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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
[ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER 0-26068
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ACACIA RESEARCH CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 95-4405754
(State or other jurisdiction of (I.R.S. Employer
incorporation organization) Identification No.)
500 NEWPORT CENTER DRIVE, NEWPORT BEACH, CA 92660
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (949) 480-8300
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
ACACIA RESEARCH - ACACIA TECHNOLOGIES COMMON STOCK, $0.001 PAR VALUE
(TITLE OF CLASS)
ACACIA RESEARCH - COMBIMATRIX COMMON STOCK, $0.001 PAR VALUE
(TITLE OF CLASS)
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Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark that disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K [ ]
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [X] No [ ]
The aggregate market value of the registrant's voting stock held by
non-affiliates of the registrant, computed by reference to the last sales price
of such stock reported on The Nasdaq Stock Market, as of June 28, 2002, was
approximately $136,536,756. (All officers and directors of the registrant are
considered affiliates.)
As of March 21, 2003, 19,640,808 shares of Acacia Research-Acacia
Technologies common stock were issued and outstanding. As of March 21, 2003,
22,985,186 shares of Acacia Research-CombiMatrix common stock were issued and
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement for its
Annual Meeting of Stockholders to be filed with the Commission within 120 days
after the close of its fiscal year are incorporated by reference into Part III.
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FORM 10-K ANNUAL REPORT
FISCAL YEAR ENDED DECEMBER 31, 2002
ACACIA RESEARCH CORPORATION
ITEM PAGE
- ---- ----
PART I
1. Business..................................................................1
2. Properties...............................................................20
3. Legal Proceedings........................................................20
4. Submission of Matters to a Vote of Security Holders......................21
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters....22
6. Selected Financial Data..................................................24
7. Management's Discussion and Analysis of Financial Condition and Results
of Operations............................................................29
7A. Quantitative and Qualitative Disclosures About Market Risk...............81
8. Financial Statements and Supplementary Data..............................81
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.....................................................81
PART III
10. Directors and Executive Officers of the Registrant.......................82
11. Executive Compensation...................................................82
12. Security Ownership of Certain Beneficial Owners and Management...........82
13. Certain Relationships and Related Transactions...........................82
14. Controls and Procedures..................................................82
PART IV
15. Exhibits, Financial Statement Schedules and Reports on Form 8-K..........83
PART I
CAUTIONARY STATEMENT
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.
As used in this Form 10-K, "we," "us" and "our" refer to Acacia
Research Corporation and its subsidiary companies.
ITEM 1. BUSINESS
Acacia Research Corporation develops, acquires and licenses enabling
technologies for the life sciences and media technologies sectors, which
comprise the two business groups of Acacia Research Corporation.
Our life sciences business, referred to as the "CombiMatrix group," is
comprised of our wholly owned subsidiary, CombiMatrix Corporation and
CombiMatrix Corporation's majority-owned subsidiaries, Advanced Material
Sciences, Inc., or Advanced Material Sciences, and CombiMatrix KK. Our core
technology opportunity in the life sciences sector has been developed by
CombiMatrix Corporation. CombiMatrix Corporation is a life sciences technology
company with a proprietary system for rapid, cost competitive creation of DNA
and other compounds on a programmable semiconductor chip. This proprietary
technology has significant applications relating to genomic and proteomic
research. Advanced Material Sciences, a development stage company, holds the
exclusive license for CombiMatrix Corporation's biological array processor
technology in certain fields of material sciences. CombiMatrix KK, a
majority-owned Japanese corporation located in Tokyo, is exploring opportunities
for CombiMatrix Corporation's active biochip system with academic,
pharmaceutical and biotechnology organizations in the Asian market.
Our media technologies business, collectively referred to as "Acacia
Technologies group," owns patented intellectual property in the media
technologies sector. The Acacia Technologies group owns patented digital media
transmission, or DMT, technology enabling the digitization, encryption, storage,
transmission, receipt and playback of digital content. The DMT technology is
protected by five U.S. and seventeen international patents. The DMT technology
is utilized by a variety of companies, including cable companies, hotel in-room
entertainment companies, Internet movie companies, Internet music companies,
on-line adult entertainment companies, on-line learning companies and other
companies that stream audio or audio/videos content. The Acacia Technologies
group also owns patented technology known as the V-chip. The V-chip was adopted
by manufacturers of televisions sold in the U.S. to provide blocking of certain
programming based upon its content rating code, in compliance with the
Telecommunications Act of 1996. The V-chip technology is protected by U.S.
Patent No. 4,554,584, which expires in July 2003.
1
Following is a summary of the principal wholly owned companies that
constitute our two business groups:
GROUP / COMPANY DESCRIPTION OF BUSINESS
- --------------- -----------------------
COMBIMATRIX GROUP:
CombiMatrix Corporation A life sciences technology company with a
proprietary system for rapid, cost
competitive creation of DNA and other
compounds on a programmable semiconductor
chip. This proprietary technology has
significant applications relating to genomic
and proteomic research, biological and
chemical detection and combinatorial
chemistry markets.
Advanced Material Sciences, a development
stage company and majority-owned subsidiary
of CombiMatrix Corporation, holds the
exclusive license for CombiMatrix
Corporation's biological array processor
technology in certain fields of material
sciences. CombiMatrix KK, a majority-owned
Japanese subsidiary of CombiMatrix
Corporation, is exploring opportunities for
CombiMatrix Corporation's active biochip
system with pharmaceutical and biotechnology
companies in the Asian market.
ACACIA TECHNOLOGIES GROUP:
Acacia Media Technologies A media technology company that owns
Corporation patented digital media transmission
technology used to digitize, encrypt, store,
transmit, receive and playback digitized
content sent via pathways such as cable,
satellite and the Internet, and covering a
variety of services such as those commonly
known as video-on-demand, audio-on-demand
and streaming media.
Soundview Technologies A media technology company that owns
Incorporated intellectual property related to the
telecommunications field, including a
television blanking system, also known as
"V-chip," which it licenses to television
manufacturers.
RECAPITALIZATION AND MERGER TRANSACTIONS
On December 11, 2002, our stockholders voted in favor of a
recapitalization transaction whereby we created two new classes of common stock
called "Acacia Research-CombiMatrix stock," or AR-CombiMatrix stock, and "Acacia
Research-Acacia Technologies stock," or AR-Acacia Technologies stock, and
divided our existing Acacia Research Corporation common stock into shares of the
two new classes of common stock. AR-CombiMatrix stock is intended to reflect
separately the performance of Acacia Research Corporation's CombiMatrix group,
and to benefit from its licensing and research and development efforts.
AR-Acacia Technologies stock is intended to reflect separately the performance
of Acacia Research Corporation's Acacia Technologies group and to benefit from
the licensing of its technologies. In the recapitalization, which became
effective on December 13, 2002, Acacia Research Corporation stockholders
received 0.5582 of a share of AR-CombiMatrix stock, and one share of AR-Acacia
Technologies stock, for each share of common stock that they owned. Although the
AR-CombiMatrix stock and the AR-Acacia Technologies stock are intended to
reflect the performance of our different business groups, they are both classes
of common stock of Acacia Research Corporation and are not stock issued by the
respective groups. The AR-Acacia Technologies stock is listed on the Nasdaq
National Market System, and the AR-CombiMatrix stock is listed on the Nasdaq
SmallCap Market.
On December 11, 2002 Acacia Research Corporation stockholders and
CombiMatrix Corporation stockholders voted in favor of a merger transaction
pursuant to which we acquired the stockholder interests in CombiMatrix
Corporation not already owned by us (52% of the total stockholder interests in
CombiMatrix Corporation). The acquisition was accomplished through a merger,
effective December 13, 2002, in which stockholders of CombiMatrix Corporation
other than Acacia Research Corporation received one share of the new
AR-CombiMatrix stock in exchange for each share of CombiMatrix Corporation
common stock that they owned immediately prior to the merger. On December 11,
2002, the stockholders of Acacia Research Corporation also approved the adoption
of two new stock incentive plans for the two business groups.
Ninety-eight percent of the Acacia Research Corporation stockholders
who voted in person or by proxy at the special meeting, voted in favor of the
recapitalization and merger transactions and for the approval of the adoption of
the new stock incentive plans.
2
COMPANY
Acacia Research Corporation, a Delaware corporation, was originally
incorporated in California in January 1993 and reincorporated in Delaware in
December 1999. Our website address is www.acaciaresearch.com. We make our
filings with the Securities and Exchange Commission, or SEC, including our
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, and amendments to those reports, available free of charge on our
website as soon as reasonably practicable after we file these reports. The
public may read and copy any materials that Acacia Research Corporation files
with the SEC at the SEC's Public Reference Room at 450 Fifth Street N.W.,
Washington, D.C. 20549. The public may obtain information on the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC
maintains an Internet website that contains reports, proxy and information
statements, and other information regarding issuers, including the Acacia
Research Corporation, that file electronically with the SEC. The public can
obtain any documents that Acacia Research Corporation files with the SEC at
http://www.sec.gov.
BUSINESS GROUPS
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BUSINESS
The CombiMatrix group is comprised of CombiMatrix Corporation, a wholly
owned subsidiary of Acacia Research Corporation, and its subsidiaries, Advanced
Material Sciences and CombiMatrix KK. The CombiMatrix group includes corporate
assets, liabilities and transactions of Acacia Research Corporation that relate
to its life sciences business. CombiMatrix Corporation is engaged in the
development of a proprietary universal biochip with applications in the
genomics, proteomics and combinatorial chemistry fields, and has emerged from
the development stage during the year ended December 31, 2002.
