Quarterly Report (10-q)
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
?
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2017
or
?
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number: 001-33852
VirnetX Holding Corporation
(Exact name of registrant as specified in its charter)
Delaware
77-0390628
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification Number)
308 Dorla Court, Suite 206 Zephyr Cove, Nevada
89448
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (775) 548-1785
Former name, former address and former fiscal year, if changed since last report:
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes? No ?
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ?No ?
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company in Rule 12b-2 of the Exchange Act.
Large accelerated filer ?
Accelerated filer ?
Non-accelerated filer ?
(Do not check if a smaller reporting company)
Smaller reporting company ?
Emerging growth company ?
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ?
The number of shares outstanding of the Registrant’s Common Stock as of May 5, 2017, was 58,144,888.
VIRNETX HOLDING CORPORATION
INDEX
Page
PART I — FINANCIAL INFORMATION
1
Item 1 —Financial Statements.
1
Condensed Consolidated Balance Sheets at March 31, 2017 (unaudited) and December 31, 2016
1
Condensed Consolidated Statements of Operations for the three months ended March 31, 2017 and 2016 (unaudited)
2
Condensed Consolidated Statements of Comprehensive Loss for the three months ended March 31, 2017 and 2016 (unaudited)
2
Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2017 and 2016 (unaudited)
3
Notes to Condensed Consolidated Financial Statements
4
Item 2 —Management’s Discussion and Analysis of Financial Condition and Results of Operations
13
Item 3 —Quantitative and Qualitative Disclosures About Market Risk
18
Item 4 —Controls and Procedures
18
PART II — OTHER INFORMATION
19
Item 1 —Legal Proceedings
19
Item 1A —Risk Factors
22
Item 5 —Other Information
30
Item 6 —Exhibit
31
SIGNATURES
32
Index
PART I — FINANCIAL INFORMATION
ITEM 1- FINANCIAL STATEMENTS.
VIRNETX HOLDING CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
As of
March 31, 2017
As of
December 31, 2016
ASSETS
(unaudited)
Current assets:
Cash and cash equivalents
$
3,609
$
6,627
Investments available for sale
6,129
9,249
Prepaid expenses and other current assets
868
588
Total current assets
10,606
16,464
Prepaid expenses, non-current
2,279
2,374
Property and equipment, net
24
33
Total assets
$
12,909
$
18,871
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities
$
651
$
1,806
Accrued payroll and related expenses
150
1,522
Income tax liability
401
396
Deferred revenue, current portion
1,500
1,500
Total current liabilities
2,702
5,224
Deferred revenue, non-current portion
2,125
2,500
Total liabilities
4,827
7,724
Commitments and contingencies (Note 4)
—
—
Stockholders’ equity:
Preferred stock, par value $0.0001 per share Authorized: 10,000,000 shares at March 31, 2017 and December 31, 2016, Issued and outstanding: 0 shares at March 31, 2017 and December 31, 2016
—
—
Common stock, par value $0.0001 per share
Authorized: 100,000,000 shares at March 31, 2017 and December 31, 2016, Issued and outstanding: 58,144,888 shares and 58,144,888 shares, at March 31, 2017 and December 31, 2016, respectively
6
6
Additional paid-in capital
170,224
169,391
Accumulated deficit
(162,131
)
(158,238
)
Accumulated other comprehensive loss
(17
)
(12
)
Total stockholders’ equity
8,082
11,147
Total liabilities and stockholders’ equity
$
12,909
$
18,871
The accompanying notes are an integral part of these consolidated financial statements.
