As many in the adult industry already know, a company called Acacia Media Technologies (Newport Beach, Calif.) owns a series of patents (the oldest dating from 1991) that describe a method for on-demand distribution of previously-stored audio and video data. On the basis of these patents, Acacia has sent letters to numerous adult Internet sites, demanding a license fee for the utilization of this technology. Adult Webmasters must now decide how to react to Acacia's claims.
This article has five parts. First, it provides an overview of Acacia and what it's trying to accomplish in the market. Second, the article analyzes the company's current strategic and financial strengths and weaknesses. Third, the article provides a summary of patent litigation and how companies typically defend themselves against accusations of patent infringement. Fourth, this article briefly investigates the strengths and weaknesses of the Acacia patent portfolio. Finally, this article suggests potential strategies that the owner of an adult Internet firm might pursue in reaction to Acacia's claims.
WHO IS ACACIA
Acacia started out as a dot-com incubator and, like most incubators, acquired small companies, and provided them with financing, management expertise, office services and so forth, in the hope of growing them into viable businesses. At some point after the crash of the dot-com market, Acacia made a transformation from being an incubator to being an intellectual property (IP) firm.
The acquisition and exploiting of IP, as a separate business model, is a relatively new phenomenon in high tech. In the past, most high tech IP was exploited by the company that actually invented it. IBM, for example, files more patents than any other company in the world - and as a result receives substantial royalty income. What's unique about "pure" IP companies, like Acacia, is that they acquire patents and then enforce them, generally without participating in the actual innovation process. Some of these companies, such as Rambus Inc. (Los Altos, Calif.), achieve yearly revenues approaching $100 million.
Acacia's strategy is to convince as many companies as possible to pay license fees when they perform any action that is apparently covered by its patents. At this point in time, Acacia wants to create an ongoing revenue stream, but also to create momentum that will help convince other companies to sign up. As of this writing, Acacia's management claims to have gathered a total of 32 licensing agreements overall, at least 10 of which are with adult Internet firms. Potentially the most significant licensing agreement has been with LodgeNet Entertainment Corporation), a major vendor of in-hotel movie systems.
Acacia CEO Paul Ryan touts the fact that much of his management team comes from Gemstar (acquired in 2000 by TV Guide International Inc.), which licenses interactive program guide services and products to companies such as AOL Time Warner. Acacia's senior vice president of intellectual property, Roy Mankovitz, was formerly Gemstar's director and patent portfolio architect. Acacia's vice president of business development is Andrew Duncan, who formerly was Gemstar's vice president of licensing. In addition, Acacia has obtained the services of Rod Dorman and Lee Rahn, who respectively were Gemstar's outside trial counsel and patent prosecution counsel.
However, despite Ryan's apparent pride in his firm's management heritage, Gemstar may not be the best role model for Acacia. Gemstar lost several patent lawsuits in 2002, greatly weakening the strength of its IP portfolio. In August 2002, Gemstar was forced to pay a $5.7 million penalty as part of the settlement of a Department of Justice investigation. The problems with accounting led to a management ouster and takeover, according to Phillip Swann, president and publisher of TVPredictions.com, an analyst firm that covers the TV industry. "If Gemstar is Acacia's rallying cry, they might want to think again," quips Swann.
Acacia's own history of patent litigation has not been much better. In September 2002, the company lost a patent lawsuit against Sony, Sharp, and Toshiba for the V-Chip, another patent that Acacia owns. Acacia is waiting for a separate ruling on a related antitrust lawsuit before deciding whether to appeal the V-Chip ruling.
HOW STRONG IS ACACIA?
Acacia's most recent quarterly financials reveal a company that has major cash flow problems. The only revenues that the company claimed were $19,000 (from license fees of its media technology) and $6,000 from a service contract related to a non-media division. The company declared a net loss of $6.8 million dollars for the quarter, of which $1.6 million was related to its media research business. (Some of the expenses that contributed to these losses were one-time charges, suggesting that subsequent quarters may be less disastrous.) On the positive side, Acacia has $54 million in cash, a figure that will allow it to tolerate significant operational losses for several quarters into the future.
Other than its media patents, the company appears to have little prospect for future revenues. Revenue from the company's medical research group, CombiMatrix, is negligible. The company no longer receives revenues from its V-Chip patent, but should the company win back its rights on appeal, Sony, Sharp, and Toshiba would be forced to pay back royalties, but only up until 2003, when the V-Chip patent expired. However, because the V-Chip is still involved in an antitrust suit and Acacia has no intention to appeal the V-Chip decision until the antitrust case is settled, Acacia is unlikely to recognize any revenue from that source for some time to come, if ever.
