VirnetX Holding Corporation — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Unless otherwise noted, financial amounts below are in thousands of dollars. VirnetX develops secure communications technology and relies primarily on patent licensing and royalties; its GABRIEL technology was in beta testing.
Financial results
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $1,612 | $368 | $1,911 | $404 |
| Research and development | $316 | $253 | $1,002 | $783 |
| General, selling and administrative | $6,429 | $9,486 | $22,150 | $27,949 |
| Operating loss | $(5,133) | $(9,371) | $(21,241) | $(28,328) |
| Net loss | $(5,134) | $(4,719) | $(20,054) | $(19,689) |
| Basic and diluted loss per share | $(0.10) | $(0.09) | $(0.39) | $(0.39) |
- Revenue was largely attributable to the Avaya license agreement. Q3 included $1,500 of estimated historical royalties and $112 of subsequent royalties from Avaya and other licensees. Avaya agreed to minimum annual payments of $2,500 over the contract period, totaling $10,000.
- Operating expenses totaled $6,745 in Q3 and $23,152 for nine months. SG&A fell year over year, primarily because of lower patent litigation legal fees ($3,546 lower for Q3 and $7,384 lower for nine months); R&D rose with employee costs.
- Interest income was $47 for Q3 and $105 for nine months. The warrant-liability revaluation produced a $48 non-cash loss for Q3 and a $1,438 non-cash gain for nine months. These items and differing tax benefits/expenses explain why net-loss trends differed from operating-loss trends.
- No gross margin is presented; the filing reports no cost-of-revenue line item.
Cash, liquidity and balance sheet
- At September 30, cash and cash equivalents were $20,948 and available-for-sale investments were $23,319, together $44,267. At December 31, 2012, the combined balance was $46,154. Working capital was $39,264, down from $53,862.
- Nine-month operating cash use was $1,859, versus $12,508 in 2012. Investing activities provided $3,117; financing activities provided $29; cash increased $1,287 to $20,948.
- The improvement in operating cash flow included a $14,963 cash-flow benefit from prepaid taxes, which were $14,963 at year-end 2012 and nil at September 30, 2013. Management attributed the decrease in cash and investments primarily to litigation costs and operating losses.
- Total current liabilities were $5,486, including $916 of deferred revenue and a $2,734 derivative liability. The filing reports no debt. Stockholders’ equity was $39,323, versus $53,944 at December 31, 2012.
- Management stated cash and short-term investments should fund operations, working capital and legal expenses for at least the next several years. This is management’s outlook, not a guarantee.
Changes, outlook and notable items
- Year-to-date revenue rose to $1,911 from $404, primarily reflecting licensing agreements. Yet year-to-date net loss was slightly higher, while operating loss improved as litigation legal fees declined.
- Management expected legal fees to remain at or rise above recent levels in the next quarter as litigation entered another trial-preparation phase, and expected continued operating losses. No formal revenue or earnings guidance was provided.
- The company reported four pending intellectual-property infringement matters. Apple appealed the prior jury judgment; the reported award exceeded $368 million, but no award or related royalties had been recognized in the financial statements, and collection was uncertain. A Cisco jury found no infringement, while finding the patents at issue valid and enforceable; VirnetX’s post-trial motions were pending. The Microsoft and further Apple actions also remained pending.
- Avaya signed a license in August and the related case was dismissed. The filing also describes a non-cancelable, ten-year promotional and marketing agreement costing $4,000; the remaining amount was due when the facility became available, anticipated in 2014 or 2015. The headquarters lease was extended through October 2015.
- The Series I warrant liability is Level 3 and remeasured each period. Management estimated that a $1 change in share price could change the liability by approximately $200, all else equal, creating potentially material non-cash earnings volatility.
- Management maintained a $13,118 valuation allowance against deferred tax assets, stating that it was more likely than not that the assets would not be fully realized. Disclosure controls were assessed as effective at quarter-end.
Important facts for investors to verify
- Progress, appellate outcomes and potential collectability of the Apple judgment, and outcomes and costs of the other patent cases.
- Whether Avaya and other licensees generate the contracted and anticipated royalties, and how deferred revenue is recognized.
- Actual legal spending, operating cash burn and whether available liquidity remains sufficient for the stated multi-year period.
- Assumptions behind estimated historical royalties and the valuation of the Level 3 warrant liability.
- Timing and payment terms of the $4,000 promotional and marketing commitment, as well as realization of deferred tax assets.