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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, 2003
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
_______
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)
_______
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 Acacia Research - Acacia
Technologies common stock and Acacia Research - CombiMatrix common stock held by
non-affiliates of the registrant, computed by reference to the last sales prices
of such stocks reported on The Nasdaq Stock Market, as of June 30, 2003, was
approximately $23,058,107 and $60,359,784, respectively. (All officers and
directors of the registrant are considered affiliates.)
As of February 27, 2004, 19,746,234 shares of Acacia Research-Acacia
Technologies common stock were issued and outstanding. As of February 27, 2004,
27,639,201 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.
================================================================================
FORM 10-K ANNUAL REPORT
FISCAL YEAR ENDED DECEMBER 31, 2003
ACACIA RESEARCH CORPORATION
ITEM PAGE
- ---- ----
PART I
1. Business................................................................................................1
2. Properties.............................................................................................15
3. Legal Proceedings......................................................................................15
4. Submission of Matters to a Vote of Security Holders....................................................16
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters..................................17
6. Selected Financial Data................................................................................19
7. Management's Discussion and Analysis of Financial Condition and Results of Operations..................23
7A. Quantitative and Qualitative Disclosures About Market Risk.............................................68
8. Financial Statements and Supplementary Data............................................................68
9. Changes in and Disagreements with Auditors on Accounting and Financial Disclosure......................68
9A. Controls and Procedures................................................................................68
PART III
10. Directors and Executive Officers of the Registrant.....................................................69
11. Executive Compensation.................................................................................69
12. Security Ownership of Certain Beneficial Owners and Management.........................................69
13. Certain Relationships and Related Transactions.........................................................69
14. Principal Accounting Fees and Services.................................................................69
PART IV
15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.......................................70
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
OVERVIEW
Acacia Research Corporation is comprised of two operating groups.
Our life sciences business, referred to as the "CombiMatrix group," is
comprised of our wholly owned subsidiary, CombiMatrix Corporation and
CombiMatrix Corporation's majority-owned subsidiary, Advanced Material Sciences,
Inc., or Advanced Material Sciences, and wholly owned subsidiary, CombiMatrix
K.K. CombiMatrix Corporation is a life sciences technology company with a
proprietary system for rapid, cost competitive creation of DNA and other
compounds on a programmable semiconductor chip. This proprietary technology has
applications in the areas of genomics, proteomics, biosensors, drug discovery,
drug development, diagnostics, combinatorial chemistry, material sciences and
nanotechnology.
Our intellectual property licensing business, referred to as the
"Acacia Technologies group," is responsible for the development, acquisition,
licensing and protection of intellectual property and proprietary technologies
and is pursuing additional licensing and strategic business alliances with
leading companies in the rapidly growing intellectual property licensing
industry. The Acacia Technologies group owns and out-licenses a portfolio of
pioneering U.S. and foreign patents covering digital audio and video
transmission and receiving systems, commonly known as audio-on-demand,
video-on-demand, and audio/video streaming. The Acacia Technologies group's
patented proprietary digital media transmission, or DMT, technology enables the
digitization, encryption, storage, transmission, receipt and playback of digital
content via several means including the Internet, cable, satellite and wireless
systems. We believe our DMT technology is utilized by a variety of companies in
activities including digital ad insertion, cable programming, satellite
programming, hotel in-room entertainment services, distance learning and other
Internet programming involving digital audio/video content. Our DMT technology
is protected by five U.S. and 31 foreign patents. The Acacia Technologies group
also owns, and has out-licensed to consumer electronics manufacturers, patented
technology known as the V-chip. The V-chip technology was protected by U.S.
Patent No. 4,554,584, which expired in July 2003. The V-chip was adopted by
manufacturers of televisions sold in the United States to provide blocking of
certain programming based upon its content rating code, in compliance with the
Telecommunications Act of 1996.
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COMPANY
RECAPITALIZATION AND MERGER TRANSACTIONS
On December 11, 2002, our stockholders voted in favor of a
recapitalization transaction, which became effective on December 13, 2002,
whereby we created two new classes of common stock called Acacia
Research-CombiMatrix stock, 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. AR-Acacia
Technologies stock is intended to reflect separately the performance of Acacia
Research Corporation's Acacia Technologies group. Although the AR-CombiMatrix
stock and the AR-Acacia Technologies stock are intended to reflect the
performance of our different business groups, they are both classes of common
stock of Acacia Research Corporation and are not stock issued by the respective
groups.
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.
OTHER
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. In
addition, we post the following information on our website:
o our corporate code of conduct;
o charters for our audit committee, nominating and corporate
governance committee and compensation committee;
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.
2
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 majority-owned
subsidiary, Advanced Material Sciences and wholly owned subsidiary, CombiMatrix
K.K. 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 array with applications in the areas of genomics, proteomics,
biosensors, drug discovery, drug development, diagnostics, combinatorial
chemistry, materials sciences and nanotechnology.
The CombiMatrix group's technology enables the rapid, parallel
synthesis, immobilization and detection of molecules and materials at discrete
electrodes on a semiconductor chip. These chips, also known as microelectrode
arrays, are used in multiple applications in the areas described above. The
CombiMatrix group's technology integrates semiconductor micro fabrication,
proprietary software, chemistry and hardware into systems that it believes will
enable it, its customers and its partners to design and fabricate arrays for
biological, material sciences and nanotechnology applications, typically within
a few days. The CombiMatrix group's system should enable researchers to conduct
rapid, iterative experiments in each of these fields.
For biological applications, the CombiMatrix group believes that its
customizable arrays will enable users to reduce the time and costs associated
with the discovery and development of pharmaceutical products. Although there
are numerous applications of the CombiMatrix group's arrays in life sciences
research, each depend on the synthesis, immobilization or detection of molecules
at discrete sites on the array. Some specific applications include studies of
genetic expression in cellular systems, genotyping and mutation analysis,
synthesis of nucleic acid drugs, and others.
The CombiMatrix group is engaged in four major business areas:
o The development, manufacture and sale of research tools and services to
life sciences researchers
o The discovery of drugs based on the mechanism of ribonucleic acid
inhibition (RNAi)
o The development, manufacture and sale of biosensor systems and
technology for national defense and homeland security
o The development of tools for applications in nanotechnology and
materials science.
MARKET OVERVIEW
The markets for the CombiMatrix group's products include pharmaceutical
and biotechnology markets (also referred to as life sciences), national defense
and homeland security applications and the emerging markets for nanotechnology
and new materials. At this time, the majority of the CombiMatrix group's efforts
are focused on the life sciences markets.
GENERAL OVERVIEW OF LIFE SCIENCES.
