Joe Lambert – Director of Marketing, Singular Research
Rob Stewart – SVP and Corporate Finance
Acacia Research Corporation (ACTG) Singular Research Annual “Best of the Uncovereds” Conference Transcript September 10, 2009 9:00 AM ET
Well, good morning once again. My name is Joe Lambert with Singular Research. We have our second presentation this morning with Acacia Research Corporation. I would like to remind you that right after this session, Acacia will have their one-on-one session back in a breakout room that is just down, off to the side. You won’t want to miss our cocktail hour because many of the CEOs that are presenting here today will be at that hour so you can network and get to know some more in more detail at 5:30. And thanks to the sponsorship of Vandham Securities and Frank Angelilli.
With that, I would like to introduce Acacia Research. Our analyst writes this in the latest report of Acacia Research. Their second quarter results fell short of our estimates, but Acacia continues to build momentum through the addition of new patent portfolios, license agreements, and positive legal outcomes. We continue to rate the shares with a Buy and increase our price target to $12. Our analyst puts a price target of $12 on Acacia Research. And today we have with us, presenting for Acacia, Rob Stewart. Thank you, Rob.
Thank you, Joe. Again, I’m Rob Steward from Acacia and want to thank Singular for having us. Singular has been covering us for a couple of years, and when they started covering us, we were a very young company. I’d still classify us as a young company growing a handful of patents and not a lot of revenue. Right now, we have about $60 million in trailing 12-month revenue. And I think when they started covering us, we were maybe doing $4 million or $5 million. So I want to thank you for all of your support.
Acacia is a leader in patent licensing. We are the only public company that is doing this. We are basically an outsourced patent licensing group for small and mid-sized technology companies, research labs, universities, things like that. For example, Los Angeles, we have a partnership with (inaudible) Hospital. They develop and innovate a lot of technologies that they don’t have the wherewithal the capabilities to license that. So we do their licensing for them and a multitude of other people like that.
Last month, we actually did our first partnership with one of the largest, I don’t know, ten global consumer electronics companies. So we are now actually partnering with large corporations to help them a lot to monetize and generate revenue from their patent portfolios. We are certainly a huge market. We will get to that in a minute. But it’s a $500 billion a year industry. As Joe said, we are now up over 100 -- I believe, over 120 now different partnerships and patent portfolios of different technologies. We have great earnings leverage. We have fixed cost and no cost of goods sold. So each dollar after we go through cash flow break even or EPS, all falls to the bottom line.
As I mentioned, we have record 12-month trailing revenue close to $60 million. We have $59 million in cash, no debt. We are all common. There is no warrants; there is no preferreds; real clean, simple balance sheet. And another nice thing is we have no direct competition. And I’d also like to add that even in these troubling times in the economy, it’s actually a great windfall for us in a couple areas.
One, as companies are struggling with either the debt market, the equity market, they have monetized their tangible side of balance sheets through sale-leasebacks, treasury, inventory, et cetera. They now have to look to their intangibles, of which intellectual property patent copyrights are a huge part. So we are seeing more and more companies coming to us with their intellectual property patent and wanting us to help them monetize that. And again, no direct competition. So it’s a great place to be.
As I mentioned, this shows you the growth of IP licensing, patent licensing in the US. It’s a big business and it continues to grow. I think this slide is important, again, to understand the macro side of this. And again I think this is where Singular kind of picked up and they saw us when we were developing this business strategy and we went up. American IP sector had a net balance of over $57 billion for trade account 2007. Without the IP surplus, American trade deficit in 2007 would have totaled well over $0.5 trillion. It’s a huge export for the US.
If you think about it, take a company that we all know, like a Qualcomm. They are exporting intellectual property patents across both oceans to the Nokias and Samsung, and the country who are importing the finished product in the form of handsets and cell phones. But that’s what we do. SanDisk is a similar thing. We are exporting intellectual property and we are importing low-margin chips for that.
Again (Audio Gap).
Okay. Sorry for the interruption. Sometime we had a technical difficult, but we are back on line with our webcast. And continuing the remarks with us is Rob Stewart, Acacia Research.
