Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Cautionary Statement
You should read the following discussion and analysis in conjunction with the consolidated financial statements and related notes thereto contained in Part I, Item 1 of this report. 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 SEC, including our Annual Report on Form 10-K for the year ended December 31, 2007, filed with the SEC on March 14, 2008.
This report contains forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. 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 included in this report. Such statements may be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “believe,” “estimate,” “anticipate,” “intend,” “continue,” or similar terms, variations of such terms or the negative of such 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 product development, capital expenditures, earnings, litigation, regulatory matters, markets for products and services, liquidity and capital resources and accounting matters. Actual results in each case could differ materially from those anticipated in such statements by reason of factors such as future economic conditions, changes in consumer demand, 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 obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein 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. Additional factors that could cause such results to differ materially from those described in the forward-looking statements are set forth in connection with the forward-looking statements and in our “Risk Factors” incorporated by reference in Part II, Item 1A of this report.
General
As used in this Form 10-Q, “we,” “us” and “our” refer to Acacia Research Corporation and/or its wholly owned operating subsidiaries. All intellectual property acquisition, development, licensing and enforcement activities are conducted solely by certain of Acacia Research Corporation’s wholly owned operating subsidiaries.
Acacia Research Corporation, a Delaware corporation, was originally incorporated in California in January 1993 and reincorporated in Delaware in December 1999.
The following discussion is based primarily on our unaudited consolidated balance sheet as of June 30, 2008, and on our unaudited consolidated statements of operations for the period from January 1, 2008 to June 30, 2008. The discussion compares the activities for the three and six months ended June 30, 2008, to the activities for the three and six months ended June 30, 2007. This information should be read in conjunction with the accompanying unaudited consolidated financial statements and notes thereto. This information should also be read in conjunction with the “Risk Factors” referred to in Part II, Item 1A of this report.
Business
Acacia Research Corporation’s operating subsidiaries acquire, develop, license and enforce patented technologies. Our operating subsidiaries generate license fee revenues and related cash flows from the granting of licenses for the use of patented technologies that our operating subsidiaries own or control. Our operating subsidiaries assist patent owners with the prosecution and development of their patent portfolios, the protection of their patented inventions from unauthorized use, the generation of licensing revenue from users of their patented technologies and, if necessary, with the enforcement against unauthorized users of their patented technologies. Currently, on a consolidated basis, our operating subsidiaries own or control the rights to 95 patent portfolios, which include U.S. patents and certain foreign counterparts, covering technologies used in a wide variety of industries.
Other
CombiMatrix Group Split-off Transaction and Related Discontinued Operations. As discussed below under the caption “Discontinued Operations – Split-off of CombiMatrix Corporation,” the CombiMatrix group, which was previously presented as a separate reportable segment, was split-off from Acacia Research Corporation (the “Split-off Transaction”), effective August 15, 2007 (the “Redemption Date”). As such, the results of operations for all historical periods for the CombiMatrix group in the accompanying consolidated financial statements are presented as part of Acacia Research Corporation’s results from discontinued operations in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” or SFAS No. 144.
Overview
Our operating activities during the three and six months ended June 30, 2008 and 2007, were principally focused on the continued development, licensing and enforcement of the patent portfolios owned or controlled by our operating subsidiaries, including the continued pursuit of multiple ongoing technology licensing and enforcement programs and the commencement of new technology licensing and enforcement programs. In addition, we continued our focus on business development, including the acquisition of several additional patent portfolios by certain of our operating subsidiaries and the continued pursuit of additional opportunities to partner with patent owners and provide our unique intellectual property licensing, development and enforcement services.
License fee revenues recognized for the three months ended June 30, 2008 totaled $7.1 million, as compared to $5.9 million for the three months ended June 30, 2007. License fee revenues recognized for the six months ended June 30, 2008 totaled $16.2 million, as compared to $31.1 million for the six months ended June 30, 2007.
