NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Description of Business
As used herein, “we,” “us,” “our,”
“Acacia” and the “Company” refer to Acacia Research Corporation and/or its wholly and majority-owned and
controlled operating subsidiaries, and/or where applicable, its management.
Acacia was incorporated on January 25, 1993 under the laws of
the State of California. In December 1999, Acacia changed its state of incorporation from California to Delaware.
Acacia’s operating subsidiaries invest in, license and
enforce patented technologies. Acacia’s operating subsidiaries partner with inventors and patent owners, applying their legal
and technology expertise to patent assets to unlock the financial value in their patented inventions. In recent years, Acacia has
also invested in technology companies. Acacia leverages its experience, expertise, data and relationships developed as a leader
in the intellectual property (“IP”) industry to pursue these opportunities. In some cases, these opportunities will
complement, and/or supplement Acacia’s primary licensing and enforcement business.
Acacia’s operating subsidiaries generate revenues and
related cash flows from the granting of IP rights (hereinafter “IP Rights”) for the use of patented technologies that
its operating subsidiaries control or own. Acacia’s 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.
Acacia’s 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.
Acacia’s operating subsidiaries own or control the rights to multiple patent portfolios, which include U.S. patents and certain
foreign counterparts, covering technologies used in a wide variety of industries.
Neither Acacia nor its operating subsidiaries invent new technologies
or products; rather, Acacia depends upon the identification and investment in new patents, inventions and companies that own IP
through its relationships with inventors, universities, research institutions, technology companies and others. If Acacia’s
operating subsidiaries are unable to maintain those relationships and identify and grow new relationships, then they may not be
able to identify new technology-based opportunities for sustainable revenue and/or revenue growth.
During the six months ended June 30, 2020, Acacia obtained control
of four new patent portfolios. During fiscal year 2019, Acacia obtained control of five new patent portfolios.
Basis of Presentation
The accompanying unaudited condensed consolidated financial
statements include the accounts of Acacia and its wholly and majority-owned and controlled subsidiaries. Material intercompany
transactions and balances have been eliminated in consolidation.
The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S.
GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly,
certain information and footnotes required by U.S. GAAP in annual financial statements have been omitted or condensed in accordance
with quarterly reporting requirements of the Securities and Exchange Commission (“SEC”). These interim unaudited condensed
consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for
the year ended December 31, 2019, as reported by Acacia in its Annual Report on Form 10-K filed with the SEC on March 16, 2020,
as well as in our other public filings with the SEC. The condensed consolidated interim financial statements of Acacia include
all adjustments of a normal recurring nature which, in the opinion of management, are necessary for a fair statement of Acacia’s
consolidated financial position as of June 30, 2020, and results of its operations and its cash flows for the interim periods presented.
The consolidated results of operations for the three and six months ended June 30, 2020 are not necessarily indicative of the results
to be expected for the entire fiscal year.
Use of Estimates
The preparation of financial
statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amount
of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial
statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from
these estimates. Acacia believes that, of the significant accounting policies described herein, the accounting policies
associated with revenue recognition, the valuation of the equity instruments, the valuation of Series A redeemable
convertible preferred stock (the “Series A Redeemable Convertible Preferred Stock”) embedded derivatives, Series
A warrants (the “Series A Warrants”), Series B warrants (the “Series B Warrants”), equity securities
derivative and forward contract, stock-based compensation expense, impairment of patent related intangible assets, the
determination of the economic useful life of amortizable intangible assets, income taxes and valuation allowances against net
deferred tax assets, require its most difficult, subjective or complex judgments.
Reclassifications
Certain reclassifications have been made to the prior fiscal
year financial information to conform with the current fiscal year presentation. Such reclassifications had no impact on net income
or cash flows.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Revenue is recognized upon transfer of control of promised bundled
IP Rights and other contractual performance obligations to licensees in an amount that reflects the consideration we expect to
receive in exchange for those IP Rights. Revenue contracts that provide promises to grant the right to use IP Rights as they exist
at the point in time at which the IP Rights are granted, are accounted for as performance obligations satisfied at a point in time
and revenue is recognized at the point in time that the applicable performance obligations are satisfied and all other revenue
recognition criteria have been met.
For the periods presented, revenue contracts executed by the
Company primarily provided for the payment of contractually determined, one-time, paid-up license fees in consideration for the
grant of certain IP Rights for patented technologies owned or controlled by Acacia. Revenues also included license fees from sales-based
revenue contracts, the majority of which were originally executed in prior periods, that provide for the payment of quarterly license
fees based on quarterly sales of applicable product units by licensees (“Recurring Revenue Agreements”). Revenues may
also include court ordered settlements or awards related to our patent portfolio. IP Rights granted included the following, as
applicable: (i) the grant of a non-exclusive, retroactive and future license to manufacture and/or sell products covered by patented
technologies, (ii) a covenant-not-to-sue, (iii) the release of the licensee from certain claims, and (iv) the dismissal of any
pending litigation. The IP Rights granted were perpetual in nature, extending until the legal expiration date of the related patents.
The individual IP Rights are not accounted for as separate performance obligations, as (i) the nature of the promise, within the
context of the contract, is to transfer combined items to which the promised IP Rights are inputs and (ii) the Company's promise
to transfer each individual IP right described above to the customer is not separately identifiable from other promises to transfer
IP Rights in the contract.
Since the promised IP Rights are not individually distinct,
the Company combines each individual IP Right in the contract into a bundle of IP rights that is distinct and accounts for all
of the IP Rights promised in the contract as a single performance obligation. The IP Rights granted generally are “functional
IP rights” that have significant standalone functionality. Acacia's subsequent activities do not substantively change that
functionality and do not significantly affect the utility of the IP to which the licensee has rights. Acacia’s operating
subsidiaries have no further obligation with respect to the grant of IP Rights, including no express or implied obligation to maintain
or upgrade the technology, or provide future support or services. The contracts provide for the grant (i.e., transfer of control)
of the licenses, covenants-not-to-sue, releases, and other significant deliverables upon execution of the contract. Licensees legally
obtain control of the IP Rights upon execution of the contract. As such, the earnings process is complete and revenue is recognized
upon the execution of the contract, when collectability is probable and all other revenue recognition criteria have been met. Revenue
contracts generally provide for payment of contractual amounts within 30-90 days of execution of the contract, or the end of the
quarter in which the sale or usage occurs for Recurring Revenue Agreements. Contractual payments made by licensees are generally
non-refundable.
For sales-based royalties, the Company includes in the transaction
price some or all of an amount of estimated variable consideration to the extent that it is probable that a significant reversal
in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is
subsequently resolved. Notwithstanding, revenue is recognized for a sales-based royalty promised in exchange for a license of IP
Rights when the later of (i) the subsequent sale or usage occurs, or (ii) the performance obligation to which some or all of the
sales-based royalty has been allocated has been satisfied. Estimates are generally based on historical levels of activity, if available.
Revenues from contracts with significant financing components
(either explicit or implicit) are recognized at an amount that reflects the price that a licensee would have paid if the licensee
had paid cash for the IP Rights when they transfer to the licensee. In determining the transaction price, the Company adjusts the
promised amount of consideration for the effects of the time value of money. As a practical expedient, the Company does not adjust
the promised amount of consideration for the effects of a significant financing component if the Company expects, at contract inception,
that the period between when the entity transfers promised IP Rights to a customer and when the customer pays for the IP Rights
will be one year or less.
In general, the Company is required to make certain judgments
and estimates in connection with the accounting for revenue contracts with customers. Such areas may include identifying performance
obligations in the contract, estimating the timing of satisfaction of performance obligations, determining whether a promise to
grant a license is distinct from other promised goods or services, evaluating whether a license transfers to a customer at a point
in time or over time, allocating the transaction price to separate performance obligations, determining whether contracts contain
a significant financing component, and estimating revenues recognized at a point in time for sales-based royalties.
Revenues were composed of the following for the periods presented:
Disaggregation of revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
|
|
(In thousands)
|
|
Paid-up Revenue Agreements
|
|
$
|
1,792
|
|
|
$
|
4,864
|
|
|
$
|
5,092
|
|
|
$
|
4,864
|
|
Recurring Revenue Agreements
|
|
|
326
|
|
|
|
596
|
|
|
|
841
|
|
|
|
3,983
|
|
Total Revenue
|
|
$
|
2,118
|
|
|
$
|
5,460
|
|
|
$
|
5,933
|
|
|
$
|
8,847
|
|
Refer to “Inventor Royalties and Contingent Legal Expenses”
below for information on related direct costs of revenues.
