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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 Regarding Forward Looking Statements 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, 2013, filed with the SEC on March 3, 2014. 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 our ability to invest in new technologies and patents, future global 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, 2013. 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 invest in, license and enforce patented technologies. Our operating subsidiaries partner with inventors and patent owners, applying our legal and technology expertise to patent assets to unlock the financial value in their patented inventions. We are an intermediary in the patent marketplace, bridging the gap between invention and application, facilitating efficiency and delivering monetary rewards to patent owners. Our operating subsidiaries generate revenues and related cash flows from the granting of patent rights for the use of patented technologies that our operating subsidiaries control or own. 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 licensing revenue from users of their patented technologies and, where necessary, with the enforcement against unauthorized users of their patented technologies through the filing of patent infringement litigation. We are a leader in licensing patented technologies and have established a proven track record of licensing success with over 1,365 license agreements executed to date, across 169 of our patent licensing and enforcement programs. Currently, on a 13 -------------------------------------------------------------------------------- consolidated basis, our operating subsidiaries own or control the rights to over 200 patent portfolios, which include U.S. patents and certain foreign counterparts, covering technologies used in a wide variety of industries. Executive Summary During the periods presented, we continued our business of empowering patent owners and rewarding invention by providing a path to patent monetization for the people and companies who have contributed valuable patented inventions to an industry, but who require a professional, experienced independent third-party licensing partner to get rewarded for those inventions. Our operating activities for the periods presented were principally focused on the continued investment in and development of our patent licensing and enforcement business, including the continued pursuit of our ongoing patent licensing and enforcement programs and the commencement of new patent licensing and enforcement programs. In addition, we continued our focus on business development, including the acquisition of several additional high quality patent portfolios by certain of our operating subsidiaries and the continued pursuit of additional opportunities to partner with patent owners or invest in patent portfolios, and continue our industry leading patent licensing and enforcement activities. For the three months ended March 31, 2014, we reported revenues of $12.6 million from 20 new revenue agreements covering 21 different licensing programs, including 3 licensing programs generating initial revenues in the quarter. Cash and investments totaled $229.0 million as of March 31, 2014 as compared to $256.7 million as of December 31, 2013. During the three months ended March 31, 2014, we invested in 3 new patent portfolios, incurring $16.2 million (including $15.3 million in future payments accrued as of March 31, 2014) of patent portfolio related up-front advances / payments to patent owners with whom we partnered for the licensing of their patented technologies. Operating activities during the periods presented included the following: Three Months Ended March 31, 2014 2013 Revenues (in thousands) $ 12,578 $ 76,861 New agreements executed 20 29 Licensing and enforcement programs generating revenues 21 31 Licensing and enforcement programs with initial revenues 3 11 New patent portfolios 3 9 Cumulative number of licensing and enforcement programs generating revenues - inception to date 169 154 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 during the periods presented were as follows (in thousands, except percentage change values): As of Date: Trailing Twelve -Month Revenues % Change March 31, 2014 $ 66,273 (49 )% December 31, 2013 $ 130,556 (28 )% September 30, 2013 $ 181,755 (10 )% June 30, 2013 $ 201,174 (12 )% March 31, 2013 $ 228,548 - % 14-------------------------------------------------------------------------------- Our revenues historically have fluctuated quarterly, and can vary significantly, based on a number of factors including the following: • 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 each period; • the timing, results and uncertainties associated with patent licensing negotiations, mediations, patent infringement actions, trial dates and other enforcement proceedings relating to our patent licensing and enforcement programs; • the relative maturity of licensing programs during the applicable periods; and • other external factors, including the periodic status or results of ongoing negotiations, the status of ongoing litigations, actual or perceived shifts in the regulatory environment, impact of unrelated patent related judicial proceedings and other macroeconomic factors. Management does not attempt to manage for smooth sequential periodic growth in revenues period to period, and therefore, periodic results can be uneven. Unlike most operating businesses and industries, licensing revenues not generated in a current period are not necessarily foregone but, most likely, depending on whether negotiations, litigation or both continue into subsequent periods, and depending on a number of other factors, such potential revenues may be pushed into subsequent fiscal periods. 