FAIR VALUE MEASUREMENTS

9 Months Ended

Sep. 30, 2021

Fair Value Disclosures [Abstract]

FAIR VALUE MEASUREMENTS

7. FAIR VALUE MEASUREMENTS

U.S. GAAP defines fair value as the price that would be received for an asset or the exit price that would be paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants on the measurement date, and also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs, where available. The three-level hierarchy of valuation techniques established to measure fair value is defined as follows:

(i) Level 1 - Observable Inputs:  Quoted prices in active markets for identical investments;

(ii) Level 2 - Pricing Models with Significant Observable Inputs:  Other significant observable inputs, including quoted prices for similar investments, interest rates, credit risk, etc.; and

(iii) Level 3 - Unobservable Inputs:  Unobservable inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model. Management estimates include certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs, including the entity’s own assumptions in determining the fair value of derivatives and certain investments.

Whenever possible, the Company is required to use observable market inputs (Level 1 - quoted market prices) when measuring fair value. In such cases, the level at which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. The assessment of the significance of a particular input requires judgment and considers factors specific to the asset or liability being measured. In certain cases, inputs used to measure fair value may fall into different levels of the fair value hierarchy.

Acacia holds the following types of financial instruments at September 30, 2021 and December 31, 2020:

Equity Securities at Fair Value. Equity securities includes investments in public company common stock and are recorded at fair value based on the quoted market price of each share on the valuation date. The fair value of these securities are within Level 1 of the valuation hierarchy. Equity investments that do not have regular market pricing, but for which fair value can be determined based on other data values or market prices, are recorded at fair value within Level 2 of the valuation hierarchy. At September 30, 2021, our Level 2 equity securities include an investment measured with an applied pricing model that includes significant observable inputs to the public company common stock value. The fair value of the Level 2 equity securities investment as of September 30, 2021 was estimated based on a discount of 7.5 percent determined using the following significant inputs to the pricing model: expected term of restriction of 6 months and volatility of approximately 45 percent.

Investments at Fair Value - Common Stock and Warrants. Acacia’s equity investment in Veritone common stock was recorded at fair value based on the quoted market price of Veritone’s common stock on the applicable valuation date (Level 1). Warrants were recorded at fair value, as based on the Black-Scholes option-pricing model (Level 2). Refer to Note 4 for additional information.

Series A Warrants. Series A Warrants are recorded at fair value, using Black-Scholes option-pricing model (Level 3). In the quarter ended March 31, 2021, there was a change in estimate with regard to the calculation of the volatility assumption used in the Black Scholes option-pricing model. As a result, the Series A Warrants are now measured as Level 3 as opposed to Level 2 as measured previously. The fair value of the Series A Warrants as of September 30, 2021 was estimated based on the following significant assumptions: volatility of 30 percent, risk-free rate of 1.16 percent, term of 6.04 years and a dividend yield of 0 percent. 

Series B Warrants. Series B Warrants are recorded at fair value, using Black-Scholes option-pricing model (Level 3). In the quarter ended March 31, 2021, there was a change in methodology used to an acceptable Black-Scholes option-pricing model from a Monte Carlo valuation technique used to value the Series B Warrants as of December 31, 2020. The fair value of the Series B Warrants as of September 30, 2021 was estimated based on the following significant assumptions: (1) volatility of 30 percent, risk-free rate of 1.17 percent, term of 6.13 years and a dividend yield of 0 percent, and (2) volatility of 25 percent, risk-free rate of 0.08 percent, term of 0.90 years and a dividend yield of 0 percent.

Embedded Derivative Liability. Embedded derivatives that are required to be bifurcated from their host contract are evaluated and valued separately from the host instrument. A binomial lattice framework is used to estimate the fair value of the embedded derivative in the Series A Redeemable Convertible Preferred Stock issued by the Company in 2019 (Level 3). The binomial model utilizes the Tsiveriotis and Fernandes implementation in which a convertible instrument is split into two separate components within a single lattice framework: a cash-only component which is subject to the selected risk-adjusted discount rate and an equity component which is subject only to the risk-free rate. The model considers the (i) implied volatility of the value of our common stock, (ii) appropriate risk-free interest rate, (iii) credit spread, (iv) dividend yield, (v) dividend accrual (and a step-up in rates), and (vi) event probabilities of the various conversion and redemption scenarios.

