Acacia Research (NASDAQ:ACTG) Q2 2020 Earnings Call

0:00 Greetings. Welcome to the FATF Research Second Quarter Financial Resource Conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. I will now turn the conference over to your host, Rob Fink of FNK IR. You may begin.

0:24 Thank you, operator. Hosting all today are Clifford Press Chief Executive Officer, also the Chief Investment Officer, and Richard Rosenstein, Chief Financial Officer. Before beginning, I would like to remind you that the information provided during this call may contain forward-looking statements related to current project expectations, estimates, forecasts, and projections about future events that are forward-looking as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements generally relate to the company's plans, objectives, and expectations for future operations, and are based on the current estimates and projections, future results or trends. Actual results may differ materially from those rejected as a result of certain risks and uncertainties.

1:10 For discussion of such risks and uncertainties, please see the risk factors described in Acacia's annual report on Form 10-K and quarterly reports on Form 10-Q that are filed with the SEC. I would like to remind everyone that a press release disclosing the company's financial results was issued this morning before the market opened. This press release may be accessed on the company's website at akisharesearch.com under the news and abouts tab. With all that said, I'd like to turn the call over to Clifford Press. Clifford, the call is yours.

1:44 Thank you, Rob, and good morning, everyone. On June 5th, our strategic alliance with Starboard Value got off to a flying start with the announcement of our first approved transaction, the acquisition of a portfolio of investments in 18 public and private life sciences companies from the former Woodford Equity Income Fund for a total consideration of £224 million or $282 million. This was an opportunistic acquisition, which we discovered during the due diligence process for another investment idea involving a company with several very large holders, one of which was the former Woodford Fund, then in liquidation.

2:29 When the pandemic hit, the potential secondary sales of the Woodford Fund stalled and we were in a position to consummate a transaction under extremely challenging circumstances. I'm sure we all remember how the markets were acting in the first week of April. We were fortunate to be able to conduct due diligence on 18 different investments, most of which were in the UK during the lockdown and complete the transaction by early June. Before I turn the call over to Al to Let me review our IP business. During the second quarter we acquired Excalibur IP, a portfolio of more than 2,500 patents spun out of Yahoo and a portfolio of nearly 150 Wi-Fi and IoT patents from L3 Harris.

3:19 As we have noted before, there continues to be a limited capital supply available in the IP market and we believe that we are able to obtain realistic pricing. Importantly, we have begun to see soft licensing revenue from these acquisitions. Mark Booth and his team continue to evaluate additional acquisitions. With that, let me turn the call over to Al Tabeer, our Chief Investment Officer. Al?

3:47 Thank you, Clifford. Following the Woodford transaction, we reached out to many of our shareholders and received inbound inquiries from other investors. We recognize that this is a rather unique transaction with a high level of complexity and we want to use this opportunity to go through the questions we have received and explain the details of the transaction. Soon after closing the transaction, we sold our entire position in four of the public entities as well as portions of a few others. To date, we have recouped $185 million of our $282 million purchase price. Having moved swiftly to de-risk the transaction, We are holding continuing positions in companies where we believe there are opportunities to create incremental value. The largest of the private company investments is a 6% stake in Oxford Nanopore Technologies, an exciting company with disruptive technology and genetic sequencing applicable to a broad range of applications in both research and commercial markets. Interestingly, this company just announced a significant new contract with the UK government to provide precise detection of COVID and other pathogens on a rapid basis.

5:01 We believe there is significant unrealized value in many of the assets we acquired, and we will work with Starboard to realize these opportunities. Additionally, our combined strategic committee continues to meet regularly to identify and evaluate additional investments. We have a significant number of potential investment opportunities currently under review. Let me now turn the call over to Rich Rosenstein, our CFO, to discuss the financing for the transaction, the GAAP accounting methodologies that have been applied in bringing them onto our balance sheet, and our court of financials. Rich?

