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Acacia Research Corporation (NASDAQ:ACTG)

Q2 2008 Earnings Call

July 24, 2008 4:30 pm ET

Executives

Paul Ryan – Chairman and Chief Executive Officer

Clayton Haynes – Senior Vice President and Chief Financial Officer

Analysts

Bennett Notman - Davenport & Company Llc.

Pat Galvan - Private Investor

Rengan Rajaratnam - Galleon Group

Rob Ammann - RK Capital

Operator

Welcome to the Acacia Research second quarter earnings release conference call. (Operator Instructions) I will now turn the conference over to Paul Ryan.

Paul Ryan

Today's call may involve what the SEC considers to be forward-looking statements. Please refer to our 8-K which was filed with the SEC today for our forward-looking statement disclaimer. With us today are Chip Harris, President of Acacia; Dooyong Lee, Executive Vice President; and Clayton Haynes, our Chief Financial Officer.

Today I will give you an overview of the progress we are making in building the business and Clayton Haynes will provide with an analysis of our financial results. We will then open the call for questions.

As we just reported, Acacia’s second quarter revenues were $7.1 million compared to $5.9 million in the year ago period. Trailing12 month revenues were $37.7 million compared $46.8 million in the year ago period. In the second quarter, Acacia subsidiaries entered into 16 new licensing agreements covering 11 different licensing programs including initial revenues from three new licensing programs. Acacia also acquired control of six new patent portfolios for future licensing and we now have generated revenues from 36 different licensing programs and control 95 patent portfolios. Our cash, cash equivalents, and investments totaled $45.7 million at the end of the second quarter compared to $46.1 million in the prior quarter.

As we stated in our earnings release, Acacia’s long-term revenue growth potential continues to increase based on several patented technologies which could commence generating revenues over the next year as well as growth in our existing licensing programs. As we have previously stated the timing of our revenue generation can vary and quarterly revenues are therefore likely to remain uneven. With $16.2 million in revenues in the first half of 2008, it is possible that we may not generate revenue growth this year over the $52.6 million recorded in 2007. We are confident in the revenue potential of our patent portfolios while recognizing that it is difficult to estimate the timing of completing negotiated licensing agreements. Often, these licensing negotiations take place with the back drop of a court calendar and the timing or events in the court system or subject to change and in turn impact the timing of negotiations and resulting licensing agreements.

Our business outlook is very positive. The licensing success that we have achieved in negotiating over 570 licensing agreements and generating over $150 million on licensing revenues combined with the scale that we have achieved in acquiring control of 95 patent portfolios is enhancing our position in the marketplace and increasing our opportunities for strategic initiatives.

Acacia has a significant number of newer portfolios that we have not discussed on prior calls and that will be contributing into our revenue growth. Some have just begun to generate revenues and other should begin generating revenues over the next year.

Today, I though it would be helpful to briefly describe just a few of these patented technologies, to demonstrate while we are so positive in our business outlook. First, I would like to describe five of our medical technology portfolios which should help drive our revenues over the next couple of years. Our picture archiving and communication systems technology relates to progressive downloading used in medical system called “PACS” that enable multiple remote users to simultaneously access image data from remote display terminals and are commonly used by hospitals to transmit patient image data to multiple locations. We signed our first license for the PACS technology with Siemens in the second quarter.

Next, our medical monitoring and medical image stabilization technologies: These were both developed by a leading hospital research group. The medical monitoring detects patient’s statistics or lab results such as vital signs or blood tests which are outside specified range and automatically pages medical personnel. And the medical image stabilization technology can be used in stabilizing medical images for procedures such as catheter stabs for visualization of arterial lesions. We anticipate completing initial licensing agreements for these technologies this year.

Our Heated Surgical Blades technology relates to surgical instruments that are heated to reduce bleeding and are widely used in a variety of surgeries. They are commonly known as the “Shaw Blade,” names after Dr. Shaw, the inventor who we partnered with. We have just commenced this licensing program. Our surgical catheter technology relates to surgical devices that are used to access the circulatory system and are used in cardiology and other surgical procedures. Again, we anticipate completing initial licensing agreements for this portfolio this year.

Moving to the non-medical tech portfolios, our remote management of imaging devices technology relates to systems and methods that provide remote control and monitoring of network image devices such as copiers, printers, and fax machines. As you may be aware, we have started our licensing program this year and have completed five initial licenses including agreements with Toshiba, Matsushita, and its affiliate Panasonic Corporation of North America. This technology has very broad licensing opportunities to copiers, printer, and fax manufacturers.

