-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JnyMyCBwGz8qe7y9WTpNsOdZM2lJFckzlj3hFzBPIMXMQ1FvMbw8nnI0AAZf41Md o5QscL4LQnPX9RBYBVFvjQ== 0001019687-03-000961.txt : 20030509 0001019687-03-000961.hdr.sgml : 20030509 20030509154717 ACCESSION NUMBER: 0001019687-03-000961 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20030331 FILED AS OF DATE: 20030509 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ACACIA RESEARCH CORP CENTRAL INDEX KEY: 0000934549 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRONIC COMPONENTS & ACCESSORIES [3670] IRS NUMBER: 954405754 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-26068 FILM NUMBER: 03690473 BUSINESS ADDRESS: STREET 1: 500 NEWPORT CENTER DRIVE STREET 2: 7TH FLOOR CITY: NEWPORT BEACH STATE: CA ZIP: 92660 BUSINESS PHONE: 9494808300 MAIL ADDRESS: STREET 1: 500 NEWPORT CENTER DRIVE STREET 2: # CITY: NEWPORT BEACH STATE: CA ZIP: 92660 10-Q 1 acacia_10q-033103.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003 COMMISSION FILE NUMBER 0-26068 ACACIA RESEARCH CORPORATION --------------------------- (Exact Name of Registrant as Specified in Its Charter) DELAWARE 95-4405754 -------- ---------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 500 NEWPORT CENTER DRIVE, NEWPORT BEACH, CA 92660 ------------------------------------------- ----- (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (949) 480-8300 -------------- 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 May 7, 2003, 19,640,808 shares of Acacia Research-Acacia Technologies common stock were issued and outstanding. As of May 7, 2003, 22,985,186 shares of Acacia Research-CombiMatrix common stock were issued and outstanding. ================================================================================ ACACIA RESEARCH CORPORATION TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION Item 1. Financial Statements Acacia Research Corporation Consolidated Financial Statements Consolidated Balance Sheets as of March 31, 2003 and December 31, 2002 (Unaudited).......................................... 4 Consolidated Statements of Operations and Comprehensive Loss for the Three Months Ended March 31, 2003 and 2002 (Unaudited)................. 5 Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2003 and 2002 (Unaudited).................................... 6 Notes to Consolidated Financial Statements............................. 7 *CombiMatrix Group Financial Statements Balance Sheets as of March 31, 2003 and December 31, 2002 (Unaudited).. 19 Statements of Operations for the Three Months Ended March 31, 2003 and 2002 (Unaudited).................................... 20 Statements of Cash Flows for the Three Months Ended March 31, 2003 and 2002 (Unaudited).................................... 21 Notes to Financial Statements.......................................... 22 *Acacia Technologies Group Financial Statements Balance Sheets as of March 31, 2003 and December 31, 2002 (Unaudited).. 25 Statements of Operations for the Three Months Ended March 31, 2003 and 2002 (Unaudited).................................... 26 Statements of Cash Flows for the Three Months Ended March 31, 2003 and 2002 (Unaudited).................................... 27 Notes to Financial Statements.......................................... 28 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................................. 31 Item 3. Quantitative and Qualitative Disclosures About Market Risk............. 60 Item 4. Controls and Procedures................................................ 60 2 PART II. OTHER INFORMATION Item 1. Legal Proceedings...................................................... 61 Item 6. Exhibits and Reports on Form 8-K....................................... 61 SIGNATURES............................................................................ 62 CERTIFICATIONS........................................................................ 63 EXHIBIT INDEX ........................................................................ 65
*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. 3 ACACIA RESEARCH CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share information) (Unaudited)
MARCH 31, DECEMBER 31, 2003 2002 ---------- ---------- ASSETS Current assets: Cash and cash equivalents .............................. $ 40,062 $ 43,083 Short-term investments ................................. 9,605 11,605 Accounts receivable .................................... 277 578 Prepaid expenses, other receivables and other assets ... 1,618 1,221 ---------- ---------- Total current assets .......................... 51,562 56,487 Property and equipment, net of accumulated depreciation ..... 3,612 4,075 Investment in affiliate, at cost ............................ 252 252 Patents, net of accumulated amortization .................... 14,880 15,280 Goodwill, net of accumulated amortization ................... 20,693 20,693 Other assets ................................................ 284 284 ---------- ---------- $ 91,283 $ 97,071 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable, accrued expenses and other ........... $ 4,490 $ 4,826 Deferred revenues ...................................... 12,183 10,675 ---------- ---------- Total current liabilities ..................... 16,673 15,501 Deferred income taxes ....................................... 3,469 3,540 ---------- ---------- Total liabilities ............................. 20,142 19,041 ---------- ---------- Minority interests .......................................... 1,819 2,171 ---------- ---------- Stockholders' equity: Preferred stock Acacia Research Corporation, par value $0.001 per share; 10,000,000 shares authorized; no shares issued or outstanding ...................... -- -- Common stock Acacia Research - Acacia Technologies stock, par value $0.001 per share; 50,000,000 shares authorized; 19,640,808 shares issued and outstanding as of March 31, 2003 and December 31, 2002 ................................. 20 20 Acacia Research - CombiMatrix stock, par value $0.001 per share; 50,000,000 shares authorized; 22,985,186 and 22,964,779 shares issued and outstanding as of March 31, 2003 and December 31, 2002, respectively ............................ 23 23 Additional paid-in capital ............................. 237,542 238,627 Deferred stock compensation ............................ (2,793) (4,023) Warrants to purchase common stock ...................... 199 199 Comprehensive loss ..................................... (17) (2) Accumulated deficit .................................... (165,652) (158,985) ---------- ---------- Total stockholders' equity .................... 69,322 75,859 ---------- ---------- $ 91,283 $ 97,071 ========== ========== THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 4
ACACIA RESEARCH CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (In thousands, except share and per share information) (Unaudited)
FOR THE THREE MONTHS ENDED ----------------------------- MARCH 31, 2003 MARCH 31, 2002 ------------- ------------- Revenues: License fee income ...................................... $ 6 $ -- Product revenue ......................................... 209 -- Grant and contract revenue .............................. 7 249 ------------- ------------- Total revenues ...................................... 222 249 ------------- ------------- Operating expenses: Cost of sales ........................................... 77 -- Research and development expenses ....................... 2,335 2,668 Non-cash stock compensation expense - research and development ........................................... 2 421 Marketing, general and administrative expenses .......... 4,255 4,072 Non-cash stock compensation expense - marketing, general and administrative .................................... 138 1,001 Amortization of patents ................................. 400 564 ------------- ------------- Total operating expenses ............................ 7,207 8,726 ------------- ------------- Operating loss ...................................... (6,985) (8,477) ------------- ------------- Other income (expense): Interest and other income (net) ......................... 215 421 Realized gains (losses) on short-term investments ....... 37 (553) Unrealized losses on short-term investments ............. -- (322) ------------- ------------- Total other income (expense) ........................ 252 (454) ------------- ------------- Loss from continuing operations before income taxes and minority interests ...................................... (6,733) (8,931) Benefit for income taxes .................................... 60 69 ------------- ------------- Loss from continuing operations before minority interests ... (6,673) (8,862) Minority interests .......................................... 6 2,435 ------------- ------------- Net loss .................................................... (6,667) (6,427) Unrealized losses on short-term investments ............. (8) (95) Unrealized losses on foreign currency translation ....... (7) (9) ------------- ------------- Comprehensive loss .......................................... $ (6,682) $ (6,531) ============= ============= Loss per common share: Attributable to the Acacia Technologies group: Net loss .................................................. $ (1,494) $ (2,841) Basic and diluted per share ............................. (0.08) (0.14) Attributable to the CombiMatrix group: Net loss .................................................. $ (5,173) $ (3,586) Basic and diluted per share ............................. (0.23) (0.16) Weighted average shares - basic and diluted: Acacia Research - Acacia Technologies stock ............... 19,640,808 19,640,808 ============= ============= Acacia Research - CombiMatrix stock ....................... 22,983,278 22,950,551 ============= ============= THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 5
ACACIA RESEARCH CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)
FOR THE THREE MONTHS ENDED --------------------- MARCH 31, MARCH 31, 2003 2002 --------- --------- Cash flows from operating activities: Net loss from continuing operations ............................................ $ (6,667) $ (6,427) Adjustments to reconcile net loss from continuing operations to net cash used in operating activities: Depreciation and amortization ............................................... 767 933 Minority interests .......................................................... (6) (2,435) Non-cash stock compensation ................................................. 140 1,422 Deferred tax benefit ........................................................ (70) (75) Net purchases of trading securities ......................................... -- (3,358) Unrealized losses on short-term investments ................................. -- 322 Other ....................................................................... 121 45 Changes in assets and liabilities: Accounts receivable, prepaid expenses, other receivables and other assets ... (96) (1,322) Accounts payable, accrued expenses and other ................................ (250) (1,085) Deferred revenues ........................................................... 1,508 531 --------- --------- Net cash used in operating activities from continuing operations ............ (4,553) (11,449) Net cash used in operating activities from discontinued operations .......... (86) (254) --------- --------- Net cash used in operating activities ....................................... (4,639) (11,703) --------- --------- Cash flows from investing activities: Purchase of property and equipment, net ..................................... (24) (134) Purchase of available-for-sale investments .................................. (469) (4,540) Sale of available-for-sale investments ...................................... 2,462 6,878 Other ....................................................................... -- (101) --------- --------- Net cash provided by investing activities from continuing operations ........ 1,969 2,103 Net cash used in investing activities from discontinued operations .......... (344) -- --------- --------- Net cash provided by investing activities ................................... 1,625 2,103 --------- --------- Cash flows from financing activities: Proceeds from the exercise of stock options and warrants .................... -- 214 Capital contributions from minority shareholders of subsidiaries, net of issuance costs ..................................................... -- 300 Repayment of capital lease obligation ....................................... -- (226) --------- --------- Net cash provided by financing activities ................................... -- 288 --------- --------- Decrease in cash and cash equivalents ............................................ (3,014) (9,312) --------- --------- Cash and cash equivalents, beginning ............................................. 43,083 59,451 Effect of exchange rate on cash .................................................. (7) (16) --------- --------- Cash and cash equivalents, ending ................................................ $ 40,062 $ 50,123 ========= ========= THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 6
ACACIA RESEARCH CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS BASIS OF PRESENTATION. The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnotes required by generally accepted accounting principles in annual financial statements have been omitted or condensed in accordance with quarterly reporting requirements of the Securities and Exchange Commission. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2002, as reported by us in our Annual Report on Form 10-K. The accompanying consolidated financial statements include the accounts of Acacia Research Corporation, and its wholly owned and majority-owned subsidiaries. Material intercompany transactions and balances have been eliminated in consolidation. The consolidated financial statements of Acacia Research Corporation include all adjustments of a normal recurring nature which, in the opinion of management, are necessary for a fair presentation of our financial position as of March 31, 2003 and results of operations and cash flows for the interim periods presented. The results of operations for the three months ended March 31, 2003 are not necessarily indicative of the results to be expected for the entire year. Acacia Research Corporation develops, acquires and licenses enabling technologies for the life sciences and media technologies sectors, which comprise the two business groups of Acacia Research Corporation. Our life sciences business, referred to as the "CombiMatrix group," is comprised of our wholly owned subsidiary, CombiMatrix Corporation and CombiMatrix Corporation's majority-owned subsidiaries, Advanced Material Sciences, Inc. ("Advanced Material Sciences") and CombiMatrix KK. Our core technology opportunity in the life sciences sector has been developed by CombiMatrix Corporation. CombiMatrix Corporation is a life sciences technology company with a proprietary system for rapid, cost competitive creation of DNA and other compounds on a programmable semiconductor chip. This proprietary technology has significant applications relating to genomic and proteomic research. Advanced Material Sciences, a development stage company, holds the exclusive license for CombiMatrix Corporation's biological array processor technology in certain fields of material sciences. CombiMatrix KK, a majority-owned Japanese corporation located in Tokyo, is exploring opportunities for CombiMatrix Corporation's active biochip system with academic, pharmaceutical and biotechnology organizations in the Asian market. Our media technologies business, referred to as "Acacia Technologies group," owns patented intellectual property in the media technologies sector. The Acacia Technologies group owns patented digital media transmission ("DMT") technology enabling the digitization, encryption, storage, transmission, receipt and playback of digital content. The DMT technology is protected by five U.S. and seventeen international patents. The DMT technology is utilized by a variety of companies, including cable companies, hotel in-room entertainment companies, Internet movie companies, Internet music companies, on-line adult entertainment companies, on-line learning companies and other companies that stream audio or audio/video content. The Acacia Technologies group's U.S. DMT patents expire in 2011 and its international DMT patents expire in 2012. The Acacia Technologies group also owns patented technology known as the V-chip. The V-chip was adopted by manufacturers of televisions sold in the U.S. to provide blocking of certain programming based upon its content rating code, in compliance with the Telecommunications Act of 1996. The V-chip technology is protected by U.S. Patent No. 4,554,584, which expires in July 2003. RECAPITALIZATION TRANSACTION On December 11, 2002, our stockholders voted in favor of a recapitalization transaction, which became effective on December 13, 2002, whereby we created two new classes of common stock called Acacia Research-CombiMatrix stock ("AR-CombiMatrix stock") and Acacia Research-Acacia Technologies stock ("AR-Acacia Technologies stock"), and divided our existing Acacia Research Corporation common stock into shares of the two new classes of common stock. AR-CombiMatrix stock is intended to reflect separately the performance of Acacia Research Corporation's CombiMatrix group. AR-Acacia Technologies stock is intended to reflect separately the performance of Acacia Research Corporation's Acacia Technologies group. Although the AR-CombiMatrix stock and the AR-Acacia Technologies stock are intended to reflect the 7 performance of our different business groups, they are both classes of common stock of Acacia Research Corporation and are not stock issued by the respective groups. All share and per share information in the consolidated financial statements and accompanying notes to the consolidated financial statements, unless otherwise noted, give effect to the recapitalization as of January 1, 2002. STOCK-BASED COMPENSATION. At March 31, 2003, Acacia Research Corporation has two stock-based employee compensation plans. Compensation cost of stock options issued to employees is accounted for in accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25") and related interpretations. Compensation cost attributable to such options is recognized based on the difference, if any, between the closing market price of the stock on the date of grant and the exercise price of the option. Compensation cost is generally deferred and amortized on an accelerated basis over the vesting period of the individual option awards using the amortization method prescribed in Financial Accounting Standards Board ("FASB") Interpretation No. 28, "Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans" ("FIN No. 28"). We have adopted the disclosure only requirements of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") with respect to options issued to employees. Compensation cost of stock options and warrants issued to non-employee service providers is accounted for under the fair value method required by SFAS No. 123 and related interpretations. The following table illustrates the effect on net loss and loss per share if Acacia Research Corporation had applied the fair value recognition provisions of SFAS No. 123 (in thousands, except per share data):
AR-ACACIA TECHNOLOGIES STOCK AR-COMBIMATRIX STOCK ----------------------- ----------------------- THREE MONTHS ENDED THREE MONTHS ENDED ----------------------- ----------------------- MARCH 31, MARCH 31, MARCH 31, MARCH 31, 2003 2002 2003 2002 ---------- ---------- ---------- ---------- Loss from continuing operations as reported .................... $ (1,494) $ (2,841) $ (5,173) $ (3,586) Add: Stock-based compensation, intrinsic value method reported in net income, net of tax .......................... -- 10 69 1,412 Deduct: Pro forma stock-based compensation fair value method, net of tax .......................................... (1,078) (1,237) (2,782) (1,795) Loss from continuing operations, pro forma ..................... (2,572) (4,068) (7,886) (3,969) Basic loss per share from continuing operations as reported .... (0.08) (0.14) (0.23) (0.16) Basic loss per share from continuing operations, pro forma ..... (0.13) (0.21) (0.34) (0.17) Diluted loss per share from continuing operations as reported .................................................... (0.08) (0.14) (0.23) (0.16) Diluted loss per share from continuing operations, pro forma ... (0.13) (0.21) (0.34) (0.17) Weighted average risk free interest rate........................ 4.75% 5.36% 4.80% 5.51%
- ----------------------- Note: The stock-based compensation information above gives effect to the recapitalization as of January 1, 2002. As a result, stock-based compensation information related to the predecessor Acacia Research Corporation common stock for 2002 has been omitted from the table above. The fair value of AR-Acacia Technologies stock options and AR-CombiMatrix stock options was determined using the Black-Scholes option-pricing model, assuming volatility of approximately 100%, with expected lives of approximately five years and no expected dividends. RECLASSIFICATIONS. Certain immaterial reclassifications of prior period amounts have been made to conform to the 2003 presentation. 2. LOSS PER SHARE LOSS PER SHARE. Basic loss per share for each class of common stock is computed by dividing the earnings allocated to each class of common stock by the weighted average number of outstanding shares of that class of common stock. Diluted earnings per share is computed by dividing the loss allocated to each class of common stock by the weighted average number of outstanding shares of that class of common stock including the dilutive effect of common stock equivalents. Potentially dilutive common stock equivalents primarily consist of employee stock options. 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 8 discretion, change the method of allocating earnings or losses to each class of common stock at any time. Management currently has no plans to change allocation methods. The following table presents a reconciliation of basic and diluted loss per share:
FOR THE THREE MONTHS ENDED ------------------------ MARCH 31, MARCH 31, 2003 2002 ----------- ----------- Acacia Research - Acacia Technologies stock - ------------------------------------------- Basic weighted average number of common shares outstanding ...... 19,640,808 19,640,808 Dilutive effect of outstanding stock options and warrants (a) ... -- -- ----------- ----------- Diluted weighted average number of common and potential common shares outstanding ........................... 19,640,808 19,640,808 =========== =========== Acacia Research - CombiMatrix stock - ----------------------------------- Basic weighted average number of common shares outstanding ...... 22,983,278 22,950,551 Dilutive effect of outstanding stock options and warrants (b) ... -- -- ----------- ----------- Diluted weighted average number of common and potential common shares outstanding ........................... 22,983,278 22,950,551 =========== ===========
- ----------------------- (a) Potential AR - Acacia Technologies common shares of 786 and 46,857 at March 31, 2003 and 2002, respectively, have been excluded from the per share calculation because the effect of their inclusion would be anti-dilutive. (b) Potential AR - CombiMatrix common shares of 441,750 and 305,256 at March 31, 2003 and 2002, respectively, have been excluded from the per share calculation because the effect of their inclusion would be anti-dilutive. 3. GOODWILL AND INTANGIBLES Goodwill is evaluated for impairment in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"), which provides that goodwill is no longer subject to amortization. Instead, goodwill is subject to a periodic review for potential impairment that must occur at least annually at a reporting unit level. As of January 1, 2002, the date of adoption of the standard, we had unamortized goodwill in the amount of $4,627,000. In 2002, we performed a transitional goodwill impairment assessment and a year end goodwill impairment assessment and determined that there was no impairment of goodwill. The fair values of our two reporting units were estimated using a discounted cash flow analysis. There can be no assurance that future goodwill impairment tests will not result in a charge to earnings. The Acacia Technologies group had $1,834,000 of goodwill at March 31, 2003 and December 31, 2002 (net of $2,258,000 of accumulated amortization). The CombiMatrix group had $18,859,000 of goodwill at March 31, 2003 and December 31, 2002 (net of $1,312,000 of accumulated amortization). Acacia Research Corporation's only identifiable intangible assets at March 31, 2003 and December 31, 2002 are patents totaling $14,880,000 (net of $8,013,000 of accumulated amortization) and $15,280,000 (net of $7,613,000 of accumulated amortization), respectively. Patent amortization expense for the three months ended March 31, 2003 and 2002 was $400,000 and $564,000, respectively. The gross carrying amounts and accumulated amortization as of March 31, 2003 and December 31, 2002 and amortization expense for the three months ended March 31, 2003 and 2002, related to patents, by segment, are as follows (in thousands): 9
ACACIA TECHNOLOGIES GROUP COMBIMATRIX GROUP ------------------------------- ------------------------------- MARCH 31, 2003 DECEMBER 31, 2002 MARCH 31, 2003 DECEMBER 31, 2002 -------------- -------------- -------------- -------------- Gross carrying amount - patents .... $ 10,798 $ 10,798 $ 12,095 $ 12,095 Accumulated amortization ........... (6,856) (6,730) (1,157) (883) -------------- -------------- -------------- -------------- Patents, net ....................... $ 3,942 $ 4,068 $ 10,938 $ 11,212 ============== ============== ============== ============== FOR THE THREE MONTHS ENDED FOR THE THREE MONTHS ENDED ------------------------------- ------------------------------- MARCH 31, 2003 MARCH 31, 2002 MARCH 31, 2003 MARCH 31, 2002 -------------- -------------- -------------- -------------- Patent amortization expense......... $ 126 $ 465 $ 274 $ 99 ============== ============== ============== ==============