The CombiMatrix group is developing a technology to allow it, its
customers and any entities with which the CombiMatrix group has joint
development efforts to rapidly produce customizable biological array processors,
which are semiconductor-based tools for use in identifying and determining the
roles of genes, gene mutations and proteins. The CombiMatrix group is designing
its products principally to be responsive to the needs of pharmaceutical and
biotechnology researchers to analyze raw genomic data in the discovery and
development of pharmaceutical products. The CombiMatrix group's biological array
processor is a semiconductor coated with a three-dimensional layer of porous
material in which DNA, RNA, proteins, peptides or small molecules can be
synthesized or immobilized within discrete test sites. The CombiMatrix group
integrates a micro-fabricated semiconductor chip, proprietary software,
chemistry and hardware into a system that it believes will enable it, its
customers and any entities with which the CombiMatrix group has joint
development efforts, to design, customize and fabricate biological array
processors made to user's specifications, typically in less than a day. The
CombiMatrix group's system should enable researchers to conduct rapid, iterative
experiments to analyze the large amounts of genomic information generated by the
Human Genome Project and other genomic research efforts. The CombiMatrix group
believes that its customizable biological array processors will enable users to
reduce the time and costs associated with the discovery and development of
pharmaceutical products.
Advanced Material Sciences is a development stage company that holds an
exclusive license to CombiMatrix Corporation's biological processor technology
within the field of material science. Material science includes fuel cell
catalysts, battery materials, sensor arrays, electronic and electrochemical
materials and other materials relating to the use, storage, conversion and
delivery of energy other than those involving living or biologic systems. On
April 25, 2002, CombiMatrix Corporation purchased Acacia Research Corporation's
interest in Advanced Material Sciences. CombiMatrix Corporation currently owns
87% of Advanced Material Sciences and the remaining interests are owned by
unaffiliated third parties.
CombiMatrix KK, a Japanese corporation, was formed in 2001 for the
purpose of exploring opportunities for CombiMatrix Corporation's active biochip
system with academic, pharmaceutical and biotechnology organizations in the
Asian market. In October 2001, CombiMatrix KK entered into a joint venture with
Marubeni Japan, one of Japan's leading trading companies. The joint venture will
focus on further development and licensing opportunities for CombiMatrix
Corporation's biochip technology in Asia. Marubeni made a $1.1 million
investment in exchange for a 10% minority interest in CombiMatrix KK.
3
MARKET OVERVIEW AND TECHNOLOGY BACKGROUND
GENERAL OVERVIEW
The pharmaceutical and biotechnology industries are faced with
increasing costs and substantial risks of failure in the drug discovery,
development and commercialization process. The time required to successfully
commercialize a new proprietary drug now averages 15 years, and the direct and
indirect costs of the process average almost $800.0 million per drug. Less than
1% of all new chemical compounds that are developed by pharmaceutical companies
result in pharmaceutical products that are approved for patient use. The
pharmaceutical and biotechnology industries are attempting to reduce their costs
and risks of failure by turning to new technologies to help identify
deficiencies in drug candidates as early as possible in the process so that drug
discovery and development become more efficient and cost-effective.
Additionally, with vast amounts of genomic data becoming available for use in
the development of therapeutics and diagnostic tests, they are searching for
ways to expedite their analysis of available genomic data so that they can be
the first to bring new therapeutics and diagnostic tests to market.
DRUG DISCOVERY AND DEVELOPMENT
The discovery and development of new drugs for a particular disease
typically involve several steps. First, researchers identify a target for
therapeutic intervention, such as a protein, that is either directly involved in
the disease or lies in a biochemical pathway leading to the disease. The next
step is to identify chemical compounds that interact with the target and
modulate the target's activity in a manner that might help reverse, inhibit or
prevent the disease. The most promising compounds to emerge from this process
advance to the next stage, where synthetic derivatives of the compounds are
generated and tested to determine a lead compound. The interactions of these
lead compounds with the target and their activity in animal or cellular models
of the disease are then tested to determine which compounds might be developed
successfully into new drugs. The best new drug candidates then begin clinical
trials in humans.
Recent advances have led to the use of genomics in choosing targets for
drug development. This process begins with the discovery and identification of
genes within the genome and the functions of these genes in regulating
biological processes and disease. This information is used to assess the value
of a particular gene or its protein product as a target for drug discovery. Once
a target is chosen, high throughput chemistry and other drug discovery methods
are used to identify chemical compounds that interact with the target and might
help reverse, inhibit or prevent the disease. These compounds are then tested in
pre-clinical and clinical development programs.
According to industry statistics, pharmaceutical and biotechnology
companies world-wide spent approximately $50.0 billion on drug research and
development during 2000. Of this amount, approximately $13.0 billion was spent
on drug discovery and $7.0 billion on pre-clinical testing and clinical trials,
with the remainder on toxicology, post-marketing evaluations and other matters.
The CombiMatrix group believes that biological array processors,
whether they contain DNA, peptides or proteins, have potential applications in
all major phases of drug discovery and development. In the discovery phase, the
CombiMatrix group believes biological array processors can facilitate the
process of identifying and validating targets and lead compounds. In the
development phase, the CombiMatrix group believes biological array processors
can enhance the speed and accuracy of the toxicology, pre-clinical and clinical
development process. The CombiMatrix group believes that biological array
processors can also play a role in monitoring the therapeutic effectiveness of
drugs that have been approved for use.
GENES AND PROTEINS
The human body is composed of billions of cells each containing DNA
that encodes the basic instructions for cellular function. The complete set of
an individual's DNA is called the genome, and is organized into 23 pairs of
chromosomes, which are further divided into smaller regions called genes. Each
gene is composed of a strand of four types of nucleotide bases, referred to as
A, C, G and T. The bases of one DNA strand bind to the bases of the other strand
in a specific fashion to form base pairs: the base A always binds with the base
T and the base G always binds with the base C.
The human genome has approximately 3.0 billion nucleotides and their
precise order is known as the DNA sequence. When a gene is turned on, or
expressed, the genetic information encoded in the DNA is copied to a specific
type of RNA, called messenger RNA, or mRNA. The mRNA provides instructions for
the synthesis of proteins. Proteins direct cellular function, the development of
individual traits and are involved in many diseases. Variations in any part of
the sequence of DNA, called polymorphisms, can interfere with the normal
function of proteins and may result in a change in cell function leading to
disease, a predisposition to disease, an adverse response to drugs or other
unwanted effects.
4
GENE EXPRESSION PROFILING
Gene expression profiling is the process of determining which genes are
active in a specific cell or group of cells and is accomplished by measuring
mRNA, the intermediary between genes and proteins. By comparing gene expression
patterns between cells from normal tissue and cells from diseased tissue,
researchers may identify specific genes or groups of genes that play a role in
the presence of disease. Studies of this type, used in drug discovery, require
monitoring thousands, and preferably tens of thousands, of mRNAs in large
numbers of samples. As the correlation between gene expression patterns and
specific diseases is determined, the CombiMatrix group believes that gene
expression profiling will have an increasingly important role as a diagnostic
tool. Diagnostic use of expression profiling tools is anticipated to grow
rapidly with the combination of the sequencing of various genomes and the
availability of more cost-effective technologies.
GENETIC VARIATION AND FUNCTION
Genetic variation is mostly due to polymorphisms in genomes, although
functional variations may also arise from differences in the way genes are
expressed in a given cell, as well as the timing and levels of their expression.
Although most cells contain an individual's full set of genes, each cell
expresses only a small fraction of this set in different quantities and at
different times.
The most common form of genetic variation occurs as a result of a
difference in a single nucleotide in the DNA sequence, commonly referred to as a
single nucleotide polymorphism, or SNP. The human genome is estimated to contain
between three and six million SNPs. By screening for polymorphisms, researchers
seek to correlate variability in the sequence of genes with a specific disease.
SNPs are believed to be associated with a large number of human diseases,
although most SNPs are believed to be benign and not to be associated with
disease. Determining which SNPs may be related to a disease is a complex process
requiring investigation of a vast number of SNPs. An SNP association study might
require testing for 300,000 possible SNPs in 1,000 patients. Although only a few
hundred of these SNPs might be clinically relevant, 300.0 million genotyping
tests, or assays, might be required to complete a study. Using available
technologies, this scale of SNP genotyping is both impractical and prohibitively
expensive.
While in some cases one SNP will be responsible for medically important
effects, it is now believed that the genetic component of most major diseases is
associated with a combination of SNPs. As a result, the scientific community has
recognized the importance of investigating combinations of many SNPs in an
attempt to discover medically valuable information. In order to understand how
genetic variation causes disease, researchers must compare gene sequence
polymorphisms, or conduct SNP genotyping, from healthy and diseased individuals.
Researchers may also compare gene expression patterns, or perform gene
expression profiling, from healthy and diseased tissues.
SNP GENOTYPING
SNP genotyping is the process of comparing individuals' gene sequences
to identify variations in these sequences and determine the significance of
these variances. The CombiMatrix group believes that large-scale SNP genotyping,
when commercially feasible, has the potential to be used for a variety of
applications including: o genomics-based drug development; o clinical trial
design and analysis; o testing for predisposition to, and diagnosis of, disease;
o predicting the effectiveness of therapeutics; and o applications outside
healthcare.
PROTEOMICS
Proteomics is the process of determining which proteins are present in
cells, how they interact with one another and how they are correlated with
genomic variation. This process is useful in drug discovery and diagnostics
because most drugs target proteins that play a role in the existence or
development of a disease. Although the potential market for proteomic products
is uncertain, the CombiMatrix group believes that proteomics may have
applications in:
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o discovery of new drug targets and new biochemical pathways;
o measurement of protein expression and modification; and
o correlation of protein variation and function with genomic
variation and function.
CURRENT TECHNOLOGIES
There are currently a variety of traditional technologies available for
analyzing genetic variation and function. Traditional technologies generally
perform assays individually, or serially, and often require relatively large
sample volumes, adding significantly to the costs of assays. In addition, most
traditional technologies have limited flexibility to perform different
applications. Arrays were developed to overcome the limitations of traditional
technologies.
An array is a collection of miniaturized test sites arranged on a
surface that permits many tests to be performed simultaneously, or in parallel,
in order to achieve higher throughput. The average size of test sites in an
array and the spacing between them defines the array's density. Higher density
increases parallel processing throughput. In addition to increasing the
throughput, higher density reduces the required volume for the sample being
tested, and thereby lowers costs. Currently, the principal commercially
available ways to produce arrays include mechanical deposition, bead
immobilization, inkjet printing and photolithography.
While current array technologies have advantages over traditional
technologies, the CombiMatrix group believes the full market potential for
testing devices to study genetic variation and function has not been realized.