1
Index
VIRNETX HOLDING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(in thousands, except per share amounts)
Three Months Ended
March 31,
2017
March 31,
2016
Revenue
$
375
$
375
Operating expense:
Research and development
475
450
Selling, general and administrative
3,806
8,543
Total operating expense
4,281
8,993
Loss from operations
(3,906
)
(8,618
)
Interest income, net
17
15
Loss before taxes
(3,889
)
(8,603
)
Provision for income taxes
(5
)
(7
)
Net loss
$
(3,894
)
$
(8,610
)
Basic and diluted loss per share
$
(0.07
)
$
(0.16
)
Weighted average shares outstanding basic and diluted
58,145
54,135
VIRNETX HOLDING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (Unaudited)
(in thousands)
Three Months Ended
March 31,
2017
March 31,
2016
Net loss
$
(3,894
)
$
(8,610
)
Other comprehensive gain (loss), net of tax:
Change in equity adjustment from foreign currency translation, net of tax
(1
)
—
Change in unrealized gain (loss) on investments, net of tax
(4
)
9
Total other comprehensive gain (loss) net of tax
(5
)
9
Comprehensive loss
$
(3,899
)
$
(8,601
)
See accompanying notes to condensed consolidated financial statements.
2
Index
VIRNETX HOLDING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in thousands)
Cash flows from operating activities:
Three Months
Ended
March 31,
2017
Three Months
Ended
March 31,
2016
Net loss
$
(3,894
)
$
(8,610
)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation
9
6
Amortization of warrant issuance costs
—
(30
)
Stock-based compensation
833
1,234
Changes in assets and liabilities:
Prepaid expenses and other current assets
(185
)
(108
)
Accounts payable and accrued liabilities
(1,155
)
1,643
Accrued payroll and related expenses
(1,372
)
(1,383
)
Related party payable
—
(11
)
Income tax liability
5
—
Deferred revenue
(375
)
(375
)
Net cash used in operating activities
(6,134
)
(7,634
)
Cash flows from investing activities:
Purchase of property and equipment
—
(2
)
Purchase of investments
—
(2,752
)
Proceeds from sale or maturity of investments
3,116
4,116
Net cash provided by investing activities
3,116
1,362
Cash flows from financing activities:
Proceeds from exercise of options
—
20
Proceeds from sale of common stock
—
6,795
Net cash provided by financing activities
—
6,815
Net increase (decrease) in cash and cash equivalents
(3,018
)
543
Cash and cash equivalents, beginning of period
6,627
8,726
Cash and cash equivalents, end of period
$
3,609
$
9,269
Cash paid for income taxes
$
—
$
—
See accompanying notes to condensed consolidated financial statements.
3
Index
VIRNETX HOLDING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts)
(Unaudited)
Note 1 — Business Description and Basis of Presentation
VirnetX Holding Corporation, which we refer to as “we”, “us”, “our”, “the Company” or “VirnetX”, is engaged in the business of commercializing a portfolio of patents. We seek to license our technology, including GABRIEL Connection Technology™, to various original equipment manufacturers, or OEMs, that use our technologies in the development and manufacturing of their own products within the IP-telephony, mobility, fixed-mobile convergence and unified communications markets. Prior to 2012 our revenue was limited to an insignificant amount of software royalties pursuant to the terms of a single license agreement. Since 2012 we had revenues from settlements of patent infringement disputes whereby we received consideration for past sales of licensees that utilized our technology, where there was no prior patent license agreement, as well as license agreement revenues from settlements providing licensing for the continued use of our technology (see “Revenue Recognition”).
Our portfolio of intellectual property is the foundation of our business model. We currently own approximately 49 U.S. and 69 foreign patents with approximately 50 pending patent applications worldwide. Our patent portfolio is primarily focused on securing real-time communications over the Internet, as well as related services such as the establishment and maintenance of a secure domain name registry. Our patented methods also have additional applications in the key areas of device operating systems and network security for Cloud services, Machine-to-Machine (“M2M”), communications in areas including “Smart City,” “Connected Car” and “Connected Home.” All our U.S. and foreign patents and pending patent applications relate generally to securing communications over the internet and as such, cover all our technology and other products. Our issued U.S. and foreign patents expire at various times during the period from 2019 to 2024. Some of our issued patents and pending patent applications were acquired by our principal operating subsidiary, VirnetX, Inc., from Leidos, Inc. (“Leidos”) (f/k/a Science Applications International Corporation, or SAIC) in 2006 and we are required to make payments to Leidos based on cash or certain other values generated from those patents in certain circumstances. The amount of such payments depends upon the type of value generated and certain categories are subject to maximums and other limitations.
