ACACIA RESEARCH CORP - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549
_____________

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004

COMMISSION FILE NUMBER 0-26068

ACACIA RESEARCH CORPORATION
---------------------------
(Exact Name of Registrant as Specified in Its Charter)

DELAWARE 95-4405754
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

500 NEWPORT CENTER DRIVE, NEWPORT BEACH, CA 92660
------------------------------------------- -----
(Address of Principal Executive Offices) (Zip Code)

Registrant's telephone number, including area code: (949) 480-8300
--------------

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]

As of April 30, 2004, 19,781,693 shares of Acacia Research-Acacia
Technologies common stock were issued and outstanding. As of April 30, 2004,
30,871,566 shares of Acacia Research-CombiMatrix common stock were issued and
outstanding.

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ACACIA RESEARCH CORPORATION
TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Acacia Research Corporation Consolidated Financial Statements

Consolidated Balance Sheets as of March 31, 2004 and
December 31, 2003 (Unaudited)....................................................... 1

Consolidated Statements of Operations and Comprehensive Loss for the
Three Months Ended March 31, 2004 and 2003 (Unaudited).............................. 2

Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2004 and 2003 (Unaudited)................................................. 3

Notes to Consolidated Financial Statements (Unaudited).............................. 4

*CombiMatrix Group Financial Statements

Balance Sheets as of March 31, 2004 and December 31, 2003 (Unaudited)............... 15

Statements of Operations for the Three Months Ended
March 31, 2004 and 2003 (Unaudited)................................................. 16

Statements of Cash Flows for the Three Months Ended
March 31, 2004 and 2003 (Unaudited)................................................. 17

Notes to Financial Statements (Unaudited)........................................... 18

*Acacia Technologies Group Financial Statements

Balance Sheets as of March 31, 2004 and December 31, 2003 (Unaudited)............... 22

Statements of Operations for the Three Months Ended
March 31, 2004 and 2003 (Unaudited)................................................. 23

Statements of Cash Flows for the Three Months Ended
March 31, 2004 and 2003 (Unaudited)................................................. 24

Notes to Financial Statements (Unaudited)........................................... 25

Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................................... 29

Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................... 63

Item 4. Controls and Procedures............................................................. 63

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings................................................................... 64

Item 6. Exhibits and Reports on Form 8-K.................................................... 65

SIGNATURES................................................................................................ 66

EXHIBIT INDEX ............................................................................................ 67

*NOTE: We are presenting the Acacia Research Corporation consolidated unaudited
interim financial statements and the separate unaudited interim financial
statements for the CombiMatrix group and the Acacia Technologies group. The
separate financial statements and accompanying notes of the two groups are being
provided as additional disclosure regarding the financial performance of the two
divisions and to provide investors with information regarding the potential
value and operating results of the respective businesses, which may affect the
respective share values. The separate financial statements should be reviewed in
conjunction with Acacia Research Corporation's consolidated financial statements
and accompanying notes. The presentation of separate financial statements is not
intended to indicate that we have changed the title to any of our assets or
changed the responsibility for any of our liabilities, nor is it intended to
indicate that the rights of our creditors have been changed. Acacia Research
Corporation, and not the individual groups, is the issuer of the securities.
Holders of the two securities are stockholders of Acacia Research Corporation
and do not have a separate and exclusive interest in the respective groups.

ii

ACACIA RESEARCH CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION)
(UNAUDITED)

MARCH 31, DECEMBER 31,
2004 2003
------------- -------------

ASSETS

Current assets:
Cash and cash equivalents .................................................. $ 32,982 $ 31,949
Short-term investments ..................................................... 17,962 18,551
Accounts receivable, net of allowance for doubtful accounts
of $0 (2004) and $145 (2003) ............................................ 339 323
Prepaid expenses, inventory, and other assets .............................. 1,522 1,180
------------- -------------

Total current assets ............................................... 52,805 52,003

Property and equipment, net of accumulated depreciation .......................... 2,552 2,823
Patents, net of accumulated amortization of $9,610 (2004) and $9,210 (2003)....... 13,284 13,683
Goodwill ......................................................................... 21,200 21,200
Other assets ..................................................................... 332 331
------------- -------------

$ 90,173 $ 90,040
============= =============

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable, accrued expenses and other ............................... $ 3,797 $ 3,244
Current portion of deferred revenues ....................................... 647 18,108
------------- -------------

Total current liabilities .......................................... 4,444 21,352

Deferred income taxes ............................................................ 3,190 3,260
Deferred revenues, net of current portion ........................................ 3,920 3,901
Other liabilities ................................................................ 1,257 --
------------- -------------

Total liabilities ........................................................ 12,811 28,513
------------- -------------

Minority interests ............................................................... 1,127 1,127
------------- -------------

Commitments and contingencies (Note 8)

Redeemable Stockholders' equity:
Preferred stock
Acacia Research Corporation, par value $0001 per share;
10,000,000 shares authorized; no shares issued or outstanding ........ -- --
Common stock
Acacia Research - Acacia Technologies stock, par value
$0.001 per share; 50,000,000 shares authorized; 19,781,693 and
19,739,984 shares issued and outstanding as of March 31, 2004
and December 31, 2003, respectively .................................. 20 20
Acacia Research - CombiMatrix stock, par value $0.001 per share;
50,000,000 shares authorized; 27,766,703 and 26,328,122 shares
issued and outstanding as of March 31, 2004 and December 31, 2003,
respectively ......................................................... 28 26
Additional paid-in capital ................................................. 249,195 244,517
Deferred stock compensation ................................................ (521) (766)
Accumulated comprehensive income ........................................... 15 8
Accumulated deficit ........................................................ (172,502) (183,405)
------------- -------------

Total stockholders' equity ......................................... 76,235 60,400
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$ 90,173 $ 90,040
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THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.

1

ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION)
(UNAUDITED)

FOR THE THREE MONTHS ENDED
--------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------

Revenues:
Research and development contract .................................... $ 17,302 $ --
License fees ......................................................... 599 6
Government contract .................................................. 217 --
Service contracts .................................................... 81 7
Products ............................................................. 16 209
------------- -------------

Total revenues ........................................... 18,215 222
------------- -------------

Operating expenses:
Cost of product sales ................................................ 4 77
Research and development expenses .................................... 1,588 2,335
Non-cash stock compensation amortization - research and development .. 69 2
Marketing, general and administrative expenses ....................... 3,886 4,255
Non-cash stock compensation amortization - marketing,
general and administrative ........................................ 334 138
Amortization of patents .............................................. 399 400
Legal settlement charges ............................................. 1,257 --
------------- -------------

Total operating expenses ................................. 7,537 7,207
------------- -------------

Operating income (loss) .................................. 10,678 (6,985)
------------- -------------

Other income:
Interest income ...................................................... 158 215
Realized gains on short-term investments ............................. -- 37
------------- -------------

Total other income ....................................... 158 252
------------- -------------

Income (loss) from operations before income taxes and minority interests.... 10,836 (6,733)

Benefit for income taxes ................................................... 67 60
------------- -------------

Income (loss) from operations before minority interests .................... 10,903 (6,673)

Minority interests ......................................................... -- 6
------------- -------------

Net income (loss) .......................................................... 10,903 (6,667)
------------- -------------

Unrealized gains (losses) on short-term investments .................. 2 (8)
Unrealized gains (losses) on foreign currency translation ............ 6 (7)
------------- -------------

Comprehensive income (loss) ................................................ $ 10,911 $ (6,682)
============= =============

Earnings (loss) per common share:
Attributable to the Acacia Technologies group:
Net income (loss) ....................................................... $ (989) $ (1,494)
Basic and diluted loss per share ........................................ (0.05) (0.08)

Attributable to the CombiMatrix group:
Basic
Net income (loss) ....................................................... $ 11,892 $ (5,173)
Basic net income (loss) per share ....................................... 0.44 (0.23)
Diluted
Net income (loss) ....................................................... $ 11,892 $ (5,173)
Diluted net income (loss) per share ..................................... 0.41 (0.23)

Weighted average shares:
Acacia Research - Acacia Technologies stock:
Basic and diluted ................................................... 19,752,335 19,640,808
============= =============
Acacia Research - CombiMatrix stock:
Basic ............................................................... 27,274,627 22,983,278
============= =============
Diluted ............................................................. 29,233,817 22,983,278
============= =============

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.

