(Editors' Note: This article has been corrected to update an error regarding the relationship between Apple and New Bay.)
Investors have been pondering yearly timelines with regard to Apple's (NASDAQ:AAPL) Appeal with VirnetX (NYSEMKT:VHC). It seems that investors disregard the due diligence performed on a company once the share price goes down. Let's go over some recent events to get a better understanding of exactly what is transpiring.
On July 3, 2013, Apple's Appeal was docketed and so began the appeal process. Forty days from that date, September 2, 2013, Apple must file their Brief. Thereafter, VirnetX has forty days to respond with their Reply Brief. VirnetX will file as soon as they are ready while Apple will likely wait the forty days. Typically, an appeal like this can take anywhere from 12 to 14 months.
Above is a chart from the United States Court of Appeals website. Looking at the fiscal year 2012, there are only three categories that surpass one year. None of these apply to the Appeal in VirnetX's case with Apple. There can be extensions and reductions in time within the appeals process. For example, VirnetX can file their Brief earlier than the due date. The possibility of this Appeal taking many years is highly unlikely.
Judge Davis's Brilliant Severance:
Message board posts went wild the day Judge Davis severed the case with Apple. Let's take a closer look at the judge's determination.
In severing the case with Apple, Judge Davis set the amount of past damages in stone while allowing the case to be appealed. During this time, the ongoing royalty rate for the sale of future products can be decided upon. Past infringement will not complicate the case, as there are precise sales numbers and device shipments that are fixed. Damages on these items can be decided upon easily as there are no more moving parts.
Within this severing, the future royalty rate for these accused products can be decided upon with more detail since there are moving parts. One example of this is Apple's removal of VPN on demand and then putting it back after the uproar of corporate users. Judge Davis felt there was no reason to stop the Appeal on past damages while he determines damages on future infringement. In my opinion, this was absolutely brilliant on Judge Davis' part.
Judge Davis will determine whether new products are colorably different from products that have been found to be infringing. On August 15, 2013, Judge Davis will hear from VirnetX and Apple with regard to the Ongoing Royalty Rate for the accused products moving forward. This can be between .80% and 1.52% (see Footnote on page 7). He can also decide whether or not newer products are colorably different from products that are infringing.
There are positives and negatives to each side of the coin. The products that are not colorably different eliminate the need for future cases with Apple regarding infringing products. These products would include the iPhone 5 and iPad Mini to name a few. This directly eliminates the case that was filed shortly after Virnetx's victory against Apple for newer products. This grey area may compel Judge Davis to request discovery and oral argument from both sides. Also in question is whether or not Judge Davis decides on the past royalty rate and/or requests arguments relating to the colorably different issue alone.
How Many Cases Against Apple Are There?
There is one case against Apple which took place in November of 2012 wherein VirnetX was victorious. Soon after that, VirnetX filed a second case for infringement on Apple's newer products. Judge Davis severed the original case into two separate cases, one relating to past damages and one relating to the future royalty rate on these products.
VirnetX is Spelled Differently Than "Rambus":
Many investors fear the worst case scenario. They compare VirnetX's legal battles to those of Rambus. The Rambus case involves issues such as destruction of documents and perjury charges. This is not the case with VirnetX. The only negative I find is Apple's termination of Christopher Allie's Deposition.
New Bay Capital:
New Bay Capital filed an interparty review ("IPR") at the USTPO regarding certain claims on VirnetX's patents. The IPR involves only the claims that were argued in the courtroom against Apple. I find it odd that a relatively unknown company with no relation to VirnetX's technology or patents would file an IPR.
An IPR will usually be decided within 12-18 months from the date it is accepted, which would be sometime in September, 2014. Adding the two months between now and September, we would not hear one way or the other for another 14-20 months. In the meantime, Apple's Appeal has a time frame of around 12 months. This IPR has a very small chance of affecting the Appeal or Apple's case.
Investors Need to Trust Judge Davis's Judgment:
Judge Davis has an amazing record with regard to appeals. His determinations have been so thorough and a challenge to overcome. In Versata v. SAP, the Judge Davis' Order was sent back for review and the case has yet to be finalized. SAP then moved to stay the appeals in hope that the USTPO would give them some leverage, although the motion was denied. Judge Davis' Response to Apple's Appeal referenced Judge Radar's Opinion (Chief Judge of the Court of Appeals for the Federal Circuit) in his Decision to sever the case. Judge Davis has been successful in removing the most appealable items, such as injunctions or future royalties. Judge Davis was brilliant in refusing to grant an injunction and severing future royalties from past damages since these are more appealable items. Judge Davis has made sure that only clear and defined items are in the Appeal, such as sales numbers and shipment information. I believe in Judge Davis not only because I am long VirnetX, but because he decides clearly upon the legal issues in this case.
How Does This Affect The Bottom Line?
A ruling on the Ongoing Royalty Rate from Judge Davis with regard to Apple could mean billions of dollars for VirnetX. This does not include the $368 million awarded to VirnetX last November for past infringement. Kendall Larson stated at the annual shareholder meeting that this number has grown to $440 million and is increasing daily with interest. This increase is due to pre- and post-judgment interest. A new trial with Cisco (NASDAQ:CSCO) is a drop in the bucket yet can be worth $100 - $200 million without treble damages. The big thing to keep in mind is not only the money that can be granted from a royalty rate decision but the precedent that it sets for future licenses. Recent trials like Cisco have further validated VirnetX's patents.
Did I Say Billions?
If Judge Davis rules "not colorably different", damages would include Apple's newer products that are infringing in essentially the same form. This would include newer products such as iPhone 5, iPad Mini and new Macs. Moreover, the Judge's Ongoing Royalty Rate decision would apply to the retail price of these products. Taking a look at Apple's first quarter of 2013 sales, Apple sold 47.8 million iPhone 5's, 22.9 million iPads and 4.1 million Macs. The most inexpensive version of the iPhone 5 sells for $649.99 at full retail price. If you apply a 1% royalty rate to that number and multiply it by Apple's quarter one sales you get $310,695,220. Next, extrapolate that number for the year for the iPhone 5, iPads and Macs and the damages number rises above the billion dollar mark.
Keep In Mind
This calculation applies if Judge Davis declares newer products not colorably different. It also uses the cheapest retail price which may not necessarily be true if a more expensive model is purchased. The ongoing royalty rate for past products that were accused at the first trial are calculated using the cheapest selling model. In Judge Davis can set a rate, in my opinion, as high as 1.52% (see linked footnote) or as low as .75%. Personally, I would like to see a rate of 0.8% or higher. A ruling of not colorably different would save the court system's time and resources of having another trial. These legal proceedings do not include "Imessage", an area of settlement or litigation that can also be profitable for VirnetX.
An investment of $10,000 in Microsoft at the time of their IPO is worth $3,600,000 today. VirnetX is a few years past their IPO, although the calculation with Microsoft is two years old. Investors must keep in mind that a falling stock price does not justify a change in the foundational elements they invested into a company for in the first place. A falling stock price can offer a purchasing opportunity. Judge Davis also has all relevant documentation to issue a ruling regarding a new case or JMOL on the '759 with Cisco. See my previous articles regarding VirnetX's case with Cisco here and here. VirnetX may get new patents approved or can even sign a licensing agreement with an Android player. With 80% of judgments being upheld at appeal, coupled with Judge Davis's record, reasonable expectations allow Investors more knowledge to make a better informed decision regarding their investment.
This being my opinion, I feel that getting a discussion started is better than having no discussion at all.
Disclosure: I am long VHC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.