Our Telematics technology relates to displaying mobile vehicle information on a map. This technology can be used in navigation and fleet management systems that combine wireless communications with GPS tracking and map displays. We commenced this licensing program in the past year and completed seven initial licenses to-date including agreements with UPS and [NetRoad].

Next, our Computer Memory Cache Coherency Technology which relates to interface circuits used by intelligent peripheral devices with cache memory to communicate with the main computer memory. By synchronizing main computer memory and main cache memory, peripheral devices such as graphics processors can operate at much higher speeds, without costs associated with their own memory. This technology can be used in desktop, notebook, and server computer systems. We are currently awaiting the outcome of a motion for summary judgment and to build a trial shortly with Intel Invia.

Next, our Compiler Technology: This patented technology generally relates to software object pre-compilation and linking in software compilers. The technology may be used in the development of application software such as operating systems, business software, video games, Internet commerce, and enterprise software. This technology has broad significant licensing opportunities.

Our Database Access Technology: This patented technology generally facilitates smoother interoperation between databases and applications and can be deployed in a variety of markets including ecommerce, healthcare, telecom, and finance. We have just commenced our licensing and enforcement efforts and we have initiated litigation with ORACLE. This technology is widely used in the market could be a major revenue producer.

Next, our Ecommerce Pricing technology: This technology generally relates to transacting business over a network such as the Internet. This technology can be used in auctions or competitive transactions where the final price is based upon the buyer's actions. We have initiated litigation with Google, Yahoo, and Microsoft.

Encrypted Media & Playback Device: This technology generally relates to encryption and decryption techniques used in media and players. It covers the devices and methods used to play back movies and other content from encrypted media. This technology is applicable to media such as high definition discs and stand-alone players, as well as game consoles and PC's with high definition drives. We have recently commenced licensing discussions related to this technology.

Our flash memory technology consists of 16 flash memory patents relating to architecture, manufacturing and operation of flash memory, including NOR flash. The patented technology covers techniques for enhancing the performance and reliability of the flash memory cell. NOR flash memory is extensively used in cell phones, and we have just initiated our licensing program for this technology.

Our Location Based Services Technology. This generally relates to the provision of cellular location based services (LBS). More specifically, the technology claimed by the patents is applicable to key aspects of several LBSs, including wireless emergency (E911) Phase II service, handset based navigation, and many other LBSs that rely on knowing the precise location of a mobile user. Given the widespread usage of this technology, this has the potential to be a large revenue producer for Acacia. We have initiated litigation with AT&T, Verizon, Sprint, Alltel, and T mobile.

Next is our Microprocessor Enhancement Technology. This generally relates to an architecture employed in advanced pipeline microprocessors. This architecture allows for conditional execution of microprocessor instructions, and a later determination of whether the instructions executed should be written back to memory yielding significant improvements in microprocessor speed. We have recently received an Appellate Court decision confirming the validity of this patent.

Next is our Peer to Peer Communications Technology which generally relates to network communications between two devices. This technology can be used by the owners of network devices, such as computers or MP3 players, to share music, photos, or other content. We have initiated litigation with Skype regarding this technology.

Our projector technology relates to products and systems that include optics for projecting images. This technology can be used in projectors for business and home theater applications, as well as rear projection TV's. We announced our first license for this technology earlier this week and have identified over 20 companies that we will believe will need to license this technology.

And finally, Rule Based monitoring. This technology can be used to monitor a variety of hardware and software systems such as network nodes, servers, databases and applications. We have completed six initial licensing agreements to date including licenses to computer researchers, FAS, and BMC. This is another program with significant licensing opportunities.

These 18 technologies represent just a fraction of our licensing opportunities going forward. So you can understand why we are very positive in our business outlook.

In summary, Acacia is still in the early stages of building its business and has the opportunity to continue to build its position as the market leader in the intellectual properties. We also think that the investment community is in the early stages of recognizing intellectual property as a major new asset class.

With that, I would like to now turn the call over to our Chief Financial Officer, Clayton Haynes.

Clayton Haynes

Thank you to everyone joining us for today’s second quarter 2008 earnings conference call. As indicated in today’s earnings press release, second quarter 2008 license fee revenues total $7,116,000 as compared to $5, 865,000 in the second quarter of 2007. License fee revenues for the 6 months ended June 30, 2008, totaled $60,164,000 as compared to $31,050,000 for the 6 months ended June 30, 2007.

Second quarter 2008 license fee revenues included license fees from 11 of our technology licensing programs including initial license fee revenues for our authorized spending accounts technology, picture archiving, and communications systems technology, and video editing technology. Second quarter 2008 license fee revenues also included fees from the licensing of our audio communications fraud detection technology, Credit Card Fraud Protection Technology, DMT 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.

