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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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, 2004
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)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
filing requirements for the past 90 days. Yes |X| No [ ]
Indicate by check mark that disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K |X|
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, 2004, was
approximately $123,737,135 and $133,494,318, respectively. (All executive
officers and directors of the registrant are considered affiliates.)
As of March 9, 2005, 27,212,769 shares of Acacia Research-Acacia
Technologies common stock were issued and outstanding. As of March 9, 2005,
31,200,496 shares of Acacia Research-CombiMatrix common stock were issued and
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement for its Annual
Meeting of Stockholders to be filed with the Commission within 120 days after
the close of its fiscal year are incorporated by reference into Part III.
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FORM 10-K ANNUAL REPORT
FISCAL YEAR ENDED DECEMBER 31, 2004
ACACIA RESEARCH CORPORATION
ITEM PAGE
- ---- ----
PART I
1. Business..................................................................1
2. Properties...............................................................22
3. Legal Proceedings.........................................................23
4. Submission of Matters to a Vote of Security Holders.......................23
PART II
5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities.........................24
6. Selected Financial Data...................................................26
7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.....................................................30
7A. Quantitative and Qualitative Disclosures About Market Risk................53
8. Financial Statements and Supplementary Data...............................54
9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure......................................................54
9A. Controls and Procedures...................................................54
9B. Other Information.........................................................54
PART III
10. Directors and Executive Officers of the Registrant........................55
11. Executive Compensation....................................................55
12. Security Ownership of Certain Beneficial Owners and Management............55
13. Certain Relationships and Related Transactions............................55
14. Principal Accounting Fees and Services....................................55
PART IV
15. Exhibits, Financial Statement Schedules...................................56
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.
COMBIMATRIX GROUP
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. The
CombiMatrix group is seeking to become a broadly diversified biotechnology
company, through the development of proprietary technologies and products in the
areas of drug development, genetic analysis, nanotechnology research, defense
and homeland security markets, as well as other potential markets where its
products could be utilized. Among the technologies being developed by the
CombiMatrix group are 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. This 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. Other technologies include
proprietary molecular synthesis and screening methods for the discovery of
potential new drugs.
ACACIA TECHNOLOGIES GROUP
Our intellectual property licensing business, referred to as the "Acacia
Technologies group," develops, acquires, and licenses patented technologies. 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(R), technology enables the digitization, encryption,
storage, transmission, receipt and playback of digital content via several means
including cable TV, which includes digital ad insertion and video on demand
programming, satellite TV programming, the Internet, which includes distance
learning and other Internet programming involving digital audio/video content,
wireless delivery of video content, fiber-optic delivery of video content and
hotel in-room digital delivery of programming.
The Acacia Technologies group owned, and 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 Acacia Technologies group concluded its V-chip licensing program in
August 2004 as discussed below.
1
On January 28, 2005, Acacia Global Acquisition Corporation, a newly formed
wholly owned subsidiary of Acacia Research Corporation, acquired the assets of
Global Patent Holdings, LLC, or Global Patent Holdings, a privately held patent
holding company based in Northbrook, Illinois, which owned 11 patent licensing
companies. The acquisition gives the Acacia Technologies group ownership of
companies that control 27 patent portfolios, which include 120 U.S. patents and
certain foreign counterparts, and cover technologies used in a wide variety of
industries, as set forth below.
The acquisition expands and diversifies the Acacia Technologies group's
revenue generating opportunities and accelerates the execution of the Acacia
Technologies group's business strategy of acquiring, developing and licensing
patented technologies.
Refer to Note 16 in the accompanying Acacia Research Corporation
consolidated financial statements for financial information related to our two
segments.
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. 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. Included in the
CombiMatrix group and the Acacia Technologies group are certain wholly owned
subsidiaries that are not material, quantitatively or qualitatively, either
individually or in the aggregate, to either group, or to Acacia Research
Corporation as a whole.
On December 13, 2002, Acacia Research Corporation 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 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, board of directors - code of conduct
and fraud policy;
o charters for our audit committee, nominating and corporate governance
committee, disclosure 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 our wholly owned subsidiary,
CombiMatrix Corporation and CombiMatrix Corporation's wholly owned subsidiary,
CombiMatrix K.K. The CombiMatrix group is seeking to become a broadly
diversified biotechnology company, through the development of proprietary
technologies and products in the areas of drug development, genetic analysis,
nanotechnology research, defense and homeland security markets, as well as other
potential markets where its products could be utilized. Among the technologies
being developed by the CombiMatrix group are 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.
This 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. Other
technologies include proprietary molecular synthesis and screening methods for
the discovery of potential new drugs.
TECHNOLOGIES
SEMICONDUCTOR BASED ARRAY
The CombiMatrix group's semiconductor based array 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, diagnostic, 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.
Utilizing this array technology, the CombiMatrix group is engaged in four
strategic 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, or RNAi, and other approaches
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.
ELECTROCHEMICAL SYNTHESIS OF MOLECULES
The CombiMatrix group is utilizing its expertise in electrochemistry to
synthesize novel compounds, which can be screened in binding and cellular assays
to determine their potential as new drugs. The types of molecules that can be
synthesized electrochemically from precursors using various approaches,
proprietary to the CombiMatrix group, include organic compounds, nucleic acids,
peptides and others. These molecules can then be utilized in biochemical and
cellular screens to determine if they have appropriate potency to be considered
for downstream pre-clinical and clinical drug development.
3
POTENTIAL DRUG COMPOUNDS
Through its minority investment in Leuchemix, Inc., the CombiMatrix group
has access to proprietary compounds that have been shown to be cytotoxic towards
certain cancers in vitro and in vivo. Many of these compounds were discovered
through combinatorial chemistry, natural product chemistry and certain cellular
screening assays. Leuchemix, Inc. has access to state of the art laboratories
and equipment, which includes flow cytometry, molecular biology and cell culture
facilities. In addition, Leuchemix, Inc. has access to a bank of over 150
primary leukemia specimens and a panel of 15 leukemia and lymphoma cell lines as
well as several xenogenic animal model systems.
