- VirnetX's day at the CAFC was not at all what you might think by looking at its recent stock performance.
- The recent stock performance offers investors an opportunity to get into the stock at an opportune price.
- Opportune prices don't always present themselves again.
With the multitude of questions I have received since writing my first article on VirnetX's (NYSEMKT:VHC) damages models in the patent trial vs. Apple (NASDAQ:AAPL), I feel that a follow up article addressing both Apple's arguments and the CAFC panel's questions is in order. I am not a lawyer, nor should my opinions be construed as either legal opinions or investment advice. This is an effort to stimulate both discussion and due diligence on a very high return potential investment.
At the CAFC appeal hearing appeal hearing, Judge Rader jumped right to the heart of the argument, asking Apple's lawyer, Mr. Lee, to skip over several issues and discuss the Entire Market Value Rule (EMVR). His first question, "Is the smallest salable unit a separate requirement, or is it a way of applying the entire market value exception?" I find this to be a quite curious way of opening the discussion as it was Judge Rader himself who, in Cornell vs. Hewlett-Packard, added the phrase "smallest saleable patent practicing unit (SSU)" into the damages lexicon, with the EMVR actually being an exception to the usage of the SSU. Mr. Lee, follows right along with that line of thinking, "The smallest salable unit has been used as a way to apply the exception". This to me is mixing the two models, the EMVR applies as the exception to the SSU. Apple seems to have the mindset from the beginning of this lawsuit that since the smallest saleable unit and the entire value of the product could arguably be equal that VirnetX is using the EMVR. Apple is refuted from the beginning by both VirnetX and Judge Davis. Also, there is no case law to support such a position.
When Judge Rader asks, "Where is the jury misled here, if at all?", Mr. Lee answers with one of the comments that I think most disturbed VirnetX's investors at first blush, "...if you have a jury instruction that allows the jury to decide something two different ways, and one is in error, it is a legal error that requires new trial." However, the error is Apple's misplaced understanding of the use of the SSU, which is not error in the jury instructions and will have no bearing on the eventual outcome.
When it came time for VirnetX's lawyer, Mr. Jakes, to address the court he started with damages and Judge Rader immediately asked why there was a disparity between the $0.29 for the Mac upgrade royalty and over $6 for the mobile devices royalty, Judge Rader actually harped on this subject until Mr. Jakes answered, "That's the way the data shook out, and that's the way our expert testified, and there's evidence to support that." Mr. Jakes one sentence told Judge Rader everything he needed to know on the subject; Judge Davis allowed the testimony, the data was what it was, and cross examination and Apple's expert witness could not refute the data. There was no error and no appealable subject matter. It seems to me that the panel agreed as the next question was about the Microsoft (NASDAQ:MSFT) license.
Judge Rader then resumes discussion of the jury instruction that Apple brought up as an "error" that would require a new trial. Mr. Jakes states, "He (Weinstein) did not rely on the entire market value. That number was not given to the jury, there was no taint. The entire revenue was never given to the jury." The trial transcript backs up Mr. Jakes' claim, the only number that Doug Cawley used in closing was the apportioned base, not the entire market value.
After this point, Mr. Jakes finds himself defending Mr. Weinstein's use of an Apple survey where 18% of iPod users "purchased it for a specific feature..." until he finds the correct response, "Our expert did not use the entire market value." Judge Chen interrupts at this time with the observation, "I think we're confusing couple different theories here", Apple has been doing this all along, but better late than never.
Having the stage, Judge Chen brings up the Nash Bargaining Solution (NBS). It breaks down into a discussion of NSB vs. the 25% rule of thumb. Mr. Jakes draws two distinctions; firstly, that NBS divides an infringer's incremental profits and not his entire profit from the product. Judge Rader doesn't seem to put much stock into that distinction as he immediately asks about the second distinction. Mr. Jakes' answer and follow up sentence should be enough to put NSB out of the reach of this particular appeal, "The second distinction is it has an academic background. It comes from a well‑ researched, well‑ published theory that people have accepted as a general theory of economics that when you have the incremental profit due to whatever it is..." and "This really is a well‑ developed theory that is accepted. I don't really think the criticism here is with the methodology. It's with the expert's conclusions. He (Weinstein) came to a conclusion that was given to the jury, and the jury actually cut it back substantially. There is substantial evidence to support the verdict."