The pharmaceutical and biotechnology industries are faced with
increasing costs and risks of failure in the drug discovery, development and
commercialization process. According to industry statistics, the time required
to commercialize a new drug averages 15 years, and the direct and indirect costs
of the process averages almost $802 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.
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DRUG DISCOVERY AND DEVELOPMENT
The discovery and development of new drugs for a particular disease
typically involves several steps. First, researchers identify a target for
therapeutic intervention, such as a protein or gene, 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 and modulate
the target's activity to inhibit or prevent the disease. Promising compounds
advance to subsequent stages, which include animal trials followed by human
trials.
Recent advances, including the sequencing of the human genome, have led
to the use of genomics in choosing and validating the 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. According
to industry statistics, pharmaceutical and biotechnology companies worldwide
spent approximately $62.0 billion on drug research and development during 2003.
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. Abnormal variations in the
sequence of a gene or in the level of gene expression can interfere with the
normal physiology of particular cells and lead to a disease, a predisposition to
a disease or an adverse response to drugs.
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 MUTATIONS
Genetic variation is also due to polymorphisms (mutations) 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.
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. A 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 million genotyping
tests, or assays, might be required to complete a study. Using currently
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
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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.
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.
CURRENT TECHNOLOGIES
Despite the recent sequencing of the human genome, scientists have a
limited understanding of the function of genes, how they interact with each
other, how they modulate disease, and how they correlate with protein
translation and function. Additionally, the role of specific mutations is poorly
understood.
Traditional technologies for analyzing genetic or protein variation and
function generally perform experiments individually, or serially, and often
require relatively large sample volumes, adding significantly to the cost of
conducting experiments. Arrays were developed to overcome the limitations of
traditional technologies.
An array is a collection of miniaturized test sites arranged in a
manner 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 such
devices has not been realized. This is true for a number of reasons, including
limited flexibility, cost, inconvenience and poor performance.
THE COMBIMATRIX SOLUTION
The CombiMatrix group believes that its integrated system will have
advantages over other existing technologies because it is being designed to 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 arrays or fabricate them
in-house, conduct their tests, analyze the results, and reorder additional
arrays (or fabricate them in-house) incorporating modified test parameters, all
within a few days. The CombiMatrix group believes that its system will offer
advantages over competing products. These advantages arise from a unique
approach to fabricating the arrays utilizing a proprietary electrochemical
synthetic method on an array of microelectrodes that have been fabricated on a
silicon device. The CombiMatrix group believes the key advantages are as
follows:
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 timeframe, typically
within a few days. 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 will be able to 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 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 which can
be measured using relatively simple instruments.
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
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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 array 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 an array 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 array for applications 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. For this application, the CombiMatrix group will
develop modified arrays, which are capable of electrochemical array preparation
as well as electrochemical detection.
The CombiMatrix group has also entered into development programs to use
its arrays for the discovery of nano-structured materials. In analogy to the
study of genes and proteins in parallel using a highly-customizable array, the
CombiMatrix group will develop a system, which enables researchers to perform
combinatorial materials discovery work in a rapid, cost effective manner.
DRUG DISCOVERY
The CombiMatrix group has initiated internally focused (Express
Track(TM)) and externally focused (siRNA Solutions(TM) programs to utilize its
arrays to discover nucleic acid drugs, based on the recently discovered
mechanism known as RNAi (Ribonucleic Acid interference). This field is often
referred to as siRNA (small interfering Ribonucleic Acid) or gene silencing.
The underlying principle in this field is that an appropriately
designed, double-stranded sequence of RNA can effectively shut down the
operation of a particular gene. If this inhibition cures a disease or alleviates
its symptom, these RNA molecules can potentially become effective therapeutics.
The process of drug discovery utilizing the RNAi mechanism involves multiple
steps, the first of which is the design and synthesis of potential RNAi
sequences. The CombiMatrix group believes that its expertise in nucleic acid
design and synthesis on its semiconductor-based arrays provides a significant
advantage in discovery.
Express Track(TM) is a comprehensive program that integrates several
key technologies developed by the CombiMatrix group into a rapid process for
designing and producing large libraries of compounds that can be screened for
maximum efficacy. The CombiMatrix group has chosen to initially focus its
integrated RNAi discovery program on viral diseases for the following reasons:
o Viral infections affect millions of individuals throughout the world
each year
o There are relatively few effective anti-viral medications
o Most emerging diseases are viruses such as SARS and West Nile Virus
o The basis of infection is through transfer of viral genetic material
o Complete viral genomic sequences have recently been made available
o The CombiMatrix group's approach is suited to viral research because it
attempts to thwart a virus by building a cocktail of drugs to target
multiple genes or all the genes of a virus
o It is believed that an RNAi effect is already operating when the body
battles viral infections
siRNA Solutions(TM) is an integrated approach to siRNA drug discovery,
which integrates the CombiMatrix group's bioinformatics software and array
technology to design, synthesize, and evaluate potential siRNA drugs. The
CombiMatrix group will seek to provide this program as a service to partners.
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THE COMBIMATRIX GROUP'S STRATEGY
FOCUSING ON HIGH-GROWTH MARKETS
The CombiMatrix group's goal is to provide customers and partners with
tools in their discovery efforts as well as to perform discovery itself.
The CombiMatrix group will focus on markets that it believes are
growing rapidly and where it believes it has a competitive advantage. The first
of these markets are for gene expression, mutation analysis, and other
applications for the development of drugs and diagnostic products. Other markets
include protein analysis, homeland security and military applications,
anti-viral drug development nanotechnology and material sciences.
PARTNERING WITH MULTIPLE COMPANIES TO EXPAND MARKET OPPORTUNITY
The CombiMatrix group plans to pursue multiple relationships to
facilitate the expansion of its semiconductor-based array 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.
MAJOR STRATEGIC ALLIANCES
The CombiMatrix group intends to rapidly commercialize its array
technology for gene expression profiling through its own sales and marketing
efforts. In addition, the CombiMatrix group has an agreement with Roche
Diagnostics GmbH, or Roche, to jointly develop its 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 array 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.
The CombiMatrix group has also entered into a design, fabrication and
manufacturing relationship with Toppan Printing of Japan, or Toppan, for the
development and manufacture of new designs of its electrochemical detection
arrays.
In addition to Roche and Toppan, the CombiMatrix group has entered into
additional relationships and plans on establishing other relationships for
multiple applications of its technology. This is especially critical for Express
Track(TM). The CombiMatrix group plans to establish relationships with expert
virologists for initial screening of its potential drugs. Subsequent to
identifying key compounds, which may be suitable as drugs, the CombiMatrix group
plans to partner with larger pharmaceutical or biotechnology companies for
downstream development and marketing.
EXPANDING TECHNOLOGIES INTO MULTIPLE PRODUCT LINES
The CombiMatrix group intends to utilize the flexibility of its
semiconductor based array 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 array 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.
