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ACACIA RESEARCH CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Cautionary Statement You should read the following discussion and analysis in conjunction with the consolidated financial statements and related notes thereto contained in Part I, Item 1 of this Quarterly Report on Form 10-Q. The information contained in this Quarterly Report on Form 10-Q is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the Securities and Exchange Commission, or the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2010, filed with the SEC on February 28, 2011, as amended on March 24, 2011. This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and concern matters that involve risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. 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 set forth under "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other sections of this Quarterly Report on Form 10-Q. Such statements may be identified by the use of forward-looking terminology such as "may," "will," "should," "could," "expect," "plan," "believe," "estimate," "anticipate," "intend," "predict," "potential," "continue," or similar terms, variations of such terms or the negative of such terms, although not all forward-looking statements contain these 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 intellectual property acquisition and development, licensing and enforcement activities, capital expenditures, earnings, litigation, regulatory matters, markets for our 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 demand for our services, legislative, regulatory and competitive developments in markets in which we and our subsidiaries operate, results of litigation and other circumstances affecting anticipated revenues and costs. We expressly disclaim any intent, obligation or undertaking to update or revise any forward-looking statements contained herein to conform such statements to actual results or 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. Readers are urged to carefully review and consider the various disclosures made by us, which attempt to advise interested parties of the risks, uncertainties, and other factors that affect our business, including without limitation the disclosures made under the captions "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Financial Statements" in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and disclosures made under the captions "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Risk Factors" and "Financial Statements and Supplementary Data" included in our Annual Report on Form 10-K for the year ended December 31, 2010. General As used in this Quarterly Report on Form 10-Q, "we," "us" and "our" refer to Acacia Research Corporation, a Delaware corporation, and/or its wholly and majority-owned and controlled operating subsidiaries. All intellectual property acquisition, development, licensing and enforcement activities are conducted solely by certain of Acacia Research Corporation's wholly and majority-owned and controlled operating subsidiaries. Our operating subsidiaries acquire, develop, license and otherwise enforce patented technologies. Our operating subsidiaries generate revenues and related cash flows from the granting of intellectual property rights for the use of, or pertaining to, patented technologies that our operating subsidiaries own or control. Our operating subsidiaries assist patent owners with the prosecution and development of their patent portfolios, the protection of their patented inventions from unauthorized use, the generation of revenue from users of their patented technologies and, if necessary, with the enforcement against unauthorized users of their patented technologies. We are a leader in licensing patented technologies and have established a proven track record of licensing success with over 1,020 license agreements executed to date across 104 of our technology licensing programs. Currently, on a consolidated basis, our operating subsidiaries own or control the rights to over 184 patent portfolios, which include U.S. patents and certain foreign counterparts covering technologies used in a wide variety of industries. We were originally incorporated in California in January 1993 and reincorporated in Delaware in December 1999. 11 --------------------------------------------------------------------------------Executive Overview Our operating activities for the periods presented were principally focused on the continued development, licensing and enforcement of the patent portfolios owned or controlled by our operating subsidiaries, including the continued pursuit of our ongoing technology licensing and enforcement programs and the commencement of new technology licensing and enforcement programs. In addition, we continued our focus on business development, including the acquisition of several additional patent portfolios by certain of our operating subsidiaries and the continued pursuit of additional opportunities to partner with individual patent owners, small technology companies, research laboratories, universities, and major technology companies seeking to effectively and efficiently monetize their portfolio of patented technologies. In March 2011, we completed a public offering of 5,750,000 shares of common stock. The public offering price was $31.50 per share, and