Opinion ID: 731320
Heading Depth: 4
Heading Rank: 1

Heading: Defendant's Income Recognition Practices

Text: 12 Plaintiffs allege that during the class period in question defendants made false statements in MIPS' quarterly income statements when they recognized revenue before it was earned. According to plaintiffs, under Generally Accepted Accounting Principles (GAAP) and MIPS' own policies, defendants could not recognize income until a binding agreement existed, until deliverables 1 were shipped, and until material contingencies were satisfied. When revenue can be recognized is what is at issue in this case. 13 Although defendants maintain that during the class period at issue no specific GAAP rules existed governing revenue recognition for technology licensing agreements, defendants do not appear to dispute plaintiffs' contentions that, under GAAP, revenue must be earned before it can be recognized. Defendants concede that, under GAAP, the earnings process must be substantially completed and an exchange must have occurred before revenue can be recognized. MIPS' own policy, which was in existence during the class period, states that technology revenue is recognized upon the completion of contract requirements. 14 That contract requirements had to be completed before revenue could be recognized as earned makes perfect sense given the way that MIPS and its customers structured their deals and given the fact that intellectual property was involved. The purchase orders that were signed by customers contained various contingencies, including the approval of foreign governments and the receipt of deliverables. In some instances, the terms of the licensing agreements had not yet been negotiated or finalized when customers signed the purchase orders. Although the signed purchase orders stated that the licensing fee was nonrecoverable, normally no money exchanged hands until after customers received the deliverables. As a result, MIPS had a policy of not shipping any deliverables until a binding agreement existed. Finally, the technology that customers purchased was not completed or taped out until March 1991. Before that date, and until MIPS' customers received the actual technology, MIPS customers had received nothing they could use. 15 Defendants, however, contend, and the district court agreed, that the bulk of MIPS' technology was transferred during the sales process. As the district court explained: 16 The manner by which MIPS recognized revenue appears to have basically been consistent with its own written policy on the subject and GAAP.... The evidence indicates that while in some instances partial deliverables remained unshipped after revenue was recognized, the bulk of the terms of the technology transfers (i.e. transfer of sufficient technology to allow the purchaser to begin RISC utilization, payment and acceptances of nonrecoverable fees, etc.) had been substantially satisfied. 17 (Emphasis added.) 18 The evidence, however, is not so clear and tells a more complicated story. We have combed through the record and are unable to determine what exactly was transferred to customers during the sales process. The technology, although licensed, had not yet been completed. If any technology was transferred during the sales process, such transfers would have been inconsistent with MIPS' policy of not transferring any technology until a binding contract had been executed. Thus, we find that plaintiffs have raised genuine issues of material fact as to whether technology transfers in fact occurred during the sales process and whether such transfers were sufficient under GAAP to support the recognition of revenue. Further, looking at the evidence in the light most favorable to plaintiffs, it appears that, in the transactions described below, defendants recognized revenue before binding agreements existed and before contract requirements were completed. 19
20 Plaintiffs contend that, in the fourth quarter of 1990, defendants recognized nearly $3 million in revenue from transactions with Sony, NEC, Control Data, Convex, and Olivetti. According to plaintiffs, had defendants not recognized this revenue, MIPS would have reported a $2,576,000 loss rather than the $546,000 loss, that was actually reported. 2 21
22 In the fourth quarter of 1990, defendants recognized $1 million in revenue from Sony based on a letter from Sony stating that it was exercising an option to purchase a license. The letter, however, stated that Sony was agree[ing] to discuss, in good faith, the details and schedule associated with the above option during the first quarter of 1991. The discussions over the licensing agreement appear to have taken place after the income was recognized. An agreement was executed in April 1991 and provided that Sony's obligation to pay was conditioned on its receipt of all deliverables. In May 1991, Sony still had not received all deliverables. 23
24 In the fourth quarter of 1990, defendants recorded $250,000 in revenue from NEC based on a signed purchase order. That purchase order contained various contingencies, none of which had been satisfied when the revenue was recognized. In addition, plaintiffs provided evidence that suggests the actual agreement may have been finalized sometime in April 1991. 25
26 In the fourth quarter of 1990, defendants recognized $250,000 in revenue from Control Data. Plaintiffs provided evidence that suggests material terms of the licensing agreement were still being negotiated when defendants recognized the revenue. 27
28 In the fourth quarter of 1990, defendants recognized $950,000 in revenue from Olivetti. According to defendants, a binding agreement in the form of a signed letter of intent existed when the revenue was recognized. However, plaintiffs have provided documentary evidence that suggests that a binding agreement may not have been executed until after the fourth quarter ended and that Olivetti may have signed a backdated agreement. It also appears that the deliverables were not shipped until February 19, 1991. 29
30 In the fourth quarter of 1990, defendants recognized $450,000 in revenue from Convex based upon a December 28, 1990 agreement, which gave Convex the right to cancel and receive a full refund if MIPS failed to tape out the R4000 by December 31, 1991. There is evidence in the record that suggests the R4000 microprocessor was behind schedule. In addition, the deliverables had not yet been shipped when the revenue was recognized. 31
32 According to plaintiffs, in the first quarter of 1991, defendants recognized $8 million in revenue from NKK, NEC, and Wang, which had not yet been earned. 3 As a result, MIPS reported a $624,000 profit for the quarter. Had defendants not recognized the alleged unearned revenue, MIPS would have recorded a loss of more than $4.3 million. 33
34 In the first quarter of 1991, defendants recognized $5 million in revenue from NKK based upon an agreement which was subject to approval from the Japanese government. In addition, plaintiffs contend that this agreement was subject to another material contingency--set out in a side letter--which stated that MIPS was required to ship deliverables by December 31, 1991. Defendants recognized the revenue before the deliverables were shipped and before the Japanese government provided its approval of the agreement. 35
36 In the first quarter of 1991, defendants recognized $2.25 million in revenue from NEC based on a purchase order for the extension of an existing licensing agreement. The purchase order, however, indicated that NEC could not formally enter into an agreement at that time. Apparently, the parties may not have reached an agreement until June 26, 1991. The June 26, 1991 agreement provided that it was not effective until executed and the Japanese government's approval obtained. 37
38 According to plaintiffs, in the second quarter of 1991, defendants improperly recognized $4.5 million revenue from NEC, Daewoo, and Tandem. 39
40 In the second quarter of 1991, defendants recognized $2 million in revenue from NEC based upon a purchase order for a joint venture with NEC called the Advanced Computing Environment (ACE) initiative. Plaintiffs, however, provided evidence that suggests that at the time the revenue was recognized, NEC and MIPS were just beginning to negotiate the terms of the licensing agreement. In fact, as will be discussed below, ACE had not yet been announced. Thus, there is a question as to whether ACE in fact existed when the revenue was recognized. 41
42 In the second quarter of 1991, defendants recognized $2 million in revenue from Daewoo based on an agreement which required the Korean government's approval before it could be considered binding. Plaintiffs' evidence shows that when the income was recognized, the terms of the licensing agreement were still being negotiated, and the Korean government had not yet approved the agreement. In fact, the approval was not obtained until the third quarter of 1991, and only after the Korean government sought various changes to the licensing agreement. 43
44 In the second quarter of 1991, defendants recognized $600,000 in revenue from Tandem. Plaintiffs contend that a licensing agreement with Tandem was not binding when signed on June 30, 1991, because the agreement had not been finalized. Plaintiffs provided evidence that suggests drafts of the agreement were circulated as late as August and September 1991. An agreement was executed on October 1, 1991. In addition, it appears that Tandem did not execute a purchase order until November 6, 1991.