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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
COMMISSION FILE NUMBER 0-26068
ACACIA RESEARCH CORPORATION
---------------------------
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 95-4405754
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
500 NEWPORT CENTER DRIVE, NEWPORT BEACH, CA 92660
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (949) 480-8300
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
filing requirements for the past 90 days. Yes [X] No [ ]
As of November 12, 2002, the registrant had 19,640,808 shares of common
stock, $0.001 par value, issued and outstanding.
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ACACIA RESEARCH CORPORATION
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets as of September 30, 2002
and December 31, 2001 (Unaudited)................................................... 3
Consolidated Statements of Operations and Comprehensive Loss for the
Three Months Ended September 30, 2002 and 2001 and the Nine Months Ended
September 30, 2002 and 2001 (Unaudited)............................................. 4
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2002 and 2001 (Unaudited)........................... 5
Notes to Consolidated Financial Statements.......................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................................ 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................... 37
Item 4. Controls and Procedures............................................................. 37
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................... 38
Item 2. Changes in Securities and Use of Proceeds........................................... 39
Item 3. Defaults Upon Senior Securities..................................................... 39
Item 4. Submission of Matters to a Vote of Security Holders................................. 40
Item 5. Other Information................................................................... 40
Item 6. Exhibits and Reports on Form 8-K.................................................... 40
SIGNATURES.............................................................................................. 41
CERTIFICATIONS.......................................................................................... 42
EXHIBIT INDEX........................................................................................... 44
2
ACACIA RESEARCH CORPORATION
CONSOLIDATED BALANCE SHEETS
As of September 30, 2002 and December 31, 2001
(In thousands, except share and per share information)
(Unaudited)
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 38,126 $ 59,451
Short-term investments 19,697 25,110
Accounts receivable 2,552 143
Prepaid expenses, other receivables and other assets 1,692 1,470
------------- -------------
Total current assets 62,067 86,174
Property and equipment, net of accumulated depreciation 4,350 4,906
Investment in affiliate, at cost 252 3,000
Patents, net of accumulated amortization 10,308 11,855
Goodwill, net of accumulated amortization 4,684 4,627
Other assets 1,063 297
------------- -------------
$ 82,724 $ 110,859
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued expenses and other $ 7,773 $ 5,756
Current portion of deferred revenues 12,640 7,088
Current portion of capital lease obligation 2,085 934
------------- -------------
Total current liabilities 22,498 13,778
Deferred income taxes 3,609 3,829
Deferred revenues, net of current portion -- 372
Capital lease obligation, net of current portion -- 1,845
------------- -------------
Total liabilities 26,107 19,824
------------- -------------
Commitments and contingencies (Note 7)
Minority interests 35,047 32,303
------------- -------------
Stockholders' equity:
Preferred stock, par value $0.001 per share; 20,000,000 shares authorized;
no shares issued or outstanding -- --
Common stock, par value $0.001 per share; 60,000,000 shares authorized;
19,640,808 and 19,592,459 shares issued and outstanding
as of September 30, 2002 and December 31, 2001, respectively 20 20
Additional paid-in capital 158,123 158,529
Warrants to purchase common stock 199 199
Comprehensive loss (11) (4)
Accumulated deficit (136,761) (100,012)
------------- -------------
Total stockholders' equity 21,570 58,732
------------- -------------
$ 82,724 $ 110,859
============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
3
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(In thousands, except share and per share information)
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------------- -----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
------------- ------------- ------------- -------------
Revenues:
License fee income $ 43 $ 10,740 $ 43 $ 23,180
Product revenue 23 -- 297 --
Grant revenue 113 91 526 365
------------- ------------- ------------- -------------
Total revenues 179 10,831 866 23,545
------------- ------------- ------------- -------------
Operating expenses:
Cost of sales 6 -- 259 --
Research and development expenses 6,449 4,153 14,143 9,954
Non-cash stock compensation
expense - research and development 753 1,712 1,867 6,123
Marketing, general and administrative expenses 4,727 8,522 14,253 24,293
Non-cash stock compensation
expense - marketing, general and administrative 1,263 3,486 3,716 14,684
Amortization of patents and goodwill 550 654 1,678 1,925
Legal settlement charges 18,471 -- 18,471 --
------------- ------------- ------------- -------------
Total operating expenses 32,219 18,527 54,387 56,979
------------- ------------- ------------- -------------
Operating loss (32,040) (7,696) (53,521) (33,434)
------------- ------------- ------------- -------------
Other (expense) income:
Impairment of cost method investment (2,748) -- (2,748) --
Interest income 266 839 966 3,064
Realized losses on short-term investments -- -- (1,483) --
Unrealized (losses) gains on short-term investments (213) 24 (690) 24
Interest expense (49) (23) (171) (23)
Equity in losses of affiliate -- (52) -- (162)
Other income (expense) (5) 8 47 68
------------- ------------- ------------- -------------
Total other (expense) income (2,749) 796 (4,079) 2,971
------------- ------------- ------------- -------------
Loss from continuing operations
before income taxes and minority interests (34,789) (6,900) (57,600) (30,463)
Benefit (provision) for income taxes 287 (778) 431 (1,018)
------------- ------------- ------------- -------------
Loss from continuing operations before minority interests (34,502) (7,678) (57,169) (31,481)
Minority interests 14,080 4,851 20,620 14,403
------------- ------------- ------------- -------------
Loss from continuing operations (20,422) (2,827) (36,549) (17,078)
Discontinued operations:
Estimated loss on disposal of Soundbreak.com (200) -- (200) --
------------- ------------- ------------- -------------
Net loss (20,622) (2,827) (36,749) (17,078)
Unrealized (losses) gains on short-term investments (1) 68 (49) 107
Unrealized (losses) gains on foreign currency translation (12) (4) 41 (4)
------------- ------------- ------------- -------------
Comprehensive loss $ (20,635) $ (2,763) $ (36,757) $ (16,975)
============= ============= ============= =============
Loss per common share:
Basic and diluted
Loss from continuing operations $ (1.04) $ (0.15) $ (1.86) $ (0.89)
Loss from discontinued operations $ (0.01) $ -- $ (0.01) $ --
------------- ------------- ------------- -------------
Net loss $ (1.05) $ (0.15) $ (1.87) $ (0.89)
============= ============= ============= =============
Weighted average number of common and potential common
shares outstanding used in computation of loss per share:
Basic and diluted 19,640,808 19,525,807 19,622,690 19,252,831
============= ============= ============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
4
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
-----------------------------
SEPTEMBER 30, SEPTEMBER 30,
2002 2001
------------- -------------
Cash flows from operating activities:
Net loss from continuing operations: $ (36,549) $ (17,078)
Adjustments to reconcile net loss from continuing
operations to net cash used in operating activities:
Depreciation and amortization 2,852 2,724
Equity in losses of affiliate -- 162
Minority interests in net loss (20,620) (14,403)
Stock-based compensation 5,583 20,807
Deferred tax benefit (220) (118)
Net sales of trading securities 2,688 --
Unrealized losses on short-term investments 690 --
Minority interests distributions 430 --
Issuance of common stock by subsidiary - legal settlement 17,471 --
Impairment of cost method investment 2,748 --
Other 87 206
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable, prepaid expenses, other receivables and other assets (3,399) (1,650)
Accounts payable, accrued expenses and other 2,350 413
Deferred revenue 5,180 2,500
------------- -------------
Net cash used in operating activities from continuing operations (20,709) (6,437)
Net cash used in operating activities from discontinued operations (812) (1,931)
------------- -------------
Net cash used in operating activities (21,521) (8,368)
------------- -------------
Cash flows from investing activities:
Purchase of property and equipment (717) (2,993)
Proceeds from sale of property and equipment 103 524
Proceeds from sale and leaseback arrangement -- 3,000
Purchase of short-term investments (12,772) (33,539)
Sale of short-term investments 14,292 24,743
Purchase of common stock from minority stockholders of subsidiaries (57) (1,101)
Other (100) --
------------- -------------
Net cash provided by (used in) investing activities from
continuing operations 749 (9,366)
Net cash (used in) provided by investing activities from
discontinued operations (3) 137
------------- -------------
Net cash provided by (used in) investing activities 746 (9,229)
------------- -------------
Cash flows from financing activities:
Proceeds from the exercise of stock options 214 1,648
Capital contributions from minority shareholders of subsidiaries,
net of issuance costs 300 1,749
Capital distributions to minority shareholders of subsidiaries (430) --
Proceeds from sale of common stock, net of issuance costs -- 18,351
Repayment of capital lease obligation (694) (73)
Other (11) --
------------- -------------
Net cash (used in) provided by financing activities (621) 21,675
------------- -------------
(Decrease) increase in cash and cash equivalents (21,396) 4,078
------------- -------------
Cash and cash equivalents, beginning 59,451 36,163
Effect of exchange rate on cash 71 (7)
------------- -------------
Cash and cash equivalents, ending $ 38,126 $ 40,234
============= =============
Schedule of non-cash investing and financing activities:
Purchase of equipment under capital lease agreement $ -- $ (3,000)
============= =============
Capital lease obligation incurred $ -- $ 3,000
============= =============
Accrued payments for purchase of common stock from minority
stockholders of subsidiary $ -- $ 1,549
============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
5
ACACIA RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
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 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, 2001 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. The accompanying consolidated financial statements also include
the accounts of CombiMatrix Corporation, a 48% owned investment (see Note 7) for
which Acacia Research Corporation possesses the power to direct or cause the
direction of the management and policies through a shareholders' agreement that
enables Acacia Research Corporation to elect the members of CombiMatrix
Corporation's board of directors. Material intercompany transactions and
balances have been eliminated in consolidation. The cost method is used where we
maintain ownership interests of less than 20% and do not exercise significant
influence over the company in which we have invested.
