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UNITED STATES DISTRICT COURT
DISTRICT OF OREGON
Mentor Graphics Corporation
and
Meta Systems
v.
Quickturn Design Systems, Inc.
SUPPLEMENTAL REPORT OF BLAINE F. NYE, Ph.D
[Responding To "Interim Supplemental Report" Of John Mack Folsom]
Pursuant to FRCP 26(a)
10/22/98
Confidential-Outside Counsel Only
Pursuant to the Protective Order entered in this action.
Case No. C96-00342-RE
<PAGE>
TABLE OF CONTENTS
I. EXECUTIVE SUMMARY
A. Mr. Folsom's Report Has Four Fundamental Problems That Impeach The
Credibility Of His Entire Analysis.
B. The Appropriate Damages Amount Is In The Range of $ 550,000.
II. QUALIFICATIONS AND TASKS ASSIGNED
A. Qualifications.
B. Tasks Relating To The Folsom Reports.
C. My Own Opinion Regarding Quickturn's Damages.
D. Materials Relied Upon.
E. Assumptions.
III. PRELIMINARY OBSERVATIONS
A. Inherent Incredibility.
B. The Recent Analysis Is At Odds With the ITC Proceeding.
1. Quickturn Apparently Has Agreed To Damages With Respect To
Mentor's Sales To Motorola And National Semiconductor.
2. The Methodology Used To Calculate The Damages For The
Motorola And National Semiconductor Sales Would Seem
Applicable To The Other Three Mentor Sales.
C. The Recent Analysis Is Apparently At Odds With Positions On
Remedies Taken By Quickturn Throughout The Case.
IV. SPECIFIC CRITICISMS OF FOLSOM'S REPORT
A. Deficiencies In The "Past Lost Sales" Analysis.
1. The "Past Lost Sales" Analysis Ignores The Testimony Of The
Customers Who Said They Would Not Have Bought.
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2. There Is No Analysis Of, Or Backup To, The Hypothetical
Quickturn Sales With Respect To Price Or Profit.
B. Deficiencies In The "Lost Future Sales (Repeat Sales)" Analysis.
1. The "Lost Future Sales (Repeat Sales)" Ignores The Testimony
Of The Customers Who Said They Would Not Have Bought.
2. There Is No Analysis Of What The "Lost" Customers Actually
Did With Respect To Emulation During The So-Called "Future"
Period.
3. There Is No Analysis Of, Or Backup To, The Hypothetical
Quickturn Sales With Respect To Price Or Profit.
C. Deficiencies In The "Price Erosion" Analysis.
1. No Analysis Of Legitimacy Of Price Per Gate As Proxy For
Product Pricing.
2. No Analysis Of Appropriateness Of Baseline Price.
3. No Support For Assumptions of Number of Gates Sold In the
Future.
4. No Analysis Of Potential Causes of Price Per Gate Decline.
5. No Analysis Of Relationship Between Decline In Price Per Gate
And Loss Of Profit.
6. Complete Failure To Analyze Future Price Erosion.
D. Deficiencies In The Reasonable Royalty Analysis.
V. A REALISTIC ASSESSMENT OF DAMAGES TOTALS NO MORE THAN $ 550,000.
A. Reasonable Royalty Is the Appropriate Measure For Four Of The Five
Emulator Sales.
B. Lost Profits May Be An Appropriate Measure For The Lost Sale To
National Semiconductor.
C. There Is No Evidence To Support Any Other Form Of Damages.
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I. EXECUTIVE SUMMARY
After reviewing the October 5, 1998 Interim Supplemental Expert Report
of James Mack Folsom, and a variety of other materials discussed below, I have
come to the following conclusions.
A. Mr. Folsom's Report Has Four Fundamental Problems That Impeach The
Credibility Of His Entire Analysis.
First, it is simply inherently incredible to claim, as Mr. Folsom does,
that Quickturn has and will lose $93,000,000 in profits in the period 1996 -
2003 because Mentor sold five items of equipment having a gross value of $3.5
million during the period 1995 -1997. No credible analysis can reach those
damage numbers based on Mentor's limited sales.
Second, Mr. Folsom's "lost profits" damages with respect to projected
sales of equipment and maintenance to Bull, UB Networks, Radix, Motorola, and
National Semiconductor, which he states are $30,973,700 (even after discounting
to present value), completely ignores sworn third party testimony from the
purchasing authorities of four of the five companies that they would not have
purchased Quickturn's products. One simply cannot base a rational lost profits
claim on sales of equipment that the purchaser states it would not have bought.
Third, Mr. Folsom's "price erosion" claim (which yields additional lost
profits of $62,208,300 before discounting) is based on a theory that (a)
Quickturn would have been able to keep its prices substantially the same as it
charged in 1996 (in spite of the common observation that electronics and
computer equipment prices fell dramatically over the same period), and (b)
Mentor's limited presence in the market in 1995 - 1997 caused and will cause
Quickturn to dramatically reduce its prices over a seven year period --
including a six year period after Mentor disappeared from the United States
market.
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Fourth, Mr. Folsom ignores some basic data points concerning the
behavior of the parties during this litigation that cast his numbers into great
doubt, including the facts that (a) Quickturn stipulated, and the ITC agreed,
that its damages with respect to Mentor's late 1996 and 1997 imports (which
include the Motorola and National Semiconductor sales) were only $425,000, and
(b) Quickturn was apparently willing to stipulate in August-September 1998 that
its damages in the Portland case were $3.5 million. There is no way to reconcile
a number in the tens of millions with this conduct.
B. The Appropriate Damages Amount Is In The Range of $ 500,000.
I believe that the appropriate amount of potential damages in this case
is in the range of $550,000 (or at most, approximately $1,000,000), consisting
of approximately $350,000 in reasonable royalties and $200,000 in lost profits.
