Acacia Research Corp: Form 10-Q for the period ended Sep 30, 2023

The following discussion should be read in conjunction with our consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q ("Quarterly Report"). This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these "forward-looking statements" as a result of various factors including the risks we discuss in Item 1A to our Annual Report on Form 10-K for the year ended December 31, 2022, “Risk Factors,” and Part II, Item 1A of our Quarterly Report on Form 10-Q for the three months ended June 30, 2023 and elsewhere herein. For additional information, refer to the section above entitled “Cautionary Note Regarding Forward-Looking Statements.”

See the consolidated financial statements included elsewhere in the Quarterly Report for the definitions of certain capitalized terms used throughout the remainder of this Quarterly Report.

General

We are an opportunistic capital platform that purchases businesses based on the differentials between public and private market valuations. We use a wide range of transactional and operational capabilities to realize the intrinsic value in the businesses that we acquire. Our ideal transactions include the acquisition of public or private companies, the acquisition of divisions of other companies, or structured transactions that can result in the recapitalization or restructuring of the ownership of a business to enhance value.

We are particularly attracted to complex situations, where value is not fully recognized in the public markets, where values of certain operations are masked by a diversified business mix, or where private ownership has not invested capital necessary to drive long-term value. We aim to operate a transactional platform through which we can initiate a strategic block position in public companies as a path to complete whole company acquisitions or strategic transactions that unlock value. We believe this business model is differentiated from private equity funds, which do not typically own public securities prior to acquiring companies, hedge funds, which do not typically acquire entire businesses, and other acquisition vehicles such as Special Purpose Acquisition Companies, which are narrowly focused on completing one singular, defining acquisition.

We have a strategic relationship with Starboard that has provided, and we expect will continue to provide, us with industry expertise, and access to operating partners and industry experts to evaluate potential acquisition opportunities and enhance the oversight and value creation of such businesses once acquired. Starboard has provided ready access to its extensive network of highly successful industry executives and, as part of our relationship, Starboard assists with sourcing and evaluating appropriate acquisition opportunities.

Our focus is companies with market values in the sub-$2 billion range and particularly on businesses valued at $1 billion or less. We are, however, opportunistic, and may pursue acquisitions that are larger under the right circumstance.

Intellectual Property Operations

The Company through its Patent Licensing, Enforcement and Technologies Business invests in IP and related absolute return assets and engage in the licensing and enforcement of patented technologies. Through our Patent Licensing, Enforcement and Technologies Business, operated under our wholly owned subsidiary, Acacia Research Group, LLC, and its wholly-owned subsidiaries (collectively, "ARG"), we are a principal in the licensing and enforcement of patent portfolios, with our operating subsidiaries obtaining the rights in the patent portfolio or purchasing the patent portfolio outright. While we, from time to time, partner with inventors and patent owners, from small entities to large corporations, we assume all responsibility for advancing operational expenses while pursuing a patent licensing and enforcement program, and when applicable, share net licensing revenue with our patent partners as that program matures, on a pre-arranged and negotiated basis. We may also provide upfront capital to patent owners as an advance against future licensing revenue.

Currently, on a consolidated basis, our operating subsidiaries own or control the rights to multiple patent portfolios, which include U.S. patents and certain foreign counterparts, covering technologies used in a variety of industries. We generate revenues and related cash flows from the granting of IP rights for the use of patented technologies that our operating subsidiaries control or own.

We have established a proven track record of licensing and enforcement success with over 1,600 license agreements executed to date, across nearly 200 patent portfolio licensing and enforcement programs. As of September 30, 2023, we have generated gross licensing revenue of approximately $1.8 billion, and have returned $859.1 million to our patent partners.

For more information related to our Intellectual Property Operations, refer to additional detailed patent business discussion below.

Industrial Operations

In October 2021, we consummated our first operating company acquisition of Printronix. Printronix is a leading manufacturer and distributor of industrial impact printers, also known as line matrix printers, and related consumables and services. The Printronix business serves a diverse group of customers that operate across healthcare, food and beverage, manufacturing and logistics, and other sectors. This mature technology is known for its ability to operate in hazardous environments. Printronix has a manufacturing site located in Malaysia and third-party configuration sites located in the United States, Singapore and Holland, along with sales and support locations around the world to support its global network of users, channel partners and strategic alliances. This acquisition was made at what we believe to be an attractive purchase price, and we are now supporting existing management in its initiative to reduce costs and operate more efficiently and in its execution of strategic partnerships to generate growth.

For more information related to our Industrial Operations, refer to the section entitled "Industrial Printing Solutions" below.

Recent Business Developments and Trends

Recapitalization

On October 30, 2022, the Company entered into a Recapitalization Agreement (the "Recapitalization Agreement") with the Investors, pursuant to which, among other things, the Company and Starboard agreed to enter into a series of transactions to restructure Starboard’s existing investments in the Company in order to simplify the Company’s capital structure. Under the Recapitalization Agreement, the Company and Starboard agreed to take certain actions related to the Series A Redeemable Convertible Preferred Stock in connection with the Recapitalization, including submitting a proposal for stockholder approval to remove the "4.89% blocker" provision contained in the Company's Amended and Restated Certificate of Designations (the "Amendment to the Amended and Restated Certificate of Designations"). The Company’s stockholders approved the Amendment to the Amended and Restated Certificate of Designations at the Company’s annual meeting of stockholders held on May 16, 2023, which became effective on June 30, 2023. Subsequently, and in accordance with the terms contained in the Series A Redeemable Convertible Preferred Stock, as amended, and the Recapitalization Agreement, on July 13, 2023, Starboard completed the Preferred Stock Conversion.