There we go. So anyway, again as I was saying [ph], intellectual property patent licensing is a large part of the US economy and the world economy. I think a lot of people are starting to realize how valuable it is. And technology, we see, looking more and more like pharma. When pharma buys a biotech company, they are buying the patents. They are not buying the sales, marketing, distribution, and manufacturing. They are buying the IP. And similar is taking place in the US in the technology market.
Hey, Joe? There we go. This slide really represents the opportunities that Acacia has. If you look at the pie chart on the left, you can see 60% of the patents in the technology space are owned by small companies, research labs, universities, et cetera. 40% is owned by the large corporations. If you look at the pie chart on the right side, you can see they get paid. The guys of the minority of the IP generate over 99% of the licensing revenue. They know how to get paid. The little guys don’t. And so what our opportunity is, is to partner with the guys, the 60%, and try and increase that little sliver to anything north of 1%. And meanwhile that pie is growing at the same time. So this really represents, I think, in large part the opportunity that we have.
We have a really unique business model. And I think that’s one of the things that Singular really came to us in the beginning and saw [ph]. Our typical view is we partner with the patent owner, the company, 50/50.on a revenue share -- net revenue share. And for that, we don’t pay anything for it. So if you think about it, we are acquiring 50% of the economics at zero cost. So we don’t need a lot of capital.
In the case where you need to go into contingency and legal, that can be expensive and risky. We won’t take one of these portfolios on unless we have one of the top law firms in the country that has [ph] full contingency. So acquiring the assets at zero cost and with expensive risky partners and litigation, we are partnering with the law firm on that. So if you look at it on margins, typically 20% goes to law firm and then we split 50/50 thereafter; 40% to the patent owner and 40% to us.
We have been having a margin expansion. Last quarter, we were about 48%. And how do you do that? You did it either, A, getting deals done quicker, we have not paying the law firm or paying the law firm less; or B, a lot of times we are using our cash to buy down the back end. So maybe we will go from 50/50 to 60/40, 70/30, et cetera, et cetera, et cetera.
Profitability at 40% margins, that’s where we kind of guide the Street, although we have been higher than that consistently. It’s about 14 million a quarter will bring us the positive cash flow and about $19 million will take us to the EPS. And the difference is the non-cash charges we acquired in 2005, the only real competitor we had, and then we have been attracting talent from a lot of large corporations in this via stock compensation. So those are the two primary reasons.
So we are -- right now, we went [ph] through the last couple of years on a cash flow positive and we think we are pretty much right there on the cusp of going into EPS positive. This really shows you, I think, the growth of our business. And this is with the real economic driver. These are the number of patent portfolios or partnerships we have. And again, I think when Singular started covering us, we only had a handful. We are now up over 120. If you look at us like an analogy of an oil company, this is us getting reserves. We continue to add reserves. And these are net numbers. So if a reserve or a patent portfolio expires, we monetize it. That will come off. So we are going net positive quarter-over-quarter.
This next slide shows you the number of these portfolios that begin to monetize. So 55 of that 120 have now begun to generate revenue. And every quarter that goes by, where we have been adding more and more portfolios in revenue, this increases our revenue and also diversifies it. Of these 55, we probably only monetize a small percentage of the opportunity. And again, if you stop bringing in assets today, you can see that this thing over the next several years will probably grow to over 100.
And then lastly, the important thing is if you can find the assets, that’s one thing. If you can monetize the assets, that’s another thing. Does it generate cash? And are these -- again using the oil analogy, are you making money out of these reserves that you can’t put it out [ph]? And this shows you our trailing 12-month revenue. Again, I think when Singular first started talking to us, we were doing about $4 million, $5 million a year max.
So we’ve had some really good revenue growth and that’s added to our cash position. Again, we are still, I would say, at very early stages of this industry, of this asset class, and as a company. And as a new company, we really started earning [ph] in the beginning of ’05. So here we are almost five years -- 4.5 years old and growing cash and assets where you grow business.