Annual aggregate amortization expense for each of the next five years through December 31, 2007 is estimated to be $1,595,000 per year ($500,000 for the Acacia Technologies group and $1,095,000 for the CombiMatrix group). At March 31, 2003 and December 31, 2002, all of our acquired intangible assets other than goodwill were subject to amortization. 4. RECENT ACCOUNTING PRONOUNCEMENTS On January 1, 2003, we adopted SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146 nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity," under which a liability for an exit cost was recognized at the date of an entity's commitment to an exit plan. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized at fair value when the liability is incurred. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 did not have a significant impact on our financial position or results of operations. In December 2002, we adopted SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure--an amendment of SFAS No. 123" ("SFAS No. 148"). This statement amends SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Acacia Research Corporation has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in APB No. 25 and related interpretations. Accordingly, compensation expense for stock options is measured as the excess, if any, of the estimate of the market value of our stock at the date of the grant over the amount an employee must pay to acquire the stock. We adopted the interim disclosure provisions for our financial report for the quarter ended March 31, 2003 (see Note 1, "Stock-based Compensation"). The adoption of SFAS No. 148 did not have a material effect on our consolidated results of operations or financial position. In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others," ("FIN 45") an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. FIN 45 also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of FIN 45 are applicable to guarantees issued or modified after December 31, 2002. The adoption of FIN 45 did not have a significant impact on Acacia Research Corporation's financial position or results of operations. In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). FIN 46 requires consolidation of variable interest entities by the entity's primary beneficiary if the equity investors in the entity do not have the characteristics of a controlling financial interest or sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from 10 other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. FIN 46 must be applied beginning July 1, 2003 to variable entities existing prior to February 1, 2003. The adoption of FIN 46 will not have a material impact on Acacia Research Corporation's results of operations or financial condition. 5. SEGMENT INFORMATION Acacia Research Corporation has adopted the provisions of SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." Our chief operating decision maker is considered to be Acacia Research Corporation's CEO. The CEO reviews and evaluates financial information presented on a group basis as described below. Management evaluates performance based on the profit or loss from continuing operations and financial position of its segments. Acacia Research Corporation has two reportable segments as described earlier in Note 1. Material intercompany transactions and transfers have been eliminated in consolidation. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. On December 13, 2002, our reporting segments were modified to reflect the attribution of assets and liabilities and the allocation of expenditures consistent with the management and allocation policies used in the preparation of the separate Acacia Technologies group and CombiMatrix group financial statements. Segment information has been adjusted for all periods presented. The tables below present information about our reportable segments in continuing operations for the three months ended March 31, 2003 and 2002 (in thousands):
ACACIA TECHNOLOGIES COMBIMATRIX Three Months Ended March 31, 2003 GROUP GROUP TOTAL - --------------------------------- ---------- ---------- ---------- Revenue ............................................................ $ 6 $ 216 $ 222 Amortization of patents ............................................ 126 274 400 Interest income .................................................... 148 67 215 Realized gain on investments ....................................... 37 -- 37 Loss from operations before income taxes and minority interests .... 1,520 5,213 6,733 Non-cash stock compensation charges ................................ -- 140 140 Segment assets ..................................................... 42,098 46,810 88,908 Investment in affiliate, at cost ................................... 252 -- 252 Purchase of property and equipment ................................. 2 22 24
11
ACACIA TECHNOLOGIES COMBIMATRIX Three Months Ended March 31, 2002 GROUP GROUP TOTAL - --------------------------------- ---------- ---------- ---------- Revenue ............................................................ $ -- $ 249 $ 249 Amortization of patents ............................................ 465 99 564 Other income ....................................................... 78 -- 78 Interest income .................................................... 153 250 403 Interest expense ................................................... -- 60 60 Realized losses on investments ..................................... 553 -- 553 Unrealized losses on investments ................................... 322 -- 322 Loss from operations before income taxes and minority interests .... 2,907 6,024 8,931 Non-cash stock compensation charges ................................ 10 1,412 1,422 Segment assets ..................................................... 55,772 42,936 98,708 Investment in affiliate, at cost ................................... 3,000 -- 3,000 Purchase of property and equipment ................................. 101 83 184
Segment information excludes discontinued operations related to Soundbreak.com as of and for the three months ended March 31, 2003 and 2002. Total assets related to discontinued operations totaled $2,600,000 and $3,940,000 at March 31, 2003 and 2002, respectively. 6. CONSOLIDATING FINANCIAL INFORMATION Presented below is consolidating financial information 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. AR-CombiMatrix stock and AR-Acacia Technologies stock are intended to reflect the separate performance of the respective division of Acacia Research Corporation. The CombiMatrix group and the Acacia Technologies group are not separate legal entities. Holders of AR-CombiMatrix stock and AR-Acacia Technologies stock are stockholders of Acacia Research Corporation. As a result, holders of AR-CombiMatrix stock and AR-Acacia Technologies stock continue to be subject to all of the risks of an investment in Acacia Research Corporation and all of its businesses, assets and liabilities. The assets that Acacia Research Corporation attributes to one of the groups could be subject to the liabilities of the other group. The group financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America, and taken together, comprise all the accounts included in the corresponding consolidated financial statements of Acacia Research Corporation. The financial statements of the groups reflect the financial condition, results of operations, and cash flows of the businesses included therein. The financial statements of the groups include the accounts or assets of Acacia Research Corporation specifically attributed to the groups and were prepared using amounts included in Acacia Research Corporation's consolidated financial statements. Minority interests represent participation of other stockholders in the net equity and in the division earnings and losses of the groups and are reflected in the caption "Minority interests" in the group financial statements. Minority interests adjust group net results of operations to reflect only the group's share of the division earnings or losses of non-wholly owned investees. Financial effects arising from one group that affect Acacia Research Corporation's results of operations or financial condition could, if significant, affect the results of operations or financial condition of the other group and the market price of the class of common stock relating to the other group. Any division net losses of the CombiMatrix group or of the Acacia Technologies group, and dividends or distributions on, or repurchases of, AR-CombiMatrix stock or AR-Acacia Technologies stock, will reduce the assets of Acacia Research Corporation legally available for payment of dividends on AR-CombiMatrix stock or AR-Acacia Technologies stock. 12
CONSOLIDATING STATEMENT OF FINANCIAL POSITION AT MARCH 31, 2003 (IN THOUSANDS) ACACIA TECHNOLOGIES COMBIMATRIX GROUP GROUP ELIMINATIONS CONSOLIDATED -------------- -------------- -------------- -------------- ASSETS Current assets: Cash and cash equivalents ................................ $ 37,097 $ 2,965 $ -- $ 40,062 Short-term investments ................................... -- 9,605 -- 9,605 Accounts receivable ...................................... 11 266 -- 277 Prepaid expenses, other receivables and other assets ..... 993 625 -- 1,618 Receivable from CombiMatrix group ........................ 225 -- (225) -- -------------- -------------- -------------- -------------- Total current assets .............................. 38,326 13,461 (225) 51,562 Property and equipment, net of accumulated depreciation ....... 147 3,465 -- 3,612 Investment in affiliate, at cost .............................. 252 -- -- 252 Patents, net of accumulated amortization ...................... 3,942 10,938 -- 14,880 Goodwill, net of accumulated amortization ..................... 1,834 18,859 -- 20,693 Other assets .................................................. 197 87 -- 284 -------------- -------------- -------------- -------------- $ 44,698 $ 46,810 $ (225) $ 91,283 ============== ============== ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable, accrued expenses and other ............. $ 2,129 $ 2,361 $ -- $ 4,490 Current portion of deferred revenues ..................... 1,536 10,647 -- 12,183 Payable to Acacia Technologies group ..................... -- 225 (225) -- -------------- -------------- -------------- -------------- Total current liabilities ......................... 3,665 13,233 (225) 16,673 Deferred income taxes ......................................... 1,119 2,350 -- 3,469 -------------- -------------- -------------- -------------- Total liabilities ................................. 4,784 15,583 (225) 20,142 -------------- -------------- -------------- -------------- Minority interests ............................................ 1,142 677 -- 1,819 -------------- -------------- -------------- -------------- Stockholders' equity: AR - Acacia Technologies stock ........................... 38,772 -- -- 38,772 AR - CombiMatrix stock ................................... -- 30,550 -- 30,550 -------------- -------------- -------------- -------------- Total stockholders' equity ........................ 38,772 30,550 -- 69,322 -------------- -------------- -------------- -------------- $ 44,698 $ 46,810 $ (225) $ 91,283 ============== ============== ============== ============== 13 CONSOLIDATING STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2003 (IN THOUSANDS) ACACIA TECHNOLOGIES COMBIMATRIX ELIMINATIONS/ GROUP GROUP RECLASSIFICATIONS CONSOLIDATED -------------- -------------- -------------- -------------- Revenues: License fee income ........................................ $ 6 $ -- $ -- $ 6 Product revenue ........................................... -- 209 -- 209 Grant revenue ............................................. -- 7 -- 7 -------------- -------------- -------------- -------------- Total revenues ............................................ 6 216 -- 222 -------------- -------------- -------------- -------------- Operating expenses: Cost of sales ............................................. -- 77 -- 77 Research and development expenses ......................... -- 2,335 -- 2,335 Non-cash stock compensation expense - research and development ............................................. -- 2 -- 2 Marketing, general and administrative expenses ............ 1,323 2,670 262 4,255 Non-cash stock compensation expense - marketing, general and administrative .............................. -- 138 -- 138 Legal expenses - patents .................................. 262 -- (262) -- Amortization of patents ................................... 126 274 -- 400 -------------- -------------- -------------- -------------- Total operating expenses .................................. 1,711 5,496 -- 7,207 -------------- -------------- -------------- -------------- Operating loss ............................................ (1,705) (5,280) -- (6,985) -------------- -------------- -------------- -------------- Other (expense) income: Interest income ........................................... 148 67 -- 215 Realized gains on short-term investments .................. 37 -- -- 37 -------------- -------------- -------------- -------------- Total other income ........................................ 185 67 -- 252 -------------- -------------- -------------- -------------- Loss from continuing operations before income taxes and minority interests ................ (1,520) (5,213) -- (6,733) Benefit for income taxes ...................................... 26 34 -- 60 -------------- -------------- -------------- -------------- Loss from continuing operations before minority interests ..... (1,494) (5,179) -- (6,673) Minority interests ............................................ -- 6 -- 6 -------------- -------------- -------------- -------------- Net loss ...................................................... $ (1,494) $ (5,173) $ -- $ (6,667) ============== ============== ============== ============== 14 CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2003 (IN THOUSANDS) ACACIA TECHNOLOGIES COMBIMATRIX GROUP GROUP ELIMINATIONS CONSOLIDATED -------------- -------------- -------------- -------------- Cash flows from operating activities: Net loss from continuing operations ........................ $ (1,494) $ (5,173) $ -- $ (6,667) Adjustments to reconcile net loss from continuing operations to net cash used in operating activities: Depreciation and amortization .......................... 161 606 -- 767 Minority interests ..................................... -- (6) -- (6) Non-cash stock compensation ............................ -- 140 -- 140 Deferred tax benefit ................................... (36) (34) -- (70) Other .................................................. (3) 124 -- 121 Changes in assets and liabilities: Accounts receivable, prepaid expenses, other receivables and other assets ......................... (229) 133 -- (96) Accounts payable, accrued expenses and other ........... (420) 170 -- (250) Deferred revenue ....................................... 33 1,475 -- 1,508 -------------- -------------- -------------- -------------- Net cash used in operating activities from continuing operations ................................ (1,988) (2,565) -- (4,553) Net cash used in operating activities from discontinued operations .............................. (86) -- -- (86) -------------- -------------- -------------- -------------- Net cash used in operating activities .................. (2,074) (2,565) -- (4,639) -------------- -------------- -------------- -------------- Cash flows from investing activities: Purchase of property and equipment ..................... (2) (22) -- (24) Purchase of available-for-sale investments ............. -- (469) -- (469) Sale of available-for-sale investments ................. -- 2,462 -- 2,462 -------------- -------------- -------------- -------------- Net cash (used in) provided by investing activities from continuing operations ................................ (2) 1,971 -- 1,969 Net cash used in investing activities from discontinued operations .............................. (344) -- -- (344) -------------- -------------- -------------- -------------- Net cash (used in) provided by investing activities .... (346) 1,971 -- 1,625 -------------- -------------- -------------- -------------- Cash flows from financing activities: Net cash attributed to the Acacia Technologies group ... (275) -- -- (275) Net cash attributed to the CombiMatrix group ........... -- 275 -- 275 -------------- -------------- -------------- -------------- Net cash (used in) provided by financing activities .... (275) 275 -- -- -------------- -------------- -------------- -------------- Decrease in cash and cash equivalents ......................... (2,695) (319) -- (3,014) -------------- -------------- -------------- -------------- Cash and cash equivalents, beginning .......................... 39,792 3,291 -- 43,083 Effect of exchange rate on cash ............................... -- (7) -- (7) -------------- -------------- -------------- -------------- Cash and cash equivalents, ending ............................. $ 37,097 $ 2,965 $ -- $ 40,062 ============== ============== ============== ============== 15 CONSOLIDATING STATEMENT OF FINANCIAL POSITION AT DECEMBER 31, 2002 (IN THOUSANDS) ACACIA TECHNOLOGIES COMBIMATRIX GROUP GROUP ELIMINATIONS CONSOLIDATED -------------- -------------- -------------- -------------- ASSETS Current assets: Cash and cash equivalents ................................ $ 39,792 $ 3,291 $ -- $ 43,083 Short-term investments ................................... -- 11,605 -- 11,605 Accounts receivable ...................................... -- 578 -- 578 Prepaid expenses, other receivables and other assets ..... 775 446 -- 1,221 Receivable from CombiMatrix group ........................ 114 -- (114) -- -------------- -------------- -------------- -------------- Total current assets .............................. 40,681 15,920 (114) 56,487 Property and equipment, net of accumulated depreciation ....... 180 3,895 -- 4,075 Investment in affiliate, at cost .............................. 252 -- -- 252 Patents, net of accumulated amortization ...................... 4,068 11,212 -- 15,280 Goodwill, net of accumulated amortization ..................... 1,834 18,859 -- 20,693 Other assets .................................................. 197 87 -- 284 -------------- -------------- -------------- -------------- $ 47,212 $ 49,973 $ (114) $ 97,071 ============== ============== ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable, accrued expenses and other ............. $ 2,524 $ 2,302 $ -- $ 4,826 Current portion of deferred revenues ..................... 1,503 9,172 -- 10,675 Payable to Acacia Technologies group ..................... -- 114 (114) -- -------------- -------------- -------------- -------------- Total current liabilities ......................... 4,027 11,588 (114) 15,501 Deferred income taxes ......................................... 1,156 2,384 -- 3,540 -------------- -------------- -------------- -------------- Total liabilities ................................. 5,183 13,972 (114) 19,041 -------------- -------------- -------------- -------------- Minority interests ............................................ 1,487 684 -- 2,171 -------------- -------------- -------------- -------------- Stockholders' equity: AR - Acacia Technologies stock ........................... 40,542 -- -- 40,542 AR - CombiMatrix stock ................................... -- 35,317 -- 35,317 -------------- -------------- -------------- -------------- Total stockholders' equity ........................ 40,542 35,317 -- 75,859 -------------- -------------- -------------- -------------- $ 47,212 $ 49,973 $ (114) $ 97,071 ============== ============== ============== ============== 16 CONSOLIDATING STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2002 (IN THOUSANDS) ACACIA TECHNOLOGIES COMBIMATRIX GROUP GROUP ELIMINATIONS CONSOLIDATED -------------- -------------- -------------- -------------- Revenues: Grant revenue ............................................. $ -- $ 249 $ -- $ 249 -------------- -------------- -------------- -------------- Total revenues ........................................ -- 249 -- 249 -------------- -------------- -------------- -------------- Operating expenses: Research and development expenses .......................... -- 2,668 -- 2,668 Non-cash compensation expense - research and development ... -- 421 -- 421 Marketing, general and administrative expenses ............. 1,577 2,284 211 4,072 Non-cash compensation expense - marketing, general and administrative ............................... 10 991 -- 1,001 Legal expenses - patents ................................... 211 -- (211) -- Amortization of patents and goodwill ....................... 465 99 -- 564 -------------- -------------- -------------- -------------- Total operating expenses .................................... 2,263 6,463 -- 8,726 -------------- -------------- -------------- -------------- Operating loss .............................................. (2,263) (6,214) -- (8,477) -------------- -------------- -------------- -------------- Other income (expense): Interest income ........................................... 153 250 -- 403 Realized losses on short-term investments ................. (553) -- -- (553) Unrealized losses on short-term investments ............... (322) -- -- (322) Interest expense .......................................... -- (60) -- (60) Other income .............................................. 78 -- -- 78 -------------- -------------- -------------- -------------- Total other income (expense) .......................... (644) 190 -- (454) -------------- -------------- -------------- -------------- Loss from continuing operations before income taxes and minority interests ................................ (2,907) (6,024) -- (8,931) Benefit for income taxes ...................................... 29 40 -- 69 -------------- -------------- -------------- -------------- Loss from continuing operations before minority interests ..... (2,878) (5,984) -- (8,862) Minority interests ............................................ 37 2,398 -- 2,435 -------------- -------------- -------------- -------------- Net loss ...................................................... $ (2,841) $ (3,586) $ -- $ (6,427) ============== ============== ============== ============== 17 CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2002 (IN THOUSANDS) ACACIA TECHNOLOGIES COMBIMATRIX GROUP GROUP ELIMINATIONS CONSOLIDATED -------------- -------------- -------------- -------------- Cash flows from operating activities: Net loss from continuing operations ........................... $ (2,841) $ (3,586) $ -- $ (6,427) Adjustments to reconcile net loss from continuing operations to net cash used in operating activities: Depreciation and amortization ............................. 502 431 -- 933 Minority interests ........................................ (37) (2,398) -- (2,435) Non-cash stock compensation expense ....................... 10 1,412 -- 1,422 Deferred tax benefit ...................................... (35) (40) -- (75) Net purchases of trading securities ....................... (3,358) -- -- (3,358) Unrealized loss on short-term investments ................. 322 -- -- 322 Other ..................................................... (35) 80 -- 45 Changes in assets and liabilities: Prepaid expenses, other receivables and other assets ...... (673) (639) (10) (1,322) Accounts payable, accrued expenses and other .............. (125) (970) 10 (1,085) Deferred revenues ......................................... -- 531 -- 531 -------------- -------------- -------------- -------------- Net cash used in operating activities from continuing operations .................................................. (6,270) (5,179) -- (11,449) Net cash used in operating activities from discontinued operations .................................................. (254) -- -- (254) -------------- -------------- -------------- -------------- Net cash used in operating activities ......................... (6,524) (5,179) -- (11,703) -------------- -------------- -------------- -------------- Cash flows from investing activities: Purchase of property and equipment .......................... (51) (83) -- (134) Purchase of available-for-sale investments .................. -- (4,540) -- (4,540) Sale of available-for-sale investments ...................... -- 6,878 -- 6,878 Other ....................................................... (101) -- -- (101) -------------- -------------- -------------- -------------- Net cash (used in) provided by investing activities ........... (152) 2,255 -- 2,103 -------------- -------------- -------------- -------------- Cash flows from financing activities: Net cash attributed to the Acacia Technologies group .......... 153 -- -- 153 Net cash attributed to the CombiMatrix group .................. -- 135 -- 135 -------------- -------------- -------------- -------------- Net cash provided by financing activities ..................... 153 135 -- 288 -------------- -------------- -------------- -------------- Decrease in cash and cash equivalents ......................... (6,523) (2,789) -- (9,312) Cash and cash equivalents, beginning .......................... 46,859 12,592 -- 59,451 Effect of exchange rate on cash ............................... -- (16) -- (16) -------------- -------------- -------------- -------------- Cash and cash equivalents, ending ............................. $ 40,336 $ 9,787 $ -- $ 50,123 ============== ============== ============== ==============
18 COMBIMATRIX GROUP (A Division of Acacia Research Corporation) BALANCE SHEETS (In thousands) (Unaudited)
MARCH 31, DECEMBER 31, 2003 2002 ------------- ------------- ASSETS Current assets: Cash and cash equivalents ................................................. $ 2,965 $ 3,291 Short-term investments .................................................... 9,605 11,605 Accounts receivable ....................................................... 266 578 Inventories, prepaid expenses and other assets ............................ 625 446 ------------- ------------- Total current assets ................................................... 13,461 15,920 Property and equipment, net of accumulated depreciation and amortization .... 3,465 3,895 Patents, net of accumulated amortization .................................... 10,938 11,212 Goodwill, net of accumulated amortization ................................... 18,859 18,859 Other assets ................................................................ 87 87 ------------- ------------- $ 46,810 $ 49,973 ============= ============= LIABILITIES AND ALLOCATED NET WORTH Current liabilities: Accounts payable, accrued expenses and other .............................. $ 2,361 $ 2,302 Deferred revenues ......................................................... 10,647 9,172 Payable to Acacia Technologies group ...................................... 225 114 ------------- ------------- Total current liabilities .............................................. 13,233 11,588 Deferred income taxes ....................................................... 2,350 2,384 ------------- ------------- Total liabilities ...................................................... 15,583 13,972 ------------- ------------- Minority interests .......................................................... 677 684 ------------- ------------- Allocated net worth: Funds allocated by Acacia Research Corporation ............................ 129,692 129,286 Accumulated net losses .................................................... (99,142) (93,969) ------------- ------------- Total allocated net worth .............................................. 30,550 35,317 ------------- ------------- $ 46,810 $ 49,973 ============= ============= The accompanying notes are an integral part of these financial statements.