Further to the terms of the Recapitalization Agreement and in accordance with the terms of the Series B Warrants, on July 13, 2023, Starboard completed the Series B Warrants Exercise, the cancellation of $60.0 million aggregate principal amount of the Senior Secured Notes held by Starboard and the receipt by the Company of aggregate gross proceeds of approximately $55.0 million.

As a result of the Recapitalization Transactions, Starboard beneficially owned 61,123,595 shares of common stock as of July 13, 2023, representing approximately 61.2% of the common stock based on 99,886,322 shares of common stock issued and outstanding as of such date and no shares of Series A Redeemable Convertible Preferred Stock, no Series B Warrants, nor any Senior Secured Notes remain outstanding.

For a detailed description of the Recapitalization and the actions taken and contemplated to be taken in connection therewith, see Notes 1 and 8 to the consolidated financial statements elsewhere herein.

Change of Chief Executive Officer and Litigation Settlement

Since 2021, we have announced various changes to our Board and senior management, including as discussed in Item 1A to our Annual Report on Form 10-K for the year ended December 31, 2022, "Risk Factors — Risks Related to Our Business, Business Strategy, and Platform. Changes in leadership and key management positions have inherent risks, and there are no assurances that any of our recent changes or future changes will not affect our operations and financial condition.

On September 19, 2023, the Company together with ARG amicably settled with Clifford Press, former President and Chief Executive Officer of the Company, all claims, including counterclaims filed by Mr. Press, in connection with the arbitration demand previously filed by the Company against Mr. Press. As part of the settlement, and, in exchange for, among other things, a release of claims by Mr. Press in favor of the Company and agreements by Mr. Press related to non-interference and cooperation, the Company paid to Mr. Press a total of $770,000 along with reimbursement of certain counsel fees and expense in the amount of $480,000.

Acquisitions

In October 2021, we consummated our first operating company acquisition in connection with our acquisition of Printronix. We acquired all of the outstanding stock of Printronix, for a cash purchase price of approximately $37.0 million, which included an initial $33.0 million cash payment and a $4.0 million working capital adjustment. The Company's consolidated financial statements include Printronix's consolidated operations. Refer to Note 1 to the consolidated financial statements elsewhere herein for additional information.

In June 2020 we acquired the Life Sciences Portfolio. In connection with the purchase of the equity securities in the Life Sciences Portfolio, we issued to the Investors $115.0 million principal amount of our senior secured notes. As of December 31, 2020, all of the equity securities in the Life Sciences Portfolio were transferred to the Company. As of September 30, 2023, we have monetized a majority of the portfolio while retaining an interest in a number of operating businesses, including a controlling interest in one of the companies in the portfolio. Further, some of the businesses in which we continue to hold an interest generate income through the receipt of royalties and milestone payments. Refer to Note 3 to the consolidated financial statements elsewhere herein for more information.

Business Strategy

We intend to grow our company by acquiring additional operating businesses and intellectual property assets. However, we may not complete any acquisitions, and any acquisitions that we complete will be costly and could negatively affect our results of operations, and dilute our stockholders’ ownership, or cause us to incur significant expense, and we may not realize the expected benefits of acquisitions.

Inflation

Historically, inflation has not had a significant impact on us or any of our subsidiaries. While insignificant to our consolidated enterprise, during the nine months ended September 30, 2023, our Printronix subsidiary experienced some inflation from higher cost of raw materials than in previous years due to higher electronic and electrical and metal components. While Printronix inventory costs have been impacted by these inflationary pressures, up to this point Printronix has generally been able to adjust selling prices in response to these higher costs. Printronix have also implemented cost rationalization measures to combat the rising cost that is driven by inflation and currency pressures.

Patent Licensing and Enforcement

Patent Litigation Trial Dates and Related Trials

As of the date of this Quarterly Report, our operating subsidiaries have seven pending patent infringement cases with scheduled trial dates in the next twelve months. Patent infringement trials are components of our overall patent licensing process and are one of many factors that contribute to possible future revenue generating opportunities for us. Scheduled trial dates, as promulgated by the respective court, merely provide an indication of when, in future periods, the trials may occur according to the court’s scheduling calendar at a specific point in time. A court may change previously scheduled trial dates. In fact, courts often reschedule trial dates for various reasons that are unrelated to the underlying patent assets and typically for reasons that are beyond our control. While scheduled trial dates provide an indication of the timing of possible future revenue generating opportunities for us, the trials themselves and the immediately preceding periods represent the possible future revenue generating opportunities. These future opportunities can result in varying outcomes. Refer to Item 1A “Risk Factors— Risks Related to our Intellectual Property Business and Industry” of our Annual Report for additional information regarding patent litigation and related risks.

Litigation and Licensing Expense

We expect patent-related legal expenses to continue to fluctuate from period to period based on the factors summarized herein, in connection with future trial dates, international enforcement, strategic patent portfolio prosecution and our current and future patent portfolio investment, prosecution, licensing and enforcement activities. Refer to Item 1A “Risk Factors” of our Annual Report for additional information regarding litigation and licensing expense risk.

Investments in Patent Portfolios

With respect to our licensing, enforcement and overall business, neither we nor our operating subsidiaries invent new technologies or products; rather, we depend upon the identification and investment in patents, inventions and companies that own IP through our relationships with inventors, universities, research institutions, technology companies and others. If our operating subsidiaries are unable to maintain those relationships and identify and grow new relationships, then we may not be able to identify new technology-based patent opportunities for sustainable revenue and /or revenue growth.