This represents a licensee. Most -- we have licensed most major technology companies, most companies. You can see here the 3Ms, A&D, Boston Scientific, Sharp, Sony, on and on. And a lot of these people we have licensed multiple of the times. And again, some of these people we have, actually they are talking to us about helping them monetize their IP.
What technology are we in? We are in -- gosh, we are very horizontal unlike a Qualcomm or InterDigital or Rambus. They are vertical. They are -- couple of people I think [ph] are miles deep. We are miles wide. We are in cell phone. We do a lot of stuff on wireless. As you can see here, lot of consumer electronics, software, database, lot of chipsets, semiconductors, medical imaging. That’s a new kind of area for us. We don’t do any biotech or pharma compounds, but we do do med devices and things like that. Here are some more online ad tracking, peer-to-peer communications. You kind of see through that and see some of the ones that we have.
In summary, again I think we are building a leading US patent licensing company. We are serving a very large and unmet need in the market. We have substantial growth, both as a company and I think as an asset class (inaudible). Chip Harris, our President, often said, I’ve been reading the Wall Street Journal for 30 years and I haven’t read anything about patents or IP in the last -- for the first 25 of these 30 years, and you can barely pick up the journal now, at least weekly if not daily, with something about IP use. A big article this week in the journal about Microsoft buying Silicon graphics IP to buy the Open Source guy. So it’s a very important asset class, and I think we are right in the middle of the growth of this asset class.
Again, I think we have great earnings leverage in our business model, no cost of goods sold, not a lot of CapEx, no real need for capital. Our asset base of new portfolios continues to grow, and we are still at the very, very early stages of the company and the asset class.
And I want to thank you for having us. Any questions, feel free. Yes.
I’m new to the story, so pardon my question. You seem to have a very (inaudible) cost structure and how come it is that you can’t generate a free cash flow positive now? Do you have like a bunch of fixed costs out there that you just can’t get rid of it (inaudible) money?
Yes. The question is, how come we are not generating -- we are generating cash. How come we are not in EPS and do we have a lot of fixed costs? And the answer is yes, we do have fixed costs. We have about 44 employees, a lot of engineers, attorneys, patent attorneys, license attorneys. So that’s our expense and rent. But the additional cost of goods sold is variable. In other words, we don’t have to pay law firms unless the revenue comes in the door. We don’t have to share revenue with the patent owner unless revenue comes in the door. So we are yet to go build a pretty sizable infrastructure to go through this. This stuff is not easy. It’s -- 97%, 96% of the patents are worthless. So we got (inaudible) thousands of these a year to go find the ones that have value. And then you got to do reverse engineering. You got to figure out there is infringement, claims construction, and see if you can buy that. So we’ve got a fixed cost. That’s a kind of our fixed cost that we have to break through. But then after that, any additional cost is variable based on revenue.
So with the 125 different patents that you have now in the portfolio, I mean, is that something that you can’t be EPS positive no matter how much --?
Oh, no, we -- we can do that. Right? Of those 125, we have probably only monetized out of that 10%, 20% of the economics maybe. I mean, the 50 -- 60, 70 of them, we haven’t generated a penny yet. It usually takes us 18 months from once we bring in a portfolio to when it starts generating revenue. It kind of generates revenue on about two to five-year, six-year basis. So again, we are very early on. We’ve gone from $0.5 million in revenue in ’04 to $60 million trailing 12-month as of right now. So we are still, again, very early on.
And to put another context, if you will, in the history of the company, you’re not going to get any real big money unless you’ve got a court aid [ph]. You’re going to trial. There is no one who is going to pay you and go through the economics if you want it, why they won’t, whether it’s Qualcomm, Broadcom, Microsoft, whoever. So in the history of the company, I think we’ve had about five or so trial days. In the next -- starting the end of this year through the end of next year, I think we have 16 or 17. And so -- you know, just going back couple of years ago, we only were generating revenue out of -- go back to this time in ’07, we only had 25. About two years ago, we had 25 portfolios generating revenue. Now we have 55. And next year, if we continue on this similar path, this 55 should go to 65, 70, 80, 100.
