VirnetX Holding Corporation — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Amounts are in thousands of dollars except per-share data and where otherwise noted.
Business context
VirnetX commercializes a portfolio of communications-security patents through licensing and litigation, and is developing and marketing its GABRIEL secure communications products. The company reported approximately 49 U.S. and 69 foreign patents, with about 50 patent applications pending. Revenue remained heavily dependent on a single multiyear settlement/license contract; management described licensing and royalties as the expected principal source of future revenue.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $375 | $375 | $1,148 | $1,150 |
| Total operating expenses | $7,662 | $6,477 | $22,407 | $22,579 |
| Operating loss | $(7,287) | $(6,102) | $(21,259) | $(21,429) |
| Net loss | $(7,387) | $(6,097) | $(21,335) | $(21,498) |
| Basic and diluted loss per share | $(0.13) | $(0.12) | $(0.38) | $(0.41) |
- Revenue and margins: Q3 revenue was recognized from the August 2013 settlement contract. The filing does not present a conventional gross-profit or gross-margin measure.
- Cash flow: Net cash used in operating activities was $15,558 for the first nine months, versus $21,754 in 2015. Investing activities provided $713; financing activities provided $14,646, including $14,626 from common-stock sales.
- Liquidity: At September 30, cash and cash equivalents were $8,527 and available-for-sale investments were $9,243, totaling $17,770. Working capital was $12,766. Total assets were $20,986 and stockholders’ equity was $12,401. The balance sheet reports no borrowing or debt balance.
- Deferred revenue: The August 2013 contract had produced $10,000 in total cash receipts; deferred revenue was $4,375 at quarter-end, including a $2,500 payment received during the nine-month period.
Material changes versus prior comparable periods
- Q3 revenue was unchanged year over year; nine-month revenue declined slightly, by $2.
- Q3 operating loss widened by $1,185, mainly as SG&A increased $1,333 to $6,318, primarily due to patent-litigation legal fees. Nine-month SG&A rose $4,089 to $20,132, including a $4,424 increase in litigation legal fees.
- Nine-month royalty expense fell to $884 from $5,264, while R&D expense increased to $1,391 from $1,272. Management attributed the R&D increase mainly to staffing.
- Nine-month net loss improved by $163, and loss per share improved to $0.38 from $0.41, in part alongside a higher weighted-average share count.
- Cash and investments declined by $910 from year-end 2015. Common shares outstanding rose to 56,689,167 from 53,198,835, largely reflecting ATM issuance.
Outlook, commentary, risks and unusual items
- Management said cash, investments, and ATM proceeds were expected to fund the current level of SG&A, including legal costs, and working capital for the foreseeable future. It expected the same or higher legal-fee levels over the next two quarters and operating losses as a result.
- On September 30, 2016, a jury awarded VirnetX $302.4 million in the Apple I patent case. The verdict remained subject to post-trial proceedings; the filing does not report the award as recognized revenue or cash. A prior $625.6 million Apple verdict was subject to the court’s July 2016 order separating the cases for retrial. The Apple II retrial date had not been set.
- VirnetX also had appeals concerning Patent Trial and Appeal Board invalidity findings, with oral arguments scheduled for November 7, 2016. Litigation outcomes, patent validity and enforceability, and the timing or amount of licensing revenue are material uncertainties.
- Management cited minimal licensing revenue, a concentrated customer/revenue base, early-stage product commercialization, long sales cycles, and potentially substantial ongoing litigation costs as key business risks. The company also disclosed possible dilution from equity issuance and stock-based awards.
- Deferred tax assets remained subject to a valuation allowance of approximately $38 million, reflecting management’s assessment that realization was not more likely than not. Federal and state net operating loss carryforwards were approximately $69 million and $37 million, respectively.
- After quarter-end, the company sold 276,550 shares under its ATM for net proceeds before stated fees and costs of $848; associated commissions, fees, and other costs were $25.
Most important facts for investors to verify
- Current procedural status, appeal and post-trial outcomes, and collectability of the $302.4 million Apple jury verdict; do not treat the verdict as assured proceeds.
- Cash burn and the adequacy of liquidity if litigation costs stay elevated or ATM financing becomes less available.
- Whether VirnetX can secure additional licenses and convert GABRIEL product adoption into material recurring revenue beyond the settlement contract.
- Future share issuance, ATM capacity and pricing, and dilution from outstanding options and other equity awards.
- Patent validity, remaining patent life, and royalty-sharing obligations to Leidos that may reduce cash generated from patent-related outcomes.