Our current or future relationships may not provide the volume or quality of technologies necessary to sustain our licensing, enforcement and overall business. In some cases, universities and other technology sources compete against us as they seek to develop and commercialize technologies. Universities may receive financing for basic research in exchange for the exclusive right to commercialize resulting inventions. These and other strategies employed by potential partners may reduce the number of technology sources and potential clients to whom we can market our solutions. If we are unable to maintain current relationships and sources of technology or to secure new relationships and sources of technology, such inability may have a material adverse effect on our revenues, operating results, financial condition and ability to maintain our licensing and enforcement business.

Patent Portfolio Intake

One of the significant challenges in the intellectual property industry continues to be quality patent intake due to the challenges and complexity associated with the current patent environment.

During the nine months ended September 30, 2023 and during 2022, we did not acquire any new patent portfolios. During 2021, we acquired one new patent portfolio consisting of Wi-Fi 6 standard essential patents. In 2020, we acquired five new patent portfolios consisting of (i) flash memory technology, (ii) voice activation and control technology, (iii) wireless networks, (iv) internet search, advertising and cloud computing technology and (v) GPS navigation. The patents and patent rights acquired in 2021 and 2020 have estimated economic useful lives of approximately five years.

Industrial Printing Solutions

Our Printronix subsidiary is a worldwide leader in multi‐technology supply‐chain printing solutions for a variety of industries, including manufacturing, transportation and logistics, retail distribution, food and beverage distribution, and pharmaceutical distribution. Printronix’s line matrix printers are used for mission critical applications within these industries, including labeling and inventory management, build sheets, invoicing, manifests and bills of lading, and reporting. In China, India and other developing countries in Asia and Africa, our printers are also prevalent in the banking and government sectors. Printronix has manufacturing, configuration and/or distribution sites located in Malaysia, the United States, Singapore, China and the Netherlands, along with sales and support locations around the world to support its global network of users, channel partners, and strategic alliances. Printronix designs and manufactures printers and related consumable products for various industrial printing applications. Printers consist of hardware and embedded software and may be sold with maintenance service agreements, which are serviced by outside contractors. Consumable products include inked ribbons which are used within Printronix's printers. Printronix’s products are primarily sold through Printronix’s global network of channel partners, such as dealers and distributors, to end‐users.

Recent Business Matters

On November 1, 2023, Merton entered into an agreement (the “Arix Shares Purchase Agreement”) with RTW Biotech Opportunities Ltd. ("RTW Bio") to sell its shares of Arix to RTW Bio for a purchase price of $57.1 million (which represents a purchase price of 1.43 British pound per share, based on the exchange rate on the date that the parties agreed to the purchase price), conditioned solely upon RTW Bio receiving the necessary approval from the United Kingdom’s Financial Conduct Authority to acquire indirect control (as defined for the purposes of the UK change in control regime under the Financial Services and Markets Act 2000) in of Arix Capital Management Limited (the “Condition”). Per the terms of the Arix Shares Purchase Agreement, the transaction contemplated thereby will close following the satisfaction of the Condition; provided, that, if the Condition is not satisfied by March 31, 2024 (as well as upon other termination triggers as set forth in such agreement), the Arix Shares Purchase Agreement will terminate.

On November 13, 2023, the Company, through its wholly owned subsidiary Benchmark Energy II Holdings LLC, invested $10.0 million to acquire a 50.4% equity interest in Benchmark Energy II, LLC (“Benchmark”), an independent oil and gas company engaged in the acquisition, production and development of oil and gas assets in mature resource plays in Texas and Oklahoma. Through its investment in Benchmark, the Company will, under the oversight of the Benchmark management team, evaluate future growth and acquisitions of oil and gas assets at attractive valuations.

Operating Activities

Intellectual Property Operations

Our Intellectual Property Operations revenues historically have fluctuated quarterly, and can vary significantly period to period, based on a number of factors including the following:

• the dollar amount of agreements executed each period, which can be driven by the nature and characteristics of the technology or technologies being licensed and the magnitude of infringement associated with a specific licensee;
• the specific terms and conditions of agreements executed each period including the nature and characteristics of rights granted, and the periods of infringement or term of use contemplated by the respective payments;
• fluctuations in the total number of agreements executed each period;
• the number of, timing, results and uncertainties associated with patent licensing negotiations, mediations, patent infringement actions, trial dates and other enforcement proceedings relating to our patent licensing and enforcement programs;
• the relative maturity of licensing programs during the applicable periods;
• other external factors, including the periodic status or results of ongoing negotiations, the status or results of ongoing litigations and appeals, actual or perceived shifts in the regulatory environment, impact of unrelated patent related judicial proceedings and other macroeconomic factors;
• the willingness of prospective licensees to settle significant patent infringement cases and pay reasonable license fees for the use of our patented technology, as such infringement cases approached a court determined trial date; and
• fluctuations in overall patent portfolio related enforcement activities which are impacted by the portfolio intake challenges discussed above.

Our management does not attempt to manage for smooth sequential periodic growth in revenues from period to period, and therefore, periodic results can be uneven. Unlike most operating businesses and industries, licensing revenues not generated in a current period are not necessarily foregone but, depending on whether negotiations, litigation or both continue into subsequent periods, and depending on a number of other factors, such potential revenues may be pushed into subsequent annual periods.

Industrial Operations

Refer to "Industrial Printing Solutions" above for information related to Printronix's operating activities.

In addition to the following results of operations discussion, more information related to our Intellectual Property Operations and Industrial Operations segment revenues and cost of revenues, may be found in Note 15 to the consolidated financial statements elsewhere herein and Note 2 included in our Annual Report on Form 10-K, for the year ended December 31, 2022, as filed with the SEC on March 17, 2023.

