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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, and/or where applicable, its management. 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 1,380 license agreements executed to date, across 173 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 June 30, 2014, we reported revenues of $50.1 million from 15 new revenue agreements covering 16 different licensing programs, including 4 licensing programs generating initial revenues in the quarter. Cash and investments totaled $220.8 million as of June 30, 2014 as compared to $256.7 million as of December 31, 2013. During the three months ended June 30, 2014, we invested in a new patent portfolio related to high speed digital display interface technology. During the three months ended June 30, 2014, we made patent related upfront advances and milestone payments to patent owners, with whom we partnered for the licensing of their patented technologies, totaling $21.1 million, which included payment of $16.3 million of patent related upfront advances and milestone payments accrued as of March 31, 2014 related to patent portfolio acquisitions prior to the second quarter of 2014. Operating activities during the periods presented included the following: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 Revenues (in thousands) $ 50,076 $ 23,110 $ 62,654 $ 99,971 New agreements executed 15 43 35 72 Licensing and enforcement programs generating revenues 16 28 31 40 Licensing and enforcement programs with initial revenues 4 3 7 14 New patent portfolios 1 7 4 16 Cumulative number of licensing and enforcement programs generating revenues - inception to date 173 157 173 157 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 June 30, 2014 $ 93,239 41 % March 31, 2014 $ 66,273 (49 )% December 31, 2013 $ 130,556 (28 )% September 30, 2013 $ 181,755 (10 )% June 30, 2013 $ 201,174 - % 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 six months ended June 30, 2014 included fees from the following technology licensing and enforcement programs: • 3G & 4G Wireless Patents technology • Online Auction Guarantee technology • 4G Wireless technology • Online Gaming technology • Audio Communications Fraud Detection • Online Newsletters with Links technology technology • • Radio Frequency Modulation Broadband Communications technology technology(1)(2) • • Reflective and Radiant Barrier Computer-Aided Design technology(1) Insulation technology • Core Fiber Optic Network • Architectures technology Semiconductor Packaging technology • DMT technology • Software Activation technology • Electronic Access Control • Speech codes used in wireless and technology(1) wireline systems technology(1)(2)• Gas Modulation Control Systems • Super Resolutions Microscopy technology technology(1) • Improved Lighting technology • Suture Anchors technology • Innovative Display technology(1)(2) • Telematics technology • Interstitial and Pop-Up Internet • Advertising technology Video Analytics for Security technology • • Wireless Data Synchronization & Data Location Based Services technology Transfer technology • • Wireless Location Based Services Messaging technology technology 15--------------------------------------------------------------------------------• Mobile Computer Synchronization • technology Wireless Monitoring technology • Multi-Display Content Delivery and Data Aggregation technology(1)(2) _________________________________________ (1) Initial revenues recognized during the six months ended June 30, 2014 (2) Initial revenues recognized during the three months ended June 30, 2014 Revenues for the six months ended June 30, 2013 included fees from the following technology licensing and enforcement programs: • • Interstitial and Pop-Up Internet 4G Wireless Handsets technology(1) Advertising technology • Audio Communications Fraud Detection • technology Lighting Ballast technology • Broadband Communications • technology(1)(2) Location Based Services technology • • Memory Circuit and Packaging Business Process Modeling technology technology(1) • Camera Support technology • Messaging technology • • Mobile Computer Synchronization Catheter Ablation technology(1)(2) technology • Computer Architecture and Power • Management technology NOR Flash technology • Digital Imaging technology(1) • Online Auction Guarantees technology • Digital Signal Processing Architecture • Online Gaming technology technology • DMT® technology • Power Management Within Integrated Circuits technology • Domain Name Redirection technology • Prescription Lens technology(1) • Electronic spreadsheet, data analysis • Semiconductor Memory and Process and software development technology(1) technology(1) • Enhanced Mobile Communications • Semiconductor Packaging technology technology(1)(2) • Facilities Operation Management System • technology Surgical Access technology • Gas Modulation Control Systems • Suture Anchors technology technology(1) • Greeting Card technology(1) • Telematics technology • Improved Memory Manufacturing • User Programmable Engine Control technology technology • • Video Analytics for Security Information Portal Software technology technology • Information Storage, Searching & • Wireless Data Synchronization & Data Retrieval technology Transfer technology(1) • • Wireless Location Based Services Intercarrier SMS technology(1) technology(1) __________________________________________ (1) Initial revenues recognized during the six months ended June 30, 2013 (2) Initial revenues recognized during the three months ended June 30, 2013 16--------------------------------------------------------------------------------Summary of Results of Operations - Overview For the Three and Six Months Ended June 30, 2014 and 2013 (In thousands, except percentage change values) Three Months Ended Six Months Ended June 30, % June 30, % 2014 2013 Change 2014 2013 Change Revenues $ 50,076 $ 23,110 117 % $ 62,654 $ 99,971 (37 )% Operating costs and expenses 58,307 46,040 27 % 96,936 115,806 (16 )% Operating loss (8,231 ) (22,930 ) (64 )% (34,282 ) (15,835 ) 116 % Loss before (provision for) benefit from income taxes (8,427 ) (22,530 ) (63 )% (34,369 ) (14,145 ) 143 % (Provision for) benefit from income taxes (4,689 ) 9,050 (152 )% (3,317 ) 5,778 (157 )% Net loss attributable to Acacia Research Corporation (12,949 ) (12,503 ) 4 % (37,370 ) (7,390 ) 406 % Overview - Three months ended June 30, 2014 compared with the three months ended June 30, 2013 • Revenues increased $27.0 million, or 117%, to $50.1 million, as compared to $23.1 million in the comparable prior year quarter, due primarily to an increase in the average revenue per agreement. • Loss before income taxes decreased 63%, to $8.4 million, as compared to $22.5 million in the comparable prior year quarter, due primarily to a 117% increase in revenues and 84% (ie. less than the 117% increase in related revenues) increase