Portfolio Operations
Cost of revenues include the costs and expenses incurred in
connection with Acacia’s patent licensing and enforcement activities, including inventor royalties paid to patent owners,
contingent legal fees paid to external patent counsel, other patent-related legal expenses paid to external patent counsel, licensing
and enforcement related research, consulting and other expenses paid to third-parties and the amortization of patent-related investment
costs. These costs are included under the caption “Portfolio operations” in the accompanying condensed consolidated
statements of operations.
Inventor Royalties and Contingent Legal Expenses
Inventor royalties are expensed in the condensed consolidated
statements of operations in the period that the related revenues are recognized. In certain instances, pursuant to the terms of
the underlying inventor agreements, upfront advances paid to patent owners by Acacia’s operating subsidiaries are recoverable
from future net revenues. Patent costs that are recoverable from future net revenues are amortized over the estimated economic
useful life of the related patents, or as the prepaid royalties are earned by the inventor, as appropriate, and the related expense
is included in amortization expense in the condensed consolidated statements of operations. Any unamortized upfront advances recovered
from net revenues are expensed in the period recovered and included in amortization expense in the condensed consolidated statements
of operations.
Contingent legal fees are expensed in the condensed consolidated
statements of operations in the period that the related revenues are recognized. In instances where there are no recoveries from
potential infringers, no contingent legal fees are paid; however, Acacia’s operating subsidiaries may be liable for certain
out of pocket legal costs incurred pursuant to the underlying legal services agreement.
Inventor royalty and contingent legal agreements typically provide
for payment by the Company of contractual amounts 30 days subsequent to the fiscal quarter end during which related license fee
payments are received from licensees by the Company.
Concentration of credit risks
Financial instruments that potentially subject Acacia to concentrations
of credit risk are cash equivalents, trading securities and accounts receivable. Acacia places its cash equivalents and trading
securities primarily in highly rated money market funds and investment grade marketable securities. Cash and cash equivalents are
also invested in deposits with certain financial institutions and may, at times, exceed federally insured limits. Acacia has not
experienced any significant losses on its deposits of cash and cash equivalents.
Three licensees accounted for 46%, 38% and 12% of revenues recognized
during the three months ended June 30, 2020, and four licensees accounted for 35%, 34%, 17% and 10% of revenues recognized during
the six months ended June 30, 2020. One licensee individually accounted for 89% of revenues recognized during the three months
ended June 30, 2019, and two licensees accounted for 55% and 27% of revenues recognized during the six months ended June 30, 2019.
The Company does not have any
material foreign operations. Based on the jurisdiction of the entity obligated to satisfy payment obligations pursuant to the
applicable revenue arrangement, for the three and six months ended June 30, 2020, 49%
and 21%,
respectively, of revenues were attributable to licensees domiciled in foreign jurisdictions. For the three and six months
ended June 30, 2019, 3%
and 32%,
respectively, of revenues were attributable to licensees domiciled in foreign jurisdictions. Three licensees
individually represented approximately 70%, 22%,
and 5%
of accounts receivable at June 30, 2020. Two licensees individually represented approximately 70%
and 17%
of accounts receivable at December 31, 2019.
Patents
Patents include the cost of patents or patent rights (hereinafter,
collectively “patents”) acquired from third-parties or obtained in connection with business combinations. Patent costs
are amortized utilizing the straight-line method over their remaining economic useful lives. Refer to Note 4 for additional information
regarding our patents.
Impairment of Long-lived Assets
Acacia reviews long-lived assets and intangible assets for potential
impairment annually (quarterly for patents) and when events or changes in circumstances indicate the carrying amount of an asset
may not be recoverable. In the event the expected undiscounted future cash flows resulting from the use of the asset is less than
the carrying amount of the asset, an impairment loss is recorded in an amount equal to the excess of the asset’s carrying
value over its fair value. If an asset is determined to be impaired, the loss is measured based on quoted market prices in active
markets, if available. If quoted market prices are not available, the estimate of fair value is based on various valuation techniques,
including a discounted value of estimated future cash flows. In the event that management decides to no longer allocate resources
to a patent portfolio, an impairment loss equal to the remaining carrying value of the asset is recorded. Refer to Note 4 for additional
information.
Fair value is generally estimated using the “Income Approach,”
focusing on the estimated future net income-producing capability of the patent portfolios over their estimated remaining economic
useful life. Estimates of future after-tax cash flows are converted to present value through “discounting,” including
an estimated rate of return that accounts for both the time value of money and investment risk factors. Estimated cash inflows
are typically based on estimates of reasonable royalty rates for the applicable technology, applied to estimated market data. Estimated
cash outflows are based on existing contractual obligations, such as contingent legal fee and inventor royalty obligations, applied
to estimated license fee revenues, in addition to other estimates of out-of-pocket expenses associated with a specific patent portfolio’s
licensing and enforcement program. The analysis also contemplates consideration of current information about the patent portfolio
including, status and stage of litigation, periodic results of the litigation process, strength of the patent portfolio, technology
coverage and other pertinent information that could impact future net cash flows.
Cash and Cash Equivalents
Acacia considers all highly liquid, trading securities with
original maturities of three months or less when purchased to be cash equivalents. For the periods presented, Acacia’s cash
equivalents are comprised of investments in AAA rated money market funds that invest in first-tier only securities, which primarily
includes: domestic commercial paper, securities issued or guaranteed by the U.S. government or its agencies, U.S. bank obligations,
and fully collateralized repurchase agreements. Acacia’s cash equivalents are measured at fair value using quoted prices
that represent Level 1 inputs.
Long Term Restricted Cash
Long-term restricted cash relates to the proceeds received from
the issuance of Series A Redeemable Convertible Preferred Stock which are held in an escrow account. The amounts are to be released
to the Company upon, among other things, (i) the consummation of a suitable investment or acquisition by the Company or (ii) the
conversion of Series A Redeemable Convertible Preferred Stock into common stock.
Prepaid Investment
Prepaid investment relates to the cash transferred to an escrow
account in connection with a Transaction Agreement with LF Equity Income Fund (“Seller”), pursuant to which the Company
will purchase from Seller certain equity securities. Refer to Note 14 for additional information on the Transaction Agreement.
The amounts are to be released to the Seller upon transfer of the specified equity securities at set prices at various future dates
following various terms and conditions per the Transaction Agreement.
Equity
Securities Derivative and Forward Contract
The equity security forward contract includes
both private and public equity securities not yet transferred, as of June 30, 2020, under the Company’s Transaction Agreement
with Seller. Refer to Note 14 for additional information on the agreement. The public company equity security forward contracts
are accounted for as derivatives and are carried at fair market value with changes in fair market value recorded in the condensed
consolidated statements of operations in other income (expense). The private company equity security forward contracts do not meet
the definition of a derivative as the underlying equity securities are not readily convertible to cash. Therefore, as the forward
contracts do not have readily determinable fair value, these forward contracts are reported at cost minus impairment, if any, plus
or minus changes resulting from observable price changes in orderly transactions involving securities similar to those underlying
the forward contract. Changes in fair market value are reported in the condensed consolidated statements of operations in other
income (expense).
Trading Securities- Debt
Investments in debt securities are reported at fair value on
a recurring basis, with related realized and unrealized gains and losses recorded in the condensed consolidated statements of operations
in other income (expense). Realized and unrealized gains and losses are recorded based on the specific identification method. Interest
is included in the condensed consolidated statements of operations in other income (expense). Accrued interest is included in the
trading securities balance on the condensed consolidated balance sheets.
Trading Securities - Equity
Investments in equity securities are reported at fair value
on a recurring basis, with related realized and unrealized gains and losses in the value of such securities recorded in the condensed
consolidated statements of operations in other income (expense). Dividend income is included in the condensed consolidated statements
of operations in other income (expense).