Results of Operations

Summary of Results of Operations

(In thousands, except percentage change values)

Results of Operations - three months ended September 30, 2023 compared with the three months ended September 30, 2022

Total revenues decreased $5.8 million to $10.1 million for the three months ended September 30, 2023, as compared to $15.9 million for the three months ended September 30, 2022, due to a decrease in our Intellectual Property Operations revenues and Industrial Operations revenues. Intellectual Property Operations revenues decreased $4.6 million due to the decrease in the average revenue per agreement. Industrial Operations revenues decreased $1.2 million due to lower units of printer sold compared to the comparable prior period. Refer to "Industrial Operations – Revenues" below for further discussion.

Income before income taxes was $2.6 million for the three months ended September 30, 2023, as compared to income of $29.1 million in the comparable prior period. The decrease in net income was comprised of the change in total revenues described above and other changes in operating expenses and other income or expense as follows:

• Inventor royalties decreased $235,000, from $732,000 to $497,000 in 2023, primarily due to license agreement activity and related revenues generated with inventor royalty obligations. Refer to "Intellectual Property Operations – Cost of Revenues" below for further discussion.
• Contingent legal fees decreased $664,000, from $1.0 million to $346,000 in 2023, primarily due to the decrease in ARG's revenues described above. Refer to "Intellectual Property Operations – Cost of Revenues" below for further discussion.
• Litigation and licensing expenses increased $1.1 million, from $939,000 to $2.0 million in 2023, primarily due to a net increase in litigation support and third-party technical consulting expenses associated with ongoing litigation. Refer to "Intellectual Property Operations – Cost of Revenues" below for further discussion.
• Printronix cost of sales, engineering and development expenses, and sales and marketing expenses decreased $761,000, from $6.9 million to $6.2 million in 2023, primarily due to decrease in related revenues. Refer to "Industrial Operations – Cost of Revenues" and "Operating Expenses" below for further discussion.
• General and administrative expenses decreased $1.2 million, from $15.0 million to $13.9 million in 2023, primarily due to lower parent company costs including compensation expense for share-based awards, variable performance-based compensation costs, payroll costs, and our Industrial Operations general and administrative costs for the third quarter of 2023, which were partially offset by a one-time bad debt expense of $2.3 million. Refer to "General and Administrative Expenses" below for further detail and discussion.
• Compensation expense for share-based awards, included in general and administrative expenses above, decreased $58,000, from $1.0 million to $973,000 in 2023, primarily due to forfeitures for terminated employees, which includes a partial offset by restricted stock and option grants issued to employees and the Board of Directors in 2023 and 2022.
• Unrealized gain from the change in fair value of our equity securities was $8.8 million in 2023, as compared to an unrealized loss of $36.4 million in the comparable prior period. The unrealized loss and gain were derived from our Life Sciences Portfolio and our trading securities portfolio. The prior period unrealized loss primarily relates to the reversal of unrealized gains previously recorded for shares sold during the quarter for realized gains. Refer to "Equity Securities Investments" below for further discussion.
• Realized gain or loss from the sale of our equity securities was zero in 2023, as compared to a realized gain of $36.1 million in the comparable prior period. The prior period realized gain primarily relates to sales activity from two Life Sciences Portfolio securities. Refer to "Equity Securities Investments" below for further discussion.
• Earnings on equity investment in joint venture increased $2.5 million, from $850,000 to $3.4 million in 2023, primarily due to the timing of milestones earned compared to the comparable prior period. Refer to "Equity Securities Investments" below for a detailed discussion.
• We recognized a gain on exercise of Series B warrants of $1.5 million in 2023, as compared to an unrealized gain of $41.6 million from the change in fair value of the Series A and Series B warrants and embedded derivative in the comparable prior period. Refer to Notes 8 and 9 to the consolidated financial statements elsewhere herein for additional information regarding the Starboard Securities and fair value measurements.
• Loss on foreign currency exchange was $70,000 in 2023, as compared to a loss on foreign currency exchange of $1.9 million in the comparable prior period. The losses were primarily derived from our foreign cash accounts exposed to fluctuations in foreign currency exchange rates between the U.S. dollar and the British Pound.
• Interest expense on Senior Secured Notes decreased $942,000, from $1.1 million to $130,000 in 2023, due to the cancellation of the remaining $60.0 million aggregate principal amount outstanding of the Senior Secured Notes on July 13, 2023 pursuant to the Series B Warrants Exercise. Refer to Note 8 to the consolidated financial statements elsewhere herein for additional information regarding the Starboard Senior Secured Notes.
• Interest income and other, net was $4.5 million in 2023, as compared to $1.2 million in the comparable prior period, mainly due to an increase in interest and dividend income from our cash equivalents. Refer to Note 2 included in our Annual Report on Form 10-K for the year ended December 31, 2022, as filed with the SEC on March 17, 2023 for additional information regarding our cash and cash equivalents and investments in equity securities.

Results of Operations - nine months ended September 30, 2023 compared with the nine months ended September 30, 2022

Total revenues decreased $13.3 million to $32.8 million for the nine months ended September 30, 2023, as compared to $46.1 million for the nine months ended September 30, 2022, due to a decrease in our Intellectual Property Operations revenues and Industrial Operations revenues. ARG executed 10 license agreements during the nine months ended September 30, 2023, a decrease of three versus the comparable prior period, which contributed to Intellectual Property Operations revenues decreasing by $10.7 million. Refer to “Investments in Patent Portfolios” above for additional information regarding the impact of portfolio acquisition trends on current and future licensing and enforcement related revenues. The decrease in Industrial Operations revenue of $2.6 million is due to lower units of printers sold. Refer to "Industrial Operations – Revenues" below for further detailed discussion.