II. QUALIFICATIONS AND TASKS ASSIGNED
A. Qualifications.
I am President of Stanford Consulting Group, Inc., which provides
research and consulting services in financial economics and related areas to
clients, including government agencies, corporations, and law firms. I have a
B.A. degree in physics from Stanford University, an M.S. degree in physics from
the University of Washington, an M.B.A. degree from Stanford, and a Ph.D. in
finance from Stanford. I have served as a consultant or expert witness on the
subjects of lost profits, and general damages in a number of actions. My
curriculum vitae is attached as Exhibit A. During the past four years I have
provided expert testimony in trial or by deposition in the matters listed in
Exhibit B. My publications during the past ten years are listed in my curriculum
vitae, Exhibit A.
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B. Tasks Relating To The Folsom Reports.
I was asked by Mentor to review Mr. Folsom's recent report and to
provide general and specific comments with respect to the following issues:
(1) "Actual" lost profits to Quickturn for equipment and service sales
to Bull, UB Networks (Tandem), National Semiconductor, Motorola, and Radix
relating to the equipment Meta actually sold to these companies.
(2) Predicted lost "repeat business" equipment and service sales to
Bull, UB Networks, National Semiconductor, and Motorola supposedly resulting
from Mentor's actual sales to these companies;
(3) Generalized price erosion of emulation equipment sold by Quickturn
from mid-1996 to July 1, 1998 as expressed by a supposedly measured decline in
"price per gate" of Quickturn emulation products;
(4) Generalized price erosion of emulation equipment beginning in July
1, 1998 and continuing for the next five years as expressed by a predicted
decline in "price per gate" of Quickturn emulation products.
(5) The reasonable royalty rate Quickturn would have received from
Mentor for infringing emulation products sold by Mentor from 1996 to July 1,
1998.
C. My Own Opinion Regarding Quickturn's Damages.
I was also asked to express my own opinions with respect to
the appropriate measure and amount of damage that could have been caused
Quickturn by Mentor's alleged infringing activities in the United States during
the period 1995 to August 1997.
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D. Materials Relied Upon.
In preparing this report and my previous report, I have reviewed all
the material that I reviewed in connection with my previous report and the
materials referenced in this report, including the declarations of Dan
Schumacher, Chuong H. Nguyen, Tim Parker, and Russell W. Guenthner.
E. Assumptions.
I assumed that the five emulation products sold by Mentor during the
period of June 1995 to July 1997 were, in fact, sales and infringed patents held
by Quickturn, (although I understand that the magistrate in the federal court
action in Portland, Oregon has recommended that the Court deny Quickturn's
motions for summary judgment of infringement).
III. PRELIMINARY OBSERVATIONS
A. Inherent Incredibility.
Quickturn has been a monopolist in the hardware emulation market since
before 1990, selling over $80,000,000 of such equipment per year in the
mid-1990s and over $100,000,000 per year in the past few years. Approximately
70-80% of these sales were in the United States. We also know that Mentor sold
or leased only five emulation systems in the United States over the period 1995
to 1Q 1997 with a total value of approximately $3.5 million. Mentor's sales of
more machines, and the support of the five existing machines, was enjoined in
the United States in the beginning of 3Q 1997. Clearly, Quickturn's sales and
marketing efforts with respect to hardware emulation equipment dwarfed Mentor's
during the short period Mentor was able to sell the few machines that it did.
In spite of these facts, Quickturn, with its complete market dominance,
asserts that Mentor's five sales caused Quickturn to lose over $50,000,000 in
profits -- not sales, but profits -
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- - in the United States during the period 1996 - September 1, 1998. After
claiming these astounding losses, Mr. Folsom predicts that even though Mentor
disappeared from the United States market in August 1997, and Quickturn will
maintain its monopoly position, Quickturn will lose another $43,000,000 in
profits by the end of 2Q 2003 (which Mr. Folsom reduces to a present value of
$28,400,000). Knowing not one other fact, any rational business person or
economist must conclude that a claim that a company with the market dominance
of Quickturn has lost and will lose $93,000,000 over a period of seven years
because a minor competitor sold $3.5 million worth of equipment over a two
year period is absurd. Knowing more facts, makes Mr. Folsom's analysis even
more incredible.
As just one example, over $30,000,000 of the claimed losses during the
period 1996 to 1998 are attributable to just five customers -- UB Networks,
Radix, National Semiconductor, Motorola, and Bull -- and are all based on the
explicit, but completely unsupported, assumption that if these companies had not
purchased a machine from Mentor (each purchased or leased one) they would have
purchased from Quickturn then and in the future. Four of the five purchasing
authorities from these companies, however, have submitted sworn declarations
saying the companies would not have purchased from Quickturn (and the fifth will
soon be deposed). Mr. Folsom dismisses these declarations as "biased third party
statements" and performs no further analysis as to why Quickturn would have made
the sales.
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B. The Recent Analysis Is At Odds With the ITC Proceeding.
1. Quickturn Apparently Has Agreed To Damages With Respect To
Mentor's Sales To Motorola And National Semiconductor.
I have had an opportunity to review (a) deposition and trial testimony
in the ITC proceeding, (b) some rulings by the ITC judge and the Commission on
the issue of Mentor's need to post a bond to cover any Quickturn injury
resulting from Mentor's importation of infringing equipment, along with
statements by the ITC staff on the same topic, (c) a damages/bond forfeiture
stipulation between Mentor and Quickturn, and (d) materials that show the Mentor
emulation equipment sold to National Semiconductor and Motorola was imported
under bond (a portion of which Mentor later agreed to forfeit to cover
Quickturn's damages). I also reviewed what Mr. Folsom had to say concerning the
ITC bond in his earlier report. I looked at these materials primarily as a form
of "sanity check" on the analyses Mr. Folsom and I are performing. I have
attached as Exhibits C-G the ITC materials I reviewed.