Trading securities for the periods presented were comprised
of the following:
Gain (loss) on trading securities
|
|
Cost
|
|
|
Gross
Unrealized
Gain
|
|
|
Gross
Unrealized
Loss
|
|
|
Fair Value
|
|
|
|
(In thousands)
|
|
Security Type
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2020:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trading securities - equity
|
|
|
22,539
|
|
|
|
1,914
|
|
|
|
(4,756
|
)
|
|
|
19,697
|
|
|
|
$
|
22,539
|
|
|
$
|
1,914
|
|
|
$
|
(4,756
|
)
|
|
$
|
19,697
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trading securities - debt
|
|
$
|
93,712
|
|
|
$
|
143
|
|
|
$
|
(12
|
)
|
|
$
|
93,843
|
|
Trading securities - equity
|
|
|
17,674
|
|
|
|
211
|
|
|
|
(745
|
)
|
|
|
17,140
|
|
|
|
$
|
111,386
|
|
|
$
|
354
|
|
|
$
|
(757
|
)
|
|
$
|
110,983
|
|
Fair Value Measurements
U.S. GAAP defines fair value as the price that would be received
for an asset or the exit price that would be paid to transfer a liability in the principal or most advantageous market in an orderly
transaction between market participants on the measurement date, and also establishes a fair value hierarchy which requires an
entity to maximize the use of observable inputs, where available. The three-level hierarchy of valuation techniques established
to measure fair value is defined as follows:
(i) Level
1 – Observable Inputs: Quoted prices in active markets for identical investments;
(ii) Level
2 – Pricing Models with Significant Observable Inputs: Other significant observable inputs, including quoted
prices for similar investments, interest rates, credit risk, etc.; and
(iii) Level
3 – Unobservable Inputs: Significant unobservable inputs, including the entity’s own assumptions
in determining the fair value of investments.
Whenever possible, the Company is required
to use observable market inputs (Level 1 – quoted market prices) when measuring fair value. In such cases, the level at which
the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement.
The assessment of the significance of a particular input requires judgment and considers factors specific to the asset or liability
being measured. In certain cases, inputs used to measure fair value fall into different levels of the fair value hierarchy. Financial
assets and liabilities measured at fair value on a recurring basis were as follows:
Schedule of fair value of financial assets and liabilities on a recurring basis
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
|
(In thousands)
|
|
Assets as of June 30, 2020:
|
|
|
|
|
|
|
|
|
|
|
|
|
Trading securities - equity
|
|
$
|
19,697
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Equity securities derivative
|
|
|
7,369
|
|
|
|
–
|
|
|
|
–
|
|
Investment at fair value - warrants (Note 5)
|
|
|
–
|
|
|
|
4,063
|
|
|
|
–
|
|
Total recurring fair value measurements as of June 30, 2020
|
|
$
|
27,066
|
|
|
$
|
4,063
|
|
|
$
|
–
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets as of December 31, 2019:
|
|
|
|
|
|
|
|
|
|
|
|
|
Trading securities - debt
|
|
$
|
–
|
|
|
$
|
93,843
|
|
|
$
|
–
|
|
Trading securities - equity
|
|
|
17,140
|
|
|
|
–
|
|
|
|
–
|
|
Investment at fair value - warrants (Note 5)
|
|
|
–
|
|
|
|
757
|
|
|
|
–
|
|
Investment at fair value - common stock (Note 5)
|
|
|
743
|
|
|
|
–
|
|
|
|
–
|
|
Total recurring fair value measurements as of December 31, 2019
|
|
$
|
17,883
|
|
|
$
|
94,600
|
|
|
$
|
–
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities as of June 30, 2020:
|
|
|
|
|
|
|
|
|
|
|
|
|
Series A warrants
|
|
$
|
–
|
|
|
$
|
6,952
|
|
|
$
|
–
|
|
Series B warrants
|
|
|
–
|
|
|
|
–
|
|
|
|
58,290
|
|
Embedded derivative liability
|
|
|
–
|
|
|
|
–
|
|
|
|
29,513
|
|
Total liabilities as of June 30, 2020
|
|
$
|
–
|
|
|
$
|
6,952
|
|
|
$
|
87,803
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities as of December 31, 2019:
|
|
|
|
|
|
|
|
|
|
|
|
|
Series A warrants
|
|
$
|
–
|
|
|
$
|
3,568
|
|
|
$
|
–
|
|
Embedded derivative liability
|
|
|
–
|
|
|
|
–
|
|
|
|
17,974
|
|
Total liabilities as of December 31, 2019
|
|
$
|
–
|
|
|
$
|
3,568
|
|
|
$
|
17,974
|
|
The following table sets forth a summary of the changes in the
estimated fair value of the Company’s Level 3 liabilities, which are measured at fair value as a on a recurring basis:
Summary of changes in financial liability Level 3
|
|
Series A Preferred Stock Embedded Derivative Liability
|
|
|
Series B Warrants Liability
|
|
|
|
(In thousands)
|
|
Opening balance as of December 31, 2019
|
|
$
|
17,974
|
|
|
$
|
–
|
|
Issuance of Series B warrants
|
|
|
–
|
|
|
|
4,600
|
|
Remeasurement to fair value
|
|
|
11,539
|
|
|
|
53,690
|
|
Balance as of June 30, 2020
|
|
$
|
29,513
|
|
|
$
|
58,290
|
|
Investments at Fair Value
On an individual investment basis,
Acacia may elect to account for investments in companies where the Company has the ability to exercise significant influence
over operating and financial policies of the investee, at fair value. If the fair value method is applied to an investment
that would otherwise be accounted for under the equity method of accounting, it is applied to all of the financial interests
in the same entity that are eligible items (i.e., common stock and warrants). We elected the fair value method for our
investment in Veritone. As of June 30, 2020, our investment in Veritone warrants totaled $4.1
4100000 million.
Other Investments
Equity investments in common stock and in-substance common stock
without readily determinable fair values in companies over which the Company has the ability to exercise significant influence,
are accounted for using the equity method of accounting. Acacia includes its proportionate share of earnings and/or losses of its
equity method investees in equity in earnings (losses) of investees in the condensed consolidated statements of operations.
Investments in preferred stock with substantive liquidation
preferences are accounted for at cost (subject to impairment considerations, as described below, if any), as adjusted for the impact
of changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer.
In-substance common stock is an investment in an entity that has risk and reward characteristics that are substantially similar
to that entity's common stock. An investment in preferred stock with substantive liquidation preferences over common stock, is
not substantially similar to common stock, and therefore is not considered in-substance common stock. A liquidation preference
is substantive if the investment has a stated liquidation preference that is significant, from a fair value perspective, in relation
to the purchase price of the investment. A liquidation preference in an investee that has sufficient subordinated equity from a
fair value perspective is substantive because, in the event of liquidation, the investor will not participate in substantially
all of the investee's losses, if any.
The initial determination of whether an investment is substantially
similar to common stock is made on the initial date of investment if the Company has the ability to exercise significant influence
over the operating and financial policies of the investee. That determination is reconsidered if:
|
(i)
|
contractual terms of the investment are changed,
|
|
(ii)
|
there is a significant change in the capital structure of the investee, including the investee's receipt of additional subordinated financing, or
|
|
(iii)
|
the Company obtains an additional interest in an investment, resulting in the method of accounting for the cumulative interest being based on the characteristics of the investment at the date at which the Company obtains the additional interest.
|
Refer to Note 5 for additional information.
Stock-Based Compensation
The compensation cost for all stock-based awards is measured
at the grant date, based on the fair value of the award, and is recognized as an expense on a straight-line basis over the employee’s
requisite service period (generally the vesting period of the equity award) which is generally two to four years. The fair value
of restricted stock and restricted stock unit awards is determined by the product of the number of shares or units granted and
the grant date market price of the underlying common stock. The fair value of each option award is estimated on the date of grant
using a Black-Scholes option-pricing model. Forfeitures are accounted for as they occur.
Restricted stock units granted in September
2019 with market-based vesting conditions vest based upon the Company achieving specified stock price targets over a three-year
period. The effect of a market condition is reflected in the estimate of the grant-date fair value of the options utilizing a
Monte Carlo valuation technique. Compensation cost is recognized with a market-based vesting condition provided that the requisite
service is rendered, regardless of when, if ever, the market condition is satisfied. Assumptions utilized in connection with the
Monte Carlo valuation technique included: estimated risk-free interest rate of 1.38 percent; term of 3.00 years; expected volatility
of 38 percent; and expected dividend yield of 0 percent. The risk-free interest rate was determined based on the yields available
on U.S. Treasury zero-coupon issues. The expected stock price volatility was determined using historical volatility. The expected
dividend yield was based on expectations regarding dividend payments.
Profits Interest Units (“Units”) were
accounted for in accordance with Accounting Standards Codification (“ASC”) 718-10, “Compensation - Stock Compensation.”