in inventor royalties and contingent legal fees, on a combined basis, which was partially offset by an increase in patent amortization expense. • Cost of Revenues and Other Operating Expenses: • Inventor royalties and contingent legal fees, on a combined basis, increased $8.1 million, or 84%, as compared to the 117%increase in related revenues for the same periods, due primarily to ahigher percentage of revenues generated during the three months ended June 30, 2014 having no inventor royalty or contingent legal fee obligations and lower overall average contingent legal fee rates, as compared to the revenues generated during the three months ended June 30, 2013. • Litigation and licensing expenses-patents increased $902,000, or 9%, to $10.8 million, due primarily to a net increase in litigation support and third-party technical consulting expensesassociated with ongoing and new licensing and enforcement programs commenced since the end of the comparable prior year quarter. • Amortization of patents increased $3.0 million, or 23%, to $15.5 million, due primarily to a net increase in acceleratedamortization related to patent portfolio sales and terminations totaling $1.7 million and an increase in quarterly amortization expense for patent portfolios acquired since the end of the prior year period totaling $1.2 million. • The effective tax rates for the three months ended June 30, 2014 and 2013 were 56% and (40)%, respectively. The effective rate for the second quarter of 2014 reflects the impact of foreign taxes withheld on certain revenue agreements executed with licensees domiciled in foreign jurisdictions and valuation allowances recorded for current period foreign withholding tax credits and net operating loss carryforward related tax assets generated during the three months ended June 30, 2014. The tax benefit recorded for the three months ended June 30, 2013 reflects the realization of foreign tax credit and net operating loss carryforward related tax assets generated during the period. Overview - Six months ended June 30, 2014 compared with the six months ended June 30, 2013 • Revenues decreased $37.3 million, or 37%, to $62.7 million, as compared to $100.0 million in the comparable prior year period, due primarily to a decrease in the total number of agreements executed. 17--------------------------------------------------------------------------------• Loss before income taxes increased 143%, to $34.4 million, as compared to $14.1 million in the comparable prior year period, due primarily to a 37% decrease in revenues and an increase in patent amortization expense, which was partially offset by a 53% (ie. greater than the 37% decrease in related revenues) decrease in inventor royalties and contingent legal fees, on a combined basis. • Cost of Revenues and Other Operating Expenses: • Inventor royalties and contingent legal fees, on a combined basis, decreased $22.9 million, or 53%, as compared to the 37%decrease in related revenues for the same periods, due primarily to a higher percentage of revenues generated during the six months ended June 30, 2014 having no inventor royalty obligations and lower overall average inventor royalty and contingent legal fee rates, as compared to the revenues generated during the six months ended June 30, 2013. • Litigation and licensing expenses-patents increased $248,000, or 1%, to $19.8 million, relatively consistent with the comparable prior year period. • Amortization of patents increased $5.7 million, or 23%, to $30.0 million, due primarily to accelerated amortization related to patent portfolio write-downs totaling $2.6 million, an increase in scheduled amortization expense for patent portfolios invested in since the end of the prior period totaling $1.8 million and a net increase in accelerated amortization related to patent portfolio sales and terminations totaling $1.7 million. • Marketing, general and administrative expenses decreased $2.2 million, or 8%, to $24.9 million, due primarily to a netdecrease in non-cash stock compensation charges, a decrease in variable performance-based compensation costs and a decrease in other corporate, general and administrative costs. • The effective tax rates for the six months ended June 30, 2014 and 2013 were 10% and (41%), respectively. The effective tax rate for the six months ended June 30, 2014 reflects the impact of foreign withholding taxes and valuation allowances recorded for the majority of tax assets generated during the period. The tax benefit recorded for the six months ended June 30, 2013 reflects the realization of foreign tax credit and net operating loss carryforward related tax assets generated during the period. 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 six months ended June 30, 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. • In April 2014, we partnered with a leading semiconductor company on patents related to high speed digital display interface technology used in industry standards such as DisplayPort and DisplayPort-related technologies and also MIPI DSI. • In June 2014, we announced that Renesas Electronics Corporation, a premier supplier of advanced semiconductor solutions, and Acacia agreed to a new phase in their strategic patent licensing alliance. Pursuant to this new agreement, we will receive broad and lengthy access to the worldwide patent portfolio of Renesas Electronics. Refer to "Liquidity and Capital Resources" below for information regarding the impact on the consolidated financial statements of upfront advances and milestone payments made in connection with patent partnering and investment activities during the periods presented. 18 -------------------------------------------------------------------------------- As of June 30, 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; • 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. Revision of Prior Period Earnings (Loss) Per Share - Two-Class Method. In connection with the preparation of our Quarterly Report on Form 10-Q as of and for the three months ended September 30, 2013, we determined that our basic and diluted net income (loss) per share calculations should have been prepared using the "two-class method." Under the two-class method, securities that participate in dividends are considered "participating securities." Our unvested restricted shares outstanding are considered "participating securities" because they include non-forfeitable rights to dividends. Pursuant to the guidance of Staff Accounting Bulletin ("SAB") No. 99, "Materiality," we concluded that the errors were not material to any of our prior period financial statements. Although the errors were immaterial to prior periods, the prior period financial statements presented herein were revised, in accordance with SAB No. 108, "Considering the Effects of Prior 19-------------------------------------------------------------------------------- |