Acacia Research (ACTG) reported its 2012 second quarter earnings last month, detailed in a previous report -A Tale Of 2 Quarters - Acacia Research Illustrates Patent Play Volatility. Negative volatility in Acacia shares around the second quarter earnings report surprised the company, which CEO Paul Ryan revealed to me during a private telephone conversation. Ryan requested a brief phone call with me after reading the earlier-referenced analysis of Acacia's quarter. During our conversation, Ryan offered his take on relevant performance metrics for Acacia's unique business model and explained why he thinks Acacia's future outlook is particularly bright.
Acacia's stock plunged below $25 per share after trading as high as $40 in the previous month, "which surprised us ... given that we had such an exceptional quarter based on what we consider our key performance metrics which are basically trailing revenues, profitability and new portfolios coming in the door," explained Ryan. As to those performance metrics, Ryan stressed that revenues are up 50% year over year, and profits by 172%, and "intake of new portfolios which really drives future performance of the company are up nearly 200%." Meanwhile, Ryan cautions that average deal size and concentrations of revenue historically lack predictive value for the company's performance.
Ryan correctly points out that average deal size is really a function of which portfolios are licensed during the quarter, and the size of the companies that Acacia is licensing. Acacia's partnership model plays a role in artificially diminishing deal size. "It's our obligation to abate all infringement," says Ryan, referring to the company's primary business model of partnering with patent owners to outsource patent licensing and split profits 50/50. If Acacia must license everybody, then such an obligation necessarily includes both large companies as well as smaller companies that inevitably pay less.
What's more, Ryan claims that the company actually likes concentrated revenues. Generally, those concentrations stem from larger companies "catching up" and negotiating licenses for multiple portfolios simultaneously. According to Ryan, "When we do larger transactions with multiple settlements at one time, some people tend to put them in a separate group." In effect, Ryan explains that the concentrated phenomenon is merely regular licensing. Some companies, according to Ryan, may not focus until Acacia brings forward multiple licensing matters, and then the licensing executives simultaneously negotiate separate deals, and the revenue all arrives in one quarter. "From a reporting standpoint, it becomes a concentration of revenue. To us, it makes no discernible difference," Ryan explained. Historically, Ryan said it was not uncommon for Acacia to experience revenue concentrations accounting for two thirds of revenue or more in any given quarter.
Continuing, Ryan provides a timely example: "We did, in the last quarter, to certain companies, four or five licenses, and we got that all in one quarter as opposed to having it come in four different quarters." Acacia issued a press release summarizing it's earnings, and revealing that Cisco (CSCO) entered agreements with Acacia and some of its subsidiaries "to resolve pending patent matters," including a list of four specific subsidiaries: Lambda Optical Solutions LLC, Teleconference Systems LLC, Video Streaming Solutions LLC, and Unified Messaging Solutions LLC. The revelation led to much speculation identifying Cisco as the likely company responsible for the $36 M revenue concentration. JPMorgan research analysts reportedly reached a similar conclusion.
Regarding reasons why revenue concentrations should not worry investors, Ryan points to the overall purpose of the reporting requirement: to track ongoing concentrations of revenue. In Acacia's case, concentrations during each quarter stem from different licensing customers. Obviously, confidentiality obligations prevent Acacia from disclosing customer identity with respect to concentrated revenue. However, Acacia likely can, and probably should, disclose some information to make investors more comfortable with large revenue concentrations. For example, for each quarter that Acacia reports a revenue concentration, it could disclose whether that same customer accounted for a concentration of revenue in the previous quarter or at any other time during the previous year.
Of course, knowing that certain companies prefer to wait for opportunities to resolve multiple matters simultaneously, Acacia could take measures to speed up the revenue generating process by re-organizing it's approach. IP licensing at Acacia, generally speaking, is vertically integrated. Each new acquired asset is placed in a separate legal entity (typically an LLC), and a licensing manager is tasked with the responsibility to license that particular portfolio--both for the benefit of Acacia and the IP partner who contributed the asset. However, by examining Acacia's overall portfolio horizontally, a licensing customer-focused agent could instead study potential licensees like Cisco, learn what technologies the customer relies on, and then identify and coordinate an approach with all of the assets relevant to the customer.
Ryan explains that, although customers tend to focus on resolving all potential matters, Acacia looks at each portfolio individually, and each IP owner is independently represented on a singular basis. Further, Ryan reveals that, Acacia has "had cases where we attempted to do that, and only 2 or 3 out of 4 or 5 matters were settled" while the others continue in litigation.
Regardless of strategy, however, Ryan explains that "the desire, increasingly as we continue to scale the company, is for both sides to try to minimize unnecessary friction costs." Ryan credits his company's growth and scale, more than specific approach strategies, with making recent inroads in improving margins.
As we've scaled, a lot of companies who were hoping we would become exhausted financially ... realize we're here to stay and that we also have developed a network of lawfirms that are sharing the burden in litigation, and therefore the strategy of trying to basically bleed us out of money is not effective. And they look at their own cost structure and decide to engage on a smarter, more efficient basis. ... We're setting up a variety of vehicles with large companies to resolve [licensing matters] and try to minimize unnecessary friction costs.
Ryan credits friction cost reduction with generating the higher margins Acacia experienced recently. Acacia's size and experience helps it negotiate licenses more quickly, and in some cases without litigation, which, according to Ryan, improves margins and benefits both IP partners and shareholders. On the future outlook of Acacia, Ryan adds, "We're hoping that's a trend that continues."