The volatility of the Company’s common stock is estimated by analyzing the Company’s historical volatility, implied volatility of publicly traded stock options, and the Company’s current asset composition and financial leverage. The selected volatility, as described below, represents a haircut from the Company’s actual realized historical volatility. A volatility haircut is a concept used to describe a commonly observed occurrence in which the volatility implied by market prices involving options, warrants, and convertible debt is lower than historical actual realized volatility. The assumed base case term used in the valuation model is the period remaining until November 15, 2027, the Series A Redeemable Convertible Preferred Stock maturity date. The risk-free interest rate is based on the yield on the U.S. Treasury with a remaining term equal to the expected term of the conversion and early redemption options. The significant assumptions utilized in the Company’s valuation of the embedded derivative at September 30, 2021 are as follows: volatility of 30 percent, risk-free rate of 1.20 percent, term of 6.13 years, discount rate of 9.40 percent and a dividend yield of 0 percent. The fair value measurement of the embedded derivative is sensitive to these assumptions and changes in these assumptions could result in a materially different fair value measurement.

Financial assets and liabilities measured at fair value on a recurring basis were as follows: 

	Level 1		Level 2		Level 3		Total
Assets	(In thousands)
September 30, 2021:
Equity securities at fair value	$	119,280	$	267,840	$	–	$	387,120
Total	$	119,280	$	267,840	$	–	$	387,120
December 31, 2020:
Equity securities at fair value	$	109,103	$	–	$	–	$	109,103
Investment at fair value - warrants		–		2,752		–		2,752
Total	$	109,103	$	2,752	$	–	$	111,855
Liabilities
September 30, 2021:
Series A warrants	$	–	$	–	$	18,527	$	18,527
Series A embedded derivative liabilities		–		–		41,411		41,411
Series B warrants		–		–		229,637		229,637
Total	$	–	$	–	$	289,575	$	289,575
December 31, 2020:
Series A warrants	$	–	$	6,640	$	–	$	6,640
Series A embedded derivative liabilities		–		–		26,728		26,728
Series B warrants		–		–		52,341		52,341
Total	$	–	$	6,640	$	79,069	$	85,709

The following tables set forth a summary of the changes in the estimated fair value of the Company’s Level 3 liabilities, which are measured at fair value on a recurring basis: 

	Series A Warrant Liability		Series A Embedded Derivative Liability		Series B Warrant Liability			Total
	(In thousands)
Balance at January 1, 2021	$	–	$	26,728	$	52,341		$	79,069
Transfers to Level 3		6,640		–		–			6,640
Remeasurement to fair value		11,824		14,463		178,198			204,485
Balance at June 30, 2021		18,464		41,191		230,539			290,194
Remeasurement to fair value		63		220		(902	)		(619	)
Balance at September 30, 2021	$	18,527	$	41,411	$	229,637		$	289,575

	Series A Warrant Liability			Series A Embedded Derivative Liability			Series B Warrant Liability			Total
	(In thousands)
Balance at January 1, 2020	$	3,568		$	17,974		$	–		$	21,542
Transfers to Level 3		–			–			5,929			5,929
Remeasurement to fair value		3,384			11,539			52,361			67,284
Balance at June 30, 2020		6,952			29,513			58,290			94,755
Remeasurement to fair value		(1,348	)		(3,831	)		(15,493	)		(20,672	)
Balance at September 30, 2020	$	5,604		$	25,682		$	42,797		$	74,083

In accordance with U.S. GAAP, from time to time, the Company measures certain assets at fair value on a nonrecurring basis. The Company reviews the carrying value of equity securities without readily determinable fair value, equity method investments and patents on a quarterly basis for indications of impairment, and other long-lived assets at least annually. When indications of potential impairment are identified, the Company may be required to determine the fair value of those assets and record an adjustment for the carrying amount in excess of the fair value determined. Any fair value determination would be based on valuation approaches, which are appropriate under the circumstances and utilize Level 2 and Level 3 measurements as required.