PROTECTING AND STRENGTHENING INTELLECTUAL PROPERTY
Through the CombiMatrix Corporation's four issued patents in the United
States and one in Europe, its 46 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 in those markets where it operates and where a market for its
products and services exists. The CombiMatrix group plans to build its
intellectual property portfolio through internal research efforts,
collaborations with industry leaders, strategic licensing and possible
7
acquisitions of complementary technologies. The CombiMatrix group also plans to
pursue patent protection for downstream products created using its proprietary
products.
REGULATORY MATTERS
The CombiMatrix group intends to sell products to the pharmaceutical,
biotechnology and academic communities for research applications as well as
non-life sciences customers. In addition, its drug development efforts are early
stage. 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.
SUBSIDIARIES
Prior to July 11, 2003, CombiMatrix K.K., a majority-owned subsidiary
of CombiMatrix Corporation, was operating under a joint venture agreement with
Marubeni Japan, or Marubeni, one of Japan's leading trading companies. The
primary purpose of the joint venture was to focus on development and licensing
opportunities for CombiMatrix Corporation's array technology with academic,
pharmaceutical and biotechnology organizations in the Japanese market. Marubeni
held a 10% minority interests in the joint venture. On July 11, 2003, Acacia
Research Corporation purchased the outstanding minority interests in CombiMatrix
K.K. from Marubeni. Acacia Research Corporation issued 200,000 shares of its
AR-CombiMatrix stock to Marubeni in exchange for Marubeni's 10% minority
interests in CombiMatrix K.K. This increase in ownership interest has been
attributed to the CombiMatrix group.
Prior to July 2, 2003, CombiMatrix Corporation owned 87% of Advanced
Material Sciences, which in turn holds an exclusive license for CombiMatrix
Corporation's array 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 will share in
the revenues earned by Advanced Material Sciences for commercialization of these
discoveries based on CombiMatrix Corporation's array technology. The term of
this arrangement is 20 years. On July 2, 2003, Acacia Research Corporation
increased its consolidated ownership interest in Advanced Material Sciences to
99% by acquiring 1,774,750 shares of Advanced Material Sciences common stock in
exchange for 295,790 shares of AR-CombiMatrix stock. This increased ownership
interest has been attributed to the CombiMatrix group.
MARKETING AND DISTRIBUTION
Where appropriate, the CombiMatrix group will market and sell its
products either directly or through distribution arrangements and/or through
other strategic alliances. For its initial products addressing the gene
expression market, the CombiMatrix group will sell its product directly, as well
as through a strategic relationship with Roche and may enable other partners to
distribute its products.
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 we consider
to be material. Such minor modifications are a standard part of the research and
development process and in our experience 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 agreements, it is contemplated that Roche will
co-develop, use, manufacture, market and distribute CombiMatrix Corporation's
array and related technology for rapid production of customizable arrays. The
agreements provide for minimum payments by Roche to CombiMatrix Corporation over
the first three years after product launch, 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
8
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 array system, and has received approximately $26.6 million in cash
payments from Roche from July 2001 through December 31, 2003.
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 arrays. Certain portions of its
manufacturing, such as semiconductor fabrication and processing, will be
outsourced to subcontractors, while the steps involved with synthesis of
biological materials and quality control will be conducted by the CombiMatrix
group.
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 AND LICENSES
CombiMatrix Corporation continues to build its intellectual property
portfolio to protect its product in those markets where it operates and where a
market for its products and services exists. In the United States, CombiMatrix
Corporation has been issued four United States patents. Three of the United
States patents (U.S. Patent No. 6,093,302; U.S. Patent No. 6,280,595 and U.S.
Patent No. 6,444,111) protect CombiMatrix Corporation's core technology relating
to methods for electrochemical synthesis of arrays. The fourth United States
Patent (U.S. Patent No. 6,456,942) describes and claims a network infrastructure
for custom microarray synthesis and analysis. Corresponding CombiMatrix
Corporation core patents describing and claiming methods for electrochemical
synthesis of arrays have been granted in Europe (entire EU) and Australia and
are pending in the remaining major industrialized markets. In total, CombiMatrix
Corporation has 46 patent applications pending in the Unites States, Europe and
elsewhere
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 and drugs 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.
9
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 greater financial, technical, human
and other resources than does 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 Affymetrix, Inc., Agilent Technologies,
Inc., 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 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.
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 $8.1 million, $18.2 million, and $11.7 million in
2003, 2002 and 2001, 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 and
non-life sciences products and services. Potential customers for these products
operate in industries 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.
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
10
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 group 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 group 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 group was awarded a $100,000 Phase I SBIR Department of Energy
grant to use the CombiMatrix group's proprietary array technology to develop
arrays of affinity probes for the analysis of gene products. In January 2000,
the CombiMatrix group was awarded a $730,000 Phase II SBIR Department of Defense
contract for the use of its array 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, the CombiMatrix group
will no longer receive grant revenues under the Phase II SBIR Department of
Defense contract beyond 2002. In February 2002, the CombiMatrix group was
awarded a six-month $100,000 Phase I National Institutes of Health grant for the
development of its protein array 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, 2003, the CombiMatrix group had 59 full-time
employees, 11 of whom hold Ph.D. degrees and 40 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,
it is subject to environmental and health and safety laws and regulations. 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.
11
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BUSINESS
The Acacia Technologies group is principally comprised of Acacia
Research Corporation's wholly owned subsidiaries, Acacia Media Technologies
Corporation, or Acacia Media Technologies, and Soundview Technologies
Incorporated, or Soundview Technologies, and includes all corporate assets and
liabilities and related transactions of Acacia Research Corporation that relate
to its intellectual property licensing business.
The Acacia Technologies group is responsible for the development,
acquisition, licensing and protection of intellectual property and proprietary
technologies and is pursuing additional licensing and strategic business
alliances with leading companies in the rapidly growing intellectual property
licensing industry.
DIGITAL MEDIA TRANSMISSION TECHNOLOGY
The Acacia Technologies group owns and out-licenses a portfolio of
pioneering U.S. and foreign patents covering digital audio and video
transmission and receiving systems, commonly known as audio-on-demand,
video-on-demand, and audio/video streaming. The Acacia Technologies group's
patented proprietary DMT technology enables the digitization, encryption,
storage, transmission, receipt and playback of digital content via several means
including the Internet, cable, satellite and wireless systems. We believe our
DMT technology is utilized by a variety of companies in activities including
digital ad insertion, cable programming, satellite programming, hotel in-room
entertainment services, distance learning, and other Internet programming
involving digital audio/video content. The Acacia Technologies group's DMT
technology is protected by five U.S. patents which expire in 2011and 31 foreign
patents which expire in 2012.