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. In the future, if the CombiMatrix group is successful in
developing approved drugs either internally or through its investments in
companies such as Leuchemix, Inc., the CombiMatrix group's market opportunities
will expand to include pharmacies, physicians, hospitals, patients and other
consumers of therapeutics. At this time, the majority of the CombiMatrix group's
efforts are focused on the life sciences and national defense markets.
GENERAL OVERVIEW OF LIFE SCIENCES AND PHARMACEUTICAL INDUSTRIES
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. Declining research and
development productivity, rising costs of commercialization, increasing
reimbursement influence and shorter exclusivity periods have driven up the cost
to develop each successful compound to $1.7 billion according to recent industry
data. Only one compound now reaches the market for every thirteen discovered and
placed in preclinical trials, compared to one for every eight between 1995 and
2000. The pharmaceutical and biotechnology industries are working to reduce
their costs and risks of failure by turning to new technologies to help identify
deficiencies in drug candidates as early as possible in the process so that drug
discovery and development become more efficient and cost-effective.
Additionally, with vast amounts of genomic data becoming available for use in
the development of therapeutics and diagnostic tests, they are searching for
ways to expedite their analysis of available genomic data so that they can be
the first to bring new therapeutics and diagnostic tests to market.
DRUG DISCOVERY AND DEVELOPMENT
The discovery and development of new drugs for a particular disease
typically 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.
4
GENE EXPRESSION PROFILING
Gene expression profiling is the process of determining which genes are
active in a specific cell or group of cells and is accomplished by measuring
mRNA, the intermediary between genes and proteins. By comparing gene expression
patterns between cells from normal tissue and cells from diseased tissue,
researchers may identify specific genes or groups of genes that play a role in
the presence of disease. Studies of this type, used in drug discovery, require
monitoring thousands, and preferably tens of thousands, of mRNAs in large
numbers of samples. As the correlation between gene expression patterns and
specific diseases is determined, the CombiMatrix group believes that gene
expression profiling will have an increasingly important role as a diagnostic
tool. Diagnostic use of expression profiling tools is anticipated to grow
rapidly with the combination of the sequencing of various genomes and the
availability of more cost-effective technologies.
GENETIC VARIATION AND 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 200,000 possible SNPs in 1,000 patients. Although only a few
hundred of these SNPs might be clinically relevant, 200 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
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 and enable the parallel evaluation of large numbers of
genes.
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 revolutionized drug discovery and
development, the CombiMatrix group believes that it's advanced array technology
provides characteristics, including flexibility, superior cost metrics, and
performance which address certain needs of the life sciences market which are
not addressed by conventional arrays.
5
THE COMBIMATRIX SOLUTION
The CombiMatrix group believes that its 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, conduct their tests, analyze the
results, and reorder additional arrays incorporating modified test parameters,
all within a few days. The CombiMatrix group believes that its system will offer
several important advantages over competing products. These advantages arise
from a unique approach to fabricating the arrays utilizing a proprietary
electrochemical synthesis method on an array of microelectrodes that have been
fabricated on a silicon device.
GENETIC ANALYSIS PRODUCTS AND SERVICES
The CombiMatrix group's technology 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.
CUSTOMARRAY(TM)
The CombiMatrix group's product for genetic studies is marketed under the
trade name CustomArray(TM). CustomArray(TM) is a highly flexible custom
oligonucleotide array that addresses researchers' specific requirements for
high-performance arrays that can interrogate small sets of target genes or whole
genomes at a low cost. CustomArrays currently come in two formats: the
lower-density CustomArray(TM) 902, and the medium-density CustomArray(TM) 12K.
The CustomArray(TM) 902 enables an analysis of roughly 1,000 genes, and the
CustomArray(TM) 12K enables analysis of up to 12,000 genes.
CustomArray(TM) is an advanced tool used to understand gene expression by
measuring mRNA activity within a cell type or groups of cells, enabling
researchers to understand disease, predisposition to disease, drug response and
drug development. CustomArray(TM) can also be used as a SNP genotyping tool
providing statistics on the effect of a SNP or groups of SNPs, giving rise to
data that is important in diagnostic testing. Because of the product's
flexibility, researchers have utilized and are evaluating the use of
CustomArrays for other applications such as gene assembly, sequencing, protein
translation and others.
ON-LINE ORDER PROCESSING AND SOFTWARE TOOLS
CustomArrays are designed and ordered through the CombiMatrix group's
on-line ordering process. Customers are able to utilize a number of tools to
design and order their arrays through an on-line interface via the World Wide
Web. Some of the tools available to the customers are referred to as the
CustomArray(TM) content software application suite of tools for designing and
ordering arrays.
The content software application provides a suite of sophisticated tools
that customers can use to design a custom array specific to their experimental
needs. This application allows the customer to submit a list of genes and/or
genomic sequences to the CombiMatrix group's probe design system. This design
process produces probe sequences optimal to the customer's requirements.
Customers also have the flexibility to re-design their array at anytime.
When the customer has finished designing their arrays using the CombiMatrix
group's proprietary software tools, the arrays may be ordered using the
e-commerce section of the CustomArray(TM) web site. Arrays are then manufactured
using our proprietary oligonucleotide synthesis technology to the specific
design requirements of the customer's order. The CombiMatrix group's proprietary
DNA synthesis technology enables product turnaround time of typically just a few
days. After production, each array is put through a rigorous quality control
process. To our knowledge, the CombiMatrix group is the only array company that
quality checks every single feature on each array produced prior to shipment.
DESIGN-ON-DEMAND(TM)
The CombiMatrix group has also launched a service known as
Design-on-Demand(TM) for its arrays. Through this service, customers can work
one-on-one with our staff of bioinformatic experts to assist them with designing
their arrays to meet their specific project goals. Customers can also access our
Design-on-Demand(TM) catalog of over 1,400 pre-designed genome arrays available
for ordering.
6
HOMELAND SECURITY AND DEFENSE APPLICATIONS
Through U.S. government funding, the CombiMatrix group's array technology
is being developed to simultaneously detect toxins, viruses, and bacteria using
either genomic analysis or antigen-antibody experiments, or assays. The ability
to conduct over 12,000 individual assays simultaneously means that the
CombiMatrix group's array can be configured to detect many biothreat agents of
interest to the U.S. Department of Defense and Department of Homeland Security
within hours and with a high degree of certainty that surpasses current
technologies. The CombiMatrix group's goal is that these systems will eventually
be portable and ultimately be completely automated.