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 September 30, 2002 and results of operations and cash flows for the interim
periods presented. The results of operations for the three and nine months ended
September 30, 2002 are not necessarily indicative of the results to be expected
for the entire year.
Acacia Research Corporation ("Acacia," "we" or "us") develops, licenses
and provides products for the media technology and life science sectors.
Acacia's media technologies business, collectively referred to as
"Acacia Media Technologies Group," owns intellectual property related to the
telecommunications field, including a television blanking system, also known as
the "V-chip," which it licenses to television manufacturers. The V-chip patent
expires in July 2003. In addition, Acacia Media Technologies Group owns a
worldwide portfolio of pioneering patents relating to audio and video
transmission and receiving systems, commonly known as audio-on-demand and
video-on-demand, used for distributing content via various methods including
computer networks, cable television systems and direct broadcasting satellite
systems. The digital media transmission patent portfolio expires in 2011 in the
U.S. and in 2012 in international markets. Acacia Media Technologies Group is
responsible for the development, licensing and protection of its intellectual
property and proprietary technologies. Acacia Media Technologies Group continues
to pursue both licensing and strategic business alliances with leading companies
in the rapidly growing media technologies industry.
Acacia's life sciences business, collectively referred to as "Acacia
Life Sciences Group," is comprised of CombiMatrix Corporation ("CombiMatrix")
and CombiMatrix'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 through our
subsidiary, CombiMatrix. CombiMatrix is a life science technology company with a
proprietary system for rapid, cost competitive creation of DNA and other
compounds on a modified 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's biological array processor technology in certain fields of
material sciences. On April 25, 2002, CombiMatrix purchased our interest in
Advanced Material Sciences. CombiMatrix issued 180,982 shares of its common
stock to us in exchange for our 58% interest in Advanced Material Sciences.
CombiMatrix currently owns 87% of Advanced Material Sciences and the remaining
interests are owned by unaffiliated third parties. The transaction was accounted
for using Acacia's basis in the net assets of Advanced Material Sciences and as
a result, Acacia's consolidated financial statements continue to reflect the
assets and liabilities of Advanced Material Sciences at historical cost.
CombiMatrix KK, a majority-owned Japanese corporation located in Tokyo,
is exploring opportunities for CombiMatrix's active biochip system with
pharmaceutical and biotechnology companies in the Asian market
6
2. LOSS PER SHARE
Loss per share is presented on both a basic and diluted basis. A
reconciliation of the denominator of the basic loss per share computation to the
denominator of the diluted loss per share computation is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------- ---------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Weighted Average Number of Common Shares Outstanding
Used in Computation of Basic Loss per Share 19,640,808 19,525,807 19,622,690 19,252,831
Dilutive Effect of Outstanding Stock Options and
Warrants (a) -- -- -- --
------------ ------------ ------------ ------------
Weighted Average Number of Common and Potential Common
Shares Outstanding Used in Computation of Diluted
Loss per Share 19,640,808 19,525,807 19,622,690 19,252,831
============ ============ ============ ============
__________________________________________
(a) Potential common shares of 860 and 165,535 during the three months
ended September 30, 2002 and 2001, respectively, have been excluded
from the per share calculation because the effect of their inclusion
would be anti-dilutive. Potential common shares of 330,968 and 724,313
during the nine months ended September 30, 2002 and 2001, respectively,
have been excluded from the per share calculation because the effect of
their inclusion would be anti-dilutive.
3. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations" ("SFAS No. 141"), and SFAS No. 142, "Goodwill and Other Intangible
Assets" ("SFAS No. 142"). SFAS No. 141 addresses financial accounting and
reporting for business combinations and supersedes Accounting Principles Board
("APB") Opinion No. 16, "Business Combinations." Changes made by SFAS No. 141
include (1) requiring the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 and (2) establishing specific
criteria for the recognition of intangible assets separately from goodwill.
These provisions are effective for business combinations for which the date of
acquisition is subsequent to June 30, 2001.
We adopted SFAS No. 142 effective January 1, 2002 and ceased amortizing
goodwill on that date. SFAS No. 142 addresses how goodwill and other intangible
assets should be accounted for after they have been initially recognized in the
financial statements. This standard provides that goodwill is not subject to
amortization. Instead, it is subject to a periodic review that must occur at
least annually at a reporting unit level for possible impairment. This review is
known as the "two-step" impairment test and provides that the initial
"first-step" reviews of each reporting unit must be completed within six months
of the adoption of the standard. The "first-step" of the goodwill impairment
test used to identify potential impairment compares the fair value of each
reporting unit with its carrying amount, including goodwill. If upon completion
of these initial reviews an impairment of goodwill is indicated, the
"second-step" is required to be performed, which will compare the implied fair
value of each reporting unit goodwill with the carrying amount of goodwill. In
connection with the adoption of SFAS No. 142, we performed a transitional
goodwill impairment assessment and determined that there was no impairment of
goodwill. The fair value of our two reporting units was estimated using a
discounted cash flow analysis. There can be no assurance that a future goodwill
impairment test will not result in a charge to earnings.
The Acacia Media Technologies Group had $1,833,000 of goodwill at
September 30, 2002 and December 31, 2001 (net of $2,258,000 of accumulated
amortization) and recorded approximately $47,000 and $136,000 of goodwill
amortization expense during the three and nine months ended September 30, 2001,
respectively. The Acacia Life Sciences Group had $2,851,000 of goodwill at
September 30, 2002 and December 31, 2001 (net of $1,311,000 of accumulated
amortization) and recorded approximately $203,000 and $605,000 of goodwill
amortization expense during the three and nine months ended September 30, 2001,
respectively.
7
Our net loss and loss per share, adjusted to exclude goodwill
amortization expense, for the three and nine months ended September 30, 2002 and
2001 are as follows (in thousands, except earnings per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------------- ---------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
---------- --------- ---------- -----------
Reported net loss $ (20,622) $ (2,827) $ (36,749) $ (17,078)
Add back: goodwill amortization -- 250 -- 741
---------- --------- ---------- -----------
Adjusted net loss $ (20,622) $ (2,577) $ (36,749) $ (16,337)
========== ========= ========== ===========
LOSS PER SHARE (BASIC AND DILUTED):
Reported net loss $ (1.05) $ (0.15) $ (1.87) $ (0.89)
Goodwill amortization -- 0.01 -- 0.04
---------- --------- ---------- -----------
Adjusted net loss $ (1.05) $ (0.14) $ (1.87) $ (0.85)
========== ========= ========== ===========
Acacia's only identifiable intangible assets are patents totaling
$10,308,000 and $11,855,000 at September 30, 2002 and December 31, 2001 (net of
$7,302,000 and $5,655,000 of accumulated amortization, respectively). The gross
carrying amounts and accumulated amortization related to acquired intangible
assets, all related to patents, by segment, as of September 30, 2002 and
December 31, 2001 are as follows (in thousands):
ACACIA MEDIA TECHNOLOGIES GROUP ACACIA LIFE SCIENCES GROUP
---------------------------------- ---------------------------------
AT SEPTEMBER 30, AT DECEMBER 31, AT SEPTEMBER 30, AT DECEMBER 31,
2002 2001 2002 2001
------------- ------------- ------------- -------------
Gross carrying amount - patents $ 10,798 $ 10,698 $ 6,812 $ 6,812
Accumulated amortization (6,536) (5,144) (766) (511)
------------- ------------- ------------- -------------
Patents, net $ 4,262 $ 5,554 $ 6,046 $ 6,301
============= ============= ============= =============
Aggregate patent amortization expense was $549,000 ($464,000 and
$85,000 for the Acacia Technologies Group and the Acacia Life Sciences Group,
respectively) and $405,000 ($306,000 and $99,000 for the Acacia Technologies
Group and the Acacia Life Sciences Group, respectively) for the three months
ended September 30, 2002 and 2001, respectively. Aggregate patent amortization
expense was $1,675,000 ($1,392,000 and $283,000 for the Acacia Technologies
Group and the Acacia Life Sciences Group, respectively) and $1,184,000 ($887,000
and $297,000 for the Acacia Technologies Group and the Acacia Life Sciences
Group, respectively) for the nine months ended September 30, 2002 and 2001,
respectively.