V-CHIP TECHNOLOGY
The Acacia Technologies group also owns and has out-licensed to
consumer electronics manufacturers, patented technology known as the V-chip. The
V-chip technology was protected by U.S. Patent No. 4,554,584, which expired in
July 2003. 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.
MARKET OVERVIEW
DIGITAL MEDIA TRANSMISSION TECHNOLOGY MARKETS
The Acacia Technologies group has launched an extensive DMT technology
licensing program. Potential licensees include cable companies, satellite
companies, hotel in-room entertainment companies and online music, movie, adult
entertainment, e-learning, sports, news and information companies.
The use of DMT technology continues to grow both in the United States
and internationally. The transmission of digital content by cable companies
continues to increase with the use of video-on-demand and digital ad insertion
systems. Satellite companies are switching to hard drive based reception systems
to offer their content with on-demand functionality. Hotel in-room entertainment
companies are switching to electronic distribution systems and digital storage
systems to reduce costs and increase profitability. Entertainment companies are
making more digital content available via the Internet in order to distribute
content directly to the consumer as opposed to using third party distributors
and retail outlets.
V-CHIP TECHNOLOGY MARKETS
All televisions with screens 13 inches or larger sold in the United
States after July 10, 1999 are required to contain V-chip technology. The Acacia
Technologies group's patent on the V-chip technology expired in July 2003. To
date, the Acacia Technologies group has out-licensed its V-chip technology to 13
television manufacturers representing approximately 75% of the television
manufacturing industry. Depending on the outcome of ongoing licensing efforts
and related infringement actions, the Acacia Technologies group may, however,
continue to collect license fees from others in the industry for televisions
sold in the United States during the patent term, which ended in July 2003.
12
THE ACACIA TECHNOLOGIES GROUP'S STRATEGY
The Acacia Technologies group's business strategy includes the following:
IDENTIFY EMERGING GROWTH AREAS WHERE PATENTED TECHNOLOGIES WILL PLAY A
VITAL ROLE
The patent process breeds innovation and invention by granting a
limited monopoly to the inventor in exchange for sharing the invention with the
public. Certain technologies, such as our DMT technology, become core
technologies in the way products and services are manufactured, sold and
delivered. The Acacia Technologies group identifies core, patented technologies
that have or are anticipated to be widely adopted by third parties in connection
with the manufacture or sale of products and services.
CONTACT AND FORM ALLIANCES WITH OWNERS OF CORE, PATENTED TECHNOLOGIES
For years, many large companies have earned substantial revenue
licensing patented technologies to third parties. Other companies that do not
have internal licensing resources and expertise have continued to record the
estimated value of intellectual property on their financial statements without
deriving income from their intellectual property. Recent changes in securities
and financial reporting regulations require these companies to evaluate and
potentially reduce or write-off these intellectual property assets if they are
unable to substantiate these reported values.
The Acacia Technologies group seeks to enter into business agreements
with owners of intellectual property that do not have experience or expertise in
the areas of intellectual property licensing and enforcement or that do not
possess the in-house resources to devote to licensing and enforcement
activities.
EFFECTIVELY AND EFFICIENTLY EVALUATE PATENTED TECHNOLOGIES FOR
ACQUISITION, LICENSING AND ENFORCEMENT
Subtleties in the language of a patent, recorded interactions with the
patent office, and the evaluation of prior art and literature can make a
significant difference in the potential licensing and enforcement revenue
derived from a patent or patent portfolio. The Acacia Technologies group's
specialists are trained and skilled in these areas. It is important to identify
potential problem areas prior to commercialization and determinate whether
potential problem areas can be overcome, before launching a licensing program.
We have developed processes and procedures for identifying problem areas and
evaluating the strength of a patent before the decision is made to allocate
resources to a licensing and enforcement effort.
PURCHASE OR ACQUIRE THE RIGHTS TO PATENTED TECHNOLOGIES
After evaluation, the Acacia Technologies group may elect to purchase
the patented technology, or become the exclusive licensing agent for the
patented technology in all or in specific fields of use. In either case, the
owner of the patent generally retains the rights to a portion of the revenues
generated from a patent's licensing and enforcement program. The Acacia
Technologies group generally controls the licensing and enforcement process and
utilizes its experienced in-house personnel to reduce outside costs, and ensure
that the Acacia Technologies group's capital is allocated and utilized in an
efficient and cost effective manner.
SUCCESSFULLY LICENSE AND ENFORCE PATENTS WITH SIGNIFICANT ROYALTY
POTENTIAL
As part of our patent evaluation process, significant consideration is
also given to the identification of potential infringers, industries within
which the potential infringers exist, longevity of the patented technology, and
a variety of other factors that directly impact the magnitude and potential
success of a licensing and enforcement program. Acacia Technologies group's
specialists are trained in evaluating potentially infringing technologies and
presenting the application of patents to such technologies. These presentations
generally take place in a non-adversarial business setting, but can also occur
through the litigation process, if necessary.
MARKETING AND DISTRIBUTION
DMT TECHNOLOGY LICENSING PROGRAM
Since November 2002, the Acacia Technologies group has entered into 117
license agreements for its DMT technology. One hundred and eight (108) of these
license agreements were executed during 2003. We have executed license
agreements with companies in the hotel in-room entertainment, online music,
movie, adult entertainment, e-learning, and sports, news and information
industries. The Acacia Technologies group is pursuing additional licensing and
strategic business alliances with leading companies in the rapidly growing
intellectual property licensing industry.
13
DMT TECHNOLOGY LITIGATION
In February 2003, Acacia Media Technologies initiated DMT patent
infringement litigation in the Federal District Court for the Central District
of California against approximately 39 defendants who provide adult oriented
digital content over the Internet. As of December 31, 2003, nine of the original
39 defendants remain in the initial litigation. In December 2003, Acacia Media
Technologies added an additional eight defendants to this pending patent
infringement litigation.
In November 2003, Acacia Media Technologies initiated a patent
infringement lawsuit in the Federal District Court for the Central District of
California against On Command Corporation, provider of interactive in-room
entertainment, information and business services to the lodging industry,
regarding Acacia Media Technologies' DMT technology.
V-CHIP LICENSING PROGRAM
The V-chip patent expired in July 2003. The Acacia Technologies group
will not be able to collect royalties for televisions containing V-chip
technology sold after the July 2003 expiration of that patent, but it may still
collect revenues from the sale of such televisions in the United States before
the expiration date. The Acacia Technologies group has licensed 13 major
television manufacturers, representing approximately 75% of the televisions sold
in the United States, 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, Philips Electronics North America
Corporation and Loewe Opta Gmbh.