2

ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

FOR THE THREE MONTHS ENDED
---------------------------------------
MARCH 31, 2004 MARCH 31, 2003
----------------- -----------------

Cash flows from operating activities:
Net income (loss) from operations ........................................... $ 10,903 $ (6,667)
Adjustments to reconcile net income (loss) from operations
to net cash used in operating activities:
Depreciation and amortization .......................................... 712 767
Minority interests ..................................................... -- (6)
Non-cash stock compensation amortization ............................... 403 140
Deferred tax benefit ................................................... (70) (70)
Non-cash legal settlement charge ....................................... 1,257 --
Other .................................................................. (27) 121
Changes in assets and liabilities:
Accounts receivable .................................................... (16) 301
Prepaid expenses, inventory and other assets ........................... (221) (397)
Accounts payable, accrued expenses and other ........................... 671 (250)
Deferred revenues ...................................................... (17,442) 1,508
----------------- -----------------

Net cash used in operating activities from continuing operations ....... (3,830) (4,553)
Net cash used in operating activities from discontinued operations ..... (87) (86)
----------------- -----------------
Net cash used in operating activities .................................. (3,917) (4,639)
----------------- -----------------

Cash flows from investing activities:
Purchase of property and equipment, net ................................ (97) (24)
Purchase of available-for-sale investments ............................. (13,605) (469)
Sale of available-for-sale investments ................................. 14,196 2,462
----------------- -----------------

Net cash provided by investing activities from continuing operations ... 494 1,969
Net cash used in investing activities from discontinued operations ..... -- (344)
----------------- -----------------
Net cash provided by investing activities .............................. 494 1,625
----------------- -----------------

Cash flows from financing activities:
Proceeds from the exercise of stock options and warrants ............... 4,450 --
----------------- -----------------

Net cash provided by financing activities .............................. 4,450 --
----------------- -----------------

Effect of exchange rate on cash ............................................... 6 (7)
----------------- -----------------

Increase (decrease) in cash and cash equivalents .............................. 1,033 (3,021)

Cash and cash equivalents, beginning .......................................... 31,949 43,083
----------------- -----------------

Cash and cash equivalents, ending ............................................. $ 32,982 $ 40,062
================= =================

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.

3

ACACIA RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS

BASIS OF PRESENTATION. The accompanying unaudited consolidated
financial statements have been prepared in accordance with generally accepted
accounting principles for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain
information and footnotes required by generally accepted accounting principles
in annual financial statements have been omitted or condensed in accordance with
quarterly reporting requirements of the Securities and Exchange Commission.
These interim consolidated financial statements should be read in conjunction
with the consolidated financial statements and notes thereto for the year ended
December 31, 2003, as reported by us in our Annual Report on Form 10-K. The
year-end consolidated balance sheet data was derived from audited financial
statements but does not include all disclosures required by accounting
principles generally accepted in the United States of America.

The accompanying consolidated financial statements include the accounts
of Acacia Research Corporation and its wholly owned and majority-owned
subsidiaries. Material intercompany transactions and balances have been
eliminated in consolidation.

The consolidated financial statements of Acacia Research Corporation
include all adjustments of a normal recurring nature which, in the opinion of
management, are necessary for a fair presentation of our financial position as
of March 31, 2004 and results of operations and cash flows for the interim
periods presented. The results of operations for the three months ended March
31, 2004 are not necessarily indicative of the results to be expected for the
entire year.

Acacia Research Corporation ("we," "us" and "our") 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 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. CombiMatrix K.K.,
a Japanese corporation located in Tokyo, is exploring opportunities for
CombiMatrix Corporation's active array system with pharmaceutical and
biotechnology companies in the Asian market.

Our intellectual property licensing business, referred to as the
"Acacia Technologies group," acquires, develops and licenses intellectual
property, and is comprised primarily of Acacia Research Corporation's wholly
owned subsidiaries, Acacia Media Technologies Corporation ("Acacia Media
Technologies") and Soundview Technologies, Inc. ("Soundview Technologies"). 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.

RECAPITALIZATION TRANSACTION

On December 11, 2002, our stockholders voted in favor of a
recapitalization transaction, which became effective on December 13, 2002,
whereby we created two new classes of common stock called Acacia
Research-CombiMatrix stock ("AR-CombiMatrix stock") and Acacia Research-Acacia
Technologies stock ("AR-Acacia Technologies stock"), and divided our existing
Acacia Research Corporation common stock into shares of the two new classes of
common stock. AR-CombiMatrix stock is intended to reflect separately the
performance of Acacia Research Corporation's CombiMatrix group. AR-Acacia
Technologies stock is intended to reflect separately the performance of Acacia
Research Corporation's Acacia Technologies group. Although the AR-CombiMatrix
stock and the AR-Acacia Technologies stock are intended to reflect the
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.

SEPARATE GROUP PRESENTATION. AR-CombiMatrix stock and AR-Acacia
Technologies stock are intended to reflect the separate performance of the
respective division of Acacia Research Corporation. The CombiMatrix group and
the Acacia Technologies group are not separate legal entities. Holders of
AR-CombiMatrix stock and AR-Acacia Technologies stock are stockholders of Acacia
Research Corporation. As a result, holders of AR-CombiMatrix stock and AR-Acacia
Technologies stock continue to be subject to all of the risks of an investment
in Acacia Research Corporation and all of its businesses, assets and

4

liabilities. The assets Acacia Research Corporation attributes to one of the
groups could be subject to the liabilities of the other group. The group
financial statements have been prepared in accordance with generally accepted
accounting principles in the United States of America, and taken together,
comprise all the accounts included in the corresponding consolidated financial
statements of Acacia Research Corporation. The financial statements of the
groups reflect the financial condition, results of operations, and cash flows of
the businesses included therein. The financial statements of the groups include
the accounts or assets of Acacia Research Corporation specifically attributed to
the groups and were prepared using amounts included in Acacia Research
Corporation's consolidated financial statements.

Financial effects arising from one group that affect Acacia Research
Corporation's results of operations or financial condition could, if
significant, affect the results of operations or financial condition of the
other group and the market price of the class of common stock relating to the
other group. Any division net losses of the CombiMatrix group or of the Acacia
Technologies group, and dividends or distributions on, or repurchases of,
AR-CombiMatrix stock or AR-Acacia Technologies stock, will reduce the assets of
Acacia Research Corporation legally available for payment of dividends on
AR-CombiMatrix stock or AR-Acacia Technologies stock.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

REVENUE RECOGNITION. We recognize revenue in accordance with Staff
Accounting Bulletin No. 104, "Revenue Recognition" ("SAB No. 104") and related
authoritative pronouncements. Revenues from multiple-element arrangements are
accounted for in accordance with Emerging Issues Task Force ("EITF") Issue
00-21, "Revenue Arrangements with Multiple Deliverables." Revenue is recognized
when (i) persuasive evidence of an arrangement exists, (ii) all obligations have
been performed pursuant to the terms of the license agreement, (iii) amounts are
fixed or determinable and (iv) collectibility of amounts is reasonably assured.

COMBIMATRIX GROUP

Revenues from multiple-element arrangements involving license fees,
up-front payments and milestone payments, which are received and/or billable by
us in connection with other rights and services that represent continuing
obligations of ours, are deferred until all of the elements have been delivered
or until we have established objective and verifiable evidence of the fair value
of the undelivered elements.

Revenues from government grants and contracts are recognized in
accordance with Accounting Research Bulletin ("ARB") No. 43, "Government
Contracts," and related pronouncements. Accordingly, revenues are recognized
under the percentage-of-completion method of accounting, using the cost-to-cost
approach to measure completeness at each reporting period. Under the
percentage-of-completion method of accounting, contract revenues and expenses
are recognized in the period that work is performed based on the percentage of
actual incurred costs to estimated total contract costs. Actual contract costs
and cost estimates include direct charges for labor and materials and indirect
charges for labor, overhead and certain general and administrative charges.
Contract change orders and claims are included when they can be reliably
estimated and are considered probable. For contracts that extend over a one-year
period, revisions in contract cost estimates, if they occur, have the effect of
adjusting current period earnings applicable to performance in prior periods.
Should current contract estimates indicate an overall future loss to be
incurred, a provision is made for the total anticipated loss in the current
period.