the net proceeds to us totaled approximately $175.2 million after deducting underwriting discounts and related offering expenses. We retained broad discretion over the use of the net proceeds from the offering and intend to use the net proceeds for operations and for other general corporate purposes, including, but not limited to, working capital, strategic acquisitions and other transactions. Operating activities during the periods presented included the following: Three Months Ended June 30, Six Months Ended June 30, 2011 2010 2011 2010 Revenues (in thousands) $ 39,746 $ 15,006 $ 100,876 $ 54,778 New agreements executed 29 89 64 129 Licensing and enforcement programs generating revenues - during the respective period 24 22 43 39 Licensing and enforcement programs with initial revenues 5 2 13 15 New patent portfolios 9 12 17 23 Cumulative number of licensing and enforcement programs generating revenues - inception to date 104 75 104 75 Our revenues historically have fluctuated quarterly, and can vary significantly, based on the dollar amount of agreements executed each period, fluctuations in the total number of agreements executed each period, the number of patented technology portfolios owned or controlled by our operating subsidiaries, the timing, results and uncertainties associated with patent filings and other enforcement proceedings relating to our intellectual property rights, the number of active licensing and enforcement programs, the relative maturity of active licensing programs during the applicable periods and other external factors. Additional factors impacting the amount of revenues recognized each period are discussed below. Although revenues from one or more of our patents or patent portfolios may be significant in a specific reporting period, we believe that none of our individual patents or patent portfolios is individually significant to our licensing and enforcement business as a whole. We measure and assess the performance and growth of the patent licensing and enforcement businesses conducted by our operating subsidiaries based on consolidated revenues recognized across all of our technology licensing and enforcement programs on a trailing twelve-month basis. Trailing twelve-month revenues were as follows (in thousands): As of Date: Trailing Twelve -Month Revenues % Change June 30, 2011 $ 177,927 16 % March 31, 2011 153,187 16 % December 31, 2010 131,829 (5 )% September 30, 2010 138,585 53 % June 30, 2010 90,805 - % 12-------------------------------------------------------------------------------- Revenues for the six months ended June 30, 2011 included fees from the following technology licensing and enforcement programs: • Audio Communications Fraud Detection • Manufacturing Data Transfer technology technology • Camera Support technology • Messaging technology(1) • Catheter Insertion technology(1) • Microprocessor Enhancement technology • Computer Architecture and Power • Mobile Computer Synchronization Management technology(1) technology • Computer Graphics technology • Network Remote Access technology • Database Retrieval technology(1)(2) • NOR Flash technology(1) • DDR SDRAM technology(1)(2) • Online Auction Guarantee technology • Digital Signal Processing • Optical Recording technology(1)(2) Architecture technology • Digital Video Enhancement technology • Optical Switching technology • DMT® technology • Pop-up Internet Advertising technology • Document Generation technology • Power Management Within Integrated Circuits technology(1) • DRAM Memory architecture technology • Rule Based Monitoring technology • Facilities Operation Management • Shape Memory Alloys technology(1)(2) System technology • Image Resolution Enhancement • Short Messaging in Cellular Telephony technology technology • Improved Commercial Print technology • Storage technology • Improved Lighting technology • Telematics technology • Interactive Mapping technology • User Programmable Engine Control technology(1) • Lighting Ballast technology • Video Encoding technology(1)(2) • Lighting Control technology(1) • Virtual Server technology • Location Based Services technology • Visual Data Evaluation technology • Location Based Services technology • Website Crawling technology • Magnetic Storage technology(1) __________________________________________ (1) Initial revenues recognized during the six months ended June 30, 2011. (2) Initial revenues recognized during the three months ended June 30, 2011. 13-------------------------------------------------------------------------------- Revenues for the six months ended June 30, 2010 included fees from the following technology licensing and enforcement programs: • Audio Communications Fraud Detection • Medical Image Stabilization technology technology • Authorized Spending Accounts • Medical Monitoring technology(1) technology • Business Process Modeling (BPM) • Mutli-Dimensional Database technology(1) Compression technology • Compiler technology(1) • Network Monitoring technology(1) • Credit Card Fraud Protection • Network Remote Access technology(1) technology • Database Access technology • Online Auction Guarantee technology • Database Management technology • Online Newsletters with Links technology(1)(2) • Digital Video Enhancement • Online Promotion technology technology(1)(2) • Disk Array Systems & Storage Area • Picture Archiving & Communications Network technology(1) System