V-CHIP LITIGATION
Litigation for patent infringement and anti-trust violations is pending
in the U.S. Court of Appeals for the Federal Circuit against Sony Corporation of
America, Mitsubishi Digital Electronics America, Inc., Sharp Electronics
Corporation and Toshiba America Consumer Products, Inc.
In September 2002 and 2003, the United States District Court for the
District of Connecticut, or U.S. District Court - Connecticut, granted the
defendants summary judgment motions for the patent infringement and antitrust
allegations, respectively. The decisions are currently being appealed to the
U.S. Court of Appeals for the Federal Circuit. While we are currently appealing
the two summary judgment rulings, litigation is inherently uncertain and we can
give no assurance that we will be successful in any such appeals.
The rulings have no impact on the revenues that we have recognized to
date from licensees of our patented V-chip technology. Further, none of the
revenues that we have recognized to date are contingent upon any court rulings
or the future outcome of any litigation with unlicensed television
manufacturers.
PATENTS AND LICENSES
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, video-on-demand and audio/video streaming, 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
31 foreign patents also relating to audio and video transmission and receiving
systems technology. Foreign rights include an initial 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. In
January 2004, the Acacia Technologies group was issued an additional European
patent for its DMT Technology. The new patent provides additional coverage in
the countries listed above. Acacia Technologies group's U.S. DMT patents expire
in 2011 and its foreign DMT patents expire in 2012.
REGULATORY MATTERS
We believe the Acacia Technologies group's DMT technology is utilized
by 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 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
14
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 our DMT technology and/or other technologies that
we may acquire or out-license. Many potential competitors 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, 2003, the Acacia Technologies group had 20 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.
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 leased approximately 7,019 square feet of office space
in Pasadena, California, which was subleased through the remaining term of the
lease agreement, which expired in November 2003. Our wholly owned 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. The leased premises is subleased through the
remaining term of the lease agreement.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of business, we are the subject of, or party to,
various pending or threatened legal actions, including various counterclaims in
connection with our intellectual property enforcement activities. 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.
SOUNDVIEW TECHNOLOGIES
On April 5, 2000, Soundview Technologies filed a federal patent
infringement and antitrust lawsuit against Sony Corporation of America, Philips
Electronics North America Corporation, the Consumer Electronics Manufacturers
Association and the Electronics Industries Alliance d/b/a Consumer Electronics
Association in the United States District Court for the Eastern District of
Virginia, alleging that television sets utilizing certain content blocking
technology (commonly known as the "V-chip") and sold in the United States
infringe Soundview Technologies' U.S. Patent No. 4,554,584.
15
In September 2002, the U.S. District Court - Connecticut, granted a
motion for summary judgment filed by defendants Sony Corporation of America,
Inc., Sony Electronics, Inc., the Electronics Industries Alliance d/b/a Consumer
Electronics Association, the Consumer Electronics Manufacturers Association,
Mitsubishi Digital Electronics America, Inc., Mitsubishi Electronics America,
Inc., Toshiba America Consumer Products, Inc. and Sharp Electronics Corporation
(the "remaining defendants"). In granting the motion, the court ruled that the
remaining defendants have not infringed on Soundview Technologies' patent.
In September 2003, a motion for summary judgment filed by the
remaining defendants was granted by the U.S. District Court - Connecticut on
Soundview Technologies' anti-trust claims due to the court's previous ruling of
non-infringement as described above.
The decisions are currently being appealed to the U.S. Court of
Appeals for the Federal Circuit. While we are currently appealing the two
summary judgment rulings, litigation is inherently uncertain and we can give no
assurance that we will be successful in any such appeals.
The rulings have no impact on the revenues that we have recognized to
date from licensees of our patented V-chip technology. Further, none of the
revenues that we have recognized to date are contingent upon any court rulings
or the future outcome of any litigation with unlicensed television
manufacturers.
ACACIA MEDIA TECHNOLOGIES CORPORATION
In February 2003, Acacia Media Technologies initiated DMT patent
infringement litigation in the Federal District Court for the Central District
of California against approximately 39 defendants who provide adult oriented
digital content over the Internet. As of December 31, 2003, nine of the original
39 defendants remain in the initial litigation. In December 2003, Acacia Media
Technologies added an additional eight defendants to its pending patent
infringement litigation described above. The new complaints, filed with the
Federal District Court for the Central District of California, seek to create a
defendant class for all adult entertainment companies that infringe Acacia Media
Technologies' DMT patents by transmitting pre-recorded, digital audio and
audio/video adult content via any electronic communication channel into or from
the Central District of California, or that operate at least one interactive
website where a user located in Central District of California can exchange
information with a host computer. Defendant class action status, which must be
approved by the court, would permit the court's rulings on certain key issues to
legally bind all members of the class, whether or not they have been
specifically named as defendants in the litigation.
In November 2003, Acacia Media Technologies initiated a patent
infringement lawsuit in the Federal District Court for the Central District of
California against On Command Corporation, provider of interactive in-room
entertainment, information and business services to the lodging industry,
regarding Acacia Media Technologies' DMT technology.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
RECENT MARKET PRICES
Acacia Research Corporation's two 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 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 classes of stock
replaced Acacia Research Corporation's common stock 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.
2003 2002(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
Low - - - - $3.65 $3.50 $5.90 $8.47
Acacia Research-Acacia Technologies stock:
High $8.58 $6.73 $1.75 $2.40 $3.40 - - -
Low $4.71 $1.25 $0.99 $0.96 $1.65 - - -
Acacia Research-CombiMatrix stock:
High $5.05 $5.07 $2.83 $3.65 $4.98 - - -
Low $2.90 $2.25 $1.71 $1.50 $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 Acacia Research-Acacia
Technologies stock and Acacia Research-CombiMatrix stock is not presented
as these classes of securities were not part of Acacia Research
Corporation's capital structure during 2001 and prior periods.
On February 27, 2004, there were approximately 162 owners of record of
Acacia Research-Acacia Technologies stock and 188 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.
17
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, 2003 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) 6,617,000 $7.28 2,208,000
2002 Acacia Technologies Stock Incentive Plan(2) 5,139,000 $8.29 470,000
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 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 Note12 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 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 12 to our consolidated financial statements.
(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.
18
ITEM 6. SELECTED FINANCIAL DATA
The consolidating selected balance sheet data as of December 31, 2003
and 2002 and the consolidating selected statement of operations data for the
years ended December 31, 2003, 2002 and 2001 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,
2001, 2000 and 1999 and for the years ended December 31, 2000 and 1999 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 and the
CombiMatrix group for the years ended December 31, 2003, 2002 and 2001 included
elsewhere herein, and the table should be read in conjunction with those
financial statements and related notes.