The estimated aggregate amortization expense for the years ended
December 31, 2002 through 2006 is as follows (in thousands):
ESTIMATED
YEAR ENDED AMORTIZATION
DECEMBER 31, EXPENSE
---------------- -----------------
2002 $ 1,862
2003 841
2004 841
2005 841
2006 841
At September 30, 2002 and December 31, 2001, all of our acquired
intangible assets were subject to amortization.
On January 1, 2002, we adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), which addresses
financial accounting and reporting for the impairment of long-lived assets and
for long-lived assets to be disposed of. SFAS No. 144 supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." SFAS No. 144 also supersedes the accounting and reporting
provisions of APB Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
8
Unusual and Infrequently Occurring Events and Transactions," for segments of a
business to be disposed of. SFAS No. 144 also amends Accounting Research
Bulletin No. 51, "Consolidated Financial Statements," to eliminate the exception
to consolidation for a temporarily controlled subsidiary. SFAS No. 144 requires
long-lived assets to be tested for recoverability whenever events or changes in
circumstances indicate that its carrying amount may not be recoverable. In
conjunction with such tests, it may be necessary to review depreciation
estimates and methods as required by APB Opinion No. 20, "Accounting Changes,"
or the amortization period as required by SFAS No. 142. The initial adoption of
SFAS No. 144 did not have a material effect on our consolidated results of
operations or financial position (see Note 4).
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections," ("SFAS No. 145"), which is effective for transactions occurring
after May 15, 2002. SFAS No. 145 rescinds SFAS No. 4 and SFAS No. 64, which
addressed the accounting for gains and losses from extinguishment of debt. SFAS
No. 44 set forth industry-specific transitional guidance that did not apply to
us. SFAS No. 145 amends SFAS No. 13 to require that certain lease modifications
that have economic effects similar to sale-leaseback transactions be accounted
for in the same manner as sale-leaseback transactions. SFAS No. 145 also makes
technical corrections to certain existing pronouncements that are not
substantive in nature. We do not expect the adoption of SFAS No. 145 to have a
significant impact on our financial position or results of operations.
In June 2002, the FASB issued 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. We do not expect the adoption of SFAS No. 146 to have a significant
impact on our financial position or results of operations.
4. IMPAIRMENT OF COST METHOD INVESTMENT
Acacia assesses the need to record impairment losses on investments and
records such losses when the impairment of an investment is determined to be
other than temporary in nature. Impairment losses are reflected in "Other income
(expenses)" in Acacia's consolidated statements of operations.
In September 2002, we recorded an impairment charge of $2.7 million for
an other-than-temporary decline in the fair value of our cost method investment.
Impairment indicators included recurring losses, a decline in working capital
and the completion of a recent equity transaction at an amount below our
carrying value.
Acacia records impairment charges as a result of management's periodic
business review and impairment analysis performed under its existing policy
regarding impairment of long-lived assets. Where impairment indicators were
identified, management determined the amount of the impairment charge by
comparing the carrying value of long-lived assets to their fair value. The fair
value of our cost method investment was determined by reference to a recent
equity transaction executed by the investee and consideration of other available
financial and market information.
5. SEGMENT INFORMATION
Acacia has two reportable segments as follows:
ACACIA MEDIA TECHNOLOGIES GROUP - Acacia Media Technologies Group owns
intellectual property related to the telecommunications field, including a
television blanking system, also known as the "V-chip," which it licenses to
television manufacturers. In addition, our media technologies group owns a
worldwide portfolio of pioneering patents relating to audio and video
transmission and receiving systems, commonly known as audio-on-demand and
video-on-demand, used for distributing content via various methods including
computer networks, cable television systems and direct broadcasting satellite
systems.
9
ACACIA LIFE SCIENCES GROUP - Acacia Life Sciences Group includes our
subsidiary, CombiMatrix, which is developing a proprietary biochip array
processor system that integrates semiconductor technology with new developments
in biotechnology and chemistry. CombiMatrix's majority-owned subsidiary,
Advanced Material Sciences, holds the exclusive license for CombiMatrix'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's active biochip system with
pharmaceutical and biotechnology companies in the Asian market.
We evaluate segment performance based on revenue earned and cost versus
earnings potential of future completed products or services. Material
intercompany transactions and transfers have been eliminated in consolidation.
The accounting policies of the segments are the same as those described in our
Annual Report on Form 10-K. Corporate and other includes corporate costs,
certain assets and liabilities and other investment activities (including
certain intangibles recorded in connection with the acquisition of various
ownership interests in our subsidiaries), which are included in our consolidated
financial statements but are not allocated to the reportable segments.
We use the management approach, which designates the internal
organization that is used by management for making operating decisions and
assessing performance as the basis of our reportable segments. At December 31,
2001, our reporting segments were adjusted to include our wholly owned
subsidiaries Soundview Technologies Incorporated ("Soundview Technologies") and
Acacia Media Technologies Corporation in our Acacia Media Technologies Group
segment. In addition, CombiMatrix and its subsidiaries comprise our Acacia Life
Sciences Group segment. 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 September 30, 2002 and 2001:
ACACIA MEDIA ACACIA LIFE
TECHNOLOGIES SCIENCES CORPORATE
Three Months Ended September 30, 2002 GROUP GROUP AND OTHER TOTAL
- ------------------------------------- -------------- -------------- -------------- --------------
Revenue $ 43,000 $ 136,000 $ -- $ 179,000
Amortization of patents 20,000 -- 530,000 550,000
Other expense -- -- 5,000 5,000
Interest income 5,000 118,000 143,000 266,000
Interest expense -- 49,000 -- 49,000
Unrealized losses on investments -- -- 213,000 213,000
Impairment of cost method investment -- -- 2,748,000 2,748,000
Loss from operations before
income taxes and minority interests 912,000 29,117,000 4,760,000 34,789,000
Non-cash stock compensation charges -- 2,016,000 -- 2,016,000
Segment assets 10,432,000 24,193,000 44,724,000 79,349,000
Investment in affiliate, at cost -- -- 252,000 252,000
Purchase of property and equipment -- 177,000 -- 177,000
ACACIA MEDIA ACACIA LIFE
TECHNOLOGIES SCIENCES CORPORATE
Three Months Ended September 30, 2001 GROUP GROUP AND OTHER TOTAL
- ------------------------------------- -------------- -------------- -------------- --------------
Revenue $ 10,740,000 $ 91,000 $ -- $ 10,831,000
Amortization of patents and goodwill 20,000 -- 634,000 654,000
Other income -- -- 8,000 8,000
Interest income 48,000 426,000 365,000 839,000
Unrealized gains on investments -- -- 24,000 24,000
Interest expense -- 23,000 -- 23,000
Equity in losses of affiliate -- -- 52,000 52,000
(Income) loss from operations before
income taxes and minority interests (6,063,000) 11,447,000 1,516,000 6,900,000
Non-cash stock compensation charges -- 5,186,000 12,000 5,198,000
Segment assets 12,256,000 42,343,000 55,042,000 109,641,000
Investment in affiliate, at equity -- -- 184,000 184,000
Investment in affiliate, at cost -- -- 3,000,000 3,000,000
Purchase of property and equipment 1,000 390,000 -- 391,000
10
The tables below present information about our reportable segments in
continuing operations for the nine months ended September 30, 2002 and 2001:
ACACIA MEDIA ACACIA LIFE
TECHNOLOGIES SCIENCES CORPORATE
Nine Months Ended September 30, 2002 GROUP GROUP AND OTHER TOTAL
- ------------------------------------ -------------- -------------- -------------- --------------
Revenue $ 43,000 $ 823,000 $ -- $ 866,000
Amortization of patents 59,000 -- 1,619,000 1,678,000