technology • DMT® technology • Pop-up Internet Advertising technology • Document Generation technology • Records Management technology(1) • Facilities Operation Management System • Rule Based Monitoring technology technology(1) • File Locking In Shared Storage • Software Installation technology(1) Networks • High Performance Computer Architecture • Storage technology • Image Resolution Enhancement • Telematics technology technology • Improved Lighting technology(1) • Virtual Computer Workspace technology • Interactive Mapping technology(1) • Virtual Server technology • Internet Radio Advertising technology • Visual Data Evaluation technology(1) • Lighting Ballast technology • Website Crawling technology(1) • Location Based Services technology ________________________________ (1) Initial revenues recognized during the six months ended June 30, 2010. (2) Initial revenues recognized during the three months ended June 30, 2010. 14-------------------------------------------------------------------------------- Summary of Results of Operations - Overview For the Three and Six Months Ended June 30, 2011 and 2010 Three Months Ended June 30, % Six Months Ended June 30, % 2011 2010 Change 2011 2010 Change Revenues $ 39,746 $ 15,006 165 % $ 100,876 $ 54,778 84 % Operating costs and expenses 37,625 19,160 96 % 78,080 39,581 97 % Operating income (loss) 2,121 (4,154 ) (151 )% 22,796 15,197 50 % (Provision for) benefit from income taxes (306 ) 13 * (7,454 ) (308 ) * Net (income) loss attributable to noncontrolling interests in operating subsidiary** - 255 (100 )% - (282 ) (100 )% Net income (loss) attributable to Acacia Research Corporation 2,139 (3,866 ) (155 )% 14,492 14,646 (1 )% _________________ * Percentage change in excess of 300% ** Refer to Note 1 to the consolidated financial statements included in this report for additional information. Overview - Three months ended June 30, 2011 compared with the three months ended June 30, 2010 • Revenues increased $24.7 million, or 165%, to $39.7 million, due primarily to an increase in the average revenue per executed agreement during the three months ended June 30, 2011. • Cost of Revenues and Other Operating Expenses: ? Inventor royalties, net (income) loss attributable to noncontrolling interests in operating subsidiary, or noncontrolling interests, and contingent legal fees, on a combined basis, increased $15.5 million, or 255%, primarily reflecting the increase in related revenues for the three months ended June 30, 2011. The percentage increase was greater than the percentage increase in related revenues due to, in the aggregate, higher inventor royalty and contingent legal fee arrangement obligations associated with the patent portfolios generating revenues during the three months ended June 30, 2011. ? Litigation and licensing expenses-patents decreased $672,000, or 15%, to $3.8 million, due to a lower net level of litigation support, third party technical consulting and professional expert expenses incurred in connection with our continued investment in ongoing licensing and enforcement programs and new licensing andenforcement programs commenced since the end of the prior year period. ? Marketing, general and administrative expenses increased $2.2 million, or 37%, to $8.3 million, due primarily to an increase in non-cash stock compensation charges resulting from an increase in the average grant date fair value of restricted shares expensed in the second quarter of 2011, an increase in variable performance based compensation charges, a net increase in business development, engineering and other personnel since the end of the prior year period, and a net increase in corporate, general andadministrative costs. ? Patent amortization increased $724,000, or 39%, to $2.6 million, due primarily to the acceleration of scheduled patent amortization related to recoupable up-front patent portfolio acquisition costs that were recovered from related net licensing proceeds during the three months ended June 30, 2011, pursuant to the provisions of the underlying inventor agreements. ? Research, consulting and other expenses-business development increased $882,000, or 195%, to $1.3 million due primarily to a net increase in third-party research, consulting and other duediligence related costs incurred in connection with the identification, review, and assessment of patent portfolio acquisition opportunities during the three months ended June 30, 2011. Overview - Six months ended June 30, 2011 compared with the six months ended June 30, 2010 • Revenues increased $46.1 million, or 84%, to $100.9 million, due primarily to an increase in the average revenue per executed agreement during the six months ended June 30, 2011. • Cost of Revenues and Other Operating Expenses: ? Inventor royalties, noncontrolling interests, and contingent legal fees, on a combined basis, increased $29.1 million, or 195%, primarily reflecting the increase in related revenues for the six months ended June 30, 2011. 