The AR-Acacia Technologies stock and the AR-CombiMatrix stock are
intended to reflect the separate performance of the respective divisions of
Acacia Research Corporation, rather than the performance of Acacia Research
Corporation as a whole. The chief mechanisms intended to cause the AR-Acacia
Technologies stock and the AR-CombiMatrix stock to reflect the financial
performance of the respective groups are provisions in our restated certificate
of incorporation and common stock policies governing dividends and distributions
to each class of stock, which specifically require the allocation of earnings to
each class based upon the performance of the two groups determined in accordance
with generally accepted accounting principles. Under these provisions, Acacia
Research Corporation factors the assets and liabilities and income or losses
attributable to the respective groups, determined as described under Item 7
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Critical Accounting Policies," into the determination of the
amounts available to pay dividends, if any, on the shares issued for the
respective groups and require Acacia Research Corporation to exchange, redeem or
distribute a dividend on the stock of a group if all or substantially all of the
assets allocated to the respective group are sold to a third party.
The Acacia Technologies group and the CombiMatrix group are not
separate legal entities. Holders of AR-Acacia Technologies stock and
AR-CombiMatrix stock are stockholders of Acacia Research Corporation. As a
result, stockholders continue to be subject to all of the risks of an investment
in Acacia Research Corporation and all of its businesses, assets and
liabilities. The assets that Acacia Research Corporation attributes to one group
could be subject to the liabilities of the other group.
19
CONSOLIDATING STATEMENT OF OPERATIONS DATA(4)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------- ------------- ------------- ------------- -------------
REVENUES:
Acacia Technologies group ..................... $ 692 $ 43 $ 24,180 $ 40 $ 122
CombiMatrix group ............................. 456 839 456 17 144
------------- ------------- ------------- ------------- -------------
ACACIA RESEARCH CORPORATION ................... $ 1,148 $ 882 $ 24,636 $ 57 $ 266
============= ============= ============= ============= =============
OPERATING (LOSS) INCOME
Acacia Technologies group ..................... $ (6,013) $ (9,865) $ 5,858 $ (12,606) $ (4,955)
CombiMatrix group ............................. (19,349) (70,460) (49,056) (24,557) (2,625)
------------- ------------- ------------- ------------- -------------
ACACIA RESEARCH CORPORATION ................... $ (25,362) $ (80,325) $ (43,198) $ (37,163) $ (7,580)
============= ============= ============= ============= =============
OTHER (EXPENSE) INCOME, NET:
Acacia Technologies group ..................... $ 408 $ (3,503) $ 2,111 $ (2,897) $ (818)
CombiMatrix group ............................. 214 392 2,055 1,662 (224)
------------- ------------- ------------- ------------- -------------
ACACIA RESEARCH CORPORATION ................... $ 622 $ (3,111) $ 4,166 $ (1,235) $ (1,042)
============= ============= ============= ============= =============
(LOSS) INCOME FROM CONTINUING OPERATIONS BEFORE
MINORITY INTERESTS:
Acacia Technologies group ..................... $ (5,468) $ (12,658) $ 7,034 $ (15,509) $ (5,791)
CombiMatrix group ............................. (18,999) (69,921) (46,846) (22,816) (2,851)
------------- ------------- ------------- ------------- -------------
ACACIA RESEARCH CORPORATION ................... $ (24,467) $ (82,579) $ (39,812) $ (38,325) $ (8,642)
============= ============= ============= ============= =============
MINORITY INTERESTS:
Acacia Technologies group ..................... $ 17 $ 104 $ (1,277) $ 866 $ (27)
CombiMatrix group ............................. 30 23,702 18,817 8,300 1,248
------------- ------------- ------------- ------------- -------------
ACACIA RESEARCH CORPORATION ................... $ 47 $ 23,806 $ 17,540 $ 9,166 $ 1,221
============= ============= ============= ============= =============
(LOSS) INCOME FROM CONTINUING OPERATIONS:
Acacia Technologies group ..................... $ (5,451) $ (12,554) $ 5,757 $ (14,643) $ (5,818)
CombiMatrix group ............................. (18,969) (46,219) (28,029) (14,516) (1,603)
------------- ------------- ------------- ------------- -------------
ACACIA RESEARCH CORPORATION ................... $ (24,420) $ (58,773) $ (22,272) $ (29,159) $ (7,421)
============= ============= ============= ============= =============
LOSS FROM DISCONTINUED OPERATIONS (1):
Acacia Technologies group ..................... $ -- $ (200) $ -- $ (9,554) $ (776)
CombiMatrix group ............................. -- -- -- -- --
------------- ------------- ------------- ------------- -------------
ACACIA RESEARCH CORPORATION ................... $ -- $ (200) $ -- $ (9,554) $ (776)
============= ============= ============= ============= =============
NET (LOSS) INCOME:
Acacia Technologies group ..................... $ (5,451) $ (12,754) $ 5,757 $ (24,197) $ (6,594)
CombiMatrix group ............................. (18,969) (46,219) (28,029) (14,762) (1,603)
------------- ------------- ------------- ------------- -------------
ACACIA RESEARCH CORPORATION ................... $ (24,420) $ (58,973) $ (22,272) $ (38,959) $ (8,197)
============= ============= ============= ============= =============
LOSS PER COMMON SHARE - BASIC AND DILUTED(5):
LOSS FROM CONTINUING OPERATIONS
Acacia Research - Acacia Technologies stock ... $ (0.28) $ (0.64) $ -- $ -- $ --
Acacia Research - CombiMatrix stock ........... (0.76) (2.01) -- -- --
Acacia Research Corporation ................... -- -- (1.16) (1.78) (0.59)
LOSS FROM DISCONTINUED OPERATIONS
Acacia Research - Acacia Technologies stock ... $ -- $ (0.01) $ -- $ -- $ --
Acacia Research - CombiMatrix stock ........... -- -- -- -- --
Acacia Research Corporation ................... -- -- -- (0.58) (0.06)
NET LOSS
Acacia Research - Acacia Technologies stock ... $ (0.28) $ (0.65) $ -- $ -- $ --
Acacia Research - CombiMatrix stock ........... (0.76) (2.01) -- -- --
Acacia Research Corporation ................... -- -- (1.16) (2.38) (0.65)
WEIGHTED AVERAGE NUMBER OF COMMON AND POTENTIAL
COMMON SHARES USED IN COMPUTATION OF LOSS PER
COMMON SHARE(2) (5):
BASIC AND DILUTED
Acacia Research - Acacia Technologies stock ... 19,661,655 19,640,808 -- -- --
============= ============= ============= ============= =============
Acacia Research - CombiMatrix stock ........... 24,827,819 22,950,746 -- -- --
============= ============= ============= ============= =============
Acacia Research Corporation ................... -- -- 19,259,256 16,346,099 12,649,133
============= ============= ============= ============= =============
20
CONSOLIDATING BALANCE SHEET DATA(4)
(IN THOUSANDS)
AT DECEMBER 31,
----------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
TOTAL ASSETS:
Acacia Technologies group ...... $ 39,978 $ 47,212 $ 62,926 $ 37,062 $ 49,788
CombiMatrix group .............. 50,161 49,973 47,963 61,561 2,003
Eliminations ................... (99) (114) (30) (107) --
---------- ---------- ---------- ---------- ----------
ACACIA RESEARCH CORPORATION .... $ 90,040 $ 97,071 $ 110,859 $ 98,516 $ 51,791