Revenue from the sale of products and services is recognized when
delivery has occurred or services have been rendered.

Deferred revenue arises from payments received in advance of the
culmination of the earnings process. Deferred revenue expected to be recognized
within the next twelve months is classified as current. Deferred revenues will
be recognized as revenue in future periods when the applicable revenue
recognition criteria as described above are met.

ACACIA TECHNOLOGIES GROUP

Under the terms of our digital media transmission ("DMT") license
agreements, the Acacia Technologies group grants an annual non-exclusive license
for the use of its patented DMT technology. In most instances, our license
agreements provide for recurring royalty payments for each year that the license
agreements are in effect through the expiration of the patents. Pursuant to the
terms of our DMT license agreements, once executed, the Acacia Technologies
group has no further obligations with respect to the grant of the annual license
each year. License fees paid to and recognized as revenue by the Acacia
Technologies group are non-refundable.

5

PER UNIT ROYALTIES. Revenue generated from license agreements that
provide for the calculation of royalties on a per-unit basis are accrued and
recognized as revenue in the period earned, provided that amounts are fixed or
determinable and collectibility is reasonably assured.

PERCENTAGE OF LICENSEE SALES ROYALTIES. Certain license agreements
provide for the calculation of license fees based on a licensee's actual
quarterly sales applied to a contractual royalty rate. Licensees that pay
license fees on a quarterly basis generally report actual quarterly sales
information and related quarterly license fees due to the Acacia Technologies
group within 30 to 45 days after the end of the quarter in which such activity
takes place. Consequently, the Acacia Technologies group recognizes revenue from
these licensing agreements on a three-month lag basis, in the quarter following
the quarter of sales, provided amounts are fixed or determinable and
collectibility is reasonably assured. The lag method described above allows for
the receipt of licensee royalty reports prior to the recognition of revenue.

MINIMUM UPFRONT ANNUAL ROYALTIES. Certain license agreements provide
for the calculation and payment of a minimum upfront annual license fee, based
upon a licensee's expected annual sales during each annual license term. These
license fee payments are deferred and amortized to revenue on a straight-line
basis over the annual license term. To the extent actual annual royalties
reported at the conclusion of each annual license term exceed the amount
prepaid, the additional royalties are recognized in revenue in the quarter
following the annual license term provided that amounts are fixed or
determinable and collectibility is reasonably assured.

License fee payments received by the Acacia Technologies group that do
not meet the revenue recognition criteria described above are deferred until the
revenue recognition criteria are met. The Acacia Technologies group assesses
collection of accrued license fees based on a number of factors, including past
transaction history and credit-worthiness. If it is determined that collection
is not reasonably assured, the fee is recognized when collectibility becomes
reasonably assured, assuming all other revenue recognition criteria have been
met, which is generally upon receipt of cash.

As a result of our licensing and any related intellectual property
enforcement activities that we choose to conduct, we may recognize royalty
revenues that relate to prior period infringements by licensees. Differences
between amounts initially recognized and amounts subsequently audited or
reported as an adjustment to those amounts will be recognized in the period the
adjustment is determined as a change in accounting estimate.

INVENTORY. Inventory, which consists primarily of raw materials to be
used in the production of the CombiMatrix group's array products, is stated at
the lower of cost or market using the first-in, first-out method.

STOCK-BASED COMPENSATION. Acacia Research Corporation has two
stock-based employee compensation plans, the 2002 CombiMatrix Stock Incentive
Plan and the 2002 Acacia Technologies Stock Incentive Plan. Compensation cost of
stock options issued to employees is accounted for in accordance with Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB No. 25") and related interpretations. Compensation cost
attributable to such options is recognized based on the difference, if any,
between the closing market price of the stock on the date of grant and the
exercise price of the option. Compensation cost is generally deferred and
amortized on an accelerated basis over the vesting period of the individual
option awards using the amortization method prescribed in Financial Accounting
Standards Board ("FASB") Interpretation No. 28, "Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award Plans" ("FIN No.
28"). We have adopted the disclosure only requirements of SFAS No. 123,
"Accounting for Stock-Based Compensation" ("SFAS No. 123"), as amended by SFAS
No. 148 "Accounting for Stock-Based Compensation--Transition and Disclosure--an
amendment of SFAS No. 123" ("SFAS No. 148"), with respect to options issued to
employees. Compensation cost of stock options and warrants issued to
non-employee service providers is accounted for under the fair value method
required by SFAS No. 123 and related interpretations.

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The following table illustrates the effect on net income (loss) and
income (loss) per share if Acacia Research Corporation had applied the fair
value recognition provisions of SFAS No. 123 (in thousands, except per share
data):

AR-ACACIA TECHNOLOGIES STOCK AR-COMBIMATRIX STOCK
THREE MONTHS ENDED THREE MONTHS ENDED
------------------------------- -------------------------------
MARCH 31, 2004 MARCH 31, 2003 MARCH 31, 2004 MARCH 31, 2003
-------------- -------------- -------------- --------------

Income (loss) from operations as reported .................... $ (989) $ (1,494) $ 11,892 $ (5,173)
Add: Stock-based compensation, intrinsic value method
reported in net income, net of tax and minority
interests ................................................. -- -- 238 69
Deduct: Pro forma stock-based compensation fair value
method, net of tax and minority interests ................. (562) (1,078) (1,772) (2,782)
Income (loss) from operations, pro forma ..................... (1,551) (2,572) 10,358 (7,886)
Basic income (loss) per share from operations as reported .... (0.05) (0.08) 0.44 (0.23)
Basic income (loss) per share from operations, pro forma ..... (0.08) (0.13) 0.38 (0.34)
Diluted income (loss) per share from operations as
reported .................................................. (0.05) (0.08) 0.41 (0.23)
Diluted income (loss) per share from operations, pro forma ... (0.08) (0.13) 0.35 (0.34)

The fair value of AR-Acacia Technologies stock options and
AR-CombiMatrix stock options was determined using the Black-Scholes
option-pricing model, assuming volatility of approximately 100%, with expected
lives of approximately five years and no expected dividends.

IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL. We review long-lived
assets and intangible assets for potential impairment annually and when events
or changes in circumstances indicate the carrying amount of an asset may not be
recoverable. In the event the sum of the expected undiscounted future cash flows
resulting from the use of the asset is less than the carrying amount of the
asset, an impairment loss equal to the excess of the asset's carrying value over
its fair value is recorded. If an asset is determined to be impaired, the loss
is measured based on quoted market prices in active markets, if available. If
quoted market prices are not available, the estimate of fair value is based on
various valuation techniques, including a discounted value of estimated future
cash flows.

Goodwill is subject to a periodic review for potential impairment at a
reporting unit level. Reviews for potential impairment must occur at least
annually and may be performed earlier, if circumstances indicate that an
impairment may have occurred. Acacia Research Corporation has elected to perform
its annual tests for indications of goodwill impairment as of December 31 of
each year. Our three reporting units are: 1) Acacia Media Technologies
Corporation and 2) Soundview Technologies, Inc., which are the primary
components of the Acacia Technologies group, and 3) the CombiMatrix group. The
fair values of our reporting units are estimated using a discounted cash flow
analysis. There can be no assurance that future goodwill impairment tests will
not result in a charge to earnings.

3. EARNINGS PER SHARE

EARNINGS PER SHARE. Earnings per share for each class of common stock
is computed by dividing the earnings allocated to each class of common stock by
the weighted average number of outstanding shares of that class of common stock.
Diluted earnings per share is computed by dividing the loss allocated to each
class of common stock by the weighted average number of outstanding shares of
that class of common stock including the dilutive effect of common stock
equivalents. Potentially dilutive common stock equivalents primarily consist of
employee stock options and warrants.

The earnings or losses allocated to each class of common stock are
determined by Acacia Research Corporation's board of directors. This
determination is generally based on the net income or loss amounts of the
corresponding group determined in accordance with accounting principles
generally accepted in the United States of America, consistently applied. Acacia
Research Corporation believes this method of allocation is systematic and
reasonable. The Acacia Research Corporation board of directors can, at its
discretion, change the method of allocating earnings or losses to each class of
common stock at any time. Management currently has no plans to change allocation
methods.