Loss before income taxes was $5.9 million for the nine months ended September 30, 2023, as compared to loss of $106.8 million in the comparable prior period. The net decrease was comprised of the change in total revenues described above and other changes in operating expenses and other income or expense as follows:

• Inventor royalties decreased $229,000, from $1.1 million to $863,000 in 2023, primarily due to license agreement activity and related revenues generated with inventor royalty obligations. Refer to "Intellectual Property Operations – Cost of Revenues" below for further discussion.
• Contingent legal fees decreased $1.4 million, from $2.3 million to $890,000 in 2023, primarily due to the change in Intellectual Property Operations revenues described above. Refer to "Intellectual Property Operations – Cost of Revenues" below for further discussion.
• Litigation and licensing expenses increased $2.4 million, from $3.3 million to $5.7 million in 2023, primarily due to a net increase in litigation support and third-party technical consulting expenses associated with ongoing litigation. Refer to "Intellectual Property Operations – Cost of Revenues" below for further discussion.
• Printronix cost of sales, engineering and development expenses, and sales and marketing expenses decreased $844,000, from $20.4 million to $19.5 million. Refer to "Industrial Operations – Cost of Revenues" and "Operating Expenses" below for further discussion.
• General and administrative expenses decreased $1.5 million, from $36.8 million to $35.3 million in 2023, primarily due to lower parent company and Intellectual Property Operations costs including, compensation expense for share-based awards, variable performance-based compensation costs, personnel costs, severance costs, and our Industrial Operations general and administrative costs offset partially by an increase in parent company consulting and legal fees related to the termination of the former Chief Executive Officer and SEC matters and accounting fees and a one-time bad debt expense of $2.3 million. Refer to "General and Administrative Expenses" below for further detail and discussion.
• Compensation expense for share-based awards, included in general and administrative expenses above, decreased $964,000, from $3.3 million to $2.3 million in 2023, primarily due to forfeitures for terminated employees, which includes a partial offset by restricted stock and option grants issued to employees and the Board in 2023 and 2022.
• Unrealized gain from the change in fair value of our equity securities was $18.8 million in 2023, as compared to an unrealized loss of $266.2 million in the comparable prior period. The unrealized gain and loss were derived from our Life Sciences Portfolio and trading securities portfolio. The prior period unrealized loss primarily relates to the reversal of unrealized gains previously recorded for shares sold during the period for realized gains. Refer to "Equity Securities Investments" below for further discussion.
• Realized loss from the sale of equity securities was $9.4 million in 2023, as compared to a realized gain of $114.4 million in the comparable prior period. The realized gains and loss were derived from the sales activity from our Life Sciences Portfolio and trading securities portfolio. Refer to "Equity Securities Investments" below for further discussion.
• Earnings on equity investment in joint venture decreased $39.5 million, from $42.9 million to $3.4 million in 2023. The current period includes the earnings on equity investment in joint venture from one milestone while the comparable prior period included two milestone payments with related accrued interest and earnings on equity investment in the joint venture. Refer to "Equity Securities Investments" below for a detailed discussion.
• Unrealized gain from the Series B warrants and the embedded derivative fair value measurements was $8.2 million in 2023, as compared to an unrealized gain of $34.6 million from the Series A and Series B warrants and embedded derivative fair value measurements in the comparable prior period. Refer to Notes 8 and 9 to the consolidated financial statements elsewhere herein for additional information regarding the Starboard Securities and fair value measurements..
• Gain on foreign currency exchange was $25,000 in 2023, as compared to a loss on foreign currency exchange of $4.5 million in the comparable prior period. The gains and losses were primarily derived from our foreign cash accounts exposed to fluctuations in foreign currency exchange rates between the U.S. dollar and the British Pound.
• Interest expense on Senior Secured Notes decreased $3.6 million, from $5.5 million to $1.9 million in 2023, due to the cancellation of the remaining $60.0 million aggregate principal amount outstanding of the Senior Secured Notes on July 13, 2023 pursuant to the Series B Warrants Exercise. Refer to Note 8 to the consolidated financial statements elsewhere herein for additional information regarding the Starboard Senior Secured Notes.
• Interest income and other, net was $12.2 million in 2023, as compared to $3.1 million in the comparable prior period, mainly due to an increase in interest income from our cash equivalents. Refer to Note 2 included in our Annual Report on Form 10-K for the year ended December 31, 2022, as filed with the SEC on March 17, 2023 for additional information regarding our cash and cash equivalents and investments in equity securities.

Intellectual Property Operations

Revenues

ARG's revenue activity for the periods presented included the following:

(In thousands, except percentage change values and count totals)

For the periods presented above, the majority of the revenue agreements executed during the relevant period provided for the payment of one-time, paid-up license fees in consideration for the grant of certain IP Rights for patented technology owned by our operating subsidiaries. These rights were primarily granted on a perpetual basis, extending until the expiration of the underlying patents. Paid-up revenue decreased $4.6 million for the three months ended September 30, 2023 and $10.2 million for the nine months ended September 30, 2023 due to a decrease in the average revenue per agreement and decrease in the number of agreements executed. Recurring revenue, that provides for quarterly sales-based license fees, decreased $30,000 for the three months ended September 30, 2023 and $499,000 for the nine months ended September 30, 2023 from various on-going license arrangements.

Refer to Note 2 included in our Annual Report on Form 10-K, for the year ended December 31, 2022, as filed with the SEC on March 17, 2023 for additional information regarding our revenue arrangements and related concentrations for the periods presented herein.

Refer to “Investments in Patent Portfolios” above for information regarding the impact of portfolio acquisition trends on current and future licensing and enforcement related revenues.

Cost of Revenues

(In thousands, except percentage change values)

Refer to detailed change explanations above for the three and nine months ended September 30, 2023 and 2022 regarding cost of revenues for our Intellectual Property Operations.