15-------------------------------------------------------------------------------- The percentage increase was greater than the percentage increase in related revenues due to, in the aggregate, lower or no inventor royalty or contingent legal fee arrangement obligations associated with certain of the revenues generated during the three months ended March 31, 2010, and in the aggregate, higher inventor royalty and contingent legal fee arrangement obligations associated with the patent portfolios generating revenues during the three months ended June 30, 2011. ? Litigation and licensing expenses-patents decreased $834,000, or 10%, to $7.3 million, due to a lower net level of litigation support, third party technical consulting and professional expert expenses incurred in connection with our continued investment in ongoing licensing and enforcement programs and new licensing andenforcement programs commenced since the end of the prior year period. ? Marketing, general and administrative expenses increased $5.9 million, or 48%, to $18.3 million, due primarily to an increase in non-cash stock compensation charges resulting from an increase in the average grant date fair value of restricted shares expensed during the six months ended June 30, 2011, an increase in annual one-time variable performance based compensation charges, an increase in other variable performance based compensation charges, a net increase in business development, engineering and other personnel since the end of the prior year period, and a net increase in corporate, general and administrative costs. ? Patent amortization increased $2.8 million, or 78%, to $6.4 million, due primarily to the acceleration of scheduled patentamortization related to recoupable up-front patent portfolio acquisition costs that were recovered from related net licensing proceeds during the six months ended June 30, 2011, pursuant to the provisions of the underlying inventor agreements. ? The increase in provision for income taxes reflects the impact of foreign withholding taxes withheld by the Korean tax authority pursuant to the requirements of the related Income TaxConvention, on payments in connection with certain licensing arrangements executed during the six months ended June 30, 2011. ? Research, consulting and other expenses-business development increased $1.2 million, or 148%, due primarily to a netincrease in third-party research, consulting and other due diligence related costs incurred in connection with the identification, review, and assessment of patent portfolio acquisition opportunities during the six months ended June 30, 2011. Enforcement Considerations The pursuit of enforcement actions in connection with our licensing and enforcement programs can involve certain risks and uncertainties, including the following: • Increases in patent-related legal expenses, including, but not limited to, increases in costs billed by outside legal counsel for discovery, depositions, economic analyses, damages assessments, expert witnesses and other consultants, case-related audio/video presentations and other litigation support and administrative costs, could increase our operating costs and decrease our revenue generating opportunities; • Our patented technologies and enforcement actions are complex, and, as a result, we may be required to appeal adverse decisions by trial courts in order to successfully enforce our patents; • New legislation, regulations or rules related to enforcement actions could significantly increase our operating costs and decrease our revenue generating opportunities; and • Courts may rule that our subsidiaries have violated certain statutory, regulatory, federal, local or governing rules or standards by pursuing such enforcement actions, which may expose us and our operating subsidiaries to material liabilities, which could harm our operating results and our financial position. Investments in Patent Portfolios We also measure and assess the performance and growth of the patent licensing and enforcement businesses conducted by our operating subsidiaries based on the number of patent portfolios owned or controlled by our operating subsidiaries on a consolidated basis. As of June 30, 2011, December 31, 2010, and June 30, 2010, on a consolidated basis, our operating subsidiaries owned or controlled the rights to approximately 184, 171 and 158 patent portfolios, respectively, which include U.S. patents and certain foreign counterparts, covering technologies used in a wide variety of industries. During the six months ended June 30, 2011, certain of our operating subsidiaries continued to execute their business strategy in the area of patent portfolio acquisitions, including the acquisition of, or the acquisition of the rights to, 17 patent portfolios covering a variety of applications, including the following: 16 -------------------------------------------------------------------------------- • Flash Memory. This patented technology consists of 16 flash memory patents relating to architecture, manufacturing and operation of flash memory, including NOR flash. The patented technology covers techniques for enhancing the performance and reliability of the flash memory cell. NOR flash memory is extensively used in cell phones. • Cellular Air Interface. This patented technology has 200 patents covering 3G and 4G cellular air interface and infrastructure technologies. These technologies may be found in mobile handsets, base stations, routers and other related equipment. • Additional Patent Portfolios Acquired. We also acquired, or acquired the rights to, additional patent portfolios related to Radiation Therapy technology, Prescription Lens technology, Application Authentication technology, DDR SDRAM technology, Power-over-Ethernet technology, Targeted Marketing