License fee revenues for the three and six months ended June 30, 2008 included license fees from 16 and 40, respectively, new license agreements covering 11 and 16, respectively, of the Company’s technology licensing programs. During the six months ended June 30, 2008, we recorded initial license fee revenues for 7 of our technology licensing programs, including our Authorized Spending Accounts technology, Picture Archiving & Communications System technology, Video Editing technology, Electronic Message Advertising technology, Remote Management of Imaging Devices technology, High Quality Image Processing technology and Wireless Traffic Information technology. Revenues for the six months ended June 30, 2008 also included fees from the licensing of our Audio Communications Fraud Detection technology, Credit Card Fraud Protection technology, DMT® technology, Electronic Address List Management technology, Image Resolution Enhancement technology, Pop-up Internet Advertising technology, Portable Storage Devices with Links technology, Remote Management of Imaging Devices technology, Rule-Based Monitoring technology and Telematics technology. License fee revenues for the three and six months ended June 30, 2007 included fees from 20 and 42, respectively, new licensing agreements, covering 8 and 12, respectively, of our technology licensing programs. On a consolidated basis, as of June 30, 2008, 35 of our licensing programs had begun generating licensing revenues, up from 25 licensing programs as of June 30, 2007.
Management measures and assesses the performance and growth of the patent licensing and enforcement businesses conducted by our individual operating subsidiaries based on consolidated license fee revenues recognized across all of our subsidiaries’ technology licensing and enforcement programs on a trailing twelve-month basis. Trailing twelve-month revenues were $37.7 million as of June 30, 2008, $36.5 million as of March 31, 2008, $52.6 million as of December 31, 2007, $47.9 million as of September 30, 2007, $46.8 million as of June 30, 2007, and $34.8 million at December 31, 2006.
Marketing, general and administrative expenses increased during the three and six months ended June 30, 2008, as compared to the three and six months ended June 30, 2007, due primarily to the hiring of additional patent licensing, business development and engineering personnel since the end of the prior year quarter, an increase in non-cash stock compensation expense, an increase in business development and licensing related patent research and consulting costs, and an increase in corporate, general and administrative costs related to ongoing operations. The increase in operating expenses is reflective of the continued growth and expansion of our operating subsidiaries’ technology licensing and enforcement businesses. Inventor royalties expenses and contingent legal fee expenses increased during the three months ended June 30, 2008, as compared to the three months ended June 30, 2007, and decreased for the six months ended June 30, 2008, as compared to the six months ended June 30, 2007, primarily due to the related fluctuations in license fee revenues, as discussed above.
During the six months ended June 30, 2008, certain of our operating subsidiaries continued to execute their business strategy in the area of patent portfolio acquisitions, including the acquisition of, or the acquisition of the rights to, ten patent portfolios covering a variety of applications. Patent rights acquired during the six months ended June 30, 2008 included the following:
| | · | Surgical Catheter. This patented technology generally relates to surgical devices, such as percutaneously insertable catheters and cannulas, that are used to access the circulatory system. These devices can be used in cardiology and other surgical procedures. |
| | · | Vehicle Maintenance Systems. This patented technology generally relates to vehicle maintenance alerts. This technology may be used to alert a driver that an oil change or other vehicle maintenance should be performed. |
| | · | Online Ad Tracking. This patented technology generally relates to tracking advertising usage on a network such as the Internet. For example, this technology can be used to track click through rates of web site advertising. |
| | · | Videoconferencing. This patented technology relates to videoconferencing systems and services based on the Internet. |
| | · | Laparoscopic Surgery. The patented technology relates to devices used by surgeons to help repair broken or damaged blood vessels or gastrointestinal organs. The devices can be used by cardiologists, gastrointestinal specialists, and other medical professionals. |
| | · | Microprocessor. This patented technology relates to the execution of instructions by a processor and has applications in personal computers, servers and embedded processors. |
| | · | Interactive TV. This patented technology generally relates to recording interactive TV responses to specific broadcast material from specific users. This technology can be used by advertisers to evaluate current advertisement effectiveness and target buyers with future advertisements. This technology can also be used by interactive television companies to study subscriber viewing and interactivity behavior. |
| | · | Internet Radio Advertisement. This patented technology generally relates to advertisement replacement for Internet radio. This technology can be used by radio stations to replace broadcast advertisements for distribution over the Internet. |
| | · | Improved Printing. This patented technology generally relates to patents relating to improving print quality based on stochastic screening. This technology renders finer detail and eliminates artifacts found in traditional halftone patterns. High-volume, commercial printers, newspapers and publishers can use this technology to improve print quality while cutting cost. |
| | · | Enterprise Content Management. This patented technology generally relates to categorization and sharing of information within an organization and can be used to organize Internet links, electronic files and hardcopy documents. |
Refer to “Liquidity and Capital Resources” below for information regarding the impact of patent and patent rights acquisitions on the consolidated financial statements for the periods presented.
