On Thursday, May 24, VirnetX (VHC) held its Annual Shareholders Meeting in South Lake Tahoe, NV. Based on reports from those in attendance, there are some interesting highlights worth discussing that may positively impact the company in the near-term. At the meeting Kendall Larsen, CEO of VirnetX, highlighted several potential developments in the company's future. Some notable items discussed were directly related to VirnetX's current legal disputes and the mounting pressure the defendants are facing.
Legal proceedings in the United States District Court (Eastern District of TX - Tyler Division) include two groups of defendants. The first group includes Apple (AAPL), Cisco (CSCO) and NEC (NIPNF.PK), and the second group includes Siemens (SI), Avaya and Mitel (MITL). Aastra (AATSF.PK) was a part of the first group, but recently settled with VirnetX as reported in my previous article, "VirnetX's Patent Portfolio Holds Promise Of Significant Upside." Separate infringement complaints were filed against each group of defendants, but one jury trial for all defendants is scheduled to start on November 5th, 2012. VirnetX and Apple are also involved in a parallel patent infringement dispute at the International Trade Commission (ITC). The hearing is scheduled to begin September 5th, 2012, and the Final Initial Determination is scheduled for December 7th, 2012.
One notable aspect of having two groups of defendants in the District Court dispute is that two Markman Hearings, otherwise known as Construction Claim Hearings, were scheduled. At these hearings, both the plaintiff and defendants argue for the Court to adopt technical definitions of terms that will be used in the trial. The judge in the case, after considering arguments from both parties, will then issue a formal construction claim opinion known as the Markman Order. This written opinion is widely considered a critical element of patent infringement cases. The first group of defendants had their Markman Hearing on January 4th, 2012, and the Markman Order was issued almost four months later on April 25th, 2012. The second group of defendants is scheduled to have their Markman Hearing on July 12th, 2012.
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At the Annual Shareholders Meeting, Kendall Larsen echoed the message from VirnetX's April 26th press release that the company is very happy with the first Markman Order as issued by Judge Davis. In particular Larsen noted the adopted construction claim for "secure communication link" was a major win for the company. Furthermore, Larsen indicated this first Markman Order may play a significant role in the upcoming Markman Hearing for the second group of defendants. Given the fact that Judge Davis gave a very detailed written opinion for each term already, it seems likely that he will not go against his previous definitions. The logic behind this assumption is that all defendants are part of one jury trial, and it will be necessary for the construction claims to be consistent.
Although there is no scheduled date for the court to complete the second written construction claim opinion, one could reasonably assume that the second Markman Order will be issued in less time than it took for the first group of defendants. The bulk of the work on defining the terms has already been done and should not take as long the second time around. Additionally, this argument is supported by the current case schedule. With the trial scheduled for November, the second group of defendants will need to have their Markman Order issued within a reasonable time frame.
In his comments to shareholders, Larsen described this next phase of litigation as the "mediation season." VirnetX has a negotiation strategy with escalating licensing rates associated with the timing of settlements (i.e. before a Markman Order, after a Markman Order, or after the trial starts). He emphasized the need to hold firm and be consistent in negotiations as each agreement has the potential to influence future agreements. It is worth noting that VirnetX announced its settlement with Aastra within a week of the first Markman Order being issued. In his comments describing the settlement, Larsen suggested that the Aastra deal may serve as a template going forward for the six remaining defendants.
A closer look at the remaining defendants, with respect to the case schedule and VirnetX's negotiation position, may illustrate which of the defendants are likely to settle before the trial begins in November:
1. Apple - As part of the first group of defendants, Apple has already had its Markman Order issued. While Apple may decide to go through with the scheduled jury trial, it is important to note they are facing additional pressure related to the ITC complaint.
2. Cisco - Similar to Apple, Cisco is part of the first group of defendants. Based on its legal maneuvers to date, they may continue to take a similar path as Apple. The additional pressure Cisco faces is related to the treble damages they may face should a jury find them guilty of willful infringement.
3. NEC - As part of the first group, NEC may already be facing a steeper settlement price since the first Markman Order has already been issued. Since Aastra has come to terms with VirnetX, NEC is likely the next candidate from the first group to reach an agreement and avoid a jury trial.
4. Siemens - Despite being the largest company in the second group of defendants, Siemens has a rather modest product line when compared to the other defendants. If the company has any inclination to put this lawsuit behind them, they are likely to do so before the court delivers the next Markman Order.
5. Avaya - A private company with plans to go public sometime in the near future, Avaya is also part of the second group of defendants. The amount of infringing products as detailed in the complaint is significant. Additionally, the threat of an escalating settlement rate could pressure Avaya into considering a settlement before the next Markman Order.
6. Mitel - Mitel is the smallest company in the second group of defendants. Similar in size and scope to Aastra, it would not be surprising to see Mitel follow in the footsteps of Aastra and come to an agreement with VirnetX in the near future.
After listening to comments made by VirnetX at the Annual Shareholders Meeting, reviewing the legal timeline, and acknowledging how quickly the Aastra settlement came after the first Markman Order, it seems that "mediation season" has indeed begun. VirnetX gave every indication that its negotiating position will only be strengthened as key legal events unfold. While it is possible that all defendants may opt to take their chances at a jury trial, it appears more likely that we will witness additional agreements prior to November. Because each defendant is faced with a unique set of circumstances, it will not be surprising to see resolutions announced at any time before the start of the scheduled trial.
A big consideration for investors is what impact any additional settlement will have on the stock price of VirnetX. The recent settlement with Aastra led to a strong upward rally in VirnetX and the stock has held those gains to date. If a company like Mitel also settles, we could witness a similar reaction in the stock price. However, if any of the other defendants come to an agreement with VirnetX, the stock could reach new all-time highs. Looking at the timeline and considering management's recent comments, VirnetX is poised to take the next step in this legal battle. This appears to be an excellent near-term opportunity for investors.
Disclosure: I am long VHC.