The CombiMatrix group's technology can simultaneously identify hundreds of
different microbes (including viruses), determine their ability to cause
disease, and discover their characteristics, such as antibiotic resistance.
Working with academia, industry, and government laboratories, the CombiMatrix
group is developing assays, arrays and bioinformatics for quickly identifying
human, animal, and plant pathogens in a single-assay format. This format and
single test eliminates the need for a different test for each disease or threat
and eliminates the time lost in developing a new test for each new disease or
threat. For disease-control agencies, it simplifies the process, reduces costs,
and allows more rapid identification and reaction, all in an environment where
increased time can equate to increased illness and loss of lives.
This program is enabled by the characteristic of the CombiMatrix group's
array technology, which allows the binding reactions to be measured through
electrochemical means instead of optical methods. Though optical detection has
been successful in many applications and our other products utilize these
methods, we feel that electrochemical detection techniques have the potential to
be far superior. By eliminating the need for light sources, optical components,
their corresponding mechanical requirements as well as their power requirements,
we feel that we will be able to build detection systems that will be less
expensive, smaller, lighter and portable. In addition, certain technical
characteristics of electrochemical detection on the arrays may enable higher
sensitivity, better dynamic range and superior reproducibility in measurements.
Though the initial focus of our Government-funded development program is a
product for military and homeland security markets, the core technology being
developed will be applicable to products in the life sciences and human
healthcare markets as well.
DRUG DISCOVERY
The CombiMatrix group has initiated both internally focused and externally
focused 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 symptoms, 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.
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
7
NANOTECHNOLOGY
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.
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 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 had agreements with several strategic
partners, such as Roche Diagnostics GmbH, or Roche, to jointly develop its
technology. For example, Roche contributed extensive expertise in the areas of
instrument and reagent development, and 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 been awarded several U.S. government grants and
contracts to develop its electrochemical detection system for the detection of
biological threat agents. Though these programs initially focused on product
development for military and homeland security applications, the CombiMatrix
group believes that the core technology being developed will be applicable to
products in the life sciences and human healthcare markets as well.
The CombiMatrix group has also entered into a design, fabrication and
manufacturing relationship with Toppan Printing of Japan, or Toppan, and Furuno
Electronic Co., or Furuno, for the development and manufacture of new designs of
its electrochemical detection arrays and bench-top array synthesizers,
respectively.
In addition to these relationships, the CombiMatrix group has entered into
additional relationships and plans on establishing other relationships for
multiple applications of its technology.
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.
8
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 patents issued in the United
States and three corresponding patents granted in Europe, Australia and Taiwan,
its 59 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 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 sells array 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 do not require approval from, or be
regulated by, the FDA, as a manufacturer nor are they subject to the FDA's
current good manufacturing practice, or cGMP, regulations. Additionally, the
CombiMatrix group's initial products are not subject to certain reagent
regulations promulgated by the FDA. However, the manufacture, marketing and sale
of certain products and services for most 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
During 2004, the CombiMatrix group launched its CustomArray(TM) products
and is currently selling these products directly and through distributors to
customers in the United States, Australia, New Zealand and Japan. Where
appropriate, the CombiMatrix group will continue to market and sell its products
directly or through distribution arrangements and/or through other strategic
alliances.
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 made minor modifications to terms of the agreements involving matters such
as milestones, payments and technical specifications, none of which were
considered 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.
9
In March 2004, the agreements were modified to indicate that CombiMatrix
Corporation had completed all phases of its research and development commitments
to Roche.
Since the inception of our relationship with Roche, CombiMatrix Corporation
has engaged in a continuous process of monitoring and reevaluating the terms of
the 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 future 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
CombiMatrix Corporation might never be realized. Since July 2001, CombiMatrix
Corporation has received approximately $26.6 million in cash payments from Roche
from July 2001 through December 31, 2003. The CombiMatrix group has not received
any additional payments from Roche since 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 on its arrays. Certain portions of its manufacturing, such as
semiconductor fabrication and processing, will be outsourced to subcontractors,
while the steps involving synthesis of biological materials and quality control
of its products 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 non-standard semiconductor manufacturing processes to fabricate the
electrode array that is a key aspect of the array structure. Although the
CombiMatrix group has a supply agreement in place with the semiconductor wafer
manufacturer to ensure availability of the raw materials, it does not guarantee
a permanent supply. These non-standard processes are not widely available and it
may be difficult or expensive to obtain sufficient quantities of semiconductor
wafers if the current manufacturer changes or discontinues its manufacturing
production capability.
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 expiration date January 5, 2018; U.S.
Patent No. 6,280,595 expiration date September 10, 2019 and U.S. Patent No.
6,444,111 expiration date October 13, 2019) 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 expiration date January
25, 2020) describes and claims a network infrastructure for custom array
synthesis and analysis. Corresponding CombiMatrix Corporation core patents
describing and claiming methods for electrochemical synthesis of arrays have
been issued in Europe (entire EU), Australia and Taiwan and are pending in the
remaining major industrialized markets. In total, CombiMatrix Corporation has 59
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.
10
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.
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 $7.2 million (including Department of Defense related
research and development expenses of $2.0 million), $8.1 million and $18.2
million during 2004, 2003 and 2002, respectively. Research and development
11
related non-cash stock compensation charges were $91,000, $466,000 and $1.9
million during 2004, 2003 and 2002, respectively and acquired in-process
research and development charges were $17.2 million in 2002. The CombiMatrix
group intends to invest 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 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 several grants from the federal
government in connection with its biological array processor technology since
it's inception. Most recently, in March of 2004, the CombiMatrix group was
awarded a two-year, $5.9 million contract with the Department of Defense to
further the development of the CombiMatrix group's array technology for the
detection of biological threat agents. Under the terms of the contract, the
CombiMatrix group will be reimbursed on a periodic basis for actual costs
incurred to perform its obligations, plus a fixed fee, of up to $5.9 million.
The CombiMatrix group will continue to pursue grants and contracts that
complement its research and development efforts.