This is true for a number of reasons, including the following:
o HIGH COST. Many currently available array technologies require
relatively expensive capital equipment for manufacturing and
customizing arrays and reading test results.
o LOW THROUGHPUT. Some array technologies produce a relatively
low density of test sites, which results in low throughput.
o LIMITED APPLICATION. Many array technologies have limited
application outside of SNP genotyping and gene expression
profiling, for example in proteomics.
o INCONVENIENCE. Many array manufacturers do not offer
researchers all elements required to design arrays and to
complete and analyze their tests, such as test devices,
software, instrumentation and reagents.
o INABILITY TO FABRICATE IN-HOUSE. Most array manufacturers will
ship pre-fabricated arrays to customers, even though large
customers have a tremendous desire to fabricate their own
arrays in-house.
THE COMBIMATRIX GROUP SOLUTION
The CombiMatrix group believes that its integrated system has
advantages over other existing technologies because it will be a cost-effective,
fast, flexible, customizable alternative to existing analytical tools designed
for similar purposes. Researchers using the CombiMatrix group's system should be
able to design and order custom biological array processors or fabricate them
in-house, conduct their tests, analyze the results in the relatively inexpensive
hybridizer-reader supplied by the CombiMatrix group or any entities with which
the CombiMatrix group has joint development efforts, and reorder additional
custom biological array processors incorporating modified test parameters, all
within a few days. In addition, customers who wish to fabricate arrays
themselves will be able to utilize the CombiMatrix group's synthesizers and
blank chips to produce their own arrays.
The CombiMatrix group believes that its biological array processor
system will offer several advantages over competing products that are
commercially available. The principal scientific advantages of its system are
derived from the following three features:
o the CombiMatrix group's proprietary software, which directs
the individually controlled electrodes at the test sites on
the surface of its semiconductors and allows the CombiMatrix
group to synthesize or immobilize different sequences of DNA
or RNA, peptides or small molecules;
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o its virtual flask technology, which uses the chemistry of
carefully engineered liquid solutions instead of physical
walls around each electrode and avoids the problem of chemical
contamination between test sites; and
o its porous reaction layer, which coats one surface of the
semiconductor and may function as a three-dimensional
environment for the synthesis or immobilization of relatively
large quantities of DNA, RNA, peptides or small molecules so
that a stronger test signal is generated at each test site.
As a result of these scientific features, the CombiMatrix group
believes that the system it is designing will have the following
characteristics:
o RAPIDLY CUSTOMIZABLE. The CombiMatrix group believes its
proprietary software, chemistry and semiconductor system will
allow it or its partners to design, customize and ship
biological array processors for SNP genotyping and gene
expression profiling that are tailored to meet a customer's
specifications in a relatively short time, typically as little
as a day. The CombiMatrix group's customization time should be
short because it intends to rely on proprietary software and
chemical processes, rather than costly and often imprecise
mechanical methods, to produce its biological array
processors. The CombiMatrix group believes researchers will be
able to compress the time required to complete an iterative
series of genomic tests because of the short turnaround time
that should be required for the delivery of its customized
biological array processors.
o VERSATILE. The CombiMatrix group system can design and create
sequences of DNA, RNA, peptides or small molecules in the test
sites on its biological array processors, although its first
product will be limited to DNA sequences.
o HIGH THROUGHPUT. The CombiMatrix group's synthesizers will
enable its customers to fabricate from six to forty custom
designed biological array processors per day with a total of
up to several thousand test sites per processor.
o ACCURATE AND COST-EFFECTIVE. Relatively large amounts of DNA,
RNA, peptides or small molecules that can be synthesized or
immobilized in the porous reaction layer at each test site
generate strong assay signals that facilitate accurate
interpretation of test data. These strong assay signals will
enable the CombiMatrix group's customers to analyze the
results of their tests without investing in the relatively
expensive capital equipment needed to detect weak signals.
o CONVENIENT AND INTEGRATED. The CombiMatrix group plans to
offer its strategic partners and customers a complete system
including the software, biological array processors,
instrumentation and reagents necessary to design and perform
their assays and obtain an analysis of the results. Typically,
tests using the CombiMatrix group's biological array
processors should be able to be completed and analyzed within
hours by using the equipment, reagents and software supplied
by the CombiMatrix group.
o MANUFACTURING SCALABILITY. The CombiMatrix group believes it
will be able to increase production to respond to increased
demand because its semiconductors are manufactured by others
using conventional semiconductor fabrication methods and its
customization equipment can be rapidly assembled by the
CombiMatrix group or any entities with which the CombiMatrix
group has joint development efforts.
PRODUCTS AND SERVICES
The CombiMatrix group's technology potentially represents a significant
advance over existing biochip technologies and other platforms for combinatorial
chemistry. The first application of the technology that the CombiMatrix group is
pursuing is in the field of genomics, where it is developing a biochip for the
analysis of DNA. The CombiMatrix group believes that this technology may be
applied to the fields of genetic analysis and disease management. The
CombiMatrix group is also developing the chip in the emerging field of
proteomics, where analysis of DNA is correlated to the levels of proteins in
patient samples. Many researchers believe that the analysis of proteomic
information will lead to the development of new drugs and better disease
management. Once the CombiMatrix group demonstrates the feasibility of its
approach in each market, it intends to enter into strategic alliances with major
participants to speed commercialization in multiple applications. In addition,
the CombiMatrix group is exploring opportunities to utilize its technology for
the detection of the presence of chemical and biological warfare agents.
7
THE COMBIMATRIX GROUP'S STRATEGY
The CombiMatrix group's goal is to provide biotechnology and
pharmaceutical companies and academic researchers with the industry standard
solution for rapid evaluation of genetic function/variation, proteomic research
and bioinformatic tools.
FOCUSING ON HIGH-GROWTH MARKETS
The CombiMatrix group is initially focusing on the gene expression
profiling, SNP genotyping, proteomic and bioinformatics markets. Initial product
sales will be derived from the CombiMatrix group's DNA synthesizers, DNA
microarrays, hybridization-reader system and bioinformatic tools. The
CombiMatrix group believes the market for its rapid customization microarrays
and in-house synthesizers has the potential for high growth due to increasing
demand for therapeutics and diagnostics based on newly available genomic
information. To date, the lack of high-throughput and cost-effective
technologies and the slow turnaround of current technologies has limited the
growth of this market.
PARTNERING WITH MULTIPLE COMPANIES TO EXPAND MARKET OPPORTUNITY
The CombiMatrix group plans to pursue multiple relationships to
facilitate the expansion of its semiconductor based microarray technologies and
to exploit large and diverse markets. The CombiMatrix group expects to enter
into relationships and collaborations to gain access to complementary
technologies, distribution channels, manufacturing infrastructure and
information content. The CombiMatrix group intends to structure relationships
that maximize its research and development efforts with the strong distribution
and manufacturing capabilities of its customers and any entities with which the
CombiMatrix group has joint development efforts, enabling industry standard
solutions for pharmaceutical and biotechnology researchers. Such a strategy will
enable the CombiMatrix group to focus on its strength, which is research and
development, and leverage the strengths of any entities with which it has
entered into agreements to commercialize its products.
COMMERCIALIZING AND MANUFACTURING DESKTOP SYNTHESIZERS AND MICROARRAY
TECHNOLOGY FOR GENE EXPRESSION PROFILING AND MOLECULAR DIAGNOSTICS
The CombiMatrix group intends to rapidly commercialize its microarray
technology for gene expression profiling through agreements to jointly develop
technology. The CombiMatrix group has an agreement with Roche Diagnostics GmbH,
or Roche, to jointly develop technology. Roche contributes extensive expertise
in instrument and reagent development, as well as offers a large and experienced
worldwide sales and marketing team. The CombiMatrix group believes that the
combination of its microarray technology with Roche's leadership position in the
genetic analysis and diagnostic markets will enable it to capture a significant
portion of the gene expression profiling and molecular diagnostic markets.
In addition to Roche, the CombiMatrix group plans on establishing other
relationships for its DNA microarray technology. The CombiMatrix group also
intends on establishing alliances for its proteomic and bioinformatic products.
EXPANDING TECHNOLOGIES INTO MULTIPLE PRODUCT LINES
The CombiMatrix group intends to utilize the flexibility of its
semiconductor based microarray technologies to develop multiple product lines.
In addition to providing new sources of revenue, it believes these product lines
will further its goal of establishing its microarray technology as the industry
standard for array-based analysis.
STRENGTHENING TECHNOLOGICAL LEADERSHIP
The CombiMatrix group plans to continue advancing its proprietary
technologies through its internal research efforts, collaborations with industry
leaders and strategic licensing. The CombiMatrix group may also pursue
acquisitions of complementary technologies and leverage its technologies into
other value-added businesses. Its efforts to strengthen its technology include
the following:
o RAPIDLY COMMERCIALIZING ITS SNP GENOTYPING AND GENE EXPRESSION
PROFILING PRODUCTS. The CombiMatrix group is initially
focusing on the SNP genotyping and gene expression profiling
markets because it believes that there is substantial demand
for tools that help analyze newly available genomic
information and thereby assist pharmaceutical and
biotechnology companies in developing new drugs and diagnostic
tools. Typically, sales of products in these markets do not
require advance clearance by the U.S. Food and Drug
Administration, or FDA, and as a result, can be achieved more
quickly and with less cost than sales of regulated devices.
8
o DEVELOPING PRODUCT APPLICATIONS IN PROTEOMICS. Proteomic
research has not developed as rapidly as SNP genotyping and
gene expression profiling because of the absence of effective
technology and tools for conducting research. The CombiMatrix
group believes that its biological array processor system can
be developed to facilitate proteomic research. The CombiMatrix
group has developed chemical processes for the rapid
immobilization of proteins and small molecules within the test
sites on its biological array processors. The CombiMatrix
group believes its system may be particularly effective in
proteomic research because the proprietary materials that can
be used to form the three-dimensional porous reaction layer on
its biological array processors are a hospitable environment
for the immobilization and study of proteins. The CombiMatrix
group has produced customized test devices with peptides and
small molecules for possible use in proteomic research. The
CombiMatrix group is currently developing its technology for
proteomic applications.
o EXPANDING PROPOSED PRODUCT OFFERINGS. The CombiMatrix group is
engaged in several research and development initiatives to
expand its product offerings by increasing the density of its
biological array processors and by developing additional
applications of its technology for drug discovery and
development. The CombiMatrix group believes that the flexible,
parallel processing capabilities of its biological array
processor system may have potential applications related to:
o gene discovery and function characterization;
o specific targeting of drug discovery efforts;
o the development of customized drugs;
o high-throughput screening for pharmaceutical
candidates;
o the development of diagnostic methods for
identifying, classifying and staging diseases;
o the prediction of successful drug therapy for a
particular patient population;
o the identification of an individual patient's
tolerance for a particular drug so that previously
abandoned drugs can be selectively prescribed;
o early recognition of potential adverse response to
drug therapy;
o identification of predisposition to disease in order
to prescribe preventative therapies; and
o identification of the presence of chemical or
biological warfare agents.