Other income 5,000 -- 42,000 47,000
Interest income 20,000 484,000 462,000 966,000
Interest expense -- 165,000 6,000 171,000
Realized losses on investments -- -- 1,483,000 1,483,000
Unrealized losses on investments -- -- 690,000 690,000
Impairment of cost method investment -- -- 2,748,000 2,748,000
Loss from operations before
income taxes and minority interests 1,868,000 44,150,000 11,582,000 57,600,000
Non-cash stock compensation charges -- 5,564,000 19,000 5,583,000
Segment assets 10,432,000 24,193,000 44,724,000 79,349,000
Investment in affiliate, at cost -- -- 252,000 252,000
Purchase of property and equipment -- 644,000 73,000 717,000
ACACIA MEDIA ACACIA LIFE
TECHNOLOGIES SCIENCES CORPORATE
Nine Months Ended September 30, 2001 GROUP GROUP AND OTHER TOTAL
- ------------------------------------ -------------- -------------- -------------- --------------
Revenue $ 23,130,000 $ 365,000 $ 50,000 $ 23,545,000
Amortization of patents and goodwill 29,000 -- 1,896,000 1,925,000
Other income -- -- 68,000 68,000
Interest income 84,000 1,718,000 1,262,000 3,064,000
Unrealized gains on investments -- -- 24,000 24,000
Interest expense -- 23,000 -- 23,000
Equity in losses of affiliate -- -- 162,000 162,000
(Income) loss from operations before
income taxes and minority interests (12,184,000) 37,033,000 5,614,000 30,463,000
Non-cash stock compensation charges -- 19,962,000 845,000 20,807,000
Segment assets 12,256,000 42,343,000 55,042,000 109,641,000
Investment in affiliate, at equity -- -- 184,000 184,000
Investment in affiliate, at cost -- -- 3,000,000 3,000,000
Purchase of property and equipment 7,000 2,949,000 37,000 2,993,000
Segment information excludes discontinued operations related to
Soundbreak.com as of and for the three and nine months ended September 30, 2002
and 2001. Total assets related to discontinued operations totaled $3,375,000 and
$4,954,000 at September 30, 2002 and 2001, respectively.
11
6. DISCOUNTINUED OPERATIONS
On February 13, 2001, the board of directors of Soundbreak.com
Incorporated ("Soundbreak.com"), a majority-owned subsidiary of Acacia, resolved
to cease operations as of February 15, 2001 and liquidate the remaining assets
and liabilities of the subsidiary. Accordingly, we reported the results of
operations and the estimated loss on disposal of Soundbreak.com as results of
discontinued operations in the 2000 consolidated statements of operations and
comprehensive loss.
In September 2002, we accrued an additional $0.5 million ($0.2 million
after minority interests) in estimated costs to be incurred in connection with
the discontinued operations of Soundbreak.com. The additional accrual relates
primarily to certain noncancellable lease obligations and the inability to sub
lease the related office space at rates commensurate with our existing
obligations.
7. COMMITMENTS AND CONTINGENCIES
COMBIMATRIX CORPORATION
On November 28, 2000, Nanogen, Inc. filed a complaint in the United
States District Court for the Southern District of California against
CombiMatrix and Donald D. Montgomery, Ph.D., an officer, director and
stockholder of CombiMatrix. Dr. Montgomery was employed by Nanogen as a senior
research scientist between May 1994 and August 1995. The Nanogen complaint
alleged, among other things, breach of contract, trade secret misappropriation
and that U.S. Patent No. 6,093,302 and other proprietary information belonging
to CombiMatrix are instead the property of Nanogen. The complaint sought, among
other things, correction of inventorship on the patent, the assignment of rights
in the patent and pending patent applications to Nanogen, an injunction
preventing disclosure of trade secrets, damages for trade secret
misappropriation and the imposition of a constructive trust.
On September 30, 2002, CombiMatrix Corporation and Dr. Donald
Montgomery entered into a settlement agreement with Nanogen to settle all
pending litigation between the parties. Pursuant to the terms of the settlement
agreement, Nanogen dismissed with prejudice its lawsuit against CombiMatrix and
Dr. Montgomery. In return, CombiMatrix agreed to pay Nanogen $500,000 within 30
days of the settlement and an additional $500,000 within one year of the
settlement. CombiMatrix also agreed to make quarterly payments to Nanogen equal
to 12.5% of payments to CombiMatrix from sales of products developed by
CombiMatrix and its affiliates and based on the patents that had been in dispute
in the litigation, up to an annual maximum of $1,500,000. The minimum quarterly
payments under the settlement agreement will be $37,500 per quarter for the
period from October 1, 2003 through October 1, 2004, and $25,000 per quarter
thereafter until the patents expire in 2018. Also pursuant to the settlement
agreement, CombiMatrix agreed to issue 4,016,346 shares, or 17.5% of its
outstanding shares post issuance, to Nanogen, subject to antidilution provisions
under specified circumstances, including the exercise of outstanding options and
warrants for a period of up to three years and issuances of additional capital
stock of CombiMatrix to certain parties, under certain circumstances, for a
period of up to three years after the execution of the settlement agreement.
The issuance of shares by CombiMatrix to Nanogen decreases our
consolidated ownership interest in CombiMatrix from 58% to 48%. We continue to
possess the ability to direct or cause the direction of the management and
policies of CombiMatrix, primarily through Acacia's ability to elect the
majority of the board of directors of CombiMatrix Corporation, pursuant to a
shareholder agreement with an officer of CombiMatrix. This shareholder agreement
stipulates that, collectively, Acacia and the officer who is party to the
stockholder agreement, will vote their shares such that the board will be
comprised of the directors nominated by Acacia and the stockholder. The
stockholder is generally prohibited from selling his shares and Acacia has a
right of first refusal should the stockholder wish to sell his shares.
Accordingly, Acacia will continue to account for its investment in CombiMatrix
under the consolidation method of accounting.
The issuance of the CombiMatrix common shares in settlement of the
litigation with Nanogen was accounted for as a nonmonetary transaction.
Accordingly, CombiMatrix recorded a non-cash litigation settlement charge in the
consolidated statement of operations for the three and nine months ended
September 30, 2002 of approximately $17.5 million, which was based on the fair
value of the CombiMatrix common shares issued to Nanogen. The fair value of the
common shares issued and the related litigation charge was based on an
independent third-party valuation of CombiMatrix as of September 30, 2002.
Total legal settlement charges recorded in the consolidated statements
of operations for the three and nine months ended September 30, 2002 include the
fair value of common shares issued to Nanogen in the amount of $17.5 million and
a charge in the amount of $1.0 million related to the cash payments due to
Nanogen discussed above.
12
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 the defendants. 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 at this time, 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.
8. SUBSEQUENT EVENTS
In October 2002, CombiMatrix was in non-compliance with one of its
covenants under its capital lease obligation with a commercial bank. CombiMatrix
paid the remaining balance of the obligation in the amount of $2.1 million on
November 1, 2002.
On March 20, 2002, our board of directors approved a proposal to create
two new classes of common stock called "AR-CombiMatrix stock" and "AR-Acacia
Technologies stock." AR-CombiMatrix stock is intended to reflect separately the
performance of our subsidiary CombiMatrix Corporation, and to benefit from its
research and development efforts. AR-Acacia Technologies stock is intended to
reflect separately the performance of our media technology business and to
benefit from the licensing of its technology and sale of its products. Although
the AR-CombiMatrix stock and the AR-Acacia Technologies stock are intended to
reflect the performance of different business groups within our company, they
are both classes of common stock of Acacia Research Corporation and are not
stock issued by the respective groups. The proposal is subject to several
conditions including the approval of our stockholders. If the recapitalization
proposal is approved and the other conditions satisfied, our stockholders would
receive shares of both of the new classes of stock in exchange for existing
shares of Acacia Research Corporation common stock.