technology, Targeted Internet Advertising technology, Microprocessor and DSP technology, Data Compression technology, Heart-Lung Machine technology, Voice-Over-IP technology, HDTV technology, Mobile Communications technology, DRAM technology and Advanced Memory and Processor technology. Refer to "Liquidity and Capital Resources" below for information regarding the impact of patent and patent rights acquisitions on the consolidated financial statements for the periods presented. As of June 30, 2011, certain of our operating subsidiaries had several option agreements with third-party patent portfolio owners regarding the potential acquisition of additional patent portfolios. Future patent portfolio acquisitions will continue to expand and diversify our future revenue generating opportunities. Critical Accounting Estimates Our unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. Preparation of these consolidated statements requires management to make judgments and estimates. Some accounting policies have a significant impact on amounts reported in these consolidated financial statements. A summary of significant accounting policies and a description of accounting policies that are considered critical may be found in the audited consolidated financial statements and notes thereto and under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" included in our Annual Report on Form 10-K for the year ended December 31, 2010. In addition, refer to Note 2 to the consolidated financial statements included in this report. Consolidated Results of Operations Comparison of the Results of Operations for the Three and Six Months Ended June 30, 2011 and 2010 Revenue (In thousands) Three Months Ended June 30, Six Months Ended June 30, 2011 2010 2011 2010 Revenues $ 39,746 $ 15,006 $ 100,876 $ 54,778 Revenues. In general, revenue arrangements provide for the payment of contractually determined fees in consideration for the grant of certain intellectual property rights for patented technologies owned or controlled by our operating subsidiaries. These rights typically include some combination of the following: (i) the grant of a non-exclusive, retroactive and future license to manufacture and/or sell products covered by patented technologies owned or controlled by our operating subsidiaries, (ii) covenants-not-to-sue, (iii) the release of the licensee from certain claims, and (iv) the dismissal of any pending litigation. Six Months Ended June Three Months Ended June 30, 30, 2011 2010 2011 2010 New agreements executed 29 89 64 129 Licensing and enforcement programs with initial revenues 5 2 13 15 17-------------------------------------------------------------------------------- Three licensees individually accounted for 30%, 28% and 12% of revenues recognized during the three months ended June 30, 2011, and three licensees individually accounted for 45%, 12% and 11% of revenues recognized during the six months ended June 30, 2011. Two licensees individually accounted for 17% and 10% of revenues recognized during the three months ended June 30, 2010, and one licensee individually accounted for 46% of revenues recognized during the six months ended June 30, 2010. On a consolidated basis, as of June 30, 2011, 104 of our licensing programs had begun generating licensing revenues, up from 91 as of December 31, 2010, and 75 as of June 30, 2010. Revenues recognized by our operating subsidiaries fluctuate from period to period primarily based on the following factors: • the dollar amount of agreements executed each period, which can be driven by the nature and characteristics of the technology or technologies being licensed and the magnitude of infringement associated with a specific licensee; • the specific terms and conditions of agreements executed each period, including the nature and characteristics of rights granted, and the periods of infringement or term of use contemplated by the respective payments; • fluctuations in the total number of agreements executed; • fluctuations in the sales results or other royalty per unit activities of our licensees that impact the calculation of fees due; • the timing of the receipt of periodic payments and/or reports from licensees; and • fluctuations in the net number of active licensees from period to period. The increase in revenues for the three and six months ended June 30, 2011 was due primarily to an increase in the average revenue per executed agreement. 18 --------------------------------------------------------------------------------Cost of Revenues (In thousands) Three Months Ended June 30, Six Months Ended June 30, 2011 2010 2011 2010 Cost of revenues: Inventor royalties $ 8,588 $ 2,877 $ 21,677 $ 6,788 Contingent legal fees 13,039 3,465 22,406 7,872 Litigation and licensing expenses - patents 3,761 4,433 7,295 8,129 Amortization of patents 2,600 1,876 6,372 3,579 Net (income) loss attributable to noncontrolling interests in operating subsidiary* - 255 - (282 ) _________________* Refer to Note 1 to the consolidated financial statements included in this report for additional information. Inventor Royalties, Noncontrolling Interests and Contingent Legal Fees Expense. Net (income) attributable to noncontrolling interests in operating subsidiary represents net inventor royalties distributable to noncontrolling interests in one of Acacia's majority owned operating subsidiaries. Net loss attributable to