VirnetX Holding Corporation — Q2 2013 Form 10-Q
Business context and reporting period. The filing covers the quarter and six months ended June 30, 2013. VirnetX develops secure communications technology and relies primarily on patent licensing and enforcement; its GABRIEL Connection Technology was in beta testing. Revenue remained minimal and results were significantly affected by litigation and noncash warrant revaluations. Financial amounts below are in millions of dollars unless stated otherwise.
Financial results and liquidity
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Revenue | $0.006 | $0.036 | $0.300 | $0.036 |
| Operating expenses | $6.584 | $11.770 | $16.408 | $18.993 |
| Operating loss | $(6.578) | $(11.734) | $(16.108) | $(18.957) |
| Net loss | $(7.029) | $(10.264) | $(14.922) | $(14.971) |
| Loss per share, basic and diluted | $(0.14) | $(0.20) | $(0.29) | $(0.29) |
- Margins: The filing does not present gross margin; revenue was too small for margins to be informative.
- Cash flow: Six-month operating cash flow was $0.099 million, versus cash used of $1.447 million in 2012. The 2013 inflow included a $14.963 million reduction in prepaid taxes; investing activities provided $13.087 million, principally from investment maturities, while financing activities provided $0.031 million.
- Liquidity: At June 30, cash and cash equivalents were $32.878 million and short-term investments were $13.382 million, totaling $46.260 million. Working capital was $42.314 million, down from $53.862 million at year-end 2012. The company reported no debt; current liabilities were $4.547 million, including a $2.686 million Series I warrant derivative liability.
- Balance sheet: Total assets were $46.926 million and stockholders’ equity was $42.379 million. The accumulated deficit was $77.847 million. Shares outstanding were 51,203,141 at June 30.
Material changes versus the prior comparable period
- Six-month revenue rose to $0.300 million from $0.036 million, while Q2 revenue declined to $0.006 million from $0.036 million. Revenue recognized in 2013 was royalty revenue associated with negotiated agreements over past sales; future license revenue is subject to the company’s recognition criteria.
- Operating expenses fell $5.286 million in Q2 and $2.585 million for the six-month period. Management attributed the decline primarily to lower legal fees; R&D expense increased, mainly due to wage, medical and share-based compensation costs.
- Six-month net loss was nearly unchanged year over year. The 2013 period included a $1.486 million noncash gain from revaluing the warrant liability, compared with a $1.979 million loss in 2012. Q2 included a $0.120 million noncash loss, versus a $2.248 million loss in Q2 2012.
- Cash and investments together were broadly similar to year-end 2012, but their composition shifted: cash increased while investments declined. Current assets also fell as the $14.963 million prepaid-tax balance at year-end was no longer reported at June 30.
Outlook, litigation, risks and unusual items
- Management said June 30 cash and investments should fund operations, working capital and legal expenses for at least the next several years. It expected legal expenses to remain at or rise above recent levels over the next two quarters as infringement cases advanced, with operating losses expected; management anticipated materially lower legal expense after the current court schedule is completed. No revenue or earnings guidance was provided.
- Litigation outcomes are central to the business model and financial outlook. In the earlier Apple case, the court upheld a jury award of more than $368 million, denied a permanent injunction, and set daily amounts for post-verdict damages and interest. Apple appealed in July 2013; the company had not recognized the award or ongoing royalties in its financial statements and stated there was no assurance of recovery. Any proceeds from that case would be subject to a 25% payment to SAIC after litigation fees and costs.
- A Cisco jury found non-infringement, although it found the asserted patents valid and enforceable. VirnetX sought a new trial and other relief; rulings were pending. An additional Apple case and a Microsoft infringement suit were pending. The ITC complaint against Apple had been terminated.
- Subsequent event: On August 7, 2013, VirnetX signed a patent license agreement with Avaya, including multiple payments and ongoing royalties, in exchange for patent licenses and dismissal of the infringement case. Payment amounts and other terms were not disclosed.
- Tax expense was $0.356 million for the first six months, compared with a $5.763 million tax benefit in 2012. The company maintained a $11.423 million valuation allowance against deferred tax assets and said those assets were not expected to be fully realizable. Federal and state tax years from 2005 onward remained open to examination.
- The warrant liability is measured using significant unobservable inputs and can cause earnings volatility. The filing estimates that a $1 increase in share price would raise the liability by approximately $0.2 million, all else equal. The company also disclosed risks from patent challenges, litigation costs and outcomes, limited licensing revenue, product commercialization, customer concentration, regulation and security or system failures.
- A ten-year promotional and marketing commitment has a stated cost of $4.0 million; $0.250 million had been prepaid, with the remaining balance due when the facility was expected to become available in 2014 or 2015. The filing reported no off-balance-sheet arrangements.
Important facts for investors to verify
- Subsequent court and appellate outcomes in the Apple cases, including whether any damages or ongoing royalties are ultimately collectible, and the resulting SAIC payment.
- The financial terms and revenue-recognition timing of the August 2013 Avaya agreement, which were not disclosed in this filing.
- Whether licensing revenue grows beyond the small amounts reported, and whether GABRIEL technology advances from beta testing toward commercialization.
- Actual legal spending, operating cash use and liquidity as litigation proceeds; the positive first-half operating cash flow included the prepaid-tax balance change.
- Future warrant-liability revaluations, tax-asset realizability and any changes in the status of the company’s pending litigation.