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 Going forward, we have strategically chosen to shift the focus of our operating business to increasingly serve a smaller number of customers each having higher quality patent portfolios. High quality patent portfolios are typically associated with higher numbers of varied defensible claims, higher revenue potential, originating from high-pedigreed patent owners and/or possessing a relatively large number of prospective licensees. In this regard, in 2014, we have continued the shift in our focus at our point of patent intake from quantity to quality. We continue to identify and assess additional opportunities to partner with companies in the technology, energy, medical technology and other sectors for the licensing and enforcement of their high quality patented technologies, and are also expanding our activity in international markets, both of which we expect will expand and diversify our future revenue generating opportunities. Revenues for the three months ended March 31, 2014 included fees from the following technology licensing and enforcement programs: • 3G & 4G Wireless Patents • Messaging technology • 4G Wireless technology • Online Gaming technology • Audio Communications Fraud Detection • Reflective and Radiant Barrier technology Insulation technology • Broadband Communications technology • Semiconductor Packaging technology • Computer-Aided Design technology(1) • Software Activation technology • Core Fiber Optic Network • Super Resolutions Microscopy Architectures technology technology(1) • DMT technology • Suture Anchors technology • Electronic Access Control • Telematics technology technology(1)• Gas Modulation Control Systems • technology Video Analytics for Security technology • Improved Lighting technology • Wireless Monitoring technology • Interstitial and Pop-Up Internet Advertising technology __________________________________________ (1) Initial revenues recognized during the three months ended March 31, 2014 15-------------------------------------------------------------------------------- Revenues for the three months ended March 31, 2013 included fees from the following technology licensing and enforcement programs: • • Memory Circuit and Packaging 4G Wireless Handsets technology(1) technology(1) • Audio Communications Fraud Detection • technology Messaging technology • • Mobile Computer Synchronization Camera Support technology technology • Computer Architecture and Power • Management technology NOR Flash technology • Digital Imaging technology(1) • Online Auction Guarantee technology • Digital Signal Processing Architecture • technology Online Gaming technology • • Pop-up Internet Advertising DMT® technology technology • Domain Name Redirection technology • Power Management Within Integrated Circuits technology • Electronic spreadsheet, data analysis • Prescription Lens technology(1) and software development technology(1) • Enhanced Mobile Communications • Semiconductor Memory and Process technology technology(1) • Facilities Operation Management System • technology Surgical Access technology • Gas Modulation Control Systems • technology(1) Suture Anchors technology • Greeting Card technology(1) • Telematics technology • Improved Memory Manufacturing • Wireless Data Synchronization & Data technology Transfer technology(1) • Intercarrier SMS technology(1) • Wireless Location Based Services technology(1) • Location Based Services technology __________________________________________ (1) Initial revenues recognized during the three months ended March 31, 2013 Summary of Results of Operations - Overview For the Three Months Ended March 31, 2014 and 2013 (In thousands, except percentage change values) Three Months Ended March 31, % 2014 2013 Change Revenues $ 12,578 $ 76,861 (84 )% Operating costs and expenses 38,629 69,766 (45 )% Operating income (loss) (26,051 ) 7,095 (467 )% Benefit from (provision for) income taxes 1,372 (3,272 ) (142 )% Net income (loss) attributable to Acacia Research Corporation (24,421 ) 5,113 (578 )% Overview - Three months ended March 31, 2014 compared with the three months ended March 31, 2013 • Revenues decreased $64.3 million, or 84%, to $12.6 million, as compared to $76.9 million in the comparable prior year quarter, due primarily to a decrease in the average revenue per executed agreement and a decrease in the total number of agreements executed. • Cost of Revenues and Other Operating Expenses: • Inventor royalties and contingent legal fees, on a combined basis, decreased $31.0 million, or 93%, as compared to the 84% decrease in related revenues for the same periods, due primarily to a higher percentage of revenues generated during the three months ended March 31, 2014 having, on average, no inventor royalty or contingent legal fee obligations and lower overall average inventor royalty rates, as compared to the revenues generated during the three months ended March 31, 2013. 