5:39 Thank you, Al. As noted, we paid a total of $282 million for the public and private company assets. We financed this with cash on hand in addition to utilizing $35 million in preferred stock, which was previously held as restricted cash, plus $115 million in new notes issuance to Starboard, which made this our first approved investment under the terms of our Starboard agreement. The Woodford portfolio is a mix of public and private company securities, which we purchased at a discount based on prices in early April when markets were depressed. Under GAAP, we account for the value of the components of the portfolio at initial fair value as follows. The public securities, which are level one assets, were valued at market value with the fair value of the private securities representing the balance of the portfolio purchase price. As a result, our cost basis in the private securities reflects the bulk purchase discount for the whole portfolio with the public securities valued at market value. At the end of each quarter, we mark the public assets to market. For the private securities, we adjust our carrying value based on observed primary or secondary transactions in those company shares or recognize any impairment.

6:57 If there are no observable transactions or impairment, we will not adjust our carrying value for these positions. As a result, our carrying value at the end of the second quarter reflected market value of our public securities and largely cost for our private securities. To follow all of this on our balance sheet, note that we paid the full purchase price of 223.9 million pounds or $282 million into escrow at closing in early June. Funds are released from escrow as securities are transferred. While nearly all securities have been or are now in the final stages of transferring as of today, on June 30th, not all securities have been transferred. For this reason, our June 30th balance sheet includes an asset called prepaid investment totaling $94 million.

7:48 That represents the balance of the purchase price for the remaining shares to be transferred at cost at June 30th. There are also two items totaling $83 million on our balance sheet at June 30th called equity securities forward contract and equity securities derivatives. These represent the embedded gain versus our attributed cost for the remaining public stakes at market value plus any fair value adjustment on any of the private shares that remain to be transferred at June 30th. Note again that most of the private securities continue to be carried at cost, not reflecting any embedded gain at this point. Once these securities transfer to us, you will see these prepaid forward contract and derivative assets be eliminated and replaced by the securities themselves moving onto our balance sheet. You will see this in our September financials.

8:42 The original Starboard funding agreement had not contemplated using these notes for short-term funding, which is what this financing represented. So, in collaboration with Starboard, we modified our agreement to permit us to repay the notes by year-end and return the preferred stock proceeds to restricted cash. Through this modification, we will no longer pay interest on the notes following repayment and our preferred dividend rate will revert back to 3% from 8% when the $35 million in preferred funds are returned to escrow. In return for this modification, Starboard has retained the seven-year exercise right of notes related to this $115 million of funding so that it may exercise 31.5 million warrants at $3.65 per share in cash even after the notes have been repaid.

9:31 This does not add any additional warrants beyond the 100 million Series B warrants already issued to Starboard, and upon repayment of the notes, we will retain the opportunity to draw on the full agreed amount of $365 million in notes in the future. Investors have asked about the impact of dilution should all of the warrants be exercised. First, no warrants have been exercised to date. Accordingly, we've recorded a number of liabilities as of June 30th, all of which are reflected in our book value. First, $115 million of notes to be repaid. Two, $35 million in preferred stock. Three, warrant liabilities. And four, the derivative value of the conversion potential in the preferred stock.

10:18 Each of these instruments are exercisable or convertible at $3.65 per share, meaning these were in the money as of June 30th. Our book value at June 30th is $164.7 million, or $3.36 on a per share basis based on 49 million shares. It is important to note that this book value reflects the gap treatment of warrant liability associated with the warrants outstanding. Given the significant appreciation in our share price, those warrant liabilities increased substantially during the quarter and are now recorded on our balance sheet at an aggregate value of $95 million or $1.93 per share. Those liabilities reflect the gap value of all warrants outstanding recognized as non-cash charges for potential future issuance of shares.

11:10 Upon exercise and or expiration, These liabilities will be eliminated and reclassified to equity. As I mentioned, our book value today is $3.36 per share, which includes the $95 million of these warrant liabilities. If the notes were to be used to exercise 31.5 million warrants at $3.65 a share and the preferred were to be converted to 9.6 million shares and the 5 million Series A warrants were all exercised, Our book value would rise by more than $200 million and our share count would increase to roughly 95 million. On this increased share count, book value would be approximately $4 per share. Note that this still reflects the carrying value of most of the private securities at cost in our recent acquisition, meaning any future observation or realization of value would be accretive to that book value.