The economic terms of patent portfolio related partnering agreements and contingent legal fee arrangements, if any, including royalty obligations, if any, royalty rates, contingent fee rates and other terms and conditions, vary across the patent portfolios owned or controlled by our operating subsidiaries. In certain instances, we have invested in certain patent portfolios without future patent partner royalty obligations. The costs associated with the forementioned obligations fluctuate period to period, based on the amount of revenues recognized each period, the terms and conditions of revenue agreements executed each period and the mix of specific patent portfolios, with varying economic terms and conditions, generating revenues each period.

Litigation and licensing expenses include patent-related litigation, enforcement and prosecution costs incurred by law firms and external patent attorneys engaged on either an hourly basis or a contingent fee basis. Litigation and licensing expenses also includes third-party patent research, development, patent prosecution and maintenance fees, re-exam and inter partes reviews, consulting and other costs incurred in connection with the licensing and enforcement of patent portfolios. Refer to “Investments in Patent Portfolios” above for additional information regarding the impact of portfolio acquisition trends on current and future licensing and enforcement related revenues.

Industrial Operations

Revenues

Printronix's net revenues for the periods presented included the following:

(In thousands, except percentage change value)

For the periods presented above, the majority of the contract agreements executed in the relevant period include various combinations of tangible products (which include printers, consumables and parts) and services. Printers and parts decreased $947,000 for the three months ended September 30, 2023 and $2.1 million for the nine months ended September 30, 2023 due to a decrease in the number of printer units sold. Refer to Note 2 included in our Annual Report on Form 10-K, for the year ended December 31, 2022, as filed with the SEC on March 17, 2023 for additional information regarding Printronix's revenue arrangements and related concentrations. Refer to “Industrial Printing Solutions” above for additional information related to Printronix's operating activities.

Cost of Revenues

(In thousands, except percentage change values)

Refer to detailed change explanations above for the three and nine months ended September 30, 2023 and 2022 regarding cost of sales for our Industrial Operations. The increase in Printronix's cost of sales for the nine months ended September 30, 2023 is due to under absorption of overhead cost. Refer to Note 2 included in our Annual Report on Form 10-K, for the year ended December 31, 2022, as filed with the SEC on March 17, 2023 for additional information regarding Printronix's cost of sales.

Operating Expenses

(In thousands, except percentage change values)

The operating expenses table above includes the Company's general and administrative expenses by operation and Printronix's engineering and development expenses and sales and marketing expenses. Refer to Note 2 to the consolidated financial statements elsewhere herein for additional information regarding Printronix's operating expenses.

General and Administrative Expenses

A summary of the main drivers of the change in general and administrative expenses is as follows:

(In thousands)

General and administrative expenses include employee compensation and related personnel costs, including variable performance based compensation and compensation expense for share-based awards, office and facilities costs, legal and accounting professional fees, public relations, stock administration, business development, fixed asset depreciation, amortization of Industrial Operations intangible assets, state taxes based on gross receipts and other corporate costs.

The decrease in personnel cost and board fees, variable performance-based compensation costs, and compensation expense for share-based awards was primarily due to a decrease in headcount and related costs. The increases in other general and administrative costs, which relates to our parent company and Intellectual Property Operations business, were primarily due to parent company consulting and legal fees related to the termination of the former Chief Executive Officer and SEC matters. The decrease in General and administrative costs of Industrial Operations is due to Printronix's initiative to reduce costs and operate more efficiently. Non-recurring employee severance costs fluctuate based on the severance arrangements of terminated employees. Refer to additional general and administrative change explanations above.

Other Income/Expense

Equity Securities Investments

(In thousands, except percentage change values)

Our equity securities investments, including the Life Sciences Portfolio and trading securities portfolio, are recorded at fair value at each balance sheet date. During the fourth quarter of 2022, Acacia fully exited its position in Oxford Nanopore. Refer to periodic change explanations above. Refer to Note 3 to the consolidated financial statements elsewhere herein for additional information regarding our investment in the Life Sciences Portfolio and other equity securities.

Our year-to-date results included an unrealized gain from the change in fair value of our equity securities as compared to an unrealized loss in the comparable prior period, and included realized loss from the sale of our equity securities as compared to an realized gain in the comparable prior period. These changes were derived from our Life Sciences Portfolio and trading securities portfolio. The current period unrealized gain primarily relates to one Life Sciences Portfolio and trading securities portfolio. The current period realized loss primarily relates to sales activity from trading securities portfolio.

During 2021, we began to recognize earnings on our equity investment in joint venture, which is part of the Life Sciences Portfolio. During the third quarter of 2023, we recorded consolidated earnings on equity investment of $3.4 million for one milestone earned during the period. During the first nine months of 2022, we recorded consolidated earnings on equity investment of $42.9 million, including two milestones and accrued interest that were due in 2022. Refer to Notes 3 to the consolidated financial statements elsewhere herein for additional information.

Income Taxes

(In thousands, except percentage change values)

Our income tax benefit for the three months ended September 30, 2023 is primarily attributable to recognizing an income tax benefit on losses incurred in jurisdictions for which a valuation allowance is not needed. Our income tax expense for the nine months ended September 30, 2023 is primarily attributable to foreign taxes withheld and state income taxes. Our income tax benefit for the three and nine months ended September 30, 2022 primarily reflects the decrease in deferred tax liabilities attributable to the unrealized gain recorded in the period.

Our 2023 effective tax rate in each period was lower than the U.S. federal statutory rate primarily due to expiration of foreign tax credits changes in valuation allowance, as well as non-deductible items. Our 2022 effective tax rate in each period was lower than the U.S. federal statutory rate primarily due to the change in valuation allowance, as well as non-deductible items. The effective tax rate may be subject to fluctuations during the year as new information is obtained which may affect the assumptions used to estimate the effective tax rate, including factors such as expected utilization of net operating loss carryforwards, changes in or the interpretation of tax laws in jurisdictions where the Company conducts business, the Company’s expansion into new states or foreign countries, and the amount of valuation allowances against deferred tax assets.