I guess what I’m driving at to is that if you have now 200 patents, is your fixed cost going to go to the point now where -- it seems like it’s always been that way. I’m just wondering at what point this is kind of current [ph] so that your EPS starts growing up positive?
Right. The question is, when will our EPS starts growing up? I think that’s the inflection point we are at now. On fixed costs, we are the same today as it was back when we were doing a lot less revenue. We are losing -- we were making cash, but losing more on an EPS basis. So we think we can grow -- probably grow this business to 50%, 100% without changing any of our fixed costs because all the work is really done in the front end. Once you bring the portfolio in and do all the heavy lifting, it’s really more maintenance as it goes through. So you can continue to add these things. So I think that’s where we are and that’s what we’re excited about. We’ve broken through the last eight quarters into cash flow positive and then now we can [ph] go to be EPS positive. If we keep these costs fixed, which is what we will do or believe that we will do, then we can sort of really start to get that positive leverage in that EPS. Yes.
Elaborate a little bit on the structure of the ownership (inaudible) who your biggest shareholder is.
The ownership structure and who our biggest shareholder is. Our largest shareholder is Apex, which is a fund out of San Francisco. I think number two is Fidelity. We saw them in town here. They added some more shares this quarter. Kingdon Capital, here in New York; Columbia, out of D.C. So we are also transitioning more to -- I would call, more traditional mutual funds, long only [ph] investors, very fortunate. I think we have -- we haven’t had a lot of turnover in our shareholder base even through these tumultuous times. Lot of the little guys, retail guys kind of went by the way (inaudible) we like everybody else got a lot of our stocks flushed out. It’s with probably 60%, 70% institutionally owned. Management owns a pretty good chunk. The management also in the last year bought a lot of stock in the open market. Yes, sir.
The question is this. We are sitting on 120 portfolios. Are we looking for more? Absolutely. That’s where we generate value for the company and the shareholders. We have an entire business development team actually in town right now going to all these conferences, talking to CFOs, CEOs. When we started this, we found all of it ourselves. We do what we call patent mining. The patents, they are public information. USPTO, you can search, you can do a word search or technology search, and we can just go through and look for areas that we really like and think exciting [ph]. I would say now the majority of that comes to us.
You see distressed asset sales, bankruptcies, re-orgs. We have been doing a lot there with these small companies, investment banks. A lot of our shareholders call and say, hey, we know this company. They got to monetize their IP. Hence we are gaining higher and higher profile, and as our success is growing, we are getting more and more people just coming to us to monetize it. So (inaudible) visibility and patent mining, so we do both. Any other questions?
I’m going to take a moment -- I'll take just a moment. I’m going to open the lines for questions from our webcast here if you’ll bear with me. Okay. At this time, the lines are open. If you would like a question to ask Rob at this time for the webcast, please feel free to ask it. You are live. And until that question comes in, I’ll pause for just a moment to see if there are any questions from the webcast.
Okay. I would like to point your attention to a couple of things here. First off, the Singular Research has a report on Acacia, and the first page of it is out there on the table. But I will mention that the revenue forecast from our analyst, and it’s Jeremy Hellman, who will be here probably later today. And -- he is one of our senior analysts. But anyhow, his revenue projections for 2009 estimate, $64.2 million estimate. And actually they are on the rate right now, $67.8 million, so little bit higher on revenues than projected. In 2010, the estimate that he has right now is $93.5 million. That’s about a 45.6% projected revenue growth here, and certainly looking at this year on turning earnings to positive. So I wanted to mention a couple of those things. And again, our price target for Acacia is $12. Are there any other questions before we adjourn and --?
Okay. Right now, I would like to thank very much Rob for joining us, and I will mention that he will have his breakout session for one-on-one starting now in Madison One. And then in about 25 minutes, we will begin with our next presentation, which will be Graham Corporation. So that presentation will begin approximately in 25, 30 minutes. Thank you very much, Rob, and appreciate your time.
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