Our board of directors and CombiMatrix's board of directors have also
approved an agreement for us to acquire the stockholder interests in CombiMatrix
not currently owned by us. The proposed acquisition would be accomplished
through a merger in which the stockholders of CombiMatrix other than us would
receive shares of the new "Acacia Research Corporation - CombiMatrix" common
stock in exchange for their existing shares.
The proposed recapitalization and merger are subject to several
conditions, including, but not limited to, receipt of approval of the
stockholders of both companies, as applicable, receipt of satisfactory tax
opinions, approval for listing of each new class of stock on NASDAQ and other
customary conditions. Our stockholders will receive a proxy describing the terms
of the proposals prior to being asked to vote upon and approve the
recapitalization and merger at a special meeting to be held on December 11, 2002
to consider these matters.
We filed a registration statement on Form S-4 with the Securities and
Exchange Commission related to the proposed recapitalization and merger
transactions discussed above. The registration statement was declared effective
on November 8, 2002.
13
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, 2001, our quarterly reports
on Form 10-Q for the quarters ended March 31, 2002 and June 30, 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," "our," "Acacia" and "Acacia
Research" 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 September 30, 2002, and on our unaudited
consolidated statement of operations for the period from January 1, 2002 to
September 30, 2002. The discussion compares the activities for the three and
nine months ended September 30, 2002 to the activities for the three and nine
months ended September 30, 2001. This information should be read in conjunction
with the accompanying unaudited consolidated financial statements and notes
thereto.
GENERAL
Acacia Research Corporation develops, licenses and provides products
for the media technology and life science sectors. Acacia's media technologies
and life sciences businesses are referred to as "Acacia Media Technologies
Group" and "Acacia Life Sciences Group," respectively. Acacia licenses its
V-chip technology to television manufacturers and owns pioneering technology for
digital streaming and audio and video-on-demand. We will continue to pursue both
licensing and strategic business alliances with leading companies in the rapidly
growing media technologies industry. Acacia's core technology opportunity in the
life science sector has been developed through our subsidiary, CombiMatrix
Corporation ("CombiMatrix"), which is developing a proprietary system for rapid,
cost competitive creation of DNA and other compounds on a modified semiconductor
chip.
14
On March 20, 2002, our board of directors approved a proposal to create
two new classes of common stock called "AR-CombiMatrix stock" and "AR-Acacia
Technologies stock." AR-CombiMatrix stock is intended to reflect separately the
performance of our subsidiary CombiMatrix Corporation, and to benefit from its
research and development efforts. AR-Acacia Technologies stock is intended to
reflect separately the performance of our media technology business and to
benefit from the licensing of its technology and sale of its products. Although
the AR-CombiMatrix stock and the AR-Acacia Technologies stock are intended to
reflect the performance of different business groups within our company, they
are both classes of common stock of Acacia Research Corporation and are not
stock issued by the respective groups. The proposal is subject to several
conditions including the approval of our stockholders. If the recapitalization
proposal is approved and the other conditions satisfied, our stockholders would
receive shares of both of the new classes of stock in exchange for existing
shares of Acacia Research Corporation common stock.
Our board of directors and CombiMatrix's board of directors have also
approved an agreement for us to acquire the stockholder interests in CombiMatrix
not currently owned by us. The proposed acquisition would be accomplished
through a merger in which the stockholders of CombiMatrix other than us would
receive shares of the new "Acacia Research Corporation - CombiMatrix" common
stock in exchange for their existing shares.
The proposed recapitalization and merger are subject to several
conditions, including, but not limited to, receipt of approval of the
stockholders of both companies, as applicable, receipt of satisfactory tax
opinions, approval for listing of each new class of stock on NASDAQ and other
customary conditions. Our stockholders will receive a proxy describing the terms
of the proposals prior to being asked to vote upon and approve the
recapitalization and merger at a special meeting to be held on December 11, 2002
to consider these matters.
We filed a registration statement on Form S-4 with the Securities and
Exchange Commission related to the proposed recapitalization and merger
transactions discussed above. The registration statement was declared effective
on November 8, 2002.
COMBIMATRIX CORPORATION
In February 2002, CombiMatrix was awarded a six month $100,000 Phase I
National Institutes of Health grant for the development of its protein biochip
technology.
In April 2002, CombiMatrix's Japanese subsidiary entered into a
technology access and purchase agreement in Japan with the Computational Biology
Research Center ("CBRC"), a division of the Japanese National Institute of
Advanced Industrial Science and Technology. CBRC has purchased and installed a
CombiMatrix gene chip synthesizer and entered into a multi-year agreement to
purchase blank chips that will be used to synthesize custom gene chips. The
agreement also gives CBRC access to CombiMatrix's set of informatics tools to
help in its efforts to expand biotechnology related businesses in Japan.
On April 25, 2002, CombiMatrix purchased our interest in Advanced
Material Sciences, a development stage company that holds the exclusive license
for CombiMatrix's biological array processor technology in certain fields of
material science. CombiMatrix issued 180,982 shares of its common stock to us in
exchange for our 58% interest in Advanced Material Sciences. As a result of the
sale of our interest in Advanced Material Sciences, CombiMatrix currently owns
87% of Advanced Material Sciences and the remaining interests are owned by
unaffiliated third parties.
In May 2002, CombiMatrix's Japanese subsidiary entered into a
technology access collaboration and purchasing agreement with the Genome Science
Laboratory at the Research Center for Advanced Science and Technology ("RCAST")
of the University of Tokyo. Under the terms of the agreement, RCAST has
installed a CombiMatrix gene chip synthesizer and entered into a multi-year
agreement to purchase blank chips that will be used in the development of
diagnostic microarray applications, drug lead development and target gene
identification for the drug discovery industry. The agreement includes a
memorandum of understanding that in the event of the discovery or development of
novel and valuable content, candidates or products, the parties will establish
an agreement for the commercialization of those discoveries.
15
In July 2002, CombiMatrix completed a prototype electrochemical
detection system and delivered the system to the U.S. Department of Defense.
CombiMatrix developed its sensor technology through grants from the U.S.
Department of Defense. The focus of the grants was aimed at developing an
ultrasensitive hand-held biochip system for detecting the deployment of chemical
and biological warfare agents.
On September 30, 2002, CombiMatrix Corporation and Dr. Donald
Montgomery entered into a settlement agreement with Nanogen, Inc. to settle all
pending litigation between the parties. Pursuant to the terms of the settlement
agreement, Nanogen dismissed with prejudice its lawsuit against CombiMatrix and
Dr. Montgomery. In return, CombiMatrix Corporation agreed to pay Nanogen
$500,000 within 30 days of the settlement and an additional $500,000 within one
year of the settlement. CombiMatrix Corporation also agreed to make quarterly
payments to Nanogen equal to 12.5% of total sales of products developed by
CombiMatrix Corporation and its affiliates and based on the patents that had
been in dispute in the litigation, up to an annual maximum of $1,500,000. The
minimum quarterly payments under the settlement agreement will be $37,500 per
quarter for the period from October 1, 2003 through October 1, 2004, and $25,000
per quarter thereafter until the patents expire in 2018. Also pursuant to the
settlement agreement, CombiMatrix Corporation agreed to issue 4,016,346 shares,
or 17.5% of its outstanding shares post issuance, to Nanogen, subject to
antidilution provisions under specified circumstances, including the exercise of
outstanding options and warrants for a period of up to three years and issuances
of additional capital stock of CombiMatrix Corporation to certain parties, under
certain circumstances, for a period of up to three years after the execution of
the settlement agreement.
In September 2002, CombiMatrix Corporation amended and restated its
non-exclusive worldwide license, supply, research and development agreements
with Roche Diagnostics GmbH ("Roche"), primarily to grant Roche manufacturing
rights with respect to the products under development in return for additional
cash consideration under the agreements. The revised agreements also make minor
modifications to terms of the agreements involving matters such as milestones,
payments and technical specifications, none of which we consider to be material.
Such minor modifications are a standard part of the research and development
process and are routinely made in development agreements. During the course of
our relationship with Roche, since the date of the original agreements, we have
engaged in a continuous process of monitoring and reevaluating the terms of our
agreements, and have amended the agreements in several respects to establish
more meaningful goals, milestones and timelines. The agreements are
non-exclusive with respect to CombiMatrix Corporation's core technology, meaning
that CombiMatrix Corporation remains free to license its core technology to
third parties for applications in the genomics, proteomics and other fields. The
agreements contain exclusivity or co-exclusivity provisions only with respect to
the specific products being co-developed for, and partially funded by, Roche
pursuant to the agreements.