========== ========== ========== ========== ==========
LONG-TERM INDEBTEDNESS:
Acacia Technologies group ...... $ -- $ -- $ -- $ -- $ --
CombiMatrix group .............. -- -- 1,845 -- --
---------- ---------- ---------- ---------- ----------
ACACIA RESEARCH CORPORATION .... $ -- $ -- $ 1,845 $ -- $ --
========== ========== ========== ========== ==========
TOTAL LIABILITIES(3):
Acacia Technologies group ...... $ 4,188 $ 5,183 $ 5,723 $ 5,075 $ 1,304
CombiMatrix group .............. 24,424 13,972 14,131 15,880 229
Eliminations ................... (99) (114) (30) (107) 100
---------- ---------- ---------- ---------- ----------
ACACIA RESEARCH CORPORATION .... $ 28,513 $ 19,041 $ 19,824 $ 20,848 $ 1,633
========== ========== ========== ========== ==========
MINORITY INTERESTS(3):
Acacia Technologies group ...... $ 1,127 $ 1,487 $ 2,194 $ 2,012 $ 3,992
CombiMatrix group .............. -- 684 30,109 15,512 904
---------- ---------- ---------- ---------- ----------
ACACIA RESEARCH CORPORATION .... $ 1,127 $ 2,171 $ 32,303 $ 17,524 $ 4,896
========== ========== ========== ========== ==========
REDEEMABLE STOCKHOLDERS' EQUITY:
Acacia Technologies group ...... $ 34,663 $ 40,542 $ 55,009 $ 29,975 $ 44,492
CombiMatrix group .............. 25,737 35,317 3,723 30,169 770
---------- ---------- ---------- ---------- ----------
ACACIA RESEARCH CORPORATION .... $ 60,400 $ 75,859 $ 58,732 $ 60,144 $ 45,262
========== ========== ========== ========== ==========
- -----------------
(1) On February 13, 2001, the board of directors of Soundbreak.com, one of our
majority-owned subsidiaries, resolved to cease operations as of February
15, 2001 and liquidate the remaining assets and liabilities of
Soundbreak.com. Operating results in 1999 have been restated to present
Soundbreak.com as discontinued operations. See Note 11 to the Acacia
Research Corporation consolidated financial statements.
(2) Potential common shares in 2003, 2002, 2001, 2000 and 1999 have been
excluded from the per share calculations because the effect of their
inclusion would be anti-dilutive. In addition, all share and per share
information has been adjusted as appropriate for all periods presented to
reflect a two-for-one stock split effected in March 1998 and a ten percent
(10%) stock dividend distributed on December 5, 2001 for stockholders of
record as of November 21, 2001.
(3) Effective January 1, 2001, we changed our accounting policy for balance
sheet classification of employee stock-based compensation resulting from
awards in consolidated subsidiaries. As a result, effective January 1,
2001, amortized non-cash stock compensation charges related to subsidiary
stock options are included in minority interests in our consolidated
balance sheet. Prior to the change in accounting policy, amortized
non-cash stock compensation charges related to subsidiary stock options
were reflected as "accrued stock compensation" in consolidated
liabilities. There is no impact on previous consolidated statements of
operations as a result of this change in accounting policy.
(4) The management and allocation policies applicable to the preparation of
the financial statements of the Acacia Technologies group and the
CombiMatrix group and as a result, to the measurement by which dividends
or performance are determined for each group, may be modified or
rescinded, or additional policies may be adopted, at the sole discretion
of the Acacia Research Board at any time without approval of the
stockholders. The Acacia Technologies group's and the CombiMatrix group's
financial statements reflect the application of the management and
allocation policies adopted by the Acacia Research Corporation's board of
directors to various corporate activities. Management has no plans to
change allocation methods or the composition of the groups. Refer to Item
7 "Management's Discussion and Analysis of Financial Condition - Critical
Accounting Policies" for a description of allocation policies applied.
(5) The 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 Acacia
Research-Acacia Technologies stock and Acacia Research-CombiMatrix stock
is not presented as these classes of securities were not part of Acacia
Research Corporation's capital structure during 2001 and prior periods.
21
FACTORS AFFECTING COMPARABILITY:
o The Acacia Technologies group revenues reflected in 1999 primarily
relate to capital management fee income, including performance fee
income, recorded by the Acacia Capital Management division. During the
fourth quarter of 1999, Acacia Research Corporation closed its Acacia
Capital Management division. Acacia Capital Management was a general
partner in two private investment partnerships and was an investment
advisor to two offshore private investment corporations.
o In the fourth quarter of 2000, Acacia Research Corporation recorded
$1.0 million in write-offs of other early stage investments and $2.6
million in write-offs of equity investments, attributed to the Acacia
Technologies group.
o During the year ended December 31, 2000, CombiMatrix Corporation
recorded deferred non-cash stock compensation charges aggregating
approximately $53.8 million in connection with the granting of stock
options. Deferred non-cash stock compensation charges are being
amortized by the CombiMatrix group over the respective option grant
vesting periods, which range from one to four years. Non-cash stock
compensation charges totaled $1.7 million, $6.4 million and $20.0
million in 2003, 2002 and 2001, respectively. Non-cash stock
compensation charges were not significant in prior periods.
o In connection with Acacia Research Corporation's increased focus on the
media technologies and life sciences sectors, certain of Acacia
Research Corporation's businesses allocated to the Acacia Technologies
group ceased operations and certain investments were written off in
2000. As a result, marketing, general and administrative costs related
to salaries, benefits, consulting, legal and other professional costs
were significantly reduced in 2001.
o In June 2003 and September 2002, Acacia Research Corporation recorded
impairment charges of $207,000 and $2.7 million, respectively, for an
other-than-temporary decline in the fair value of a cost method
investment, attributed to the Acacia Technologies group.
o On December 13, 2002, Acacia Research Corporation increased its
consolidated ownership interest in CombiMatrix Corporation from 48% to
100% as discussed at Item 7 "Critical Accounting Policies - Accounting
for Business Combinations." $17.2 million of the total purchase price
of $46.0 million was attributed to acquired in-process research and
development, or IPR&D, and was charged to expense in the consolidated
statement of operations and comprehensive loss for the year ended
December 31, 2002. Amounts allocated to IPR&D have been attributed to
the CombiMatrix group.
o On September 30, 2002, CombiMatrix Corporation and Dr. Donald
Montgomery, an officer and stockholder of CombiMatrix Corporation,
entered into a settlement agreement with Nanogen to settle all pending
litigation between the parties. In addition to other terms of the
settlement agreement as described elsewhere herein, CombiMatrix
Corporation agreed to pay Nanogen $1.0 million and issued 4,016,346
shares, or 17.5% of its outstanding shares post issuance, to Nanogen.
