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Investors in VirnetX (NYSEMKT:VHC) have been impatiently awaiting final word from the Honorable Judge Davis regarding VirnetX's first trial with Apple (NASDAQ:AAPL). The judge recently issued a very comprehensive and detailed order, an order that investors should be more than pleased with. I have taken parts of the lengthy order to provide readers with an overview of each section of the judge's comprehensive order. They serve to provide information as to why this order is a positive event for VirnetX. The wording of the order and the dialogue is more powerful than what can be written on behalf of it, so I have provided numerous quotations from the order for a more in depth analysis. This is amazing news for VirnetX investors and provides another reason to have a positive sentiment on the stock.

The order starts by going through each of Apple's arguments against their infringement of VPN on Demand and FaceTime. The judge goes through the points argued by Apple in their position that they do not infringe upon VirnetX's patents. The judge also provides analysis afterwards of why Apple's arguments are lacking and do not provide for an adequate defense. Moreover, the judge denied Apple's request for a new trial or a reduction in the amount of damages awarded.

VPN On Demand Takeaways:

  1. "Apple contends VirnetX's expert Dr. Jones's interpretation of the "determining whether" step is unsupported by claim language"(6). The judge responds, "Ultimately, Apple is re-arguing the infringement theory it presented at trial, which the jury was free to reject. Here, VirnetX produced substantial evidence that the VPN On Demand feature meets the 'determining whether' limitation" (8).
  2. "Apple contends that VirnetX ... failed to demonstrate that the feature creates an encrypted of secure channel between the client and the secure server" (8). In response to this the judge stated, "Accordingly, VirnetX did present substantial evidence to support the jury verdict that the VPN On Demand feature meets the 'encrypted channel' and 'secure channel' claim limitations" (10).
  3. The judge further states that, " Accordingly, VirnetX produced substantial evidence to demonstrate Apple's VPN On Demand meets all the claim limitations of the asserted claims of the '135 and '151 patent" (10).
  4. "Finally, Apple alleges VirnetX failed to demonstrate that Apple directly infringes any asserted method claim of the '135 patent" (10). The judge states, "In light of Dr. Jones' testimony and the claim language, VirnetX provided substantial evidence to establish Apple directly infringed the method claims of the '135 patent" (12).

The judge has thoroughly upheld the fact that Apple does infringe upon VirnetX's patents directly related to VPN on Demand. This is the first part of the positive news for VirnetX because it solidifies the fact that Apple's VPN on Demand feature does infringe upon VirnetX's patents. Apple was proven guilty of infringement of VPN on Demand in the courtroom, and now the judge has shot down Apple's arguments, thus compounding the fact that Apple does infringe VirnetX's patents with regards to VPN on Demand.

FaceTime

  • During trial VirnetX and Apple argued as to whether FaceTime meets the direct communication claim limitation. "Both parties agree that 'secure communication' requires a direct communication, however the parties dispute whether a network address translator (NYSE:NAT) allows for direct communication" (12). VirnetX and Apple were both in agreement that, "... the FaceTime feature can operate either via a relay server or via a NAT or other devices containing a NAT functionality" (12). The order goes on to state that, "VirnetX concedes that the feature does not infringe if calls are routed through a relay server, because there is no direct communication through a relay server" (12). When relay servers are taken out of the picture, the only item left are those related to the network address translator. This is the main area of argument between the parties as demonstrated by, "The only dispute is whether a NAT impedes direct communication between the devices" (12).
  • The court goes on to give some background regarding what a NAT actually is by stating, " NATS alter or readdress the IP address of data packets sent between devices" (12). With concern to the network address translator Apple argues that, "...this readdressing of data packets interrupts any direct communication between the two Apple devices" (12). The judge states in response, "However, Dr. Jones explained in his testimony that NATS do not impede direct communication" (13).
  • In dealing with whether a router, firewall or similar servers could impede direct communication the court stated, "VirnetX produced evidence that a NAT operated like a router, firewall or other similar servers and did not impede direct communication"
  • In closing of the FaceTime related section of the order the court stated, "... there was substantial evidence to support a finding that NATs allow direct communication" (13).
  • "Apple also alleges that VirnetX failed to produce sufficient evidence that the feature satisfies that 'look up service' limitation, that the feature meets the domain name limitation, as required by the '504 and '211 patents" (14). The response by the court was powerful, " However, VirnetX provided a detailed analysis how the FaceTime feature meets every single claim limitation" (14).
  • Following the last statement the court goes on to state that, "VirnetX has presented evidence that the feature meets the 'lookup service limitation'... VirnetX has introduced evidence that the feature provides an indication, when FaceTime provides an accept push message which contains the information necessary to establish a secure communication link... Dr. Jones also explained how e-mail addresses or telephone numbers are domain names as required by the claims, since e-mail addresses and telephone numbers have corresponding IP addresses" (14).