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The following table presents a reconciliation of basic and diluted loss per share:

FOR THE THREE MONTHS ENDED
----------------------------------
MARCH 31, 2004 MARCH 31, 2003
--------------- ---------------

ACACIA RESEARCH - ACACIA TECHNOLOGIES STOCK
- -------------------------------------------

Basic weighted average number of common shares outstanding ....................... 19,752,335 19,640,808

Dilutive effect of outstanding stock options and warrants ........................ -- --
--------------- ---------------

Diluted weighted average number of common and
potential common shares outstanding .............................................. 19,752,335 19,640,808
=============== ===============

Potential AR-Acacia Technologies stock common shares excluded from the per
share calculation because the effect of their inclusion would be anti-dilutive.... 1,436,257 786
=============== ===============

ACACIA RESEARCH - COMBIMATRIX STOCK
- -----------------------------------

Basic weighted average number of common shares outstanding ....................... 27,274,627 22,983,278

Dilutive effect of outstanding stock options and warrants(1) ..................... 1,959,190 --
--------------- ---------------

Diluted weighted average number of common and
potential common shares outstanding .............................................. 29,233,817 22,983,278
=============== ===============

Potential AR-CombiMatrix stock common shares excluded from the per
share calculation because the effect of their inclusion would be anti-dilutive ... -- 441,750
=============== ===============

- ---------------
(1) Includes 84,299 shares of potentially dilutive AR-CombiMatrix stock
issuable as of March 31, 2004 related to certain anti-dilution provisions
of the September 2002 settlement agreement between CombiMatrix Corporation,
Dr. Donald Montgomery, and Nanogen, Inc.

4. GOODWILL AND INTANGIBLES

The Acacia Technologies group had $1,776,000 of goodwill at March 31,
2004 and December 31, 2003. The CombiMatrix group had $19,424,000 of goodwill at
March 31, 2004 and December 31, 2003.

Acacia Research Corporation's only identifiable intangible assets at
March 31, 2004 and December 31, 2003 are patents. The gross carrying amounts and
accumulated amortization as of March 31, 2004 and December 31, 2003, related to
patents, by segment, are as follows (in thousands):

ACACIA TECHNOLOGIES GROUP COMBIMATRIX GROUP
------------------------------- -------------------------------
MARCH 31, DECEMBER 31, MARCH 31, DECEMBER 31,
2004 2003 2004 2003
------------- ------------- ------------- -------------

Gross carrying amount - patents.... $ 10,798 $ 10,798 $ 12,095 $ 12,095
Accumulated amortization .......... (7,357) (7,232) (2,252) (1,978)
------------- ------------- ------------- -------------
Patents, net ...................... $ 3,441 $ 3,566 $ 9,843 $ 10,117
============= ============= ============= =============

See Note 10 for patent amortization expense by segment for the three
months ended March 31, 2004 and 2003.

Annual aggregate amortization expense for each of the next five years
through December 31, 2008 is estimated to be $1,595,000 per year ($500,000 for
the Acacia Technologies group and $1,095,000 for the CombiMatrix group).

At March 31, 2004 and December 31, 2003, all of our acquired intangible
assets other than goodwill were subject to amortization.

5. REVENUES

In March 2004, the CombiMatrix group completed all phases of its
research and development agreement with Roche Diagnostics, GmbH ("Roche"). As a
result of completing all of its obligations under this agreement and in
accordance with the CombiMatrix group's revenue recognition policies for
multiple-element arrangements, the CombiMatrix group recognized all previously
deferred Roche related contract revenues totaling $17,302,000 during the first
quarter of 2004.

8

6. INCOME TAXES

We estimate that there will be sufficient losses from operations in the
current fiscal year to offset any taxable income related to the Roche deferred
contract revenues totaling $17,302,000 recognized during the three months ended
March 31, 2004, resulting in no significant tax liability or expense in the
current period or for the year ending December 31, 2004. Additionally, there was
a deferred tax asset that was previously recognized for income tax purposes that
was offset by a valuation allowance; as a result of the deferred revenue
recognition, the associated deferred tax asset and related valuation allowance
were reduced in the current period by approximately $3.5 million.

7. RECENT ACCOUNTING PRONOUNCEMENTS

In March 2004, the Emerging Issues Task Force ("EITF") issued EITF
Issue No. 03-6, "Participating Securities and the Two-Class Method under FASB
Statement No. 128, Earnings Per Share," ("EITF 03-6") which addresses questions
regarding the computation of earnings per share ("EPS") by companies that have
issued securities other than common stock that contractually entitle the holder
to participate in dividends and earnings of the company when, and if, it
declares dividends on its common stock. The issue also provides further guidance
in applying the two-class method of calculating EPS and clarifies what
constitutes a participating security and how to apply the two-class method of
computing EPS once it is determined that a security is participating, including
how to allocate undistributed earnings to such a security. EITF 03-6 defines
participation rights based solely on whether the holder would be entitled to
receive any dividends if the entity declared them during the period and requires
the use of the two-class method for computing basic EPS when participating
convertible securities exist. In addition, EITF 03-6 expands the use of the
two-class method to encompass other forms of participating securities, including
options, warrants, forwards, and other contracts to issue an entity's common
stock. The provisions of EITF 03-6 are effective for fiscal periods beginning
after March 31, 2004. We do not expect the adoption of EITF 03-6 to have a
material impact on the Acacia Research Corporation's, the CombiMatrix group's or
the Acacia Technologies group's financial position, results of operations or
cash flows.

8. COMMITMENTS AND CONTIGENCIES

On September 30, 2002, CombiMatrix Corporation and Dr. Donald
Montgomery entered into a settlement agreement with Nanogen, Inc. to settle all
pending litigation between the parties. During the three months ended March 31,
2004, we recorded a non-cash charge totaling $1,257,000 in connection with
certain anti-dilution provisions of that agreement. The non-cash charge reflects
management's estimate of the fair value of AR-CombiMatrix stock that will be
issued to Nanogen, Inc. as a result of certain options and warrants exercised
during the quarter and the fair value of AR-CombiMatrix stock potentially
issuable to Nanogen, Inc. as of the balance sheet date. The liability is
adjusted at each balance date for changes in the market value of the
AR-CombiMatrix stock and is reflected as long-term until settled in equity. The
anti-dilution provisions of the settlement agreement expire in September 2005.

In addition to other terms of the settlement agreement, CombiMatrix
Corporation is also required to make quarterly payments to Nanogen, Inc. equal
to 12.5% of payments to CombiMatrix Corporation from sales of products developed
by CombiMatrix Corporation and its affiliates and based on the patents that had
been in dispute in the litigation, up to an annual maximum of $1,500,000. The
minimum quarterly payments under the settlement agreement will be $37,500 per
quarter for the period from October 1, 2003 through October 1, 2004, and $25,000
per quarter thereafter until the patents expire in 2018.

In connection with the purchase of the outstanding ownership interests
in Acacia Media Technologies in November 2001, Acacia Media Technologies also
executed related assignment agreements which granted to the former owners of
Acacia Media Technologies' current patent portfolio the right to receive a
royalty of 15% of future net revenues, as defined in the agreements, generated
by Acacia Media Technologies' current patent portfolio, which includes its DMT
patents. No royalty obligation has been incurred as of March 31, 2004. Any
royalties paid pursuant to the agreements will be expensed in the consolidated
statement of operations.

LITIGATION

Acacia Research Corporation is subject to other claims, counterclaims
and legal actions that arise in the ordinary course of business. Management
believes that the ultimate liability with respect to these claims and legal
actions, if any, will not have a material effect on our financial position,
results of operations or cash flows.

9

SOUNDVIEW TECHNOLOGIES

In September 2002, the United States District Court for the District of
Connecticut granted a motion for summary judgment filed by the defendants in
Soundview Technologies pending 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 (filed on April 5, 2000), alleging
that television sets utilizing certain content blocking technology (commonly
known as the "V-chip") and sold in the United States infringe Soundview
Technologies' U.S. Patent No. 4,554,584. In granting the motion, the court ruled
that the 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 United States District Court for the District of
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. All of the defendants were previously
notified of our belief that their conduct infringes on our patent rights. As of
March 31, 2004, 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 Court, 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.