12:04 Now I will discuss our financial results for the quarter. Cash and short-term investments totaled $184 million at June 30th compared to $158 million at March 31st and $168.3 million at December 31st. Debt was $115 million in senior secured notes issued to Starboard. Book value totaled $164.7 million as of June 30th compared to $175 million at December 31st. Revenues for the second quarter of 2020 were $2.1 million in line with our expectations. We are just beginning to see contributions from our recently acquired IP portfolios. More detail on these results have been made available in the press release issued this morning and also in the upcoming quarterly report on Form 10-Q, which we will file with the SEC later today. Now let me turn the call back to Clifford for closing comments.

13:00 Clifford?

13:02 Thanks, Rich. When we announced the strategic partnership with Starboard, we indicated that we had retained the right to offer existing Acacia common stockholders the opportunity to purchase up to $100 million in senior secured notes and warrants to purchase up to $27 million of shares of common stock on substantially the same terms as Starboard. We reaffirmed this goal today and intend to commence an initial offering of $31.5 million in senior secured notes and warrants to purchase common stock as soon as reasonably practicable. In conclusion, we have taken a significant step to build out Acacia's asset base with the strategic acquisition of a portfolio of life science assets.

13:55 We immediately worked to reduce the inherent risks of this portfolio by selling liquid assets, Thank you very much. We can pursue investments in multiple ways, including acquiring public or private entities or acquiring assets directly. We believe that together with Starboard, we are well positioned to pursue corporate development opportunities of greater scale and flexibility.

14:46 We are now happy to answer any questions that you have. Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Our first question is from Anthony Stoss with Craig Hadlam. Please proceed with your question.

15:28 Good morning, guys. I have a couple of questions. I'm curious the level of interest in the private companies that you hold. Also, do you think that all of the private entities will be transferred over this quarter? And I'm curious your philosophy, if there's any of them that you think are just jewels that you want to hang on to, even if there's interest in selling them. Why don't we start with that, then have a follow up afterwards.

15:55 Thanks, Tony. Clifford, would you like to talk about the private companies and our process for looking for liquidity in the future?

16:05 Yes. We view this as a portfolio trade and we intend to realize cash for all of the assets as soon as practically possible. We've established with the board a waterfall timetable to do that. We do believe that Several of these assets have substantial upside and we hope with the process we're going through now to realize on that and we will be shortly providing details of the assets that we continue to hold and provide some outlook on what we expect for them.

16:46 Okay. I'll just say as an overview. Go ahead. I'm sorry, Clifford. Continue, please.

16:54 As an overview matter, because of the nature of buying a portfolio that was in liquidation after operating for a long period of time, what we have here are late-stage life sciences investments, most of which are within 12 to 24 months of a commercial inflection point. And I think that's a very important factor to remember about these assets. They're not early-stage assets on the whole. so that they're realizable in the near term.

17:29 Thank you for that. And then if you wouldn't mind commenting about the engagement or how active Starboard is with you folks. I know out of the gate, it's been very active. And I know, you know, there's no deal until there's a deal. I'm just curious if you can comment on operating businesses. Clearly, you're highlighting them in your press release, so perhaps that you're maybe getting closer than before. Any thoughts on timelines or goals you have to try to secure an operating business acquisition?

18:02 Tony, what I would say is that if you looked at our original timeline that we laid out, this transaction occurred fairly quickly and it was a difficult transaction in terms of complexity and the amount of work we put into it. We are flexible in our mandate, as you can see, and we are continuing to progress as rapidly as possible. Understand that the markets have moved dramatically. Hit rates are low, and so we continue to work as expeditiously as possible, and that's kind of what I would say along that. We're in constant contact with Starboard and collaborating as aggressively as you would expect.

18:52 Okay, there may be a question for Rich here in the press release. Al and Clifford and Rich, you're talking about hiring more professionals. What should we think of in terms of OpEx going forward? Is it a small bump up or, you know, I know it's tough to say ahead of an operating business acquisition. I'm just curious, whatever detail you can give.