Second quarter 2007 revenues included license fees from 20 new licensing agreements covering eight of our technology licensing programs. To date we have generated revenues from 36 of our technology licensing programs. License fee revenues continue to fluctuate from period to period based on fluctuations in the dollar amount of individual agreements executed each period which is primarily driven by the nature and characteristics of a technology being licensed and the magnitude of infringement or use associated with a specific licensee.

Secondly, the specific terms and conditions of license agreement executed in each period in a period of infringement contemplated by the respected license fee payments, and lastly, fluctuations in a total number of agreements executed each period.

Trailing 12-month license fee revenues was $37.7 million as of June 30, 2008 as compared to $52.6 million as of December 31, 2007 and $46.8 million as of June 30, 2007. The average margin to define as gross license fees less inventor royalties’ expense and contingent legal fees for the portfolios generating revenues during the period was approximately 42% for both the second quarter of 2008 and 2007.

Quarterly average margins fluctuate period-to-period based on the mix of patent portfolios that generate revenues each period and the related economics associated with the underlying inventor agreements and contingent legal fee arrangements if any.

For the second quarter of 2008, Acacia Research reported a consolidated GAAP net loss from continuing operations of $5,041,000 or $0.17 a share versus a net loss from continuing operations of $3,588,000 or $0.13 a share in the second quarter of 2007 as illustrated in our comparative income statements provided in today’s press release and related 8-K filed with the SEC.

Excluding the impact of non-cash patent amortization charges of $1.2 million and non-cash stock compensation of $1.9 million, the second quarter of 2008 net loss was 1.9 million as compared to a net loss excluding non-cash items of $1.1 million for the second quarter of 2007.

For the six months, ended June 30, 2008, Acacia Research reported a GAAP net loss of $9.5 million or $0.33 a share versus GAAP net income of $847,000 or $0.03 a share for the six months ended June 30, 2007.

Excluding the impact of non-cash patent amortization charges of $2.6 million and non-cash stock compensation charges of $3.8 million, Acacia Research’s net loss for the six months ended June 30, 2008 was $3.2 million as compared to net income, excluding non-items of $5.4 million for the six months ended June 30, 2007.

Operating expenses for the second quarter of 2008 and 2007 included inventor royalties’ expenses of $2.2 million and $1.6 million respectively and contingent legal fees expenses of $1.9 million and $1.8 million respectively. Inventor royalties and contingent legal fees expenses fluctuate period-to-period based on the amounts of the revenues recognized each period and the mix of specific patent portfolios with varying economic terms generating revenues each period.

The second quarter of 2008 increase in inventor royalties’ expense and contingent legal fees expense was primarily due to the increase in license fee revenues in the second quarter of 2008 versus the second quarter of 2007 as described earlier.

Second quarter 2008 marketing, general, and administrative expenses, excluding non-cash stock compensation charges increased $963.000 to $4,009,000 from $3,046,000 in a comparable 2007 period. The net increase was due to primarily to the addition of licensing, business development, and engineering personnel since the end of the prior year quarter, an increase in business development and licensing related to patent research and consulting expenses for new and on-going programs and an increase in corporate, general, and administrative cost, all of which continue to be reflective of the growth and expansion of our operations and the operations of our subsidiaries since the prior year period.

Non-cash stock compensation charges increased by $794,000 in the second quarter of 2008 versus the second quarter of 2007 due primarily to the issuance of equity based incentive rewards to new and existing employees since the end of the prior year quarter in accordance with our normal stock based incentive compensation practices.

Patent related legal expenses totaled $1.1 million in the second quarter of 2008 and 2007 remaining relatively flat quarter-to-quarter. Patent related legal expenses include prosecution and enforcement costs incurred by outside patent attorneys engaged on an hourly basis and the out-of-pocket expenses incurred by law firms engaged on a contingent fee basis and fluctuate from period-to-period based on patent enforcement and prosecution activity associated with on-going 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 and in connection with our current and future patent commercialization and enforcement programs.

Looking forward, for fiscal 2008, estimated fixed costs are expected to be in the range of $13.5 million to $13.8 million. Fixed costs include employees’ salaries and benefits. Facilities cost, corporate, legal, accounting, and other general, and administrative cost and are included in the marketing, general, and administrative expense line in our income statement.