19 COMBIMATRIX GROUP (A Division of Acacia Research Corporation) STATEMENTS OF OPERATIONS (In thousands) (Unaudited)
FOR THE THREE MONTHS ENDED ----------------------------------- MARCH 31, 2003 MARCH 31, 2002 ---------------- ---------------- Revenues: Product revenue ............................................. $ 209 $ -- Grant and contract revenue .................................. 7 249 ---------------- ---------------- Total revenues ........................................... 216 249 ---------------- ---------------- Operating expenses: Cost of sales ............................................... 77 -- Research and development expenses ........................... 2,335 2,668 Non-cash compensation expense - research and development .... 2 421 Marketing, general and administrative expenses .............. 2,670 2,284 Non-cash compensation expense - marketing, general and administrative ........................................ 138 991 Amortization of patents ..................................... 274 99 ---------------- ---------------- Total operating expenses ................................. 5,496 6,463 ---------------- ---------------- Operating loss ........................................... (5,280) (6,214) ---------------- ---------------- Other income (expense): Interest income ............................................. 67 250 Interest expense ............................................ -- (60) ---------------- ---------------- Total other income ....................................... 67 190 ---------------- ---------------- Loss from operations before income taxes and minority interests ...................................... (5,213) (6,024) Benefit for income taxes ...................................... 34 40 ---------------- ---------------- Loss from operations before minority interests ................ (5,179) (5,984) Minority interests ............................................ 6 2,398 ---------------- ---------------- Division net loss ............................................. $ (5,173) $ (3,586) ================ ================ The accompanying notes are an integral part of these financial statements.
20 COMBIMATRIX GROUP (A Division of Acacia Research Corporation) STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)
FOR THE THREE MONTHS ENDED ----------------------------------- MARCH 31, 2003 MARCH 31, 2002 ---------------- ---------------- Cash flows from operating activities: Division net loss from continuing operations ........................ $ (5,173) $ (3,586) Adjustments to reconcile division net loss from continuing operations to net cash used in operating activities: Depreciation and amortization ................................... 606 431 Minority interests .............................................. (6) (2,398) Non-cash stock compensation expense ............................. 140 1,412 Deferred tax benefit ............................................ (34) (40) Other ........................................................... 124 80 Changes in assets and liabilities: Accounts receivable, prepaid expenses, other receivables and other assets .................................................. 133 (639) Accounts payable, accrued expenses and other .................... 170 (970) Deferred revenues ............................................... 1,475 531 ---------------- ---------------- Net cash used in operating activities of continuing operations .. (2,565) (5,179) ---------------- ---------------- Cash flows from investing activities: Purchase of property and equipment .............................. (22) (83) Purchase of available-for-sale investments ...................... (469) (4,540) Sale of available-for-sale investments .......................... 2,462 6,878 ---------------- ---------------- Net cash provided by investing activities ....................... 1,971 2,255 ---------------- ---------------- Cash flows from financing activities: Net cash flows attributed to the CombiMatrix group .............. 275 135 ---------------- ---------------- Decrease in cash and cash equivalents .............................. (319) (2,789) ---------------- ---------------- Cash and cash equivalents, beginning ............................... 3,291 12,592 Effect of exchange rate on cash .................................... (7) (16) ---------------- ---------------- Cash and cash equivalents, ending .................................. $ 2,965 $ 9,787 ================ ================ The accompanying notes are an integral part of these financial statements.
21 COMBIMATRIX GROUP (A DIVISION OF ACACIA RESEARCH CORPORATION) NOTES TO FINANCIAL STATEMENTS 1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION DESCRIPTION OF BUSINESS. The CombiMatrix group, a division of Acacia Research Corporation, is intended to reflect the performance of Acacia Research Corporation's wholly owned subsidiary, CombiMatrix Corporation, and CombiMatrix Corporation's majority-owned subsidiaries, Advanced Material Sciences, Inc. ("Advanced Material Sciences") and CombiMatrix K.K. (the "KK"), as well as the assets, liabilities and related transactions of Acacia Research Corporation attributed to the CombiMatrix group. The CombiMatrix group's core technology opportunity in the life sciences sector has been primarily developed through CombiMatrix Corporation which is a life sciences technology company with a proprietary system for rapid, cost competitive creation of DNA and other compounds on a programmable semiconductor chip (referred to as active biochips or microarrays). This proprietary technology has applications relating to genomic and proteomic research, biological and chemical detection and combinatorial chemistry markets. CombiMatrix Corporation's majority-owned subsidiary, Advanced Material Sciences, holds the exclusive license for CombiMatrix Corporation's biological array processor technology in certain fields of material sciences. On December 11, 2002, Acacia Research Corporation's stockholders voted in favor of a recapitalization transaction, which became effective on December 13, 2002, whereby Acacia Research Corporation created two new classes of common stock called Acacia Research-CombiMatrix stock ("AR-CombiMatrix stock") and Acacia Research-Acacia Technologies stock ("AR-Acacia Technologies stock"), and divided Acacia Research Corporation's existing Acacia Research Corporation common stock into shares of the two new classes of common stock. AR-Acacia Technologies stock is intended to reflect separately the performance of Acacia Research Corporation's Acacia Technologies group. AR-CombiMatrix stock is intended to reflect separately the performance of Acacia Research Corporation's CombiMatrix group. BASIS OF PRESENTATION. The unaudited interim CombiMatrix group financial statements as of March 31, 2003, and for the three months ended March 31, 2003 and 2002 have been prepared in accordance with generally accepted accounting principles for interim financial information. These interim financial statements should be read in conjunction with the CombiMatrix group financial statements and Acacia Research Corporation's consolidated financial statements and notes thereto for the year ended December 31, 2002. The CombiMatrix group financial statements include all adjustments of a normal recurring nature which, in the opinion of management, are necessary for a fair presentation of its financial position as of March 31, 2003, and the results of its operations and its cash flows for the three months ended March 31, 2003 and 2002. The results of operations for the three months ended March 31, 2003 are not necessarily indicative of the results to be expected for the entire year. AR-CombiMatrix stock is intended to reflect the separate performance of the respective division of Acacia Research Corporation. The CombiMatrix group is not a separate legal entity. Holders of AR-CombiMatrix stock are stockholders of Acacia Research Corporation. As a result, holders of AR-CombiMatrix stock are subject to all of the risks of an investment in Acacia Research Corporation and all of its businesses, assets and liabilities. The assets that Acacia Research Corporation attributes to the CombiMatrix group could be subject to the liabilities of the Acacia Technologies group. The CombiMatrix group financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America, and taken together with the Acacia Technologies group financial statements, comprise all the accounts included in the corresponding consolidated financial statements of Acacia Research Corporation. The financial statements of the CombiMatrix group reflect the financial condition, results of operations, and cash flows of the businesses included therein. The financial statements of the CombiMatrix group include the accounts or assets of Acacia Research Corporation specifically attributed to the CombiMatrix group and were prepared using amounts included in Acacia Research Corporation's consolidated financial statements. 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. 22 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES STOCK-BASED COMPENSATION. Compensation cost of stock options issued to employees of Acacia Research Corporation is accounted for in accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25") and related interpretations. Compensation cost attributable to such options is recognized based on the difference, if any, between the closing market price of the stock on the date of grant and the exercise price of the option. Compensation cost is deferred and amortized on an accelerated basis over the vesting period of the individual option awards using the amortization method prescribed in Financial Accounting Standards Board ("FASB") Interpretation No. 28, "Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans" ("FIN No. 28"). Compensation cost of stock options and warrants issued to non-employee service providers is accounted for under the fair value method required Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") and related interpretations. As a result of the recapitalization transaction discussed earlier, in future periods, stock compensation expense, if any, resulting from the issuance of AR-CombiMatrix stock will generally be allocated to the CombiMatrix group. Stock option and related option plan information is omitted from the CombiMatrix group footnotes because AR-CombiMatrix stock is part of the capital structure of Acacia Research Corporation. The CombiMatrix group is not a separate legal entity. Holders of AR-CombiMatrix stock continue to be stockholders of Acacia Research Corporation. This presentation reflects the fact that the CombiMatrix group does not have legally issued common or preferred stock and Acacia Research Corporation AR-CombiMatrix stock transactions are not legal transactions of the CombiMatrix group. Refer to the Acacia Research Corporation consolidated financial statements for disclosures regarding Acacia Research Corporation's stock option plans. EARNINGS PER SHARE. Earnings per share information is omitted from the CombiMatrix group statements of operations because AR-CombiMatrix stock is part of the capital structure of Acacia Research Corporation. The CombiMatrix group is not a separate legal entity. Holders of AR-CombiMatrix stock continue to be stockholders of Acacia Research Corporation. This presentation reflects the fact that the CombiMatrix group does not have legally issued common or preferred stock and Acacia Research Corporation 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." 3. RECENT ACCOUNTING PRONOUNCEMENTS On January 1, 2003, the CombiMatrix group adopted SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146 nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity," under which a liability for an exit cost was recognized at the date of an entity's commitment to an exit plan. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized at fair value when the liability is incurred. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 did not have a significant impact on the CombiMatrix group's financial position or results of operations. On January 1, 2003, the CombiMatrix group adopted FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others," ("FIN 45") an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. FIN 45 also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of FIN 45 are applicable to guarantees issued or modified after December 31, 2002. The adoption of FIN 45 did not have a significant impact on the CombiMatrix group's financial position or results of operations. In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). FIN 46 requires consolidation of variable interest entities by the entity's primary beneficiary if the equity investors in the entity do not have the characteristics of a controlling financial interest or sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. FIN 46 must be applied beginning 23 July 1, 2003 to variable entities existing prior to February 1, 2003. The adoption of FIN 46 will not have a material impact on the CombiMatrix group's results of operations or financial condition. 4. GOODWILL AND INTANGIBLES Goodwill is evaluated for impairment in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"), which provides that goodwill is no longer subject to amortization. Instead, goodwill is subject to a periodic review for potential impairment that must occur at least annually at a reporting unit level. As of January 1, 2002, the date of adoption of the standard, the CombiMatrix group had unamortized goodwill in the amount of $2,851,000. In 2002, the CombiMatrix group performed a transitional goodwill impairment assessment and a year end goodwill impairment assessment and determined that there was no impairment of goodwill. The fair value of the CombiMatrix group reporting unit was estimated using a discounted cash flow analysis. There can be no assurance that future goodwill impairment tests will not result in a charge to earnings. The CombiMatrix group had $18,859,000 of goodwill at March 31, 2003 and December 31, 2002 (net of $1,312,000 of accumulated amortization). The CombiMatrix group's only identifiable intangible assets are patents. The gross carrying amount and accumulated amortization related to acquired intangible assets as of March 31, 2003 and December 31, 2002 and related patent amortization expense for the three months ended March 31, 2003 and 2002 are as follows (in thousands): MARCH 31, 2003 DECEMBER 31, 2002 -------------- -------------- Gross carrying amount - patents ... $ 12,095 $ 12,095 Accumulated amortization .......... (1,157) (883) -------------- -------------- Patents, net ...................... $ 10,938 $ 11,212 ============== ============== FOR THE THREE MONTHS ENDED ------------------------------- MARCH 31, 2003 MARCH 31, 2002 -------------- -------------- Patent amortization expense ....... $ 274 $ 99 ============== ============== Annual aggregate amortization expense for each of the next five years through December 31, 2007 is estimated to be $1,095,000 per year. At March 31, 2003 and December 31, 2002, all of the CombiMatrix group's acquired intangible assets other than goodwill were subject to amortization. 5. SUBSEQUENT EVENTS In the second quarter of 2003, CombiMatrix Corporation entered into a multi-year strategic alliance with Toppan Printing Corporation to develop and manufacture microarrays utilizing the CombiMatrix group's proprietary electrochemical detection approach. Under the terms of the agreement, Toppan will pay CombiMatrix Corporation an upfront fee of $1,000,000 and additional development and milestones payments. CombiMatrix Corporation and Toppan will co-develop semiconductor microarrays for applications in life science research and development as well as diagnostics. 24 ACACIA TECHNOLOGIES GROUP (A Division of Acacia Research Corporation) BALANCE SHEETS (In thousands) (Unaudited)
MARCH 31, DECEMBER 31, 2003 2002 ------------- ------------- ASSETS Current assets: Cash and cash equivalents ................................ $ 37,097 $ 39,792 Prepaid expenses, other receivables and other assets ..... 1,004 775 Receivable from CombiMatrix group ........................ 225 114 ------------- ------------- Total current assets .................................. 38,326 40,681 Property and equipment, net of accumulated depreciation .... 147 180 Investment in affiliate, at cost ........................... 252 252 Patents, net of accumulated amortization ................... 3,942 4,068 Goodwill, net of accumulated amortization .................. 1,834 1,834 Other assets ............................................... 197 197 ------------- ------------- $ 44,698 $ 47,212 ============= ============= LIABILITIES AND ALLOCATED NET WORTH Current liabilities: Accounts payable, accrued expenses and other ............. $ 2,129 $ 2,524 Deferred revenues ........................................ 1,536 1,503 ------------- ------------- Total current liabilities ............................. 3,665 4,027 Deferred income taxes ...................................... 1,119 1,156 ------------- ------------- Total liabilities ..................................... 4,784 5,183 ------------- ------------- Minority interests ......................................... 1,142 1,487 ------------- ------------- Allocated net worth: Funds allocated by Acacia Research Corporation ........... 105,281 105,557 Accumulated net losses ................................... (66,509) (65,015) ------------- ------------- Total allocated net worth ............................. 38,772 40,542 ------------- ------------- $ 44,698 $ 47,212 ============= ============= The accompanying notes are an integral part of these financial statements.
25 ACACIA TECHNOLOGIES GROUP (A Division of Acacia Research Corporation) STATEMENTS OF OPERATIONS (In thousands) (Unaudited)
FOR THE THREE MONTHS ENDED ----------------------------------- MARCH 31, 2003 MARCH 31, 2002 ---------------- ---------------- Revenues: License fee income ................................. $ 6 $ -- ---------------- ---------------- Total revenues .................................. 6 -- ---------------- ---------------- Operating expenses: Marketing, general and administrative expenses ..... 1,323 1,577 Non-cash stock compensation - marketing, general and administrative .................................. -- 10 Legal expenses - patents ........................... 262 211 Amortization of patents ............................ 126 465 ---------------- ---------------- Total operating expenses ........................ 1,711 2,263 ---------------- ---------------- Operating loss .................................. (1,705) (2,263) ---------------- ---------------- Other income (expense): Interest income ............................... 148 153 Realized gains (losses) on short-term investments.................................. 37 (553) Unrealized losses on short-term investments ... -- (322) Other income .................................. -- 78 ---------------- ---------------- Total other income (expenses) ................... 185 (644) ---------------- ---------------- Loss from continuing operations before income taxes and minority interests ................ (1,520) (2,907) Benefit for income taxes ............................. 26 29 ---------------- ---------------- Loss from continuing operations before minority interests ................................. (1,494) (2,878) Minority interests ................................... -- 37 ---------------- ---------------- Division net loss .................................... $ (1,494) $ (2,841) ================ ================ The accompanying notes are an integral part of these financial statements.
26 ACACIA TECHNOLOGIES GROUP (A Division of Acacia Research Corporation) STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)
FOR THE THREE MONTHS ENDED ------------------------------------- MARCH 31, 2003 MARCH 31, 2002 ----------------- ----------------- CASH FLOWS FROM OPERATING ACTIVITIES: Division net loss from continuing operations ...................... $ (1,494) $ (2,841) Adjustments to reconcile division net loss from continuing operations to net cash used in operating activities: Depreciation and amortization ................................. 161 502 Minority interests ............................................ -- (37) Non-cash stock compensation ................................... -- 10 Deferred tax benefit .......................................... (36) (35) Net purchases of trading securities ........................... -- (3,358) Unrealized losses on short-term investments ................... -- 322 Other ......................................................... (3) (35) Changes in assets and liabilities: Prepaid expenses, other receivables and other assets .......... (229) (673) Accounts payable, accrued expenses and other .................. (420) (125) Deferred revenues ............................................. 33 -- ----------------- ----------------- Net cash used in operating activities from continuing operations ....................................... (1,988) (6,270) Net cash used in operating activities from discontinued operations ..................................... (86) (254) ----------------- ----------------- Net cash used in operating activities ......................... (2,074) (6,524) ----------------- ----------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment ............................ (2) (51) Other ......................................................... -- (101) ----------------- ----------------- Net cash used in investing activities from continuing operations ....................................... (2) (152) Net cash used in investing activities from discontinued operations ..................................... (344) -- ----------------- ----------------- Net cash used in investing activities ......................... (346) (152) ----------------- ----------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net cash flows attributed to the Acacia Technologies group .... (275) 153 ----------------- ----------------- Decrease in cash and cash equivalents ............................ (2,695) (6,523) ----------------- ----------------- Cash and cash equivalents, beginning ............................. 39,792 46,859 ----------------- ----------------- Cash and cash equivalents, ending ................................ $ 37,097 $ 40,336 ================= ================= The accompanying notes are an integral part of these financial statements.
