ACTG

Business Context and Reporting Period

Company: Acacia Research Corporation
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and nine months ended September 30, 1999
Business Overview: The Company provides investment advisory services and makes direct investments in emerging corporations with intellectual property rights, primarily in unproven technologies. Key portfolio companies include CombiMatrix (DNA synthesis), Soundbreak.com (Internet music/lifestyle), and others. Management anticipates closing its money management division in the fourth quarter of 1999.

Key Financial Metrics

Note: Revenue consists entirely of capital management fee income. The Company has no committed lines of credit.

Material Changes vs. Prior Period

• Revenue Decline: Capital management fees decreased slightly year-over-year ($116k vs $118k for 9 months) due to lower returns and reduced assets under management. Management plans to exit this division in Q4 1999.
• Expense Surge: Operating expenses increased 35% year-over-year ($6.0M vs $4.4M). This was driven by:
  • Expanded R&D at CombiMatrix ($1.6M vs $993k).
  • Start-up costs for Soundbreak.com ($491k R&D).
  • Increased headcount, wages, and office lease costs.
• Equity Losses: Equity in losses of affiliates increased significantly to $906k (9 months 1999) from $469k (9 months 1998), primarily due to losses at Signature-mail.com, Greenwich Information Technologies, and Whitewing Labs.
• Liquidity Improvement: Cash and cash equivalents increased to $12.4M from $7.5M at year-end 1998, bolstered by financing activities including warrant exercises and private placements.

Guidance, Outlook, and Risks

• Outlook: Management expects operating expenses to continue increasing as the Company and affiliates expand staffing and operations. The money management division is expected to close in Q4 1999 with no material exit costs.
• Capital Resources: The Company anticipates existing working capital ($12.0M) is sufficient for operating expenses for at least the next 12 months without major new investments. However, additional financing will be sought for new or existing businesses, which may be dilutive.
• Subsequent Events:
  • Soundbreak.com completed a $6.5M private equity financing in October 1999 (Company invested $1M).
  • Company issued a warrant call in October 1999; if fully exercised, it would raise $10M.
  • Soundbreak.com entered a 60-month lease commitment in November 1999 with minimum payments of $36k/month.
• Risks:
  • Technology Risk: No assurance that portfolio technologies (e.g., DNA synthesis, Internet services) will be successful or commercialized.
  • Year 2000: While internal systems are largely compliant, the Company faces risks from third-party vendors and utilities. Remediation for subsidiaries is ongoing.
  • Liquidity: No assurance that additional funding will be available on favorable terms.

Investor Verification Checklist

• Capital Burn Rate: Verify the sustainability of the $12.4M cash balance against the accelerating operating expense trend ($6M for 9 months).
• Portfolio Valuation: Assess the viability of key investments (CombiMatrix, Soundbreak.com) given the significant equity losses reported from affiliates.
• Debt Conversion: Confirm the status of CombiMatrix's $1.45M subordinated notes, which are subject to an exchange offer for common stock.
• Warrant Exercise: Monitor the outcome of the October 1999 warrant call to determine if the potential $10M cash infusion materializes.
• Soundbreak.com Leverage: Review the impact of the new $36k/month lease commitment on Soundbreak.com's cash flow requirements.