Under the terms of the revised agreements, it is contemplated that
Roche will co-develop, use, manufacture, market and distribute CombiMatrix
Corporation's biochips (microarrays) and related technology for rapid production
of customizable biochips. Additionally, CombiMatrix Corporation and Roche will
develop a platform technology, providing a range of standardized biochips for
use in important research applications. Roche has made and will continue to make
payments for the deliverables stipulated and for expanded license and
manufacturing rights.
ACACIA MEDIA TECHNOLOGIES
In July 2002, Acacia was granted a patent for its digital media
transmission technology in Japan. The patent provides coverage through January
2, 2012. The granting of the Japanese patent strengthens Acacia's worldwide
intellectual property position, which includes five patents in the United States
and issued patents in 17 foreign countries.
In July 2002, Acacia executed a license agreement with Loewe Opta GmbH,
whereby Acacia will receive payment and grant a non-exclusive license of its
patented V-chip technology to Loewe Opta GmbH, a manufacturer of televisions
sold under the Loewe brand name.
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 the defendants. 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.
16
The ruling has no effect on the revenues that we have received from
current licensees of our patented V-Chip technology. Further, none of the
revenues that we have received are contingent upon any court rulings or the
future outcome of any litigation with unlicensed television manufacturers.
Soundview continues to pursue its antitrust claim against the defendants.
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 at this time, 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.
RESULTS OF OPERATIONS
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------------- ---------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
------------- ------------- ------------- -------------
Net revenues $ 179,000 $ 10,831,000 $ 866,000 $ 23,545,000
Cost of sales (6,000) -- (259,000) --
Research and development expenses (6,449,000) (4,153,000) (14,143,000) (9,954,000)
Non-cash stock compensation
expense - research and development (753,000) (1,712,000) (1,867,000) (6,123,000)
Marketing, general and administrative expenses (4,727,000) (8,522,000) (14,253,000) (24,293,000)
Non-cash stock compensation
expense - marketing, general and administrative (1,263,000) (3,486,000) (3,716,000) (14,684,000)
Amortization of patents and goodwill (550,000) (654,000) (1,678,000) (1,925,000)
Legal settlement charges (18,471,000) -- (18,471,000) --
Other income (expense), net (2,749,000) 796,000 (4,079,000) 2,971,000
Benefit (provision) for income taxes 287,000 (778,000) 431,000 (1,018,000)
Minority interests 14,080,000 4,851,000 20,620,000 14,403,000
Loss from disposal of Soundbreak.com (200,000) -- (200,000) --
------------- ------------- ------------- -------------
Net loss $(20,622,000) $ (2,827,000) $(36,749,000) $(17,078,000)
============= ============= ============= =============
COMPARISON OF THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 TO THE THREE
AND NINE MONTHS ENDED SEPTEMBER 30, 2001
REVENUES
LICENSE FEE INCOME. During the three months ended September 30, 2002,
license fee income was $43,000 as compared to $10.7 million in license fee
income during the three months ended September 30, 2001. During the nine months
ended September 30, 2002, license fee income was $43,000 as compared to $23.2
million in license fee income during the nine months ended September 30, 2001.
License fee income for the three and nine months ended September 30, 2001
includes license fees received from television manufacturers with whom we
executed separate settlement and/or license agreements during the first, second
and third quarters of 2001 and December 2000. During 2002, we executed one
license agreement Loewe Opta GmbH. Pursuant to the terms of the respective
settlement and/or license agreements with each of the television manufacturers,
Soundview Technologies granted to such manufacturers, non-exclusive licenses for
its patented V-chip technology. The Acacia Media Technologies Group continues to
pursue both licensing and strategic business alliances with leading companies in
the media technologies industry.
Acacia Media Technologies Group's patent on the V-chip technology
expires in July 2003. The Acacia Media 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 Media
Technologies Group is beginning to market its digital media transmission
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. The eventual licensing and sale of these
technologies is intended to replace the revenue generated by licensing the
V-chip technology. If we do not succeed in acquiring such technologies or are
unable to commercially license our existing and future technologies, our
financial condition may be adversely impacted.
17
PRODUCT REVENUE AND COST OF SALES. During the three and nine months
ended September 30, 2002, product revenue was $23,000 and $297,000,
respectively, as compared to $0 in product revenue during the three and nine
months ended September 30, 2001. During the three and nine months ended
September 30, 2002, cost of sales was $6,000 and $259,000, respectively, as
compared to $0 in cost of sales during the three and nine months ended September
30, 2001. Product revenue and cost of sales relates to the sale of a gene chip
synthesizer, a gene-chip reader and biochips to a Japanese government
institution by CombiMatrix's Japanese subsidiary.
GRANT REVENUE. During the three months ended September 30, 2002, grant
revenue was $113,000, as compared to $91,000 in grant revenue during the three
months ended September 30, 2001. During the nine months ended September 30,
2002, grant revenue was $526,000, as compared to $365,000 in grant revenue
during the nine months ended September 30, 2001. Grant revenue during the nine
months ended September 30, 2002 includes $273,000 ($91,000 in each of the first,
second and third quarters of 2002) in grant revenue from CombiMatrix's
continuing performance under its Phase II SBIR Department of Defense contract,
$141,000 (recognized in the first quarter of 2002) in one-time contract research
and development revenues and $105,000 ($17,000, $73,000 and $15,000 in the
first, second and third quarters of 2002, respectively) in revenue related to
performance under its Phase I National Institutes of Health ("NIH") grant. Grant
revenue for the three and nine months ended September 30, 2001 related to
CombiMatrix's continued performance under its Phase II SBIR contract.
CombiMatrix was awarded a two-year $0.7 million Phase II SBIR contract
in January 2000, which expired in July 2002. We received and recognized the
final Phase II SBIR contract payment in the amount of $91,000 in the third
quarter of 2002. In February 2002, CombiMatrix was awarded a six month $100,000
Phase I National Institutes of Health grant for the development of its protein
biochip technology. CombiMatrix received and recognized the final NIH grant
payment in the amount of $15,000 in the third quarter of 2002.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT EXPENSES. During the three months ended
September 30, 2002, research and development expense was $6.4 million, as
compared to $4.2 million in the three months ended September 30, 2001. During
the nine months ended September 30, 2002, research and development expense was
$14.1 million, as compared to $10.0 million in the nine months ended September
30, 2001. Research and development expenses for both periods relate to
CombiMatrix. The increase in research and development expense for 2002, as
compared to the same period in 2001 was primarily due to an increase in research
and development activities related to CombiMatrix's continuing performance under
the product commercialization phase of its license, supply, research and
development agreements with Roche, including increases in labor, supplies and
materials, development of prototype microarrays and instruments, and the use of
outside consultants for certain engineering and manufacturing efforts.
CombiMatrix's research and development activities during the third and
fourth quarters of 2001 and the first three quarters of 2002 were focused on
efforts to further develop and enhance its microarray technologies as well as to
commercialize these technologies. The majority of these efforts were driven by
CombiMatrix's obligations under its license, research and development agreements
with Roche, which were executed in July 2001 and amended in September 2002.
These projects include development of production microarray synthesis
techniques, higher density microarrays and the overall commercialization efforts
of the technologies that Roche is licensing from CombiMatrix.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. We incurred marketing,
general and administrative expenses of $4.7 million ($2.4 million related to
CombiMatrix) during the three months ended September 30, 2002, as compared to
$8.5 million ($2.5 million related to CombiMatrix) in the three months ended
September 30, 2001. Marketing, general and administrative expenses were $14.3
million ($6.8 million related to CombiMatrix) during the nine months ended
September 30, 2002, as compared to $24.3 million ($8.9 million related to
CombiMatrix) in the nine months ended September 30, 2001.
The decrease in marketing, general and administrative expenses for 2002
as compared to the same period in 2001 was due to: a decrease in salaries and
benefits costs related to a decrease in headcount at Acacia corporate resulting
from the closure and/or write-off of several of our early stage investments at
the end of 2000; a decrease in CombiMatrix's sales and marketing staff and
related expenses, recruitment and relocation expenses, administrative staff and
legal costs; and a decrease in legal fees incurred related to Soundview
Technologies' patent licensing and related infringement settlements. Legal fees
related to the license fee agreements executed with television manufacturers are
generally incurred on a contingency basis, based on license fee payments
received and totaled $4.7 million and $10.3 million for the three and nine
months ended September 30, 2001, respectively. Marketing, general and
administrative expenses for the nine months ended September 30, 2002 include
18
approximately $1.1 million in professional fees incurred in connection with the
preparation and filing of our registration statement on Form S-4 related to the
proposed recapitalization transaction discussed elsewhere herein.