The vesting conditions did not meet the definition of service, market or performance conditions, as defined in ASC 718. As such,
the Units were classified as liability awards. Compensation expense was adjusted for changes in fair value prorated for the portion
of the requisite service period rendered. Initially, compensation expense was recognized on a straight-line basis over the employee’s
requisite service period (generally the vesting period of the equity award) which was five years. Upon full vesting of the award,
which occurred during the three months ended September 30, 2017, previously unrecognized compensation expense was immediately
recognized in the period. The Company has a purchase option to purchase the vested Units that are not otherwise forfeited
after termination of continuous service. The exercise price of the purchase option is the fair market value of the Units on the
date of termination of continuous service. As of June 30, 2020, the Units totaled $591,000, which
was their fair value as of December 31, 2018 after termination of service.
Series A Warrants
The fair value of the Series A Warrants is estimated using a
Black-Scholes option-pricing model. The fair value of the Series A Warrants as of June 30, 2020 was estimated based on the following
assumptions: volatility of 27 percent, risk-free rate of 0.51 percent, term of 7.29 years and a dividend yield of 0 percent. Refer
to Notes 10 and 11 for additional information.
Series B Warrants
The fair value of the Series B
Warrants is estimated using Monte Carlo valuation technique. The fair value of the Series B Warrants as of June 30, 2020 was
estimated based on event probabilities of future exercise scenarios and the following weighted-average assumptions: (1)
volatility of 47
percent, risk-free rate of 0.51
percent, term of 2.15
years, dividend yield of 0
percent, and a discount for lack of marketability of 10
percent, and (2) volatility of 27 percent, risk-free rate of 0.51 percent, term of 7.38 years and a dividend yield of 0
percent, and a discount for lack of marketability of 10 percent. Refer to Notes 10 and 12 for additional
information.
Embedded derivatives
Embedded derivatives that are required to be bifurcated from
their host contract are valued separately from host instrument. A binomial lattice framework is used to estimate the fair value
of the embedded derivative in the Series A Redeemable Convertible Preferred Stock. The binomial model utilizes the Tsiveriotis
and Fernandes implementation in which a convertible instrument is split into two separate components: a cash-only component which
is subject to the selected risk-adjusted discount rate and an equity component which is subject only to the risk-free rate. The
model considers the (i) implied volatility of the value of our common stock, (ii) appropriate risk-free interest rate, (iii) credit
spread, (iv) dividend yield, (v) dividend accrual (and a step-up in rates), and (vi) event probabilities of the various conversion
and redemption scenarios.
The implied volatility of the Company’s common stock is
estimated based on a haircut applied to the historical volatility. A volatility haircut is a concept used to describe a commonly
observed occurrence in which the volatility implied by market prices involving options, warrants, and convertible debt is lower
than historical actual realized volatility. The assumed base case term used in the valuation model is the period remaining until
November 15, 2027, the maturity date. The risk-free interest rate is based on the yield on the U.S. Treasury with a remaining term
equal to the expected term of the conversion and early redemption options. The significant assumptions utilized in the Company’s
valuation of the embedded derivative at June 30, 2020 are as follows: volatility of 27 percent, risk-free rate of 0.51 percent,
a credit spread of 25 percent and a dividend yield of 0 percent. The fair value measurement of the embedded derivative is sensitive
to these assumptions and changes in these assumptions could result in a materially different fair value measurement. Refer to Note
10 for additional information.
Treasury Stock
Repurchases of the Company’s outstanding common stock
are accounted for using the cost method. The applicable par value is deducted from the appropriate capital stock account on the
formal or constructive retirement of treasury stock. Any excess of the cost of treasury stock over its par value is charged to
additional paid-in capital, and reflected as treasury stock on the condensed consolidated balance sheets.
Impairment of Investments
Acacia reviews its investments quarterly for indicators of other-than-temporary
impairment. This determination requires significant judgment. In making this judgment, Acacia considers available quantitative
and qualitative evidence in evaluating potential impairment of its investments. If the cost of an investment exceeds its fair value,
Acacia evaluates, among other factors, general market conditions and the duration and extent to which the fair value is less than
cost. Acacia also considers specific adverse conditions related to the financial health of and business outlook for the investee,
including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline
in fair value is determined to be other-than-temporary, an impairment charge is recorded in the condensed consolidated statements
of operations and a new cost basis in the investment is established.
Income Taxes
Income taxes are accounted for using an asset and liability
approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events
that have been recognized in Acacia’s condensed consolidated financial statements or consolidated income tax returns. A valuation
allowance is established to reduce deferred tax assets if all, or some portion, of such assets will more than likely not be realized,
or if it is determined that there is uncertainty regarding future realization of such assets.
The provision for income taxes for interim periods is determined
using an estimate of Acacia’s annual effective tax rate, adjusted for discrete items, if any, that are taken into account
in the relevant period. Each quarter, Acacia updates the estimate of the annual effective tax rate, and if the estimated tax rate
changes, a cumulative adjustment is recorded.
The Company’s effective tax rates were 0% and 21% for
the three and six months ended June 30, 2020, respectively and 0% and (3%) for the three and six months ended June 30, 2019, respectively.
Tax benefit (expense) for the periods presented primarily reflects the impact of state taxes and foreign taxes withholding or refund
incurred on revenue agreements executed with third-party licensees domiciled in foreign jurisdictions. The Company has recorded
full valuation allowance against our net deferred tax assets as of June 30, 2020 and 2019. These assets primarily consist of foreign
tax credits, capital loss carryforwards and net operating loss carryforwards.
3. INCOME (LOSS) PER SHARE
The following table presents the shares of common stock outstanding
used in the calculation of basic and diluted net income (loss) per share:
Calculation of basic and diluted net loss per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended
June 30,
|
|
|
Six
Months Ended
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
|
|
(In thousands, except share and per share information)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable to Acacia Research Corporation
|
|
$
|
6,148
|
|
|
$
|
(5,757
|
)
|
|
$
|
(5,143
|
)
|
|
$
|
(10,141
|
)
|
Dividend on Series A redeemable convertible preferred stock
|
|
|
(388
|
)
|
|
|
–
|
|
|
|
(651
|
)
|
|
|
–
|
|
Accretion of Series A redeemable convertible preferred stock
|
|
|
(680
|
)
|
|
|
–
|
|
|
|
(1,311
|
)
|
|
|
–
|
|
Undistributed earnings allocated to participating
securities
|
|
|
(879
|
)
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Net
income (loss) attributable to common stockholders - basic and diluted
|
|
|
4,201
|
|
|
|
(5,757
|
)
|
|
|
(7,105
|
)
|
|
|
(10,141
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average
shares used in computing net income (loss) per share attributable to common stockholders - basic
|
|
|
48,457,620
|
|
|
|
49,696,016
|
|
|
|
49,166,508
|
|
|
|
49,676,059
|
|
Potentially dilutive common shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock units
|
|
|
576,204
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Weighted-average
shares used in computing net income (loss) per share attributable to common stockholders - diluted
|
|
|
49,033,824
|
|
|
|
49,696,016
|
|
|
|
49,166,508
|
|
|
|
49,676,059
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income (loss) per common share
|
|
$
|
0.09
|
|
|
$
|
(0.12
|
)
|
|
$
|
(0.14
|
)
|
|
$
|
(0.20
|
)
|
Diluted net income (loss) per common share
|
|
$
|
0.09
|
|
|
$
|
(0.12
|
)
|
|
$
|
(0.14
|
)
|
|
$
|
(0.20
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Anti-dilutive
potential common shares excluded from the computation of diluted net income (loss) per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity-based incentive awards
|
|
|
476,583
|
|
|
|
1,766,191
|
|
|
|
2,321,016
|
|
|
|
1,766,191
|
|
Series A warrants
|
|
|
5,000,000
|
|
|
|
–
|
|
|
|
5,000,000
|
|
|
|
–
|
|
Series B warrants
|
|
|
100,000,000
|
|
|
|
–
|
|
|
|
100,000,000
|
|
|
|
–
|
|
Total
|
|
|
105,476,583
|
|
|
|
1,766,191
|
|
|
|
107,321,016
|
|
|
|
1,766,191
|
|
4. PATENTS
Acacia’s only identifiable intangible assets at June 30,
2020 and December 31, 2019 are patents and patent rights. Patent-related accumulated amortization totaled $325,122,000 and $322,774,000
as of June 30, 2020 and December 31, 2019, respectively. Acacia’s patents have remaining estimated economic useful lives
ranging from one to fifty-eight months. The weighted-average remaining estimated economic useful life of Acacia’s patents
is approximately four years.