9. SUBSEQUENT EVENTS

In April 2004, Acacia Research Corporation raised gross proceeds of
$15,000,000 through the sale of 3,000,000 shares of Acacia Research -
CombiMatrix common stock at a price of $5.00 per share in a registered direct
offering. Net proceeds raised of approximately $13,600,000, which are net of
related issuance costs, were attributed to the CombiMatrix group.

10

10. CONSOLIDATING SEGMENT INFORMATION

Acacia Research Corporation has adopted the provisions of SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." Our chief
operating decision maker is considered to be Acacia Research Corporation's Chief
Executive Officer ("CEO"). The CEO reviews and evaluates financial information
presented on a group basis as described below. Management evaluates performance
based on the profit or loss from continuing operations and financial position of
its segments. Acacia Research Corporation has two reportable segments as
described earlier in Note 1.

Material intercompany transactions and transfers have been eliminated
in consolidation. The accounting policies of the segments are the same as those
described in the summary of significant accounting policies.

Presented below is consolidating financial information for our
reportable segments reflecting the businesses of the CombiMatrix group and the
Acacia Technologies group. Earnings attributable to each group has been
determined in accordance with accounting principles generally accepted in the
United States.

11

CONSOLIDATING BALANCE SHEETS (IN THOUSANDS)

AT MARCH 31, 2004 AT DECEMBER 31, 2003
----------------------------------------- ----------------------------------------
ACACIA ACACIA
TECHNO- COMBI- TECHNO- COMBI-
LOGIES MATRIX ELIMI- CONSOLI- LOGIES MATRIX ELIMI- CONSOLI-
GROUP GROUP NATIONS DATED GROUP GROUP NATIONS DATED
--------- --------- --------- --------- --------- --------- --------- ---------

ASSETS

Current assets:
Cash and cash equivalents ................. $ 29,500 $ 3,482 $ -- $ 32,982 $ 28,142 $ 3,807 $ -- $ 31,949
Short-term investments .................... 3,029 14,933 -- 17,962 5,059 13,492 -- 18,551
Accounts receivable ....................... 121 218 -- 339 124 199 -- 323
Prepaid expenses, inventory and other
assets .................................. 1,063 459 -- 1,522 903 277 -- 1,180
Receivable from CombiMatrix group ......... 212 -- (212) -- 99 -- (99) --
--------- --------- --------- --------- --------- --------- --------- ---------

Total current assets .............. 33,925 19,092 (212) 52,805 34,327 17,775 (99) 52,003

Property and equipment, net of accumulated
depreciation ................................. 97 2,455 -- 2,552 71 2,752 -- 2,823
Patents, net of accumulated amortization ....... 3,441 9,843 -- 13,284 3,566 10,117 -- 13,683
Goodwill ....................................... 1,776 19,424 -- 21,200 1,776 19,424 -- 21,200
Other assets ................................... 238 94 -- 332 238 93 -- 331
--------- --------- --------- --------- --------- --------- --------- ---------

$ 39,477 $ 50,908 $ (212) $ 90,173 $ 39,978 $ 50,161 $ (99) $ 90,040
========= ========= ========= ========= ========= ========= ========= =========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable and accrued expenses...... $ 2,139 $ 1,658 $ -- $ 3,797 $ 1,572 $ 1,672 $ -- $ 3,244
Current portion of deferred revenues ...... 130 517 -- 647 104 18,004 -- 18,108
Payable to Acacia Technologies group ...... -- 212 (212) -- -- 99 (99) --
--------- --------- --------- --------- --------- --------- --------- ---------

Total current liabilities ......... 2,269 2,387 (212) 4,444 1,676 19,775 (99) 21,352

Deferred income taxes .......................... 976 2,214 -- 3,190 1,012 2,248 -- 3,260
Deferred revenues, net of current portion ...... 1,500 2,420 -- 3,920 1,500 2,401 -- 3,901
Other liabilities .............................. -- 1,257 -- 1,257 -- -- -- --
--------- --------- --------- --------- --------- --------- --------- ---------

Total liabilities ................. 4,745 8,278 (212) 12,811 4,188 24,424 (99) 28,513
--------- --------- --------- --------- --------- --------- --------- ---------

Minority interests ............................. 1,127 -- -- 1,127 1,127 -- -- 1,127
--------- --------- --------- --------- --------- --------- --------- ---------

Redeemable Stockholders' equity:
AR - Acacia Technologies stock ............ 33,605 -- -- 33,605 34,663 -- -- 34,663
AR - CombiMatrix stock .................... -- 42,630 -- 42,630 -- 25,737 -- 25,737
--------- --------- --------- --------- --------- --------- --------- ---------

Total stockholders' equity ........ 33,605 42,630 -- 76,235 34,663 25,737 -- 60,400
--------- --------- --------- --------- --------- --------- --------- ---------

$ 39,477 $ 50,908 $ (212) $ 90,173 $ 39,978 $ 50,161 $ (99) $ 90,040
========= ========= ========= ========= ========= ========= ========= =========

- ---------------
NOTE: Segment information for the Acacia Technologies group includes discontinued operations related to Soundbreak.com. Total assets
related to discontinued operations totaled $2,104,000 and $2,150,000 at March 31, 2004 and December 31, 2003, respectively. Total
liabilities related to discontinued operations totaled $349,000 and $395,000 at March 31, 2004 and December 31, 2003, respectively.

12

CONSOLIDATING STATEMENTS OF OPERATIONS (IN THOUSANDS)

FOR THE THREE MONTHS ENDED FOR THE THREE MONTHS ENDED
MARCH 31, 2004 MARCH 31, 2003
----------------------------------------- ------------------------------------------
ACACIA ELIMI- ACACIA ELIMI-
TECHNO- COMBI- NATIONS/ TECHNO- COMBI- NATIONS/
LOGIES MATRIX RECLASSI- CONSOLI- LOGIES MATRIX RECLASSI- CONSOLI-
GROUP GROUP FICATIONS DATED GROUP GROUP FICATIONS DATED
--------- --------- --------- --------- --------- --------- --------- ---------

Revenues:
Research and development, government
and service contracts .................. $ -- $ 17,600 $ -- $ 17,600 $ -- $ 7 $ -- $ 7
License fees .............................. 599 -- -- 599 6 -- -- 6
Products .................................. -- 16 -- 16 -- 209 -- 209
--------- --------- --------- --------- --------- --------- --------- ---------

Total revenues ............................ 599 17,616 -- 18,215 6 216 -- 222
--------- --------- --------- --------- --------- --------- --------- ---------

Operating expenses:
Cost of product sales ..................... -- 4 -- 4 -- 77 -- 77
Research and development expenses ......... -- 1,588 -- 1,588 -- 2,335 -- 2,335
Non-cash stock compensation
amortization - research and
development ............................. -- 69 -- 69 -- 2 -- 2
Marketing, general and
administrative expenses ................. 1,006 2,278 602 3,886 1,323 2,670 262 4,255
Non-cash stock compensation
amortization - marketing, general
and administrative ...................... -- 334 -- 334 -- 138 -- 138
Legal expenses - patents .................. 602 -- (602) -- 262 -- (262) --
Amortization of patents ................... 125 274 -- 399 126 274 -- 400
Legal settlement charges .................. -- 1,257 -- 1,257 -- -- -- --
--------- --------- --------- --------- --------- --------- --------- ---------

Total operating expenses ............ 1,733 5,804 -- 7,537 1,711 5,496 -- 7,207
--------- --------- --------- --------- --------- --------- --------- ---------

Operating income (loss) ............. (1,134) 11,812 -- 10,678 (1,705) (5,280) -- (6,985)
--------- --------- --------- --------- --------- --------- --------- ---------

Other income:
Interest income ........................... 112 46 -- 158 148 67 -- 215
Realized gains on short-term
investments ............................. -- -- -- -- 37 -- -- 37
--------- --------- --------- --------- --------- --------- --------- ---------

Total other income .................. 112 46 -- 158 185 67 -- 252
--------- --------- --------- --------- --------- --------- --------- ---------

Income (loss) from continuing
operations before income taxes and
minority interests ......................... (1,022) 11,858 -- 10,836 (1,520) (5,213) -- (6,733)