RECENT ACTIVITIES
Significant milestones for the CombiMatrix group during 2004 include the
following:
GENETIC ANALYSIS PRODUCTS AND SERVICES
o In March 2004, the CombiMatrix group launched the CustomArray(TM) DNA
Microarray platform, its first commercially-available array product,
to the worldwide research marketplace. This platform offers
researchers the ability to order fully customizable arrays on demand
in any quantity they choose. CustomArrays(TM) are produced on a
standard slide format, a configuration that is most familiar to
researchers. The commercial launch of CustomArray(TM) also provides
the marketplace with full access to the CombiMatrix group's suite of
software applications, including array design and submission, online
ordering and extraction of experimental results.
o In June 2004, the CombiMatrix group entered into a co-marketing
relationship with Axon Instruments, Inc. and in July, the CombiMatrix
group entered into a co-marketing agreement with Strand Genomics.
o In July 2004, the CombiMatrix group launched the CustomArray(TM)12K
DNA expression array, offering researchers the ability to order a
fully customizable array with more than 12,000 sites.
CustomArray(TM)12K and related products enable researchers to study
any combination of genes from any genome on a single chip. Also in
July 2004, the CombiMatrix group made available to researchers new
CustomArrays(TM) for Human Drug Metabolism, Human Toxicology, and a
Core 67 Cancer Array.
o In August 2004, the CombiMatrix group entered into a multi-year
collaborative strategic alliance with Furuno Electric Company, Ltd.
("Furuno") to design, engineer and build CombiMatrix Corporation's
Bench-Top DNA Microarray Synthesizer for CustomArray(TM) formatted
arrays. Under the terms of the agreement, Furuno paid CombiMatrix
Corporation an upfront fee of $1,000,000 and will make additional
development and milestone payments in the future, in accordance with
the agreement.
12
o In December 2004, the CombiMatrix group launched Design-on-Demand(TM)
Arrays, which provides the marketplace with a comprehensive catalog of
microarray expression products for microbial, eukaryotic, and viral
genomes. These arrays offer scientists an affordable and flexible tool
to conduct whole-genome expression studies on a wide range of
organisms, including Influenza, HIV, Anthrax, and SARS coronavirus.
HOMELAND SECURITY AND DEFENSE APPLICATIONS
o In March 2004, the CombiMatrix group executed a two-year, $5.9 million
contract with the Department of Defense to further the development of
the CombiMatrix group's microarray technology for the detection of
biological threat agents. Additionally, In July 2004, the CombiMatrix
group announced that it will receive an additional $2.3 million from a
Department of Defense appropriations bill passed by Congress.
o In October 2004, the CombiMatrix group and Science Applications
International Corporation (SAIC) announced a collaboration to develop
arrays for the identification of multiple bio-threat organisms. The
intent of the collaboration is to leverage each company's respective
Department of Defense funding in order to expedite the development and
testing of new identification and diagnostic assays and products
against conventional bio-threat agents and emerging and genetically
engineered pathogens.
DRUG DISCOVERY
o In January 2004, the CombiMatrix group made the first commercially
available microarray designed for the H5N1 influenza A virus ("bird
flu"). The World Health Organization appealed on January 27, 2004 for
technical assistance and expert advice to help stop the threat to
humans and agriculture posed by bird flu virus. The CombiMatrix group
utilized its proprietary probe-design software and ability to rapidly
synthesize novel DNA arrays to respond within two days.
o During 2004, the CombiMatrix group entered into a number of
collaborations in the field of drug discovery and development,
including collaborations with: 1) Washington University in St. Louis
to develop a system for the synthesis of libraries of diverse,
non-nucleic acid molecules; 2) Professor Bonaventura Clotet, M.D.,
Ph.D., of the Retrovirology Laboratory irsiCaixa, to conduct the
initial efficacy screening of pooled siRNA compounds against the
hepatitis C virus; 3) Dr. Ulrich Melcher, Department of Biochemistry
and Molecular Biology and Dr. Alexander C. Lai, Department of
Microbiology and Molecular Genetics from Oklahoma State University to
utilize CombiMatrix group's `Bird Flu' CustomArray(TM) devices to
characterize Bird flu viruses at the genomic level; 4) St. Jude
Children's Research Hospital to study the genetic variation in the H9
variant of Bird Flu; and 5) Case Western Reserve University for work
in developing a novel diagnostic for Alzheimer's disease using the
CustomArray(TM) platform.
o In October 2004, the CombiMatrix group entered into an agreement to
acquire up to a one-third ownership interest in Leuchemix, Inc.
("Leuchemix"), a private drug development firm, which is developing
several compounds for the treatment of leukemia and other cancers. In
accordance with the terms of the purchase agreement, the CombiMatrix
group will purchase 3,137,500 shares of Series A Preferred Stock of
Leuchemix for a total purchase price of $4,000,000, to be paid
quarterly over the next two years. In accordance with the terms of the
purchase agreement, CombiMatrix Corporation's Chief Executive Officer
was named a director of Leuchemix.
NANOTECHNOLOGY
o In January 2004, the CombiMatrix group entered into collaboration with
Cyrano Sciences (which has been acquired by Smiths Detection) to
develop nanotechnology-based chemical sensors to be used for the
detection of biological agents in air and water.
o In September 2004, the CombiMatrix group and Intel Corporation entered
into an agreement to work together on the feasibility of various
projects utilizing the CombiMatrix group's core technology. The terms
and conditions of the agreement are confidential.
o During 2004, the CombiMatrix group's strategic partner, Nanomaterials
Discovery Corporation, was granted a U.S. patent entitled, "Electrode
Array for Development and Testing of Materials." In August 2004,
Nanomaterials Discovery Corporation received a $2.5 million Department
of Defense appropriation for the development of fuel cell technology,
which will utilize CombiMatrix group's NanoArray(TM) technology as a
13
component of this development. In December 2004, Nanomaterials
Discovery Corporation delivered its first prototype nanomaterials
workstation to the CombiMatrix group.