However, the CombiMatrix group has not yet produced products to
address or access the potential of its technology in these areas.
o PROTECTING AND STRENGTHENING INTELLECTUAL PROPERTY. Through
the CombiMatrix Corporation's two issued patents in the United
States and one in Europe, its more than 44 patent applications
pending in the United States, Europe and elsewhere and its
trade secrets, the CombiMatrix group believes it has suitable
intellectual property protection for its proprietary
technologies. The CombiMatrix group plans to build its
intellectual property portfolio through internal research
efforts, collaborations with industry leaders, strategic
licensing and possible acquisitions of complementary
technologies. The CombiMatrix group also plans to pursue
patent protection for downstream products created using its
proprietary products.
THE COMBIMATRIX GROUP SYSTEM AND TECHNOLOGY
The CombiMatrix group anticipates that a customer wishing to use its
bioarray product will use its proprietary software to provide the CombiMatrix
group, or an entity with which the CombiMatrix group has joint development
efforts, with information relating to the sequences that the customer wishes to
evaluate. Array design software will design an initial array of DNA segments and
then instruct a synthesizer unit to customize one or more biological array
processors containing these selected DNA segments. This process will be entirely
automated. The completed biological array processor will be shipped to the
customer along with kits including specific instructions and reagents needed to
conduct these evaluations. The CombiMatrix group expects that the time interval
9
between receipt of the customer's order and shipment of the biological array
processors and reagent kits will typically be a few days or less. Alternatively
for a customer with an in-house synthesizer, the process will be completed
typically overnight. To use the processor, the customer will prepare a sample
and introduce it to the processor. The processor will then be inserted into a
hybridizer-reader unit that the CombiMatrix group, or an entity with which the
CombiMatrix group has joint development efforts, will have supplied to the
customer. Proprietary software will enable the customer to image the processor,
format the data and perform analysis.
In practical operation, the CombiMatrix group expects that a customer
will typically analyze the results of an initial experiment and choose to change
the composition of its biological array processors to further optimize its
performance. For example, a customer may choose to change the sequences of some
array elements, eliminate some sequences altogether or incorporate additional
sequences. The CombiMatrix group's biological array processor system will allow
a researcher to order or fabricate successive arrays with the desired changes.
THE COMBIMATRIX GROUP PROCESS
Each of the CombiMatrix group's biological array processors is made up
of a semiconductor chip on which the CombiMatrix group has installed electrical
conduits and applied a layer of porous material. It will have up to
approximately 10,000 test sites, one for each electrode site on the
semiconductor. The CombiMatrix group can synthesize or immobilize DNA, RNA,
peptides or small molecules within the porous reaction layer at each test site
on the surface of its semiconductor. The CombiMatrix group confines the chemical
synthesis within each test site using chemistry of carefully engineered liquid
solutions. This avoids the problem of chemical contamination between different
test sites. Because confinement is accomplished without physical walls, the
CombiMatrix group refers to this enabling technology as a virtual flask. This
virtual flask technology enables the CombiMatrix group to use semiconductor
devices that are fabricated by contractors using conventional semiconductor
processes.
In the case of the CombiMatrix group's DNA arrays, each test site, or
virtual flask, will contain a particular DNA segment, or capture probe, that is
made by putting nucleotide bases, A, G, C, or T, together one at a time. These
DNA probes typically contain between 16 and 60 nucleotide bases. The CombiMatrix
group's software selectively activates each electrode where a new nucleotide
base is to be added. Once activated, the electrode causes an electrochemical
reaction to occur that produces chemicals that react with the existing chains of
DNA at that site to activate them for bonding with the next nucleotide base.
These electrochemically-generated chemicals are confined by the CombiMatrix
group's virtual flask technology to the region of the porous reaction layer that
surrounds the electrode where they are produced. A fluidics delivery unit then
floods the semiconductor with a solution containing a nucleotide base, which
binds only to the capture probe at activated sites. This cycle is repeated over
and over to produce different DNA segments at each test site. Quality assurance
tests are performed following completion of the synthesis process. The
CombiMatrix group's laboratory tests have confirmed that other substances, such
as peptides, immobilized proteins and antibodies, small organic molecules and
enzymes, among others, can also be chemically isolated in the virtual flasks.
SEMICONDUCTOR COMPONENT
The CombiMatrix group's semiconductors are manufactured by others using
conventional semiconductor fabrication processes. The CombiMatrix group believes
that the total number of test sites on a semiconductor is limited only by the
degree of miniaturization of the semiconductor fabrication process. The
CombiMatrix group believes that its semiconductor architecture is scalable and,
as a result, that it can benefit directly from the substantial investments that
have been made by the semiconductor industry in miniaturizing chip fabrication
processes. At the present time, the CombiMatrix group is using devices made with
a 3.0 micron process size that yield 1,024 potential test sites within less than
a square centimeter. Each of the individual sites is 100 microns in diameter,
about the diameter of a human hair. The CombiMatrix group believes that by using
a standard 0.25 micron semiconductor fabrication process, it can produce a
biological array processor with over 1,000,000 sites per square centimeter,
although it has not yet made or tested a biological array processor with more
than 18,000 potential test sites.
HYBRIDIZER-READER
Hybridization is the binding of DNA sequences in a test sample with the
DNA material that has been created at specific test sites on its biological
array processors. In the case of DNA, segments bind together when the DNA
segments in a sample and the DNA segments on its test sites are complementary.
The CombiMatrix group is developing a combination hybridization chamber and
biological array processor reader that it calls the hybridizer-reader. The
hybridization chamber is being designed to help researchers standardize their
experimental conditions, such as temperature, so that consistent results may be
obtained from experiment to experiment. In the hybridization chamber, a solution
that the researcher wants to analyze will be washed over one or more of the
CombiMatrix group's biological array processors. DNA in the sample that is
10
complementary with the DNA on the capture probes of the CombiMatrix group's
biological array processors will bond. The hybridizer-reader will measure and
identify the presence or absence and relative strength of bonding in the test
sites on the biological array processors using conventional equipment. Because
the optical signals resulting from the tests are stronger than those obtained
from chips that contain a single molecular layer of test material, at its
current chip density the CombiMatrix group will be able to read test results
with a standard video camera system that should be substantially less expensive
than the typical optical reader system needed to read other chips on the market.
If the CombiMatrix group is able to increase substantially the density of its
biological array processor, researchers may be required to use more expensive
equipment to analyze the smaller volume of material bonded at each test site.
IN-HOUSE SYNTHESIZERS
The process of fabricating bioarray processors is performed using an
electrochemical technique, which takes advantage of the virtual flask
technology. This capability enables us to build synthesizers (desk top versions
as well as high-throughput industrial versions) that can be operated at the site
of use. Therefore, customers who choose to fabricate their own arrays can do so
by purchasing, leasing or licensing one of our synthesizers for operation in
their own facilities. This capability will enable customers to utilize array
processors quickly by eliminating the time necessary for shipping from a central
manufacturing facility. In addition, these customers will never be required to
disclose to any party, including the CombiMatrix group, the sequences or genes
in which they are investigating.
SOFTWARE
The CombiMatrix group has designed and is testing integrated, modular
software that will direct the design and customization of its biological array
processors for use in DNA applications. The software required to enable
proteomic research is in the early stages of development.
The CombiMatrix group's current software is being designed to:
o permit customers to access public databases for gene sequence
information;
o permit customers to transmit their research objectives to the
CombiMatrix group or partners over the Internet, or to their
own in-house synthesis lab behind their IT firewall;
o enable the CombiMatrix group to rapidly screen potential DNA
segments against large numbers of DNA targets during its
design process;
o enable the CombiMatrix group to direct its manufacturing
equipment to synthesize DNA segments designed by it on the
surface of its biological array processors; and
o permit the CombiMatrix group to quality check the finished
product.
REGULATORY MATTERS
The CombiMatrix group intends to sell products to the pharmaceutical,
biotechnology and academic communities for research applications. Therefore, its
initial products will not require approval from, or be regulated by, the FDA, as
a manufacturer nor will they be subject to the FDA's current good manufacturing
practice, or cGMP, regulations. Additionally, the CombiMatrix group's initial
products will not be subject to certain reagent regulations promulgated by the
FDA. However, the manufacture, marketing and sale of certain products and
services for any clinical or diagnostic applications will be subject to
extensive government regulation as medical devices in the United States by the
FDA and in other countries by corresponding foreign regulatory authorities.
The FDA requires that a manufacturer seeking to market a new or
modified medical device, or an existing medical device for a new indication,
obtain either a pre-market notification clearance under the Federal Food, Drug
and Cosmetic Act or a showing of substantial equivalence in function to an
existing regulated device. The CombiMatrix group anticipates that its products
will become subject to medical device regulations in the United States only when
they are marketed for clinical uses for any clinical or diagnostic purpose,
excluding pure research or product discovery research purposes. Material changes
to existing medical devices are also subject to FDA review and clearance or
approval prior to commercialization in the United States.