As of June 30, 2008, certain of our operating subsidiaries had several option agreements with third-party patent portfolio owners regarding the potential acquisition of additional patent portfolios. Future patent portfolio acquisitions will continue to expand and diversify our future revenue generating opportunities.
Critical Accounting Estimates
Our unaudited interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. Preparation of these statements requires management to make judgments and estimates. Some accounting policies have a significant impact on amounts reported in these financial statements. A summary of significant accounting policies and a description of accounting policies that are considered critical may be found in our 2007 Annual Report on Form 10-K, filed with the SEC on March 14, 2008, in the Notes to the Consolidated Financial Statements and the Critical Accounting Estimates section. In addition, refer to Note 2 to the consolidated interim financial statements included in Part I, Item 1 of this report.
Acacia Research Corporation
Comparison of the Results of Operations for the Three and Six Months Ended June 30, 2008 and 2007
Net Loss (In thousands)
| | | For the Three Months Ended | | | For the Six Months Ended | |
| | | June 30, 2008 | | | June 30, 2007 | | | June 30, 2008 | | | June 30, 2007 | |
| | | | | | | | | | | | | |
| Income (loss) from continuing operations | | $ | (5,041 | ) | | $ | (3,588 | ) | | $ | (9,530 | ) | | $ | 847 | |
| Loss from discontinued operations - Split-off of CombiMatrix Corporation and other | | | - | | | | (3,667 | ) | | | - | | | | (5,800 | ) |
| Net income (loss) | | $ | (5,041 | ) | | $ | (7,255 | ) | | $ | (9,530 | ) | | $ | (4,953 | ) |
The changes in net Income (loss) were primarily due to operating results and activities as discussed below.
Revenues (In thousands)
| | | For the Three Months Ended | | | For the Six Months Ended | |
| | | June 30, 2008 | | | June 30, 2007 | | | June 30, 2008 | | | June 30, 2007 | |
| | | | | | | | | | | | | |
| License fees | | $ | 7,116 | | | $ | 5,865 | | | $ | 16,164 | | | $ | 31,050 | |
License Fees. Revenues for the three months ended June 30, 2008 included license fees from 16 new licensing agreements covering 11 of our technology licensing and enforcement programs, as compared to 20 new licensing agreements covering 8 of our technology licensing and enforcement programs in the comparable 2007 period. Revenues for the six months ended June 30, 2008 included license fees from 40 new licensing agreements covering 16 of our technology licensing and enforcement programs, as compared to 42 new licensing agreements covering 12 of our technology licensing and enforcement programs in the comparable 2007 period. License fee revenues recognized by our operating subsidiaries fluctuate from period to period primarily based on the following factors:
| | · | the dollar amount of agreements executed each period, which is primarily driven by the nature and characteristics of the technology being licensed and the magnitude of infringement associated with a specific licensee; |
| | · | the specific terms and conditions of agreements executed each period and the periods of infringement contemplated by the respective payments; |
| | · | fluctuations in the total number of agreements executed; |
| | · | fluctuations in the sales results or other royalty per unit activities of our licensees that impact the calculation of license fees due; |
| | · | the timing of the receipt of periodic license fee payments and/or reports from licensees; and |
| | · | fluctuations in the net number of active licensees period to period. |
Two licensees individually accounted for 27% and 21% of license fee revenues recognized during the three months ended June 30, 2008, and two licensees individually accounted for 15% and 12% of license fee revenues recognized during the six months ended June 30, 2008. Three licensees individually accounted for 21%, 14% and 14% of license fee revenues recognized during the three months ended June 30, 2007, and two licensees individually accounted for 31% and 20% of license fee revenues recognized during the six months ended June 30, 2007.
Costs incurred in connection with our operating subsidiaries licensing and enforcement activities, other than inventor royalties expense, contingent legal fees expense and patent-related legal expenses, are included in marketing, general and administrative expenses.
