VirnetX Holding Corporation — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015. Financial amounts below are in thousands of dollars, except per-share amounts and where noted.
Business context
VirnetX develops secure communications software and technologies and primarily seeks to monetize its intellectual property through patent licenses and royalties. Its products, including the Gabriel Secure Communication Platform and Collaboration Suite, were in public beta at more than 80 small and medium businesses; general release was expected in the first half of 2015, subject to successful completion of beta testing. The company reported more than 100 U.S. and international patents and more than 75 pending applications.
Financial results and liquidity
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Revenue | $375 | $250 |
| Research and development expense | $392 | $347 |
| Selling, general and administrative expense | $5,742 | $6,856 |
| Total operating expense | $6,134 | $7,203 |
| Loss from operations | $(5,759) | $(6,953) |
| Net loss | $(5,855) | $(6,087) |
| Basic and diluted loss per share | $(0.11) | $(0.12) |
| Net cash used in operating activities | $(6,964) | $(8,103) |
- Revenue was entirely described as recognition of non-refundable upfront fees under an August 2013 contract settlement. VirnetX recognized $375 in Q1 2015 and had received $5,000 of the contract’s total $10,000 over four years; amounts not yet collected were not recognized.
- SG&A declined by $1,114, primarily because legal fees associated with patent infringement actions fell by $949. R&D increased by $45, primarily due to employee wage and medical costs.
- The company recorded a non-cash $117 loss from revaluing Series I warrants, versus an $838 gain in Q1 2014. All remaining Series I warrants were exercised or expired during the quarter; the derivative liability was zero at March 31, 2015.
- Cash and cash equivalents were $13,290 and available-for-sale investments were $21,410 at March 31, 2015, totaling $34,700. At December 31, 2014, the respective balances were $18,658 and $22,571. Working capital was $26,356, down from $29,919.
- Operating cash use was partly offset by $1,165 of net investing cash inflow and $431 of financing cash inflow, including warrant exercises. Cash declined by $5,368 during the quarter.
- Total assets were $38,767 and total liabilities were $9,426 at March 31, 2015. The balance sheet reported no debt; principal liabilities included $6,100 of royalty payable and $1,625 of deferred revenue.
- Management said cash and short-term investments were sufficient to fund the current level of SG&A, including legal expenses, and related working capital for the foreseeable future. The filing provides no numerical cash runway estimate.
- No gross profit or margin measure was presented; the filing reports revenue and operating expenses separately.
Material changes, outlook and risks
- Compared with Q1 2014, net loss narrowed by $232, principally alongside lower SG&A, partly offset by the change from a derivative gain to a derivative loss. Revenue remained small relative to operating costs.
- Management expects most future revenue to come from patent license fees and royalties, but cautions that licensing success and timing are uncertain. The company reported minimal revenue from licensing activities and said it could not assure that its strategy would succeed.
- On May 8, 2015, after quarter-end, VirnetX entered a three-year-base-term agreement with IPValue Management to assist with negotiating certain patent licenses in exchange for commissions from resulting revenue. The agreement also provides for stop-notice fees under specified circumstances.
- The principal disclosed litigation is VirnetX’s patent dispute with Apple. The Federal Circuit had vacated the earlier damages award and remanded issues for further proceedings. On March 30, 2015, the district court consolidated related actions; the jury trial was reset for January 25, 2016, with jury selection scheduled for January 18. The prior verdict exceeding $368 million is not a current assured recovery; the filing does not provide a clear value for any litigation recovery or related contingency accrual.
- Key risks include unsuccessful or delayed licensing, patent validity and enforcement challenges, costly litigation and adverse outcomes, FRAND restrictions on certain licensing terms, lengthy sales cycles, product and cybersecurity risks, and dependence on a limited prospective customer base. The company also warned that its stock price and results could be volatile.
- Management reported effective disclosure controls as of March 31, 2015 and no material changes in internal control over financial reporting during the quarter. The company reported no off-balance-sheet arrangements.
Important facts for investors to verify
- Progress and commercial adoption of the Gabriel products following the stated first-half 2015 release expectation.
- Whether additional licenses or royalties generate meaningful revenue, and the timing and collectability of contract payments.
- Developments in the consolidated Apple litigation, including trial timing, remanded infringement and damages issues, and any resulting financial impact.
- Future cash use, legal spending, and liquidity relative to management’s “foreseeable future” assessment.
- The economic terms and realized results of the IPValue agreement, including commissions and any stop-notice fees.