11
Should the CombiMatrix group market products for any clinical or
diagnostic purpose or act as a manufacturer or supplier of products for a
third-party customer to market for any clinical or diagnostic purpose, it will
be required to register as a medical device manufacturer with the FDA. As a
registered manufacturer, the CombiMatrix group would be subject to routine
inspection by the FDA for compliance with cGMP regulations and other applicable
regulations. In addition, the CombiMatrix group must currently comply with a
variety of other federal, state and local laws and regulations relating to safe
work conditions and manufacturing practices. The extent of government regulation
that might result from any future legislation or administration cannot be
predicted. Moreover, there can be no assurance that the CombiMatrix group or its
third-party customers will be able to obtain appropriate FDA regulatory
approvals on a timely basis, or at all, or that the CombiMatrix group will be
able to comply with cGMP regulations.
Sales of the CombiMatrix group's products outside the United States
will be subject to foreign regulatory requirements that vary from country to
country. Additional approvals from foreign regulatory authorities may be
required, and there can be no assurance that the CombiMatrix group will be able
to obtain foreign marketing approvals on a timely basis, or at all, or that it
will not be required to incur significant costs in obtaining or maintaining
foreign regulatory approvals. For example, if the CombiMatrix group products are
marketed for clinical or diagnostic purposes in the European Union, the
CombiMatrix group will have to obtain the certificates required for the "CE"
mark to be affixed to the CombiMatrix group products for sales in European Union
member countries. The "CE" mark is a European Union symbol of adherence to
quality assurance standards and compliance with applicable European Union
directives and regulations.
JOINT VENTURES
In October 2001, CombiMatrix KK, a majority-owned subsidiary of
CombiMatrix Corporation, formed a joint venture with Marubeni Japan, one of
Japan's leading trading companies. The joint venture will focus on development
and licensing opportunities for CombiMatrix Corporation's biochip technology
with academic, pharmaceutical and biotechnology organizations in the Japanese
market. Marubeni made an investment to acquire a 10% minority interest in the
joint venture.
Prior to April 25, 2002, CombiMatrix Corporation owned 28.5% of
Advanced Material Sciences, which in turn held an exclusive license for
CombiMatrix Corporation's microarray synthesis technology for the development
and discovery of advanced electronic materials for such purposes as fuel cell
catalysts. In consideration for this exclusive license, CombiMatrix Corporation
would share in the revenues earned by Advanced Material Sciences for
commercialization of these discoveries based on CombiMatrix Corporation's
microarray technology. The term of this arrangement was 20 years. As the
technology was being developed at Advanced Material Sciences, management
realized that it was inefficient to build redundant infrastructure to perform
this research. Rather than build and buy new equipment and facilities to conduct
materials discovery, it was decided to utilize the existing infrastructure at
CombiMatrix Corporation to more efficiently and quickly perform materials
discovery research. On April 25, 2002, CombiMatrix Corporation acquired Acacia
Research Corporation's majority interest in Advanced Material Sciences in
consideration of 180,982 shares of CombiMatrix Corporation's common stock.
MARKETING AND DISTRIBUTION
In July 2001, CombiMatrix Corporation entered into non-exclusive
worldwide license, supply, research and development agreements with Roche. These
agreements were amended in September 2002, 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 is
considered to be material. Such minor modifications are a standard part of the
research and development process and are routinely made in development
agreements. Since the inception of our relationship with Roche, CombiMatrix
Corporation has 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.
The agreements provide for minimum payments by Roche to CombiMatrix
Corporation over the first three years, including milestone achievements,
payments for products, royalties and research and development projects.
Nevertheless, because our agreements with Roche contain provisions that would
allow Roche to terminate the agreements, the future payments by Roche to
12
CombiMatrix Corporation might never be realized. Since July 2001, CombiMatrix
Corporation has completed several milestones in its strategic alliance with
Roche including demonstration of several key performance metrics of its custom
in-situ microarray system, and has received approximately $16.8 million in cash
payments from Roche from July 2001 through December 31, 2002.
MANUFACTURING AND CUSTOMIZATION
The CombiMatrix group is developing automated, computer-directed
manufacturing processes for the synthesis of sequences of DNA, RNA, peptides or
small molecules in the virtual flasks on its biological array processors.
The CombiMatrix group's biological array processor manufacturing
process will involve:
o processing wafers of semiconductors manufactured by others
into individual devices and installing electrical contacts on
the semiconductor devices; and
o applying the porous reaction layer to the semiconductor
devices.
The CombiMatrix group, or any entities with which the CombiMatrix group
has joint development efforts, will then customize its biological array
processors in response to customer orders by:
o synthesizing test materials in the virtual flasks on the
biological array processors using its synthesis module; and
o checking the quality of the customized biological array
processors.
Initially, the CombiMatrix group plans to rely upon third-party
manufacturers to produce the semiconductors, chemical reagents and accessories
for its products. The CombiMatrix group intends to continue the outsourcing of
portions of its manufacturing process to subcontractors where the CombiMatrix
group determines it is in its best commercial interest.
Substantially all of the components and raw materials used in the
manufacture of the CombiMatrix group's products, including semiconductors and
reagents, are currently provided from a limited number of sources or in some
cases from a single source. Although the CombiMatrix group believes that
alternative sources for those components and raw materials are available, any
supply interruption in a sole-sourced component or raw material might result in
up to a several-month production delay and materially harm the CombiMatrix
group's ability to manufacture products until a new source of supply, if any,
could be located and qualified. In addition, an uncorrected impurity or
supplier's variation in a raw material, either unknown to the CombiMatrix group
or incompatible with its manufacturing process, could have a material adverse
effect on its ability to manufacture products. The CombiMatrix group may be
unable to find a sufficient alternative supply channel in a reasonable time
period, or on commercially reasonable terms, if at all. The CombiMatrix group
utilizes semiconductors made with a 3.0 micron fabrication process that is no
longer in wide use due to increased miniaturization of semiconductors. If the
CombiMatrix group is unable to achieve higher densities of test sites, it may
become difficult or more expensive for the CombiMatrix group to obtain
sufficient quantities of semiconductors as manufacturers phase out 3.0 micron
production capacity.
PATENTS, LICENSES AND FRANCHISES
The CombiMatrix group's primary patent strategy is to protect all
aspects of its biological array processor system, including the porous reaction
layer, the virtual flask technology, processes for designing capture probes,
unique properties of a protein-based biological array processor and business
methods for automating ordering, creating and manufacturing custom made
biological array processors. The CombiMatrix group's patent applications are
divided by subject matter into areas of its core biological array processor
technology, other hardware for detection and manufacturing, software for
designing experiments using biological array processors and chemical
compositions and processes.
CombiMatrix Corporation has 44 patent applications pending in the
United States and Europe. The CombiMatrix group's policy is to file patent
applications and to seek intellectual property protection for its proprietary
products and technology using patents, copyrights and trade secret protections,
as appropriate.
In July 2000, CombiMatrix Corporation was granted U.S. Patent No.
6,093,302, which expires in July 2017, for its biochip microarray processor
system. This system enables quick and economical turnaround of custom-designed
microarrays for use in biological research. A microarray consists of a chemical
13
"virtual flask" located on the surface of a semiconductor chip containing
thousands of microarrays, which are separated from each other using special
solutions instead of physical barriers. Each microarray has electronic circuitry
that may be directed by a computer to construct a specified compound. The patent
covers CombiMatrix Corporation's core technology, which is a method for
producing microarrays by synthesizing biological materials on a
three-dimensional, active surface.
The CombiMatrix group seeks to protect its corporate identity with
trademarks and service marks. In addition its trademark strategy includes
protecting the identity and goodwill associated with its biological array
processor products. The CombiMatrix group purchases chemical reagents from
suppliers who are licensed under appropriate patent rights. It is the
CombiMatrix group's policy to obtain licenses from patent holders if needed to
practice its chemical processes.
The CombiMatrix group's success will depend, in part, upon its ability
to obtain patents and maintain adequate protection of its intellectual property
in the United States and other countries. If it does not protect its
intellectual property adequately, competitors may be able to use its
technologies and thereby erode any competitive advantage that the CombiMatrix
group may have. The laws of some foreign countries do not protect proprietary
rights to the same extent as the laws of the United States, and many companies
have encountered significant problems in protecting their proprietary rights
abroad. These problems can be caused by the absence of rules and methods for
defending intellectual property rights.
The patent positions of companies developing tools for the
biotechnology and pharmaceutical industries, including the CombiMatrix group's
patent position, generally are uncertain and involve complex legal and factual
questions. The CombiMatrix group will be able to protect its proprietary rights
from unauthorized use by third parties only to the extent that its proprietary
technologies are covered by valid and enforceable patents or are effectively
maintained as trade secrets. The CombiMatrix group's existing patent and any
future patents it obtains may not be sufficiently broad to prevent others from
practicing its technologies or from developing competing products. There also is
risk that others may independently develop similar or alternative technologies
or design around its patented technologies. In addition, others may challenge or
invalidate the CombiMatrix group's patents, or its patents may fail to provide
it with any competitive advantage. Enforcing its intellectual property rights
may be difficult, costly and time consuming, and ultimately may not be
successful.
The CombiMatrix group also relies upon trade secret protection for its
confidential and proprietary information. It seeks to protect its proprietary
information by entering into confidentiality and invention disclosure and
transfer agreements with employees, collaborators and consultants. These
measures, however, may not provide adequate protection for the CombiMatrix
group's trade secrets or other proprietary information. Employees, collaborators
or consultants may still disclose its proprietary information, and the
CombiMatrix group may not be able to meaningfully protect its trade secrets. In
addition, others may independently develop substantially equivalent proprietary
information or techniques or otherwise gain access to its trade secrets.
The CombiMatrix group cannot assure you that any of its patent
applications will result in the issuance of any additional patents, that its
patent applications will have priority of invention or filing date over similar
rights of others, or that, if issued, any of its patents will offer protection
against its competitors. Additionally, the CombiMatrix group cannot assure you
that any patent issued to it will not be challenged, invalidated or circumvented
in the future or that the intellectual property rights it has created will
provide a competitive advantage. Litigation may be necessary to enforce its
intellectual property rights or to determine the enforceability, scope of
protection or validity of the intellectual property rights of others.
COMPETITION
The CombiMatrix group expects to encounter competition in the area of
business opportunities from other entities having similar business objectives.