Benefit for income taxes ..................... 33 34 -- 67 26 34 -- 60
--------- --------- --------- --------- --------- --------- --------- ---------

Income (loss) from continuing
operations before minority interests ....... (989) 11,892 -- 10,903 (1,494) (5,179) -- (6,673)

Minority interests ........................... -- -- -- -- -- 6 -- 6
--------- --------- --------- --------- --------- --------- --------- ---------

Net income (loss) ............................ $ (989) $ 11,892 $ -- $ 10,903 $ (1,494) $ (5,173) $ -- $ (6,667)
========= ========= ========= ========= ========= ========= ========= =========

13

CONSOLIDATING STATEMENTS OF CASH FLOWS (IN THOUSANDS)

FOR THE THREE MONTHS ENDED FOR THE THREE MONTHS ENDED
MARCH 31, 2004 MARCH 31, 2003
------------------------------------------ ----------------------------------------
ACACIA ACACIA
TECHNO- COMBI- TECHNO- COMBI-
LOGIES MATRIX ELIMI- CONSOLI- LOGIES MATRIX ELIMI- CONSOLI-
GROUP GROUP NATIONS DATED GROUP GROUP NATIONS DATED
--------- --------- --------- --------- --------- --------- -------- ---------

Cash flows from operating activities:
Net income (loss) from operations .......... $ (989) $ 11,892 $ -- $ 10,903 $ (1,494) $ (5,173) $ -- $ (6,667)
Adjustments to reconcile net income
(loss) from operations to net cash
used in operating activities:
Depreciation and amortization ............ 136 576 -- 712 161 606 -- 767
Minority interests ....................... -- -- -- -- -- (6) -- (6)
Non-cash stock compensation
amortization ........................... -- 403 -- 403 -- 140 -- 140
Deferred tax benefit ..................... (36) (34) -- (70) (36) (34) -- (70)
Non-cash legal settlement charge ......... -- 1,257 -- 1,257 -- -- -- --
Other .................................... -- (27) -- (27) (3) 124 -- 121
Changes in assets and liabilities:
Accounts receivable ...................... 3 (19) -- (16) (11) 312 -- 301
Prepaid expenses, other receivables
and other assets ....................... (234) (101) 114 (221) (218) (179) -- (397)
Accounts payable, accrued expenses
and other liabilities .................. 615 170 (114) 671 (420) 170 -- (250)
Deferred revenues ........................ 26 (17,468) -- (17,442) 33 1,475 -- 1,508
--------- --------- --------- --------- --------- --------- -------- ---------

Net cash used in operating
activities from continuing
operations ............................. (479) (3,351) -- (3,830) (1,988) (2,565) -- (4,553)
Net cash used in operating
activities from discontinued
operations ............................. (87) -- -- (87) (86) -- -- (86)
--------- --------- --------- --------- --------- --------- -------- ---------
Net cash used in operating
activities ............................. (566) (3,351) -- (3,917) (2,074) (2,565) -- (4,639)
--------- --------- --------- --------- --------- --------- -------- ---------

Cash flows from investing activities:
Purchase of property and equipment,
net .................................... (36) (61) -- (97) (2) (22) -- (24)
Purchase of available-for-sale
investments ............................ -- (13,605) -- (13,605) -- (469) -- (469)
Sale of available-for-sale
investments ............................ 2,030 12,166 -- 14,196 -- 2,462 -- 2,462
--------- --------- --------- --------- --------- --------- -------- ---------

Net cash provided by (used in)
investing activities from
continuing operations .................. 1,994 (1,500) -- 494 (2) 1,971 -- 1,969
Net cash used in investing
activities from discontinued
operations ............................. -- -- -- -- (344) -- -- (344)
--------- --------- --------- --------- --------- --------- -------- ---------
Net cash provided by (used in)
investing activities ................... 1,994 (1,500) -- 494 (346) 1,971 -- 1,625
--------- --------- --------- --------- --------- --------- -------- ---------

Cash flows from financing activities:
Net cash attributed to the Acacia
Technologies group ..................... (70) -- -- (70) (275) -- -- (275)
Net cash attributed to the
CombiMatrix group ...................... -- 4,520 -- 4,520 -- 275 -- 275
--------- --------- --------- --------- --------- --------- -------- ---------

Net cash provided by (used in)
financing activities ................... (70) 4,520 -- 4,450 (275) 275 -- --
--------- --------- --------- --------- --------- --------- -------- ---------

Effect of exchange rate on cash .......... -- 6 -- 6 -- (7) -- (7)
--------- --------- --------- --------- --------- --------- -------- ---------

Increase (decrease) in cash and
cash equivalents ....................... 1,358 (325) -- 1,033 (2,695) (326) -- (3,021)

Cash and cash equivalents, beginning ..... 28,142 3,807 -- 31,949 39,792 3,291 -- 43,083
--------- --------- --------- --------- --------- --------- -------- ---------

Cash and cash equivalents, ending ........ $ 29,500 $ 3,482 $ -- $ 32,982 $ 37,097 $ 2,965 $ -- $ 40,062
========= ========= ========= ========= ========= ========= ======== =========

14

COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)

MARCH 31, DECEMBER 31,
2004 2003
-------------- --------------

ASSETS

Current assets:
Cash and cash equivalents .................................................. $ 3,482 $ 3,807
Available-for-sale investments ............................................. 14,933 13,492
Accounts receivable, net of allowance for doubtful accounts
of $0 (2004) and $145 (2003) ............................................. 218 199
Inventory, prepaid expenses and other assets ............................... 459 277
-------------- --------------

Total current assets ................................................. 19,092 17,775

Property and equipment, net of accumulated depreciation and amortization ...... 2,455 2,752
Patents, net of accumulated amortization of $2,252 (2004) and $1,978 (2003).... 9,843 10,117
Goodwill ...................................................................... 19,424 19,424
Other assets .................................................................. 94 93
-------------- --------------

$ 50,908 $ 50,161
============== ==============

LIABILITIES AND ALLOCATED NET WORTH

Current liabilities:
Accounts payable and accrued expenses ...................................... $ 1,658 $ 1,672
Current portion of deferred revenues ....................................... 517 18,004
Payable to Acacia Technologies group ....................................... 212 99
-------------- --------------

Total current liabilities ............................................ 2,387 19,775

Deferred income taxes ......................................................... 2,214 2,248
Deferred revenues, net of current portion ..................................... 2,420 2,401
Other liabilities ............................................................. 1,257 --
-------------- --------------

Total liabilities .................................................... 8,278 24,424
-------------- --------------

Commitments and contingencies (Note 7)

Allocated net worth:

Funds allocated by Acacia Research Corporation ............................. 143,676 138,675

Accumulated net losses ..................................................... (101,046) (112,938)
-------------- --------------

Total allocated net worth ............................................ 42,630 25,737
-------------- --------------

$ 50,908 $ 50,161
============== ==============

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

15

COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF OPERATION
(IN THOUSANDS)
(UNAUDITED)

FOR THE THREE MONTHS ENDED
-------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------

Revenues:
Research and development contract ..................................... $ 17,302 $ --
Government contract ................................................... 217 --
Service contracts ..................................................... 81 7
Products .............................................................. 16 209
------------- -------------

Total revenues ..................................................... 17,616 216
------------- -------------

Operating expenses:
Cost of product sales ................................................. 4 77
Research and development expenses ..................................... 1,588 2,335
Non-cash stock compensation amortization - research and development ... 69 2
Marketing, general and administrative expenses ........................ 2,278 2,670
Non-cash stock compensation amortization - marketing, general
and administrative .................................................. 334 138
Amortization of patents ............................................... 274 274
Legal settlement charges .............................................. 1,257 --
------------- -------------

Total operating expenses ........................................... 5,804 5,496
------------- -------------

Operating income (loss) ............................................ 11,812 (5,280)
------------- -------------

Other income:
Interest income ....................................................... 46 67
------------- -------------

Total other income ................................................. 46 67
------------- -------------

Income (loss) from operations before income taxes
and minority interests ................................................. 11,858 (5,213)

Benefit for income taxes ................................................. 34 34
------------- -------------

Income (loss) from operations before minority interests .................. 11,892 (5,179)