Operating Expenses (In thousands)
| | | For the Three Months Ended | | | For the Six Months Ended | |
| | | June 30, 2008 | | | June 30, 2007 | | | June 30, 2008 | | | June 30, 2007 | |
| | | | | | | | | | | | | |
Marketing, general and administrative expenses (including non-cash stock compensation expense of $1,938 and $3,767 for the three and six months ended June 30, 2008 and $1,144 and $1,907 for the three and six months ended June 30, 2007) | | $ | 5,947 | | | $ | 4,190 | | | $ | 12,573 | | | $ | 8,518 | |
| Inventor royalties and contingent legal fees expense - patents | | | 4,105 | | | | 3,406 | | | | 8,836 | | | | 17,528 | |
| Legal expenses - patents | | | 1,073 | | | | 1,069 | | | | 2,089 | | | | 2,436 | |
Marketing, General and Administrative Expenses. Marketing, general and administrative expenses include employee compensation and related personnel costs, including non-cash stock compensation expenses, office and facilities costs, legal and accounting professional fees, public relations, marketing, stock administration and other corporate costs, and patent related development, commercialization, research, consulting and maintenance costs.
A summary of the main drivers of the change in marketing, general and administrative expenses, including the impact of non-cash stock compensation charges, for the periods presented, is as follows (in thousands):
| | | For the Three Months | | | For the Six Months | |
| | | Ended June 30, | | | Ended June 30, | |
| | | 2008 vs. 2007 | | | 2008 vs. 2007 | |
| | | | | | | |
| Addition of licensing, business development and engineering personnel | | $ | 374 | | | $ | 1,200 | |
| One time employee severance charges | | | 231 | | | | (129 | ) |
| Foreign taxes paid on licensing fees | | | (6 | ) | | | (151 | ) |
| Business development and licensing related patent research and consulting costs | | | 202 | | | | 1,001 | |
| Corporate, general and administrative costs | | | 162 | | | | 348 | |
| Non-cash stock compensation expense | | | 794 | | | | 1,860 | |
| Consulting expenses paid to former CEO of Global Patent Holdings, LLC | | | - | | | | (74 | ) |
The net increase in marketing, general and administrative expense for the periods presented is reflective of the continued growth and expansion of our operating subsidiaries’ intellectual property acquisition, licensing and enforcement businesses and related ongoing operations.
Non-cash stock compensation charges increased during the three and six months ended June 30, 2008, as compared to the three and six months ended June 30, 2007, primarily due to the issuance of additional equity based incentive awards to new and existing employees since May 2007, in accordance with our ordinary stock based incentive compensation practices. The fluctuation also reflects an increase in the average fair value of equity based incentive awards expensed in each period. The average fair value of equity based incentive awards expensed was approximately $10.51 and $10.70, for the three and six months ended June 30, 2008, respectively, as compared to approximately $6.16 and $5.80 for the three and six months ended June 30, 2007, respectively. The fair value of restricted stock awards to be expensed over the applicable vesting period on a straight-line basis is determined by the product of the number of shares granted and the grant date market price of the underlying common stock.
Inventor Royalties and Contingent Legal Fees Expense. For the three and six months ended June 30, 2008, inventor royalties expenses were $2.2 million and $4.3 million, as compared to $1.6 million and $7.1 million for the three and six months ended June 30, 2007, respectively. Contingent legal fees expenses incurred during the three and six months ended June 30, 2008 were $1.9 million and $4.6 million, as compared to $1.8 million and $10.4 million during the three and six months ended June 30, 2007, respectively. Inventor royalties expenses and contingent legal fees expenses for the periods presented were incurred in connection with the recognition of the related license fee revenues, summarized above. The majority of the patent portfolios owned or controlled by our operating subsidiaries are subject to patent and patent rights agreements containing provisions granting to the original patent owner the right to receive inventor royalties based on future net revenues, as defined in the respective agreements, and may also be subject to contingent legal fee arrangements with external law firms engaged on a contingent fee basis. The economic terms of the inventor and contingent fee arrangements, if any, vary across our patent portfolios. As such, inventor royalties and contingent legal fee expenses fluctuate period to period based on the amount of revenues recognized each period and the mix of specific patent portfolios, with varying economic terms, generating revenues each period. The increase in inventor royalties expense and contingent legal fees expense for the three months ended June 30, 2008 and 2007 and the decrease in inventor royalties expense and contingent legal fees expense for the six months ended June 30, 2008 and 2007 primarily reflects the fluctuations in license fee revenues for same periods, as discussed above.