27 ACACIA TECHNOLOGIES GROUP (A DIVISION OF ACACIA RESEARCH CORPORATION) NOTES TO FINANCIAL STATEMENTS 1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION DESCRIPTION OF BUSINESS. The Acacia Technologies group, a division of Acacia Research Corporation, is primarily comprised of Acacia Research Corporation's interests in two wholly owned media technologies subsidiaries: (1) Acacia Media Technologies Corporation, ("Acacia Media Technologies") a Delaware corporation and (2) Soundview Technologies, Inc., ("Soundview Technologies") a Delaware corporation, and also includes all corporate assets, liabilities, and related transactions of Acacia Research Corporation attributed to the Acacia Technologies group. The Acacia Technologies group owns patented digital media transmission ("DMT") technology enabling the digitization, encryption, storage, transmission, receipt and playback of digital content. The DMT technology is protected by five U.S. and seventeen international patents. The DMT technology is utilized by a variety of companies, including cable companies, hotel in-room entertainment companies, Internet movie companies, Internet music companies, on-line adult entertainment companies, on-line learning companies and other companies that stream audio or audio/video content. Acacia Technologies group's digital media transmission patent portfolio expires in 2011 in the U.S. and in 2012 in international markets. The Acacia Technologies group also owns patented technology known as the V-chip. The V-chip was adopted by the manufacturers of televisions sold in the U.S. to provide blocking of certain programming based upon its content rating code, in compliance with the Telecommunications Act of 1996. The V-chip technology is protected by U.S. Patent No. 4,554,584, which expires in July 2003. On December 11, 2002, Acacia Research Corporation's stockholders voted in favor of a recapitalization transaction, which became effective on December 13, 2002, whereby Acacia Research Corporation created two new classes of common stock called Acacia Research-CombiMatrix stock ("AR-CombiMatrix stock") and Acacia Research-Acacia Technologies stock ("AR-Acacia Technologies stock"), and divided Acacia Research Corporation's existing Acacia Research Corporation common stock into shares of the two new classes of common stock. AR-Acacia Technologies stock is intended to reflect separately the performance of Acacia Research Corporation's Acacia Technologies group. AR-CombiMatrix stock is intended to reflect separately the performance of Acacia Research Corporation's CombiMatrix group. BASIS OF PRESENTATION. The unaudited interim Acacia Technologies group financial statements as of March 31, 2003, and for the three months ended March 31, 2003 and 2002, have been prepared in accordance with generally accepted accounting principles for interim financial information. These interim financial statements should be read in conjunction with the Acacia Technologies group financial statements and Acacia Research Corporation's consolidated financial statements and notes thereto for the year ended December 31, 2002. The Acacia Technologies group financial statements include all adjustments of a normal recurring nature which, in the opinion of management, are necessary for a fair presentation of its financial position as of March 31, 2003, and the results of its operations and its cash flows for the three months ended March 31, 2003 and 2002. The results of operations for the three months ended March 31, 2003 are not necessarily indicative of the results to be expected for the entire year. AR-Acacia Technologies stock is intended to reflect the separate performance of the respective division of Acacia Research Corporation. The Acacia Technologies group is not a separate legal entity. Holders of AR-Acacia Technologies stock are stockholders of Acacia Research Corporation. As a result, holders of AR-Acacia Technologies stock are subject to all of the risks of an investment in Acacia Research Corporation and all of its businesses, assets and liabilities. The assets Acacia Research Corporation attributes to Acacia Technologies could be subject to the liabilities of the CombiMatrix group. The Acacia Technologies group financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America, and taken together with the CombiMatrix group financial statements, comprise all the accounts included in the corresponding consolidated financial statements of Acacia Research Corporation. The financial statements of Acacia Technologies group reflect the financial condition, results of operations, and cash flows of the businesses included therein. The financial statements of the Acacia Technologies group include the accounts or assets of Acacia Research Corporation specifically attributed to the Acacia Technologies group and were prepared using amounts included in Acacia Research Corporation's consolidated financial statements. 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 28 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 STOCK-BASED COMPENSATION. Compensation cost of stock options issued to employees of Acacia Research Corporation is accounted for in accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25") and related interpretations. Compensation cost attributable to such options is recognized based on the difference, if any, between the closing market price of the stock on the date of grant and the exercise price of the option. Compensation cost is deferred and amortized on an accelerated basis over the vesting period of the individual option awards using the amortization method prescribed in Financial Accounting Standards Board ("FASB") Interpretation No. 28, "Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans" ("FIN No. 28"). Compensation cost of stock options and warrants issued to non-employee service providers is accounted for under the fair value method required Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") and related interpretations. As a result of the recapitalization transaction discussed earlier, in future periods, stock compensation expense, if any, resulting from the issuance of AR-Acacia Technologies stock will generally be allocated to the Acacia Technologies group. Stock option and related option plan information is omitted from the Acacia Technologies group footnotes because AR-Acacia Technologies stock is part of the capital structure of Acacia Research Corporation. The Acacia Technologies group is not a separate legal entity. Holders of AR-Acacia Technologies stock continue to be stockholders of Acacia Research Corporation. This presentation reflects the fact that the Acacia Technologies group does not have legally issued common or preferred stock and Acacia Research Corporation AR-Acacia Technologies stock transactions are not legal transactions of the Acacia Technologies group. Refer to the Acacia Research Corporation consolidated financial statements for disclosures regarding Acacia Research Corporation's stock option plans. EARNINGS PER SHARE. Earnings per share information is omitted from the Acacia Technologies group statements of operations because AR-Acacia Technologies stock is part of the capital structure of Acacia Research Corporation. The Acacia Technologies group is not a separate legal entity. Holders of AR-Acacia Technologies stock continue to be stockholders of Acacia Research Corporation. This presentation reflects the fact that the Acacia Technologies group does not have legally issued common or preferred stock and Acacia Research Corporation 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." 3. RECENT ACCOUNTING PRONOUNCEMENTS On January 1, 2003, the Acacia Technologies group adopted SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146 nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity," under which a liability for an exit cost was recognized at the date of an entity's commitment to an exit plan. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized at fair value when the liability is incurred. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 did not have a significant impact on the Acacia Technologies group's financial position or results of operations. On January 1, 2003, the Acacia Technologies group adopted FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others," ("FIN 45") an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. FIN 45 also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of FIN 45 are applicable to guarantees issued or modified after December 31, 2002. The adoption of FIN 45 did not have a significant impact on the Acacia Technologies group's financial position or results of operations. 29 In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). FIN 46 requires consolidation of variable interest entities by the entity's primary beneficiary if the equity investors in the entity do not have the characteristics of a controlling financial interest or sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. FIN 46 must be applied beginning July 1, 2003 to variable entities existing prior to February 1, 2003. The adoption of FIN 46 will not have a material impact on the Acacia Technologies group's results of operations or financial condition. 4. GOODWILL AND INTANGIBLES Goodwill is evaluated for impairment in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"), which provides that goodwill is no longer subject to amortization. Instead, goodwill is subject to a periodic review for potential impairment that must occur at least annually at a reporting unit level. As of January 1, 2002, the date of adoption of the standard, the Acacia Technologies group had unamortized goodwill in the amount of $1,776,000. In 2002, the Acacia Technologies group performed a transitional goodwill impairment assessment and a year end goodwill impairment assessment and determined that there was no impairment of goodwill. The fair value of the Acacia Technologies group reporting unit was estimated using a discounted cash flow analysis. There can be no assurance that future goodwill impairment tests will not result in a charge to earnings. The Acacia Technologies group had $1,834,000 of goodwill at March 31, 2003 and December 31, 2002 (net of $2,258,000 of accumulated amortization). The Acacia Technologies group's only identifiable intangible assets are patents. The gross carrying amount and accumulated amortization related to acquired intangible assets as of March 31, 2003 and December 31, 2002 and related patent amortization expense for the three months ended March 31, 2003 and 2002 are as follows (in thousands): MARCH 31, 2003 DECEMBER 31, 2002 -------------- -------------- Gross carrying amount - patents ... $ 10,798 $ 10,798 Accumulated amortization .......... (6,856) (6,730) -------------- -------------- Patents, net ...................... $ 3,942 $ 4,068 ============== ============== FOR THE THREE MONTHS ENDED ------------------------------- MARCH 31, 2003 MARCH 31, 2002 -------------- -------------- Patent amortization expense........ $ 126 $ 465 ============== ============== Annual aggregate amortization expense for each of the next five years through December 31, 2007 is estimated to be $500,000 per year. At March 31, 2003 and December 31, 2002, all of the Acacia Technologies group's acquired intangible assets other than goodwill were subject to amortization. 30 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CAUTIONARY STATEMENT You should read the following discussion and analysis in conjunction with the consolidated financial statements and related notes thereto contained elsewhere in this report. The information contained in this Quarterly Report on Form 10-Q is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended December 31, 2002 and our Registration Statement on Form S-4 filed with the Securities and Exchange Commission on May 7, 2002, as amended, that discuss our business in greater detail. This report contains forward-looking statements within the meaning of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. Reference is made in particular to the description of our plans and objectives for future operations, assumptions underlying such plans and objectives, and other forward-looking statements included in this report. Such statements may be identified by the use of forward-looking terminology such as "may," "will," "expect," "believe," "estimate," "anticipate," "intend," "continue," or similar terms, variations of such terms or the negative of such terms. Such statements are based on management's current expectations and are subject to a number of factors and uncertainties, which could cause actual results to differ materially from those described in the forward-looking statements. Such statements address future events and conditions concerning product development, capital expenditures, earnings, litigation, regulatory matters, markets for products and services, liquidity and capital resources and accounting matters. Actual results in each case could differ materially from those anticipated in such statements by reason of factors such as future economic conditions, changes in consumer demand, legislative, regulatory and competitive developments in markets in which we and our subsidiaries operate, and other circumstances affecting anticipated revenues and costs. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based. Additional factors that could cause such results to differ materially from those described in the forward-looking statements are set forth in connection with the forward-looking statements. OVERVIEW As used in this Form 10-Q, "we," "us" and "our" refer to Acacia Research Corporation and its subsidiary companies. Acacia Research Corporation, a Delaware corporation, was originally incorporated in California in January 1993 and reincorporated in Delaware in December 1999. The following discussion is based primarily on our unaudited consolidated balance sheet as of March 31, 2003 and on our unaudited consolidated statement of operations for the period from January 1, 2003 to March 31, 2003. The discussion compares the activities for the three months ended March 31, 2003 to the activities for the three months ended March 31, 2002. This information should be read in conjunction with the accompanying unaudited consolidated financial statements and notes thereto. Acacia Research Corporation develops, acquires and licenses enabling technologies for the life sciences and media technologies sectors, which comprise the two business groups of Acacia Research Corporation. Acacia Research Corporation's media technologies and life sciences businesses are referred to as the "Acacia Technologies group" and the "CombiMatrix group," respectively. The Acacia Technologies group owns and has licensed patented digital media transmission, or DMT, technology enabling the digitization, encryption, storage, transmission, receipt and playback of digital content, commonly known as audio-on-demand, video-on-demand and streaming media and also owns and has licensed technology, commonly known as the V-chip. To date, the Acacia Technologies group has licensed its V-chip technology to 13 television manufacturers representing approximately 75% of the industry. We will continue to pursue both licensing and strategic business alliances with leading companies in the rapidly growing media technologies industry. The CombiMatrix group's core technology opportunity in the life sciences sector has been developed through our wholly owned subsidiary, CombiMatrix Corporation, which is developing a proprietary system for rapid, cost competitive creation of DNA and other compounds on a programmable semiconductor chip. 31 COMBIMATRIX GROUP o During the first quarter of 2003, the CombiMatrix group's financial condition and results of operations were highlighted by the CombiMatrix KK's sale and installation of a genomics microarray synthesizer system to Keio University of Japan. In addition, CombiMatrix KK received an advance payment from the Nihon Gene Research Laboratory of Japan for the sale of a genomics microarray synthesizer system. The installation of this system is expected to be completed during the third quarter of 2003. Total consideration received by CombiMatrix KK from these genomic microarray synthesizer system sales and related microarray products and services to existing customers totaled $487,000, $216,000 of which was recognized as revenues during the first quarter of 2003 and $271,000 of which were recorded as deferred revenues as of March 31, 2003. Also during the first quarter 2003, the CombiMatrix group received $1,739,000 in milestone payments pursuant to its license, research and development agreements with Roche. All milestone payments received from Roche to date have been recorded as deferred revenues. ACACIA TECHNOLOGIES GROUP o To date, the Acacia Technologies group has entered into 21 license agreements for its DMT technology. The Acacia Technologies group's DMT license agreements provide for recurring license fee payments to be made by the respective licensees over the term of the license. o In February 2003, Acacia Media Technologies initiated DMT patent infringement litigation in the Federal District Court for the Central District of California against approximately 40 defendants who provide digital content over the Internet. o The Acacia Technologies group's patent on the V-chip technology expires in July 2003. Depending on the outcome of ongoing licensing efforts and related infringement actions, the Acacia Technologies group may, however, continue to collect license fees on televisions sold in the United States during the patent term, subsequent to the July 2003 patent expiration date. The Acacia Technologies group is marketing its DMT technology and is from time to time may acquire other technologies. Acacia Technologies group's digital media transmission patent portfolio expires in 2011 in the U.S. and in 2012 in international markets. If we do not succeed in acquiring additional technologies or are unable to successfully commercially license our existing and future technologies, our financial condition may be adversely impacted. ACACIA RESEARCH CORPORATION CONSOLIDATED RESULTS OF OPERATIONS (IN THOUSANDS)
FOR THE THREE MONTHS ENDED ------------------------------- March 31, 2003 March 31, 2002 -------------- -------------- Net revenues .................................................................. $ 222 $ 249 Cost of sales ................................................................. (77) -- Research and development expenses ............................................. (2,335) (2,668) Non-cash stock compensation expense - research and development ................ (2) (421) Marketing, general and administrative expenses ................................ (4,255) (4,072) Non-cash stock compensation expense - marketing, general and administrative ... (138) (1,001) Amortization of patents ....................................................... (400) (564) Other income (expenses), net .................................................. 252 (454) Benefit for income taxes ...................................................... 60 69 Minority interests ............................................................ 6 2,435 -------------- -------------- Net loss ...................................................................... $ (6,667) $ (6,427) ============== ==============
32 COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2003 TO THE THREE MONTHS ENDED MARCH 31, 2002 REVENUES LICENSE FEE INCOME. During the three months ended March 31, 2003, license fee revenues were $6,000, as compared to zero during the three months ended March 31, 2002. First quarter 2003 revenues relate solely to DMT technology license fees which the Acacia Technologies group began to recognize in the first quarter of 2003. Under the terms of the respective DMT license Agreement with each individual licensee, the Acacia Technologies group granted a one-year non-exclusive license for the use of its patented DMT technology in exchange for an annual license fee. Prepaid license fee payments received are amortized to revenue over the license term. PRODUCT REVENUES AND COST OF SALES. During the three months ended March 31, 2003, product revenues were $209,000, as compared to zero during the three months ended March 31, 2002, with related cost of sales of $77,000 and zero for the same periods, respectively. Product revenues and cost of sales were recognized by the CombiMatrix group's Japanese subsidiary from the sale of a genomics microarray synthesizer and related microarray products and services to Japanese research institutions. GRANT AND CONTRACT REVENUE. During the three months ended March 31, 2003, grant and contract revenues were $7,000, as compared to $249,000 during the three months ended March 31, 2002. Contract revenues recognized during 2003 relate to ongoing contract maintenance and service revenues earned by CombiMatrix KK, which were zero in the comparable 2002 period. There were no grant revenues recognized during the three months ended March 31, 2003. During the comparable period in 2002, grant and contract revenues included $91,000 from CombiMatrix Corporation's performance under its Phase I Small Business Innovative Research, or SBIR, Department of Defense contract, $141,000 in one-time contract research and development revenues and $17,000 in grant revenues related to performance under its Phase I National Institutes of Health, or NIH, grant. The SBIR Department of Defense and NIH grants were completed during the third quarter of 2002. OPERATING EXPENSES RESEARCH AND DEVELOPMENT EXPENSES. During the three months ended March 31, 2003, research and development expenses were $2.3 million, as compared to $2.7 million during the three months ended March 31, 2002. The CombiMatrix group's research and development activities continue to be driven primarily by ongoing performance obligations under the product commercialization phase of its license, research and development agreements with Roche. These activities include costs associated with direct labor, supplies and materials, development of prototype microarrays and instruments and the use of outside consultants for certain engineering efforts. Due to the achievement of several significant milestones during the third and fourth quarters of 2002, these research and development activities decreased during the first quarter of 2003 as compared to the same period in 2002. The CombiMatrix group expects its research and development expenses to be volatile and could increase in future periods as additional milestones are achieved for both existing and future contract research and development agreements. MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. During the three months ended March 31, 2003, marketing, general and administrative expenses were $4.3 million, as compared to $4.1 million during the three months ended March 31, 2002. The increase was due primarily to an increase in CombiMatrix Corporation's rent and utilities expenses as a result of the increase in occupancy of its headquarters in Mukilteo, Washington, an increase in CombiMatrix group severance-related expenses, and an increase in expenses related to Acacia Technologies group's ongoing DMT patent marketing and commercialization efforts, including increased personnel, consulting, research and engineering costs. The increase was partially offset by a decrease in legal and accounting related expenses related to the recapitalization and merger transactions consummated in December 2002. NON-CASH STOCK COMPENSATION EXPENSE. RESEARCH AND DEVELOPMENT. During the three months ended March 31, 2003, research and development related non-cash stock compensation charges, all of which relate to the CombiMatrix group, were $2,000, as compared to $421,000 during the three months ended March 31, 2002. 33 MARKETING, GENERAL AND ADMINISTRATIVE. During the three months ended March 31, 2003, marketing, general and administrative non-cash stock compensation charges, primarily related to the CombiMatrix group, were $138,000, as compared to $1.0 million during the three months ended March 31, 2002. The decrease in non-cash stock compensation charges related to research and development and marketing, general and administrative related expenses is primarily due to the accelerated method of amortization utilized pursuant to Financial Accounting Standards Board Interpretation No. 28, "Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans" ("FIN No. 28"), which results in higher amounts of amortization in the early vesting periods. Total non-cash stock compensation amortization expense is net of $743,000 and $724,000 in stock compensation expense reversals related to the forfeiture of certain unvested stock options during the three months ended March 31, 2003 and 2002, respectively. AMORTIZATION OF PATENTS. During the three months ended March 31, 2003, amortization of patents was $400,000, as compared to $564,000 during the three months ended March 31, 2002. The increase is due to the December 13, 2002 step acquisition of CombiMatrix Corporation by Acacia Research Corporation, which resulted in the recognition of additional core technology patent valued at $5.3 million. As a result, Acacia Research Corporation will record additional amortization expense of approximately $755,000 on an annual basis (over the economic useful life of approximately 7 years), related to the core technology patent intangible asset identified in connection with the application of the purchase method of accounting. The increase was offset by a reduction in patent amortization expense due to V-chip technology related patent costs and other intangibles that were fully amortized during 2002. OTHER INCOME (EXPENSES), NET OTHER INCOME (EXPENSES), NET. During the three months ended March 31, 2003, other income, net was $252,000, as compared to $454,000 in other expenses, net during the three months ended March 31, 2002. The significant components of other income (expense) were as follows: INTEREST INCOME. During the three months ended March 31, 2003, interest income was $215,000, as compared to $403,000 during the three months ended March 31, 2002. The decrease was primarily due to a decrease in average cash balances related to net operating cash outflows and the impact of a decrease in interest rates on our short-term investments resulting from interest rate cuts by the Federal Open Market Committee and other external economic factors negatively impacting rates of return on short-term investments occurring during 2002 and continuing in 2003. REALIZED AND UNREALIZED LOSSES ON SHORT-TERM INVESTMENTS. During the three months ended March 31, 2003, net realized gains on investments was $37,000, as compared to net realized losses on investments of $553,000. During the three months ended March 31, 2003, net unrealized losses on investments was zero, as compared to net unrealized losses on investments of $322,000 during the three months ended March 31, 2002. The decrease is due to an overall reduction in investments classified as trading securities. MINORITY INTERESTS. During the three months ended March 31, 2003, minority interests in the losses of consolidated subsidiaries was $6,000, as compared to $2.4 million during the three months ended March 31, 2002. Minority interests recorded during the three months ended March 31, 2002 relate primarily to our majority ownership interest in CombiMatrix Corporation during 2002. As a result of our merger with CombiMatrix Corporation in December 2002, which increased our ownership interest to 100%, we no longer record minority interests related to our investment in CombiMatrix Corporation. 