Minority interests ....................................................... -- 6
------------- -------------

Division net income (loss) ............................................... $ 11,892 $ (5,173)
============= =============

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

16

COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

FOR THE THREE MONTHS ENDED
--------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------

Cash flows from operating activities:
Division net income (loss) from operations ............................ $ 11,892 $ (5,173)
Adjustments to reconcile division net income (loss) from operations
to net cash used in operating activities:
Depreciation and amortization .................................... 576 606
Minority interests ............................................... -- (6)
Non-cash stock compensation amortization ......................... 403 140
Deferred tax benefit ............................................. (34) (34)
Non-cash legal settlement charge ................................. 1,257 --
Other ............................................................ (27) 124
Changes in assets and liabilities:
Accounts receivable .............................................. (19) 312
Inventory, prepaid expenses and other assets ..................... (101) (179)
Accounts payable, accrued expenses and other ..................... 170 170
Deferred revenues ................................................ (17,468) 1,475
------------- -------------

Net cash used in operating activities ............................ (3,351) (2,565)
------------- -------------

Cash flows from investing activities:
Purchase of property and equipment, net .......................... (61) (22)
Purchase of available-for-sale investments ....................... (13,605) (469)
Sale of available-for-sale investments ........................... 12,166 2,462
------------- -------------

Net cash provided by (used in) investing activities .............. (1,500) 1,971
------------- -------------

Cash flows from financing activities:
Net cash flows attributed to the CombiMatrix group ............... 4,520 275
------------- -------------

Effect of exchange rate on cash ......................................... 6 (7)
------------- -------------

Increase (decrease) in cash and cash equivalents ........................ (325) (326)

Cash and cash equivalents, beginning .................................... 3,807 3,291
------------- -------------

Cash and cash equivalents, ending ....................................... $ 3,482 $ 2,965
============= =============

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

17

COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)

1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

DESCRIPTION OF BUSINESS. Acacia Research Corporation is comprised of
two separate divisions: the CombiMatrix group and the Acacia Technologies group.

Our life sciences business, referred to as the "CombiMatrix group," is
primarily comprised of our wholly owned subsidiary, CombiMatrix Corporation and
CombiMatrix Corporation's 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, also referred to as an array. This proprietary technology
has applications in the areas of genomics, proteomics, biosensors, drug
discovery, drug development, diagnostics, combinatorial chemistry, material
sciences and nanotechnology. CombiMatrix K.K., a Japanese corporation located in
Tokyo, is exploring opportunities for CombiMatrix Corporation's active array
system with pharmaceutical and biotechnology companies in the Asian market.

RECAPITALIZATION TRANSACTION

On December 11, 2002, Acacia Research Corporation's stockholders voted
in favor of a recapitalization transaction, which became effective on December
13, 2002, whereby Acacia Research Corporation created two new classes of common
stock called Acacia Research-CombiMatrix stock ("AR-CombiMatrix stock") and
Acacia Research-Acacia Technologies stock ("AR-Acacia Technologies stock"), and
divided Acacia Research Corporation's existing Acacia Research Corporation
common stock into shares of the two new classes of common stock.

BASIS OF PRESENTATION. The unaudited interim CombiMatrix group
financial statements as of March 31, 2004, and for the interim periods
presented, have been prepared in accordance with generally accepted accounting
principles for interim financial information. These interim financial statements
should be read in conjunction with the CombiMatrix group financial statements
and Acacia Research Corporation's consolidated financial statements and notes
thereto for the year ended December 31, 2003. The year-end balance sheet data
was derived from audited financial statements but does not include all
disclosures required by accounting principles generally accepted in the United
States of America.

The CombiMatrix group financial statements include all adjustments of a
normal recurring nature which, in the opinion of management, are necessary for a
fair presentation of its financial position as of March 31, 2004, and the
results of its operations and its cash flows for the interim periods presented.
The results of operations for the three months ended March 31, 2004 are not
necessarily indicative of the results to be expected for the entire year.

AR-CombiMatrix stock is intended to reflect the separate performance of
the CombiMatrix group, a division of Acacia Research Corporation. The
CombiMatrix group is not a separate legal entity. Holders of AR-CombiMatrix
stock are stockholders of Acacia Research Corporation. As a result, holders of
AR-CombiMatrix stock are subject to all of the risks of an investment in Acacia
Research Corporation and all of its businesses, assets and liabilities. The
assets that Acacia Research Corporation attributes to the CombiMatrix group
could be subject to the liabilities of the Acacia Technologies group.

The CombiMatrix group financial statements taken together with the
Acacia Technologies group financial statements, comprise all the accounts
included in the corresponding consolidated financial statements of Acacia
Research Corporation. The financial statements of the CombiMatrix group reflect
the financial condition, results of operations, and cash flows of the businesses
included therein. The financial statements of the CombiMatrix group include the
accounts or assets of Acacia Research Corporation specifically attributed to the
CombiMatrix group and were prepared using amounts included in Acacia Research
Corporation's consolidated financial statements.

Financial effects arising from one group that affect Acacia Research
Corporation's results of operations or financial condition could, if
significant, affect the results of operations or financial condition of the
other group and the market price of the class of common stock relating to the
other group. Any division net losses of the CombiMatrix group or the Acacia
Technologies group and dividends or distributions on, or repurchases of,

18

AR-CombiMatrix stock or AR-Acacia Technologies stock or repurchases of preferred
stock of Acacia Research Corporation will reduce the assets of Acacia Research
Corporation legally available for payment of dividends on AR-CombiMatrix stock
or AR-Acacia Technologies stock.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

REVENUE RECOGNITION. The CombiMatrix group recognizes revenue in
accordance with Staff Accounting Bulletin No. 104, "Revenue Recognition" ("SAB
No. 104") and related authoritative pronouncements. Revenue is recognized when
(i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or
services have been rendered, (iii) the fees are fixed or determinable, and (iv)
collectibility is reasonably assured.

Revenues from multiple-element arrangements are accounted for in
accordance with Emerging Issues Task Force ("EITF") Issue 00-21, "Revenue
Arrangements with Multiple Deliverables." Multiple-element arrangements
typically include license fees, up-front payments and milestone payments that
are received and/or billable by the CombiMatrix group in connection with other
rights and services that represent continuing obligations of the CombiMatrix
group. Payments received or billable by the CombiMatrix group are deferred until
all of the elements have been delivered or until the CombiMatrix group has
established objective and verifiable evidence of the fair value of the
undelivered elements.

Revenues from government grants and contracts are recognized in
accordance with Accounting Research Bulletin ("ARB") No. 43, "Government
Contracts," and related pronouncements. Accordingly, revenues are recognized
under the percentage-of-completion method of accounting, using the cost-to-cost
approach to measure completeness at each reporting period. Under the
percentage-of-completion method of accounting, contract revenues and expenses
are recognized in the period that work is performed based on the percentage of
actual incurred costs to estimated total contract costs. Actual contract costs
and cost estimates include direct charges for labor and materials and indirect
charges for labor, overhead and certain general and administrative charges.
Contract change orders and claims are included when they can be reliably
estimated and are considered probable. For contracts that extend over a one-year
period, revisions in contract cost estimates, if they occur, have the effect of
adjusting current period earnings applicable to performance in prior periods.
Should current contract estimates indicate an overall future loss to be
incurred, a provision is made for the total anticipated loss in the current
period.

Revenue from the sale of products and services is recognized when
delivery has occurred or services have been rendered.

Deferred revenue arises from payments received in advance of the
culmination of the earnings process. Deferred revenue expected to be recognized
within the next twelve months is classified as current. Deferred revenues will
be recognized as revenue in future periods when the applicable revenue
recognition criteria as described above are met.

INVENTORY. Inventory, which consists primarily of raw materials to be
used in the production of the CombiMatrix group's array products, is stated at
the lower of cost or market using the first-in, first-out method.

STOCK-BASED COMPENSATION. Refer to Note 2 to the Acacia Research
Corporation consolidated financial statements included elsewhere herein.