The judge has strongly stated that Apple's FaceTime feature does infringe upon VirnetX's patents. The judge has shown in response to each Apple argument here that VirnetX is correct with regards to their arguments of infringement by Apple. This is beneficial for VirnetX because the FaceTime feature is an integral part of the infringement Apple was found guilty of at trial and the judge has upheld VirnetX's position in his most recent order. Regarding VPN on Demand and FaceTime, the judge Denied Apple's motion for a judgment as a matter of law regarding direct infringement. VPN on Demand and FaceTime have been upheld in post trial motions, signifying the fact that Apple does infringe upon VirnetX's patents related to the two.

Judgment As A Matter of Law Regarding Indirect Infringement

Moving along in the order, Apple requested a judgment as a matter of law with regards to VirnetX's claims of indirect infringement. Apple took the stance that VirnetX did not provide sufficient evidence to appropriately conclude that Apple influenced it's customers to infringe VirnetX's Patents.

  • Apple argued here that, "...VirnetX failed to demonstrate that Apple was willfully blind to its customers' infringement, that Apple was aware of the patents prior to the lawsuit and that Apple intentionally encouraged its customers to infringe the patents-in-suit" (16). These are the stances that Apple has taken with regards to VHC's claims of indirect infringement. The court goes on to state that " VirnetX did produce substantial evidence that Apple induced its customers' infringement of the patents-in-suit" (16).
  • Further the order explains that "It [VirnetX] presented testimony that Apple believed there was a high probability that its customers infringed and took deliberate actions to avoid confirming infringement" (16). Apple states that "... this evidence merely shows that Apple understood how its product worked, had notice of the patents after the suit was filed, and that some of its employees avoided reviewed in the patents-in-suit". The judge responded to this motion with, "...VirnetX presented evidence that Apple believed there was a high probability that the technology at issue was patented... VirnetX presented evidence of a clear pattern of behavior by Apple employees..." (17).
  • The order then states, " The fact that Apple instructed its customers to use the accused features in an infringing manner adequately supports the jury's finding" (17).

The judge has taken a firm stance here in response to Apple's argument that VirnetX did not provide sufficient evidence to support a finding that Apple influenced it's customers to infringe upon VirnetX's patents. These responses by the judge demonstrates that VirnetX did provide enough evidence to support the fact that apple influenced their customers to infringe upon VirnetX's patents.

Kiuchi Short Summary

VirnetX and Apple argued in the courtroom over whether or not the Kiuchi reference "...discloses a 'secure communication link'..." (18). The judge states here that VirnetX has provided ample evidence to support the fact that the Kuichi prior art reference does not mention numerous claim limitations such as "... a 'secure communication link,' 'virtual private network.' 'a DNS proxy server,' 'an encrypted channel,' and 'secure channel' "(18). The judge goes on to state that, "for each of the reasons stated above, Apple has not demonstrated it is entitled to judgment as a matter of law as to invalidity" (20). This is another powerful plus for VirnetX since the Kiuchi prior art does not prove invalidity of VirnetX's patents. Furthermore it upholds the strength of the patents as this alleged prior art is demonstrated to not include several claim limitations.

New Trial or Reduction In Award

Apple requested a new trial in post trial motions, that if granted would be a setback to VirnetX because they would have to reestablish infringement in a courtroom and also would be delayed in getting paid for their intellectual property. Moreover this request by Apple involves them requesting a remittitur or what is known as a reduction in the awards provided by the jury. This second item if granted would lower the damages award amount the jury granted VirnetX back in November and that would negatively impact the company. Furthermore, the judge sided with VirnetX in regards to Mr. Weinstein's reasonable royalty rate of 1%. The judge went on to state that VirnetX did provide sufficient evidence to support this reasonable rate on damages. The court saw this order as not holding ground as Apple's request for a new trial or a remittitur was denied. This was a win for VirnetX as they now know there will not be a retrial or a reduction in the awards amount granted to them by the jury.