noncontrolling interests in operating subsidiary represents net expenses recoverable from any future net licensing and enforcement proceeds attributable to noncontrolling interests in the majority owned operating subsidiary. The economic terms of the inventor agreements, operating agreements and contingent legal fee arrangements associated with the patent portfolios owned or controlled by our operating subsidiaries, if any, including royalty rates, contingent fee rates and other terms, vary across the patent portfolios owned or controlled by our operating subsidiaries. As such, these costs fluctuate period to period, based on the amount of revenues recognized each period, the terms and conditions of agreements executed each period and the mix of specific patent portfolios with varying economic terms and obligations generating revenues each period. Three Months Ended June 30, Six Months Ended June 30, 2011 vs. 2010 2011 vs. 2010 Increase in revenues 165 % 84 % Increase in inventor royalties and noncontrolling interests 228 % (a) 207 % (b) Increase in contingent legal fees expense 276 % (a) 185 % (b) Increase in inventor royalties expense, noncontrolling interests and contingent legal fees expense 255 % (a) 195 % (b) Three Months Ended June 30, Six Months Ended June 30, 2011 2010 2011 2010 Inventor royalties and noncontrolling interests as a percentage of revenues 22 % 17 % (a) 21 % 13 % (b) Contingent legal fees expense as a percentage of revenues 33 % 23 % (a) 22 % 14 % (b) Inventor royalties, noncontrolling interests and contingent legal fees, combined, as a percentage of revenues 54 % 41 % (a) 44 % 27 % (b) ______________________ (a) The percentage increase in inventor royalties, noncontrolling interests and contingent legal fees expense was greater than the percentage increase in revenues for the three month periods presented, primarily due to, in the aggregate, higher inventor royalty and contingent legal fee arrangement obligations associated with the portfolios generating revenues during the three months ended June 30, 2011, as compared to the three months ended June 30, 2010. (b) The percentage increase in inventor royalties, noncontrolling interests and contingent legal fees expense was greater than the percentage increase in revenues for the six month periods presented, due to the relationships discussed in Note (a) above for the three month periods presented, and in addition, due to a portion of revenues recognized during the three months ended March 31, 2010 having no corresponding inventor royalty or contingent legal fee arrangement obligations, 19--------------------------------------------------------------------------------and in the aggregate, lower inventor royalty and contingent legal fee rates associated with the portfolios generating revenues during the three months ended March 31, 2010. Certain revenue agreements with unrelated third parties entered into in the six months ended June 30, 2011 and 2010 resulted in the grant of certain intellectual property rights and recognition of revenues, portions of which were not subject to inventor royalty and contingent legal fee arrangements, as well as the grant of licenses from certain of our operating subsidiaries and recognition of revenues that were subject to inventor royalties and contingent legal fee arrangements. Revenues recognized subject to inventor royalties and contingent legal fees are based on a determination by the respective operating subsidiaries. Litigation and Licensing Expenses - Patents. Litigation and licensing expenses-patents include patent-related prosecution and enforcement costs incurred by outside patent attorneys engaged on an hourly basis and the out-of-pocket expenses incurred by law firms engaged on a contingent fee basis. Litigation and licensing expenses-patents also includes licensing and enforcement related third-party patent research, development, consulting, and other costs incurred in connection with the licensing and enforcement of patent portfolios. Litigation and licensing expenses-patents fluctuate from period to period based on patent enforcement and prosecution activity associated with ongoing licensing and enforcement programs and the timing of the commencement of new licensing and enforcement programs in each period. Litigation and licensing expenses-patents decreased for the three and six month periods presented due to lower net levels of litigation support, third-party technical consulting and professional expert expenses associated with our continued investment in ongoing licensing and enforcement programs. The decrease was partially offset by an increase in litigation and licensing expenses incurred in connection with our continued investment in new licensing and enforcement programs commenced since the end of the prior year period. We expect patent-related legal expenses to continue to fluctuate period to period based on the factors summarized above, in connection with upcoming scheduled and/or anticipated trial dates and our current and future patent acquisition, development, licensing and enforcement activities. Amortization of Patents. The increase was due primarily to an increase in accelerated patent amortization related to recoupable up-front patent portfolio acquisition costs that were recovered from related net licensing proceeds during the three and six months ended June 30, 2011 and a net increase