, 2005 and 2004, include
charges, net of minority interests, of $210,000 and $104,000, respectively,
related to estimated additional costs to be incurred in connection with the
discontinued operations of Soundbreak.com (originally ceased operations in
February 2001), related primarily to certain noncancellable lease obligations
and a reduction in estimated amounts recoverable from existing sublease
arrangements. The related lease obligations, which are guaranteed by Acacia
Research Corporation, expire in August 2005.
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 $39.2 million at June 30, 2005, compared to $28.6
million at December 31, 2004. Working capital at June 30, 2005, was $38.9
million, compared to $27.1 million at December 31, 2004.
The net change in cash and cash equivalents for the six months ended
June 30, 2005, and 2004, was comprised of the following (in thousands):
FOR THE SIX MONTHS ENDED
-------------------------------------
JUNE 30, 2005 JUNE 30, 2004
--------------- ---------------
Net cash provided by (used in) continuing operations:
Operating activities ................................. $ (2,329) $ (998)
Investing activities ................................. (20,326) (3,006)
Financing activities ................................. 19,479 (155)
Net cash used in discontinued operations .................. (433) (509)
--------------- ---------------
Decrease in cash and cash equivalents ..................... $ (3,609) $ (4,668)
=============== ===============
Cash receipts from licensees for the Acacia Technologies group for the
six months ended June 30, 2005, increased to $4.3 million, as compared to $1.6
million in the same period in 2004. Cash outflows from operations increased to
$6.6 million, as compared to $2.6 million in the same period in 2004, due to
increases in personnel costs, GPH Acquisition related consulting expenses,
contingent legal fees and inventor royalty expenses, general and administrative
expenses and the impact of the timing of vendor payments and related accruals.
The change in net cash flows used in continuing investing activities
was due to net purchases of available-for-sale investments by the Acacia
Technologies group in connection with ongoing short-term cash management
55
activities. Net cash outflows from investing activities also reflects the cash
consideration and related acquisition and registration costs totaling $5.8
million, paid by the Acacia Technologies group in connection with the GPH
Acquisition in the first quarter of 2005.
Cash flows provided by financing activities for the six months ended
June 30, 2005 included net proceeds of approximately $19.5 million, related to
the sale of 3.5 million shares of AR-Acacia Technologies stock in February 2005.
We believe that the Acacia Technologies group's cash and cash
equivalent balances, anticipated cash flow from operations, availability under
Acacia Research Corporation's shelf registration statement and other external
sources of available credit, will be sufficient to meet the its cash
requirements through at least the next twelve months. Total maximum proceeds
under Acacia Research Corporation's shelf registration were $50.0 million, of
which $12.2 million remains available subsequent to the July 5, 2005 direct
offering of AR-CombiMatrix stock, as described above. The Acacia Technologies
group may however encounter unforeseen difficulties that may deplete its capital
resources more rapidly than anticipated, including those set forth in Acacia
Research Corporation's Risk Factors on pages 5, 6, 8, 9, 12 and 13 of Acacia
Research Corporation's amended registration statement on Form S-3/A filed with
the SEC on May 6, 2005, incorporated by reference herein. 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 the Acacia Technologies group fails
to obtain additional funding when needed, it may not be able to execute its
business plans and its business may suffer.
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 2005. Other
than as set forth below, 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 as of
June 30, 2005:
PAYMENTS DUE BY PERIOD (IN THOUSANDS)
-----------------------------------------------------------------------
REMAINING 2009 AND
CONTRACTUAL OBLIGATIONS 2005 2006 2007 2008 THEREAFTER
---------- ---------- ---------- ---------- ----------
Operating Leases (1) ....................... $ 209 $ 515 $ 65 $ -- $ --
Consulting contract (2) .................... 519 1,074 99 -- --
---------- ---------- ---------- ---------- ----------
Total Contractual Cash Obligations ......... $ 728 $ 1,589 $ 164 $ -- $ --
========== ========== ========== ========== ==========
--------------------
(1) Excludes any allocated rent expense in connection with Acacia Research
Corporation's management allocation policies.
(2) Reflects $2.0 million consulting contract commitment, including
estimated reimbursable expenses, to be paid over two years in
connection with the Acacia Technologies group's purchase of the assets
of Global Patent Holdings, LLC in January 2005, as described above.
In connection with the acquisition of certain patents and patent
rights, certain companies included in the Acacia Technologies group executed
related agreements which grant to the former owners of the respective patents or
patent rights, the right to receive inventor royalties based on future net
license fee revenues (as defined in the respective agreements) generated by the
Acacia Technologies group as a result of licensing the respective patents or
patent portfolios. Inventor royalties paid pursuant to the agreements are
expensed in the consolidated statement of operations in the period that the
related license fee revenues are recognized.
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
56
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.
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 and in our annual report on Form 10-K
for the year ending December 31, 2004, filed with the Securities and Exchange
Commission on March 15, 2005. If any of the risks incorporated by reference into
this quarterly report or into our annual report actually occur, our business,
financial condition and results of operations could be materially adversely
affected. If this were to occur, the trading price of our securities could
decline significantly and you may lose all or part of your investment. You
should carefully review the "Risk Factors" set forth on pages 5 through 27 of
our amended registration statement on Form S-3/A filed with the SEC on May 6,
2005, and hereby incorporated by reference.
57
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, elsewhere herein,
incorporated by reference.