NON-CASH STOCK COMPENSATION EXPENSE.
RESEARCH AND DEVELOPMENT. During the three and nine months
ended September 30, 2002, research and development related non-cash stock
compensation charges, all of which relate to CombiMatrix, were $0.8 million and
$1.9 million, respectively, as compared to $1.7 million and $6.1 million,
respectively, during the comparable periods in 2001.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. During the
three and nine months ended September 30, 2002, marketing, general and
administrative non-cash stock compensation charges, primarily related to
CombiMatrix, were $1.3 million and $3.7 million, respectively, as compared to
$3.5 million and $14.7 million, respectively, in the comparable period in 2001.
The decrease in non-cash stock compensation charges related to research
and development and marketing, general and administrative expenses is primarily
due to the forfeiture and cancellation of certain options in the third and
fourth quarters of 2001 and a reduction in scheduled stock compensation
amortization related to the accelerated method of amortization utilized by us
pursuant to FASB 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, and
lower amounts of amortization in subsequent vesting periods. CombiMatrix
non-cash stock compensation amortization expense for the nine months ended
September 30, 2002 is net of $748,000 in stock compensation expense reversal
related to the forfeiture of certain unvested stock options in the first and
second quarters of 2002.
AMORTIZATION OF PATENTS AND GOODWILL. During the three months ended
September 30, 2002 and 2001, amortization expense relating to patents and
goodwill was $0.6 million. During the nine months ended September 30, 2002,
amortization expense was $1.7 million, as compared to $1.9 million in
amortization expense during the nine months ended September 30, 2001.
Amortization expense relating to patents and goodwill for the three and nine
months ended September 30, 2002 excludes $0.3 million and $0.7 million,
respectively, of amortization expense pursuant to SFAS No. 142, "Goodwill and
Other Intangible Assets" ("SFAS No. 142"), which requires goodwill to be tested
for impairment under certain circumstances and written off when determined to be
impaired, rather than being amortized as previous standards required. The
reduction in goodwill amortization in the three and nine months ended September
30, 2002 was offset by an increase in patent amortization related to the
increase in our ownership interest in Acacia Media Technologies Corporation
(formerly Greenwich Information Technologies, a limited liability company) from
33% to 100% through the purchase of the ownership interest of Acacia Media
Technologies Corporation's other member in November 2001. As a result of the
purchase, we will be recording additional patent amortization of $0.2 million on
a quarterly basis over the related patents' economic useful lives (approximately
10 years) related to the intangibles identified in connection with the
application of the purchase method of accounting.
LEGAL SETTLEMENT. On September 30, 2002, CombiMatrix and Dr. Donald
Montgomery, an officer and stockholder of CombiMatrix, entered into a settlement
agreement with Nanogen to settle all pending litigation between the parties. In
addition to other terms of the settlement agreement as described elsewhere
herein, CombiMatrix agreed to pay Nanogen $1.0 million and to issue 4,016,346
shares, or 17.5% of its outstanding shares post issuance, to Nanogen. The $1.0
million in payments have been accrued and are included in the consolidated
statements of operations for the three and nine months ended September 30, 2002
under "Legal Settlement Charges." The issuance of the CombiMatrix common shares
in settlement of the litigation with Nanogen has been accounted for as a
nonmonetary transaction. Accordingly, included in "Legal Settlement Charges" in
the consolidated statements of operations for the three and nine months ended
September 30, 2002, is a charge in the amount of $17.5 million based on the fair
value of the CombiMatrix common shares issued to Nanogen. The fair value of the
common shares issued and the related charge in the consolidated statement of
operations was based on an independent third-party valuation of CombiMatrix as
of September 30, 2002, the date of the settlement agreement.
OTHER INCOME (EXPENSE), NET
OTHER INCOME (EXPENSE), NET. During the three months ended September
30, 2002, other expense, net (primarily comprised of an impairment charge on our
cost method investment, interest income, realized and unrealized gains and
losses on trading securities, equity in losses of affiliate and other) was
$2,749,000, as compared to $0.8 million in net other income in 2001. During the
nine months ended September 30, 2002, other expense, net (primarily comprised of
an impairment charge on our cost method investment, interest income, realized
and unrealized gains and losses on trading securities, equity in losses of
affiliate and other) was $4.1 million as compared to $3.0 million in net other
income in 2001.
19
IMPAIRMENT OF COST METHOD INVESTMENT. In September 2002, we
recorded an impairment charge of $2.7 million for an other-than-temporary
decline in the fair value of our cost method investment. Impairment indicators
included recurring losses, a decline in working capital and the completion of a
recent equity transaction at an amount below our carrying value.
Acacia records impairment charges as a result of management's
periodic business review and impairment analysis performed under its existing
policy regarding impairment of long-lived assets. Where impairment indicators
are identified, management determines the amount of the impairment charge by
comparing the carrying value of long-lived assets to their fair value. The fair
value of our cost method investment was determined by reference to a recent
equity transaction executed by the investee and consideration of other available
financial and market information.
INTEREST INCOME. During the three months ended September 30,
2002, interest income was $0.3 million, as compared to $0.8 million in the three
months ended September 30, 2001. During the nine months ended September 30,
2002, interest income was $1.0 million, as compared to $3.1 million in the nine
months ended September 30, 2001. The decrease in interest income during 2002 was
primarily due to the impact of a decrease in interest rates on our short-term
investments related to sharp 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 the third and fourth quarters
of 2001.
REALIZED LOSSES ON SHORT-TERM INVESTMENTS. During the three
months ended September 30, 2002 and 2001, net realized losses on short-term
investments was $0. During the nine months ended September 30, 2002, net
realized losses on short-term investments was $1.5 million, as compared to no
realized losses on short-term investments in the nine months ended September 30,
2001. The increase in realized losses on short-term investments during 2002 was
due to realized losses recorded on certain trading securities during the three
and nine months ended September 30, 2002. We did not record any realized gains
or losses on trading securities held during the three or nine months ended
September 30, 2001.
UNREALIZED (LOSSES) GAINS ON SHORT-TERM INVESTMENTS. During
the three months ended September 30, 2002, net unrealized losses were $0.2
million, as compared to $24,000 in unrealized gains in the same period in 2001.
During the nine months ended September 30, 2002, net unrealized losses were $0.7
million, as compared to $24,000 in unrealized gains in the same period in 2001.
The increase is due to the results of certain trading securities held during the
respective periods.
EQUITY IN LOSSES OF AFFILIATE. During the three months ended
September 30, 2002, equity in losses of affiliate was $0, as compared to $52,000
in the three months ended September 30, 2001. During the nine months ended
September 30, 2002, equity in losses of affiliate was $0, as compared to
$162,000 in the nine months ended September 30, 2001. Equity in losses of
affiliate during the three and nine months ended September 30, 2001 was
comprised of losses recorded for our equity investment in Acacia Media
Technologies Corporation. As of December 31, 2001, we no longer account for any
of our investments under the equity method as we posses the ability to direct or
cause the direction of the management and policies of all of our subsidiaries
and as a result, account for our investments in our subsidiaries under the
consolidation method of accounting.
MINORITY INTERESTS. Minority interests in the losses of consolidated
subsidiaries was $14.1 million during the three months ended September 30, 2002,
as compared to $4.9 million in the same period in 2001. Minority interests in
the losses of consolidated subsidiaries was $20.6 million during the nine months
ended September 30, 2002, as compared to $14.4 million in the same period in
2001. Minority interests in the losses of consolidated subsidiaries for the
three and nine months ended September 30, 2002 were primarily comprised of
minority interests in the net losses of CombiMatrix totaling $14.0 million and
$20.4 million, respectively. Minority interests in the losses of consolidated
subsidiaries for the three and nine months ended September 30, 2001 were
comprised primarily of minority interests in the net losses of CombiMatrix
totaling $4.8 million and $15.7 million, respectively. Minority interests in the
losses of consolidated subsidiaries for the nine months ended September 30, 2001
was partially offset by minority interests in the net income of Soundview
Technologies totaling $1.3 million. The decrease in minority interests in the
losses of consolidated subsidiaries is primarily due to a reduction in
CombiMatrix's net losses for the three and nine months ended September 30, 2002
as compared to the same periods in 2001.
