VirnetX Holding Corporation — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Financial statement amounts below are in thousands of dollars, except per-share data, unless otherwise noted. The interim statements are unaudited.
Business context
VirnetX seeks to commercialize and license its secure-communications patent portfolio, technology and GABRIEL products. It reported approximately 185 patents and pending applications. Revenue remains dependent on licensing and royalty activity; management described product commercialization as an early-stage effort.
Key financial metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $16 | $396 | $22 | $771 |
| Operating expenses | $6,478 | $4,207 | $14,092 | $8,488 |
| Operating loss | $(6,462) | $(3,811) | $(14,070) | $(7,717) |
| Net loss | $(6,450) | $(3,798) | $(14,055) | $(7,691) |
| Loss per share, basic and diluted | $(0.10) | $(0.07) | $(0.23) | $(0.13) |
- Cash flow: Net cash used in operating activities was $11,484 for the first half of 2018, versus $9,390 in the prior-year period. Investing activities provided $711; financing activities provided $11,606, principally from common-stock sales. Cash and cash equivalents ended the period at $3,968, compared with $3,135 at year-end 2017.
- Liquidity: Short-term investments were $724 at June 30, 2018, versus $1,453 at December 31, 2017. Working capital was $1,974, up from $697. Management said cash, investments and access to equity offerings should fund current costs and working capital for the foreseeable future.
- Balance sheet and debt: Total assets were $7,371 and total liabilities were $3,724 at June 30, 2018. The filing reports no debt balance. Accounts payable and accrued liabilities rose to $2,966 from $414 at year-end; accrued payroll fell to $219 from $2,175.
- Margins: Revenue was very small relative to operating costs, and the company reported substantial operating and net losses; a positive operating margin was not reported.
Material changes versus the prior comparable period
- First-half revenue fell to $22 from $771. The company attributed the reported decline primarily to adoption of ASC 606: it removed $750 of revenue that would have been recognized under prior accounting. Q2 revenue was $16 versus $396, including a $375 prior-year deferred-revenue recognition that was not recognized in 2018 under the new standard.
- First-half SG&A increased $5,286 to $11,901, primarily because patent-litigation legal fees increased $5,165. Q2 SG&A rose $2,042 to $5,292.
- First-half R&D increased $318 to $2,191, primarily due to higher staff expense.
- First-half net loss widened to $14,055 from $7,691. The filing attributes the increase primarily to litigation-related legal fees.
- VirnetX sold 3,072,610 shares through its ATM offering in the first half, with gross proceeds of $12,000 and fees and costs of $360. Common shares outstanding were 62,292,808 at June 30, versus 59,051,978 at December 31, 2017.
Outlook, litigation and risks
- Management expected legal fees at the same or higher levels over the next two quarters and expected operating losses as a result. No numerical revenue or earnings guidance was provided.
- VirnetX disclosed a $439.7 million final judgment in Apple I, which Apple appealed, and a $502.6 million Apple II jury verdict, with willful infringement found. Post-trial motions and final judgment in Apple II remained pending; the company had requested enhanced damages. These amounts are litigation awards or verdicts, not reported revenue or cash received. Appeals, patent-validity challenges and other court outcomes could reduce, delay or eliminate any recovery.
- The company cautioned that litigation is costly and distracting, and that potential licensees may wait for litigation outcomes. It also warned that commercialization may not generate significant revenue and that further capital raises could dilute shareholders.
- On January 1, 2018, VirnetX adopted ASC 606 using the modified-retrospective method. Adoption reduced deferred revenue and accumulated deficit by $2,500 at adoption; the filing shows a $750 reduction to first-half 2018 revenue and net income compared with the pre-adoption presentation.
- Management maintained a full valuation allowance against deferred tax assets, citing uncertainty about future taxable income. Federal and state NOL carryforwards were approximately $103 million and $117 million, respectively.
- Other disclosed risks include patent challenges and litigation outcomes, limited customer and revenue base, competition, lengthy sales cycles, data-security and privacy regulation, and share-price volatility. The filing also notes that the PITA agreements terminated in March 2018 and a dispute over termination could lead to litigation.
- The company reported effective disclosure controls as of June 30, 2018, with no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Current status, appeal outcomes and enforceability of the Apple I judgment and Apple II verdict, including whether any damages are ultimately affirmed and collected.
- Cash burn, legal-fee trajectory and the adequacy of liquidity if ATM or other financing proceeds are unavailable or dilutive.
- Whether licensing, GABRIEL product adoption and customer growth generate recurring revenue beyond the small amounts reported.
- The effects of ASC 606 when comparing reported revenue with prior periods and the underlying timing and terms of licensing receipts.
- Patent validity, expiration and potential NOL realizability; the filing states patents expire at various times from 2019 to 2024 and maintains a full deferred-tax-asset valuation allowance.