The Company has recorded a partial valuation allowance against our net deferred tax assets as of September 30, 2023 and December 31, 2022. Refer to Note 2 to the consolidated financial statements elsewhere herein for additional income tax information.

Liquidity and Capital Resources

General

Our foreseeable material cash requirements as of September 30, 2023, are recognized as liabilities or generally are otherwise described in Note 11, "Commitments and Contingencies," to the consolidated financial statements included elsewhere herein. On July 13, 2023, in accordance with the terms of the Recapitalization Agreement, Starboard completed the Series B Warrants Exercise and pursuant to the Series B Warrants Exercise, the Company cancelled $60.0 million aggregate principal amount of Senior Secured Notes held by Starboard and received aggregate gross proceeds of approximately $55.0 million. At the closing of the Series B Warrants Exercise, the Company paid to Starboard an aggregate amount of $66.0 million. Upon the Series B Warrants Exercise, the Investors exercised the Series B Warrants at a reduced price and Company issued an aggregate of 31,506,849 shares of the Company's common stock to the Investors in consideration of their cash payment and cancellation of any outstanding Senior Secured Notes. For additional information, see Note 8, "Starboard Investment" to the consolidated financial statements included elsewhere herein.

Cash requirements are generally derived from our operating and investing activities including expenditures for working capital (discussed below), human capital, business development, investments in equity securities and intellectual property, and business combinations. Our facilities lease obligations, guarantees and certain contingent obligations are further described in Note 11 to the consolidated financial statements. Historically, we have not entered into off-balance sheet financing arrangements. At September 30, 2023, we had unrecognized tax benefits, as further described in Note 2 to the consolidated financial statements.

Certain of our operating subsidiaries are often required to engage in litigation to enforce their patents and patent rights. In connection with any of our operating subsidiaries’ patent enforcement actions, it is possible that a defendant may request and/or a court may rule that an operating subsidiary has violated statutory authority, regulatory authority, federal rules, local court rules, or governing standards relating to the substantive or procedural aspects of such enforcement actions. In such event, a court may issue monetary sanctions against us or our operating subsidiaries or award attorney’s fees and/or expenses to a defendant(s), which could be material.

At September 30, 2023, our primary sources of liquidity are cash and cash equivalents on hand and cash generated from our operating activities. Our cash and cash equivalents on hand includes proceeds of the completed Rights Offering and Concurrent Private Rights Offering at September 30, 2023. We satisfied our obligations under the existing Senior Secured Notes on July 13, 2023 and made the Recapitalization Payment with cash on hand pursuant to the Series B Warrants Exercise.

Furthermore, we intend to grow our company by acquiring additional operating businesses and intellectual property assets. We expect to finance such acquisitions through cash on hand or by engaging in equity or debt financing.

Our management believes that our cash and cash equivalent balances and cash flows from operations will be sufficient to meet our cash requirements through at least twelve months from the date of this Quarterly report 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 under Item 1A, “Risk Factors” of our Annual Report. Any efforts to seek additional funding could be made through issuances of equity or debt, or other external financing. However, additional funding may not be available to us on favorable terms, or at all. The capital and credit markets have experienced extreme volatility and disruption in recent years, and the volatility and impact of the disruption may continue. At times during this period, the volatility and disruption has reached unprecedented levels. In several cases, the markets have exerted downward pressure on stock prices and credit capacity for certain issuers, and the commercial paper markets may not be a reliable source of short-term financing for us. If we fail to obtain additional financing when needed, we may not be able to execute our business plans and our business, conducted by our operating subsidiaries, may suffer.

Cash, Cash Equivalents and Investments

Our consolidated cash, cash equivalents and equity securities totaled $409.2 million at September 30, 2023, compared to $349.4 million at December 31, 2022.

Cash Flows Summary

The net change in cash and cash equivalents and restricted cash for the periods presented was comprised of the following:

(In thousands)

Cash Flows from Operating Activities

Cash flows from operating activities were comprised of the following for the periods presented:

(In thousands)

Cash receipts from ARG's licensees totaled $6.3 million and $14.2 million for the nine months ended September 30, 2023 and 2022, respectively. Cash receipts from Printronix's customers totaled $28.8 million and $30.4 million for the nine months ended September 30, 2023 and 2022, respectively. The fluctuations in cash receipts for the periods presented primarily reflects the corresponding fluctuations in revenues recognized during the same periods, as described above, and the related timing of payments received from licensees and customers.

Our reported cash used in operations for the nine months ended September 30, 2023 was $18.0 million, compared to $13.6 million cash provided by operations in the comparable prior period. The increase in cash used in operations was primarily due to net outflows from the total changes in assets and liabilities (refer to Working Capital discussion below), inventory related purchases and royalties and contingent legal fees related payments, and by the total change in net income (described above) and related noncash adjustments.

Working Capital

Our working capital related to cash flows from operating activities at September 30, 2023 increased to $17.0 million, compared to $15.1 million at December 31, 2022, which was comprised of the changes in assets and liabilities presented above. The increase is primarily due to change in prepaid expenses and other current assets, inventories, and accounts payable, which is related to the timing of the insurance payments and severance accruals, partially offset by decrease in accrued expenses and other current liabilities, which is related to legal fees and installments of the accrued patent cost (refer to Note 6).