ADDITIONS TO THE COMBIMATRIX GROUP'S SCIENTIFIC ADVISORY BOARD
o In February 2004, the CombiMatrix group named F. Mark Modzelewski to
its Scientific Advisory Board. Mr. Modzelewski is currently a
principal of Lux Capital, a New York based venture capital firm, and
is also a member of the Nanotechnology Technical Advisory Group to
President Bush's Council of Advisors on Science and Technology
(PCAST). Mr. Modzelewski was recognized by Forbes magazine as one of
nanotech's five "powerbrokers" and he has testified before the U.S.
Senate on nanotechnology funding, investment, technology transfer and
global competition.
o In April 2004, the CombiMatrix group named Mark A. Kay, M.D., Ph.D.,
to its Scientific Advisory Board. Dr. Kay is a Professor, Departments
of Pediatrics and Genetics, and Director, Program in Human Gene
Therapy, at the Stanford University School of Medicine. Dr. Kay is one
of the founders of and is currently the Vice President of the American
Society of Gene Therapy and a leader and pioneer in areas including
RNAi, gene and nucleic-acid drug delivery, and gene therapy.
EMPLOYEES
As of December 31, 2004, the CombiMatrix group had 71 full-time employees,
14 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.
14
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BUSINESS
The Acacia Technologies group, a division of Acacia Research Corporation,
including companies recently acquired from Global Patent Holdings as described
earlier, is currently comprised of certain of Acacia Research Corporation's
wholly owned subsidiaries and limited liability companies including: Acacia
Global Acquisition Corporation, Acacia Internet Access Corporation, Acacia Media
Technologies Corporation, Acacia Patent Acquisition Corporation, Acacia
Technologies Services Corporation, AV Technologies LLC, Broadcast Innovation
LLC, Data Innovation LLC, Financial Services Innovation LLC, Information
Technology Innovation LLC, InternetAd LLC, IP Innovation LLC, KY Data Systems
LLC, New Medium LLC, TechSearch LLC, VData LLC, Soundview Technologies, Inc.,
and Spreadsheet Automation Corporation and also includes all corporate assets,
liabilities, and related transactions of Acacia Research Corporation attributed
to the Acacia Research Corporation's intellectual property licensing business.
The Acacia Technologies group develops, acquires, licenses and enforces
patented technologies. From time to time, companies comprising the Acacia
Technologies group engage in litigation to enforce their patents. For a current
listing of pending patent enforcement litigation, see "Patent Enforcement
Litigation," below.
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 cable TV, which includes digital ad insertion and video on demand
programming, satellite TV programming, the Internet, which includes distance
learning and other Internet programming involving digital audio/video content,
wireless delivery of video content, fiber-optic delivery of video content and
hotel in-room digital delivery of programming. 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.
MARKET OVERVIEW
The Acacia Technologies group has launched an extensive DMT technology
licensing program. Potential licensees include cable TV companies, satellite TV
companies, hotel in-room entertainment companies, telecommunications companies,
wireless 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 TV companies
continues to increase with the use of video-on-demand and digital ad insertion
systems. Satellite TV 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.
Telecommunications companies have announced plans to deliver digital video via
fiber-optic and wireless companies have begun to deliver digital video content
with 3G delivery systems. 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.
MARKETING AND DISTRIBUTION
DMT Technology Licensing Program
Acacia Technologies group is currently licensing its DMT technology and has
entered into 294 DMT licensing agreements to date, including 107 cable TV
licenses, 182 licenses for online entertainment, movies, news, sports,
e-learning and corporate websites and licenses with 5 companies that provide
over 90% of video-on-demand TV entertainment to the hotel industry in the United
States. During 2004, we executed 170 DMT license agreements. Licensees include
Bloomberg L.P., Capella Education Company, Callaway Golf Company, B&C
Cablevision, Central Valley Cable TV, LLC, CinemaNow, Inc., Disney Enterprises,
Inc., General Dynamics Interactive Corporation, Grupo Pegaso, Harley-Davidson,
Inc., LodgeNet Entertainment Corporation, NXTV, Inc., On Command Corporation,
Oral Roberts University, Revlon Consumer Products Corporation, Seren
Innovations, Sonoco Products Company, The Travelers Indemnity Company, T. Rowe
Price Associates, Inc., 24/7 University, Inc., Wachovia Corporation, Wendy's
International, Inc., World Wrestling Entertainment, Inc. and Xerox Corporation.
15
In the first, second, third and fourth quarters of 2004, the Acacia
Technologies group recorded DMT license fee revenues of $599,000, $666,000,
$740,000 and $779,000, respectively, compared to DMT license fee revenues of
$6,000, $19,000, $186,000 and $481,000, respectively, in the comparable 2003
periods.
RECENT ACQUISITION
On January 28, 2005, Acacia Global Acquisition Corporation acquired the
assets of Global Patent Holdings, LLC, which owned 11 patent licensing
companies. The acquisition gives the Acacia Technologies group ownership of
companies that control 27 patent portfolios, which include 120 U.S. patents and
certain foreign counterparts, and cover technologies used in a wide variety of
industries, including:
o AUDIO/VIDEO ENHANCEMENT AND SYNCHRONIZATION
-------------------------------------------
These patented technologies generally relate to the use of a noise
reduction filtering system for digital video compression, and for
video and audio signals received by digital radios and video displays.
Other aspects of the technologies generally relate to the
synchronization of audio/video signals. These technologies can be used
by broadcasters, broadcast equipment manufacturers, other electronics
manufacturers, and low frame rate video production, such as that used
on the Internet.
o BROADCAST DATA RETRIEVAL
------------------------
This patented technology generally relates to a system for
broadcasting and receiving programming content together with
supplemental data such as the title of a song, artist, content
description or a catalog number, which can be stored and recalled for
later viewing. This technology can be used in satellite radio, and
other broadcasting where data is transmitted along with the content.
o COMPUTER MEMORY CACHE COHERENCY
-------------------------------
This patented technology generally relates to interface circuits used
by intelligent peripheral devices with cache memory to communicate
with the main computer memory. By synchronizing main computer memory
and main cache memory, peripheral devices such as graphics processors
can operate at much higher speeds, without costs associated with their
own memory. This technology can be used in desktop, notebook, and
server computer systems.
o CREDIT CARD FRAUD PROTECTION
----------------------------
This patented technology generally relates to a computerized system
for protecting retailers and consumers engaged in credit card, check
card, and debit transactions. The system includes an electronic card
reader, and the generation and use of a transaction number, which
specifically identifies each transaction processed within the system.