It appeared from the materials I reviewed that after Mentor was
preliminarily enjoined by the ITC in mid-1996 from importing the supposedly
infringing emulators, the law allowed Mentor to continue to import the emulators
but only if Mentor posted a bond in the amount to cover any damage caused to
Quickturn by the machines imported. During the hearings on the temporary
exclusion order, and later as well, the parties and their experts put on proof
as to what the damage to Quickturn -- including lost profits, reasonable
royalty, and price erosion -- would be if Mentor was allowed to import
infringing emulators. Mr. Folsom, in fact, testified in those proceedings.
Mentor initially was required to post a bond in the amount of 43% of the
"entered value" (the value of the goods as imported as opposed to when they were
sold to customers) of the emulators and associated equipment that Mentor would
import. This was supposed to cover
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all of Quickturn's injury from the imported goods. See August 12, 1996
Commission Opinion on Remedy, The Public Interest, and Bonding (Exhibit C).
Later, in July 1997, the ITC judge recommended to the ITC Commission
that the bond amount be increased to 180% of the entered value of Mentor's
emulators in order to make sure that the bond covered all of Quickturn's injury
resulting from the importation of infringing goods. See July 31, 1997 Final
Initial and Recommended Determinations at 181-183, 363-367 (Exhibit D). I found
it interesting that the judge's opinion determined that entered value was 22% to
34% of actual sales price of the equipment. What this means is that a bond of
180% of entered value is actually a bond equal to 39.6% to 61.2% of the sales
price of the imported Mentor equipment and that, under the ITC's rulings, this
would be sufficient to cover all of Quickturn's damage, including price erosion.
I understand that Mentor did import equipment and did post a bond as
required by the ITC's orders. At the conclusion of the ITC proceedings, it
appears that Quickturn moved for a forfeiture of the bond to cover its damages
caused by the imports and Mentor moved for a return of the bonds on the theory
that the imports had not harmed Quickturn. In July of this year, Mentor and
Quickturn stipulated to a bond forfeiture amount of $425,000. See Joint Motion,
Etc. (Exhibit E). I found the ITC Staff's response to the stipulation very
informative. In recommending that the ITC approve the stipulation, the Staff
said:
The statutory purpose of requiring such bonds is to protect Complainant
from any injury due to importations and sales of infringing goods
during the pendency of the investigation. 19 U.S.C. Section1337(e)(1).
Complainant's agreement to the stipulated bond forfeiture amount is a
compelling basis to concluding that Complainant is adequately protected
from injury by Respondent's transactions.
See Commission Investigative Staff's Response to Joint Motion, Etc. at 6-7
(Exhibit F). Finally, the ITC judge approved the stipulation, stating:
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With respect to the dollar value of respondents' bond forfeiture,
complainant's agreement to the stipulated bond forfeiture amount of
$425,000 shows that complainant believes that amount is sufficient to
protect it from any injury by any transactions of respondents Mentor
Graphics Corporation and Meta Systems.
July 22, 1998 Order No. 106 at 8 (Exhibit G).
In order to put the $425,000 stipulated figure in perspective, I looked
at what Mentor equipment was covered by the stipulation and orders. Attached as
Exhibit H is a list of all the equipment that was imported under bond and I have
been able to determine that the Motorola emulator, the National Semiconductor
emulator, and some components sent to UB Networks were all covered by the
$425,000 forfeited bond that the ITC determined was "sufficient to protect
[Quickturn] from any injury by any transactions of respondents Mentor Graphics
Corporation and Meta Systems." While I believe the $425,000 figure is a bit high
as a measure of Quickturn's damages for these particular items of equipment, the
figure is certainly within the ballpark of my analysis. Mr. Folsom's most recent
analysis, however, pegs the damages attributable to just the Motorola and
National Semiconductor sales in the tens of millions of dollars. Nowhere does he
explain why his current figures are so radically different from the case
presented to the ITC and what Quickturn stipulated to.
Finally, it seems readily apparent that before an expert opines with
respect to damages attributable to equipment that apparently has been the
subject of a stipulated settlement, there ought to be some explanation as to why
any recovery should be allowed and, if so, a thorough explanation as to why the
requested recovery is so much larger than that presented at trial, the rulings
at trial, and what the parties agreed to. My point here is not to opine one way
or the other as to whether the stipulation and order is a bar to Quickturn's
claim on the Motorola and National Semiconductor emulators, but I do believe
that the ITC materials are a very good
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indicator of the level of damages we should be talking about in this case --
hundreds of thousands of dollars and not tens of millions.
2. The Methodology Used To Calculate The Damages For The
Motorola And National Semiconductor Sales Would Seem
Applicable To The Other Three Mentor Sales.
I understand that it is not in dispute that some of the Mentor
emulation equipment was imported before it was subject to a bonding requirement
- -- specifically the emulators sold to Bull, Radix, and UB Networks. It seems to
me, however, that the methodology Quickturn used to prove the harm that would
result from importation is just as applicable to the equipment that already had
been imported. Indeed, I can see no reason why the appropriate methodology and
analysis would be different -- price erosion, lost profits, etc. are the same no
matter when a bonding order goes into affect. The bond, as I understand it, is
to compensate for all injury, so the method used to determine the bond should be
just as applicable to damages in general.
When one applies the ITC-approved damages approach to the Bull, Radix,
and UB Networks equipment --including the price erosion proof Quickturn advanced
in the ITC -- the damages figures fall in the range of hundreds of thousands
rather than tens of millions of dollars. This result provides solid confirmation
that my approach to damages is much closer to the mark than Mr. Folsom's tens of
millions.
C. The Recent Analysis Is Apparently At Odds With Positions On
Remedies Taken By Quickturn Throughout The Case.
In addition to what happened in the ITC proceedings, I cross-checked
Mr. Folsom's numbers, and mine, against positions the parties have taken earlier
in the case. First, I read with great interest the correspondence between the
lawyers for the parties in July - August 1998 as they appeared to attempt to
reach a stipulated damage figure. See Exhibits I-N. Although the
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numbers that were being exchanged, particularly those advanced by Quickturn,
were much higher than I believe are appropriate for this case, they provide yet
another reference point as to what the reasonable damages in this case might be.