Many of these potential competitors possess financial, technical, human and
other resources greater than those of the CombiMatrix group. The CombiMatrix
group anticipates that it will face increased competition in the future as new
companies enter the market and advanced technologies become available. In the
life sciences industry, many competitors have more experience in research and
development than the CombiMatrix group. Technological advances or entirely
different approaches developed by one or more of its competitors could render
the CombiMatrix group's processes obsolete or uneconomical. The existing
approaches of competitors or new approaches or technology developed by
competitors may be more effective than those developed by the CombiMatrix group.
The CombiMatrix group is aware of other companies or companies with
divisions that have, or are developing, technologies for the SNP genotyping,
gene expression profiling and proteomic markets. The CombiMatrix group believes
that its primary competitors will be Abbott Laboratories, Affymetrix, Inc.,
Agilent Technologies, Inc., Bayer AG, Becton, Dickinson and Company, Ciphergen
Biosystems, Inc., Gene Logic Inc., Illumina, Inc., Johnson & Johnson, Nanogen,
Inc., Orchid Biosciences, Inc., Applera Corporation, Roche Diagnostics GmbH and
14
Sequenom, Inc. However, the CombiMatrix group's market is rapidly changing, and
the CombiMatrix group expects to face additional competition from new market
entrants, new product developments and consolidation of its existing
competitors. Many of the CombiMatrix group's competitors have existing strategic
relationships with major pharmaceutical and biotechnology companies, greater
commercial experience and substantially greater financial and personnel
resources than it does. The CombiMatrix group expects new competitors to emerge
and the intensity of competition to increase in the future.
The CombiMatrix group believes that the principal competitive factors
in selling its products will be:
o the time required to engineer, produce and ship products;
o the speed and accuracy with which test results can be read and
interpreted;
o the density of testing devices;
o the cost and pricing of the installed base of competing
products; and
o access to proprietary genetic databases.
The CombiMatrix group believes that it will be able to compete
favorably with regard to these factors even though it has competitors who
currently produce testing devices with higher densities than its proposed
initial products, and, initially, it will not offer its customers access to
proprietary genetic information.
RESEARCH, DEVELOPMENT AND ENGINEERING
The CombiMatrix group's research and development expenses excluding
non-cash stock compensation charges and acquired in-process research and
development charges were $18.2 million, $11.7 million and $5.9 million in 2002,
2001 and 2000, respectively. The CombiMatrix group intends to invest
aggressively in its proprietary technologies through internal development and,
to the extent available, licensing of third-party technologies to increase and
improve other characteristics of its products. The CombiMatrix group also plans
to continue to invest in improving the cost-effectiveness of its products
through further automation and improved information technologies. The
CombiMatrix group's future research and development efforts may involve research
conducted by the CombiMatrix group, collaborations with other researchers and
the acquisition of chemistries and other technologies developed by universities
and other academic institutions.
The CombiMatrix group is developing a variety of life sciences related
products and services. These industries are characterized by rapid technological
development. The CombiMatrix group believes that its future success will depend
in large part on its ability to continue to enhance its existing products and
services and to develop other products and services, which complement existing
ones. In order to respond to rapidly changing competitive and technological
conditions, the CombiMatrix group expects to continue to incur significant
research and development expenses during the initial development phase of new
products and services, as well as on an ongoing basis.
There are four major development hurdles to the CombiMatrix group's
core technology platform, three of which have been overcome, as described below:
o DESIGN AND FABRICATION OF SEMICONDUCTOR ARRAYS. The
CombiMatrix group has utilized common tools well known to the
semiconductor industry such as EDA (electronic design
automation) software, lithography fabrication techniques and
other semiconductor processing methods to fabricate a number
of array designs that are utilized as the base electronic
component of its products. The CombiMatrix group continues to
utilize these tools to advance their designs in a manner
similar to semiconductor companies. The core functional needs
of the devices have been achieved in designing and building
semiconductor arrays.
o DESIGN AND FABRICATION OF INSTRUMENTATION FOR SYNTHESIS OF DNA
ON ARRAYS AND THE ACTUAL SYNTHESIS OF DNA ON SUCH ARRAYS. In
order to produce bioarrays with in-situ synthesized DNA, the
CombiMatrix group designed and built unique instrumentation.
Such instrumentation incorporates standard electronic,
mechanical and fluidic components, as well as customized
firmware and user interface software. These prototype systems
operate in a manner that allows the synthesis of DNA, RNA and
other small molecules on multiple arrays.
o DESIGN AND FABRICATION OF INSTRUMENTATION TO PERFORM ASSAYS ON
ARRAYS AS WELL AS TO MEASURE SUCH PERFORMANCE. Instruments,
commonly known as Reader-Hybridizers, have been designed and
prototypes have been built to automate the process of
15
performing an assay on the CombiMatrix group's bioarrays as
well as to measure the performance of the assay. These
instruments incorporate standard, electronic, mechanical,
robotic and fluidic components, as well as firmware and
software to function.
o DEVELOPMENT OF A COST-EFFECTIVE, COMMERCIALLY VIABLE APPROACH
TO MANUFACTURE ARRAYS. As the CombiMatrix group moves forward
to broad commercialization of its technology platform,
advanced manufacturing techniques are being developed to
provide the most reliable and cost-effective approach to
manufacture bioarrays, as well as to develop products that are
commercially viable. These methods will utilize certain
protocols (many of which are well known in the manufacturing
sector), including robotic automation, as well as some
internally developed protocols. These processes are currently
in development.
GOVERNMENT GRANTS AND CONTRACTS
Government grants and contracts have allowed the CombiMatrix group to
fund certain internal scientific programs and exploratory research. The
CombiMatrix group retains ownership of all intellectual property and commercial
rights generated during these projects. The United States government, however,
retains a non-exclusive, non-transferable, paid-up license to practice the
inventions made with federal funds pursuant to applicable statutes and
regulations. The CombiMatrix group does not believe that the retained license
will have any impact on its ability to market its products. The CombiMatrix
group does not need government approval to enter into collaborations or other
relationships with third parties.
The CombiMatrix Corporation has been awarded two grants and two
contracts from the federal government in connection with its biological array
processor technology. In July 1999, the CombiMatrix Corporation was awarded a
$60,000 Phase I Small Business Innovative Research, or SBIR, contract from the
U.S. Department of Defense to develop nanode array sensor microchips to enable
simultaneous detection of numerous chemical and biological warfare agents. Also
in July 1999, the CombiMatrix Corporation was awarded a $100,000 Phase I SBIR
Department of Energy grant to use the CombiMatrix Corporation's proprietary
biochip technology to develop microarrays of affinity probes for the analysis of
gene products. In January 2000, the CombiMatrix Corporation was awarded a
$730,000 Phase II SBIR Department of Defense contract for the use of its biochip
technology to further develop nanode array sensor microchips. The term of the
Phase II SBIR Department of Defense contract ended July 2002 upon delivery of a
prototype electrochemical biological detection system to the Department of
Defense. As such, CombiMatrix Corporation will no longer receive grant revenues
under the Phase II SBIR Department of Defense contract beyond 2002. In February
2002, the CombiMatrix Corporation was awarded a six-month $100,000 Phase I
National Institutes of Health grant for the development of its protein biochip
technology, entitled "Self-Assembling Protein Microchips." This grant was
completed in August of 2002.
The CombiMatrix group will continue to pursue grants and contracts that
complement its research and development efforts.
EMPLOYEES
As of December 31, 2002, the CombiMatrix group had 99 full-time
employees, 18 of whom hold Ph.D. degrees and 71 of whom are engaged in full-time
research and development activities. The CombiMatrix group is not a party to any
collective bargaining agreement. The CombiMatrix group considers its employee
relations to be good.
ENVIRONMENTAL MATTERS
The operations of the CombiMatrix group involve the use,
transportation, storage and disposal of hazardous substances, and as a result,
these subsidiaries are subject to environmental and health and safety laws and
regulations. Although the CombiMatrix group currently uses fairly small
quantities of hazardous substances, as it expands its operations, its use of
hazardous substances will likely increase and lead to additional and more
stringent requirements. The cost of complying with these and any future
environmental regulations could be substantial. In addition, if the CombiMatrix
group fails to comply with environmental laws and regulations, or releases any
hazardous substance into the environment, the CombiMatrix group could be exposed
to substantial liability in the form of fines, penalties, remediation costs and
other damages, or could suffer a curtailment or shut down of its operations.
16
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BUSINESS
The Acacia Technologies group is principally comprised of Acacia Media
Technologies Corporation, or Acacia Media Technologies, formerly Greenwich
Information Technologies LLC, Soundview Technologies Incorporated, or Soundview
Technologies, and includes all corporate assets and liabilities and related
transactions of Acacia Research Corporation that relate to its media technology
businesses. Both Acacia Media Technologies and Soundview Technologies are wholly
owned subsidiaries of Acacia Research Corporation.
The Acacia Technologies group owns and is developing a portfolio of
U.S. and international pioneering patents covering the transmission and receipt
of digital content. These transmission and receiving systems are commonly
referred to as audio-on-demand, video-on-demand and audio/video streaming. The
Acacia Technologies group calls its proprietary technology Digital Media
Transmission, or DMT, technology.
The Acacia Technologies group also owns a patent for a system that
screens television content by content rating code, commonly referred to as
V-chip technology. The system, which uses the audio and video blanking interval
in conjunction with rating codes which are transmitted with television
programming, was approved by the Federal Communication Commission, or FCC, and
adopted by television manufacturers as the industry standard in response to the
U.S. Telecommunications Act of 1996.
The Acacia Technologies group is responsible for the development,
licensing and protection of its intellectual property and proprietary
technologies and continues to pursue both licensing and strategic business
alliances with leading companies in the rapidly growing media technologies
industry.
MARKET OVERVIEW
ACACIA MEDIA TECHNOLOGIES' MARKETS
The market for audio-on-demand, video-on-demand and audio/video
streaming utilizing the Acacia Technologies group's DMT technology continues to
grow both in the United States and internationally. It has recently been
reported that cable TV operators have rolled out video-on-demand services to
nearly 10.0 million homes. It has recently been reported that over 3.9 billion
video streams were served in 2002, a 52% increase over the previous year. The
Acacia Technologies group's DMT patents expire in 2011 and its international DMT
patents expire in 2012.