Given the company's balance sheet, it's not surprising that the investment community has been underwhelmed by Acacia's stock, which traded above $2.00 for a brief period after it was first issued late in 2002, and as of this writing, was trading at $1.79. The company's market capitalization (the value of all its outstanding shares) is $35 million - less than the company's cash on hand. This is an unusual situation, and could be reflective of a lack of investor confidence in the company's long-term profitability.
In order to make Acacia's media business profitable, the management will probably have to secure a significant (e.g. more than $1 million a year) return on its media patents. So far, the company has announced 27 license agreements for its streaming media patents, 13 of which were executed in the second quarter of 2003.
All of these license agreements provide for recurring license fee payments.
Without adjusting for the fact that some of the licensees may not have paid a full quarter's fees, Acacia's declared quarterly revenue of $19,000 comes out to an average of around $703 per quarter per licensee. Because this is a negligible amount (compared to Acacia's operating costs) it's reasonable to assume that at least some of the license fees that Acacia is receiving are symbolic rather than substantive, and may have been granted in order to create momentum for the patent rather than to add much to the company's revenue stream.
In order to remain viable and to increase the value of its stock, Acacia will probably have to demonstrate an ability to extract significant revenue from its media technology licensees, which means getting some large corporations to pony up. So far, the largest company that's announced a licensing agreement is LodgeNet. However, if Acacia's quarterly revenues do not spike sharply upwards in the third quarter of this year, investors are likely to conclude that the LodgeNet agreement was part of Acacia's ongoing attempt to create credibility and momentum, rather than to add substantial amounts to Acacia's revenue stream.
HOW ARE PATENT RIGHTS DETERMINED?
In general, patent disputes are resolved through the legal system, although not every patent dispute goes to trial. The vast majority, perhaps as many as 90 percent, are either thrown out of court by a summary judgment or settled out-of-court between the principals.
There are two ways that companies "beat" a patent infringement case. The first is to prove that the product or process that's been called into question does not, in fact, infringe upon the patent. This is often the case when product or process has a different "pedigree" that did not involve the patent in question, but in fact was based upon a different concept or invention.
However, in the unusual circumstance when one person accidentally "re-invents" an invention that's covered in a previous patent and brings a product based upon that invention to market, it is still infringement - even if the inventor was completely unaware of the original patent. If the second inventor was indeed aware of the original patent and ignored it, it's called willful infringement and the holder of the original patent is entitled to receive triple damages. The burden of proof for infringement falls upon the plaintiffs, in this case Acacia.
The second way to "beat" a patent infringement case is to invalidate the patent - to prove that the patent should not have been issued in the first place. When looking at the validity of a patent, a judge looks at two basic elements - the language of the patent itself and the language contained in the "wrapper," a file that contains a hotchpotch of information, including references to prior art, articles, white paper, correspondence, and so forth. Patent validity often hinges on the specific meaning of specific words in the patent, something that a judge typically determines in what's called a Markman hearing (after the name of the case that gave rise to the idea for such hearings). During such a hearing, the judge examines the patent and the wrapper to determine what the words in the patent actually mean.
When inventors file patents, they typically include references to prior art, scientific papers, and so forth, in order to help establish that their invention is unique enough to justify the granting of a patent. Because the patent is granted based primarily upon the references provided by the patent applicant, those wishing to fight a patent infringement case usually attempt to locate prior art and technical references that illustrate that the ideas behind the patent were common knowledge or well-understood in other circles, prior to the patent filing. Ideally, such references come from previous patents that were missed by the patent examiner who originally determined that the invention could be patented. More often they come from scientific papers, technical descriptions, and prior art that the original patent filer did not manage to locate before filing the patent. The burden of proof for the invalidity of the patent falls upon the defendants, not the plaintiffs.
In practice, attempts to prove or disprove infringement are accompanied by attempts to prove or disprove validity. For example, in 1998, Wang charged Netscape with violating a 1985 patent describing certain features of a patented 1980s VideoTex system by incorporating features from that system into Netscape browser. Netscape took the typical two-pronged approach. One the one hand, Netscape argued that their browser was based upon a fundamentally different technology. On the other hand, Netscape sent a bulletin to its engineers asking for examples of prior inventions and was swamped with multiple examples of earlier technologies. In the end, the judge threw out Wang's case on the basis of a lack of infringement. However, if the judge had ruled that the patent had been infringed, Netscape was probably preparing to attempt to prove that the patent itself was invalid.
HOW CREDIBLE ARE THE ACACIA PATENTS?