in scheduled patent amortization expense related to patent portfolios acquired since the end of the prior year period. For the three months ended June 30, 2011 and 2010, accelerated amortization expense related to the recovery of up-front patent acquisition costs totaled $1,063,000 and $221,000, respectively. For the six months ended June 30, 2011 and 2010, accelerated amortization expense related to the recovery of up-front patent acquisition costs totaled $3,446,000 and $644,000, respectively. Operating Expenses (In thousands) Three Months Ended June 30, Six Months Ended June 30, 2011 2010 2011 2010 Marketing, general and administrative expenses (including non-cash stock compensation expense of $3,422 and $6,323 for the three and six months ended June 30, 2011, respectively, and $2,064 and $3,959 for the three and six months ended June 30, 2010, respectively) $ 8,302 $ 6,056 $ 18,287 $ 12,388 20-------------------------------------------------------------------------------- Marketing, General and Administrative Expenses. Marketing, general and administrative expenses include employee compensation and related personnel costs, including non-cash stock compensation expenses, office and facilities costs, legal and accounting professional fees, public relations, marketing, stock administration, gross receipts based state taxes and other corporate costs. A summary of the main drivers of the change in marketing, general and administrative expenses, including the impact of non-cash stock compensation charges, for the periods presented, is as follows (in thousands): Three Months Six Months Ended June 30, Ended June 30, 2011 vs. 2010 2011 vs. 2010 Addition of business development, engineering and other personnel costs $ 522 $ 1,024 Increase in annual variable performance-based compensation and other variable performance-based compensation costs 48 1,774 Corporate, general and administrative costs 318 737 Non-cash stock compensation expense 1,358 2,364 Income Taxes (in thousands) Three Months Ended June 30, Six Months Ended June 30, 2011 2010 2011 2010 (Provision for) benefit from income taxes $ (306 ) $ 13 $ (7,454 ) $ (308 ) Effective tax rate 14 % - % 33 % 2 % Provision for Income Taxes. The increase in our effective tax rate for the six month periods presented reflects the impact of Korean foreign withholding taxes totaling $7.6 million, which were withheld by the Korean tax authority pursuant to the requirements of the applicable Income Tax Convention, on payments in connection with certain licensing arrangements executed during the six months ended June 30, 2011. In general, foreign taxes withheld may be claimed as a deduction on future U.S. corporate income tax returns, or as a credit against future U.S. income tax liabilities, subject to certain limitations. We continue to record a full valuation allowance against our net deferred tax assets due to management's determination that the criteria for recognition have not been met. As a result, amounts related to foreign taxes withheld are reflected in tax expense for the six months ended June 30, 2011. Liquidity and Capital Resources General Our primary sources of liquidity are cash and cash equivalents and investments generated from our operating activities. In March 2011, we completed a public offering of 5,750,000 shares of common stock. The public offering price was $31.50 per share, and the net proceeds to the Company totaled approximately $175.2 million after deducting underwriting discounts and related offering expenses. We retained broad discretion over the use of the net proceeds from the offering and intend to use the net proceeds for operations and for other general corporate purposes, including, but not limited to, working capital, strategic acquisitions and other transactions. Our management believes that the cash and cash equivalent balances, investments, anticipated cash flow from operations, and other external sources of available credit, will be sufficient to meet our cash requirements through at least August 2012 and for the foreseeable future. We may, however, encounter unforeseen difficulties that may deplete our capital resources more rapidly than anticipated, including those set forth under the caption "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2010. Any efforts to seek additional funding could be made through issuances of equity or debt, or other external financing. However, additional funding may not be available on favorable terms, or at all. The capital and credit markets have experienced extreme volatility and disruption since late 2007, and the volatility and impact of the disruption has continued into 2011. At times during this period, the volatility and disruption has reached unprecedented levels. In several cases, the markets have exerted downward pressure on stock prices and credit capacity for certain issuers, and there can be no assurance that the commercial paper markets will be a reliable source of short-term financing for us. In August 2010, our wholly owned subsidiary became the general partner of the Acacia Intellectual Property Fund, L.P., or Acacia IP Fund, which was formed in August 2010. The Acacia IP Fund is authorized to raise up to $250 million. The 21 --------------------------------------------------------------------------------Acacia IP Fund acquires, licenses and enforces intellectual property consisting