Quickturn was trying to obtain a stipulation in the low seven figures and Mentor
was apparently willing to stipulate in the high hundreds of thousands or very
low seven figures. These discussions provide confirmation that my estimate of
damages is of the right order of magnitude, while Mr. Folsom's is truly
excessive.
I also found interesting in a pleading that was filed by Quickturn in
September 1996. Quickturn was opposing a motion made by Mentor to have the
damages issues tried separately from the patent liability issues and in the
course of that opposition made it very clear that it thought that the damages
case would be simple, short, and duplicative of the ITC damages case ("because
virtually the same discovery is presently being taken in the ITC, and because
the discovery is relatively straightforward and relates to a finite number of
sales and offers to sell by Mentor, there are no real efficiencies to be gained
by bifurcating the damages issues in this case"). August 30, 1996 Quickturn
Opposition to Plaintiff's Motion to Bifurcate, Etc. (Exhibit O). The interesting
aspect of this brief is that it is entirely consistent with a damages case that
would consist of the application of a royalty percentage or a profit percentage
to a small number of machines. The statements in the brief, however, are
completely inconsistent with the notion of conducting discovery and trial for a
case that would analyze (a) what potential emulation buyers would and would not
have done in the absence of Mentor in the past and in the future, (b) price per
gate as an adequate proxy for price and profit, (c) causes for movement in price
per gate, and (d) numerous other issues raised by Mr. Folsom's claims. I am not
stating that the brief was wrong, I am simply using the statements made in it as
additional consideration that leads me to conclude that Mr. Folsom's damages
report is at odds with reality.
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IV. SPECIFIC CRITICISMS OF FOLSOM'S REPORT
A. Deficiencies In The "Past Lost Sales" Analysis.
I reviewed that portion of Mr. Folsom's report in which he opines that
Quickturn lost $4,500,400 in profits it would have made on what he calls "past"
equipment sales (and maintenance fees for such equipment) made by Mentor to
Bull, UB Networks, Radix, Motorola, and National Semiconductor during the period
1995 through 2Q 1997. His analysis has at least the following deficiencies:
1. The "Past Lost Sales" Analysis Ignores The Testimony
Of The Customers Who Said They Would Not Have Bought.
A central point of Mr. Folsom's report is that if Mentor had not made
the five sales to Bull, UB Networks, Radix, Motorola, and National
Semiconductor, Quickturn would have. Mr. Folsom, however, provides no support
for his central point and simple ignores the following testimony of four of the
five purchasing authorities for those companies:
I was the decision-maker at Motorola as to which vendor -- Mentor or
Quickturn -- would be selected in this particular contract.
The primary reason Quickturn was not selected was because I did not
feel that their product would satisfy our project's needs. Therefore,
if Mentor's SimExpress was not an option for Motorola, I would not have
purchased any emulation system.
July 9, 1998 Declaration of Chuong H. Nguyen (Exhibit P hereto).
Ultimately, as a team, we decided that Quickturn's emulation system did
not satisfy our project needs and would not likely be enhanced to meet
our project needs within our timeframe. The deficiencies were mainly in
terms of 1) compile time and 2) the cycle time that was achievable on
the Quickturn system. We had absolute requirements on a lower limit for
cycle time based on the lowest speed that the rest of our system would
run.
Our team based our conclusion that Quickturn's system could not satisfy
our project needs based mostly upon 1) our own internal evaluation of
the system, and 2) considerations from presentations by Quickturn
personnel.
Quickturn's system was rejected by our Bull even after Quickturn
offered to reduce its price to approximately one-half the price of the
Meta system.
If importation of Meta's system had not been an option, our team would
have not
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recommended purchase of the Quickturn system. Rather, we would have
chosen one of several other options. Two of those options were: 1) to
keep the emulation aspects of our project in Bull's French facility
(Les Clayes, France), or 2) to continue our design process using the
ZyCad machines we already had in place in both Phoenix, Arizona and
France.
June 19, 1998 Declaration of Russell W. Guenthner (Exhibit Q hereto).
I lead the technical committee that was given the responsibility at
Radix of deciding which vendor -- IKOS, Quickturn, or Mentor -- would
be selected. Overall, Quickturn placed third in our rankings, behind
both Mentor and IKOS.
Quickturn's third place ranking resulted primarily from the following
factors. First, I had worked with Quickturn's emulation products before
at Kaiser Electronics, and found the product to be unreliable also,
Quickturn product support was poor at best. Second, Quickturn's team
was unwilling and apparently unable to demonstrate that the product
could successfully map our design. That is, they did not perform our
benchmark mapping of a completed portion of our design into their
emulation system. Hence, they did not run our benchmark verification
vectors against the mapped design. Mentor was the only company that
successfully mapped and verified our design benchmark. Third, they did
not meet the final deadlines for quote and proposal.
Our technical committee unanimously selected Mentor as the lead
contender around the middle of 1996. IKOS was the second contender in
my mind and the minds of the other committee members.
June 24, 1998 Declaration of Tim Parker (Exhibit R hereto).
I was the main purchasing decision maker at UB Networks as to
verification technology. It was primarily my decision to purchase an
emulation system from Mentor Graphics Corporation in April 1996.
Had purchasing a Mentor systems not been an option for UB Networks, I
would most likely have subcontracted our verification work out to a
third party. I definitely would not have purchased an emulation systems
from Quickturn Design Systems, Inc.
In my judgment at the time, purchasing a Quickturn emulation system
would have involved hidden costs and risks that UB Networks was too
small to support. In my judgment, UB Networks would have had to
purchase several additional workstations and budget substantial
personnel time to support Quickturn's emulation system. Also, it is my
view that the Quickturn emulation systems offered us at that time had
technical flaws resulting in substantial problems to the user, such as
hold-time violations.
