VirnetX Holding Corporation — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012. Financial statement amounts below are in thousands of dollars, except per-share data. VirnetX develops secure Internet communications technology and relies primarily on patent licensing; its GABRIEL Connection Technology was in beta testing.
Financial results and position
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Royalty revenue | $36 | $1 | $36 | $17 |
| Operating expenses | $11,770 | $3,755 | $18,993 | $6,524 |
| Operating loss | $(11,734) | $(3,754) | $(18,957) | $(6,507) |
| Derivative-liability loss | $(2,248) | $(7,059) | $(1,979) | $(12,189) |
| Net loss | $(10,264) | $(9,805) | $(14,971) | $(16,928) |
| Loss per share, basic and diluted | $(0.20) | $(0.20) | $(0.29) | $(0.34) |
- Q2 general, selling and administrative expense was $11,496, up $7,976 year over year; management attributed the increase mainly to $7,719 of additional legal fees, along with higher employee costs. Six-month legal fees increased $11,893 year over year.
- Income tax benefits were $3,590 in Q2 and $5,763 for the first half, versus $940 and $1,640, respectively, in 2011.
- Cash and cash equivalents were $37,949 and available-for-sale investments were $25,803 at June 30, totaling $63,752. Working capital was $58,417. Total assets were $69,533; current liabilities were $10,952, including a $5,263 warrant derivative liability. No debt is reported on the balance sheet.
- First-half operating cash use was $1,447, compared with $13,912 in 2011. Investing activities used $11,417, mainly reflecting net investment purchases; financing provided $1,331. Cash declined by $11,533 in the period.
- Stockholders’ equity was $58,581, down from $68,277 at December 31, 2011. The company had 51,010,827 common shares outstanding at June 30 and 51,096,240 at August 3, 2012.
Changes, outlook, and risks
- Revenue remained nominal relative to expenses. Management said licensing revenue, excluding settlement provisions for prior periods, was expected to remain nominal in the immediate future.
- Six-month net loss narrowed year over year, primarily alongside a substantially smaller non-cash warrant revaluation loss. Operating loss, however, widened as legal and other operating costs rose. Q2 net loss increased slightly year over year.
- Management expected legal fees to stay at the same or higher levels over the next two quarters as trials approached, with legal expenses expected to decrease materially after the current court schedule. It forecast operating losses as a result. No numerical revenue or earnings guidance was provided.
- Management stated cash and short-term investments should fund operations, working capital, and legal expenses for at least 48 months. This depends on spending, litigation, and licensing outcomes.
- VirnetX reported three patent-infringement lawsuits and an ITC complaint against Apple. It cautioned that litigation outcomes are uncertain and costly. After quarter-end, it reported license agreements with Mitel and NEC, each providing for an undisclosed one-time payment and ongoing royalties; the amounts and full terms were not disclosed. The Aastra agreement was entered into in May 2012, with financial terms undisclosed.
- The Series I warrant liability is measured using significant unobservable inputs and creates potentially material non-cash earnings volatility. The company estimated that, all else equal, a $1 increase or decrease in its share price would change the liability by approximately $200.
- Other stated risks include limited licensing revenue, patent challenges, dependence on litigation and a concentrated customer base, product-development and market-adoption uncertainty, and potential dilution from options. Management reported disclosure controls were effective at June 30, 2012; the filing also describes a prior material weakness and restatement related to warrant accounting.
Important facts for investors to verify
- Whether the Aastra, Mitel, and NEC licenses produce material initial payments and recurring royalties, and when those amounts are recognized.
- Progress and outcomes in the remaining patent litigation and the Apple ITC matter, including related legal costs and any effects on licensing discussions.
- Whether operating and legal spending remains consistent with management’s stated 48-month liquidity estimate.
- The assumptions and valuation sensitivity for the Series I warrant liability, and the potential dilution from outstanding options and other awards.
- The realizability of deferred tax assets and the status of tax loss carryforwards and uncertain tax positions.