Pre-judgment Interest

Apple did not argue against providing VirnetX with pre-judgment interest, the two sides disagreed over what the interest rate should be set at though. VirnetX argued for a 5% rate and Apple argued for a 3.25% rate, both rates being compounded quarterly. The judge upheld the usual practice of his court, granting the prime interest rate of 3.25%. This means that, "...VirnetX shall be awarded pre-judgment interest on the $368,160,000.00 damage award at the prime rate, compounded quarterly, such that the pre-judgment interest is $8,755,381 through October 31, 2012, with daily interest of $33,561" (35). Apple may have gotten their interest rate on pre-judgment interest, but it is the standard practice of the judge's court. This is still a huge number and will only increase the total amount of the damage award.

Post Verdict Damages

In this argument, Apple requests that the judge deny VirnetX's request for post-verdict damages because VirnetX overestimated the number. The two numbers proposed by each sides are, "VirnetX amended its request in light of the new data to $330,021 per day from November 6, 2012 through the date of the final judgment... Apple instead proposes awarding post-verdict damages of $279,229 per day" (36). The court goes on to reject Apple's suggestion and sided with VirnetX since their reasoning is more acceptable. This is another win for VirnetX since they have now gained $330k per day from November 6, 2012 until the final judgment. I am unsure of whether this per day post verdict damages ends on the date of this order, February 26, or a different date outlined with a future order from the judge. This has to be extrapolated upon by someone with more legal knowledge, and we all would benefit and appreciate anyone's opinion regarding this. It is my view that this is an ongoing payment until things are settled between the two companies, so if Apple appeals and this is drawn out for another 365 days, Apple risks owing VirnetX another $121 million in post verdict damages.

Permanent Injunction

The judge has sided with Apple on the area of a permanent injunction and denied VirnetX's request for one. In my first article I detailed why the judge could issue a permanent injunction against Apple, and the disparity between Apple's cost and time estimates with regard to a workaround. Apple argues here that, "...VirnetX has misrepresented the nature of the Gabriel technology, and VirnetX has not demonstrated its failure to succeed in the market is a result of Apple;s alleged infringement" (39). These are strong arguments by Apple and the judge has sided not to grant a permanent injunction. This was a debated factor and personally I believed a permanent injunction would be granted do to the fact that VirnetX could not compete in the market when Apple gave away the VirnetX technology for free. In his order the judge recognized the disparity between the costs Apple stated during and post trial with regards to comply with an injunction, but "... the balance of hardships weigh against enjoining Apple" (41). The denial of a permanent injunction may be a blessing in disguise though behind its face value. This is because it is one less item that Apple can appeal.

Ongoing Royalty

In the result that the court did not provide VirnetX with the permanent injunction order against Apple that it requested, VirnetX made a request of the judge regarding an ongoing royalty. The judge sided with VirnetX in his order, " The parties are ORDERED to meet and confer to schedule mediation within 45 days of this order to attempt to negotiate a license. Should the parties fail to agree regarding Apple's future use of VirnetX's patents at the mediation, VirnetX is ORDERED to file the appropriate motion" (42). This is powerful wording by the judge and holds immense value for VirnetX. This means that Apple has 45 days to settle with VirnetX during mediation or the honorable judge Davis will most likely grant the royalty rate. If the post verdict damages do apply to this 45 day period, I don't think that VirnetX will mind waiting and call the shots during negotiation. It is my opinion that after VirnetX files the appropriate form in the case they do not settle during mediation, the judge will grant the ongoing royalty rate. These 45 days will likely comprise intense negotiation talks between the parties.

