Issue #21-1 | February 14, 2013

Revenue recognition standard to change for licensees

We are early yet, but valuators should be aware that the FASB and the International Accounting Standards Board (IASB) have released a revised proposal that would create a single revenue recognition standard for U.S. GAAP and IFRS. The standard, designed to streamline accounting for revenue across industries and correct inconsistencies in existing standards and practices, would go into effect during annual reporting periods beginning on or after Jan. 1, 2015.

The latest proposal includes a detailed section of implementation guidance. Here is the guidance issued with respect to IP and licensing revenue:

Today: Revenue from an IP license (including licenses of motion pictures, software, technology, and other intangibles) cannot be recognized before inception of the license term. Once the term begins, revenue is to be recognized consistent with the nature of the transaction and the earnings process. Additional license revenue recognition guidance is industry-specific.

Proposed: Revenue from a license or other right-to-use arrangement is recognized when the licensee obtains control of the rights.

  • Revenue cannot be recognized before the beginning of the period when the licensee can use and benefit from the license property; and
  • Revenue is generally recognized at a point in time, unless:
    • The fee is sales-based;
    • The fee is not sales-based, but the entity is otherwise constrained by the reasonably assured criterion; and
    • The right to use is combined with other performance obligations (that is, it is not distinct).

Source: FASB Exposure Draft, paragraphs 85, IG33–IG37, and IG81

So far, the Nash Bargaining Solution is no stand-alone substitute for the 25% rule of thumb

Uniloc put to rest the 25% rule of thumb. Assuming the problem is the “of-thumb” nature of the 25% rule, seeking more rigorous proof, plaintiffs in patent infringement cases have tried turning to the Nash Bargaining Solution as a mathematical construct for calculating damages. So, how’s that going for them?

Oracle tried to use it in the $6 billion damages request against Google, and Judge Alsup wanted no part of it: “No jury could follow this Greek or testimony trying to explain it. The Nash Bargaining Solution would invite a miscarriage of justice by clothing a fifty-percent assumption in an impenetrable façade of mathematics.”

In Mformation Techs., Inc. v. Research in Motion Ltd, No. C 08-04990 JW (N.D. Cal.), the court reasoned that the expert had conducted an “extensive” Georgia-Pacific analysis and that the Nash bargaining solution was used only as a “check” instead of as the primary methodology, and thus it denied the defendant’s motion to exclude the expert’s royalty rate calculation.

The court in Sanofi-Aventis Deutschland GmbH v. Glenmark Pharmaceuticals Inc. approved a 50-50 split based on game theory, accepting the explanation that plaintiff’s expert ‘‘did not arbitrarily apply a 50-50 profit split, but rather reached that result after considering the facts of the case, specifically the relationship between the parties and their relative bargaining power, the relationship between the patent and the accused product, the standard profit margins in the industry, and the presumed validity of the patent.’’

For a scientific look at the Nash Bargaining Solution, start here. For our purposes, a Nash Bargaining Solution determines a licensing fee based on:

  • The total benefits available from the licensing agreement;
  • The other next best alternative available to each party;
  • An allocation of a portion of the benefits to each party that equals the benefits from their next best alternative; and
  • A split of the remainder according to the relative bargaining strength of the parties (the assumption is that two parties with equal alternatives and equal bargaining strength will split the remaining benefits 50-50).

By itself, the Nash Bargaining Solution is not faring well as a mathematical proof of damages. We’ll keep a watchful eye on how successful damages experts are in using it as just part of their analysis.

Expert’s apportionment is not enough to save patent damages—but it saves copyright claims

After a jury awarded the plaintiff $60 million for copyright infringement and just over $51 million for patent infringement, the defendant appealed both verdicts, claiming they lacked sufficient evidence.

In particular, the defendant argued that the standard of copyright damages mirrors that of patent law, i.e., that the plaintiff had to prove its copyrighted features drove consumer demand for the infringing product. But that overstated the standard, the court held. The plaintiff must only establish causation—that “but for” the infringement, the defendant wouldn’t have made its gross sales. “The burden then shifts to [the defendant] to apportion that gross revenue between profit and expenses and among infringing and non-infringing features of the product.”

