VirnetX Holding Corporation — FY2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013. The filing also reports unaudited fourth-quarter results. Unless otherwise noted, financial figures below are in millions of dollars.
Business context
VirnetX develops and licenses patented technology for secure Internet communications, including its GABRIEL Connection Technology and planned secure domain name registry. Its business is centered on patent licensing and royalties; the company was beta testing GABRIEL and pursuing licensing relationships. It reported more than 80 U.S. and international patents and over 100 pending applications, with issued patents generally expiring from 2019 to 2024.
Financial performance and liquidity
| Metric | FY2013 | FY2012 |
|---|---|---|
| Revenue | $2.197 | $0.412 |
| Operating expenses | $30.784 | $39.273 |
| Operating loss | $28.587 | $38.861 |
| Net loss | $27.608 | $26.924 |
| Loss per share | $0.54 | $0.53 |
| Cash used in operating activities | $7.284 | $19.593 |
Revenue rose substantially from a low base, but remained small relative to expenses; operating and net margins remained deeply negative. FY2013 revenue included $1.5 million attributed to historical royalties and $697,000 from post-settlement royalties and other licensees. One 2013 agreement provides for minimum annual payments of $2.5 million over its contract period, totaling $10 million; amounts and timing recognized depend on the agreement and revenue-recognition criteria.
General, selling and administrative expense fell to $29.002 million from $37.718 million, mainly due to lower legal fees. Legal fees were $16.363 million, versus $26.537 million in 2012. Research and development expense increased to $1.782 million from $1.555 million. A noncash $1.608 million gain from revaluing Series I warrants partly offset the operating loss; 2012 had a $927,000 noncash loss.
At year-end, cash and cash equivalents were $19.173 million and available-for-sale investments were $19.815 million, totaling $38.988 million, down from $46.154 million a year earlier. Current liabilities were $5.374 million; total assets were $39.398 million. The balance sheet showed no borrowings or long-term debt. Management said cash was sufficient for short-term capital needs, while expecting continued legal and other costs. There were no off-balance-sheet arrangements.
Fourth-quarter 2013 revenue was $286,000, operating loss was $7.347 million, and net loss was $7.554 million, compared with Q4 2012 revenue of $8,000 and net loss of $7.234 million.
Changes, outlook, risks and unusual items
- FY2013 revenue increased from $412,000 in 2012, largely reflecting patent settlements and licensing, while net loss widened modestly. Operating loss narrowed as legal costs declined.
- Management did not provide numerical earnings or revenue guidance. It expected near-term results not to resemble the 2010 profit, which was largely attributable to a $200 million Microsoft settlement. It anticipates future revenue primarily from licenses and royalties, but cautioned that success is uncertain.
- The company’s prior Apple jury verdict exceeded $368 million, but Apple appealed. VirnetX had not recognized the verdict, related royalties, or proceeds in its financial statements; outcome and collection were uncertain. VirnetX also owed Leidos 25% of certain Apple litigation proceeds after specified legal costs. In a separate Cisco trial, the jury found non-infringement, while finding the patents at issue not invalid; post-trial motions remained pending.
- Four patent-infringement lawsuits were pending at year-end, including matters involving Apple, Cisco and Microsoft. Litigation could continue for years, consume significant resources, and produce adverse outcomes. VirnetX also stated that it had generated net income in only one annual reporting period since becoming public.
- Other key risks include dependence on a small number of licensees and litigation-related receipts, challenges to patent validity or enforcement, uncertain adoption of its products and registry, competition, long sales cycles, and changing regulation. The company also flagged potential security, product, and third-party infrastructure failures.
- A $4.0 million non-cancelable promotional and marketing commitment was disclosed; $250,000 had been prepaid and the remaining amount was expected to be due when the facility became available, anticipated in 2014. The filing lists total contractual obligations of $3.852 million, including $3.750 million due in 2014 and lease commitments.
- The auditor issued unqualified opinions on the financial statements and internal controls as of December 31, 2013. The company reported effective disclosure controls and financial reporting controls; it also disclosed a prior restatement related to warrant accounting.
Important facts for investors to verify
- Current status and collectability of the Apple appeal, ongoing-royalty proceedings, Cisco post-trial motions, and other patent cases; confirm that litigation awards remain unrecognized unless recognition criteria are met.
- Cash burn, investment maturities, and funding runway relative to continuing legal expenses and the $3.75 million contractual payment expected in 2014.
- Whether the $10 million minimum-payment license agreement is collected as scheduled and how future payments are recognized; assess customer concentration and royalty reporting.
- Commercial progress of GABRIEL, the secure domain name registry, and FRAND licensing efforts, including any required ICANN accreditation and actual customer adoption.
- Potential dilution from equity awards and the accounting volatility of the Series I warrant liability; outstanding options and restricted stock units totaled about 5.23 million at year-end.