As a result, the retailer does not necessarily have to print detailed
information concerning the cardholder's identity or account number on
the customer's receipt.
o DATA ENCRYPTION AND PRODUCT ACTIVATION
--------------------------------------
These patented technologies generally relate to accessing clear data,
and encrypted data via an identification label. Once decrypted, the
clear and decrypted data are combined to activate software programs,
and other files. Other aspects of the technologies generally relate to
the use of an operating system to transparently create an encrypted
file storage subsystem to fully secure user files from access by
anyone other than the user.
o DATABASE MANAGEMENT
-------------------
This patented technology generally relates to the improved
combination, display, and coordination of certain information from
data tables in a relational database software program. The user is
able to easily track the impact of a change to one table, on other
tables in the program through various tools including a graphical
representation.
o DIGITAL VIDEO PRODUCTION
------------------------
These patented technologies generally relate to features that can be
found in production video processing equipment. They cover improved
methods of equipment interconnection, aspects of graphical user
interface displays, and automation of video processing. These features
allow ease of equipment interconnection, clearer information display,
and automation of video production tasks previously performed
manually. Other aspects of the technologies generally relate to
automatic color correction, commonly used when transferring film to
video, and certain 3D effects, commonly used in video scene
transitions.
16
o DYNAMIC MANUFACTURING MODELING
------------------------------
This patented technology generally relates to a modeling and control
process used to decrease costs and increase production for factory
operations. Such simulation modeling can include a variety of
parameters such as products, fabrication sequences, collections of job
sets, scheduling rules, and machine reliability standards. This
technology can be used for exacting manufacturing processes such as
semiconductor fabrication.
o ENHANCED INTERNET NAVIGATION
----------------------------
These patented technologies generally relate to enhanced Internet
navigation by retrieving a page from a hyper-linked website for
retrieval offline on a personal computer. This enables certain website
content to be saved, retrieved, and accessed locally, without the need
for Internet connectivity. Other aspects of the technologies generally
relate to information distribution and processing via the use of a
linking reference to access sets of data. These technologies can be
used in email transmissions with links to websites, special offers,
and other information.
o IMAGE RESOLUTION ENHANCEMENT
----------------------------
This patented technology generally relates to the modification of a
video or printed display to improve the perceived image quality beyond
the basic pixel resolution of the display. The apparent improvement in
the resolution of an image occurs without requiring an increase in the
resolution of the signal or input. This technology can be used in
certain CRT, plasma and LCD televisions and displays, low resolution
cameras such as camera phones, and consumer and commercial printers.
o INTERACTIVE DATA SHARING
------------------------
This patented technology generally relates to the real time sharing of
changes to content, enabling users to interactively view, change and
add to the content from multiple remote terminals. This technology can
be used in certain types of conferencing such as web conferencing,
interactive gaming, and other forms of collaborative interactive
communication.
o INTERACTIVE TELEVISION
----------------------
These patented technologies generally relate to various aspects of
interactive television including receivers such as set-top boxes and
certain televisions used in digital satellite TV and digital cable TV
systems that permit television viewers to access interactive
television features supplied by their satellite TV and cable TV
providers as part of their digital programming packages. Data, which
is associated with the interactive television features and is
broadcast along with the video signal, is extracted and processed by
components within the receivers, and is then made available to viewers
who choose to access the interactive television features through their
remote control. Examples of such data include sports scores, weather
information, stock updates, interactive games, and movie listings.
Other aspects of the technologies generally relate to the scrambling
or encrypting of broadcast signals whereby the unscrambling or
decryption is accomplished through a removable card, commonly known as
a "smart card."
o INTERSTITIAL INTERNET ADVERTISING
---------------------------------
This patented technology generally relates to the display of certain
advertising, informational, and branding messages that appear between
or outside web pages when the user is conducting a search, by storing
the message prior to being displayed. This technology is most commonly
used by travel based and other reservation based websites.
o MICROPROCESSOR ENHANCEMENT
--------------------------
This patented technology generally relates to an architecture employed
in advanced pipeline microprocessors. This architecture allows for
conditional execution of microprocessor instructions, and a later
determination of whether the instructions executed should be written
back to memory. By conditionally executing instructions in this
architecture, significant improvements in microprocessor speed can be
achieved. Certain pipelined processor manufacturers are adopting this
method of processing to improve processor speed.
17
o MULTI-DIMENSIONAL BAR CODES
---------------------------
This patented technology generally relates to encoding and reading a
data matrix consisting of an array of data cells with a border. The
data matrix can contain a variety, amount, and depth of information
that would not fit on to an ordinary bar code. This patented
technology can have many applications in the manufacturing,
distribution, operations, accounting, and security industries such as
tracking the movement of products, collection of data, improved
production capabilities and anti-counterfeiting.
o NETWORK DATA BACK-UP
--------------------
This patented technology generally relates to a computer network
system for backing up data and program files listed by users from
networked work stations. User lists are stored locally, resulting in
increased speed and security. This technology can be used by network
software.
o RESOURCE SCHEDULING
-------------------
This patented technology generally relates to the creation and
maintenance of a schedule through the periodic management and
monitoring of interrelated and interdependent resources from a
database. These resource management tools can be part of scheduling
software used to plan and monitor the use of facilities, the
allocation of manpower, and the use and scheduling of other resources.
o ROTATIONAL VIDEO IMAGING
------------------------
This patented technology generally relates to a rotational video
imaging device for viewing the interior of a cavity or structure. This
technology can be used for medical devices such as endoscopes, and
non-medical devices capable of noninvasive surveillance and analysis.
o SPREADSHEET AUTOMATION
----------------------
This patented technology generally relates to automating the
production of worksheet files for use by electronic spreadsheet
programs. Specifically, the patented technology permits the efficient
retrieval of data from external databases by allowing the user to
select specific data from a database and import the specified data
into a spreadsheet program through uniquely streamlined spreadsheet
commands. The adaptive quality of the technology permits, among other
things, the user to retrieve updated information from an external
database without creating formatting issues in the user's spreadsheet
program.