Legal Expense – Patents. Patent-related legal expenses include patent-related prosecution and enforcement costs incurred by outside law firms engaged on an hourly basis and the out-of-pocket expenses incurred by law firms engaged on a contingent fee basis. Patent-related legal expenses fluctuate from period to period based on patent enforcement and prosecution activity associated with ongoing licensing and enforcement programs and the timing of the commencement of new licensing and enforcement programs in each period. We expect patent-related legal expenses to continue to fluctuate quarter to quarter based on the factors summarized above, in connection with our current and future patent commercialization and enforcement programs.
Discontinued Operations – Split-off of CombiMatrix Corporation
In January 2006, Acacia Research Corporation’s board of directors approved a plan for its wholly owned subsidiary, CombiMatrix Corporation, to become an independent public company. On August 15, 2007 (the “Redemption Date”), CombiMatrix Corporation was split-off from Acacia Research Corporation through the redemption of all outstanding shares of AR-CombiMatrix common stock in exchange for the distribution of new shares of CombiMatrix Corporation, on a pro-rata basis, to the holders of AR-CombiMatrix stock as of the Redemption Date (the “Split-off Transaction”). Subsequent to the Redemption Date, Acacia Research Corporation no longer owns any equity interests in CombiMatrix Corporation and the two companies operate independently of each other.
As a result of the Split-off Transaction, we disposed of our investment in CombiMatrix Corporation, and therefore, in accordance with guidance set forth in SFAS No. 144, Acacia Research Corporation’s accompanying consolidated statements of operations and statements of cash flows for all historical periods presented reflect the results of operations and cash flows for CombiMatrix Corporation as discontinued operations. CombiMatrix Corporation was previously presented as a separate operating segment of Acacia Research Corporation under SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.”
Refer to Note 7 to the unaudited consolidated financial statements included elsewhere herein for information regarding the accounting for the Split-off Transaction and information regarding the revenues and pretax loss included in discontinued operations for the historical periods presented.
Inflation
Inflation has not had a significant impact on Acacia Research Corporation and or its subsidiaries.
Liquidity and Capital Resources
Acacia Research Corporation’s consolidated cash and cash equivalents and investments totaled $45.7 million at June 30, 2008, compared to $51.4 million at December 31, 2007. Working capital at June 30, 2008 was $40.9 million, compared to $48.1 million at December 31, 2007. The change in working capital primarily reflects the impact of cash flows used in continuing operating and investing activities, as discussed below. In addition, the change in working capital also reflects the reclass of $2.8 million (par value) of auction rate securities collateralized by student loans to noncurrent assets as of June 30, 2008, as discussed below.
The net increase (decrease) in cash and cash equivalents related to continuing operations for the periods presented was comprised of the following (in thousands):
| | | For the Six Months Ended | |
| | | June 30, 2008 | | | June 30, 2007 | |
| Net cash provided by (used in) continuing operations: | | | | | | |
| Operating activities | | $ | (3,882 | ) | | $ | 3,590 | |
| Investing activities | | | 4,330 | | | | (4,073 | ) |
| Financing activities | | | 142 | | | | 3,159 | |
Cash Flows from Continuing Operating Activities. Cash receipts from licensees for the six months ended June 30, 2008 decreased to $13.1 million, from $29.0 million in the comparable 2007 period, due to the decrease in license fee revenues, as discussed above. Cash outflows from operations for the six months ended June 30, 2008 decreased to $17.0 million, as compared to $25.1 million in the comparable 2007 period, due to the net decrease in operating expenses, as discussed above, and the impact of the timing of payments to inventors, attorneys and other vendors. Accounts receivable increased to $4.4 million at June 30, 2008, compared to $1.4 million at December 31, 2007.
Cash Flows from Continuing Investing Activities. The change in net cash flows used in investing activities was primarily due to net purchases and sales of available-for-sale investments in connection with ongoing short-term cash management activities during the periods presented. Net cash outflows from investing activities for the six months ended June 30, 2008 also included patent related acquisition costs totaling $1.7 million, as compared to $1.4 million in the comparable 2007 period.
Cash Flows from Continuing Financing Activities. Net cash flows provided by financing activities during the six months ended June 30, 2008 included proceeds from the exercise of Acacia Research Corporation common stock options totaling $142,000, as compared to $3.2 million for the comparable 2007 period.