Estimated variable cost for fiscal 2008 excluding inventor royalties and contingent legal fees are expected to be in the range of $8 million to $8.5 million. Variable costs include patent related legal expenses, patent related research, consulting, and maintenance expenses, and other patent related development and commercialization expenses. These costs fluctuate quarter-to-quarter based on business development, licensing, enforcement, research, and prosecution activities each quarter. All variable costs excluding patent related legal costs are included in the marketing, general, and administrative expense line in our income statement. Variable cost included in MGNA for the second quarter of 2008 totaled approximately 692,000 versus 517,000 in the second quarter of 2007.

Total consolidated assets as of June 30, 2008 totaled $67.4 million compared to $71.1 million as of December 31, 2007. As of June 30, 2008, cash and investment balances totaled approximately $45.8 million versus $51.4 million as of December 31, 2007. Net cash flows from the operations for the second quarter of 2008 were break even versus net cash outflows from operations of $3.7 million for the second quarter of 2007. Net cash outflows from operations for the six months ended June 30, 2008, totaled $3.9 million versus net cash inflows from operations for the six months end of June 30, 2007 of $3.6 million.

Accounts receivable from license fees totaled $4.4 million at June 30, 2008 compared to $1.4 million as of December 31, 2007. The majority of the receivables at June, 30, 2008 were collected shortly after quarter end in accordance with terms of the underlying license agreements.

I will not turn the call back over to Paul Ryan to begin the Q&A portion of today’s conference call.

Paul Ryan

We will open up the line for questions?

Question-and-Answer-Session

Operator

(Operator Instructions) And our first question will come from Bennett Notman of Davenport & Co.

Bennett Notman - Davenport & Co.

I guess the question probably a lot of people are wondering is in the last 12 months you guys have added a lot of IP and you have added a lot of talented executives but the revenue growth just doesn’t seem to be coming. Could you just talk a little bit about whether something has changed with the licensees that you are approaching and maybe in the court system or just in the overall environment that really seems to be sort of creating a bottleneck for you here?

Paul Ryan

We don’t see anything from a fundamental standpoint. I guess the only area, there probably is more IP litigation and than there was three or four years ago and to some small degree probably the litigation calendars are taking a little longer. I know certainly, we, over the past year have filed some litigations when appropriate at Eastern District of Texas and there the time to trials has grown from roughly 18 months to three years or more. But aside from that, we don’t see any reason and quite fundamentally a lot of the new programs that I have described in the prepared remarks are programs that are right after inception and so we think that we will certainly, as we have indicated in our release, we expect a good long-term growth and again our revenues are exclusively generated from negotiated licensing agreements and it is difficult to estimate when you are going to get into a conclusion out on a negotiated deal as you could see today Qualcomm segues with Nokia for a year and a half on an existing deal. So even large guys sometimes wait until the court house steps for the settlements but certainly, in their case, it paid off and they got $12 billion in market value from one license today. So, we are very optimistic about the value of these portfolios. We are conscious that it takes time to negotiate these deals with not only with us but other people in the industry including even Qualcomm and, we are confident that the moneys will come in but predicting the timing, when your revenues were based on negotiated licensing agreement, is unpredictable. So, the short answer is we do not see anything in the climate that is negatively impacting our business. We just think we are in a little hesitation period. We did have some pretty solid revenues that came in from the global acquisitions. Some things that had already been queued up and we are two or three years into the licensing process and so there is a little bridge period where some of our newer portfolios that we have acquired over the last two years have to get to that process in the licensing phase where they start yielding revenues and we think that it will start in the second half and certainly next year.

Bennett Notman - Davenport & Co.

Just to ask the same question in a different way and this is the first time where you guys have sort of said that you might not have growth on a year-over-year basis but prior to this you have been anticipating that you would end with. I am just trying to gauge maybe what changed or what went different so far this year versus maybe what you would have anticipated towards the end of last year when you were looking for growth on a year-over-year basis?

Paul. Ryan

Well, there are some newer programs that we had anticipated. We would have first deals done yet, which we don’t yet – which hopefully will happen in the second half. I guess if anything, it is just, there is more of an inclination to push revenues a little further out. Court calendars tend to slow down, not speed up, negotiations always take time. So, if anything it is just again trying to estimate within a window period of 12 months. It is always difficult to do and we have had such positive momentum that we have always had no problem with anticipating growth. Obviously, where we stand at mid-year with $60 million which we think it is prudent people to advise people that we may not get that growth this year. It is obviously, that means we have to regenerate over $38 million on the second half. While that is certainly possible based on licensing discussions and programs we have. We just want to caution people that it may not occur this year. But again, it has no impact in our long term viability of growth. It is just simply a timing issue related to the nature of these revenues.

Bennett Notman - Davenport & Co.