Note 2 — Summary of Significant Accounting Policies
Unaudited Interim Financial Information
The accompanying Condensed Consolidated Balance Sheet as of March 31, 2017, the Condensed Consolidated Statements of Income for the three months ended March 31, 2017 and 2016, the Condensed Consolidated Statements of Comprehensive Loss for the three months ended March 31, 2017 and 2016, and the Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2017 and 2016 are unaudited. These unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). In our opinion, the unaudited interim consolidated financial statements include all adjustments of a normal recurring nature necessary for the fair presentation of our financial position as of March 31, 2017, our results of operations for the three months ended March 31, 2017 and 2016, and our cash flows for the three months ended March 31, 2017 and 2016. The results of operations for interim periods are not necessarily indicative of the results to be expected for a full year.
These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016, filed with the SEC on March 16, 2017.
Use of Estimates
We prepare our consolidated financial statements in accordance with U.S. GAAP. In doing so, we must make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues, and expenses, as well as related disclosure of contingent assets and liabilities. In some cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in our accounting estimates are reasonably likely to occur. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, at the time they are made and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss further below.
Basis of Consolidation
The consolidated financial statements include the accounts of VirnetX Holding Corporation and our wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated.
4
Index
Revenue Recognition
We derive our revenue from patent licensing. The timing and amount of revenue recognized from each licensee depends upon a variety of factors, including the specific terms of each agreement and the nature of the deliverables and obligations. Such agreements may be complex and include multiple elements. These agreements may include, without limitation, elements related to the settlement of past patent infringement liabilities, up-front and non-refundable license fees for the use of patents, patent licensing royalties on covered products sold by licensees, and the compensation structure and ownership of intellectual property rights associated with contractual technology development arrangements. Licensing agreements are accounted for under the Financial Accounting Standards Board (“FASB”) revenue recognition guidance, “Revenue Arrangements with Multiple Deliverables.” This guidance requires consideration to be allocated to each element of an agreement that has stand-alone value using the relative fair value method. In other circumstances, such as those agreements involving consideration for past and expected future patent royalty obligations, after consideration of the particular facts and circumstances, the appropriate recording of revenue between periods may require the use of judgment. In all cases, revenue is only recognized after all the following criteria are met: (1) written agreements have been executed; (2) delivery of technology or intellectual property rights has occurred or services have been rendered; (3) fees are fixed or determinable; and (4) collectability of fees is reasonably assured.
Patent License Agreements : Upon signing a patent license agreement, including licenses entered upon settlement of litigation, we provide the licensee permission to use our patented technology in specific applications. We account for patent license agreements in accordance with the guidance for revenue recognition for arrangements with multiple deliverables, with amounts allocated to each element based on their fair values. We have elected to utilize the leased-based model for revenue recognition with revenue being recognized over the expected period of benefit to the licensee. Under our patent license agreements, we do or expect to typically receive one or a combination of the following forms of payment as consideration for permitting our licensees to use our patented inventions in specific applications and products:
• Consideration for Past Sales : Consideration related to a licensee’s product sales from prior periods may result from a negotiated agreement with a licensee that utilized our patented technology prior to signing a patent license agreement with us or from the resolution of a litigation, disagreement or arbitration with a licensee over the specific terms of an existing license agreement. We may also receive royalty for past sales in connection with the settlement of patent litigation where there was no prior patent license agreement. These amounts are negotiated, typically based upon application of a royalty rate to historical sales prior to the execution of the license agreement. In each of these cases, because delivery has occurred, we record the consideration as revenue when we have obtained a signed agreement, identified a fixed or determinable price, and determined that collectability is reasonably assured.