In preparing an earlier article on Acacia, I asked patent attorney Bruce D. Sunstein of Bromberg & Sunstein LLP (Boston, Mass.) to take a look at the original 1991 Acacia patent filing. "The number of prior art references in a patent is one indication of whether a patent filer did his or her homework," he explained. Sunstein pointed out that the original patent included more than 30 references and two articles from publications of the IEEE (Institute of Electrical and Electronics Engineers), a trade organization that sets standards for computers and communications. "On the scale of things that's pretty good - a pretty serious patent," he said, although he also noted that he had filed patents for his clients that contained as many as 100 references.
I also contacted PatentRatings LLC, an independent research and rating service that attempts to provide companies, investors, and law firms with objective statistical analysis and ratings of patents and patent portfolios. PatentRating calculates something it calls the IPQ (Intellectual Property Quotient), a measurement that is supposed to objectively score and rate patent assets based on a statistical methodology. After PatentRatings ran its program against Acacia's five U.S. patents, PatentRatings CEO Jonathan A. Barney characterized Acacia's patents as "quite strong," and noted that all files of the patents rated substantially "above average" on their IPQ scale.
I also asked the opinion of Greg Aharonian, publisher of Internet Patent News Service ([email protected]) and self-proclaimed "professional Internet patent buster." During our conversation, Aharonian stated his opinion that the Acacia patent was "dubious" and accused Acacia of "failing to discover that there were entire IEEE conferences and journals on this type of technology prior to the original 1991 patent application." He believes that the Acacia patents can be beaten, and made public statements to that effect in his online newsletter. Ryan, however, has since questioned Aharonian's credibility, claiming that Acacia originally hired Aharonian, without disclosing Acacia's identity, and that at that time Aharonian gave Acacia a thumbs up on the patent's validity. (Aharonian had no subsequent comment.)
Ryan claims his company has had three separate patent attorneys examine their patent portfolio, and has hired multiple "experts" to determine whether the patents will hold up in court. However, Juanita Brooks, an attorney at Fish & Richardson (which is representing several adult Internet firms on this matter) points out that there are significant inconsistencies between Acacia's five patents. "Prior art cited on one patent isn't cited on another," she says. "If the prior art were relevant, it would have been cited on both patents." She claims that her clients have located multiple examples of prior art and seems confident that she can win in court.
There's little question that Acacia's patents are credible enough to be taken seriously. Whether they are actually valid, or whether the adult Internet firms are infringing upon them, will ultimately have to be decided in court.
WHAT ARE THE CHOICES?
Any owner of an adult Internet firm should consult with legal counsel prior to making any decision on this matter. That said, it's fair to say that, based upon the way other companies have reacted to similar lawsuits in the past, there are three basic strategies from which adult Internet firms can choose:
Move away from on-demand video distribution. Acacia's patents do not cover the downloading of photographs or the written word, nor do they cover the broadcasting of live performances. Sites that are distributing no video or audio content need not be concerned with Acacia's claims. However, since video content appears to be a significant revenue generator for many adult sites, this option may not be viable in many cases.
Negotiate a favorable contract. At this point, Acacia appears to be more concerned with creating momentum and credibility for its patent than with creating a major revenue stream. Because of this, Acacia appears willing to offer favorable licensing terms to firms that sign a licensing agreement early. The disadvantage to this approach is that any adult Internet firm that signs a license agreement would probably still have to pay the fee, even if subsequent litigation invalidated Acacia's claims on other, similar Websites.
Fight the patent in the courts. This involves putting up a legal defense that either disproves infringement or proves the patent is invalid. Unfortunately, pursuing the defense of a patent case can cost anywhere from $1 million to $3 million, probably more than many adult sites would pay in license fees if they signed a contract. However, it must be noted that the cost would probably be significantly diminished by joining with other adult Websites in a coordinated defense.
Ignoring Acacia's letters and trying to stay on the sidelines are probably not viable strategies, especially for adult Internet firms that have significant revenue streams. Several statements made by Acacia's management strongly suggest the company is receiving the advice of at least one adult industry insider. Acacia probably has a good sense of which adult sites are generating significant revenues.
In short, there is no easy way out. Adult Internet firms must decide whether it is more economical to fight or to cooperate with Acacia. However, even if Acacia's claims fall flat in court, that's no guarantee that other companies with other patents won't someday attempt to extract license fees from adult Internet firms. Whatever the situation may have been in the past, the adult Internet industry is now part of the larger business community and is no longer flying below the radar screen. For better or worse, that means struggling with patent rights and patent lawsuits.
Geoffrey James is the author of several books and numerous articles on high tech issues.