The acquisition expands and diversifies the Acacia Technologies group's
revenue generating opportunities and accelerates the execution of the Acacia
Technologies group's business strategy of acquiring, developing and licensing
patented technologies.
V-CHIP TECHNOLOGY
The Acacia Technologies group also owned and 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.
V-CHIP LICENSING PROGRAM
The V-chip patent expired in July 2003. 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. To date, the Acacia
Technologies group has recognized $25.7 million in V-chip license fees,
including $1.5 million in previously deferred V-chip license fees in 2004. We
concluded the V-chip licensing program in August 2004 and do not expect to
receive any additional V-chip related revenues in future periods.
18
PATENT ENFORCEMENT LITIGATION
From time to time, companies comprising the Acacia Technologies group
engage in litigation to enforce their patents. A summary of patent enforcement
related litigation initiated by Acacia Technologies group companies is provided
below.
SOUNDVIEW TECHNOLOGIES
Litigation for patent infringement and anti-trust violations was 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 August 2004, the U.S. Court of Appeals for the Federal Circuit affirmed
the September 2002 U.S. District Court for the District of Connecticut ruling
that the remaining television manufacturers named in the Acacia Technologies
group's V-chip patent infringement lawsuit do not infringe the Acacia
Technologies group's V-chip patent. Refer to Item 7. "Management's Discussion
and Analysis of Financial Condition and Results of Operations," for details of
the financial statement impact of the final ruling. The remaining non-Soundview
parties have a motion pending before the United States District Court for the
District of Connecticut seeking reimbursement of certain attorney's fees.
Management believes that the ultimate liability with respect to this claim, if
any, will not have a material effect on our financial position, results of
operations or cash flows.
ACACIA MEDIA TECHNOLOGIES CORPORATION
CABLE AND SATELLITE TV
In 2004, Acacia Media Technologies filed a Complaint in the District Court
for the Northern District of California alleging infringement of Acacia Media
Technologies' DMT patents against Comcast Corporation, Charter Communications,
Inc., The DirectTV Group, Inc., Echostar Communications Corporation, Boulder
Ridge Cable TV, Central Valley Cable TV, LLC, Seren Innovations, Inc., Cox
Communications, Inc., Hospitality Network, Inc. (a wholly owned subsidiary of
Cox that supplies hotel on-demand TV services) and Mediacom, LLC. As of December
31, 2004, Acacia Media Technologies has executed license and settlement
agreements with Boulder Ridge Cable TV, Central Valley Cable TV, and Seren
Innovations.
In September 2004, Acacia Media Technologies filed complaints in the U.S.
District Court for the District of Arizona, U.S. District Court for the District
of Minnesota and the U.S. District Court for the Northern District of Ohio -
Eastern Division, alleging infringement of Acacia Media Technologies' DMT
patents against certain cable and satellite companies located in Arizona,
Minnesota, and Ohio. Companies named in the lawsuits include Armstrong Group,
Arvig Communication Systems, Block Communications, Inc., Cable America
Corporation, Cable One, Inc., Cable System Services, Inc., Cannon Valley
Communications, Inc., East Cleveland Cable TV and Communications, LLC, Loretel
Cablevision, Massillon Cable TV, Inc., Mid-Continent Media, Inc., Nelsonville TV
Cable, Inc., NPG Cable, Inc., Precis Communications, Inc. San Carlos
Cablevision, LLC, Savage Communications, Inc., Sjoberg's Cablevision, Inc., US
Cable, and Wide Open West, LLC. As of December 31, 2004, Acacia Media
Technologies has executed license agreements with Precis Communications and
Cable System Services and dismissed the action against San Carlos Cablevision
and Nelsonville TV Cable.
INTERNET WEBSITES
In 2003, Acacia Media Technologies initiated DMT patent infringement
litigation in the Federal District Court for the Central District of California
(the "Court") against defendants who provide adult oriented digital content over
the Internet. As of December 31, 2004, New Destiny Internet Group, Inc., Audio
Communications Inc., VS Media, Ademia Multimedia, LLC, International Web
Innovations, Inc., Offendale Commercial BV, Ltd., Adult Entertainment Broadcast
Network, Cybertrend, Inc., Lightspeed Media Corp., Adult Revenue Services,
Innovative Ideas International, AskCS.com, Game Link, Inc., Club Jenna, Inc.,
Cybernet Ventures, Inc., ACMP, LLC, Global AVS, Inc. d/b/a DrewNet, ICS, Inc. /
AP Net Marketing, Inc., and National A-1 Advertising, remained in the
litigation.
HOTEL ON-DEMAND TV INDUSTRY
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. In June 2004, Acacia Media Technologies
entered into a license agreement for its DMT technology with On Command
Corporation settling all outstanding litigation between the parties.
19
PATENT ENFORCEMENT LITIGATION - RELATED TO ACQUIRED COMPANIES
Certain companies acquired as a result of the January 2005 acquisition of
the assets of Global Patent Holdings, as described above, have initiated patent
enforcement related litigation as follows:
IP INNOVATION, LLC
o IP Innovation, LLC et. al. v. Lexmark International, Inc., United
States District Court for the Northern District Of Illinois
o IP Innovation, LLC. v. Dell Computer, United States District Court for
the Northern District of Illinois
o IP Innovation, LLC v. WebCT., Digital Think, Inc., eCollege.com,
Docent Inc., United States District Court for the Southern District of
Texas, on appeal to the U.S. Court of Appeals for the Federal Circuit
IP INNOVATION, LLC AND NEW MEDIUM, LLC
o IP Innovation, LLC and New Medium, LLC et. al. v. Sony Electronics,
Inc., United States District Court for the Northern District of
Illinois
o IP Innovation, LLC and New Medium, LLC et. al. v. Matsushita Electric
Corporation of America, et. al., United States District Court for the
Northern District of Illinois
VDATA LLC
o VCode Holdings, Inc. et. al. v. Adidas America, AMD, Stamps.com,
Hitachi Global Storage Technologies Thailand, Ltd, et. al., United
States District Court for the District of Minnesota
INFORMATION TECHNOLOGY INNOVATION, LLC
o Information Technology Innovation, LLC et. al. v. Motorola, Inc.,
United Sates District Court for the Northern District of Illinois
BROADCAST INNOVATION, LLC
o Broadcast Innovation, LLC et. al. v. Echostar Communications
Corporation et. al., United States District Court for the District of
Colorado
o Broadcast Innovation, LLC et. al. v. Charter Communications Inc. et.
