VirnetX Holding Corporation — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions unless otherwise noted.
Business context
VirnetX develops and licenses patented secure-communications technology and software, including its GABRIEL products. Its business model depends substantially on patent licensing and enforcement. The first-half results were dominated by a one-time payment from Apple in the Apple I litigation, rather than recurring product or licensing activity.
Financial highlights
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $0.018m | $0.038m | $302.594m | $0.046m |
| Operating expenses | $10.504m | $4.590m | $129.886m | $10.231m |
| Operating income (loss) | $(10.486)m | $(4.552)m | $172.708m | $(10.185)m |
| Net income (loss) | $(8.040)m | $(4.130)m | $291.905m | $(9.738)m |
| Diluted EPS | $(0.11) | $(0.06) | $4.05 | $(0.14) |
- Apple payment: VirnetX received $454.034m in March 2020. The filing allocated $302.428m to royalty revenue, $41.271m to a gain for willful infringement, $108.221m to interest income, and $2.114m to reimbursement of litigation costs. The filing also reports $90.101m in licensing costs associated with the proceeds.
- Cash flow: First-half operating cash flow was $332.937m, investing cash outflow was $0.226m, and financing cash outflow was $65.663m, including the $70.841m dividend. Cash increased by $267.048m to $270.183m.
- Liquidity and liabilities: At June 30, cash and cash equivalents were $270.183m and short-term investments were $2.622m; working capital was $223.683m. Total liabilities were $49.716m, including $38.863m income taxes payable and $9.438m accrued licensing costs. The balance sheet reports no debt.
- Margins: Not especially informative given minimal Q2 revenue and the one-time litigation recovery in first-half results.
- Dividend and shares: The company paid a one-time $1-per-share cash dividend totaling $70.841m. Shares outstanding were 71,058,570 at June 30, 2020, versus 69,586,764 at year-end 2019.
Material changes versus comparable periods
- Q2 revenue remained minimal and declined from the prior-year quarter; Q2 net loss widened to $8.040m from $4.130m.
- First-half revenue and earnings moved sharply from prior-year losses, principally because of the Apple I payment. The company cautions that this does not represent a recurring revenue level.
- First-half operating expenses increased to $129.886m from $10.231m, including $90.101m in licensing costs and higher legal and staffing expenses. First-half SG&A rose to $34.077m, with legal fees increasing by $21.820m before the Apple litigation-cost reimbursement.
- Cash and working capital increased substantially following the Apple receipt, while the dividend distributed $70.841m to shareholders.
Outlook, risks and unusual items
- Management said available cash should fund current SG&A, including legal expenses, and working capital for the foreseeable future. It expects the majority of future revenue to come from licensing and royalties, but provides no quantified revenue or earnings guidance.
- Management expected legal fees to remain at similar or lower levels over the next two quarters and expected operating losses during that period.
- Apple’s motion to vacate the Apple I judgment remained unresolved; Apple indicated it would seek restitution if it obtained relief. The company cannot assure that it will retain the payment.
- In Apple II, the Federal Circuit affirmed infringement for VPN on Demand but reversed the FaceTime infringement finding and remanded damages. The district court ordered a new damages trial, scheduled for August 17, 2020; patent challenges could also affect the case.
- McKool Smith sought $36.3m, or 8% of the Apple payment, in arbitration as a claimed contingency fee. VirnetX denied the claim and said it would contest it.
- A stockholder derivative action alleged fiduciary-duty breaches, corporate waste and unjust enrichment; defendants moved to dismiss. Patent litigation, patent validity challenges, commercialization uncertainty, customer concentration and the potential impact of COVID-19 are significant risks.
- The company reported effective disclosure controls as of June 30, 2020 and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether Apple’s unresolved Apple I motion could require repayment of any part of the $454.034m, and the timing and outcome of the Apple II damages retrial.
- The basis, timing and potential financial impact of the $90.101m accrued licensing costs, and the status of the $36.3m McKool Smith arbitration claim.
- Whether recurring licensing or product revenue grows enough to support operations after the one-time Apple recovery; Q2 revenue was only $18,000.
- How legal spending, the tax position and deferred tax asset realization evolve, and whether the company maintains sufficient liquidity without further litigation proceeds.
- The effects of patent challenges and patent expirations, including patents scheduled to expire during 2020–2024, on the value of the licensing portfolio.