Management believes that the cash and cash equivalent balances, investments, anticipated cash flow from operations and other external sources of available credit, will be sufficient to meet Acacia Research Corporation and its subsidiaries’ cash requirements through at least July 2009 and for the foreseeable future. We may however encounter unforeseen difficulties that may deplete our capital resources more rapidly than anticipated, including those set forth in Acacia Research Corporation’s Risk Factors on page 6 of our Annual Report on Form 10-K for the year ended December 31, 2007, filed with the SEC on March 14, 2008. Any efforts to seek additional funding could be made through equity, debt or other external financing; however there can be no assurance that additional funding will be available on favorable terms, if at all. If we fail to obtain additional funding when needed, we may not be able to execute our business plans and our business may suffer.
Auction Rate Securities. As of June 30, 2008, we held investment grade auction rate securities with a par value totaling $4.95 million. Our auction rate securities consist of high credit quality securities issued by closed-end investment companies with portfolio asset coverage of at least 200%, and auction rate investments backed by student loans, issued under programs such as the Federal Family Education Loan Program, all of which carry credit ratings of AAA. Auction rate securities are classified as available-for-sale securities and reflected at fair value in accordance with the requirements of SFAS No. 157.
Historically, our auction rate securities were recorded at cost, which approximated their fair market value due to their variable interest rates, which typically reset every 7 to 35 days, despite the long-term nature of their stated contractual maturities. The Dutch auction process that resets the applicable interest rate at predetermined calendar intervals is intended to provide liquidity to the holder of auction rate securities by matching buyers and sellers within a market context enabling the holder to gain immediate liquidity by selling such interests at par or rolling over their investment. If there is an imbalance between buyers and sellers, the risk of a failed auction exists. Due to recent liquidity issues in the global credit and capital markets, these securities experienced several failed auctions since February 2008. In such case of a failure, the auction rate securities continue to pay interest at the maximum rate in accordance with their terms; however, we may not be able to access the par value of the invested funds until a future auction of these investments is successful, the security is called by the issuer, or a buyer is found outside of the auction process.
As a result of the recent failed auctions, there are no reliable current observable market prices available for these securities for purposes of establishing fair market value as of June 30, 2008. As a result, the fair values of these securities are estimated utilizing an analysis of certain unobservable inputs and by reference to a discounted cash flow analysis as of June 30, 2008. These analyses considered, among other items, the underlying structure of each security, the collateral underlying the security investments, the creditworthiness of the counterparty, the present value of future principal and contractual interest payments discounted at rates considered to be reflective of current market conditions, consideration of the probabilities of default, continued auction failure, or repurchase or redemption at par for each period, and estimates of the time period over which liquidity related issues will be resolved. Observable market data for instruments with similar characteristics to our auction rate securities was also considered when possible.
At June 30, 2008, the par value of auction rate securities collateralized by student loan portfolios totaled $2.8 million. As a result of the liquidity issues associated with the failed auctions, we estimate that the fair value of these auction rate securities no longer approximates their par value. Due to the estimate that the market for these student loan collateralized instruments may take in excess of twelve months to fully recover, we have classified these investments as noncurrent in the accompanying June 30, 2008 unaudited Consolidated Balance Sheet. In addition, as a result of the analysis described above and the estimate that it will take in excess of twelve months for the market for student loan collateralized instruments to recover, we recorded an other-than-temporary loss of $263,000 in the accompanying unaudited statements of operations for the six months ended June 30, 2008, for our student loan collateralized instruments,. The balance of our auction rate securities, with a par value totaling $2.15 million, are issued by high credit quality closed-end investment companies, for which the market has recently had a number of successful auctions and or redemptions at par value. Management believes that the fair value of our auction rate securities issued by closed-end investment companies continue to approximate their par value and are appropriately classified as current assets in the accompanying consolidated balance sheet as of June 30, 2008.
We will continue to monitor and evaluate our investments in auction rate securities for any further reduction in liquidity and potential impairment in future periods. If it is determined that any future valuation adjustments are other-than-temporary, we would record additional charges to earnings as appropriate. Any future fluctuation in fair value related to these instruments that are deemed to be temporary, would be recorded to accumulated other comprehensive income.