The following table presents the scheduled annual aggregate
amortization expense as of June 30, 2020:
Schedule of intangible assets
|
|
|
|
|
|
For the years ending December 31,
|
|
|
|
|
(In thousands)
|
|
|
|
|
|
Remainder of 2020
|
|
|
$
|
2,332
|
|
2021
|
|
|
|
4,451
|
|
2022
|
|
|
|
4,451
|
|
2023
|
|
|
|
4,376
|
|
2024
|
|
|
|
3,005
|
|
Thereafter
|
|
|
|
630
|
|
Patents, net
|
|
|
$
|
19,245
|
|
5. INVESTMENTS
Investment at Fair Value
During 2016 and 2017, Acacia made certain investments in Veritone,
Inc. (“Veritone”). As a result of these transactions, Acacia received an aggregate total of 4,119,521 shares of Veritone
common stock and warrants to purchase a total of 1,120,432 shares of Veritone common stock at an exercise price of $13.61 per share
expiring between 2020 and 2027. During the year ended December 31, 2018, Acacia sold 2,700,000 shares Veritone common stock and
recorded a realized loss of $19.1 million. During the year ended December 31, 2019, Acacia sold 1,121,071 shares Veritone common
stock and recorded a realized loss of $9.2 million. During the three months ended March 31, 2020, Acacia sold all remaining 298,450
shares Veritone common stock and recorded a realized loss of $3.3 million.
During the three months ended June 30, 2020, Acacia exercised
154,312 warrants of the total 1,120,432 Veritone common stock purchase warrants at a price of $13.61 per warrant, and then sold
the 154,312 shares of Veritone stock received at $17.23 per share, and recorded a realized gain of $554,000. At June 30, 2020,
the fair value of the 966,120 remaining warrants held by Acacia totaled $4,063,000.
Changes in the fair value of Acacia’s investment in Veritone
are recorded as unrealized gains or losses in the consolidated statements of operations. For the three and six months ended June
30, 2020 and 2019, the accompanying condensed consolidated statements of operations reflected the following:
Schedule of gain (loss) on investments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
|
|
(In thousands)
|
|
Change in fair value of investment, warrants
|
|
$
|
2,677
|
|
|
$
|
3,091
|
|
|
$
|
3,306
|
|
|
$
|
2,394
|
|
Change in fair value of investment, common stock
|
|
|
–
|
|
|
|
3,889
|
|
|
|
3,479
|
|
|
|
11,494
|
|
Gain on sale of investment, warrants
|
|
|
554
|
|
|
|
–
|
|
|
|
554
|
|
|
|
–
|
|
Loss on sale of investment, common stock
|
|
|
–
|
|
|
|
(1,642
|
)
|
|
|
(3,316
|
)
|
|
|
(7,232
|
)
|
Net realized and unrealized gain (loss) on investment at fair value
|
|
$
|
3,231
|
|
|
$
|
5,338
|
|
|
$
|
4,023
|
|
|
$
|
6,656
|
|
6. COMMITMENTS AND CONTINGENCIES
Patent Enforcement
Certain of Acacia’s operating subsidiaries are often required
to engage in litigation to enforce their patents and patent rights. In connection with any of Acacia’s operating subsidiaries’
patent enforcement actions, it is possible that a defendant may request and/or a court may rule that an operating subsidiary has
violated statutory authority, regulatory authority, federal rules, local court rules, or governing standards relating to the substantive
or procedural aspects of such enforcement actions. In such event, a court may issue monetary sanctions against Acacia or its operating
subsidiaries or award attorney’s fees and/or expenses to a defendant(s), which could be material.
Facility Leases
The Company primarily leases office facilities under operating
lease arrangements that will end in various years through July 2024.
On June 7, 2019, we entered into a building lease agreement
(the “New Lease”) with Jamboree Center 4 LLC (the “Landlord”). Pursuant to the New Lease, we have leased
approximately 8,293 square feet of office space for our corporate headquarters in Irvine, California. The New Lease commenced on
August 1, 2019. The term of the New Lease is 60 months from the commencement date, provides for annual rent increases, and does
not provide us the right to early terminate or extend our lease terms.
The Company subleased a facility under another operating lease
agreement (the “Old Lease”) that we ceased using in December 2018, and the sublease went through the remaining term
of the Old Lease, which ended on January 31, 2020.
On January 7, 2020, we entered into a building lease agreement
(the “New York Office Lease”) with Sage Realty Corporation (the “New York Office Landlord”). Pursuant to
the New York Office Lease, we have leased approximately 4,000 square feet of office space in New York, New York. The New York Office
Lease commenced on February 1, 2020. The term of the New York Office Lease is 24 months from the commencement date, provides for
annual rent increases, and does not provide us the right to early terminate or extend our lease terms.
Operating lease costs, net of sublease income, were $164,000
and $114,000 for the three months ended June 30, 2020 and 2019, respectively. Operating lease costs, net of sublease income, were
$285,000 and $205,000 for the six months ended June 30, 2020 and 2019, respectively.
The table below presents aggregate future minimum payments due
under the New Lease and the New York Office Lease discussed above, reconciled to lease liabilities included in the consolidated
balance sheet as of June 30, 2020:
Schedule of future minimum operating lease payments
|
|
|
|
|
|
|
|
|
Operating Leases
|
|
|
|
|
(In thousands)
|
|
2020
|
|
|
$
|
287
|
|
2021
|
|
|
|
589
|
|
2022
|
|
|
|
370
|
|
2023
|
|
|
|
364
|
|
2024
|
|
|
|
218
|
|
Total minimum payments
|
|
|
$
|
1,828
|
|
Less: short-term lease liabilities
|
|
|
|
(579
|
)
|
Long-term lease liabilities
|
|
|
$
|
1,249
|
|
Other Matters
Acacia is subject to claims, counterclaims and legal actions
that arise in the ordinary course of business. Management believes that the ultimate liability with respect to these claims and
legal actions, if any, will not have a material effect on Acacia’s condensed consolidated financial position, results of
operations or cash flows.
On September 6, 2019, Slingshot Technologies, LLC (“Slingshot”)
filed suit in Delaware Chancery Court against the Company, Acacia Research Group, LLC, and Monarch Networking Solutions LLC (collectively,
the “Acacia Entities”), Acacia board member Katharine Wolanyk, and Transpacific IP Group, Ltd. (“Transpacific”).
Slingshot alleges that the Acacia Entities misappropriated its confidential and proprietary information, purportedly furnished
to the Acacia Entities by Ms. Wolanyk, in acquiring a patent portfolio from Transpacific after Slingshot’s exclusive option
to purchase the same patent portfolio from Transpacific had already expired. Slingshot seeks monetary damages, as well as equitable
and injunctive relief related to its alleged right to own the portfolio. The Acacia Entities maintain that Slingshot’s allegations
are baseless, that Ms. Wolanyk had no involvement in the acquisition, that the Acacia Entities neither had access to nor used Slingshot’s
information in acquiring the portfolio, that the Acacia Entities acquired the portfolio as a result of the independent efforts
of its IP licensing group, and that Slingshot suffered no damages given its exclusive option to purchase the portfolio had already
ended and it has proven itself incapable of closing on the portfolio purchase.
On December 6, 2017, the Federal Court of Canada allowed a counterclaim
for invalidity of a patent asserted by Rapid Completions LLC and awarded costs payable by Rapid Completions LLC in an amount to
be determined.
During the six months ended June 30, 2020, operating expenses
included a net income for settlement offset by contingency accruals totaling $308,000, net of prior accruals. During the six months
ended June 30, 2019, operating expenses included expenses for settlement and contingency accruals totaling $650,000. At June 30,
2020, our contingency accruals totaled $1.4 million.
7. STOCKHOLDERS’ EQUITY
Repurchases of Common Stock
On August 5, 2019, Acacia’s Board of Directors approved
a stock repurchase program, which authorized the purchase of up to $10.0 million of the Company's common stock through open market
purchases, through block trades, through 10b5-1 plans, or by means of private purchases, from time to time, through July 31, 2020.