EARNINGS PER SHARE INFORMATION AND STOCK OPTION AND RELATED OPTION PLAN
INFORMATION. Earnings per share and stock option and related option plan
information is omitted from the CombiMatrix group footnotes because
AR-CombiMatrix stock is part of the capital structure of Acacia Research
Corporation. The CombiMatrix group is not a separate legal entity. Holders of
AR-CombiMatrix stock are stockholders of Acacia Research Corporation. This
presentation reflects the fact that the CombiMatrix group does not have legally
issued common or preferred stock and AR-CombiMatrix stock transactions are not
legal transactions of the CombiMatrix group. Refer to the Acacia Research
Corporation consolidated financial statements for earnings per share information
for Acacia Research Corporation's classes of stock, computed using the two-class
method in accordance with SFAS No. 128, "Earnings per Share." Refer to the
Acacia Research Corporation consolidated financial statements for disclosures
regarding Acacia Research Corporation's stock option plans.

IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL. Refer to Note 2 to the
Acacia Research Corporation consolidated financial statements included elsewhere
herein.

19

3. RECENT ACCOUNTING PRONOUNCEMENTS

Refer to Note 7 to the Acacia Research Corporation consolidated
financial statements included elsewhere herein.

4. GOODWILL AND INTANGIBLES

The CombiMatrix group's only identifiable intangible assets are
patents, which have remaining economic useful lives up to 2020. Annual aggregate
amortization expense for each of the next five years through December 31, 2008
is estimated to be $1,095,000 per year. At March 31, 2004 and December 31, 2003,
all of the CombiMatrix group's acquired intangible assets other than goodwill
were subject to amortization.

5. REVENUES

In March 2004, the CombiMatrix group completed all phases of its
research and development agreement with Roche Diagnostics, GmbH ("Roche"). As a
result of completing all of its obligations under this agreement and in
accordance with the CombiMatrix group's revenue recognition policies for
multiple-element arrangements, the CombiMatrix group recognized all previously
deferred Roche related contract revenues totaling $17,302,000 during the first
quarter of 2004.

6. INCOME TAXES

The CombiMatrix group estimates that there will be sufficient losses
from operations in the current fiscal year to offset any taxable income related
to the Roche deferred contract revenues totaling $17,302,000 recognized during
the three months ended March 31, 2004, resulting in no significant tax liability
or expense in the current period or for the year ending December 31, 2004.
Additionally, there was a deferred tax asset that was previously recognized for
income tax purposes that was offset by a valuation allowance; as a result of the
deferred revenue recognition, the associated deferred tax asset and related
valuation allowance were reduced in the current period by approximately $3.5
million.

7. COMMITMENTS AND CONTINGENCIES

On September 30, 2002, CombiMatrix Corporation and Dr. Donald
Montgomery entered into a settlement agreement with Nanogen, Inc. to settle all
pending litigation between the parties. During the three months ended March 31,
2004, we recorded a non-cash charge totaling $1,257,000 in connection with
certain anti-dilution provisions of that agreement. The non-cash charge reflects
management's estimate of the fair value of AR-CombiMatrix stock that will be
issued to Nanogen, Inc. as a result of certain options and warrants exercised
during the quarter and the fair value of AR-CombiMatrix stock potentially
issuable to Nanogen, Inc. as of the balance sheet date. The liability is
adjusted at each balance date for changes in the market value of the
AR-CombiMatrix stock and is reflected as long-term until settled in equity. The
anti-dilution provisions of the settlement agreement expire in September 2005.

In addition to other terms of the settlement agreement, CombiMatrix
Corporation is also required to make quarterly payments to Nanogen, Inc. equal
to 12.5% of payments to CombiMatrix Corporation from sales of products developed
by CombiMatrix Corporation and its affiliates and based on the patents that had
been in dispute in the litigation, up to an annual maximum of $1,500,000. The
minimum quarterly payments under the settlement agreement will be $37,500 per
quarter for the period from October 1, 2003 through October 1, 2004, and $25,000
per quarter thereafter until the patents expire in 2018.

The CombiMatrix group is subject to other claims and legal actions that
arise in the ordinary course of business. Management believes that the ultimate
liability with respect to these claims and legal actions, if any, will not have
a material effect on CombiMatrix group's financial position, results of
operations or cash flows.

20

8. SUBSEQUENT EVENTS

In April 2004, Acacia Research Corporation raised gross proceeds of
$15,000,000 through the sale of 3,000,000 shares of Acacia Research -
CombiMatrix common stock at a price of $5.00 per share in a registered direct
offering. Net proceeds raised of approximately $13,600,000, which are net of
related issuance costs, were attributed to the CombiMatrix group.

21

ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)

MARCH 31, DECEMBER 31,
2004 2003
----------------- -----------------

ASSETS

Current assets:
Cash and cash equivalents .................................................. $ 29,500 $ 28,142
Short-term investments ..................................................... 3,029 5,059
Accounts receivable ........................................................ 121 124
Prepaid expenses and other assets .......................................... 1,063 903
Receivable from CombiMatrix group .......................................... 212 99
----------------- -----------------

Total current assets ................................................. 33,925 34,327

Property and equipment, net of accumulated depreciation ....................... 97 71
Patents, net of accumulated amortization of $7,358 (2003) and $7,232 (2003) ... 3,441 3,566
Goodwill ...................................................................... 1,776 1,776
Other assets .................................................................. 238 238
----------------- -----------------

$ 39,477 $ 39,978
================= =================

LIABILITIES AND ALLOCATED NET WORTH

Current liabilities:
Accounts payable and accrued expenses ...................................... $ 2,139 $ 1,572
Deferred revenues .......................................................... 130 104
----------------- -----------------

Total current liabilities ............................................ 2,269 1,676

Deferred income taxes ......................................................... 976 1,012
Deferred revenues, net of current portion ..................................... 1,500 1,500
----------------- -----------------

Total liabilities .................................................... 4,745 4,188
----------------- -----------------

Minority interests ............................................................ 1,127 1,127
----------------- -----------------

Commitments and contingencies (Note 5)

Allocated net worth:
Funds allocated by Acacia Research Corporation ............................. 105,060 105,129

Accumulated net losses ..................................................... (71,455) (70,466)
----------------- -----------------

Total allocated net worth ............................................ 33,605 34,663
----------------- -----------------

$ 39,477 $ 39,978
================= =================

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

22

ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
(UNAUDITED)

FOR THE THREE MONTHS ENDED
---------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------

Revenues:
License fees ....................................... $ 599 $ 6
-------------- --------------

Total revenues .................................. 599 6
-------------- --------------

Operating expenses:
Marketing, general and administrative expenses ..... 1,006 1,323
Legal expenses - patents ........................... 602 262
Amortization of patents ............................ 125 126
-------------- --------------

Total operating expenses ........................ 1,733 1,711
-------------- --------------

Operating loss .................................. (1,134) (1,705)
-------------- --------------

Other income:
Interest income .................................... 112 148
Realized gains on short-term investments ........... -- 37
-------------- --------------

Total other income .............................. 112 185
-------------- --------------

Loss from continuing operations before income taxes ... (1,022) (1,520)

Benefit for income taxes .............................. 33 26
-------------- --------------

Division net loss ..................................... (989) (1,494)
============== ==============

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

23

ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

FOR THE THREE MONTHS ENDED
---------------------------------
MARCH 31, 2004 MARCH 31, 2003
-------------- --------------

Cash flows from operating activities:
Division net loss from operations ................................................... $ (989) $ (1,494)
Adjustments to reconcile division net loss from operations
to net cash used in operating activities:
Depreciation and amortization .................................................... 136 161
Deferred tax benefit ............................................................. (36) (36)
Other ............................................................................ -- (3)
Changes in assets and liabilities:
Accounts receivable .............................................................. 3 (11)
Prepaid expenses, other receivables and other assets ............................. (234) (218)
Accounts payable, accrued expenses ............................................... 615 (420)
Deferred revenues ................................................................ 26 33
-------------- --------------

Net cash used in operating activities from continuing operations ................. (479) (1,988)
Net cash used in operating activities from discontinued operations ............... (87) (86)
-------------- --------------
Net cash used in operating activities ............................................ (566) (2,074)
-------------- --------------

Cash flows from investing activities:
Purchase of property and equipment, net .......................................... (36) (2)
Sale of available-for-sale investments ........................................... 2,030 --
-------------- --------------

Net cash provided by (used in) investing activities from continuing operations ... 1,994 (2)
Net c