VirnetX Holding Corporation — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Dollar amounts below are in thousands, except per-share data. VirnetX develops secure communications technology and relies primarily on patent licensing; its Gabriel products were available for trial on Windows, Mac OS X and Android, while iOS release was planned for later in 2015.
Financial results and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Revenue | $400 | $268 | $775 | $518 |
| Operating expenses | $9,967 | $6,439 | $16,102 | $13,643 |
| Operating loss | $(9,567) | $(6,171) | $(15,327) | $(13,125) |
| Net loss | $(9,546) | $(6,670) | $(15,401) | $(12,758) |
| Loss per share, basic and diluted | $(0.18) | $(0.13) | $(0.30) | $(0.25) |
- Revenue grew about 49% in Q2 and 50% for the six-month period year over year, but remained small relative to operating costs. The filing does not provide a meaningful gross-margin figure.
- Royalty expense was $4,236 in the 2015 quarter and first half, versus none in 2014, primarily for revenue sharing and litigation-related reimbursements owed to Leidos. The $7,989 royalty payable at June 30 was paid in full after quarter-end.
- SG&A declined $780 in Q2 and $1,894 for the first half, mainly from lower patent-litigation legal fees; management said stock compensation and related payroll taxes partly offset the decrease. R&D increased to $417 in Q2 and $809 for the first half.
- Cash and cash equivalents were $13,044 and available-for-sale investments $15,038 at June 30, for combined liquid funds of $28,082, versus $41,229 at December 31, 2014. Working capital was $18,560, down from $29,919.
- First-half operating cash use was $13,579, compared with $13,293 in 2014. Investing provided $7,534, including investment maturities and sales; financing provided $431, including warrant exercises. Cash declined $5,614 during the period.
- Total liabilities were $10,385; the filing reports no debt. Stockholders’ equity was $21,657. Share count was 52.189 million at June 30, and 52.364 million as of August 4.
Material changes and unusual items
- First-half net loss widened by $2,643 year over year, despite higher revenue and lower SG&A, chiefly reflecting the new $4,236 royalty expense. Q2 also included a $530 derivative-liability loss in 2014 but none in 2015; all remaining Series I Warrants expired or were settled in Q1 2015.
- Most 2015 first-half revenue, $750, was recognized from a five-year contract settlement begun in August 2013. The contract’s total value is $10,000; $5,000 had been received through June 30, 2015. Revenue is recognized over time, and $1,250 remained deferred at June 30.
- VirnetX entered a 12-month aircraft-use lease with K2 Investment Fund LLC, managed by its CEO and Chief Administrative Officer. It incurred approximately $303 in fees and reimbursements during the first half; the agreement is cancellable on 30 days’ notice.
Outlook, litigation and risks
- Management said cash and investments at June 30 should fund current operations, working capital and legal expenses for the foreseeable future, but noted it may seek capital within the next 12 months. No quantified revenue or earnings guidance was provided.
- Management expected legal fees at the same or higher levels over the next two quarters as litigation advanced, with operating losses expected; it anticipated a material decrease in legal costs after the current court schedule concludes.
- The company’s principal pending matter is consolidated patent litigation against Apple. A prior jury award exceeding $368 million was vacated on appeal as to damages, with issues remanded; the court consolidated the related proceedings and set jury trial for January 25, 2016. The outcome, recoveries and timing are uncertain. The earlier Cisco jury found non-infringement; that case was closed.
- Key risks include dependence on uncertain patent licensing and litigation outcomes, challenges to patent validity or enforceability, ongoing legal costs, limited current revenue, possible need for additional capital and dilution, and volatility in the stock price. Management maintained a full valuation allowance against deferred tax assets given the history of losses and uncertainty of future taxable income.
Important facts for investors to verify
- Whether the Apple proceedings produced a favorable result and any resulting damages or license revenue, given the vacated prior award and remand.
- Whether Leidos was paid the $7,989 royalty payable after quarter-end and whether further royalty, revenue-share or litigation-reimbursement obligations arise.
- Cash burn and legal spending relative to management’s liquidity assessment, including whether additional capital is raised and on what terms.
- Whether licensing revenue broadens beyond the deferred settlement stream, and whether Gabriel products achieve commercial adoption.
- The effect of stock-based compensation, outstanding options and warrants on future expenses and shareholder dilution.