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 $49.7 million at March 31, 2003, as compared to $54.7 million at December 31, 2002. We have no commitments for capital expenditures. Our minimum rental commitments on operating leases related to continuing operations total $10.0 million through December 2007. We have no committed lines of credit or other committed funding or long-term debt. Management believes that our cash and cash equivalent and short term investments, anticipated cash flow from operations and other external sources of available credit will be sufficient to meet our cash requirements for the foreseeable future. 34 There can be no assurances that we will not encounter unforeseen difficulties that may deplete our capital resources more rapidly than anticipated. Any efforts to seek additional funding could be made through equity, debt or other external financing and there can be no assurance that additional funding will be available on favorable terms, if at all. Such financing transactions may be dilutive to existing investors. If we fail to obtain additional funding when needed, we may not be able to execute our business plans and our business may suffer. RECENT ACCOUNTING PRONOUNCEMENTS Refer to Note 4 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. 35 DISCUSSION OF SEGMENTS' OPERATIONS, FINANCIAL RESOURCES AND LIQUIDITY COMBIMATRIX GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS (A DIVISION OF ACACIA RESEARCH CORPORATION) YOU SHOULD READ THIS DISCUSSION IN CONJUNCTION WITH THE COMBIMATRIX GROUP FINANCIAL STATEMENTS AND RELATED NOTES AND THE ACACIA RESEARCH CORPORATION CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES, BOTH INCLUDED ELSEWHERE HEREIN. HISTORICAL RESULTS AND PERCENTAGE RELATIONSHIPS ARE NOT NECESSARILY INDICATIVE OF OPERATING RESULTS FOR ANY FUTURE PERIODS. GENERAL The CombiMatrix group, a division of Acacia Research Corporation, is comprised of CombiMatrix Corporation and its majority-owned subsidiaries, CombiMatrix KK and Advanced Material Sciences, and includes all corporate assets, liabilities and transactions related to Acacia Research Corporation's life sciences businesses. The CombiMatrix group's core technology opportunity in the life sciences sector has been primarily developed through CombiMatrix Corporation, which was formed in October 1995. CombiMatrix Corporation is a life sciences technology company with a proprietary system for rapid, cost competitive creation of DNA and other compounds on a programmable semiconductor chip. This proprietary technology has significant applications relating to genomic and proteomic research. Advanced Material Sciences, a development stage company, holds the exclusive license for CombiMatrix Corporation's biological array processor technology in certain fields of material sciences. Advanced Material Sciences has no operating history, and subsequent to April 2002 is a majority-owned subsidiary of CombiMatrix Corporation. CombiMatrix KK, a majority-owned Japanese corporation, is exploring opportunities for CombiMatrix Corporation's active biochip system with academic, pharmaceutical and biotechnology organizations in the Asian market. Although AR-CombiMatrix stock is intended to reflect the separate performance of the respective division of Acacia Research Corporation, rather than the performance of Acacia Research Corporation as a whole, the CombiMatrix group is not a separate legal entity. Holders of AR-CombiMatrix stock are stockholders of Acacia Research Corporation. As a result, they continue to be subject to all of the risks of an investment in Acacia Research Corporation and all of its businesses, assets and liabilities. The assets Acacia Research Corporation attributes to the CombiMatrix group could be subject to the liabilities of the Acacia Technologies group. During the first quarter of 2003, the CombiMatrix group's financial condition and results of operations were highlighted by the CombiMatrix KK's sale and installation of a genomics microarray synthesizer system to Keio University of Japan. In addition, CombiMatrix KK received an advance payment from the Nihon Gene Research Laboratory of Japan for the sale of a genomics microarray synthesizer system. The installation of this system is expected to be completed during the third quarter of 2003. Total consideration received by CombiMatrix KK from these genomic microarray synthesizer system sales and related microarray products and services to existing customers totaled $487,000, $216,000 of which was recognized as revenues and $271,000 of which were recorded as deferred revenues as of March 31, 2003. Also during the first quarter of 2003, the CombiMatrix group received $1,739,000 in milestone payments pursuant to its license, research and development agreements with Roche. All milestone payments received from Roche to date have been recorded as deferred revenues. 36 COMBIMATRIX GROUP (A DIVISION OF ACACIA RESEARCH CORPORATION) RESULTS OF OPERATIONS (IN THOUSANDS)
FOR THE THREE MONTHS ENDED ------------------------------- March 31, 2003 MARCH 31, 2002 -------------- -------------- Product revenue ................................................... $ 209 $ -- Grant and contract revenue ........................................ 7 249 Cost of sales ..................................................... (77) -- Research and development expenses ................................. (2,335) (2,668) Non-cash stock compensation expenses - research and development ... (2) (421) Marketing, general and administrative expenses .................... (2,670) (2,284) Non-cash stock compensation expenses - marketing, general and administrative ................................................. (138) (991) Amortization of patents ........................................... (274) (99) Other income, net ................................................. 67 190 Benefit for income taxes .......................................... 34 40 Minority interests ................................................ 6 2,398 -------------- -------------- Division net loss ................................................. $ (5,173) $ (3,586) ============== ==============
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2003 TO THE THREE MONTHS ENDED MARCH 31, 2002 PRODUCT REVENUES AND COST OF SALES. During the three months ended March 31, 2003, product revenues were $209,000, as compared to zero during the three months ended March 31, 2002, with related cost of sales of $77,000 and zero for the same periods, respectively. Product revenues and cost of sales were recognized by CombiMatrix KK from the sale of a genomics microarray synthesizer and related microarray products and services to Japanese research institutions. GRANT AND CONTRACT REVENUES. During the three months ended March 31, 2003, grant and contract revenues were $7,000, as compared to $249,000 during the three months ended March 31, 2002. Contract revenues recognized during 2003 relate to ongoing contract maintenance and service revenues earned by CombiMatrix KK, which were zero in the comparable 2002 period. There were no grant revenues recognized during the three months ended March 31, 2003. During the comparable period in 2002, grant and contract revenues included $91,000 from CombiMatrix Corporation's performance under its Phase I Small Business Innovative Research, or SBIR, Department of Defense contract, $141,000 in one-time contract research and development revenues and $17,000 in grant revenues related to performance under its Phase I NIH grant. The SBIR Department of Defense and NIH grants were completed in the third quarter of 2002. RESEARCH AND DEVELOPMENT EXPENSES. During the three months ended March 31, 2003, research and development expenses were $2.3 million, as compared to $2.7 million during the three months ended March 31, 2002. The CombiMatrix group's research and development activities continue to be driven primarily by ongoing performance obligations under the product commercialization phase of its license, research and development agreements with Roche. These activities include costs associated with direct labor, supplies and materials, development of prototype microarrays and instruments and the use of outside consultants for certain engineering efforts. Due to the achievement of several significant milestones during the third and fourth quarters of 2002, these research and development activities decreased during the first quarter of 2003 as compared to the same period in 2002. The CombiMatrix group expects that its research and development activities will be volatile and could increase in future periods as additional milestones are achieved for both existing and future contract research and development agreements. Since July 2001, most of the CombiMatrix group's research and development efforts have been driven by obligations under its agreements with Roche. These projects include development of production microarray instrumentation and hardware, improved microarray synthesis techniques, development of higher density microarrays and the development of a robust manufacturing process for its microarray platform. These projects are expected to continue into 2005 as determined by the timelines specified in the agreements. MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. During the three months ended March 31, 2003, marketing, general and administrative expenses were $2.7 37 million, as compared to $2.3 million during the three months ended March 31, 2002. This increase was due primarily to an increase in CombiMatrix Corporation's rent and utilities expenses as a result of the increase in occupancy of its headquarters in Mukilteo, Washington, as well as severance-related expenses incurred during the first quarter of 2003 that were not incurred in the comparable 2002 period. NON-CASH STOCK COMPENSATION EXPENSE. RESEARCH AND DEVELOPMENT. For the three months ended March 31, 2003, research and development related non-cash stock compensation charges were $2,000, as compared to $421,000 during the three months ended March 31, 2002. MARKETING, GENERAL AND ADMINISTRATIVE. For the three months ended March 31, 2003, marketing, general and administrative related non-cash stock compensation charges were $138,000, as compared to $991,000 during the three months ended March 31, 2002. The decrease in non-cash stock compensation charges related to research and development and marketing, general and administrative expenses is primarily due to the accelerated method of amortization utilized by the CombiMatrix group pursuant to FIN No. 28, which results in higher amounts of amortization in the early vesting periods. The CombiMatrix group's total non-cash stock compensation amortization expense is net of $743,000 and $724,000 in stock compensation expense reversals related to the forfeiture of certain unvested stock options during the three months ended March 31, 2003 and 2002, respectively. AMORTIZATION OF PATENTS. During the three months ended March 31, 2003, amortization of patents was $274,000, as compared to $99,000 during the three months ended March 31, 2002. The increase in patent amortization was due to the December 13, 2002 step acquisition of CombiMatrix Corporation by Acacia Research Corporation, which resulted in the recognition of additional core technology patent valued at $5.3 million which was allocated to the CombiMatrix group. As a result, the CombiMatrix group will record additional amortization expense of approximately $755,000 on an annual basis (over the economic useful life of approximately 7 years), related to the core technology patent intangible asset identified in connection with the application of the purchase method of accounting. OTHER INCOME, NET. During the three months ended March 31, 2003, other income, net was $67,000, as compared to $190,000 during the three months ended March 31, 2002. Other income, net is comprised of the following: INTEREST INCOME. During the three months ended March 31, 2003, interest income was $67,000, as compared to $250,000 during the three months ended March 31, 2002. The decrease was due primarily to lower average cash and cash equivalents balances and short-term investments during the first quarter of 2003, as compared to the same period in 2002, as well as lower market interest rates earned on the CombiMatrix group's cash and investments. INTEREST EXPENSE. During the three months ended March 31, 2003, interest expense was zero, as compared to $60,000 during the three months ended March 31, 2002. Interest expense relates to CombiMatrix Corporation's capital lease obligation with a financial institution, which was executed in September 2001. In November 2002, the remaining balance of this obligation was repaid in full. As a result, no interest expense charges were incurred during the first quarter of 2003. MINORITY INTERESTS. During the three months ended March 31, 2003, minority interests in the net losses of the CombiMatrix group were $6,000, as compared to $2.4 million during the three months ended March 31, 2002. As a result of Acacia Research Corporation's merger with CombiMatrix Corporation in December 2002, which increased Acacia Research Corporation's ownership interest to 100%, the CombiMatrix group no longer records minority interests related to Acacia Research Corporation's investment in CombiMatrix Corporation, resulting in the overall decrease in minority interests recognized during the first quarter of 2003, as compared to the same period in 2002. INFLATION Inflation has not had a significant impact on the CombiMatrix group. LIQUIDITY AND CAPITAL RESOURCES As of March 31, 2003 and December 31, 2002, cash and cash equivalents and short-term investments totaled $12.6 million and $14.9 million, respectively. 38 CombiMatrix group's rental expenses, including its share of the common area maintenance and operating expenses, are approximately $185,000 per month (excluding any allocated rent expense) at its headquarters and research facilities in Mukilteo, Washington. That amount increases over time, subject to acceleration based on actual usage of the premises, to approximately $200,000 per month by mid 2006 through 2008. The CombiMatrix group has no long-term debt or commitments for capital expenditures. The CombiMatrix group is required to pay Nanogen $500,000 in September 2003, representing the second and final installment of the $1.0 million cash payment due to Nanogen in accordance with the September 30, 2002 settlement agreement entered into between CombiMatrix Corporation, Dr. Don Montgomery and Nanogen. The CombiMatrix group's long-term capital requirements will be substantial and the adequacy of our available funds will depend upon many factors, including: o the CombiMatrix group's continued progress in research and development programs; o the costs involved in filing, prosecuting, enforcing and defending any patents claims, should they arise; o the CombiMatrix group's ability to license technology; o competing technological developments; o the creation and formation of strategic partnerships; o the costs associated with leasing and improving our headquarters in Mukilteo, Washington; o the costs of commercialization activities; and o other factors that may not be within the CombiMatrix group's control. The CombiMatrix group believes that its cash and cash equivalent and short-term investment balances, anticipated cash flow from operations and other external sources of available credit will be sufficient to meet its cash requirements for the foreseeable future. However, changes may occur that would cause the CombiMatrix group's available capital resources to be consumed significantly sooner than it currently expects. The CombiMatrix group may be unable to raise sufficient additional capital on favorable terms or at all. If it fails to do so, it may have to curtail or cease operations or enter into agreements requiring it to relinquish rights to certain technologies, products or markets because it will not have the capital necessary to exploit them. RECENT ACCOUNTING PRONOUNCEMENTS Refer to Note 3 to the CombiMatrix group financial statements included elsewhere herein. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The CombiMatrix group's exposure to market risk is limited to interest income sensitivity, which is affected by changes in the general level of United States interest rates, particularly because the majority of the group's investments are in short-term debt securities issued by the U.S. treasury and by U.S. corporations. The primary objective of the group's investment activities is to preserve principal while at the same time maximizing the income the CombiMatrix group receives without significantly increasing risk. To minimize risk, the CombiMatrix group maintains its portfolio of cash, cash equivalents and short-term investments in a variety of investment-grade securities and with a variety of issuers, including corporate notes, commercial paper, government securities and money market funds. Due to the nature of its short-term investments, the CombiMatrix group believes that it is not subject to any material market risk exposure. At March 31, 2003 and December 31, 2002, the CombiMatrix group had certain assets and liabilities denominated in Japanese Yen as a result of forming CombiMatrix KK. However, due to the relative insignificance of those amounts, the CombiMatrix group does not believe that it has significant exposure to foreign currency exchange rate risks. The CombiMatrix group currently does not use derivative financial instruments to mitigate this exposure. The CombiMatrix group continues to review this and may begin hedging certain foreign exchange risks through the use of currency forwards or options in future periods. 39 ACACIA TECHNOLOGIES GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS (A DIVISION OF ACACIA RESEARCH CORPORATION) YOU SHOULD READ THIS DISCUSSION IN CONJUNCTION WITH THE ACACIA TECHNOLOGIES GROUP FINANCIAL STATEMENTS AND RELATED NOTES AND THE ACACIA RESEARCH CORPORATION CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES, BOTH INCLUDED ELSEWHERE HEREIN. HISTORICAL RESULTS AND PERCENTAGE RELATIONSHIPS ARE NOT NECESSARILY INDICATIVE OF OPERATING RESULTS FOR ANY FUTURE PERIODS. GENERAL The Acacia Technologies group, a division of Acacia Research Corporation, is comprised primarily of Acacia Research Corporation's wholly owned media technology subsidiaries, Acacia Media Technologies and Soundview Technologies and also includes all other related corporate assets and liabilities and related transactions of Acacia Research Corporation that are attributed to its media technology businesses. Although the AR-Acacia Technologies stock is intended to reflect the separate performance of the respective division of Acacia Research Corporation, rather than the performance of Acacia Research Corporation as a whole, the Acacia Technologies group is not a separate legal entity. Holders of the AR-Acacia Technologies stock are stockholders of Acacia Research Corporation. As a result, they continue to be subject to all of the risks of an investment in Acacia Research Corporation and all of Acacia Research Corporation's businesses, assets and liabilities. The assets Acacia Research Corporation attributes to the Acacia Technologies group could be subject to the liabilities of the CombiMatrix group. The Acacia Technologies group owns and is developing a portfolio of U.S. and international pioneering patents covering the transmission and receipt of digital content. These transmission and receiving systems are commonly referred to as audio-on-demand, video-on-demand, and audio/video streaming. The Acacia Technologies group's patented proprietary digital media transmission technology is referred to as "DMT" technology. The Acacia Technologies group also owns a patent for a system that screens television content by content rating code, commonly referred to as V-chip technology. The system, which uses the audio and video blanking interval in conjunction with rating codes which are transmitted with television programming, was approved by the Federal Communication Commission or FCC and adopted by television manufacturers as the industry standard in response to the U.S. Telecommunications Act of 1996. The Acacia Technologies group is responsible for the development, licensing and protection of its intellectual property and proprietary technologies. The Acacia Technologies group continues to pursue both licensing and strategic business alliances with leading companies in the rapidly growing media technologies industry. To date, the Acacia Technologies group has entered into 21 license agreements for its DMT technology. The Acacia Technologies group's DMT license agreements generally provide for recurring license fee payments to be made by the respective licensees over the term of the license. In February 2003, Acacia Media Technologies initiated DMT patent infringement litigation in the Federal District Court for the Central District of California against approximately 40 defendants who provide digital content over the Internet. All of the defendants were previously notified of their infringing activity. The Acacia Technologies group's patent on the V-chip technology expires in July 2003. However, depending on the outcome of ongoing licensing efforts and related infringement actions, the Acacia Technologies group may continue to collect license fees on televisions sold in the United States during the patent term, subsequent to the July 2003 patent expiration date. The Acacia Technologies group is marketing its DMT technology and is looking to acquire other technologies. Acacia Technologies group's digital media transmission patent portfolio expires in 2011 in the U.S. and in 2012 in international markets. If we do not succeed in acquiring such technologies or are unable to successfully commercially license our existing and future technologies, our financial condition may be adversely impacted. 40 ACACIA TECHNOLOGIES GROUP (A DIVISION OF ACACIA RESEARCH CORPORATION) RESULTS OF OPERATIONS (IN THOUSANDS)
FOR THE THREE MONTHS ENDED ------------------------------- MARCH 31, 2003 MARCH 31, 2002 -------------- -------------- Net revenues ...................................... $ 6 $ -- Marketing, general and administrative expenses .... (1,323) (1,577) Non-cash stock compensation expenses - marketing, general and administrative ..................... -- (10) Legal expenses - patents .......................... (262) (211) Amortization of patents ........................... (126) (465) Other income (expenses), net ...................... 185 (644) Benefit for income taxes .......................... 26 29 Minority interests ................................ -- 37 -------------- -------------- Division net loss ................................. $ (1,494) $ (2,841) ============== ==============
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2003 TO THE THREE MONTHS ENDED MARCH 31, 2002 REVENUES LICENSE FEE INCOME. During the three months ended March 31, 2003, license fee revenues were $6,000, as compared to zero during the three months ended March 31, 2002. First quarter 2003 revenues relate solely to DMT technology license fees which the Acacia Technologies group began to recognize in the first quarter of 2003. Under the terms of the respective DMT license Agreement with each individual licensee, the Acacia Technologies group granted a one-year non-exclusive license for the use of its patented DMT technology in exchange for an annual license fee. Prepaid license fee payments received are amortized to revenue over the license term. OPERATING EXPENSES MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. During the three months ended March 31, 2003, marketing, general and administrative expenses were $1.3 million, as compared to $1.6 million during the three months ended March 31, 2002. The decrease is due primarily to a reduction in legal and accounting related expenses related to the recapitalization and merger transactions consummated in December 2002, offset by an increase in Acacia Technologies group's ongoing patent marketing and commercialization efforts, including increased personnel, consulting, research and engineering costs. LEGAL EXPENSES - PATENTS. During the three months ended March 31, 2003, patent related legal expenses were $262,000, as compared to $211,000 during the three months ended March 31, 2002. Patent related legal expenses in both periods relates to legal fees incurred in connection with the Acacia Technologies group's ongoing DMT patent marketing and commercialization efforts, including patent claims construction, patent prosecution and related research costs. OTHER INCOME (EXPENSES), NET OTHER INCOME (EXPENSES), NET. During the three months ended March 31, 2003, other income, net was $185,000, as compared to $644,000 in net other expenses during the three months ended March 31, 2002. The significant components of other income (expenses) were as follows: INTEREST INCOME. During the three months ended March 31, 2003, interest income was $148,000, as compared to $153,000 during the three months ended March 31, 2002. The decrease was primarily due to a decrease in average cash balances related to net operating cash outflows and the impact of a decrease in interest rates on our short-term investments resulting from interest rate cuts by the Federal Open Market Committee and other external economic factors negatively impacting rates of return on short-term investments occurring during 2002 and continuing during 2003. 41 REALIZED AND UNREALIZED LOSSES ON SHORT-TERM INVESTMENTS. During the three months ended March 31, 2003, net realized gains on investments were $37,000, as compared to net realized losses on investments of $553,000. During the three months ended March 31, 2003, net unrealized losses on investments were zero, as compared to net unrealized losses on investments of $322,000 during the three months ended March 31, 2002. The decrease is due to an overall reduction in investments classified as trading securities. INFLATION Inflation has not had a significant impact on Acacia Research Corporation. LIQUIDITY AND CAPITAL RESOURCES The Acacia Technologies group's cash and cash equivalents totaled $37.1 million at March 31, 2003, as compared to $39.8 million at December 31, 2002. The Acacia Technologies group has no commitments for capital expenditures. The Acacia Technologies group's minimum rental commitments on operating leases related to continuing operations total $1.3 million through December 2007. The Acacia Technologies group has no committed lines of credit or other committed funding or long-term debt. Management believes that the Acacia Technologies group's cash and cash equivalent and short term investments, anticipated cash flow from operations and other external sources of available credit will be sufficient to meet its cash requirements for the foreseeable future. RECENT ACCOUNTING PRONOUNCEMENTS Refer to Note 3 to the Acacia Technologies group financial statements included elsewhere herein. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Acacia Technologies group's exposure to market risk is limited primarily to interest income sensitivity, which is affected by changes in the general level of United States interest rates, particularly because a significant portion of our investments are in short-term debt securities issued by United States corporations, institutional money market funds and other money market instruments. The primary objective of our investment activities is to preserve principal while at the same time maximizing the income received without significantly increasing risk. To minimize risk, we maintain a portfolio of cash, cash equivalents and short-term investments in a variety of investment-grade securities and with a variety of issuers, including U.S. government and corporate notes and bonds, commercial paper and money market instruments. Due to the nature of our short-term investments, we believe that we are not subject to any material market risk exposure. We do not have any derivative financial instruments. 42 RISK FACTORS AN INVESTMENT IN OUR STOCK INVOLVES A NUMBER OF RISKS. BEFORE MAKING A DECISION TO PURCHASE OUR SECURITIES, YOU SHOULD CAREFULLY CONSIDER ALL OF THE RISKS DESCRIBED IN THIS ANNUAL REPORT. IF ANY OF THE RISKS DISCUSSED IN THIS ANNUAL REPORT ACTUALLY OCCUR, OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE MATERIALLY ADVERSELY AFFECTED. IF THIS WERE TO OCCUR, THE TRADING PRICE OF OUR SECURITIES COULD DECLINE SIGNIFICANTLY AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT. GENERAL RISKS THE CONTINUING WORLDWIDE ECONOMIC SLOWDOWN AND RELATED UNCERTAINTIES MAY CONTINUE TO ADVERSELY IMPACT OUR REVENUES AND OPERATING RESULTS. Slower economic activity, concerns about inflation, decreased consumer confidence, reduced corporate profits and capital spending, adverse business conditions and liquidity concerns in the technology and biotechnology and related industries, and recent international conflicts and terrorist and military activity have resulted in a continuing downturn in worldwide economic conditions. We cannot predict the timing, strength and duration of any economic recovery in our industries. In addition, the events of September 11, 2001 and subsequent international conflicts and terrorist acts can be expected to place further pressure on economic conditions in the United States and worldwide. These conditions make it extremely difficult for us to accurately forecast and plan future business activities. If such conditions continue or worsen, our business, financial condition and results of operations will likely be materially and adversely affected. BECAUSE OUR BUSINESS OPERATIONS ARE SUBJECT TO MANY INHERENT AND UNCONTROLLABLE RISKS, WE MAY NOT SUCCEED. We have significant economic interests in our subsidiary companies. Our business operations are subject to numerous risks, challenges, expenses and uncertainties inherent in the establishment of new business enterprises. Many of these risks and challenges are subject to outside influences over which we have no control, including: o our subsidiary companies' products and services face uncertain market acceptance; o technological advances may make our subsidiary companies' products and services obsolete or less competitive; o competition; o increases in operating costs, including costs for supplies, personnel and equipment; o the availability and cost of capital; o general economic conditions; and o governmental regulation that excessively restricts our subsidiary companies' businesses. We cannot assure you that our subsidiary companies will be able to market any product or service on a large commercial scale, that our subsidiary companies will ever achieve or maintain profitable operations or that they, or we, will be able to remain in business. WE HAVE A HISTORY OF LOSSES AND EXPECT TO INCUR ADDITIONAL LOSSES IN THE FUTURE. We have sustained substantial losses since our inception resulting in an accumulated deficit, as of March 31 ,2003, of $165.7 million (including a reclassification of accumulated deficit in the amount of $21.7 million to permanent capital representing the fair value of the ten percent (10%) stock dividend paid in 2001) on a consolidated basis. We may never become profitable or if we do, we may never be able to sustain profitability. We expect to incur significant research and development, marketing, general and administrative expenses. As a result, we expect to incur significant losses for the foreseeable future. BECAUSE OUR OPERATING RESULTS HAVE FLUCTUATED SIGNIFICANTLY AND MAY CONTINUE TO DO SO IN THE FUTURE, OUR STOCK PRICE MAY BE VERY VOLATILE. Our operating results may vary significantly from quarter to quarter due to a variety of factors, including: 43 o the operating results of our current and future subsidiary companies; o the nature and timing of our investments in new subsidiary companies; o our decisions to acquire or divest interests in our current and future subsidiaries, which may create changes in losses or income and amortization of goodwill; o changes in our methods of accounting for our current and future subsidiaries, which may cause us to recognize gains or losses under applicable accounting rules; o the timing of the sales of equity interests in our current and future subsidiary companies; o our ability to effectively manage our growth and the growth of our subsidiary companies; o general economic conditions; and o the cost of future acquisitions, which may increase due to intense competition from other potential acquirers of technology-related companies or ideas. We have incurred and expect to continue to incur significant expenses in pursuing and developing new business ventures. To date, we have lacked a consistent source of recurring revenue. Each of the factors we have described may cause our stock to be more volatile than the stock of other companies. BECAUSE CERTAIN OF OUR SUBSIDIARY COMPANIES MAY NOT GENERATE ANY SIGNIFICANT REVENUES, AND OPERATING RESULTS FROM OUR SUBSIDIARY COMPANIES MAY FLUCTUATE SIGNIFICANTLY, OUR OWN OPERATING RESULTS MAY BE NEGATIVELY AFFECTED. Our operating results may be materially impacted by the operating results of our subsidiary companies. We cannot assure that these companies will be able to meet their anticipated working capital needs to develop their products and services. If they fail to properly develop these products and services, they will be unable to generate meaningful product sales. We anticipate that our operating results are likely to vary significantly as a result of a number of factors, including: o the timing of new product introductions by each subsidiary company; o the stage of development of the business of each subsidiary company; o the technical feasibility of each subsidiary company's technologies and techniques; o the novelty of the technology owned by our subsidiary companies; o the accuracy, effectiveness and reliability of products developed by our subsidiary companies; o the level of product acceptance; o the strength of each subsidiary company's intellectual property rights; o the ability of each subsidiary company to avoid infringing the intellectual property rights of others; o each subsidiary company's ability to exploit and commercialize its technology; o the volume and timing of orders received and product line maturation; o the impact of price competition; and o each subsidiary company's ability to access distribution channels. Many of these factors are beyond our subsidiary companies' control. We cannot provide any assurance that any subsidiary company will experience growth in the future or be profitable on an operating basis in any future period. IF WE, OR OUR SUBSIDIARIES, ENCOUNTER UNFORESEEN DIFFICULTIES AND CANNOT OBTAIN ADDITIONAL FUNDING ON FAVORABLE TERMS, OUR BUSINESS MAY SUFFER. As of March 31, 2003, we had cash and short-term investments of $49.7 million on our consolidated financial statements. To date, our subsidiary companies have relied primarily upon selling equity securities, including sales to and loans from us, to generate the funds needed to finance implementing their plans of operations. Our subsidiary companies may be required to obtain additional financing through bank borrowings, debt or equity financings or otherwise, which would require us to make additional investments or face a dilution of our equity interests. We cannot assure that we will not encounter unforeseen difficulties that may deplete our capital resources more rapidly than anticipated. Any efforts to seek additional funds could be made through equity, debt or other external financings. However, we cannot assure that additional funding will be available on favorable terms, if at all. If we fail to obtain additional funding when needed for our subsidiary companies and ourselves, we may not be able to execute our business plans and our business may suffer. 44 OUR BUSINESS MAY BE HARMED IF MARKET AND OTHER CONDITIONS ADVERSELY AFFECT OUR ABILITY TO DISPOSE OF CERTAIN ASSETS AT FAVORABLE PRICES. An element of our business plan involves disposing of, in public offerings or private transactions, our subsidiary companies and future partner companies, or portions of assets thereof, to the extent such assets are no longer consistent with our business plan. If we sell any such subsidiary companies or assets, the price we receive will depend upon market and other conditions. Therefore, we may not be able to sell at favorable prices. Market and other conditions beyond our control affect: o our ability to effect these sales; o the timing of these sales; and o the amount of proceeds from these sales. In some instances, we may not be able to sell some or any of these assets due to poor market and other conditions. As a result, we may be adversely affected because we will be unable to dispose of assets or may receive a lesser amount for our assets than we believe is favorable. FAILURE TO EFFECTIVELY MANAGE OUR GROWTH COULD PLACE STRAINS ON OUR MANAGERIAL, OPERATIONAL AND FINANCIAL RESOURCES AND COULD ADVERSELY AFFECT OUR BUSINESS AND OPERATING RESULTS. Our growth has placed, and is expected to continue to place, a significant strain on our managerial, operational and financial resources. Further, as the number of our subsidiary companies and their respective businesses grow, we will be required to manage multiple relationships. Any further growth by us or our subsidiary companies or an increase in the number of our strategic relationships will increase this strain on our managerial, operational and financial resources. This strain may inhibit our ability to achieve the rapid execution necessary to successfully implement our business plan. In addition, our future success depends on our ability to expand our organization to match the growth of our business and our subsidiaries. OUR FUTURE SUCCESS DEPENDS IN PART ON THE CONTINUED SERVICE OF OUR KEY EXECUTIVES, AND THE LOSS OF ANY OF THESE KEY EXECUTIVES COULD ADVERSELY AFFECT OUR BUSINESS AND OPERATING RESULTS. Our success depends in part upon the continued service of our executive officers, particularly Paul R. Ryan, our Chairman and Chief Executive Officer, Robert L. Harris, II, our President and Dr. Amit Kumar, President and Chief Executive Officer of CombiMatrix Corporation. Neither Mr. Ryan, Mr. Harris nor Dr. Kumar has an employment or non-competition agreement with us. The loss of any of these key individuals would be detrimental to our ongoing operations and prospects. OUR FUTURE SUCCESS AND THE SUCCESS OF OUR SUBSIDIARY COMPANIES DEPENDS ON OUR AND THEIR ABILITIES TO ATTRACT AND RETAIN QUALIFIED TECHNICAL PERSONNEL AND QUALIFIED MANAGEMENT AND MARKETING TEAMS. FAILURE TO DO SO WOULD HARM OUR ONGOING OPERATIONS AND BUSINESS PROSPECTS. We believe that our success will depend on continued employment by us and our subsidiary companies of senior management and key technical personnel. Our subsidiary companies will need to attract, retain and motivate qualified management personnel to execute their current business plans and to successfully develop commercially viable products and services. Competition for qualified personnel is intense and we cannot assure you that we will successfully retain our existing key employees or attract and retain any additional personnel we may require. Each of our subsidiary companies has key executives upon whom we significantly depend, and the success of those subsidiary companies depends on their ability to retain and motivate those individuals. BECAUSE WE HAVE A LIMITED OPERATING HISTORY, WE CANNOT ASSURE THAT OUR OPERATIONS WILL BE PROFITABLE. We commenced operations in 1993 and, accordingly, have a limited operating history. In addition, certain of our subsidiary companies are in the early stages of development and or operations and have limited operating histories. You should consider our prospects in light of the risks, expenses and difficulties frequently encountered by companies with such limited operating histories. Since we have a limited operating history, we cannot assure you that our operations will be profitable or that we will generate sufficient revenues to meet our expenditures and support our activities. 45 During the three months ended March 31, 2003 and the fiscal year ended December 31, 2002, we had operating losses of approximately $7.0 million and $80.3 million, respectively, and net losses of approximately $6.7 million and $59.0 million, respectively. If we continue to incur operating losses, we may not have enough money to expand our business and our subsidiary companies' businesses in the future. THE AVAILABILITY OF SHARES FOR SALE IN THE FUTURE COULD REDUCE THE MARKET PRICE OF OUR COMMON STOCK. In the future, we may issue securities to raise cash for acquisitions. We may also pay for interests in additional subsidiary companies by using a combination of cash and our common stock or just our common stock. We may also issue securities convertible into our common stock. Any of these events may dilute your ownership interest in us and have an adverse impact on the price of our common stock. In addition, sales of a substantial amount of our common stock in the public market, or the perception that these sales may occur, could reduce the market price of our common stock. This could also impair our ability to raise additional capital through the sale of our securities. DELAWARE LAW AND OUR CHARTER DOCUMENTS CONTAIN PROVISIONS THAT COULD DISCOURAGE OR PREVENT A POTENTIAL TAKEOVER OF ACACIA RESEARCH CORPORATION THAT MIGHT OTHERWISE RESULT IN OUR STOCKHOLDERS RECEIVING A PREMIUM OVER THE MARKET PRICE OF THEIR SHARES. Provisions of Delaware law and our certificate of incorporation and bylaws could make more difficult the acquisition of Acacia Research Corporation by means of a tender offer, proxy contest or otherwise, and the removal of incumbent officers and directors. These provisions include: o Section 203 of the Delaware General Corporation Law, which prohibits a merger with a 15%-or-greater stockholder, such as a party that has completed a successful tender offer, until three years after that party became a 15%-or-greater stockholder; o amendment of our bylaws by the stockholders requires a two-thirds approval of the outstanding shares; o the authorization in our certificate of incorporation of undesignated preferred stock, which could be issued without stockholder approval in a manner designed to prevent or discourage a takeover; o provisions in our bylaws eliminating stockholders' rights to call a special meeting of stockholders, which could make it more difficult for stockholders to wage a proxy contest for control of our board of directors or to vote to repeal any of the anti-takeover provisions contained in our certificate of incorporation and bylaws; and o the division of our board of directors into three classes with staggered terms for each class, which could make it more difficult for an outsider to gain control of our board of directors. Such potential obstacles to a takeover could adversely affect the ability of our stockholders to receive a premium price for their stock in the event another company wants to acquire us. WE ARE AT RISK OF SECURITIES CLASS ACTION LITIGATION DUE TO STOCK PRICE VOLATILITY. In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. Due to the potential volatility of our stock price, we may be the target of such litigation in the future. Securities litigation could result in substantial costs and divert management's attention and resources, which could seriously harm our business, financial condition and results of operations. RISKS RELATING TO A CAPITAL STRUCTURE WITH TWO SEPARATE CLASSES OF COMMON STOCK HOLDERS OF BOTH CLASSES OF STOCK ARE STOCKHOLDERS OF ONE COMPANY, AND THE FINANCIAL PERFORMANCE OF ONE GROUP COULD AFFECT THE OTHER, THUS EXPOSING THE HOLDERS OF EACH GROUP'S STOCK TO THE RISKS OF AN INVESTMENT IN THE ENTIRE COMPANY. Holders of AR-CombiMatrix stock and AR-Acacia Technologies stock are stockholders of a single company, Acacia Research Corporation. The CombiMatrix group and the Acacia Technologies group are not separate legal entities. As a result, stockholders will continue to be subject to all of the risks of an investment in Acacia Research Corporation and all of our businesses, assets and liabilities. The issuance of the AR-CombiMatrix stock and the AR-Acacia Technologies stock and the allocation of assets and liabilities and stockholders' equity between the CombiMatrix group and the Acacia Technologies group did not result in a distribution or spin-off to stockholders of any of our 46 assets or liabilities and did not affect ownership of our assets or responsibility for our liabilities or those of our subsidiaries. The assets we attribute to one group could be subject to the liabilities of the other group, whether such liabilities arise from lawsuits, contracts or indebtedness that we attribute to the other group. If we are unable to satisfy one group's liabilities out of the assets we attribute to it, we may be required to satisfy those liabilities with assets we have attributed to the other group. Financial effects from one group that affect our consolidated results of operations or financial condition could, if significant, affect the results of operations or financial condition of the other group and the market price of the common stock relating to the other group. In addition, net losses of either group and dividends or distributions on, or repurchases of, either class of common stock will reduce the funds we can pay as dividends on each class of common stock under Delaware law. For these reasons, you should read our consolidated financial information with the financial information we provide for each group. THE HOLDERS OF AR-COMBIMATRIX STOCK AND THE HOLDERS OF AR-ACACIA TECHNOLOGIES STOCK HAVE ONLY LIMITED SEPARATE STOCKHOLDER RIGHTS. Holders of AR-CombiMatrix stock and AR-Acacia Technologies stock have the rights customarily held by common stockholders. They also have these specific rights related to their corresponding group: o certain rights with regard to dividends and liquidation; o requirements for a mandatory dividend, redemption or conversion upon the disposition of all or substantially all of the assets of their corresponding group; and o a right to vote on matters as a separate voting class in the limited circumstances provided under Delaware law, by stock exchange rules or as determined by our board of directors (such as an amendment of our certificate of incorporation that changes the rights, privileges or preferences of the class of stock held by such stockholder). We will not hold separate stockholder meetings for holders of AR-CombiMatrix stock and AR-Acacia Technologies stock. THE HOLDERS OF AR-COMBIMATRIX STOCK AND THE HOLDERS OF AR-ACACIA TECHNOLOGIES STOCK WILL HAVE CERTAIN LIMITS ON THEIR RESPECTIVE VOTING POWERS. GROUP COMMON STOCK WITH A MAJORITY OF VOTING POWER CAN CONTROL VOTING OUTCOMES. The holders of AR-CombiMatrix stock and AR-Acacia Technologies stock will vote together as a single class, except in limited circumstances. If a separate vote on a matter by the holders of either the AR-CombiMatrix stock or the AR-Acacia Technologies stock is not required under Delaware law or by stock exchange rules, and if our board of directors does not require a separate vote, either class of common stock that is entitled to more than the number of votes required to approve such matter could control the outcome of such vote - even if the matter involves a divergence or conflict of the interests between the holders of the AR-CombiMatrix stock and the AR-Acacia Technologies stock. In addition, if the holders of common stock having a majority of the voting power of all shares of common stock outstanding approve a merger, the terms of which did not require separate class voting under stock exchange rules, then the merger could be consummated -- even if the holders of a majority of either class of common stock were to vote against the merger. GROUP COMMON STOCK WITH LESS THAN MAJORITY VOTING POWER CAN BLOCK ACTION IF A CLASS VOTE IS REQUIRED. If Delaware law, stock exchange rules or our board of directors requires a separate vote on a matter by the holders of either the AR-CombiMatrix stock or the AR-Acacia Technologies stock, such as a proposal to amend the terms of one class of stock, those holders could prevent approval of the matter, even if the holders of a majority of the total number of votes cast or entitled to be cast, voting together as a class, were to vote in favor of it. HOLDERS OF ONLY ONE CLASS OF COMMON STOCK CANNOT ENSURE THAT THEIR VOTING POWER WILL BE SUFFICIENT TO PROTECT THEIR INTERESTS. Since the relative voting power per share of AR-CombiMatrix stock and AR-Acacia Technologies stock will fluctuate based on the market values of the two classes of common stock, the relative voting power of a class of common stock could decrease. As a result, holders of shares of only one of the two classes of common stock cannot ensure that their voting power will be sufficient to protect their interests. 47 OUR RESTATED CERTIFICATE OF INCORPORATION MAY BE AMENDED TO INCREASE OR DECREASE THE AUTHORIZED SHARES OF EITHER CLASS OF COMMON STOCK WITHOUT THE APPROVAL OF EACH CLASS VOTING SEPARATELY. Our restated certificate of incorporation provides that an amendment to the restated certificate to increase or decrease the number of authorized shares of either class of common stock will require the approval of the holders of a majority of the voting power of all shares of common stock, voting together as a single class, and will not require the approval of each class of stock voting as a separate class. Accordingly, if the holders of one class of common stock hold a majority of the voting power of all shares of common stock, then that majority could approve an amendment to the restated articles to increase or decrease the authorized shares of stock of either class without the approval of the holders of the minority class of stock. STOCKHOLDERS MAY NOT HAVE ANY REMEDIES FOR BREACH OF FIDUCIARY DUTIES IF ANY ACTION BY OUR DIRECTORS OR OFFICERS HAS A DISADVANTAGEOUS EFFECT ON EITHER CLASS OF COMMON STOCK. Stockholders may not have any remedies if any action or decision of our directors and officers has a disadvantageous effect on either class of common stock compared to the other class of common stock. We are not aware of any legal precedent under Delaware law involving the fiduciary duties of directors and officers of corporations having two classes of common stock, or separate classes or series of capital stock, the rights of which, like the AR-CombiMatrix stock and AR-Acacia Technologies stock, are defined by reference to separate businesses of the corporation. Principles of Delaware law established in cases involving differing treatment of two classes of capital stock or two groups of holders of the same class of capital stock provide that a board of directors owes an equal duty to all stockholders regardless of class or series. Under these principles of Delaware law and the related principle known as the "business judgment rule," absent abuse of discretion, a good faith business decision made by a disinterested and adequately informed board of directors, board of directors' committee or officer with respect to any matter having different effects on holders of AR-CombiMatrix stock and holders of AR-Acacia Technologies stock would be a defense to any challenge to such determination made by or on behalf of the holders of either class of common stock. As of March 21, 2003, our executive officers, directors and their affiliates beneficially owned approximately 8.0% of the outstanding AR-CombiMatrix stock and 13.0% of the outstanding AR-Acacia Technologies stock. NUMEROUS POTENTIAL CONFLICTS OF INTERESTS EXIST BETWEEN THE AR-COMBIMATRIX STOCK AND THE AR-ACACIA TECHNOLOGIES STOCK WHICH MAY BE DIFFICULT TO RESOLVE BY OUR BOARD OR WHICH MAY BE RESOLVED ADVERSELY TO ONE OF THE CLASSES. The existence of separate classes of common stock could give rise to occasions when the interests of the holders of AR-CombiMatrix stock and AR-Acacia Technologies stock diverge or conflict. Examples include determinations by our directors or officers to: o pay or omit the payment of dividends on AR-CombiMatrix stock or AR-Acacia Technologies stock; o allocate consideration to be received by holders of each of the classes of common stock in connection with a merger or consolidation involving Acacia Research Corporation; o convert one class of common stock into shares of the other; o approve certain dispositions of the assets of either group; o allocate the proceeds of future issuances of our stock either to the Acacia Technologies group or the CombiMatrix group; o allocate corporate opportunities between the groups; and o make other operational and financial decisions with respect to one group that could be considered detrimental to the other group. When making decisions with regard to matters that create potential diverging or conflicting interests, our directors and officers will act in accordance with their fiduciary duties, the terms of the restated certificate of incorporation, and, to the extent applicable, the management and allocation policies described herein. 