• Current Royalty Payments : Ongoing royalty payments cover a licensee’s obligations to us related to its sales of covered products in the current contractual reporting period. Licensees that owe these current royalty payments are obligated to provide us with quarterly or semi-annual royalty reports that summarize their sales of covered products and their related royalty obligations to us. We expect to receive these royalty reports subsequent to the period in which our licensees’ underlying sales occurred. As a result, it is impractical for us to recognize revenue in the period in which the underlying sales occur, and, in most cases, we will recognize revenue in the period in which the royalty report is received and other revenue recognition criteria are met due to the fact that without royalty reports from our licensees, our visibility into our licensees’ sales is limited.
• Non-Refundable Up-Front Fees and Minimum Fee Contracts : For licenses that provide for non-refundable up-front or fixed minimum fees over their term, for which we have no future obligations or performance requirements, revenue is generally recognized over the license term. For licenses that provide for fees that are not fixed or determinable, including licenses that provide for extended payment terms and/or payment of a significant portion of the fee after expiration of the license or more than 12 months after delivery, the fees are generally presumed not to be fixed or determinable, and revenue is deferred and recognized as earned, but generally not in advance of collection.
• Non-Royalty Elements : Elements that are not related to royalty revenue in nature, such as settlement fees, expense reimbursement, and damages, if any, are recorded as gain from settlement which is reflected as a separate line item within the operating expenses section in the consolidated statements of operations.
Deferred revenue
In August 2013, we began receiving annual payments on a contract requiring payment to us over 4 years totaling $10,000 ("August 2013 Contract Settlement"). In accordance with our revenue recognition policy we defer and recognize revenue over the life of the contract, but not ahead of collection. We collected the final payment under the contract in 2016 and recognized $375 of revenue, related to the August 2013 Contract Settlement, during the three months ended March 31, 2017 and 2016.
Activity under the August 2013 Contract Settlement was as follows:
Deferred Revenue, December 31, 2016
$
4,000
Less: Amount amortized as revenue
375
Deferred Revenue, March 31, 2017
$
3,625
5
Index
Earnings Per Share
Basic earnings per share are computed by dividing earnings available to common stockholders by the weighted average number of outstanding common shares during the period. Diluted earnings per share are computed by dividing net income by the weighted average number of shares outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued.
Concentration of Credit Risk and Other Risks and Uncertainties
Our cash and cash equivalents are primarily maintained at two major financial institutions in the United States. A portion of those balances are insured by the Federal Deposit Insurance Corporation. During the three months ended March 31, 2017 we had funds which were uninsured. We do not believe that we are subject to any unusual financial risk beyond the normal risk associated with commercial banking relationships with major financial institutions. We have not experienced any losses on our deposits of cash and cash equivalents.
Prepaid Expenses
Prepaid expenses at March 31, 2017 include the current portion of prepaid rent for a facility lease for corporate promotional and marketing purposes. From inception, the prepayment totaling $4,000 is being amortized over the 10-year term of the lease. The unamortized non-current portion of the prepayment is included in Prepaid expenses-non-current on the consolidated balance sheet.
Impairment of Long-Lived Assets
On an annual basis, we identify and record impairment losses on long-lived assets when events and changes in circumstances indicate that the carrying amount of an asset might not be recoverable. Recoverability is measured by comparison of the anticipated future net undiscounted cash flows to the related assets’ carrying value. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the projected discounted future net cash flows arising from the asset.
Fair Value of Financial Instruments
Fair value is the price that would result from an orderly transaction between market participants at the measurement date. A fair value hierarchy prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). Level 2 measurements utilize either directly or indirectly observable inputs in markets other than quoted prices in active markets.
Our financial instruments are stated at amounts that equal, or approximate, fair value. When we estimate fair value, we utilize market data or assumptions that we believe market participants would use in pricing the financial instrument, including assumptions about risk and inputs to the valuation technique. We use valuation techniques, primarily the income and market approach, which maximizes the use of observable inputs and minimize the use of unobservable inputs for recurring fair value measurements.
Mutual Funds: Valued at the quoted net asset value of shares held.
U.S. government and U.S. agency securities : Fair value measured at the closing price reported on the active market on which the individual securities are traded.
