VirnetX Holding Corporation — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Unaudited financial statements; amounts below are in millions of dollars except per-share data and where stated. VirnetX seeks to commercialize and license its communications-security patent portfolio and GABRIEL products. It reported approximately 185 patents and pending applications.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $0.007 | $0.375 | $0.028 | $1.146 |
| Research and development | $0.932 | $0.783 | $3.123 | $2.656 |
| Selling, general and administrative | $4.023 | $3.154 | $15.923 | $9.770 |
| Operating loss | $(4.948) | $(3.562) | $(19.018) | $(11.280) |
| Net loss | $(4.934) | $(3.552) | $(18.989) | $(11.244) |
| Loss per share, basic and diluted | $(0.08) | $(0.06) | $(0.31) | $(0.19) |
- Revenue and margins: Revenue was minimal relative to operating costs; the filing does not present a meaningful gross-margin measure. Reported revenue fell sharply, but the comparison is affected by VirnetX’s January 2018 adoption of ASC 606. The adoption reduced 2018 revenue by $0.375 for Q3 and $1.125 for the nine-month period; the company’s pre-adoption figures were $0.382 and $1.153, respectively. 2017 revenue included amounts recognized from a prior settlement contract.
- Cash flow: Nine-month operating cash use was $17.759, versus $11.520 in 2017. Investing activities provided $0.789; financing provided $25.231, primarily from common-stock sales. Cash and cash equivalents rose by $8.261 to $11.396.
- Liquidity and debt: Cash and cash equivalents were $11.396 and short-term investments were $0.645 at September 30, 2018. Working capital was $11.791, compared with $0.697 at year-end 2017. No borrowings are shown on the balance sheet; total liabilities were $1.185.
- Equity financing: ATM sales during the first nine months raised $26.004 gross through sales of approximately 7.124 million shares; associated fees and costs were $0.730. Common shares outstanding were 66.376 million at quarter-end and 66.763 million as of November 6, 2018.
Changes versus the prior comparable period
- Nine-month net loss increased to $18.989 million from $11.244 million, principally due to higher legal costs associated with patent litigation. SG&A rose $6.153 million year over year, including a $5.719 million increase in litigation legal fees. R&D increased $0.467 million, primarily from product-development compensation.
- Management expected legal fees at the same or higher levels over the next two quarters and expected operating losses as a result.
- ASC 606 adoption reduced deferred revenue and accumulated deficit by $2.500 million at adoption. It reduced reported nine-month 2018 revenue by $1.125 million and increased the reported net loss by the same amount; it had no effect on operating cash flow.
Outlook, litigation, risks, and unusual items
- Outlook: No numerical revenue or earnings guidance was provided. Management said cash, short-term investments and access to securities sales under its ATM and shelf registration were expected to fund current costs, including legal expenses, and working capital for the foreseeable future. Longer-term revenue is expected mainly from patent licenses and royalties; realization is uncertain.
- Apple litigation: Final judgments totaled $439.7 million in Apple I and $595.9 million in Apple II. Apple appealed both awards; the Apple II appeal was docketed in October 2018, with Apple’s opening brief pending. These awards are disputed and should not be treated as received cash or assured proceeds. VirnetX also has appeals concerning patent-validity findings and other patent proceedings; some arguments had not yet been scheduled.
- Commercialization and patent risks: VirnetX disclosed minimal licensing revenue and early-stage GABRIEL commercialization. Management cautioned that litigation may deter prospective licensees and that product adoption, licensing arrangements and future revenue are not assured. Patent challenges, litigation expense, and patent expirations from 2019 through 2024 are material considerations.
- Capital and dilution: The company has a $100 million shelf registration and a $50 million ATM program. Additional equity sales could dilute shareholders and pressure the stock price. Subsequent to quarter-end through November 6, it sold 386,434 shares for $1.834 million gross under the ATM.
- Other items: Payments to an aircraft-service LLC controlled by the CEO and Chief Administrative Officer were $0.579 million for Q3 and $1.262 million for the nine months, versus $0.218 million and $0.690 million in 2017. The company reported a full valuation allowance against deferred tax assets. Management stated disclosure controls were effective and reported no material change in internal controls during the quarter.
Important facts for investors to verify
- Current status and likely timing of Apple appeals, other patent appeals and challenges to patent validity; whether any judgments ultimately become collectible.
- Actual operating cash burn and legal spending, and how long available liquidity and remaining financing capacity can support operations.
- Evidence of GABRIEL adoption converting into material recurring revenue, and progress in obtaining new licensees despite ongoing litigation.
- Future ATM share sales, dilution, and the related-party aircraft-service costs and governance oversight.
- Potential impact of patent expirations and any payments owed to Leidos under the acquired-patent arrangements.