September 10, 1998 Declaration of Dan Schumacher (Exhibit S hereto).
What these declarations demonstrate is that the assumption that
Quickturn would have made any sales to these four companies is not supportable.
Therefore, he has no basis to
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conclude that Quickturn lost the "past" equipment and maintenance sales to these
four customers (which total approximately $4,000,000).
It is not clear from his report exactly how Mr. Folsom has chosen to
deal with this evidence directly undercutting his major assumption. On the one
hand, it would appear that Mr. Folsom was not given access to these statements,
since he does not list this evidence as information he considered when arriving
at his new opinion. On the other hand, Mr. Folsom makes a statement that appears
to indicate that he has discounted these statements. At paragraph 18, he refers
to unspecified third party statements offhandedly as "biased."
There are two primary failings with his statement that third party
customers are somehow biased. First, neither he nor I have been retained to
opine on the credibility of third-party sworn testimony. It seems to me to be
unreasonable for an expert witness to discount third party sworn testimony as
"biased" while relying wholeheartedly on "data" and "information" from the party
who has hired him. Second, it does not matter what Quickturn or Mentor thought
with respect to who the competitors were or what the customer might or might not
do. What matters is what the customers themselves say they would have done if
Mentor did not get their business. Mr. Folsom apparently ignores these facts,
which is per se unreasonable.
Mr. Folsom's conclusion that Quickturn had the capacity to produce and
to sell each of these five products is undercut by data which he apparently did
not review, namely the testimony of Radix's representative Tim Parker. Mr.
Parker stated that Mentor was unable to meet the bidding and product
specifications on time, apparently because Quickturn was capacity restrained and
could not bid these projects successfully. It would not be reasonable to
conclude that Quickturn had the capacity to make these sales in light of the
above information which directly indicates to the contrary.
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In the context of lost service revenue on "lost" sales, Mr. Folsom errs
by not considering the fact that Mentor was enjoined from making any service
sales to these customers beginning in August 1997. Thus, Quickturn did not lose
any service sales to Mentor after August 1997, since Mentor did not make any
itself. If Quickturn sold maintenance services to these companies related to
Mentor's products, then Quickturn clearly has no damages in this area. On the
other hand, if the customers bought services from suppliers other than
Quickturn, it shows that Mr. Folsom's assumption that all follow-up service
sales would go to Quickturn is incorrect.
2. There Is No Analysis Of, Or Backup To, The Hypothetical
Quickturn Sales With Respect To Price Or Profit.
In addition to the assumption that Quickturn would have made the
equipment and maintenance sales to begin with, Mr. Folsom's "past" lost profits
numbers are based on (a) projected equipment prices Quickturn would have
received, (b) projected 70% profits it would have received from sales at those
prices, (c) projected three year maintenance agreements, (d) projected revenues
from the maintenance agreements (10% of equipment sales), and (e) projected 70%
profits it would have received from those revenues. My major concern about these
numbers is that Mr. Folsom offers no analysis, support, or backup for any of
these assumptions and figures -- he simply appears to adopt what Mr. Ostby told
him. When I looked at Mr. Ostby's declaration, I did not see any verification or
analysis there either.
However, now that we are in October 1998 there is no need to assume,
opine, or speculate about what Bull, UB Networks, Radix, Motorola, and National
Semiconductor needed or did with respect to purchasing emulation machines or
servicing them in 1996 - June 1998, or the profits Quickturn would have made if
it had made these sales. One needs only to gather the existing data.
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B. Deficiencies In The "Lost Future Sales (Repeat Sales)" Analysis.
Under the category of lost "future" profits, Mr. Folsom opines that
during the period 1Q 1997 to 3Q 1998, Quickturn lost $20,965,000 in profits with
respect to equipment sales it would have made to just Bull, UB Networks,
National Semiconductor, and Motorola if only Mentor had not made the four sales
it did in 1995 - 1997. In addition to these losses, even after discounting his
figures to present value, Mr. Folsom adds another $5,508,000 in lost profits
Quickturn should make on servicing the machines it should have sold in 1Q 1997
to 3Q 1998. The "future" analysis is subject to the following deficiencies:
1. The "Lost Future Sales (Repeat Sales)" Ignores The Testimony
Of The Customers Who Said They Would Not Have Bought.
The two predicates to Mr. Folsom's lost "future" sales to Bull, UB
Networks, National Semiconductor, and Motorola is that Quickturn would have made
the sales Mentor did in 1995 - 1997, and then it would have obtained the repeat
business Mr. Folsom now predicts. As I stated above, Mr. Folsom's conclusion is
fundamentally undercut by the declarations of the purchasing authorities of
Bull, UB Networks, and Motorola.
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<PAGE>
2. There Is No Analysis Of What The "Lost" Customers Actually
Did With Respect To Emulation During The So-Called "Future"
Period.
There are two significant omissions from Mr. Folsom's analysis of
"future" sales. The first is that Mr. Folsom is not talking about the "future"
at all -- the years have passed and we do not need to speculate on what
emulation equipment Bull, UB Networks, National Semiconductor, and Motorola
would have purchased during 1Q 1997 - 3Q 1998. That time period is history, not
future. Second, there is no recognition that Mentor was enjoined from selling
any additional equipment or service since June 1997. Therefore, no customer has
returned to Mentor for follow-up service or equipment sales.
Since Quickturn asserts that it did not make any sales to these
customers, we can assume that these customers did not buy millions of dollars
worth of emulation equipment and services from either Quickturn or Mentor. These
companies either got along with what they had previously purchased, bought from
other suppliers, or stopped using emulation. Each of these three possibilities
shows that Quickturn is very unlikely to have suffered damages for lost future
sales. The hypothesis of "future" equipment and service sales has been
effectively impeached by the history of no sales. The most reasonable assumption
- -- and the one borne out by experience -- is that Quickturn has no damages for
lost sales in future years.