48 THE PERFORMANCE OF ONE GROUP OR THE DIVIDENDS PAID TO ONE GROUP MAY ADVERSELY AFFECT THE DIVIDENDS AVAILABLE FOR THE OTHER GROUP. Our board of directors currently has no intention to pay dividends on the AR-CombiMatrix stock or the AR-Acacia Technologies stock. Determinations as to future dividends on the AR-CombiMatrix stock and the AR-Acacia Technologies stock will be based primarily on the financial condition, results of operations and business requirements of the relevant group and Acacia Research Corporation as a whole. Subject to the limitations referred to below, our board of directors has the authority to declare and pay dividends on the AR-CombiMatrix stock and the AR-Acacia Technologies stock in any amount and could, in its sole discretion, declare and pay dividends exclusively on the AR-CombiMatrix stock, exclusively on the AR-Acacia Technologies stock, or on both, in equal or unequal amounts. Our board of directors will not be required to consider the amount of dividends previously declared on each class, the respective voting or liquidation rights of each class or any other factor. The performance of one group may cause our board of directors to pay more or less dividends on the common stock relating to the other group than if that other group was a stand-alone company. In addition, Delaware law and the new certificate of incorporation impose limitations on the amount of dividends which may be paid on each class of common stock. PROCEEDS OF MERGERS OR CONSOLIDATIONS MAY BE ALLOCATED UNFAVORABLY. Our restated certificate of incorporation does not contain any provisions governing how consideration to be received by holders of common stock in connection with a merger or consolidation involving Acacia Research Corporation is to be allocated among holders of each class of common stock. Our board of directors will determine the percentage of the consideration to be allocated to holders of each class of common stock in any such transaction. Such percentage may be materially more or less than that which might have been allocated to such holders had our board of directors chosen a different method of allocation. HOLDERS OF EITHER CLASS OF COMMON STOCK MAY BE ADVERSELY AFFECTED BY A CONVERSION OF GROUP COMMON STOCK. Our board of directors could, in its sole discretion and without stockholder approval, determine to convert shares of AR-Acacia Technologies stock into shares of AR-CombiMatrix stock, or vice versa, at a time when either or both classes of common stock may be considered to be overvalued or undervalued. Any such conversion would dilute the interests in Acacia Research Corporation of the holders of the class of common stock being issued in the conversion. It could also give holders of shares of the class of common stock converted a greater or lesser premium than any premium that might be paid by a third-party buyer of all or substantially all of the assets of the group whose stock is converted. HOLDERS OF EITHER CLASS OF COMMON STOCK COULD BE ADVERSELY AFFECTED BY A DISPOSITION OF THE ASSETS ALLOCATED TO THEIR RESPECTIVE GROUPS. Our board of directors could, in its sole discretion and without stockholder approval, determine to dispose of all or substantially all the assets of a group. If a disposition of group assets occurs at a time when those assets are considered undervalued, then holders of that group's stock would receive less consideration than they could have received had the assets been disposed of at a time when they had a higher value. PROCEEDS OF FUTURE ISSUANCES OF OUR STOCK COULD BE ALLOCATED UNFAVORABLY. We may in the future issue a new class of stock, such as a class of preferred stock, or additional shares of AR-CombiMatrix stock or AR-Acacia Technologies stock. Proceeds from any future issuance of any class of stock would be allocated among the CombiMatrix or the Acacia Technologies group as determined by our board of directors. There is no requirement that the proceeds from an issuance of AR-CombiMatrix stock or AR-Acacia Technologies stock be allocated to the corresponding group. Such allocations might be materially more or less for the respective groups than what might have been allocated had our board of directors chosen a different allocation method. Also, any designated preferred class may be designed to reflect the performance of Acacia Research Corporation as a whole, rather than the performance of the CombiMatrix group or the Acacia Technologies group. 49 ALLOCATION OF CORPORATE OPPORTUNITIES COULD FAVOR ONE GROUP OVER ANOTHER. Our board of directors may be required to allocate corporate opportunities between the groups. In some cases, our directors could determine that a corporate opportunity, such as a business that we are acquiring, should be shared by the groups. Any such decisions could favor one group at the expense of the other. OTHER OPERATIONAL AND FINANCIAL DECISIONS WHICH MAY FAVOR ONE GROUP OVER THE OTHER. Our board of directors or our senior officers will review other operational and financial matters affecting the CombiMatrix group and the Acacia Technologies group, including the allocation of financing resources and capital, technology and know-how and corporate overhead, taxes, debt, interest and other matters. Any decision of our board of directors or our senior officers in these matters could favor one group at the expense of the other. OUR BOARD OF DIRECTORS MAY CHANGE OUR MANAGEMENT AND ALLOCATION POLICIES WITHOUT STOCKHOLDER APPROVAL TO THE DETRIMENT OF EITHER GROUP. Our board of directors may modify or rescind our policies with respect to the allocation of corporate overhead, taxes, debt, interest and other matters, or may adopt additional policies, in its sole discretion without stockholder approval. However, our board of directors has no present intention to do so. A decision to modify or rescind these policies, or adopt additional policies could have different effects on holders of either class of common stock or could result in a benefit or detriment to one class of stockholders compared to the other class. Our board of directors will make any such decision in accordance with its good faith business judgment that the decision is in the best interests of Acacia Research Corporation and all of our stockholders as a whole. EITHER GROUP MAY FINANCE THE OTHER GROUP ON TERMS UNFAVORABLE TO ONE OF THE GROUPS. We may transfer cash and other property between groups to finance their business activities. The group providing the financing will be subject to the risks relating to the group receiving the financing. We will account for those transfers generally as a short-term or long-term loan between groups or as a repayment of a previous borrowing. THERE ARE LIMITS ON THE CONSIDERATION WHICH MAY BE RECEIVED BY THE STOCKHOLDERS IN THE EVENT OF THE DISPOSITION OF ASSETS OF A GROUP. Our restated certificate of incorporation provides that if a disposition of all or substantially all of the properties and assets of either group occurs, we must, subject to certain exceptions: o distribute through a dividend or redemption to holders of the class of common stock relating to such group an amount equal to the net proceeds of such disposition; or o convert at a 10% premium such common stock into shares of the class of common stock relating to the other group. If the group subject to the disposition were a separate, independent company and its shares were acquired by another person, certain costs of that disposition, including corporate level taxes, might not be payable in connection with that acquisition. As a result, stockholders of the separate, independent company might receive a greater amount than the net proceeds that would be received by holders of the class of common stock relating to that group if the assets of such group were sold. In addition, we cannot assure you that the net proceeds per share of the common stock relating to that group will be equal to or more than the market value per share of such common stock prior to or after announcement of a disposition. The term "substantially all of the properties and assets" of a group is subject to potentially conflicting interpretations. Resolution of such a dispute could adversely impact the holders of either the class of common stock related to the assets being disposed or the holders of the other class because the consideration, if any, to be received by the holders of the class related to the disposed assets may depend on whether the disposition involved "substantially all" of the properties and assets of that class. HOLDERS OF EITHER CLASS OF COMMON STOCK MAY BE ADVERSELY AFFECTED BY A REDEMPTION OF THEIR COMMON STOCK. We are entitled to redeem the outstanding common stock relating to a group when all or substantially all of that group's assets are sold. We can 50 redeem the assets for cash, securities, a combination of cash and securities or other property at fair value. A disposition-related redemption could occur when the assets being disposed of are considered undervalued. If that is the case, the holders of our common stock related to that group would receive less consideration for their shares than they may deem reasonable. We can also redeem on a pro rata basis all of the outstanding shares of a group's common stock for shares of the common stock of one or more of our wholly owned subsidiaries. If this were to occur, the holders of the redeemed class of common stock would no longer have stockholder voting rights in Acacia Research Corporation or any other benefits to be derived from holding a class of stock in Acacia Research Corporation. In addition, if the outstanding shares of a class of our common stock are redeemed for shares that are not publicly traded, the holders of such redeemed stock will no longer be able to publicly trade their shares and accordingly their investment will be substantially less liquid. OUR CAPITAL STRUCTURE AND THE VARIABLE VOTE PER SHARE COULD ENABLE A POTENTIAL ACQUIRER TO TAKE CONTROL OF ACACIA RESEARCH CORPORATION THROUGH THE ACQUISITION OF ONLY ONE OF THE CLASSES OF OUR COMMON STOCK. A potential acquirer could acquire control of Acacia Research Corporation by acquiring shares of common stock having a majority of the voting power of all shares of common stock outstanding. Such a majority could be obtained by acquiring a sufficient number of shares of both classes of common stock or, if one class of common stock has a majority of such voting power, only shares of that class. Currently, the AR-CombiMatrix stock has a majority of the voting power. As a result, currently, it might be possible for an acquiror to obtain control of Acacia Research Corporation by purchasing only shares of AR-CombiMatrix stock. DECISIONS BY DIRECTORS AND OFFICERS THAT AFFECT DIFFERENTLY ONE CLASS OF OUR COMMON STOCK COMPARED TO THE OTHER COULD ADVERSELY AFFECT THE MARKET VALUE OF EITHER OR BOTH OF THE CLASSES OF OUR COMMON STOCK. The relative voting power per share of the AR-CombiMatrix stock and the AR-Acacia Technologies stock and the number of shares of one class of common stock issuable upon the conversion of the other class of common stock will vary depending upon the relative market values of the AR-CombiMatrix stock and the AR-Acacia Technologies stock. The market value of either or both classes of common stock could be affected by market reaction to decisions by our board of directors or our management that investors perceive to affect differently one class of common stock compared to the other. These decisions could involve changes to our management and allocation policies, allocations of corporate opportunities and financing resources between groups, and changes in dividend policies. INVESTORS MAY NOT VALUE THE AR-COMBIMATRIX STOCK AND THE AR-ACACIA TECHNOLOGIES STOCK BASED ON GROUP FINANCIAL INFORMATION AND POLICIES. We cannot assure you that investors will value the AR-CombiMatrix stock and the AR-Acacia Technologies stock based on the reported financial results and prospects of the separate groups or the dividend policies established by our board of directors with respect to those groups. Holders of AR-CombiMatrix stock and AR-Acacia Technologies stock will continue to be common stockholders of Acacia Research Corporation subject to all the risks associated with an investment in Acacia Research Corporation as a whole. Additionally, the separate stockholder rights related to each group are limited and relate to events that may never occur, such as dividend and liquidation rights and the disposition of all or substantially all of the assets of a group. Accordingly, investors may discount the value of AR-CombiMatrix stock and AR-Acacia Technologies stock because both groups are part of a common enterprise rather than a stand-alone entity and each class of stock has limited separate stockholder rights. HOLDERS OF AR-COMBIMATRIX STOCK AND AR-ACACIA TECHNOLOGIES STOCK MAY NOT RECEIVE A PREMIUM FROM AN INVESTOR ACQUIRING CONTROL OF THEIR RESPECTIVE CLASSES OF STOCK. Control of AR-CombiMatrix stock or AR-Acacia Technologies stock may not provide control of Acacia Research Corporation as a whole. Accordingly, unlike many acquisition transactions, holders of AR-CombiMatrix stock and AR-Technologies stock may not receive a controlling interest premium from an investor acquiring control of their respective classes of stock. THERE ARE CERTAIN PROVISIONS IN OUR TWO-CLASS CAPITAL STRUCTURE THAT COULD HAVE ANTITAKEOVER EFFECTS. The existence of the two classes of common stock could, under certain circumstances, prevent stockholders from profiting from an increase in the market value of their shares as a result of a change in control of Acacia Research Corporation by delaying or preventing such change in control. The existence of two classes of common stock could present complexities and could, 51 in certain circumstances, pose obstacles, financial and otherwise, to an acquiring person. We could, in the sole discretion of our board of directors and without stockholder approval, exercise the right to convert the shares of one class of common stock into shares of the other at a 10% premium over their respective average market values. This conversion could result in additional dilution to persons seeking control of Acacia Research Corporation. Our board of directors could issue shares of preferred stock or common stock that could be used to create voting or other impediments to discourage persons seeking to gain control of Acacia Research Corporation, and preferred stock could also be privately placed with purchasers favorable to our board of directors in opposing such action. RISKS RELATING TO THE COMBIMATRIX GROUP The risk factors beginning on this page discuss risks relating to the CombiMatrix group. Because each holder of AR-CombiMatrix stock is a holder of the common stock of one company, Acacia Research Corporation, the risks associated with the Acacia Technologies group could affect the AR-CombiMatrix stock. As such, we also urge you to read carefully the section "Risks Relating to the Acacia Technologies Group" beginning on page 57. THE COMBIMATRIX GROUP HAS A HISTORY OF LOSSES AND EXPECTS TO INCUR ADDITIONAL LOSSES IN THE FUTURE. The CombiMatrix group has sustained substantial losses since its inception. The CombiMatrix group may never become profitable or if it does, it may never be able to sustain profitability. We expect the CombiMatrix group to incur significant research and development, marketing, general and administrative expenses. As a result, we expect the CombiMatrix group to incur significant losses for the foreseeable future. THE COMBIMATRIX GROUP MAY FAIL TO MEET MARKET EXPECTATIONS BECAUSE OF FLUCTUATIONS IN ITS QUARTERLY OPERATING RESULTS, WHICH COULD CAUSE ITS STOCK PRICE TO DECLINE. The CombiMatrix group's revenues and operating results have fluctuated in the past and may continue to fluctuate significantly from quarter to quarter in the future. It is possible that in future periods the CombiMatrix group's revenues could fall below the expectations of securities analysts or investors, which could cause the market price of the AR-CombiMatrix stock to decline. The following are among the factors that could cause the CombiMatrix group's operating results to fluctuate significantly from period to period: o its unpredictable revenue sources, as described below; o the nature, pricing and timing of the CombiMatrix group's and its competitors' products; o changes in the CombiMatrix group's and its competitors' research and development budgets; o expenses related to, and the CombiMatrix group's ability to comply with, governmental regulations of its products and processes; and o expenses related to, and the results of, patent filings and other proceedings relating to intellectual property rights. The CombiMatrix group anticipates significant fixed expenses due in part to its need to continue to invest in product development. It may be unable to adjust its expenditures if revenues in a particular period fail to meet its expectations, which would harm its operating results for that period. As a result of these fluctuations, the CombiMatrix group believes that period-to-period comparisons of the CombiMatrix group's financial results will not necessarily be meaningful, and you should not rely on these comparisons as an indication of its future performance. THE COMBIMATRIX GROUP'S REVENUES WILL BE UNPREDICTABLE, AND THIS MAY HARM ITS FINANCIAL CONDITION. The amount and timing of revenues that the CombiMatrix group may realize from its business will be unpredictable because: o whether products are commercialized and generate revenues depends, in part, on the efforts and timing of its potential customers; o its sales cycles may be lengthy; and 52 o it cannot be sure as to the timing of receipt of payment for its products. As a result, the CombiMatrix group's revenues may vary significantly from quarter to quarter, which could make its business difficult to manage and cause its quarterly results to be below market expectations. If this happens, the price of the CombiMatrix group's common stock may decline significantly. TECHNOLOGY COMPANY STOCK PRICES ARE ESPECIALLY VOLATILE, AND THIS VOLATILITY MAY DEPRESS THE PRICE OF THE AR-COMBIMATRIX STOCK. The stock market has experienced significant price and volume fluctuations, and the market prices of technology companies, particularly biotechnology companies, has been highly volatile. We believe that various factors may cause the market price of the AR-CombiMatrix stock to fluctuate, perhaps substantially, including, among others, announcements of: o its or its competitors' technological innovations; o developments or disputes concerning patents or proprietary rights; o supply, manufacturing or distribution disruptions or other similar problems; o proposed laws regulating participants in the biotechnology industry; o developments in relationships with collaborative partners or customers; o its failure to meet or exceed securities analysts' expectations of its financial results; or o a change in financial estimates or securities analysts' recommendations. In the past, companies that have experienced volatility in the market price of their stock have been the objects of securities class action litigation. If the AR-CombiMatrix stock was the object of securities class action litigation, it could result in substantial costs and a diversion of management's attention and resources, which could materially harm the business and financial results of the CombiMatrix group. THE COMBIMATRIX GROUP IS DEPLOYING NEW AND UNPROVEN TECHNOLOGIES WHICH MAKES EVALUATION OF ITS BUSINESS AND PROSPECTS DIFFICULT AND IT MAY BE FORCED TO CEASE OPERATIONS IF IT DOES NOT DEVELOP COMMERCIALLY SUCCESSFUL PRODUCTS. The CombiMatrix group has not proven its ability to commercialize products on a large scale. In order to successfully commercialize products on a large scale, it will have to make significant investments, including investments in research and development and testing, to demonstrate their technical benefits and cost-effectiveness. Problems frequently encountered in connection with the commercialization of products using new and unproven technologies might limit its ability to develop and commercialize its products. For example, the CombiMatrix group's products may be found to be ineffective, unreliable or otherwise unsatisfactory to potential customers. The CombiMatrix group may experience unforeseen technical complications in the processes it uses to develop, manufacture, customize or receive orders for its products. These complications could materially delay or limit the use of products the CombiMatrix group attempts to commercialize, substantially increase the anticipated cost of its products or prevent it from implementing its processes at appropriate quality and scale levels, thereby causing its business to suffer. THE COMBIMATRIX GROUP MAY NEED TO RAISE ADDITIONAL CAPITAL IN THE FUTURE, AND IF ADDITIONAL CAPITAL IS NOT AVAILABLE ON ACCEPTABLE TERMS, THE COMBIMATRIX GROUP MAY HAVE TO CURTAIL OR CEASE OPERATIONS. The CombiMatrix group's future capital requirements will be substantial and will depend on many factors including how quickly it commercializes its products, the progress and scope of its collaborative and independent research and development projects, the filing, prosecution, enforcement and defense of patent claims and the need to obtain regulatory approval for certain products in the United States or elsewhere. Changes may occur that would cause the CombiMatrix group's available capital resources to be consumed significantly sooner than it expects. The CombiMatrix group may be unable to raise sufficient additional capital on favorable terms or at all. If it fails to do so, it may have to curtail or cease operations or enter into agreements requiring it to relinquish rights to certain technologies, products or markets because it will not have the capital necessary to exploit them. 53 IF THE COMBIMATRIX GROUP DOES NOT ENTER INTO SUCCESSFUL PARTNERSHIPS AND COLLABORATIONS WITH OTHER COMPANIES, IT MAY NOT BE ABLE TO FULLY DEVELOP ITS TECHNOLOGIES OR PRODUCTS, AND ITS BUSINESS WOULD BE HARMED. Since the CombiMatrix group does not possess all of the resources necessary to develop and commercialize products that may result from its technologies on a mass scale, it will need either to grow its sales, marketing and support group or make appropriate arrangements with strategic partners to market, sell and support its products. The CombiMatrix group believes that it will have to enter into additional strategic partnerships to develop and commercialize future products. If it does not enter into adequate agreements, or if its existing arrangements or future agreements are not successful, its ability to develop and commercialize products will be impacted negatively, and its revenues will be adversely affected. The current business of the CombiMatrix group is substantially dependent on its existing arrangement with Roche. The CombiMatrix group currently relies upon payments by Roche for a majority of its future revenues and expends a majority of its resources toward fulfilling its contractual obligations to Roche. Roche's primary service to the CombiMatrix group is to distribute and proliferate its technology platform. If the CombiMatrix group were to lose its relationship with Roche, the CombiMatrix group would be required to establish a distribution agreement with another partner or distribute its technology platform itself. This could prove difficult, time-consuming and expensive, and the CombiMatrix group may not be successful in achieving this objective. THE COMBIMATRIX GROUP HAS LIMITED EXPERIENCE COMMERCIALLY MANUFACTURING, MARKETING OR SELLING ANY OF ITS POTENTIAL PRODUCTS, AND UNLESS IT DEVELOPS THESE CAPABILITIES, IT MAY NOT BE SUCCESSFUL. Even if the CombiMatrix group is able to develop its products for commercial release on a large-scale, it has limited experience in manufacturing its products in the volumes that will be necessary for it to achieve commercial sales and in marketing or selling its products to potential customers. We cannot assure you that the CombiMatrix group will be able to commercially produce its products on a timely basis, in sufficient quantities or on commercially reasonable terms. THE COMBIMATRIX GROUP FACES INTENSE COMPETITION AND WE CANNOT ASSURE YOU THAT IT WILL BE SUCCESSFUL. The CombiMatrix group expects to compete with companies that design, manufacture and market instruments for analysis of genetic variation and function and other applications using established sequential and parallel testing technologies. The CombiMatrix group is also aware of other biotechnology companies that have or are developing testing technologies for the SNP genotyping, gene expression profiling and proteomic markets. The CombiMatrix group anticipates that it will face increased competition in the future as new companies enter the market with new technologies and its competitors improve their current products. The markets for the CombiMatrix group's products are characterized by rapidly changing technology, evolving industry standards, changes in customer needs, emerging competition and new product introductions. One or more of the CombiMatrix group's competitors may offer technology superior to those of the CombiMatrix group and render its technology obsolete or uneconomical. Many of its competitors have greater financial and personnel resources and more experience in marketing, sales and research and development than it has. Some of its competitors currently offer arrays with greater density than it does and have rights to intellectual property, such as genomic information or proprietary technology, which provides them with a competitive advantage. If the CombiMatrix group is not able to compete successfully, its business and financial condition would be materially harmed. IF THE COMBIMATRIX GROUP'S NEW AND UNPROVEN TECHNOLOGY IS NOT USED BY RESEARCHERS IN THE PHARMACEUTICAL, BIOTECHNOLOGY AND ACADEMIC COMMUNITIES, ITS BUSINESS WILL SUFFER. The CombiMatrix group's products may not gain market acceptance. In that event, it is unlikely that its business will succeed. Biotechnology and pharmaceutical companies and academic research centers have historically analyzed genetic variation and function using a variety of technologies, and many of them have made significant capital investments in existing technologies. Compared to existing technologies, the CombiMatrix group's technologies are new and unproven. In order to be successful, its products must meet the commercial requirements of the biotechnology, pharmaceutical and academic communities as tools for the large-scale analysis of genetic variation and function. Market acceptance will depend on many factors, including: o the development of a market for its tools for the analysis of genetic variation and function, the study of proteins and other purposes; o the benefits and cost-effectiveness of its products relative to others available in the market; 54 o its ability to manufacture products in sufficient quantities with acceptable quality and reliability and at an acceptable cost; o its ability to develop and market additional products and enhancements to existing products that are responsive to the changing needs of its customers; o the willingness and ability of customers to adopt new technologies requiring capital investments or the reluctance of customers to change technologies in which they have made a significant investment; and o the willingness of customers to transmit test data and permit the CombiMatrix group to transmit test results over the Internet, which will be a necessary component of its product and services packages unless customers purchase or license its equipment for use in their own facilities. IF THE MARKET FOR ANALYSIS OF GENOMIC INFORMATION DOES NOT DEVELOP OR IF GENOMIC INFORMATION IS NOT AVAILABLE TO THE COMBIMATRIX GROUP'S POTENTIAL CUSTOMERS, ITS BUSINESS WILL NOT SUCCEED. The CombiMatrix group is designing its technology primarily for applications in the biotechnology, pharmaceutical and academic communities. The usefulness of the CombiMatrix group's technology depends in part upon the availability of genomic data. The CombiMatrix group is initially focusing on markets for analysis of genetic variation and function, namely SNP genotyping and gene expression profiling. These markets are new and emerging, and they may not develop as the CombiMatrix group anticipates, or at all. Also, researchers may not seek or be able to convert raw genomic data into medically valuable information through the analysis of genetic variation and function. If genomic data is not available for use by the CombiMatrix group's customers or if its target markets do not emerge in a timely manner, or at all, demand for its products will not develop as it expects, and it may never become profitable. THE COMBIMATRIX GROUP'S FUTURE SUCCESS DEPENDS ON THE CONTINUED SERVICE OF ITS ENGINEERING, TECHNICAL AND KEY MANAGEMENT PERSONNEL AND ITS ABILITY TO IDENTIFY, HIRE AND RETAIN ADDITIONAL ENGINEERING, TECHNICAL AND KEY MANAGEMENT PERSONNEL. There is intense competition for qualified personnel in the CombiMatrix group's industry, particularly for engineers and senior level management. Loss of the services of, or failure to recruit, engineers or other technical