Conclusion and Effect on VirnetX

This order by the judge confirms another reason as to why an investment in VirnetX is the correct choice. The judge has approved several key motions in his order and has taken the correct stance with an overall motto, Apple has infringed upon VirnetX's intellectual property and they owe VirnetX compensation for it. What stands out to me is the 45 day window for negotiations, and how the judge did not set a discrete rate yet. He wants the parties to work out a deal in good faith and if they do not then he will set the rate. This is a good point because then Apple can not appeal the item on the grounds of them having no chance to negotiate a fair rate as the judge has ordered them to mediation to negotiate one. Setting an ongoing royalty rate for VirnetX provides a valuable and large set of income on a yearly basis, such as earning the 1% royalty rate they covet. Post verdict damages and pre judgment interest here have been granted and will add to the money flowing into VirnetX as a company, when talking about the total award number. One of the bigger takeaways is the fact that the judge has again confirmed infringement of VirnetX's patents by Apple with regard to VPN on Demand and FaceTime. This further confirms the VirnetX patent portfolio in that the judge has denied Apple's motions to break the infringement argument and is holding them liable. This is important because when it comes down to it, Apple infringes and they will pay dearly for it, to the benefit of VirnetX share holders.

This order further compounds the reasoning behind why a long term investment in VirnetX is a good idea. Regarding this order, VirnetX's intellectual property was upheld, some serious post verdict damages and pre judgment interest was award to VirnetX, there will not be a new trial or a decrease in damages and intense negotiations will take place over the next 45 days as to the an ongoing royalty. This is a huge win for VirnetX as their plans to develop and profit from their intellectual property and grow as a company has taken another step in the right direction. This order set in stone the fact that Apple will be paying an ongoing royalty rate soon, and confirms the $368.2 November jury verdict. This order is another confirmation as to why an investment in VirnetX is the right choice, as the judge has seen Apple's infringement of VirnetX's patents has occurred and wants VirnetX to be compensated. VirnetX's legal and management team should be congratulated for their enormous work in pursuing their strategic plan.

This order will help to establish a higher price floor for the stock and add even more confirmation to the VirnetX investment thesis. This removes doubt over post trial motions with this positive order clearing the air for investors. Obtaining the 1% rate during negotiations is key for Apple, since their lawyers would most likely not want to return to Judge Davis's courtroom for him to set the rate. Although if he does set the royalty rate there is nothing to fear, as he agrees with Mr. Weinstein's 1% reasonable royalty rate so investors should assume he will enact a 1% rate or a higher ongoing royalty. This on going royalty is huge for VirnetX as it provides them with massive compensation on a yearly basis for their intellectual property that they could spend any way their management team decides is best for the company.

Because of this order, VirnetX has stated they plan to withdraw their complaint against Apple at the International Trade Commission. This is because the judge has ordered the parties into mediation and upheld the jury verdict, so VirnetX no longer needs the leverage the ITC could grant them. This also frees us VirnetX's legal team so they can focus directly on negotiations with Apple and the upcoming trial with Cisco (NASDAQ:CSCO). In other news, all claims of VirnetX's '180 patent have been found valid and enforceable on February 27th as well. This is a foundational patent for VirnetX and has been completely approved This patent will not be discussed here but it again further cements the strength of VHC's patent portfolio and intellectual property.

The $368.2 damages number has been upheld, an ongoing royalty is in the works, and pre judgment interest and post verdict damages has been established. After the ongoing royalty rate is set in stone, all of these sources will provide VirnetX with a war chest of money. This does not include income from other litigants and non-litigants who will have to pay a fee plus an ongoing royalty rate for use of VirnetX's technology. This money can be used to expand VirnetX as a company or to issue dividends. The VirnetX business model is moving forward and the company is coming more and more into fruition.

For the reasons outlined above, this order is a direct positive for VirnetX and constitutes further reason to be a long term investor. Apple has been shot down again in the courtroom to VirnetX's benefit. It was not chance that VirnetX won in this order, they have viable and real intellectual property that the judge viewed as such, and wants VirnetX to be compensated for their technology. The future of VirnetX has even become clearer with the language regarding an ongoing royalty rate. This royalty rate will provide immense future income for VirnetX. The VirnetX story continues to develop and they have gained the upper hand in the fact that after years of infringement by Apple, it has been asserted by VirnetX and recognized by the court for what its worth. Moreover the trial with Cisco is just weeks away. I expect VirnetX's stock to react positively to this order, and in the end it is one more stone in the secure investment castle that is VirnetX.

On a side note, VirnetX investors should appreciate the hard work and diligence of the VHC message board on the Investor Village site, especially Penaki who diligently provided the report.

Source: The VirnetX Story Continues To Develop: The Judge's Recent Order