Stock repurchases for the periods presented, all of which were purchased as part of a publicly announced plan or program, were
as follows:
Schedule of repurchased shares
|
|
Total Number
of Shares
Purchased
|
|
|
Average
Price
paid per
Share
|
|
|
Approximate Dollar
Value of Shares that
May Yet be Purchased
under the Program
|
|
|
Plan Expiration Date
|
|
|
|
|
|
|
|
|
|
|
|
|
March 20, 2020 - March 31, 2020
|
|
|
576,898
|
|
|
$
|
2.28
|
|
|
$
|
8,686,000
|
|
|
July 31, 2020
|
April 1, 2020 - April 23, 2020
|
|
|
1,107,639
|
|
|
$
|
2.42
|
|
|
$
|
6,001,000
|
|
|
July 31, 2020
|
Totals for 2020
|
|
|
1,684,537
|
|
|
$
|
2.37
|
|
|
|
|
|
|
|
In determining whether or not to repurchase any shares of Acacia’s
common stock, Acacia’s Board of Directors consider such factors as the impact of the repurchase on Acacia’s cash position,
as well as Acacia’s capital needs and whether there is a better alternative use of Acacia’s capital. Acacia has no
obligation to repurchase any amount of its common stock under the Stock Repurchase Program. Repurchases to date were made in the
open market in compliance with applicable SEC rules. The authorization to repurchase shares presented an opportunity to reduce
the outstanding share count and enhance stockholder value.
Tax Benefits Preservation Plan
On March 12, 2019, Acacia’s Board of Directors announced
that it had unanimously approved the adoption of a Tax Benefits Preservation Plan (the “Plan”). Our stockholders ratified
the adoption of the Plan in July 2019. The purpose of the Plan is to protect the Company’s ability to utilize potential tax
assets, such as net operating loss carryforwards and tax credits to offset potential future taxable income.
The Plan is designed to reduce the likelihood that the Company
will experience an ownership change by discouraging (i) any person or group from acquiring beneficial ownership of 4.9% or more
of the Company’s outstanding common stock and (ii) any existing stockholders who, as of the time of the first public announcement
of the adoption of the Plan, beneficially own more than 4.9% of the Company’s then-outstanding shares of the Company’s
common stock from acquiring additional shares of the Company’s common stock (subject to certain exceptions). There is no
guarantee, however, that the Plan will prevent the Company from experiencing an ownership change.
In connection with the adoption of the Plan, Acacia’s
Board of Directors authorized and declared a dividend distribution of one right for each outstanding share of the Company’s
common stock to stockholders of record at the close of business on March 16, 2019. On or after the distribution date, each right
would initially entitle the holder to purchase one one-thousandth of a share of the Company’s Series B Junior Participating
Preferred Stock, $0.001 par value for a purchase price of $12.00.
The Company also has a provision in its Amended and Restated
Certificate of Incorporation, as amended (the “Charter Provision”) which generally prohibits transfers of its common
stock that could result in an ownership change. Like the Plan, the purpose of the Charter Provision is to protect the Company’s
ability to utilize potential tax assets, such as net operating loss carryforwards and tax credits to offset potential future taxable
income. The Charter Provision was approved by the Company’s stockholders on July 15, 2019.
8. RECENT ACCOUNTING PRONOUNCEMENTS
Recent Accounting Pronouncements - Not Yet Adopted
In December 2019, the Financial Accounting Standards Board (“FASB”)
issued ASU No. 2019-12 Income Taxes (Topic 740) — Simplifying the Accounting for Income Taxes, to remove certain exceptions
and improve consistency of application, including, among other things, requiring that an entity reflect the effect of an enacted
change in tax laws or rates in the annual effective tax rate computation in the interim period that includes the enactment date.
The amendments in this update will be effective for the Company beginning with fiscal year 2021, with early adoption permitted.
Most amendments within the standard are required to be applied on a prospective basis, while certain amendments must be applied
on a retrospective or modified retrospective basis. Management is currently evaluating the impact that the amendments in this update
will have on the Company’s consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13,Financial Instruments—Credit
Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, to replace the incurred loss methodology with an expected
credit loss model that requires consideration of a broader range of information to estimate credit losses over the lifetime of
the asset, including current conditions and reasonable and supportable forecasts in addition to historical loss information, to
determine expected credit losses. Pooling of assets with similar risk characteristics and the use of a loss model are also required.
Also, in April 2019, the FASB issued ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments—Credit
Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, to clarify the inclusion of recoveries of trade
receivables previously written off when estimating an allowance for credit losses. The amendments in this update will be effective
for the Company in fiscal year 2023, with early adoption permitted. Management is currently evaluating the impact that the amendments
in this update will have on the Company’s consolidated financial statements.
9. FAIR VALUE DISCLOSURES
Acacia holds the following types of financial instruments at
June 30, 2020 and December 31, 2019.
Trading securities - debt. Debt securities include corporate
bonds with fair value that is determined by third party quotations from outside pricing services and/or computerized pricing models,
which may be based on transactions, bids or estimates. Acacia classifies the fair value of corporate bonds within Level 2 of the
valuation hierarchy.
Trading securities - equity. Equity securities include
investments in public companies common stock and are recorded at fair value based on the quoted market price of each share on the
valuation date. The fair value of these securities are within Level 1 of the valuation hierarchy.
Equity securities derivative. Public
company equity securities derivative are recorded at fair value based on the quoted market price of the underlying shares on the
valuation date and settlement expectations. The fair value of these equity securities derivative are within Level 1 of the valuation
hierarchy.
Investments at fair value - common stock. Acacia’s
equity investment in Veritone common stock is recorded at fair value based on the quoted market price of Veritone’s common
stock on the applicable valuation date (Level 1).
Investments at fair value - warrants. Warrants are recorded
at fair value, as based on the Black-Scholes option-pricing model (Level 2).
Series A Warrants. Series A Warrants are recorded at
fair value, using Black-Scholes option-pricing model (Level 2).
Series B Warrants. Series B Warrants are recorded at
fair value, using Monte Carlo valuation technique (Level 3).
Embedded derivative liability. Embedded
derivatives that are required to be bifurcated from their host contract are evaluated and valued separately from the host instrument.
A binomial lattice framework is used to estimate the fair value of the embedded derivative in the Series A Redeemable Convertible
Preferred Stock issued by the Company in 2019 (Level 3).
10. SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK
On November 18, 2019, the Company entered into a Securities
Purchase Agreement (the “Securities Purchase Agreement”) with Starboard Value LP (“Starboard”) pursuant
to which the Company issued (i) 350,000 shares of Series A Redeemable Convertible Preferred Stock with a par value of $0.001 per
share and a stated value of $100 per share, and (ii) Series A Warrants to purchase up to 5,000,000 shares of the Company’s
common stock to Starboard. The Securities Purchase Agreement also established the terms of certain senior secured notes and Series
B Warrants that may be issued to Starboard on a subsequent date. Refer to Notes 11 and 12 for additional information regarding
the issuance of the Series A and Series B Warrants.
The Series A Redeemable Convertible Preferred Stock can be converted
into a number of shares of common stock equal to (i) the stated value thereof plus accrued and unpaid dividends, divided by (ii)
the conversion price of $3.65 (subject to certain anti-dilution adjustments). Holders may elect to convert the Series A Redeemable
Convertible Preferred Stock into common stock at any time. The Company may elect to convert the Series A Redeemable Convertible
Preferred Stock into shares of Common Stock any time on or after November 15, 2025, provided that the closing price of the Company’s
common stock equals or exceeds 190% of the conversion price for 30 consecutive trading days and assuming certain other conditions
of the common stock have been met.
Holders have the option to redeem all or a portion of the Series
A Redeemable Convertible Preferred Stock during the periods of May 15, 2021 through August 15, 2021 and May 15, 2022 through August
15, 2022, provided that the Company has not issued at least $50.0 million aggregate principal of senior secured notes to Starboard
pursuant to the Securities Purchase Agreement. Holders also have the option to redeem all or a portion of the Series A Redeemable
Convertible Preferred Stock during the period of November 15, 2024 through February 15, 2025. Additionally, holders have the option
to redeem all or a portion of the Series A Redeemable Convertible Preferred Stock upon the occurrence of (i) a change of control
or (ii) various other triggering events, such as the suspension from trading or delisting of the Company’s common stock.
If the Series A Redeemable Convertible Preferred Stock is redeemed at the option of the holders, the redemption price may include
a make-whole amount or a stated premium, depending on the redemption scenario.