By the same token, Mr. Folsom points to absolutely no evidence
supporting the claim that if these four companies had just tried one of
Quickturn's machines, they would have purchased millions of dollars of
Quickturn's product. There is also no proof that Quickturn even tried to make
sales to these customers and was rejected after Meta was enjoined. Furthermore,
there is no evidence at all that, after the temporary exclusion order, Quickturn
tried to make any sales to these people and were rebuffed because of loyalty
toward Meta. Finally, any sale eventually
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made by Quickturn could just as easily be explained by Quickturn's finally
having a product that the companies are interested in purchasing. My
understanding is that it is Quickturn's burden to prove all of these issues and
it has produced no evidence at all.
3. There Is No Analysis Of, Or Backup To, The Hypothetical
Quickturn Sales With Respect To Price Or Profit.
The comments that I made earlier in the "past" lost profits discussion
with respect to the complete lack of support and analysis of the prices that
would have been charged and profits that could have been made apply here as well
because as of October 1998 we are speaking of the past when we refer to 1Q 1997
to 3Q 1998. There is simply no analysis provided by Mr. Folsom that supports any
of his assertions with respect to prices or profits.
C. Deficiencies In The "Price Erosion" Analysis.
Another new category of damages in the "Interim Supplemental Report" is
price erosion. Mr. Folsom hypothesizes that Mentor caused a price decline in
every emulator sold between July 1996 and July 1, 1998, and another price
decline for every emulator that will be sold for the next five years. He opines
that the loss to Quickturn will be $42,909,900 (which he discounts to
$28,440,000). This opinion is unreasonable and without factual support.
Mr. Folsom's approach to the notion of seeking damages from Mentor for
a decrease in emulator prices has changed drastically since his 1997 report,
even though he points to no information or data supporting such a change. In
1997, he opined that Quickturn lowered its price to a few specific customers in
response to competition from Mentor by approximately 25% more than it otherwise
would have. He never pointed to specific customers. The lack of data and
analysis supporting this turnabout, and Mr. Folsom's total inconsistency are
sufficient reasons to view his new conclusions as insupportable.
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<PAGE>
1. No Analysis Of Legitimacy Of Price Per Gate As Proxy For
Product Pricing.
Mr. Folsom bases his assessment of price declines on a dubious
calculation of "price per gate." Mr. Folsom gives no analysis or justification
for why "price per gate" is an appropriate measure of emulator costs. Since he
bases his entire theory on this yardstick, there should be some presentation as
to why it is the appropriate yardstick.
To the contrary, Mr. Ostby has testified that Quickturn does not use
"price per gate" pricing:
Q: Does Quickturn calculate the price of its hardware emulation
systems on a per gate basis?
A: We are aware of pricing on a per gate basis. We don't set our
pricing on the per gate basis. It is metric that we have used, but
it is not our pricing model.
Ostby Testimony, p. 45.
Indeed, it appears that price per gate is a particularly inappropriate
way to measure emulator costs. Customers, for example, do not purchase emulators
on a per gate basis, as if they were a fungible commodity. Rather, customers
purchase entire emulation systems based on design specifications for a
particular project. Quickturn itself does not price its emulation systems on a
price per gate basis; "price per gate" is not quoted in the sales and marketing
materials that I have reviewed of either Quickturn or Mentor. "Price per gate"
is not a measure of any economic fact, including customer needs, cost of
production, or marketing realities. Mr. Folsom's selection of "price per gate"
has no justifiable basis.
If Mr. Folsom had somehow justified the use of "price per gate," his
conclusions nonetheless would suffer from the additional failing of identifying
to what "gates" he is referring. Emulated gates are an ASIC design that a
machine can emulate; physical gates could be simply
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the number of transistor gates in the machine. Mr. Folsom does not identify
which "gates" he is talking about or why he chose one type of gate over another.
2. No Analysis Of Appropriateness Of Baseline Price.
Mr. Folsom assumes that a "normal" price per gate was $REDACTED in 1995
and $0.85 in 1996 and that price per gate would normally drop $REDACTED per
year. These assumptions are wholly without support or analysis. For example, he
does not indicate any price per gate figures before 1994. If he were to use a
different year, his conclusions might be far different. He has not explained the
basis, if any, for his selection of benchmark prices or of the time span he has
selected.
In fact, Mr. Ostby has admitted that per gate prices declined
precipitously before Mentor ever entered the market. He testified that
Quickturn's price per gate declined from $8 per gate in 1991, to $6, to $4, and
then to $2 by late 1994, then to $REDACTED by 1996. Ostby testimony, p. 1605.
This decline, of course, cannot be attributed to Mentor. It also reveals that
the rate of decline apparently slowed when Mentor entered the market, a fact
directly contrary to Mr. Folsom's numbers.
Mr. Folsom also does not explain the volatility of price per gate
except to attribute it to differences between domestic and foreign market share.
He does not attempt to separate domestic prices from foreign price per gate,
although this data surely must be available to him from Quickturn. His analysis
also uses a price per gate figure that appears to blend domestic and foreign
prices, even though Meta competes in foreign markets but not in domestic
markets.
3. No Support For Assumptions of Number of Gates Sold In the
Future.
Mr. Folsom appears simply to assume a number of gates sold in the
future at various assumed prices. He provides no support, analysis, or
explanation for why it is reasonable to
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<PAGE>
make these assumptions. There is no discussion of changes in Quickturn's
products that have occurred or that will occur. There is no discussion of how
a change in the market or market prices could affect the number of gates
sold. Indeed, there is so little explanation or analysis, there is no way to
assess the reasonableness of his analysis or assumptions. He does not provide
any reason to believe that his conclusions are reasonable.
4. No Analysis Of Potential Causes of Price Per Gate Decline.
Without any substantial analysis, Mr. Folsom assumes that 100% of the
decline in his benchmark pricing is attributable to competition from Mentor.