SOUNDVIEW TECHNOLOGIES' MARKETS
All televisions with screens 13 inches or larger sold in the U.S. after
July 10, 1999 are required to contain V-chip technology. Approximately 26.0
million new televisions are sold in the U.S. each year. The Acacia Technologies
group's V-chip patent expires in July 2003. To date, the Acacia Technologies
group has entered into licensing agreements with 13 television manufacturers
accounting for approximately 75% of the market.
MARKETING AND DISTRIBUTION
DIGITAL MEDIA TRANSMISSION TECHNOLOGY
The Acacia Technologies group has launched an extensive licensing
program for its DMT technology. Potential licensees include cable companies,
hotel in-room entertainment companies, content aggregators, Internet movie
companies, Internet music companies, on-line education services, on-line adult
entertainment companies, on-line news, sports and information services, hardware
and software manufacturers, and consumer electronics manufacturers.
As of March 31, 2003, the Acacia Technologies group has entered into 12
License Agreements for its DMT technology. The Acacia Technologies group has
also formed a joint venture with Grupo Pegasso to license its DMT technology
throughout Mexico. In addition, the Acacia Technologies group has initiated
patent infringement litigation in the Federal District Court for the Central
District of California against approximately 40 defendants who provide digital
content over the Internet. The Acacia Technologies group is in discussions with
several other potential licensees of its DMT technology.
17
V-CHIP TECHNOLOGY
During 2001, the Acacia Technologies group licensed 12 major television
manufacturers including Samsung Electronics, Hitachi America, Ltd., LG
Electronics, Inc., Funai Electric Co., Ltd., Daewoo Electronics Corporation of
America, Sanyo Manufacturing Corporation, Thomson Multimedia, Inc., JVC Americas
Corporation, Matsushita Electric Industrial Co., Ltd., Orion Electric Co. Ltd.,
Pioneer Electronics (USA) Incorporated and Philips Electronics North America
Corporation. In 2002, the Acacia Technologies group licensed one additional
television manufacturer. Litigation for patent infringement and anti-trust
violations is pending against Sony Corporation of America, Mitsubishi Digital
Electronics America, Inc., Sharp Electronics Corporation and Toshiba America
Consumer Products, Inc. These 13 licensees and 4 litigants manufacture most of
the television sets sold in the United States. The license agreements executed
contain provisions in some cases for lump sum payments, in other cases
provisions for ongoing royalty payments or a combination of both.
The Acacia Technologies group has identified several additional
companies that also manufacture televisions for sale in the U.S. and it intends
to continue to attempt to enter into licenses with these companies. The Acacia
Technologies group expects to enter into licenses with these companies, but may
initiate additional litigation against these companies if they use Acacia
Technologies group's V-chip technology without a license. The Acacia
Technologies group's success in entering into licenses or litigation with these
companies may, however, be impacted by developments in its existing litigation.
In pending litigation against Sony Corporation of America, Mitsubishi Digital
Electronics America, Inc., Sharp Electronics Corporation and Toshiba America
Consumer Products, Inc., the court in September 2002 ruled that the defendants
had not infringed the V-chip patent. While the Acacia Technologies group is
currently exploring strategies in connection with this ruling and intends to
appeal, litigation is inherently uncertain and there can be no assurance that
the Acacia Technologies group will be successful in any such appeal. As a result
of this ruling, in October 2002 Soundview Technologies voluntarily filed to
dismiss, without prejudice, its pending action for infringement of the V-chip
patent against seventeen television manufacturers. 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 lawsuit against Sony, Mitsubishi, Sharp and
Toshiba. The Acacia Technologies group's V-chip patent expires in July 2003.
However, the Acacia Technologies group may continue to collect license fees on
televisions sold in the United States during the patent term, subsequent to the
July 2003 patent expiration date.
PATENTS, LICENSES AND FRANCHISES
The Acacia Technologies group owns five issued U.S. 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 as follows: U.S. Patent No. 5,132,992, U.S. Patent No. 5,253,275, U.S.
Patent No. 5,550,863, U.S. Patent No. 6,002,720 and U.S. Patent No. 6,144,702.
In addition, the Acacia Technologies group owns seventeen foreign patents also
relating to audio and video transmission and receiving systems technology.
Foreign rights include a patent granted by the European Patent Office covering
Austria, Belgium, Denmark, Finland, France, Germany, Greece, Italy, Luxembourg,
Monaco, the Netherlands, Spain, Sweden, Switzerland and the United Kingdom, and
patents in Japan, Taiwan and Mexico. Those patents that have already been issued
and granted were issued or granted during the past ten years, the earliest of
which will expire in 2011. The Acacia Technologies group is pursuing business
opportunities with possible providers of information-on-demand systems and
others involved in supplying related information-on-demand services.
The Acacia Technologies group's patent that describes a method for
implementing the V-chip system in parallel with the existing closed-captioning
circuits already in place in televisions was issued in November 1985 and expires
in July 2003. In April 1998, the U.S. Patent and Trademark Office issued a
reexamination certificate confirming the approval of all existing and newly
added claims of its issued patent. The reexamination was requested by Soundview
Technologies in August 1996 to confirm the strength of its patent in light of
other existing patents. Over 30 new prior art references were introduced and
examined during the process, which took more than eighteen months for the U.S.
Patent and Trademark Office to complete. As a result, patentability of all
original claims as issued was confirmed and 17 new claims more specific to the
V-chip implementation were granted.
REGULATORY MATTERS
The Acacia Technologies group markets and licenses technologies
relating to audio-on-demand and video-on-demand. These technologies can be used
to transmit content by several means including satellite, cable and
telecommunications systems. The satellite, cable and telecommunications
industries are subject to federal regulation, including FCC licensing and other
requirements. These industries are also often subject to extensive regulation by
18
local and state authorities. While most satellite, cable and telecommunication
industry regulations do not apply directly to the Acacia Technologies group,
they affect programming distributors, one of the large potential customers for
the technologies covered by the Acacia Technologies group patent portfolio. The
Acacia Technologies group monitors pending legislation and administrative
proceedings to ascertain relevance, analyze impact and develop strategies
regarding regulatory trends and developments within these industries.
Federal law requires cable operators to reserve up to one-third of a
system's channel capacity for local commercial television stations that have
elected must-carry status. In addition, a cable system is generally required to
carry local non-commercial television stations. The FCC has also implemented
comparable rules for satellite carriers requiring that if a satellite system
carries one local broadcast station in a local market pursuant to a royalty-free
license granted under the Satellite Home Viewer Improvement Act of 1999, then it
must carry all local broadcast stations in that market. To meet these
requirements, some cable and satellite systems must decide which programming
services to keep and which to remove in order to make space available for local
television stations. These must-carry requirements may impact the Acacia
Technologies group's information-on-demand and streaming media business by
causing cable and satellite systems operators to reduce the number of channels
on their systems that would have used technologies covered by Acacia
Technologies group's patent portfolio.
COMPETITION
The Acacia Technologies group expects to encounter competition in the
area of business opportunities from other entities having similar business
objectives. Many of these potential competitors may possess financial,
technical, human and other resources greater than those of the Acacia
Technologies group. The Acacia Technologies group anticipates that it will face
increased competition in the future as new companies enter the market and
advanced technologies become available.
Other companies may develop competing technologies that offer better or
less expensive alternatives to the V-chip technology and/or the Acacia
Technologies group's audio-on-demand and video-on-demand technologies. Many
potential competitors, including television manufacturers and other media
technology companies, have significantly greater resources. Technological
advances or entirely different approaches developed by one or more of its
competitors could render Acacia Technologies group's technologies obsolete or
uneconomical.
EMPLOYEES
As of December 31, 2002, the Acacia Technologies group had 14 full-time
employees. None of the companies included in the Acacia Technologies group is a
party to any collective bargaining agreement. The Acacia Technologies group
considers its employee relations to be good.
19
ITEM 2. PROPERTIES
Acacia Research Corporation leases approximately 7,143 square feet of
office space in Newport Beach, California, under a lease agreement that expires
in February 2007. We also lease approximately 7,019 square feet of office space
in Pasadena, California, under a lease agreement that expires in November 2003,
which is subleased through the remaining term of the lease agreement. Our
consolidated subsidiary, CombiMatrix Corporation, leases office and laboratory
space totaling approximately 90,111 square feet located north of Seattle,
Washington, under a lease agreement that expires in December 2008. Presently, we
are not seeking any additional facilities.
We are a guarantor under a lease agreement for office space in
Hollywood, California that expires in August 2005. The lease agreement was
entered into by Soundbreak.com Incorporated, or Soundbreak.com, which ceased
operations in February 2001. A portion of the leased premises is subleased
through the remaining term of the lease agreement, and we continue to pursue
opportunities to sublease the remaining space.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of its business, we are the subject of, or party
to, various pending or threatened legal actions. We believe that any liability
arising from these actions will not have a material adverse effect on our
financial position, results of operations or cash flows.
COMBIMATRIX GROUP
On September 30, 2002, CombiMatrix Corporation and Dr. Montgomery
entered into a settlement agreement with Nanogen, Inc., or 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 Corporation and Dr. Montgomery. In return, CombiMatrix Corporation
agreed to pay Nanogen $0.5 ,million within 30 days of the settlement and an
additional $0.5 million 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 $1.5 million. 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. Also, pursuant to the settlement agreement, CombiMatrix
Corporation issued to Nanogen 4,016,346 shares, or 17.5% of its outstanding
shares post issuance, subject to an antidilution provision related to the
exercise of CombiMatrix Corporation options and warrants that were outstanding
on the effective date of the agreement, for a period of up to three years.
ACACIA TECHNOLOGIES GROUP
In 2000, Soundview Technologies filed a federal patent infringement and
antitrust lawsuit against certain television manufacturers, the Consumer
Electronics Manufacturers Association and the Electronics Industries Alliance
d/b/a/ Consumer Electronics Association. In its lawsuit now pending before the
United States District Court for the District of Connecticut, Soundview
Technologies alleges that television sets fitted with V-chips and sold in the
United States infringe Soundview Technologies' patent. Additionally, Soundview
Technologies alleges that the Consumer Electronics Manufacturers Association has
induced infringement of Soundview Technologies' patent and that the defendants
have violated the federal Clayton and Sherman Antitrust Acts by engaging in
collusive attempts to prevent others in the electronics and television
broadcasting industries from entering into licensing agreements with Soundview
Technologies. Soundview Technologies is seeking monetary damages, an injunction
preventing unlicensed use of its patented technology and other remedies. In
September 2002, the court granted a motion for summary judgment filed by the
defendants, ruling 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.