The Company may redeem all, and not less than all, of the Series
A Redeemable Convertible Preferred Stock (i) upon a change of control or (ii) during the period of May 15, 2022 through August
15, 2022, provided that the Company has not issued at least $50.0 million aggregate principal of the senior secured notes, and
assuming certain conditions of the common stock have been met. If the Series A Redeemable Convertible Preferred Stock is redeemed
at the option of the Company, the redemption price would include a make-whole amount or a 15% premium depending on the circumstances.
If any Series A Redeemable Convertible Preferred Stock remains
outstanding on November 15, 2027, the Company shall redeem such Series A Redeemable Convertible Preferred Stock in cash.
In all redemption scenarios, the redemption price for the Series
A Redeemable Convertible Preferred Stock includes the stated value plus accrued and unpaid dividends. In addition, depending on
the redemption scenario, the redemption price may also include a make-whole amount or stated premium as described above.
When the Company issues senior secured notes, the Holder may
exchange the Series A Redeemable Convertible Preferred Stock for (i) senior secured notes and (ii) Series B Warrants to purchase
common stock.
The Series A Redeemable Convertible Preferred Stock accrues
cumulative dividends quarterly at annual rate of 3.0% on the stated value. Upon consummation of an approved investment (an investment
to be identified and approved by each of the Company and Starboard), the dividend rate will increase to 8.0% on the stated value.
Upon certain triggering events, the dividend rate will increase to 7.0% if the triggering event occurs before an approved investment
or 10.0% on the stated value if the triggering event occurs after an approved investment. The Series A Redeemable Convertible Preferred
Stock also participates on an as-converted basis in any regular or special dividends paid to common stockholders. There are no
accrued and unpaid dividends as of June 30, 2020.
Holders of the Series A Redeemable Convertible Preferred Stock
have the right to vote with common stockholders on an as-converted basis on all matters. Holders of Series A Redeemable Convertible
Preferred Stock will also be entitled to a separate class vote with respect to amendments to the Company’s organizational
documents that generally have an adverse effect on the Series A Redeemable Convertible Preferred Stock.
Upon liquidation of the Company, holders of Series A Redeemable
Convertible Preferred Stock have a liquidation preference over holders of our common stock and will be entitled to receive, prior
to any distribution to holders of our common stock, an amount equal to the greater of (i) the stated value plus accrued and unpaid
dividends or (ii) the amount that would have been received if the Series A Redeemable Convertible Preferred Stock had been converted
into common stock immediately prior to the liquidation event at the then effective conversion price.
The Company determined that certain features of the Series A
Redeemable Convertible Preferred Stock should be bifurcated and accounted for as a derivative. Each of these features are bundled
together as a single, compound embedded derivative.
Total proceeds received and transaction costs incurred from
the issuance of the Series A Redeemable Convertible Preferred Stock amounted to $35 million and $1.2 million, respectively. Proceeds
received were allocated based on the fair value of the instrument without the Series A Warrants and of the Series A Warrants themselves
at the time of issuance. The proceeds allocated to the Series A Redeemable Convertible Preferred Stock were then further allocated
between the host preferred stock instrument and the embedded derivative, with the embedded derivative recorded at fair value and
the Series A Redeemable Convertible Preferred Stock recorded at the residual amount. The portion of the proceeds allocated to the
Series A Warrants, embedded derivative, and Series A Redeemable Convertible Preferred Stock was $4.8 million, $21.2 million, and
$8.9 million, respectively. Transaction costs were also allocated between the Series A Redeemable Convertible Preferred Stock and
the Series A Warrants on the same basis as the proceeds. The transaction costs allocated to the Series A Redeemable Convertible
Preferred Stock were treated as a discount to the Series A Redeemable Convertible Preferred Stock. The transaction costs allocated
to the Series A Warrants were expensed as incurred.
The Company classifies the Series A Redeemable Convertible Preferred
Stock as mezzanine equity as the instrument will become redeemable at the option of the holder in various scenarios or otherwise
on November 15, 2027. As it is probable that the Series A Redeemable Convertible Preferred Stock will become redeemable, the Company
accretes the instrument to its redemption value using the effective interest method and recognizes any changes against additional
paid in capital in the absence of retained earnings. Accretion was $0.7 million and $1.3 million, respectively, for the three and
six months ended June 30, 2020.
In connection with the issuance of the Series A Redeemable Convertible
Preferred Stock, the Company executed a Registration Rights Agreement and a Governance Agreement with Starboard. Under the Registration
Rights Agreement, the Company agreed to provide certain registration rights with respect to the Series A Redeemable Convertible
Preferred Stock and shares of Common Stock issued upon conversion. In accordance with the Governance Agreement, the Company agreed
to (i) increase the size of the Board of Directors from six to seven members, (ii) appoint a director of the Company, (iii) grant
Starboard the right to recommend two additional directors for appointment to the board, (iv) form a Strategic Committee of the
Board tasked with sourcing and performing due diligence on potential acquisition targets, (v) appoint certain directors to the
Strategic Committee, and (vi) appoint a director to the Nominating and Corporate Governance Committee.
The following features of the Series A Redeemable Convertible
Preferred Stock are required to be bifurcated from the host preferred stock and accounted for separately as an embedded derivative:
(i) the right of the holders to redeem the shares (put option), (ii) the right of the holders to receive common stock upon conversion
of the shares (conversion option), (iii) the right of the Company to redeem the shares (call option), and (iv) the change in dividend
rate upon consummation of an approved investment or a triggering event (contingent dividend rate feature).
These features are required to be accounted for separately from
the Series A Redeemable Convertible Preferred Stock because the features were determined to be not clearly and closely related
to the debt-like host and also did not meet any other scope exceptions for derivative accounting. Therefore, these features are
bundled together and are accounted for as a single, compound embedded derivative liability.
Accordingly, we have recorded an embedded derivative liability
representing the combined fair value of each of these features. The embedded derivative liability is adjusted to reflect fair value
at each period end with changes in fair value recorded in the “Change in fair value of redeemable preferred stock embedded
derivative” financial statement line item of the accompanying condensed consolidated statements of operations. As of June
30, 2020, the fair value of the Series A embedded derivative was $29.5 million.
11. SERIES A WARRANTS
On November 18, 2019, in connection with the issuance of the
Series A Redeemable Convertible Preferred Stock, the Company issued detachable Series A Warrants to acquire up to 5,000,000 shares
of common stock at a price of $3.65 per share (subject to certain antidilution adjustments) at any time during a period of eight
years beginning on the instrument’s issuance date of the Series A Warrants. As of June 30, 2020, the Series A Warrants have
not been exercised.
The Series A Warrants will be recognized at fair value at each
reporting period until exercised, with changes in fair value recognized in the condensed consolidated statements of operations
in other income (expense) in the accompanying condensed consolidated statements of operations. As of December 31, 2019, the fair
value of the Series A Warrants was $3.6 million. As of June 30, 2020, the fair value of the Series A Warrants was $7.0 million.
The Series A Warrants are classified as a liability in accordance
with ASC 480, Distinguishing Liabilities from Equity, as the agreement provides for net cash settlement upon a change in control,
which is outside the control of the Company.
12. SERIES B WARRANTS
On February 25, 2020, pursuant to the terms of the Securities
Purchase Agreement with Starboard, the Company issued Series B Warrants to purchase up to 100 million shares of the Company’s
common stock at an exercise price (subject to certain price-based anti-dilution adjustments) of either (i) $5.25 per share, if
exercising by cash payment, within 30 months from the issuance date (i.e., August 25, 2022); or (ii) $3.65 per share, if exercising
by cancellation of a portion of senior secured notes. The Company issued the Series B Warrants for an aggregate purchase price
of $4.6 million. The Series B Warrants expire on November 15, 2027.
In connection with the issuance of the Senior Secured Notes
on June 4, 2020, the terms of certain of the Series B Warrants were amended to permit the payment of the lower exercise price of
$3.65 through the payment of cash, rather than only through the cancellation of Notes outstanding, at any time until the expiration
date of November 15, 2027. Only 31,506,849 of the Series B Warrants are subject to this adjustment with the remaining balance of
68,493,151 Series B Warrants continuing under their original terms. Refer to Note 13 for additional information on the modifications
to Series A Redeemable Convertible Preferred Stock and Series B Warrants.
As of June 30, 2020, the Series B Warrants have not been exercised.