The $1.0 million in payments have been expensed in the consolidated
statement of operations for the year ended December 31, 2002 under
"legal settlement charges." The issuance of the CombiMatrix Corporation
common shares in settlement of the litigation with Nanogen has been
accounted for as a nonmonetary transaction. Accordingly, included in
"legal settlement charges" in the consolidated statements of operations
for the year ended December 31, 2002 is a charge in the amount of $17.5
million based on the fair value of the CombiMatrix Corporation common
shares issued to Nanogen. Amounts related to the settlement have been
attributed to the CombiMatrix group.
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR
FINANCIAL STATEMENTS INCLUDED ELSEWHERE IN THIS FORM 10-K. THIS DISCUSSION
CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE
FORWARD-LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS INCLUDING THOSE SET
FORTH UNDER "RISK FACTORS" HEREIN.
GENERAL
Acacia Research Corporation is comprised of two operating groups, the
CombiMatrix group and the Acacia Technologies group.
The CombiMatrix group's core technology opportunity in the life
sciences sector has been developed through our wholly owned subsidiary,
CombiMatrix Corporation, which is developing a platform technology to rapidly
produce customizable arrays, which are semiconductor-based tools for use in
identifying and determining the roles of genes, gene mutations and proteins. The
CombiMatrix group's technology has a wide range of potential applications in the
areas of genomics, proteomics, biosensors, drug discovery, drug development,
diagnostics, combinatorial chemistry, material sciences and nanotechnology.
The Acacia Technologies group is responsible for the development,
acquisition, licensing and protection of intellectual property and proprietary
technologies and is pursuing additional licensing and strategic business
alliances with leading companies in the rapidly growing intellectual property
licensing industry. The Acacia Technologies group owns and out-licenses a
portfolio of pioneering U.S. and foreign patents covering digital audio and
video transmission and receiving systems, commonly known as audio-on-demand,
video-on-demand, and audio/video streaming. The Acacia Technologies group's
patented proprietary digital media transmission, or DMT technology, enables the
digitization, encryption, storage, transmission, receipt and playback of digital
content via several means including the Internet, cable, satellite and wireless
systems. The Acacia Technologies group also owns and has out-licensed to
consumer electronics manufacturers, patented technology known as the V-chip. The
V-chip technology was protected by U.S. Patent No. 4,554,584, which expired in
July 2003.
COMBIMATRIX GROUP
During 2003, the CombiMatrix group received significant payments from
its strategic partners and licensees. By continuing the CombiMatrix group's
efforts with these partners and by identifying new strategic relationships, the
CombiMatrix group intends to maximize the opportunities in the life sciences
sector that will be created by commercializing its array system. Highlights of
the operating activities for the year ended December 31, 2003 include the
following:
o For the year ended December 31, 2003, the CombiMatrix group received
cash payments from Roche totaling $9.8 million. Since the inception of
its relationship with Roche in July 2001, the CombiMatrix group has
received cash payments totaling $26.6 million through December 31,
2003. All payments received from Roche have been recorded as deferred
revenues at December 31, 2003.
o In March 2003, the CombiMatrix group's Japanese subsidiary, CombiMatrix
K.K., sold and installed a genomics array synthesizer system to Keio
University of Japan. CombiMatrix K.K. received and recognized $216,000
in revenues related to the sale and installation of the genomics array
synthesizer system in the first quarter of 2003.
o In April 2003, CombiMatrix K.K. sold a DNA array synthesizer to Nihon
Gene Research Laboratory, or NGRL. Under the terms of the agreement,
NGRL purchased a custom slide array synthesizer and entered into a
multi-year agreement to purchase arrays that will be used to provide
contract research services in Japan. CombiMatrix K.K. received an
advance payment of $182,000 from NGRL for the sale of the synthesizer
system, which was recognized as revenue during the third quarter of
2003. CombiMatrix K.K. and NGRL also entered into a co-development and
research agreement to investigate various aspects of genetic analysis.
o In April 2003, the CombiMatrix group designed and fabricated the first
array based on the SARS (Severe Acute Respiratory Syndrome) corona
virus genome. The first arrays were fabricated within 48 hours of
publication of the corona virus genome sequence believed to be
responsible for SARS, underscoring the CombiMatrix group's ability to
rapidly design and build custom arrays. Due to the public health and
economic implications of SARS, the CombiMatrix group made the decision
to provide a limited number of the new SARS arrays to key government
and academic researchers at no cost.
23
o In May 2003, the CombiMatrix group produced pools of small interfering
RNA molecules directed at specific genes of the SARS corona virus. The
CombiMatrix group is collaborating with the National Institute of
Allergy and Infectious Diseases, a division of the National Institutes
of Health, or NIH, and the U.S. Army Medical Research Institute of
Infectious Diseases to conduct the initial screening of the siRNA
samples against the SARS corona virus.
o In May 2003, the CombiMatrix group entered into a multi-year strategic
alliance with Toppan to develop arrays utilizing the CombiMatrix
group's proprietary electrochemical detection approach. Under the terms
of the agreement, Toppan paid the CombiMatrix group an upfront fee of
$1.0 million in the second quarter of 2003 and an additional
development and milestone payment of $1.4 million in December 2003. The
CombiMatrix group and Toppan will co-develop semiconductor arrays for
applications in life sciences research and development as well as
molecular diagnostics. Payments received from Toppan have been recorded
as deferred revenues at December 31, 2003.
o In May 2003, Acacia Research Corporation completed a private equity
financing raising gross proceeds of $5.2 million through the issuance
of 2,417,000 units. Each unit consists of one share of Acacia
Research-CombiMatrix common stock, or AR-CombiMatrix stock, and
one-half, five-year callable common stock purchase warrant. Each full
common stock purchase warrant entitles the holder to purchase a share
of AR-CombiMatrix stock at a price of $2.75 per share and is callable
by Acacia Research Corporation once the daily average of the high and
low prices of Acacia Research Corporation's AR-CombiMatrix stock on the
Nasdaq SmallCap Market is equal to or above $4.50 for 20 consecutive
trading days. Net