Acacia Research Corporation — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Unless otherwise noted, amounts below are in U.S. dollars; financial statement amounts are in millions. Acacia invests in and licenses or enforces patent portfolios, and also invests in technology companies.
Financial results and position
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $19.5 | $1.7 | $25.4 | $10.6 |
| Operating loss | $(2.8) | $(5.1) | $(13.1) | $(16.0) |
| Net income (loss) attributable to Acacia | $38.3 | $(7.6) | $33.2 | $(17.7) |
| Basic / diluted EPS | $0.63 / $0.32 | $(0.15) / $(0.15) | $0.51 / $0.36 | $(0.36) / $(0.36) |
| Cash from operating activities | — | $5.5 | $(0.8) |
Q3 revenue rose 1,038% year over year; nine-month revenue rose 141%. Operating margins remained negative: approximately (14%) for Q3 and (52%) for the nine months. Net income was driven substantially by fair-value and investment-related gains, not operating profit: Q3 other income was $41.2 million and nine-month other income was $45.0 million. Those amounts included large, potentially reversible mark-to-market movements, including $84.5 million of Q3 gains on trading and private equity securities and a $20.7 million Q3 gain from revaluing Series A/B warrants and embedded derivatives. Nine-month results included a $99.4 million net gain on LF Fund securities, but a $46.6 million loss from revaluing the warrants and embedded derivative.
At September 30, cash and cash equivalents were $162.6 million; cash, cash equivalents and restricted cash totaled $197.6 million. Management reported $222.0 million of cash, cash equivalents, trading securities and restricted cash. Working capital was $227.7 million, up from $160.1 million at year-end 2019. Total assets were $426.5 million and total liabilities were $214.1 million. Current liabilities included $113.9 million of senior secured notes payable; royalties and contingent legal fees payable were $14.2 million.
Operating cash flow improved to $5.5 million from an outflow of $0.8 million. Investing activities used $9.8 million, including $13.8 million for patent acquisitions and $276.3 million of prepaid investment purchases, largely offset by trading-security maturities and sales. Financing provided $109.5 million, primarily from the notes issuance. The $35.0 million of long-term restricted cash relates to Series A preferred proceeds held in escrow.
Material changes and transactions
- Q3 revenue primarily reflected newly executed paid-up licensing agreements; paid-up revenue was $19.4 million versus $1.2 million a year earlier. Recurring revenue fell to $0.1 million from $0.5 million. For the nine months, paid-up revenue increased to $24.5 million while recurring revenue declined to $0.9 million from $4.5 million.
- Acacia acquired control of four patent portfolios in the first nine months, versus five in 2019. Nine-month general and administrative expenses rose 50% to $18.1 million, partly due to legal and business-development costs, including LF Fund transaction fees. Patent litigation and licensing expense fell 47% to $3.5 million.
- Acacia issued $115 million of senior notes in June at 6% interest, subsequently exchanged for notes issued by subsidiary Merton and guaranteed by Acacia. The notes were originally due to be redeemed by December 31, 2020; the initial and final redemption dates were later extended to November 9, 2020 and January 15, 2021, respectively. At September 30, the notes were classified as current, with $1.7 million of accrued unpaid interest.
- In February, Acacia issued Series B warrants for up to 100 million common shares. The warrants and the Series A warrants and preferred-stock embedded derivative are recorded as liabilities, with fair-value changes flowing through earnings. The large warrant pool and preferred securities create material potential dilution; actual diluted share calculations vary with the applicable accounting treatment and period.
- Acacia entered an agreement to acquire public and private company securities from LF Equity Income Fund for approximately £223.9 million (about $277.5 million at the transaction-date exchange rate), with the purchase price placed in escrow and securities transferring over time subject to conditions. The filing reports $42.9 million of prepaid investment at quarter-end. Q3 included substantial offsetting fair-value movements and a $2.8 million gain related to returned prepaid funds and a derivative sale.
Outlook, risks and contingencies
No quantitative revenue or earnings guidance is provided. Management said available cash and anticipated operating cash flows should meet cash requirements for at least 12 months from the filing date. Management also cautioned that licensing revenue is irregular and difficult to forecast because agreements, litigation outcomes, trial schedules and portfolio intake vary; one patent infringement case had a trial scheduled within the next 12 months.
- Revenue concentration is significant: one licensee generated 98% of Q3 2020 revenue. Four licensees generated 75%, 9%, 8% and 4% of nine-month revenue.
- Investment values and reported earnings are exposed to market volatility and valuation assumptions. Private securities and derivative valuations involve judgment; fair-value changes may reverse.
- Patent enforcement carries litigation, appeal, legal-cost, adverse-ruling and potential sanctions risks. The company disclosed a Delaware lawsuit by Slingshot Technologies alleging misuse of confidential information in a patent acquisition; Acacia disputes the allegations. Contingency accruals were $1.4 million at quarter-end.
- COVID-19 was not expected by management to present direct business risks at the time, but the filing warns that pandemic-related effects could evolve and harm the company or its partners.
- Series A preferred stock carries redemption rights, a liquidation preference and cumulative dividends. Its dividend rate may increase under specified circumstances; the notes and securities also contain covenants and change-of-control provisions.
Key facts for investors to verify
- Whether the senior notes were redeemed by the extended January 15, 2021 deadline, and the resulting cash, interest and covenant position.
- How much of the LF Fund portfolio transferred, the remaining escrow or purchase obligations, and the basis and sustainability of the large fair-value gains.
- Whether Q3 revenue concentration persists and whether newly executed licenses produce repeatable cash receipts.
- The potential dilution and economic terms of the 100 million Series B warrants, Series A warrants and Series A preferred stock.
- Developments in the Slingshot litigation and other patent enforcement proceedings, including any material sanctions, settlements or changes in accrued contingencies.