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 June 30, 2005, 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 June 30, 2005.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
(a) Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
conducted an evaluation of our disclosure controls and procedures, as such term
is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of
1934, as amended. Based on this evaluation, our principal executive officer and
our principal financial officer concluded that, as of the end of the period
covered by this quarterly report, our disclosure controls and procedures were
effective to ensure that the information required to be disclosed by us in the
reports that we file or submit under the Securities Exchange Act of 1934 is
accumulated and communicated to management, including our chief executive
officer and chief financial officer, to allow timely decisions regarding
required disclosure, and that such information is recorded, processed,
summarized and reported within the time periods prescribed by the SEC.
CHANGES IN INTERNAL CONTROLS
(b) There were no changes in our internal control over financial
reporting that occurred during our last fiscal quarter (the quarter ended June
30, 2005) that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
58
PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 5. OTHER INFORMATION
Unaudited Pro Forma Consolidated Financial Information
The update to the unaudited pro forma consolidated statement of
operations included in Acacia Research Corporation's Current Report on Form 8-K
filed with the Securities and Exchange Commission on February 1, 2005, as
amended, is being provided in connection with guidance set forth by Rule 3-05
and Article 11 of Regulation S-X.
The unaudited pro forma consolidated statement of operations reflects
the pro forma effect on Acacia Research Corporation's unaudited consolidated
statements of operations for the six months ended June 30, 2005, as reported by
us in this Quarterly Report on Form 10-Q, from the acquisition of substantially
all of the assets of Global Patent Holdings, LLC, as discussed elsewhere herein.
The unaudited pro forma statement of operations for the six months ended June
30, 2005 reflects the acquisition as if it had taken place on January 1, 2005.
The unaudited pro forma consolidated statement of operations is for
informational purposes only. It does not purport to indicate the results that
would have actually been obtained had the acquisition been completed on the
assumed date or for the period presented, or which may be obtained in the
future. The unaudited pro forma consolidated statement of operations should be
read in conjunction with Management's Discussion and Analysis of Financial
Condition and Results of Operations and the consolidated financial statements,
including the notes, included in this Quarterly Report on Form 10-Q and our
Registration Statement on Form S-3, Number 333-122452, filed with the Securities
and Exchange Commission on February 1, 2005, as amended. The unaudited pro forma
consolidated statement is presented in thousands, except share and per share
information.
ACACIA RESEARCH CORPORATION
UNAUDITED PRO FORMA CONSOLIDATED INCOME STATEMENTS
----------------------------------------------------------------------------
FOR THE SIX MONTHS ENDED JUNE 30, 2005 (1)
----------------------------------------------------------------------------
ACACIA RESEARCH
ACACIA RESEARCH GLOBAL PATENT PRO FORMA CORPORATION
CORPORATION HOLDINGS, LLC(1) ADJUSTMENTS(1) PRO FORMA
--------------- ---------------- --------------- ---------------
Total revenues ................................ $ 7,471 $ -- $ -- $ 7,471
--------------- ---------------- --------------- ---------------
Total operating expenses ...................... 18,316 -- 477 (3),(4) 18,793
--------------- ---------------- --------------- ---------------
Operating income (loss) ....................... (10,845) -- (477) (11,322)
--------------- ---------------- --------------- ---------------
Total other income (expense) .................. 554 -- -- 554
--------------- ---------------- --------------- ---------------
Income (loss) from continuing operations
before income taxes ........................ (10,291) -- (477) (10,768)
Benefit for income taxes ...................... 134 -- -- 134
Estimated loss on discontinued operations ..... (210) -- -- (210)
--------------- ---------------- --------------- ---------------
Net income (loss) ............................. $ (10,367) $ -- $ (477) $ (10,844)
=============== ---------------- =============== ===============
Pro forma earnings (loss) per common share:
Attributable to the Acacia Technologies group:
Net loss ...................................... $ (3,634) $ (477) $ (4,111)
Basic and diluted loss per share ......... (0.14) (0.16)
Weighted average shares (2):
Acacia Research - Acacia Technologies stock:
Basic and diluted ........................ 25,922,412 587,561 (5) 26,509,973
=============== =============== ===============
- --------------------
(1) Results of operations for Global Patent Holdings, LLC were not material for
the 2005 periods presented. Pro forma adjustments reflect the impact of the
acquisition for the 28-day period from January 1, 2005 to January 28, 2005,
the date of the acquisition.
(2) There is no pro forma impact on earnings (loss) per share attributable to
the CombiMatrix group as presented in the accompany statements of
operations for the periods presented.
(3) To reflect amortization of the patent related intangible assets acquired on
a straight-line basis over the estimated economic useful life of the
patents or groups of patents totaling $393,000 for the six months ended
June 30, 2005 (amortization for the 28-day period from January 1, 2005
through January 28, 2005).
59
(4) To reflect consulting expense related to a consulting agreement between
Acacia Global Acquisition Corporation as described in Item 2.
"Management's discussion and Analysis of financial Condition and Results of
Operations," totaling $84,000 for the six months ended June 30, 2005
(reflects expenses for the 28-day period from January 1, 2005 through
January 28, 2005).
(5) Represents incremental increase in weighted average shares as if the
3,938,832 shares of AR-Acacia Technologies common stock issued a partial
consideration for the GPH Acquisition were issued as of the beginning of
the interim periods presented.
ITEM 6. 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
60
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: August 5, 2005
61
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
62