Rather than apportion the profits, however, the defendant’s expert said it was only obligated to pay the amount saved by copying the plaintiff’s copyrighted information, instead of generating it on its own, which amounted to no more than $6,000. In response, the court found the plaintiff didn’t have to offer an expert to apportion damages—but it was a good thing it did, because his rebuttal testimony showed the defendant made $93 million in net profits, sufficient to support the jury’s $60 million award.

Entire market value is exception rather than rule. The expert’s apportionment analysis for patent damages did not fare so well. The current standard requires experts to calculate a reasonable royalty using the “smallest saleable unit,” the court said. “That is the rule.” If they don’t, then they can only use the entire market value of the infringing product if the patented feature drives consumer demand. In this case, the expert relied on gross sales of the defendant’s infringing product, which he believed was the “smallest saleable unit.” The court disagreed, finding the product consisted of many patented and unpatented parts.

Even so, the plaintiff argued, its expert appropriately apportioned damages between the product’s patented and unpatented features. Not good enough, the court said: “The Federal Circuit has rejected [this] methodology. Absent evidence that the patented feature drives demand, [the plaintiff’s expert] should not have used the entire market value … to establish its royalty base.” The court found the same flaws undermined his lost profits calculus, and reversed the $51 million patent award. Read the complete digest of Brocade Communication Systems, Inc. v. A10 Networks, Inc., 2013 U.S. Dist. (Jan. 10, 2013) in the March 2013 Business Valuation Update; the district court’s decision will be posted soon at BVLaw.

Book reveals real-world tactics for increasing IP value

Analysts who follow IP valuation assignments with formal or informal consulting arrangements to help clients increase the value of their companies or assets will benefit from Andrew Sherman’s Harvesting Intangible Assets: Uncover Hidden Revenue in Your Company’s Intellectual Property.

Using real-world examples with numerous guidelines and charts, Sherman shares his insight on how to effectively leverage intangible assets and intellectual property to create competitive advantage, thereby increasing company and asset value. This is a five-star selection on Amazon and worth the read.

Amazon granted patent for secondary marketplace for used digital rights

Amazon has been granted a patent for an “electronic marketplace,” where owners who purchased IP rights to digital content can resell those rights. The company originally filed for the patent in 2009.

Here’s how it would work:

Digital objects, including e-books, audio, video, computer applications, etc., purchased from an original vendor by a user are stored in a user’s personalized data store. Content in a personalized data store may be accessible to the user via transfer such as moving, streaming, or download. When the user no longer desires to retain the right to access the now-used digital content, the user may move the used digital content to another user’s personalized data store when permissible, and the used digital content is deleted from the originating user’s personalized data store.

Amazon anticipates problems with this. In its Detailed Description of the patent claims, “digital object” is qualified to mean “one which a user has legitimately obtained access rights to, and may permissibly transfer to another user.” The same is true with Amazon’s qualification of the actual transfer of ownership: “Transfer of used digital objects from the original purchaser to a subsequent purchaser of the used digital object may pose problems with respect to the first sale doctrine, license obligations, etc.” Copyright, anyone?

Nonetheless, valuation analysts ask for and need details on secondary marketplaces for assets they are valuing. Though the details remain to be worked out, this endeavor bears watching.

Retailers with e-commerce websites that rely on shopping carts can breathe a little easier

Soverain claimed that patents 5,715,314 and 5,909,492 allowed it to demand a royalty on “shopping carts” used by e-commerce sites such as Macy’s, Home Depot, RadioShack, Kohl’s, and a host of others. It was rewarded for its litigious efforts by securing substantial victories over Victoria’s Secret and Avon.

It all came to an end, presumably, as the U.S. Court of Appeals for the Federal Circuit last week overturned a district court ruling and found for Newegg, another firm being sued by Soverain, dismissing Soverain’s patents as obvious and claims as embodied in prior art.

ArsTechnica summarized the loss this way: Soverain will lose the $2.5 million it stood to gain from Newegg, plus the $18 million and 1% running royalty it gained from Victoria’s Secret and Avon. And that should be the end of it.

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