DISCONTINUED OPERATIONS. On February 13, 2001, the board of directors
of Soundbreak.com resolved to cease operations as of February 15, 2001 and
liquidate the remaining assets and liabilities of the company. Accordingly, we
reported the results of operations and the estimated loss on disposal of
Soundbreak.com as results of discontinued operations in the consolidated
statements of operations and comprehensive loss in 2000. In September 2002, we
20
accrued an additional $0.5 million ($0.2 million after minority interests) in
estimated costs to be incurred in connection with the disposal of
Soundbreak.com. The additional accrual relates primarily to certain
noncancellable lease obligations and the inability to sub lease the related
office space at rates commensurate with our existing obligations.
DEFERRED NON-CASH STOCK COMPENSATION CHARGES
During the year ended December 31, 2000, our subsidiary, CombiMatrix,
recorded deferred non-cash stock compensation charges aggregating approximately
$53.8 million in connection with the granting of stock options. The stock
options were granted at exercise prices equal to the fair value of the
underlying CombiMatrix stock on the date of grant as determined in good faith by
CombiMatrix's board of directors. Such exercise prices were subsequently
determined to be below fair value due to a substantial step-up in the fair value
of CombiMatrix pursuant to a valuation provided by an investment banker in
contemplation of a potential CombiMatrix initial public offering in 2000. In
connection with the proposed CombiMatrix initial public offering and pursuant to
Securities and Exchange Commission rules and guidelines, we were required to
reassess the value of stock options issued during the one-year period preceding
the potential initial public offering and utilize the stepped-up fair value
provided by the investment banker for purposes of determining whether such stock
option issuances were compensatory, resulting in the calculation of the $53.8
million in deferred non-cash stock compensation charges in 2000. Deferred
non-cash stock compensation charges are being amortized by CombiMatrix over the
respective option grant vesting periods, which range from one to four years. At
September 30, 2002, remaining non-cash deferred stock compensation, net of past
amortization, and the impact of previous forfeitures and cancellations totaled
$5.6 million.
The remaining deferred non-cash stock compensation balance as of
September 30, 2002 related to stock options issued by CombiMatrix represents the
future non-cash deferred stock compensation expense that will be reflected in
our consolidated statements of operations and comprehensive loss as non-cash
stock compensation charges over the next nine quarters from October 1, 2002
through December 31, 2004 as follows:
FIRST SECOND THIRD FOURTH
YEAR QUARTER QUARTER QUARTER QUARTER TOTAL
---- -------- ---------- -------- ---------- ----------
2002 $ -- $ -- $ -- $1,097,000 $1,097,000
2003 999,000 1,002,000 964,000 542,000 3,507,000
2004 327,000 322,000 292,000 59,000 1,000,000
----------
$5,604,000
==========
Non-cash deferred stock compensation expense scheduled to be recognized
in future periods reflected above may be impacted by certain subsequent stock
option transactions including modification of terms, cancellations, forfeitures
and other activity.
INFLATION
Inflation has not had a significant impact on us or our subsidiaries.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2002, we had cash and short-term investments of $57.8
million on a consolidated basis, including discontinued operations, of which
Acacia Research Corporation, on a stand-alone basis excluding our subsidiaries,
had $35.3 million. Working capital was $39.6 million on a consolidated basis at
September 30, 2002. There were no significant financing activities for the three
months ended September 30, 2002.
In October 2002, CombiMatrix was in non-compliance with one of its
covenants under its capital lease obligation with a commercial bank. CombiMatrix
paid the remaining balance of the obligation in the amount of $2.1 million on
November 1, 2002.
We have no significant commitments for capital expenditures in 2002.
Our minimum rental commitments, including CombiMatrix, on operating leases
related to continuing operations total $13.4 million through February 2007. We
have no committed lines of credit or other significant committed funding. We
anticipate that existing working capital reserves will provide sufficient funds
to meet our working capital needs for at least the next twelve months in the
absence of making any major new investments.
21
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 3 to the interim financial statements included elsewhere
herein.
RISK FACTORS
Set forth below and elsewhere in this Quarterly Report and in the
other documents we file with the Securities and Exchange Commission are risks
and uncertainties that could cause our actual results to differ materially from
the results contemplated by the forward-looking statements contained in this
Quarterly Report.
RISKS RELATING TO OUR BUSINESS
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 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.
BECAUSE OF THE RISKS INHERENT IN INVESTING IN EMERGING COMPANIES, INCLUDING THE
LACK OF OPERATING HISTORIES AND UNPROVEN TECHNOLOGIES AND PRODUCTS, WE MAY INCUR
SUBSTANTIAL LOSSES.
Investing in emerging companies carries a high degree of risk,
including difficulties in selecting ventures with viable business plans and
acceptable likelihoods of success and future profitability. There is a high
probability of loss associated with investments in emerging companies. We must
also dedicate significant amounts of financial resources, management attention
and personnel to identify and develop each new business opportunity without any
assurance that these expenditures will prove fruitful.
We generally invest in start-up ventures with no operating histories,
unproven technologies and products and, in some cases, without experienced
management. We may not be successful in developing these start-up ventures.
Because of the uncertainties and risks associated with such start-up ventures,
we could experience substantial losses associated with failed ventures.
22
In addition, the market for venture capital in the United States is
increasingly competitive. As a result, we may lose business opportunities and
may need to accept financing and equity investments on less favorable terms.
Also, we may be unable to participate in additional ventures because we lack the
financial resources to provide them with full funding. We, as well as our
subsidiary companies, may need to depend on external financing to provide
sufficient capital.
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 of $136.8 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, including operating losses of $43.2 million in
2001 and $53.5 million for the nine months ended September 30, 2002. 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.
TECHNOLOGY COMPANY STOCK PRICES ARE ESPECIALLY VOLATILE, AND THIS VOLATILITY MAY
DEPRESS OUR STOCK PRICE.
Our common stock, which is quoted on the NASDAQ Market, has experienced
significant price and volume fluctuations. Additionally, the stock market
generally, and the stock prices of technology companies specifically, have been
very volatile. The market price of our common stock may fluctuate significantly
in response to a number of factors beyond our control, including:
o changes in financial estimates by securities analysts;
o our failure to meet the expectations of securities analysts;
o announcements by us, our customers, our subsidiaries or our
competitors;
o changes in market valuations of similar companies;
o changes in accounting rules and regulations; and
o future sales of our common stock by our existing stockholders.
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.
BECAUSE OUR OPERATING RESULTS HAVE FLUCTUATED SIGNIFICANTLY AND MAY CONTINUE TO
DO SO IN THE FUTURE, OUR STOCK PRICE MAY BE VERY VOLATILE.
Each of the risk factors described below may cause our operating
results to vary significantly from quarter to quarter. As a result of these and
other risk factors, the price of our stock may be more volatile than the stock
prices of other companies. Certain risk factors specific to our subsidiaries are
listed in the following risk factor.
The risks affecting our operating results include:
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;
23
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;
o the cost of future acquisitions, which may increase due to
intense competition from other potential acquirers of
technology-related companies or ideas; and
o our ability to generate a consistent source of recurring
revenue to fund expenses incurred in pursuing and developing
new business ventures.
BECAUSE OUR SUBSIDIARY COMPANIES MAY NOT GENERATE ANY 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. The revenues and operating results of each
of our subsidiary companies have fluctuated in the past and may continue to
fluctuate significantly from quarter to quarter in the future. 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. The following are among the factors that could cause each subsidiary
company's operating results to fluctuate significantly from period to period:
o the stage of development of the business;
o the technical feasibility of their technologies and
techniques;
o their ability to exploit and commercialize technology;
o the timing of new product introductions;
o the novelty of their technology;
o the accuracy, effectiveness and reliability of their products;
o the level of product acceptance;
o the volume and timing of orders received and product line
maturation;
o the nature, pricing and timing of their and their competitors'
products;
o changes in their and their competitors' research and
development budgets;
o access to distribution channels;
o the timing of payments under the terms of any customer or
license agreements;
o the strength of their intellectual property rights;
o their ability to avoid infringing the intellectual property
rights of others;
o expenses related to, and the results of, patent filings and
other proceedings relating to intellectual property rights;
o expenses related to, and their ability to comply with,
governmental regulations of products and processes; and
o costs related to acquisitions, alliances, licenses and other
efforts to expand