In regards to the damage award from the jury Judge Davis wrote,
"Apple never produced any other testimony or evidence regarding how one should properly calculate the damages for the iOS devices, instead it relied solely on the upgrade price for a dissimilar product. If Apple had advanced a different theory showing the iOS device was not the smallest saleable unit, there may have been a different result."
In Cornell vs. Hewlett-Packard, Judge Rader states:
"Accordingly, because this court finds that Hewlett-Packard's hypothetical processor revenue calculation represents the only reliable evidence in this record of adequate compensation for infringement of the claimed invention, [summary judgment is granted]." (Id. at 290.)
To quickly cover the claim construction complaints brought up by Mr. Lee, I'll pull two of his quotes about Domain Name from very early on in his discussion (where we know he hasn't been interrupted by interrogation and can assume he is bringing his strongest points). Firstly, after telling the court what Apple feels the construction should have been, "That is actually the way this court used the term in the Akamai panel decision". That is really Apple's first line of defense? Even a novice patent play investor learns very early on that the entire reason for the Markman hearing is because patent claims define themselves, they do not draw from outside sources or even adopt the ordinary meaning of the term. Secondly, "VirnetX concedes that is the, to use their words, typical meaning of the claim. I would draw the court's attention to A7138 in the Markman briefing process." Ok, let's look at page A7138 and see what VirnetX said, "The Defendants' argument completely misses the point. For claim construction purposes, it is irrelevant that the most typical syntax of domain names is the hierarchical syntax of domain names on the Internet. Nor does it matter that the specification gives examples of hierarchical domain names." Not really much of a defense.
On Secure Communication Link, Mr. Lee says, "What we can say, and have said in our brief is, the background of the invention says it's required. The summary invention, says it's required. The detailed description of the invention, says it's required. In every disclosed embodiment, it says, it's required." But yet, Judge Davis, one of "the top trial patent judges in the world" as proclaimed by Judge Rader on the CAFC record, missed that distinction in all four places.
Lastly, and one of the main things that needs to be considered, is the high legal standard that applies to an appeal to the Federal Circuit. This is VirnetX's viewpoint:
Seeking to overturn the jury verdict, Apple raises numerous issues and only tells half the story for each. With little room in its brief to educate the Court on all issues, Apple does not even begin to identify evidence the jury reasonably relied on to find infringement, no anticipation, and damages. Nor does Apple address intrinsic evidence supporting the district court's claim construction. Further, although nearly all contested issues are reviewed for substantial evidence or abuse of discretion, Apple treats them like legal issues, ignoring this Court's standard of review. As discussed below, substantial evidence supports the jury verdict on infringement, anticipation, and damages, and Chief Judge Davis properly exercised his discretion on evidentiary issues. Moreover, the intrinsic and extrinsic evidence supports the court's construction of "domain name" and "secure communication link," limitations from two of the four patents-in-suit.
There were a myriad of articles, tweets, and message board posts issued after the CAFC hearing tape was released. A number of these used innuendo, rumor, or misstated facts to bring fear to many an average retail investor. I think that a careful reading of the transcripts and a follow up into the actual court documents and transcripts can allay many of these fears. At its current stock price and now with a jury verdict, an enhanced on going royalty, and a very good showing at the CAFC oral arguments versus Apple in hand, VirnetX offers the educated investor a great opportunity to get in (or back in) at a great time in the company's history. Mobile communication security is rising to the forefront of many a conversation, both in the private sector and the enterprise. An investment in VirnetX's prospects has never looked better.
Disclosure: I am long VHC and may increase my position at any time. 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.