primarily of patents, patent rights, and patented technologies. Cash and Investments Our consolidated cash and cash equivalents and investments totaled $301.4 million at June 30, 2011, compared to $104.5 million at December 31, 2010. The net change in cash and cash equivalents for the periods presented was comprised of the following (in thousands): Six Months Ended June 30, 2011 2010 Net cash provided by (used in): Operating activities $ 25,119 $ 16,188 Investing activities (1,858 ) (2,307 ) Financing activities 173,639 1,885 Cash Flows from Operating Activities. Cash receipts from licensees for the six months ended June 30, 2011 increased to $88.6 million, from $55.8 million in the comparable 2010 period, primarily reflecting the net increase in revenues for the same periods, as discussed above. Cash outflows from operations for the six months ended June 30, 2011 increased to $63.5 million, as compared to $39.6 million in the comparable 2010 period, due to the net increase in cost of revenues and other operating expenses, as discussed above, and the impact of the timing of payments to inventors, attorneys and other vendors. Cash Flows from Investing Activities. Net cash used in investing activities for the six months ended June 30, 2011 included patent-related acquisition costs totaling $1.8 million, as compared to $2.3 million in the comparable 2010 period. Cash Flows from Financing Activities. Net cash provided by financing activities during the six months ended June 30, 2011 included net proceeds from the sale of common stock totaling $175.2 million, as described above. Net cash provided by financing activities during the six months ended June 30, 2011 also included proceeds from exercises of stock options totaling$404,000, as compared to $4,673,000 in the comparable 2010 period. Net cash provided by financing activities during the six months ended June 30, 2011 also included $877,000 in capital contributions to the Acacia IP Fund, offset by distributions to non-controlling interests totaling $2,897,000. Distributions to non-controlling interests totaled $2,788,000 for the six months ended June 30, 2010. Working Capital Working capital at June 30, 2011 increased to $291.4 million, compared to $92.3 at December 31, 2010. The primary components of working capital are cash and cash equivalents, accounts receivable, prepaid expenses, accounts payable, accrued expenses, and royalties and contingent legal fees payable. Refer to "Liquidity and Capital Resources - Cash and Investments" above for a discussion of the impact of activities related to cash and investments on working capital for the periods presented. Consolidated accounts receivable from licensees increased to $20.4 million at June 30, 2011, compared to $8.0 million at December 31, 2010. Accounts receivable balances fluctuate based on the timing, magnitude and payment terms associated with revenue agreements executed during the period, and the timing of cash receipts on accounts receivable balances recorded in previous periods. Consolidated royalties and contingent legal fees payable increased to $22.7 million at June 30, 2011, compared to $12.8 million at December 31, 2010. Royalties and contingent legal fees payable balances fluctuate based on the factors described above and the timing of payment of current and prior period royalties and contingent legal fees payable to inventors and outside attorneys, respectively. The majority of accounts receivable from licensees at June 30, 2011 were collected or scheduled to be collected in the third quarter of 2011, in accordance with the terms of the related underlying agreements. The majority of royalties and contingent legal fees payable are scheduled to be paid in the third quarter of 2011, upon receipt by us of the related fee payments from licensees, in accordance with the underlying contractual arrangements. Accounts payable and accrued expenses increased to $7.6 million at June 30, 2011, from $7.1 million at December 31, 2010, due primarily to the related timing of payments to attorneys and other vendors, and an increase in accrued variable 22 --------------------------------------------------------------------------------performance based compensation charges. Off-Balance Sheet Arrangements We have not entered into off-balance sheet financing arrangements, other than operating leases. We have no significant commitments for capital expenditures in 2011. We have no committed lines of credit or other committed funding or long-term debt. The following table lists our known contractual obligations and future cash commitments as of June 30, 2011: Payments Due by Period (In thousands) Less than 1 More than 5 Contractual Obligations Total year 1-3 years 3-5 years years Operating leases $ 3,572 $ 301 $ 1,497 $ 1,408 $ 366 Scheduled patent acquisition related payments 1,550 1,050 250 250 - Payments to consultants 500 350 150 - - Total contractual obligations $ 5,622 $ 1,701 $ 1,897 $ 1,658 $ 366 As of June 30, 2011, the liability for uncertain tax positions, associated primarily with state income taxes, was $86,000, none of which is expected to be paid within one year. The liability for uncertain tax positions is recorded in other long-term liabilities in our consolidated balance sheets included in this report. Recent Accounting Pronouncements Refer to Note 8 to the consolidated financial statements included in this report. |