Off-Balance Sheet Arrangements
We have not entered into off-balance sheet financing arrangements, other than operating leases. We have no significant commitments for capital expenditures in 2008. We have no committed lines of credit or other committed funding or long-term debt. The following table lists our material known future cash commitments as of June 30, 2008:
| | | Payments Due by Period (in thousands) | |
| Contractual Obligations | | | | | Remaining | | | | | | | | | | | | | | | 2013 and | |
| | Total | | | 2008 | | | 2009 | | | 2010 | | | 2011 | | | 2012 | | | Thereafter | |
| Operating leases | | | $3,345 | | | | $363 | | | | $903 | | | | $939 | | | | $977 | | | | $163 | | | | $ - | |
| Total contractual cash obligations | | | $3,345 | | | | $363 | | | | $903 | | | | $939 | | | | $977 | | | | $163 | | | | $ - | |
FIN 48 Liability. As of June 30, 2008, the liability for uncertain tax positions, associated primarily with state income taxes, was $72,000, of which none is expected to be paid within one year. The liability for uncertain tax positions is recorded in other long-term liabilities in the consolidated balance sheet.
Recent Accounting Pronouncements
Refer to Note 2 and Note 8 to the Acacia Research Corporation consolidated financial statements included in Part I, Item 1 of this report.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary objective of our investment activities is to preserve principal while concurrently maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we may invest in may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the current value of the principal amount of our investment will decline. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, high-grade corporate bonds, government and non-government debt securities and certificates of deposit. In general, money market funds are not subject to market risk because the interest paid on such funds fluctuates with the prevailing interest rate. As of June 30, 2008, our investments were comprised of money market funds and auction rate securities. A hypothetical 100 basis point increase in interest rates would not have a material impact on the fair value of our available-for-sale securities as of June 30, 2008. Refer to Part II. Item 1A. “Risk Factors,” Part I. Item 2. “Liquidity and Capital Resources,” and Note 8 to the Acacia Research Corporation consolidated financial statements included in this report for additional information.
Item 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
(a) Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our principal executive officer and our principal financial officer concluded that, as of the end of the period covered by this quarterly report, our disclosure controls and procedures were effective to ensure that the information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to management, including our chief executive officer and chief financial officer, to allow timely decisions regarding required disclosure, and that such information is recorded, processed, summarized and reported within the time periods prescribed by the SEC.
Changes in Internal Controls
(b) There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter (the quarter ended June 30, 2008) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II--OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Refer to Note 6 to the Acacia Research Corporation consolidated financial statements, contained in Part I, Item 1 of this report, and hereby incorporated by reference.
Item 1A. RISK FACTORS
Our annual report on Form 10-K for the year ended December 31, 2007, filed with the Securities and Exchange Commission on March 14, 2008, contains a full discussion of our risk factors. There have been no material changes to the risk factors disclosed in our Form 10-K for the year ended December 31, 2007, except for the risk factor set forth below.
OUR INVESTMENTS IN AUCTION RATE SECURITIES ARE SUBJECT TO RISKS, INCLUDING THE CONTINUED FAILURE OF FUTURE AUCTIONS, WHICH MAY CAUSE US TO INCUR LOSSES OR HAVE REDUCED LIQUIDITY.
At June 30, 2008, our investments in marketable securities include certain auction rate securities. Our auction rate securities are investment grade quality and were in compliance with our investment policy when purchased. Historically, our auction rate securities were recorded at cost, which approximated their fair market value due to their variable interest rates, which typically reset every 7 to 35 days, despite the long-term nature of their stated contractual maturities. The Dutch auction process that resets the applicable interest rate at predetermined calendar intervals is intended to provide liquidity to the holder of auction rate securities by matching buyers and sellers within a market context enabling the holder to gain immediate liquidity by selling such interests at par or rolling over their investment. If there is an imbalance between buyers and sellers the risk of a failed auction exists. Due to recent liquidity issues in the global credit and capital markets, these securities experienced several failed auctions since February 2008. In such case of a failure, the auction rate securities continue to pay interest, at the maximum rate, in accordance with their terms, however, we may not be able to access the par value of the invested funds until a future auction of these investments is successful, the security is called by the issuer or a buyer is found outside of the auction process.
At June 30, 2008, the par value of auction rate securities collateralized by student loan portfolios totaled $2.8 million. As a result of the liquidity issues associated with the failed auctions, we estimate that the fair value of these auction rate securities no longer approximates their par value. Due to the estimate that the market for these student loan collateralized instruments may take in excess of twelve months to fully recover, we have classified these investments as noncurrent in the accompanying June 30, 2008 unaudited Consolidated Balance Sheet. In addition, as a result of our analysis of the estimated fair value of our student loan collateralized instruments, as described at Note 8 to the consolidated financial statements included elsewhere herein, and the estimate that it will take in excess of twelve months for the market for student loan collateralized instruments to recover, we have recorded an other-than-temporary loss of $263,000 for our student loan collateralized instruments in the accompanying unaudited consolidated statements of operations for the six months ended June 30, 2008. The balance of our auction rate securities, with a par value totaling $2.15 million, are issued by high credit quality closed-end investment companies, for which the market has recently had a number of successful auctions and or redemptions at par value. Management believes that the fair value of our auction rate securities issued by closed-end investment companies continue to approximate their par value and are appropriately classified as current assets in the accompanying consolidated balance sheet as of June 30, 2008.