Okay, and then also, just maybe one housekeeping item, unless my numbers are wrong. I thought you guys had 93 portfolios at the end of last quarter. Now you are saying you have 95 active ones which it makes you think maybe several either were finished or were otherwise rendered inactive and I am just wondering sort of which ones they were and so what process leads to that coming.

Paul. Ryan

Yes. You are correct. The number we state is the net amount of portfolios that we believe are active and can generate revenues and I can outline, dig out the ones that we subtracted from the amount. There were a couple smaller portfolios that we think we have essentially concluded the licensing on. So we took them off the list and then also we combine some and actually put them in as one combined portfolio. So, what we do is just give the net number of total portfolios but separately will give the amount of new ones that we have acquired during the quarter.

Operator

And we will take our next question from [Pat Galvan] a private investor.

[Pat Galvan]

Yes. Were we part of that Qualcomm $12 billion deal?

Paul Ryan

No, I wish we were. It is just that indication certainly of the value that is resident in IP and also the difficulty sometimes of getting the user of the technology to agree to pay you. That is all. I was using it by a way of example.

Operator

And we will take our next question from Rengan Rajaratnam from Galleon Group.

Rengan Rajaratnam - Galleon Group

I just wanted to ask if there is any portfolios that you are excited about in terms of modernization in the next three or six months in the CMB horizon.

Paul Ryan

Well, in answer to your question, any or all of the 18 that I just went over earlier on the call certainly are medical portfolios we think they are about ready, they are at the stage. You have to prepare, you have to get the other side of a like mind. You have to do a lot of upfront work to get to the point where you get in to viable monetary negotiations over licensing agreements. So, we have been doing a lot of that work on these portfolios over the last year or so and then you get to the point where it is logical we can start doing deals and we just did the first one which was Siemens on the PACS technology and we have a lot of discussions going on with our other medical portfolios. We certainly expect that out of those, as well as I am quite sure, the continuation of a number of the programs that have just started generating money and deals like the Projector technology and the Rule Based Monitoring technology, and Telematics. The odds are increasing. Once you get three or four or five deals done it is a momentum business. Other users of the technology that are more inclined, wants several other companies decide to take a license to fall in line and take a license. It is always a little more difficult to get the initial deals done. But we are pretty confident of those portfolios I went over earlier in the call that based on where we are in discussions now. It is highly probable that we are going to get the initial licensing deals done in a number of those and hopefully will lead to significant momentum in the licensing programs for those technologies.

Operator

We will go next to Rob Ammann from RK Capital.

Rob Ammann - RK Capital

Can you disclose the headcount at the end of the quarter?

Paul Ryan

At the end of the quarter we had 37 full-time employees and 6 part-time employees.

Rob Ammann - RK Capital

In the past when you get enough metrics if you disclose the total or just the full-time?

Paul Ryan

In the past it has been total.

Rob Ammann - RK Capital

Okay. So, basically unchanged first of last quarter at 53 total?

Paul Ryan

Yes. It is essentially we are up. Yes. We are pretty much where we need to be at the beginning of the year. As you know we hired in a couple of very experienced licensing executives and a couple of senior engineers. We are pretty well set from the manpower standpoint.

Rob Ammann - RK Capital

Okay. Maybe a little bit of splitting hairs here but fix expense guidance went up a little bit in terms of adjusting that range and it is the second time we seen it adjusted this year. Can you talk a little bit about that given that you are set on the head count? I understand not being able to talk when reds come in but it seems like the expenses tend to creep a little faster than you normally expect as well?

Paul Ryan

Let us see, I believe the guidance for that was given in the first quarter. I believe was between 13 and 13.5…

Rob Ammann - RK Capital

I think it was twelve and half to thirteen and a half if I think my transcript is correct.

Paul Ryan

Okay. Yes. It is just based on what we are seeing, as the business, progresses each quarter. I had tried to take a look at it and updating under the guidance just based upon with the expenses as they are being carried this quarter and look it out as far as the next couple of quarters are concerned. We take a look at all aspects of the business and the expenses that we think that we are going to incur and just try to give a good benchmark as to everything is going forward.

Rob Ammann - RK Capital

Any thoughts in terms of the revenue run rate and which are your cash break even?

Paul Ryan

Yes, if you look at it from of macro standpoint. Our breakeven is roughly $50 million a year and 12.5 per quarter with 40% margins.

Operator

And that does conclude the question-and-answer-session.

Paul Ryan

Thank you for being with us. If any of you have specific questions, please give Clayton and I a call we will be happy to help you out. Thank so much and we look forward to talking with you next quarter.

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