16-------------------------------------------------------------------------------- • Litigation and licensing expenses-patents decreased $654,000, or 7%, to $9.0 million, due primarily to a net decrease in litigation costs, which were partially offset by an increase in strategic and other patent related prosecution costs associated with ongoing and new licensing and enforcement programs commenced since the end of the comparable prior year quarter. • Amortization of patents increased $2.7 million, or 23%, to $14.5 million, due primarily to an increase in scheduled amortization expense for patent portfolios invested in since the end of the prior period totaling $981,000 and accelerated amortization related to patent portfolio write-downs totaling $2,565,000. The increase was partially offset by a decrease in accelerated patent amortization related to the recoupment of upfront advances to partners of $435,000 and other scheduled amortization totaling $369,000. • Marketing, general and administrative expenses decreased $2.2 million, or 16%, to $11.7 million, due primarily to a decrease in variable performance-based compensation costs and a decrease in other corporate, general and administrative costs. • The effective tax rates were 5% and (39%) for the three months ended March 31, 2014 and 2013, respectively. The effective rate for the first quarter of 2014 reflects the impact of an increase in the valuation allowance recorded for certain tax assets generated during the three months ended March 31, 2014. 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 patent portfolio partnering / intake opportunities closed by our operating subsidiaries on a consolidated basis during the applicable reporting periods. During the three months ended March 31, 2014, patent portfolio intake activities included the following: • In February 2014, we partnered with a leading research institute to monetize the institute's patents relating to ceramics and associated manufacturing processes for medical devices. • In March 2014, we invested in U.S. patents and foreign counterparts related to the use of shared memory in multimedia processing systems such as mobile phones, tablets and other consumer electronic devices. Refer to "Liquidity and Capital Resources" below for information regarding the impact on the consolidated financial statements of upfront advances in connection with patent partnering and investment arrangements entered into during the periods presented. As of March 31, 2014, certain of our operating subsidiaries had several patent partnering option agreements with third-party patent portfolio owners regarding potential additional patent portfolio partnering / investment opportunities. Future patent portfolio intake arrangements will continue to expand and diversify our future revenue generating opportunities. Our operating subsidiaries are principals in the licensing and enforcement effort, obtaining control of the rights in the patent portfolio, or control of the patent portfolio outright. Patent Licensing and Enforcement We expect patent-related legal expenses to continue to fluctuate from period to period based on the factors summarized herein, in connection with future trial dates, international enforcement, strategic patent portfolio prosecution and our current and future patent acquisition, prosecution, licensing and enforcement activities. 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 associated with patent infringement litigation, 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, re-exam and inter partes review costs, case-related audio/video presentations and other litigation support and administrative costs could increase our operating costs and decrease our profit 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; 17-------------------------------------------------------------------------------- • New legislation, regulations or rules related to enforcement actions, including any fee or cost shifting provisions, could significantly increase our operating costs and decrease our profit generating opportunities. Increased focus on the growing number of patent-related lawsuits may result in legislative changes which increase our costs and related risks of asserting patent enforcement actions. For instance, the United States House of Representatives passed a bill that would require non-practicing entities that bring patent infringement lawsuits to pay legal costs of the defendants, if the lawsuits are unsuccessful and certain standards are not met; • 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; and • The complexity of negotiations and potential magnitude of exposure for potential infringers associated with higher quality patent portfolios may lead to increased intervals of time between the filing of litigation and potential revenue events (i.e. markman dates, trial dates), which may lead to increased legal expenses, consistent with the higher revenue potential of such portfolios. 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, 2013. Refer to Note 2 to the consolidated financial statements included in this report. |