This simplistic assumption is not reasonable. It is elementary economics that
any decline in prices can be caused by a multitude of factors in our economy,
including the demand for the products, the income and resources of clients, the
capabilities of the products, marketing approaches, the availability and pricing
of substitute products, changes in the national and global economies, individual
negotiations, the collapse of demand for ASICs (which has crippled semiconductor
equipment manufacturers such as Applied Materials), the rapid and continual
decline in component prices (see, for example, the Form 10-K's of Quickturn's
supplier Xilinx), currency fluctuations, increased component performance, and
any other number of factors that dramatically affect the price of computer
equipment. Assuming that Mentor's entering and exiting the hardware emulation
market is the only factor affecting pricing is completely unreasonable and
insupportable.
Mr. Folsom completely misunderstands the notion of monopoly pricing.
Monopolists do not charge any price (e.g. $.83 per gate) -- by definition, they
charge a profit- maximizing price. A monopolist's inability to charge any price
while holding the quantity demanded steady is not a reflection of past players
in the market, it is the inevitable result of the downward sloping demand curve
facing a monopolist. For example, if there was only one multinational oil
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<PAGE>
company, that monopolist would rationally charge a profit-maximizing price,
which would imply a profit-maximizing quantity sold. If it charged a higher or
lower price, there would be shifts in quantity demanded as more or fewer people
walked, road bicycles, or gave up driving altogether and, of course, profit
would be reduced because the new price would not be the profit-maximizing price.
There is no support or analysis for Mr. Folsom's assumption that
Quickturn, as the monopolist Mr. Folsom apparently claims it is, is unable to
raise prices to a profit-maximizing level now that Mentor is out of the market.
A monopolist can charge a profit-maximizing price. When a monopolist raises
prices to a profit maximizing level, some customers will forego the product,
i.e., the quantity sold may decline, but profits will increase to the maximum
level. Once Mentor was out of the market, it could have had no causal affect on
Quickturn's pricing or profits.
5. No Analysis Of Relationship Between Decline In Price Per Gate
And Loss Of Profit.
Mr. Folsom's price erosion theory does not address at all the critical
item of inquiry: profit. He appears to confuse price per gate with profit by
assuming that any difference in charges on a price per gate basis is 100% profit
to Quickturn. He presents no justification for this assumption which, on its
face, is implausible, since it assumes that Quickturn is now irrationally
charging a nonprofit-maximizing price. Assuming Quickturn's prices are
profit-maximizing, however, if Quickturn were to raise prices to the level
suggested by Mr. Folsom, economic theory would predict reduced quantity sold and
lower profits because the percentage increase in profit per unit would be more
than offset by the percentage decrease in quantity sold.
6. Complete Failure To Analyze Future Price Erosion.
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<PAGE>
Mr. Folsom presents a single paragraph positing $42,909,900 (discounted
to $28,440,000) in future price erosion. Without any real analysis, he takes his
insupportable past price erosion theory (discussed above) and extrapolates it
out for five years. This is apparently based on two assumptions: (a) that
Quickturn cannot charge a profit-maximizing price in any future years because
Mentor was once in the market; and (b) that the "benchmark" price of emulation
systems will continue to decline after Mentor has left the market, and somehow
will be attributable to Mentor. He does not attempt to justify these assumptions
and indeed, they appear wholly unjustifiable.
Mr. Folsom's report does not represent a serious attempt to examine the
future emulation market. He does not project demand, costs of sales, product
substitution, other sources of competition, product changes, market saturation,
or any of the multitude of effects on the market for the next five years.
D. Deficiencies In The Reasonable Royalty Analysis.
Mr. Folsom's analysis here suffers from many flaws. The single biggest
flaw is that he does not use the "willing licensor/willing licensee" standard.
Instead, he specifically posits that Quickturn would be an unwilling licensor.
He provides no analysis at all of what Mentor might be willing to pay, or could
pay. This is not reasonable and is contrary to accepted reasonable royalty
analyses.
For example, a license fee that is more than the gross margin that the
licensee could achieve selling the product would surely be one that a licensor
would be willing to receive, but if the licensee could not pay it, the royalty,
by definition would not be reasonable (because there would be no willing
licensee). The reasonable royalty figure must contemplate that the licensee will
have a realistic potential of making a profit after paying the license fee. Mr.
Folsom never
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<PAGE>
addresses this. Instead, he looks at all the reasons Quickturn
would not want to license the patents and then arrives at a license rate that
would discourage or prohibit a licensee from licensing the patents.
V. A REALISTIC ASSESSMENT OF DAMAGES TOTALS
NO MORE THAN $ 550,000.
A. Reasonable Royalty Is the Appropriate Measure
For Four Of The Five Emulator Sales.
As discussed earlier in this report, four of the five customers who
purchased Mentor emulator equipment have declared that they would not have
purchased Quickturn systems had Mentor's product not been available. (The
evidence is not yet in regarding the fifth customer, National Semiconductor.)
Because Quickturn would not have made the sales, Mr. Folsom cannot measure
alleged damages by lost profits. Rather, the appropriate measure to employ is to
determine what reasonable royalty a willing licensee would have paid a willing
licensor to obtain the right to sell that product. My analysis leads me to
conclude that a reasonable royalty rate would be 7.8% of the sales price of the
design verification equipment.
In determining what royalty would be reasonable, on sales that are
defined as sales the licensor would not make, the most important factor is the
operating margin of the licensee for design verification products. A licensee
will not pay a royalty rate that is so high that it prevents the licensee from
making a profit on the product. On the other hand, a hypothetical willing
licensor would like to obtain a royalty as high as possible, but recognizes that
without a license agreement, it would get nothing. The reasonable royalty
arising from negotiations between the two parties lies somewhere between 0% and
the licensee's operating margin, depending on the relative strengths of the
parties positions. ("Operating margin" is the profit earned by the company after
manufacturing and operating costs are subtracted from total revenue.)