19:15 I'll start and then Clifford may want to jump in. So we have a research and investment team in place and we've all been working very hard. We're adding to that team as mentioned, but we're doing it deliberately. So we're not ramping up our operating expense significantly. We're doing it through deliberate hires where we have specific needs around both our research and execution process. I don't know if you want to add anything to that, Clifford.

19:46 Yes, thank you, Rich. I would say, look, Acacia is now configured as an exceptional platform, and we've been stretched very thin executing on the transactions that we've been doing. We do need to add some particularly execution capability. We have increased our research team as well. and we have a very dynamic interaction through our strategic committee with our starboard representatives which also generates potential activity for us but we definitely need to improve to increase the throughput capacity of the team.

20:26 Thanks Clifford. Best of luck guys.

20:29 Thanks. And again, if you have any questions, you may press star 1 on your telephone keypad. Doing so will ensure that you are in the question queue. Our next question is from Brett Race from Danny Montgomery Scott. Please proceed with your question.

20:49 Morning, gentlemen. Got a couple of them. How does the acquisition pipeline with patents, you know, look going forward? What's Mark Booth telling you guys?

21:04 So, Brett, I would say that the to-date patents that we acquired, we were very impressed with Mark's diligence on those and the ability to bring in what we think are high-quality patents. One is in partnership with a very substantial company, and one was at the tail end of a wind-down of a company, but both we think were very well-vetted and very positive developments. to Clifford's point about the market pricing. There's been hopefully some rationality in the market after years of sort of a dislocation. And we continue to evaluate a pretty active pipeline from Mark's group.

21:49 We have a process in place now for the board to vet very formally the requests that Mark puts in front of us for capital. And we're allocating the way you know, you would hope we would allocate to any platform that we develop.

22:05 Okay. Clifford, do you want to add anything to that?

22:08 No, I think that's correct. We continue to believe, Brent, that there are opportunities available at realistic prices that are worth pursuing.

22:19 Okay. I noted the other day there was a Biohaven Pharmaceutical did a royalty deal with Royal Farmer for $450 million. Is that the type of thing – because I know we were looking at doing a farmer royalty deal. Is that something you – the kind of thing you've looked at, passed on? Are you familiar with that one?

22:50 Yeah. Clifford may want to jump in here, Brett, but I wouldn't comment on sort of one specific deal. We obviously, you know, in researching and ending up with the Woodford portfolio, there are some royalty type of companies in that portfolio. A royalty stream is similar to an IP, you know, licensing stream, so it's something we're relatively familiar with. and that's just one piece of our ongoing research efforts. I wouldn't overly dwell on that, any one specific investment within that segment of business.

23:34 Okay. And can you just give us a rundown on where we, I've gotten a number of questions on this. On the remaining warrants with Veritone, did we monetize some of them? What do we have left there?

23:54 I can answer that. We have a number of tranches of those warrants. And in the June quarter, we exercised some of those warrants and sold the shares. The warrants were in the money section. and so we took advantage of that market opportunity. There'll be more detail of this in our 10Q but we sold a portion of them already, about 15%.

24:27 Okay. Richard, I may circle back to you offline because I need a little bit more understanding on, you know, the accounting on the non-cash liabilities, the warrants and the embedded I'll circle back to you on that. And then one final one, the $31.5 million in notes and the warrants to purchase common that ultimately shareholders will be given the right to share pari patu with Starboard. The warrants will be at $365,000, and what will the interest rate on that instrument be with the notes?

25:19 So they'll be on the same terms, so the same interest rate, the 6% interest rate on the notes, and the warrants will also be at the same strike.

25:33 Which is $365,000? Correct. Okay. And when will we, you know, you'll be doing the filing and, you know, when are the milestone dates on that?

25:47 So we've said as soon as reasonably practicable, which is to say we will have more to report to you when we have more to report. Okay. But we're working quickly to do that.

26:00 All right. Fair enough. Thank you for taking the question. And good show on that portfolio.

26:08 Thank you, Brett. And we have reached the end of the question and answer session. And also with that, this concludes today's conference. And you may disconnect your line at this time. Thank you for your participation.