al., United States District Court for the District of Colorado, on
appeal to the U.S. Court of Appeals for the Federal Circuit
FINANCIAL SYSTEMS INNOVATION, LLC
o Ware et. al. v. H.E. Butt Grocery Company, Williams-Sonoma, Inc.,
Linens 'N Things, Inc., Petco Animal Supplies, Inc., Costco Wholesale
Corporation,, The Bombay Company , United Sates District court for the
Northern District of Texas
o Ware et. al. v. The Kroger Co. United States District court for the
Northern District of Georgia
o Financial Systems Innovation, LLC v. Via Technologies, Inc. et. al.,
CD, California
AV TECHNOLOGIES, LLC
o Technology Licensing Corporation et. al. v. Thomson, Inc., E.D.
California
20
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.
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,
21
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.
In July 2004, the Acacia Technologies group acquired U.S. Patent No.
6,226,677 from LodgeNet Entertainment Corporation. The patent covers technology
and methods for redirecting users to a login page when accessing the Internet
and expires in 2019.
As a result of the January 28, 2005 acquisition of the assets of Global
Patent Holdings, LLC, discussed above, the Acacia Technologies group acquired
ownership of companies that control 27 patent portfolios, which include 120 U.S.
patents and certain foreign counterparts, and cover technologies used in a wide
variety of industries.
REGULATORY MATTERS
We believe the Acacia Technologies group's DMT technology is utilized by
cable TV, satellite TV and telecommunications systems. The cable TV, satellite
TV 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 cable
TV, satellite TV and telecommunication industry regulations do not apply
directly to the Acacia Technologies group, they affect programming distributors,
one of the large potential customers for the technologies covered by the Acacia
Technologies group patent portfolio. The Acacia Technologies group monitors
pending legislation and administrative proceedings to ascertain relevance,
analyze impact and develop strategies regarding regulatory trends and
developments within these industries.
Federal law requires cable TV 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 TV system is generally required
to carry local non-commercial television stations. The FCC has also implemented
comparable rules for satellite TV carriers requiring that if a satellite TV
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 TV and satellite TV 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 TV and satellite TV 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.
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, 2004, the Acacia Technologies group had 21 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 9,147 square feet of
office space in Newport Beach, California, under a lease agreement that expires
in February 2007. Subsequent to December 31, 2004, Acacia Research Corporation
executed an amendment to the Newport Beach, California location lease agreement
to rent an additional 2,993 square feet of office space. 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.
22
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.
From time to time, companies comprising the Acacia Technologies group
engage in litigation to enforce their patents. A summary of patent enforcement
related litigation is provided at Item 1. "Business," under the caption "Patent
Enforcement Litigation."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
23
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHAES OF EQUITY SECURITIES
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 and Acacia Research-CombiMatrix common stock are listed on the
Nasdaq National Market System under the symbols "ACTG" and "CBMX," respectively.
Acacia Research-CombiMatrix 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.
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.
2004 2003
------------------------------------- -------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- -------
Acacia Research-Acacia Technologies stock:
High ........................................ $5.60 $7.14 $7.25 $7.50 $8.58 $6.73 $1.75 $2.40
Low ......................................... $3.91 $2.77 $4.84 $5.15 $4.71 $1.25 $0.99 $0.96
Acacia Research-CombiMatrix stock:
High ........................................ $4.39 $4.85 $6.99 $9.30 $5.05 $5.07 $2.83 $3.65
Low ......................................... $2.71 $2.52 $3.10 $3.16 $2.90 $2.25 $1.71 $1.50
On March 9, 2005, there were approximately 171 owners of record of Acacia
Research-Acacia Technologies stock and 162 owners of record of Acacia
Research-CombiMatrix stock. The majority of the outstanding shares of Acacia
Research-Acacia Technologies stock and Acacia Research-CombiMatrix stock are
held by a nominee holder on behalf of an indeterminable number of ultimate
beneficial owners.
DIVIDEND POLICY
To date, we have not declared or paid any cash dividends with respect to
our capital stock, and the current policy of the board of directors is to retain
earnings, if any, to provide for the growth of Acacia Research Corporation.
Consequently, we do not expect to pay any cash dividends in the foreseeable
future. Further, there can be no assurance that our proposed operations will
generate revenues and cash flow needed to declare a cash dividend or that we
will have legally available funds to pay dividends.
24
USE OF PROCEEDS
In April 2004, Acacia Research Corporation raised net proceeds of
approximately $13,715,000 through the sale of three million shares of Acacia
Research - CombiMatrix common stock in a registered direct offering. The net
proceeds from this offering were attributed to the CombiMatrix group. The net
proceeds are being utilized to provide working capital for the CombiMatrix
group's business.
All of the shares of Acacia Research-CombiMatrix common stock were offered
pursuant to an effective registration statement previously filed with the
Securities and Exchange Commission.
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information as of December 31, 2004 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 (B) WEIGHTED FUTURE ISSUANCE UNDER
ISSUED UPON EXERCISE AVERAGE EXERCISE EQUITY COMPENSATION PLANS
OF OUTSTANDING PRICE OF OUTSTANDING (EXCLUDING SECURITIES
PLAN CATEGORY OPTIONS OPTIONS REFLECTED IN COLUMN (A))
- ------------------------------------------------------------- -------------------- -------------------- -------------------------
EQUITY COMPENSATION PLANS APPROVED BY SECURITY HOLDERS
2002 CombiMatrix Stock Incentive Plan(1) 6,232,000 $7.44 2,166,000
2002 Acacia Technologies Stock Incentive Plan(2) 5,726,000 $7.81 228,000
Subtotal(3) N/A N/A N/A
EQUITY COMPENSATION PLANS NOT APPROVED BY SECURITY HOLDERS(4)
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TOTAL(3) N/A N/A N/A
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(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
shares 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.
(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