Given the deteriorating credit markets, and the increased incidence of failure within the auction market since February 2008, there can be no assurance as to when we would be able to liquidate a particular issue. Furthermore, if these market conditions were to persist despite our ability to hold such investments until maturity, we may be required to record an impairment charge in a future period. The systemic failure of future auctions for auction rate securities may result in a loss of liquidity, substantial impairment to our investments, realization of substantial future losses, or a complete loss of the investment in the long-term which may have a material adverse effect on our business, results of operations, liquidity, and financial condition. Refer to Note 8 in our accompanying Consolidated Financial Statements for additional information about our investments in auction rate securities and the implementation of SFAS No. 157, Fair Value Measurements.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our annual meeting of stockholders on May 20, 2008 in Newport Beach, California.
(i) At the annual meeting, the following persons were elected directors for a three-year term ending in 2011 based on the voting results below:
| Name | For | Withheld |
| Edward W. Frykman | 20,340,929 | 1,185,719 |
| William S. Anderson | 20,932,008 | 594,640 |
The following persons’ terms as directors continued after the annual meeting and end in 2009: Paul R. Ryan, and G. Louis Graziadio.
The following persons' terms as directors continued after the annual meeting and end in 2010: Robert L. Harris, II and Fred A. deBoom
(ii) The stockholders approved the amendment and restatement of the Company’s Certificate of Incorporation to eliminate references to Acacia Research-CombiMatrix common stock (“AR-CombiMatrix stock”) and all provisions relating to the rights and obligations pursuant to the AR-CombiMatrix stock. As a result, the name of Acacia Research-Acacia Technologies stock changed to common stock, and it is the only class of common stock of Acacia Research Corporation outstanding.
| For | Against | Abstain |
| 21,228,244 | 288,221 | 10,183 |
(iii ) The stockholders also ratified the appointment of Grant Thornton LLP as our independent registered public accounting firm for the fiscal year ending December 31, 2008. The voting results were as follows:
| For | Against | Abstain |
| 21,384,700 | 132,630 | 9,318 |
Item 6. EXHIBITS
| 3.1 | Amended and Restated Certificate of Incorporation filed with the California Secretary of State on June 3, 2008 (1) |
| 31.1 | Certifications of the Chief Executive Officer provided pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934 |
| 31.2 | Certifications of the Chief Financial Officer provided pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934 |
| 32.1 | Certifications of the Chief Executive Officer provided pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350 |
| 32.2 | Certifications of the Chief Financial Officer provided pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350 |
___________________
| | (1) | Incorporated by reference to Acacia Research Corporation’s Report on Form 8-K filed with the SEC on June 5, 2008 (SEC File No. 000-026068). |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | ACACIA RESEARCH CORPORATION | |
| | | | |
| | | | |
| | By: | /s/ Paul R. Ryan | |
| | | Paul R. Ryan Chief Executive Officer (Authorized Signatory) | |
| | | |
| | | | |
| | By: | /s/ Clayton J. Haynes | |
| | | Clayton J. Haynes Chief Financial Officer /Treasurer (Principal Financial Officer) | |
Date: July 30, 2008
EXHIBIT INDEX
EXHIBIT NUMBER | EXHIBIT |
| | |
| 3.1 | Amended and Restated Certificate of Incorporation filed with the California Secretary of State on June 3, 2008 (1) |
| 31.1 | Certifications of the Chief Executive Officer provided pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934 |
| 31.2 | Certifications of the Chief Financial Officer provided pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934 |
| 32.1 | Certifications of the Chief Executive Officer provided pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350 |
| 32.2 | Certifications of the Chief Financial Officer provided pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350 |
___________________
| | (1) | Incorporated by reference to Acacia Research Corporation’s Report on Form 8-K filed with the SEC on June 5, 2008 (SEC File No. 000-026068). |
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