VirnetX Holding Corporation — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. Financial statements are unaudited. VirnetX commercializes a portfolio of patents through licensing and is developing secure communications products, including GABRIEL. Its revenue remains dependent primarily on patent licensing and litigation-related outcomes.
Financial performance and liquidity
Unless otherwise noted, amounts below are in thousands of dollars.
| Metric | Q1 2017 | Q1 2016 / comparison |
|---|---|---|
| Revenue | $375 | $375 |
| Research and development expense | $475 | $450 |
| Selling, general and administrative expense | $3,806 | $8,543 |
| Operating loss | $(3,906) | $(8,618) |
| Net loss | $(3,894) | $(8,610) |
| Basic and diluted loss per share | $(0.07) | $(0.16) |
| Net cash used in operating activities | $(6,134) | $(7,634) |
- Revenue was recognized from amortization of deferred fees under a 2013 settlement contract; the filing does not report revenue from new product sales for the quarter.
- Cash and cash equivalents were $3.609 million and available-for-sale investments were $6.129 million at March 31, 2017, together $9.738 million, down from $15.876 million at year-end 2016. Working capital was $7.904 million, versus $11.240 million.
- Total assets were $12.909 million and total liabilities were $4.827 million. Liabilities included $3.625 million in deferred revenue. The filing reports no debt balance.
- Operating cash outflow was partly offset by $3.116 million of investment maturities or sales; there were no financing proceeds in Q1 2017. Cash declined by $3.018 million during the quarter.
- The filing does not provide a gross margin figure. Interest income, net, was $17 thousand; income tax expense was $5 thousand. A full valuation allowance was maintained against deferred tax assets.
Material changes versus prior comparable period
- SG&A expense fell by $4.737 million, primarily because legal fees related to patent infringement actions decreased by $4.622 million.
- Net loss narrowed by $4.716 million, while revenue was unchanged. R&D expense increased by $25 thousand.
- Operating cash use improved by $1.500 million year over year, although cash and investments fell substantially from December 31, 2016 as the company funded legal costs and operating losses.
- Weighted-average shares outstanding rose to 58.145 million from 54.135 million. No shares were sold under the ATM offering during Q1 2017.
Outlook, risks, contingencies and unusual items
- Management said cash, investments and potential ATM or shelf-registration proceeds were expected to fund the current level of SG&A, including legal expenses, and working capital for the “foreseeable future.” No quantified revenue or earnings guidance was provided.
- Management expects most future revenue to come from licensing fees and royalties, but cautions that licensing opportunities may not be realized. The filing says more than 80 small and medium businesses had installed GABRIEL products; the products were not reported as generating revenue.
- The company disclosed nine pending intellectual-property infringement lawsuits or related appellate proceedings. In Apple I, a September 2016 jury verdict awarded VirnetX $302.4 million; post-trial motions and final judgment remained pending. The separate Apple II retrial date had not been set. These verdicts are contingent litigation outcomes, not reported Q1 revenue.
- Several Federal Circuit decisions affirmed PTAB patent invalidity findings in proceedings involving VirnetX patents; the company said it was evaluating options in certain matters. Litigation outcomes, patent validity, licensing success and legal costs are key uncertainties.
- VirnetX’s patents expire at various times from 2019 to 2024. Certain patents acquired from Leidos carry potential payment obligations tied to value generated.
- Aircraft use and reimbursements from K2 Investment Fund LLC, whose managing partners include the CEO and Chief Administrative Officer, totaled approximately $252 thousand in Q1 2017, versus $132 thousand in Q1 2016.
- Other disclosed risks include potential dilution from future capital raises or outstanding options, customer and revenue concentration, product commercialization and adoption, security and privacy requirements, and volatile share trading. Management reported disclosure controls were effective as of March 31, 2017.
Investor verification priorities
- Track court rulings, final judgments, appeals and collectability relating to the Apple verdicts; do not treat jury awards as realized cash or recognized revenue.
- Assess cash burn against the $9.738 million cash-and-investment balance and verify whether financing or licensing receipts support management’s stated liquidity outlook.
- Verify progress converting GABRIEL installations, licensing initiatives and the patent portfolio into recurring revenue, given quarterly revenue of $375 thousand from an older settlement contract.
- Monitor patent validity proceedings, patent expiry dates and any resulting effect on licensing leverage and future economics.
- Review potential dilution and related-party aircraft costs, as well as the continuing level of legal spending.