and key management personnel could be significantly detrimental to the group and could adversely affect its business and operating results. The CombiMatrix group may not be able to continue to attract and retain engineers or other qualified personnel necessary for the development of its products and business or to replace engineers or other qualified personnel who may leave the group in the future. The CombiMatrix group's anticipated growth is expected to place increased demands on its resources and likely will require the addition of new management personnel. THE EXPANSION OF THE COMBIMATRIX GROUP'S PRODUCT LINES MAY SUBJECT IT TO REGULATION BY THE UNITED STATES FOOD AND DRUG ADMINISTRATION AND FOREIGN REGULATORY AUTHORITIES, WHICH COULD PREVENT OR DELAY ITS INTRODUCTION OF NEW PRODUCTS. If the CombiMatrix group manufactures, markets or sells any products for any regulated clinical or diagnostic applications, those products will be subject to extensive governmental regulation as medical devices in the United States by the FDA and in other countries by corresponding foreign regulatory authorities. The process of obtaining and maintaining required regulatory clearances and approvals is lengthy, expensive and uncertain. Products that CombiMatrix Corporation manufactures, markets or sells for research purposes only are not subject to governmental regulations as medical devices or as analyte specific reagents to aid in disease diagnosis. We believe that the CombiMatrix group's success will depend upon commercial sales of improved versions of products, certain of which cannot be marketed in the United States and other regulated markets unless and until the CombiMatrix group obtains clearance or approval from the FDA and its foreign counterparts, as the case may be. Delays or failures in receiving these approvals may limit our ability to benefit from new CombiMatrix group products. AS THE COMBIMATRIX GROUP'S OPERATIONS EXPAND, ITS COSTS TO COMPLY WITH ENVIRONMENTAL LAWS AND REGULATIONS WILL INCREASE, AND FAILURE TO COMPLY WITH THESE LAWS AND REGULATIONS COULD HARM ITS FINANCIAL RESULTS. The CombiMatrix group's operations involve the use, transportation, storage and disposal of hazardous substances, and as a result it is subject to environmental and health and safety laws and regulations. As the CombiMatrix group expands its operations, its use of hazardous substances will increase and lead to additional and more stringent requirements. The cost to comply with 55 these and any future environmental and health and safety regulations could be substantial. In addition, the CombiMatrix group's failure to comply with laws and regulations, and any releases of hazardous substances into the environment or at its disposal sites, could expose the CombiMatrix group to substantial liability in the form of fines, penalties, remediation costs and other damages, or could lead to a curtailment or shut down of its operations. These types of events, if they occur, would adversely impact the group's financial results. THE COMBIMATRIX GROUP'S BUSINESS DEPENDS ON ISSUED AND PENDING PATENTS, AND THE LOSS OF ANY PATENTS OR THE GROUP'S FAILURE TO SECURE THE ISSUANCE OF PATENTS COVERING ELEMENTS OF ITS BUSINESS PROCESSES WOULD MATERIALLY HARM ITS BUSINESS AND FINANCIAL CONDITION. The CombiMatrix group's success depends on its ability to protect and exploit its intellectual property. The CombiMatrix group currently has two patents issued in the United States, one patent issued in Europe and more than 44 patent applications pending in the United States, Europe and elsewhere. The patent application process before the Unites States Patent and Trademark Office and other similar agencies in other countries is initially confidential in nature. Patents that are filed outside the United States, however, are published approximately eighteen months after filing. The CombiMatrix group cannot determine in a timely manner whether patent applications covering technology that competes with its technology have been filed in the United States or other foreign countries or which, if any, will ultimately issue or be granted as enforceable patents. Some of the CombiMatrix group's patent applications may claim compositions, methods or uses that may also be claimed in patent applications filed by others. In some or all of these applications, a determination of priority of inventorship may need to be decided in a proceeding before the United States Patent and Trademark Office or a foreign regulatory body or a court. If the CombiMatrix group is unsuccessful in these proceedings, it could be blocked from further developing, commercializing or selling products. Regardless of the ultimate outcome, this process is time-consuming and expensive. ANY INABILITY TO ADEQUATELY PROTECT THE COMBIMATRIX GROUP'S PROPRIETARY TECHNOLOGIES COULD MATERIALLY HARM THE COMBIMATRIX GROUP'S COMPETITIVE POSITION AND FINANCIAL RESULTS. If the CombiMatrix group does not protect its intellectual property adequately, competitors may be able to use its technologies and erode any competitive advantage that it may have. The laws of some foreign countries do not protect proprietary rights to the same extent as the laws of the United States, and many companies have encountered significant problems in protecting their proprietary rights abroad. These problems can be caused by the absence of rules and methods for defending intellectual property rights. The patent positions of companies developing tools for the biotechnology, pharmaceutical and academic communities, including the CombiMatrix group's patent position, generally are uncertain and involve complex legal and factual questions. The CombiMatrix group will be able to protect its proprietary rights from unauthorized use by third parties only to the extent that its proprietary technologies are covered by valid and enforceable patents or are effectively maintained as trade secrets. The CombiMatrix group's existing patents and any future issued or granted patents it obtains may not be sufficiently broad in scope to prevent others from practicing its technologies or from developing competing products. There also is a risk that others may independently develop similar or alternative technologies or designs around the CombiMatrix group's patented technologies. In addition, others may oppose or invalidate its patents, or its patents may fail to provide it with any competitive advantage. Enforcing the CombiMatrix group's intellectual property rights may be difficult, costly and time-consuming and ultimately may not be successful. The CombiMatrix group also relies upon trade secret protection for its confidential and proprietary information. While it has taken security measures to protect its proprietary information, these measures may not provide adequate protection for its trade secrets or other proprietary information. The CombiMatrix group seeks to protect its proprietary information by entering into confidentiality and invention disclosure and transfer agreements with employees, collaborators and consultants. Nevertheless, employees, collaborators or consultants may still disclose its proprietary information, and the CombiMatrix group may not be able to meaningfully protect its trade secrets. In addition, others may independently develop substantially equivalent proprietary information or techniques or otherwise gain access to its trade secrets. ANY LITIGATION TO PROTECT THE COMBIMATRIX GROUP'S INTELLECTUAL PROPERTY OR ANY THIRD-PARTY CLAIMS OF INFRINGEMENT, COULD DIVERT SUBSTANTIAL TIME AND MONEY FROM THE COMBIMATRIX GROUP'S BUSINESS AND COULD SHUT DOWN SOME OF ITS OPERATIONS. The CombiMatrix group's commercial success depends in part on its non-infringement of the patents or proprietary rights of third parties. Many companies developing tools for the biotechnology and pharmaceutical industries use litigation aggressively as a strategy to protect and expand the scope of 56 their intellectual property rights. Accordingly, third parties may assert that the CombiMatrix group is employing their proprietary technology without authorization. In addition, third parties may claim that use of the CombiMatrix group's technologies infringes their current or future patents. The CombiMatrix group could incur substantial costs and the attention of its management and technical personnel could be diverted while defending ourselves against any of these claims. The CombiMatrix group may incur the same liabilities in enforcing its patents against others. The CombiMatrix group has not made any provision in its financial plans for potential intellectual property related litigation, and it may not be able to pursue litigation as aggressively as competitors with substantially greater financial resources. If parties making infringement claims against the CombiMatrix group are successful, they may be able to obtain injunctive or other equitable relief, which effectively could block the CombiMatrix group's ability to further develop, commercialize and sell products, and could result in the award of substantial damages against it. If the CombiMatrix group is unsuccessful in protecting and expanding the scope of its intellectual property rights, its competitors may be able to develop, commercialize and sell products that compete with it using similar technologies or obtain patents that could effectively block its ability to further develop, commercialize and sell its products. In the event of a successful claim of infringement against it, the CombiMatrix group may be required to pay substantial damages and either discontinue those aspects of its business involving the technology upon which it infringed or obtain one or more licenses from third parties. While the CombiMatrix group may license additional technology in the future, it may not be able to obtain these licenses at a reasonable cost, or at all. In that event, it could encounter delays in product introductions while it attempts to develop alternative methods or products, which may not be successful. Defense of any lawsuit or failure to obtain any of these licenses could prevent it from commercializing available products. RISKS RELATING TO THE ACACIA TECHNOLOGIES GROUP The risk factors beginning on this page discuss risks relating to the Acacia Technologies group. Because each holder of AR-Acacia Technologies stock is a holder of the common stock of one company, Acacia Research Corporation, and the risks associated with the CombiMatrix group could affect the AR-Acacia Technologies stock. As such, we also urge you to read carefully the section "Risks Relating to the CombiMatrix Group" beginning on page 52. THE V-CHIP TECHNOLOGY PATENT HELD BY THE ACACIA TECHNOLOGIES GROUP WILL EXPIRE IN JULY 2003, AND IF THE GROUP DOES NOT DEVELOP OTHER RECURRING SOURCES OF REVENUE, ITS FINANCIAL CONDITION WILL BE ADVERSELY IMPACTED. The Acacia Technologies group, and Acacia Research Corporation as a whole, has generated substantially all of its revenues to date from licensing the patented V-chip technology to television manufacturers. The Acacia Technologies group's patent on the V-chip technology will expire in July 2003. The Acacia Technologies group will not be able to collect royalties for televisions containing V-chip technology sold after the expiration of that patent, but it may still collect revenues from the sale of such televisions in the U.S. before that date. The Acacia Technologies group is beginning to market its digital media transmission technology and is developing other technologies and products. The eventual licensing and sale of these technologies is intended to replace the revenue currently being generated by licensing its V-chip technology. If the Acacia Technologies group does not succeed in developing such technologies or is unable to commercially license its existing and future technologies, its financial condition will be adversely impacted. THE ACACIA TECHNOLOGIES GROUP MAY FAIL TO MEET MARKET EXPECTATIONS BECAUSE OF FLUCTUATIONS IN ITS QUARTERLY OPERATING RESULTS, WHICH COULD CAUSE THE PRICE OF AR-ACACIA TECHNOLOGIES STOCK TO DECLINE. The Acacia Technologies group revenues and operating results have fluctuated in the past and may continue to fluctuate significantly from quarter to quarter in the future. It is possible that in future periods the Acacia Technologies group's revenues could fall below the expectations of securities analysts or investors, which could cause the market price of the AR-Acacia Technologies stock to decline. The following are among the factors that could cause the Acacia Technologies group's operating results to fluctuate significantly from period to period: o its unpredictable revenue sources, as described below; o costs related to acquisitions, alliances, licenses and other efforts to expand its operations; o the timing of payments under the terms of any customer or license agreements into which the Acacia Technologies group may enter; and o expenses related to, and the results of, patent filings and other proceedings relating to intellectual property rights. 57 THE ACACIA TECHNOLOGIES GROUP'S REVENUES WILL BE UNPREDICTABLE, AND THIS MAY HARM ITS FINANCIAL CONDITION. The amount and timing of revenues that the Acacia Technologies group may realize from its business will be unpredictable because: o whether the Acacia Technologies group generates revenues depends, in part, on the success of its licensing efforts; o its cycle of obtaining licensees may be lengthy; and o it cannot be sure as to the timing of receipt of payment. As a result, the Acacia Technologies group's revenues may vary significantly from quarter to quarter, which could make its business difficult to manage and cause its quarterly results to be below market expectations. If this happens, the price of the AR-Acacia Technologies stock may decline significantly. TECHNOLOGY COMPANY STOCK PRICES ARE ESPECIALLY VOLATILE, AND THIS VOLATILITY MAY DEPRESS THE PRICE OF AR-ACACIA TECHNOLOGIES STOCK. The stock market has experienced significant price and volume fluctuations, and the market prices of technology companies have been highly volatile. We believe that various factors may cause the market price of the AR-Acacia Technologies stock to fluctuate, perhaps substantially, including, among others, announcements of: o its or its competitors' technological innovations; o developments or disputes concerning patents or proprietary rights; o developments in relationships with licensees; o its failure to meet or exceed securities analysts' expectations of its financial results; or o a change in financial estimates or securities analysts' recommendations. In the past, companies that have experienced volatility in the market price of their stock have been the objects of securities class action litigation. If the AR-Acacia Technologies stock was the object of securities class action litigation, it could result in substantial costs and a diversion of management's attention and resources, which could materially harm the business and financial results of the Acacia Technologies group. THE ACACIA TECHNOLOGIES GROUP FACES INTENSE COMPETITION, AND WE CANNOT ASSURE YOU THAT IT WILL BE SUCCESSFUL. The Acacia Technologies group believes that Soundview Technologies' V-chip technology is protected by enforceable patent rights. Other companies, however, may develop competing technologies that offer better or less expensive alternatives to those offered by Soundview Technologies. Additionally, the V-chip technology patent will expire in July 2003, and the Acacia Technologies Group will not be able to collect royalties for televisions containing V-chip technology sold after that date. Furthermore, many potential competitors, including television manufacturers, have significantly greater resources than we do. Although the Acacia Technologies group believes that Acacia Media Technologies has marketing and licensing rights to enforceable patents and other intellectual property relating to video and audio on demand, the Acacia Technologies group cannot assure you that other companies will not develop competing technologies that offer better or less expensive alternatives to those offered by Acacia Media Technologies. In the event a competing technology emerges, Acacia Media Technologies would expect substantial additional competition. THE MARKETS SERVED BY THE ACACIA TECHNOLOGIES GROUP ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE, AND IF THE ACACIA TECHNOLOGIES GROUP IS UNABLE TO DEVELOP AND INTRODUCE NEW PRODUCTS, ITS REVENUES COULD STOP GROWING OR COULD DECLINE. The markets served by the Acacia Technologies group frequently undergo transitions in which products rapidly incorporate new features and performance 58 standards on an industry-wide basis. Products for communications applications, as well as for high-speed computing applications, are based on continually evolving industry standards. A significant portion of the Acacia Technologies group's revenues in recent periods has been, and is expected to continue to be, derived from sales of products based on existing transmission standards. However, the Acacia Technologies group's ability to compete in the future will depend on its ability to identify and ensure compliance with evolving industry standards. THE ACACIA TECHNOLOGIES GROUP'S SUCCESS IS BASED ON ITS ABILITY TO PROTECT ITS PROPRIETARY TECHNOLOGY AND ITS ABILITY TO DEFEND ITSELF AGAINST INFRINGEMENT CLAIMS. The success of the Acacia Technologies group relies, to varying degrees, on its proprietary rights and their protection or exclusivity. Although reasonable efforts will be taken to protect the Acacia Technologies group's proprietary rights, the complexity of international trade secret, copyright, trademark and patent law, and common law, coupled with limited resources and the demands of quick delivery of products and services to market, create risk that these efforts will prove inadequate. For example, in our pending litigation against certain television manufacturers alleging their infringement of Soundview Technologies' V-chip patent, a motion for summary judgment filed by the defendants was granted in September 2002. The court ruled that the defendants have not infringed on Soundview Technologies' patent. If we are unsuccessful in our intended appeal of this ruling, legal principles would preclude us from claiming infringement of our patents by other parties. Accordingly, if we are unsuccessful in this or other litigation to protect our intellectual property rights, the future revenues of the Acacia Technologies group could be adversely affected. From time to time, the Acacia Technologies group may be subject to third-party claims in the ordinary course of business, including claims of alleged infringement of proprietary rights. Any such claims may harm the Acacia Technologies group by subjecting it to significant liability for damage and invalidating its proprietary rights. These types of claims, with or without merit, could subject the Acacia Technologies group to costly litigation and diversion of its technical and management personnel. The Acacia Technologies group depends largely on the protection of enforceable patent rights. The Acacia Technologies group has applications on file with the U.S. Patent and Trademark Office seeking patents on its core technologies and has patents or rights to patents that have been issued. We cannot assure you that the pending patent applications of the Acacia Technologies group will be issued, that third parties will not violate, or attempt to invalidate these intellectual property rights, or that certain aspects of those intellectual property will not be reverse-engineered by third parties without violating the patent rights of the Acacia Technologies group. For Acacia Media Technologies and Soundview Technologies, proprietary rights constitute their only significant assets. The Acacia Technologies group also owns licenses from third parties and it is possible that it could become subject to infringement actions based upon such licenses. The Acacia Technologies group generally obtains representations as to the origin and ownership of such licensed content. However, this may not adequately protect the Acacia Technologies group. The Acacia Technologies group enters into confidentiality agreements with third parties and generally limits access to information relating to its proprietary rights. Despite these precautions, third parties may be able to gain access to and use the Acacia Technologies group's proprietary rights to develop competing technologies and products with similar or better features and prices. Any substantial unauthorized use of the Acacia Technologies group's proprietary rights could materially and adversely affect its business and operational results. 59 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Refer to the caption "Quantitative and Qualitative Disclosures About Market Risk" on pages 35, 39 and 42. The primary objective of our investment activities is to preserve principal while concurrently maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we may invest in may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the current value of the principal amount of our investment will decline. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, high-grade corporate bonds, government and non-government debt securities and certificates of deposit. In general, money market funds are not subject to market risk because the interest paid on such funds fluctuates with the prevailing interest rate. As of March 31, 2003, all of our investments were in money market funds, high-grade corporate bonds, and U.S. government debt securities. A hypothetical 100 basis point increase in interest rates would result in an approximate $40,000 decrease in the fair value of our available-for-sale securities as of March 31, 2003. ITEM 4. CONTROLS AND PROCEDURES (a) Within the 90 days prior to the date of this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us (including our consolidated subsidiaries) required to be included in our periodic SEC filings. (b) There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referred to above. 60 PART II--OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS SOUNDVIEW TECHNOLOGIES On April 5, 2000, Soundview Technologies filed a federal patent infringement and antitrust lawsuit against Sony Corporation of America, Philips Electronics North America Corporation, the Consumer Electronics Manufacturers Association and the Electronics Industries Alliance d/b/a Consumer Electronics Association in the United States District Court for the Eastern District of Virginia, alleging that television sets utilizing certain content blocking technology (commonly known as the "V-chip") and sold in the United States infringe Soundview Technologies' U.S. Patent No. 4,554,584. In September 2002, the United States District Court for the District of Connecticut granted a motion for summary judgment filed by defendants Sony Corporation of America, Inc., Sony Electronics, Inc., the Electronics Industries Alliance d/b/a Consumer Electronics Association, the Consumer Electronics Manufacturers Association, Mitsubishi Digital Electronics America, Inc., Mitsubishi Electronics America, Inc., Toshiba America Consumer Products, Inc. and Sharp Electronics Corporation. In granting the motion, the court ruled that the defendants have not infringed on Soundview Technologies' patent. While we are currently exploring strategies in response to this ruling and intend to appeal it, litigation is inherently uncertain and we can give no assurance that we will be successful in any such appeal. In August 2002, Soundview Technologies filed a federal patent infringement lawsuit against seventeen television manufacturers in the United States District Court for the District of Nevada. In this lawsuit, Soundview alleges that television sets fitted with V-chips and sold in the United States infringe Soundview Technologies' patent. As a result of the summary judgment ruling in the case before the United States District Court for the District of Connecticut, in October 2002, Soundview Technologies voluntarily filed to dismiss, without prejudice, the Nevada infringement lawsuit. By voluntarily dismissing this lawsuit, Soundview Technologies will be able to refile the action in the event that a favorable final decision is reached with respect to the issue of infringement in the Connecticut lawsuit. In February 2003, Acacia Media Technologies initiated DMT patent infringement litigation in the Federal District Court for the Central District of California against approximately 40 defendants who provide digital content over the Internet. All of the defendants were previously notified of our belief that their conduct infringes on our patent rights. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 99.1 Certification of Paul R. Ryan, Chairman and Chief Executive Officer of Acacia Research Corporation, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification of Clayton J. Haynes, Chief Financial Officer of Acacia Research Corporation, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K On February 28, 2003, Acacia filed a Current Report on Form 8-K to report results for the fourth quarter and fiscal year end of 2002. On April 29, 2003, Acacia filed a Current Report on Form 8-K to report results for the first quarter of 2003. 61 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ACACIA RESEARCH CORPORATION By: /S/ Paul R. Ryan ---------------------------------- Paul R. Ryan Chief Executive Officer (Authorized Signatory) By: /S/ Clayton J. Haynes ---------------------------------- Clayton J. Haynes Chief Financial Officer /Treasurer (Principal Financial Officer) Date: May 9, 2003 62 CERTIFICATION ------------- I, Paul Ryan, certify that: I have reviewed this quarterly report on Form 10-Q of Acacia Research Corporation; Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 9, 2003 /S/ Paul R. Ryan ---------------------------------- Paul R. Ryan Chief Executive Officer 63 CERTIFICATION ------------- I, Clayton J. Haynes, certify that: I have reviewed this quarterly report on Form 10-Q of Acacia Research Corporation; Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 9, 2003 /S/ Clayton J. Haynes ---------------------------------- Clayton J. Haynes Chief Financial Officer 64 EXHIBIT INDEX EXHIBIT NUMBER EXHIBIT - ------ ------- 99.1 Certification pursuant to 18 U.S.C Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Paul R. Ryan 99.2 Certification pursuant to 18 U.S.C Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Clayton J. Haynes 65 EX-99.1 3 acacia_10q-exh991.txt EXHIBIT 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Acacia Research Corporation (the "Company") on Form 10-Q for the period ended March 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Paul R. Ryan, Chairman and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: May 9, 2003 / S / Paul R. Ryan ---------------------------- ------------------------------ Paul R. Ryan Chairman and Chief Executive Officer (Principal Executive Officer) EX-99.2 4 acacia_10q-exh992.txt EXHIBIT 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Acacia Research Corporation (the "Company") on Form 10-Q for the period ended March 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Clayton J. Haynes, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: May 9, 2003 / S / Clayton J. Haynes ---------------------------------- ------------------------------ Clayton J. Haynes Chief Financial Officer (Principal Financial Officer) -----END PRIVACY-ENHANCED MESSAGE-----