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<PAGE>
It is my understanding that Mentor did not make a profit on its few
sales of emulation equipment in the United States. Because Mentor's profit
margin was so low, Mentor would have been unable and unwilling to pay a
substantial royalty payment for its use of the technology. The portion of my
analysis below uses this state of affairs as a working assumption. I also
performed an analysis based on Quickturn's operating margin as a proxy for what
Mentor's profits might have been had they been in the U.S. market.
The sale of emulation equipment was not profitable to Quickturn from
1988 through 1993. Its first year of earning any profits from emulation
equipment was 1994 and in that year, its operating margin was only approximately
6.2%. In 1995, Quickturn's operating margin was only 14.3%. In 1996, Quickturn's
operating margin was only 15.6%. Any licensing negotiations between Quickturn
and Mentor would have to have occurred in approximately 1995, near the
commencement of infringement.
In my opinion, based on the facts of this case, it is reasonable to
conclude that the appropriate royalty in this case is 7.8%, the midpoint between
0% and Mentor's margin (approximated by Quickturn's margin).
Applying a 7.8% reasonable royalty rate to the amounts of the four
sales (using Quickturn's project sales numbers), lead to a total royalties as
follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
Customer Sale Amount Royalty Rate Total Royalty
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Radix $REDACTED 7.8% $REDACTED
- ----------------------------------------------------------------------------------------------------------------
Motorola $REDACTED 7.8% $REDACTED
- ----------------------------------------------------------------------------------------------------------------
UB Networks $REDACTED 7.8% $REDACTED
- ----------------------------------------------------------------------------------------------------------------
Bull HN $REDACTED 7.8% $REDACTED
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
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<PAGE>
<TABLE>
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
TOTAL $4,454,000 7.8% $347,412
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
At this point, I should note that I could change the assumptions with
respect to Mentor's profits and still obtain a total damages figure that is
relatively low. For example, if I assumed that Mentor's operating margin was
40%, one could assume a reasonable royalty rate of 20%. Under these assumptions,
the total damages for these four equipment sales would be only $890,800.
As I have discussed, Quickturn should have data available indicating
whether or not service and maintenance sales to the four customers above were
made by Quickturn. They certainly were not made by Mentor, since Mentor was
enjoined. In that situation, Quickturn would be entitled to no damages from
Mentor. Of course, if those service and maintenance sales were made by
Quickturn, it again would have no damages. It is possible that these customers
performed their own service and maintenance, or that none was required. Mr.
Folsom presents no data or reasonable assumptions to support any more detailed
analysis of these alleged damages.
B. Lost Profits May Be An Appropriate Measure
For The Lost Sale To National Semiconductor.
The only design verification product sale by Mentor that is potentially
suitable for a lost profits analysis is Mentor's $590,952 sale to National
Semiconductor, since on all other sales, the customers have declared that they
would not have purchased a Quickturn system in any event. In calculating
Quickturn's potential lost profits on that sale, one would apply Quickturn's
incremental margin to the gross value of that sale.
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<PAGE>
I have reviewed the 10-K and annual reports of Quickturn during the
relevant time period to assess its incremental profit rate, had it -- rather
than Mentor -- made the sales to National Semiconductor. The proper
incremental profit rate includes all costs that vary with the sales and
production on an additional unit. In accounting terms, the incremental profit
rate includes all manufacturing costs(1) that vary with the production of an
additional unit and all operating costs(2) that vary with sale of an
additional unit. Mr. Folsom uses gross margin(3) which only considers the
manufacturing costs of producing an additional unit for his lost profits
calculation. He does not consider increases in operating costs as the result
of additional sales. Hence, Mr. Folsom does not use an incremental profit
rate for his lost profits calculation. Mr. Folsom assumes that Quickturn's
operating costs are fixed. A quick review of Quickturn's 10-K shows that this
is not the case, operating costs clearly change as Quickturn's sales change,
making some portion of Quickturn's operating expenses variable. I have
performed a regression analysis on Quickturn's variable and fixed costs
during the time period of 1989 through 1996. (I chose this time period
because that was the data available at the time.) The results of my analysis
are summarized in Exhibit T.
I conclude that the appropriate incremental profit that Quickturn would
have earned on a sale to National Semiconductor in 1996 is 34%. Therefore, any
lost profits to Quickturn with respect to the National Semiconductor device
would be 34% of $590,952, or approximately $200,924.
- --------
(1) Manufacturing costs include raw material costs, direct labor costs,
depreciation, and direct overhead. These costs are commonly referred to as
Cost of Goods Sold.
(2) Operating costs include marketing costs, selling costs, commissions,
administrative costs, engineering costs, and research and development
costs.
(3) Gross Margin is defined as Total Revenue less Costs of Goods Sold (COGS)
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<PAGE>
Please note that the deposition of National Semiconductor has not yet
occurred, and so, no conclusion can be drawn concerning whether or not lost
profits or reasonable royalty is the appropriate measure of damages.
C. There Is No Evidence To Support Any Other Form Of Damages.
In this report and my previous report, I have discussed the various
types of damages potentially available for an infringement of Quickturn's
patents. For the Mentor sales where the evidence indicates that Quickturn would
not have made the sale, a reasonable royalty is the appropriate damages measure.
As discussed above, I have concluded that applying a reasonable royalty to the
appropriate sales yields potential damages of approximately $347,416 (or at the
outside, $890,800). For the Mentor sale where Quickturn might have made the
sale, I have conservatively assumed that Quickturn would be entitled to its lost
profits, which yields potential damages of approximately $200,000.
No other categories of damages are appropriate in this case. I conclude
that the damages to which Quickturn could be entitled to as a result of
infringement of its patents by Mentor is not more than $548,336, and at the very
most, $1,091,724.
Dated: October 22, 1998
---------------------------
Blaine F. Nye, Ph.D
30