Cash Flows from Investing Activities

Cash flows from investing activities were comprised of the following for the periods presented:

(In thousands)

Cash flows from investing activities for the nine months ended September 30, 2023 decreased to $8.6 million, as compared to cash flow of $124.3 million in the comparable prior period, primarily due to net cash inflows from our Life Sciences Portfolio and trading securities portfolio equity securities transactions in 2023. Refer to “Other Income/Expense – Equity Securities Investments” above for additional information.

Cash Flows from Financing Activities

Cash flows from financing activities included the following for the periods presented:

(In thousands)

Cash inflows from financing activities for the nine months ended September 30, 2023 increased to $66.4 million, as compared to cash outflow of $174.6 million in the comparable prior period, primarily due to activity related to the Rights Offering and Concurrent Private Rights Offering (refer to Note 8).

On October 30, 2022, the Company entered into a Recapitalization Agreement with Starboard and the Investors. On July 13, 2023, Starboard completed the Series B Warrants Exercise through a combination of a "Note Cancellation" and a "Limited Cash Exercise." Refer to Note 8 to the consolidated financial statements elsewhere herein for additional information.

Critical Accounting Estimates

Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. In preparing these financial statements, we make assumptions, judgments and estimates that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition or results of operations. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. On a regular basis, we evaluate our assumptions, judgments and estimates and make changes accordingly.

We believe that of the significant accounting policies discussed in Note 2 included in our Annual Report on Form 10-K, for the year ended December 31, 2022, as filed with the SEC on March 17, 2023, the following accounting policies require our most difficult, subjective or complex assumptions, judgments and estimates:

• revenue recognition;
• valuation of long-lived assets, goodwill and other intangible assets;
• accounting for income taxes.

Our critical accounting estimates have not changed materially from those disclosed in the Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K, for the year ended December 31, 2022, as filed with the SEC on March 17, 2023. For further information on the significant accounting policies related to the valuation of long-lived assets, goodwill and other intangible assets and income taxes, refer to Note 2 to the consolidated financial statements and other related significant account policies included in our Annual Report on Form 10-K, for the year ended December 31, 2022, as filed with the SEC on March 17, 2023.

Recent Accounting Pronouncements

Refer to Note 2 to consolidated financial statements included elsewhere herein.

The primary objective of our short-term investment activities is to preserve principal while concurrently maximizing the income we receive from our equity securities without significantly increasing risk. Some of the securities that we invest in may be subject to interest rate risk and/or market risk. This means that a change in prevailing interest rates, with respect to interest rate risk, or a change in the value of the United States equity markets, with respect to market risk, may cause the principal amount or market value of the equity securities 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 may decline. To minimize these risks in the future, we intend to maintain our portfolio of cash equivalents and equity securities in a variety of securities. Cash equivalents are comprised of investments in U.S. treasury securities and AAA rated money market funds that invest in first-tier only securities, which primarily include domestic commercial paper and securities issued or guaranteed by the U.S. government or its agencies. In general, money market funds are not subject to market risk because the interest paid on such funds fluctuates with the prevailing interest rate. Accordingly, a 100 basis point increase in interest rates or a 10% decline in the value of the United States equity markets would not be expected to have a material impact on the value of such money market funds. Declines in interest rates over time will, however, reduce our interest income.

Investment Risk

We are exposed to investment risks related to changes in the underlying financial condition of certain of our equity investments in technology companies. The fair value of these investments can be significantly impacted by the risk of adverse changes in securities markets generally, as well as risks related to the performance of the companies whose securities we have invested in, risks associated with specific industries, and other factors. These investments are subject to significant fluctuations in fair value due to the volatility of the securities markets and of the underlying businesses.

As of September 30, 2023 and December 31, 2022, the carrying value of our equity investments in public and private companies was $101.3 million and $98.4 million, respectively.

We record our equity investments in publicly traded companies at fair value, which are subject to market price volatility. As of September 30, 2023, a hypothetical 10% adverse change in the market price of our investments in publicly traded common stock would have resulted in a decrease of approximately $6.5 million in such equity investments. We evaluate our equity investments in private companies for impairment when events and circumstances indicate that the decline in fair value of such assets below the carrying value is other-than temporary.

Foreign Currency Exchange Risk

Although we historically have not had material foreign operations, we are also exposed to market risks related to fluctuations in foreign currency exchange rates between the U.S. dollar, and the British Pound and Euro currency exchange rates, primarily related to foreign cash accounts, a note receivable and certain equity security investments. As of September 30, 2023, a hypothetical 10% change in exchange rates related to our at risk foreign denominated equity securities would have approximately a $5.0 million effect on our financial position and results of operations.

Evaluation of Disclosure Controls and Procedures

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 defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act.

Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of September 30, 2023, 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 Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate 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 Control Over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter (the quarter ended September 30, 2023) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

Our management, including our principal executive officer and principal financial officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of the effectiveness of controls to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

An investment in our common stock involves risks. Before making an investment decision, you should carefully consider all of the information in this Quarterly Report on Form 10-Q, including in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I, Item 2, as well as our consolidated financial statements and the accompanying notes thereto. In addition, you should carefully consider the risks and uncertainties in the section entitled “Risk Factors” in Part I, Item 1A of our Annual Report and in Part II, Item 1A of our Quarterly Report on Form 10-Q for the three months ended June 30, 2023, as well as in our other public filings with the SEC. If any of the identified risks are realized, our business, financial condition, operating results and prospects could be materially and adversely affected. In that case, the trading price of our common stock may decline, and you could lose all or part of your investment. In addition, other risks of which we are currently unaware, or which we do not currently view as material, could have a material adverse effect on our business, financial condition, operating results and prospects. There have been no changes to the Risk Factors previously reported in our Annual Report, except as follows described in Part II, Item 1A of our Quarterly Report on Form 10-Q for the three months ended June 30, 2023.