The Series B Warrants will be recognized at fair value at each reporting period until exercised, with changes in fair value recognized
in the condensed consolidated statements of operations in other income (expense). As of June 30, 2020, the fair value of the Series
B Warrants was $58.3 million.
The Series B Warrants are classified as
a liability in accordance with ASC 480, Distinguishing Liabilities from Equity, as the agreement provides for net cash settlement
upon a change in control, which is outside the control of the Company.
13. SENIOR SECURED NOTES
Pursuant to the Securities Purchase Agreement dated November
18, 2019 with Starboard, on June 4, 2020, the Company issued $115 million in Senior Secured Notes (the “Notes”) to
Starboard. Also on June 4, 2020, in connection with the issuance of the Notes, the Company entered into a Supplemental Agreement
with Starboard (the “Supplemental Agreement”), pursuant to which the Company agreed to redeem $80 million aggregate
principal amount of the Notes by September 30, 2020, and $35 million aggregate principal amount of the Notes by December 31, 2020,
resulting in the total principal outstanding being paid by December 31, 2020. Per the Supplemental Agreement, interest is payable
semiannually at a rate of 6% per annum, and in an event of default, the interest rate is increased to 10% per annum. The Notes
include certain financial and non-financial covenants. Additionally, all or any portion of the principal amount outstanding under
the Notes may, at the election of Starboard, be surrendered to the Company for cancellation in payment of the exercise price upon
the exercise of Series B Warrants.
On June 30, 2020, the Company entered into an Exchange Agreement
(the “Exchange Agreement”) with Merton Acquisition HoldCo LLC, a Delaware limited liability company and wholly-owned
subsidiary of the Company (“Merton”) and Starboard, on behalf of itself and on behalf of certain funds and accounts
under its management, including the holders of the Notes. Pursuant to the Exchange Agreement, the holders of the Notes exchanged
the entire outstanding principal amount for new senior notes (the “New Notes”) issued by Merton having an aggregate
outstanding original principal amount of $115 million.
The New Notes bear interest at a rate of 6.00% per annum and
will mature December 31, 2020. The New Notes are fully guaranteed by the Company and are secured by an all-assets pledge of the
Company and Merton and non-recourse equity pledges of each of the Company’s material subsidiaries. Pursuant to the Exchange
Agreement, the New Notes (i) are deemed to be “Notes” for purposes of the Securities Purchase Agreement, (ii) are deemed
to be “June 2020 Approved Investment Notes” for purposes of the Supplemental Agreement, and therefore the Company has
agreed to redeem $80 million principal amount of the New Notes by September 30, 2020 and (iii) are deemed to be “Notes”
for the purposes of the Series B Warrants, and therefore may be tendered pursuant to a Note Cancellation under the Series B Warrants
on the terms set forth in the Series B Warrants and the New Notes. Delivery of notes in the form of the New Notes will satisfy
the delivery of Exchange Notes pursuant to Section 16(i) of the Certificate of Designations of the Company’s Series A Convertible
Preferred Stock, par value $0.001 per share. The New Notes will not be deemed to be “Notes” for the purposes of the
Registration Rights Agreement, dated as of November 18, 2019, by and between the Company, Starboard and the Buyers.
Because the New Notes will be settled within twelve months pursuant
to their terms, they are classified as current liabilities on the balance sheet. The Company capitalized $4.6 million in lender fees and
$0.5 million in other issuance costs associated with the issuance of the Notes. The $4.6 million of lender fees are
recognized as long term deferred debt issuance cost and will be amortized to interest expense until November 15, 2027, the maturity
date of Series A Redeemable Convertible Preferred Stock. The $0.5 million issuance costs are recognized as a discount on the Notes
and will be amortized to interest expense over the contractual life of the Notes. There are no accrued and unpaid interest on the
New Note as of June 30, 2020.
Modifications to Series A Redeemable Convertible Preferred
Stock and Series B Warrants
The June 4, 2020 Supplemental Agreement also provided for (i)
a waiver of increased dividends under the original terms of the Series A Preferred Stock that would have otherwise accrued due
to the Company’s use of the $35 million proceeds received from Starboard upon the issuance of the Series A Redeemable Convertible
Preferred Stock in November 2019, (ii) the replacement of original optional redemption rights for the Series A Redeemable Convertible
Preferred Stock provided to both the Company and Starboard that otherwise would have been nullified through the issuance of the
Notes, and (iii) an amendment to the terms of the previously issued Series B Warrants to permit the payment of the lower exercise
price of $3.65 through the payment of cash, rather than only through the cancellation of Notes outstanding, at any time until the
expiration of the Series B Warrants on November 15, 2027. Only 31,506,849 of the Series B Warrants are subject to this adjustment
with the remaining balance of 68,493,151 Series B Warrants continuing under their original terms.
We analyzed the amendments to the Series A Redeemable Convertible
Preferred Stock and determined that the amendments were not significant. Therefore, the amendments are accounted for as a modification
on a prospective basis.
The incremental fair value of the Series B Warrants associated
with their modification in connection with the issuance of the Notes is $1.3 million and is recognized as a discount on the Notes
and will be amortized to interest expense over the contractual life of the Notes.
14. LF EQUITY INCOME FUND PORTFOLIO INVESTMENT
On April 3, 2020, the Company entered into
an Option Agreement with Seller, which included general terms through which the Company was provided the option to purchase life
sciences equity securities in a portfolio of public and private companies (“Portfolio Companies”) for an aggregate
purchase price of £223.9 million, approximately $277.5 million at the exchange rate on April 3, 2020. The option term was
set to expire on May 1, 2020, but could be extended by the Company until May 15, 2020 upon demonstrating certain terms and conditions
had been met. By mutual agreement of the parties, the Company further extended the option agreement from May 15, 2020 until May
22, 2020, at which time, the Company exercised its option to purchase the portfolio, pursuant to the terms of the option contract.
On June 4, 2020, the Company executed the
Transaction Agreement between Link Fund Solutions Limited, Seller, and the Company. Pursuant to the Transaction Agreement, the
Company will purchase from Seller and the Seller will transfer to the Company the specified equity securities of all Portfolio
Companies at set prices at various future dates. The transfer dates will vary among the Portfolio Companies as the Transaction
Agreement gives the Company the exclusive right to determine when to call for transfer of each security, and because each Portfolio
Company (or its existing equity holders) may be required to approve the transfer due to rights of first refusals and other company-specific
terms and conditions. Thus, the execution of the Transaction Agreement resulted in forward contracts for the Company to purchase
equity securities in each public and private company at a specified price on a future date.
In accordance with the Transaction Agreement,
the Company transferred the total purchase price of £223.9 million into an escrow account. As each of the equity securities
in the Portfolio are transferred to the Company, the associated funds will be released from the escrow account to the Seller based
on the consideration amount assigned to the equity securities in the Transaction Agreement.
For accounting purposes, the total purchase price of the portfolio
was allocated to the individual equity securities based on their individual fair values as of April 3, 2020, in order to establish
an appropriate cost basis for each of the acquired securities. The fair values of the public company securities were based on their
quoted market price. The fair values of the private company securities were estimated based on recent financing transactions and
secondary market transactions and factoring in a discount for the illiquidity of these securities.
Changes in the fair value of Acacia’s investment in the
Portfolio Companies are recorded as unrealized gains or losses in the condensed consolidated statements of operations. For the
three and six months ended June 30, 2020 and 2019, the accompanying condensed consolidated statements of operations reflected the
following:
Changes in fair value of Acacias Investment
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June
30,
|
|
|
June
30,
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
|
|
(In thousands)
|
|
Change in fair value of trading security - LF Fund public
securities
|
|
$
|
(1,069
|
)
|
|
$
|
–
|
|
|
$
|
(1,069
|
)
|
|
$
|
–
|
|
Change in fair value of equity securities derivative
|
|
|
6,891
|
|
|
|
–
|
|
|
|
6,891
|
|
|
|
–
|
|
Change in fair value of equity securities forward contract
|
|
|
74,662
|
|
|
|
–
|
|
|
|
74,662
|
|
|
|
–
|
|
Loss on sale of trading security - LF Fund
public securities
|
|
|
(6,110
|
)
|
|
|
–
|
|
|
|
(6,110
|
)
|
|
|
–
|
|
Net
realized and unrealized gain on investment in LF Fund securities
|
|
$
|
74,374
|
|
|
$
|
–
|
|
|
$
|
74,374
|
|
|
$
|
–
|
|
15. SUBSEQUENT EVENTS
None.