VirnetX Holding Corporation — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; interim financial statements are unaudited. Amounts are in thousands of dollars except per-share data and where otherwise noted.
Business context
VirnetX commercializes a portfolio of communications-security patents primarily through licensing and litigation, while developing its GABRIEL secure communications products. The company reported approximately 46 U.S. and 69 foreign patents and approximately 75 pending applications. It described more than 80 small and medium businesses as having installed GABRIEL products.
Financial performance and liquidity
| Metric | Q1 2016 | Q1 2015 / comparison |
|---|---|---|
| Revenue | $375 | $375 |
| Research and development | $450 | $392 |
| Selling, general and administrative | $8,543 | $5,742 |
| Operating loss | $(8,618) | $(5,759) |
| Net loss | $(8,610) | $(5,855) |
| Basic and diluted loss per share | $(0.16) | $(0.11) |
| Operating cash used | $(7,634) | $(6,964) |
Revenue consisted of fees recognized over the term of a 2013 license settlement; no revenue was reported from the new Apple verdict. Gross profit and gross margin are not separately presented. Operating loss was approximately 23 times revenue (an operating margin of about negative 2,298%, calculated from reported figures).
At March 31, cash and cash equivalents were $9.269 million and available-for-sale investments were $8.599 million, totaling $17.868 million. Working capital was $12.961 million, down from $13.788 million at December 31, 2015. Total assets were $21.494 million and total liabilities were approximately $6.951 million. No interest-bearing debt is identified in the balance sheet presented.
Investing activities provided $1.362 million; financing activities provided $6.815 million, including $6.795 million gross proceeds from ATM share sales. Cash increased $543,000 during the quarter. Shares outstanding were 54.890 million at quarter-end and 55.664 million on May 4, 2016. Subsequent to quarter-end, the company sold another 773,713 ATM shares for $3.772 million gross proceeds, less $113,000 of fees and costs.
Material changes versus prior year
- Net loss increased by $2.755 million, while revenue was unchanged.
- SG&A rose $2.801 million; management attributed this primarily to a $2.960 million increase in legal fees related to patent infringement actions. R&D increased $58,000.
- Operating cash use increased $670,000. The company cited legal costs and the period’s loss as principal factors in the decline in cash and investments from year-end.
- The 2015 period included a $117,000 noncash loss from revaluation of Series I warrant liabilities; no comparable 2016 charge occurred because the warrants had been settled or expired.
Outlook, litigation, risks and unusual items
- Management said cash, short-term investments and ATM proceeds were expected to fund the current level of SG&A, including legal costs, and working capital for the foreseeable future. It expects longer-term revenue primarily from patent licensing and royalties; the filing provides no quantified revenue or earnings guidance.
- On February 4, 2016, a jury awarded VirnetX $625.6 million against Apple for alleged infringement of four patents and found infringement willful. The award remained subject to post-trial motions and mediation scheduled for May 2016. The filing does not establish that the award would be upheld, collected, or recognized as revenue.
- Revenue remains concentrated and dependent on licensing arrangements, litigation outcomes, and the timing of royalty or license payments. Management noted that the company currently derives minimal revenue from licensing activities and warned that litigation can consume significant resources.
- Deferred revenue related to the August 2013 settlement was $2.625 million at quarter-end. The company had collected $7.5 million of a $10 million contract total and stated that the remaining $2.5 million would not be recognized until collected.
- The company recorded a $7,000 income tax expense and maintained a valuation allowance of approximately $33 million against deferred tax assets, citing uncertainty about their realization. Federal and state NOL carryforwards were approximately $59 million and $37 million, respectively.
- Related-party aircraft rental fees and reimbursements were approximately $132,000, versus $82,000 in Q1 2015; the CEO and Chief Administrative Officer control the lessor.
- Key risks include patent validity and enforcement, adverse litigation or inter partes review outcomes, limited licensing and product adoption, competition, security or product failures, and stock-price volatility. The company reported effective disclosure controls and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Subsequent court rulings, appeals, mediation, and collectability related to the $625.6 million Apple jury verdict; do not treat the verdict as cash or recognized revenue.
- Cash burn and legal spending relative to the $17.868 million of cash and investments, including whether ATM fundraising continues and its dilution effects.
- Progress in converting the patent portfolio, GABRIEL products, and the reported installed base into recurring, diversified revenue.
- Timing and collection of the remaining $2.5 million under the 2013 settlement and the company’s revenue concentration.
- Patent challenges, potential royalty obligations to Leidos, and related-party aircraft costs and governance oversight.