The ruling has no effect on the revenues that the Acacia Technologies
group has received from current licensees of our patented V-chip technology.
Further, none of the revenues that we have received to date are contingent upon
any court rulings or the future outcome of any litigation with unlicensed
television manufacturers. Soundview Technologies continues to pursue its
antitrust claim against the defendants.
20
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.
In February 2003, the Acacia Technologies group initiated DMT
technology patent infringement litigation in the Federal District Court for the
Central District of California against approximately 40 defendants who provide
digital content over the Internet. All of the defendants were previously
notified of their infringing activity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Acacia Research Corporation held a special meeting of stockholders, or
Special Meeting, on December 11, 2002. At the Special Meeting, the stockholders
voted on the following four items:
(a) A proposal to amend our certificate of incorporation to recapitalize
our company was approved as follows:
FOR AGAINST ABSTAIN BROKER NON-VOTES
- --- ------- ------- ----------------
11,248,369 279,282 165,310 0
(b) A proposal to approve and adopt an Agreement and Plan of Reorganization
and the transactions contemplated thereby was approved as follows:
FOR AGAINST ABSTAIN BROKER NON-VOTES
- --- ------- ------- ----------------
11,404,519 265,021 23,421 0
(c) A proposal to approve and adopt the Acacia Research Corporation 2002
CombiMatrix Stock Incentive Plan was approved as follows:
FOR AGAINST ABSTAIN BROKER NON-VOTES
- --- ------- ------- ----------------
9,481,771 2,063,218 147,972 0
(d) A proposal to approve and adopt the Acacia Research Corporation 2002
Acacia Technologies Stock Incentive Plan was approved as follows:
FOR AGAINST ABSTAIN BROKER NON-VOTES
- --- ------- ------- ----------------
9,454,823 2,087,439 150,699 0
21
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
RECENT MARKET PRICES
Acacia Research Corporation's two new classes of common stock, Acacia
Research-CombiMatrix common stock and Acacia Research-Acacia Technologies common
stock, commenced trading on the Nasdaq Stock Market on December 16, 2002. The
two new classes of common stock were created as a result of Acacia Research
Corporation's recapitalization that was approved by Acacia Research
Corporation's stockholders on December 11, 2002. The two new classes of stock
replace Acacia Research Corporation's common stock that formerly traded on the
Nasdaq stock market under the symbol ACRI. Acacia Research-Acacia Technologies
common stock is now listed on the Nasdaq National Market System and Acacia
Research-CombiMatrix common stock is now listed on the Nasdaq SmallCap Market.
Acacia Research-CombiMatrix common stock is intended to reflect the performance
of Acacia Research Corporation's CombiMatrix group, and Acacia Research-Acacia
Technologies stock is intended to reflect the performance of Acacia Research
Corporation's Acacia Technologies group.
Holders of Acacia Research-Acacia Technologies stock and Acacia
Research-CombiMatrix stock are stockholders of Acacia Research Corporation. As a
result, holders of Acacia Research-Acacia Technologies stock and Acacia
Research-CombiMatrix stock continue to be subject to all of the risks of an
investment in Acacia Research Corporation and all of its businesses, assets and
liabilities. The assets Acacia Research Corporation attributes to one group
could be subject to the liabilities of the other group.
The markets for securities such as the two classes of our common stock
have historically experienced extreme price and volume fluctuations during
certain periods. These broad market fluctuations and other factors, such as new
product developments and trends in our industry and the investment markets
generally, as well as economic conditions and quarterly variations in our
results of operations, may adversely affect the market price of our two classes
of common stock.
On October 22, 2001, our board of directors declared a 10% stock
dividend. The stock dividend, totaling 1,777,710 shares, was distributed on
December 5, 2001 for stockholders of record as of November 21, 2001. All share
and per share information presented herein is adjusted for the stock dividend.
The high and low bid prices for our two classes of common stock as
reported by NASDAQ for the periods indicated are as follows. Such prices are
inter-dealer prices without retail markups, markdowns or commissions and may not
necessarily represent actual transactions.
2002(1) 2001(1)
-------------------------------------- ---------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
Acacia Research Corporation
(through December 13, 2002):
High $5.61 $7.15 $11.50 $13.26 $13.42 $16.66 $16.14 $18.98
Low $3.65 $3.50 $5.90 $8.47 $8.29 $5.83 $4.69 $5.23
Acacia Research-Acacia Technologies stock:
High $3.40 - - - - - - -
Low $1.65 - - - - - - -
Acacia Research-CombiMatrix stock:
High $4.98 - - - - - - -
Low $2.70 - - - - - - -
- -------------------
(1) 2002 share and per share information gives effect to the recapitalization
transaction described elsewhere herein as of January 1, 2002. Historical share
and per share information for the new classes of securities is not presented as
these classes of securities were not part of Acacia Research Corporation's
capital structure during 2001 and prior periods.
On March 21, 2003, the closing bid and asked quotations for our Acacia
Research-Acacia Technologies stock were $1.16 and $1.17, respectively. On March
21, 2003, the closing bid and asked quotations for our Acacia
Research-CombiMatrix stock were $1.80 and $1.90, respectively.
22
On March 21, 2003, there were approximately 170 owners of record of
Acacia Research-Acacia Technologies stock and 280 owners of record of Acacia
Research-CombiMatrix stock. The majority of the outstanding shares of Acacia
Research-Acacia Technologies stock and Acacia Research-CombiMatrix stock are
held by a nominee holder on behalf of an indeterminable number of ultimate
beneficial owners.
DIVIDEND POLICY
To date, we have not declared or paid any cash dividends with respect
to our capital stock, and the current policy of the board of directors is to
retain earnings, if any, to provide for the growth of Acacia Research
Corporation. Consequently, we do not expect to pay any cash dividends in the
foreseeable future. Further, there can be no assurance that our proposed
operations will generate revenues and cash flow needed to declare a cash
dividend or that we will have legally available funds to pay dividends.
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information as of December 31, 2002 with
respect to our common shares issuable under our equity compensation plans:
(c) NUMBER OF SECURITIES
(a) NUMBER OF REMAINING AVAILABLE FOR
SECURITIES TO BE FUTURE ISSUANCE UNDER
ISSUED UPON EXERCISE (b) WEIGHTED AVERAGE EQUITY COMPENSATION PLANS
OF OUTSTANDING EXERCISE PRICE OF (EXCLUDING SECURITIES
PLAN CATEGORY OPTIONS OUTSTANDING OPTIONS REFLECTED IN COLUMN (a))
- ------------------------------------------------------ -------------------- -------------------- -------------------------
EQUITY COMPENSATION PLANS APPROVED BY SECURITY HOLDERS
2002 CombiMatrix Stock Incentive Plan(1) 5,620,000 $9.24 2,876,000
2002 Acacia Technologies Stock Incentive Plan(2) 4,295,000 $9.36 913,000
Subtotal(3) N/A N/A N/A
EQUITY COMPENSATION PLANS NOT APPROVED BY SECURITY HOLDERS(4)
- ------------------------------------------------------ -------------------- -------------------- -------------------------
TOTAL(3) N/A N/A N/A
- --------------------------------
(1) Our 2002 CombiMatrix Stock Incentive Plan, as amended, or the CombiMatrix
Plan, allows for the granting of stock options and other awards to
eligible individuals, which generally includes directors, officers,
employees and consultants. The CombiMatrix Plan does not segregate the
number of securities remaining available for future issuance among stock
options and other awards. The 2,876,000 shares authorized for future
issuance represents the total number of shares available through any
combination of stock options or other awards. The share reserve under the
CombiMatrix Plan automatically increases on the first trading day in
January each calendar year by an amount equal to three percent (3%) of the
total number of shares of our Acacia Research-CombiMatrix stock
outstanding on the last trading day of December in the prior calendar
year, but in no event will this annual increase exceed 600,000 shares and
in no event will the total number of common stock in the share reserve (as
adjusted for all such annual increases) exceed twenty million shares. See
Note 11 to our consolidated financial statements.
(2) Our 2002 Acacia Technologies Stock Incentive Plan, as amended, or the
Acacia Technologies Plan, allows for the granting of stock options and
other awards to eligible individuals, which generally includes directors,
officers, employees and consultants. The Acacia Technologies Plan does not
segregate the number of securities remaining available for future issuance
among stock options and other awards. The 913,000 shares authorized for
future issuance represents the total number of shares available through
any combination of stock options or other awards. The share reserve under
the Acacia Technologies Plan automatically increases on the first trading
day in January each calendar year by an amount equal to three percent (3%)
of the total number of shares of our Acacia Research-Acacia Technologies
stock outstanding on the last trading day of December in the prior
calendar year, but in no event will this annual increase exceed 500,000
shares and in no event will the total number of common stock in the share
reserve (as adjusted for all such annual increases) exceed twenty million
shares. See Note 11 to our consolidated financial statements.
23
(3) Subtotal and total information is not provided because the CombiMatrix
Plan and the Acacia Technologies Plan relate to two different classes of
our common stock.
(4) We have not authorized the issuance of equity securities under any plan
not approved by security holders.
ITEM 6. SELECTED FINANCIAL DATA
The consolidating selected balance sheet data as of December 31, 2002
and 2001 and the consolidating selected statement of operations data for the
years ended December 31, 2002, 2001 and 2000 set forth below have been derived
from our audited consolidated financial statements included elsewhere herein,
and should be read in conjunction with those financial statements (including
notes thereto). The consolidating selected financial data as of December 31,
2000, 1999 and 1998 and for the years ended December 31, 1999 and 1998 have been
derived from audited consolidated financial statements not included herein, but
which were previously filed with the SEC.
Acacia Research Corporation derived the Acacia Technologies group and
CombiMatrix group balance sheet data and statement of operations data from the
separate audited financial statements of the Acacia Technologies group