VirnetX Holding Corporation — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Financial amounts below are in millions of dollars unless otherwise noted. VirnetX primarily commercializes and licenses its patent portfolio and secure-communications products. The reported nine-month results were dominated by a one-time Apple judgment payment, rather than recurring product or licensing activity.
Financial results and liquidity
| Metric | Three months ended September 30, 2020 | Nine months ended September 30, 2020 | Prior-year comparable period |
|---|---|---|---|
| Revenue | $0.026 | $302.620 | $0.004 and $0.050, respectively |
| Operating expenses | $5.361 | $135.247 | $4.980 and $15.212, respectively |
| Operating income (loss) | $(5.335) | $167.373 | $(4.976) and $(15.162), respectively |
| Net income (loss) | $(4.025) | $287.880 | $(4.956) and $(14.694), respectively |
| Basic / diluted EPS | $(0.06) / $(0.06) | $4.07 / $4.02 | $(0.07) / $(0.07) and $(0.22) / $(0.22), respectively |
- One-time Apple proceeds: VirnetX collected $454.034 in March 2020 on the Apple I judgment. The company classified $302.428 as royalty revenue, $41.271 as a willful-infringement gain, $108.221 as interest income, and $2.114 as reimbursement of litigation costs. It also recorded $90.101 of licensing costs associated with the proceeds.
- Margins and recurring performance: The nine-month operating and net income figures are not representative of recurring operations because of the judgment recovery. Q3 revenue remained minimal and the company reported an operating loss. No meaningful recurring-product margin is provided.
- Cash flow: Nine-month operating cash flow was $308.120, investing cash outflow was $19.681, and financing cash outflow was $65.663. Financing included the $70.841 one-time dividend. Cash and cash equivalents increased by $222.776 to $225.911.
- Liquidity and balance sheet: At September 30, cash and cash equivalents were $225.911 and available-for-sale investments were $22.077; working capital was $220.603. Current liabilities were $27.787, including $17.414 of income taxes payable and $9.438 of accrued licensing costs. The balance sheet reports no debt line item. Total assets were $258.545.
- Tax: Nine-month income tax expense was $29.036. The effective tax rate was favorably affected by a $37.585 reversal of valuation allowances; deferred tax assets were $8.754 at quarter-end.
- Capital and shares: The company paid a one-time $1-per-share dividend totaling $70.841. Nine-month ATM sales generated $4.627 gross proceeds from 1,049,382 shares; $21.964 of ATM capacity remained. Shares outstanding were 71,058,570 at September 30.
Changes versus the prior comparable period
- Nine-month revenue rose to $302.620 from $0.050, and net income shifted to $287.880 from a $14.694 loss, primarily because of the collected Apple judgment.
- Nine-month operating expenses increased to $135.247 from $15.212, including $90.101 of licensing costs and higher legal expense. SG&A increased $26.021, with legal fees cited as the principal driver.
- Cash and investments rose substantially from year-end 2019, principally reflecting the Apple payment. The company also returned $70.841 to shareholders through the one-time dividend.
- Q3 remained loss-making: the net loss narrowed to $4.025 from $4.956, while revenue was only $0.026 versus $0.004.
Outlook, litigation, and risks
- Management stated that available cash and investments should fund the current level of SG&A, including legal costs, and provide working capital for the foreseeable future. It expects to derive most future revenue from patent licenses and royalties, but provides no quantified revenue or earnings guidance.
- Management expected legal fees to remain at similar or lower levels over the next two quarters and expected operating losses. It cautions that commercialization and new licensing agreements are uncertain and that potential customers may await litigation outcomes.
- Apple II: On October 30, 2020, after quarter-end, a jury returned a $502.8 million verdict for VirnetX, based on $0.84 per accused device and U.S. sales. Judgment-related motions remained pending. This subsequent verdict was not part of September 30 results and remains subject to further proceedings.
- Apple I: The company received $454.034 in March; the district court denied Apple’s motion for relief on September 1, 2020, and the company reported the case closed. The payment could be subject to restitution if that ruling were later disturbed.
- Patent validity challenges and appeals remain significant risks. The filing notes pending appeals of PTAB invalidity findings and that successful challenges could affect patent rights and potential awards. The company’s patents expire at various times from 2020 through 2024.
- Other contingencies include a law firm’s arbitration claim for a contingency fee related to the Apple payment and a shareholder derivative action. The filing gives inconsistent amounts for the law firm claim: approximately $36.3 million in one discussion and $36.2 million in another.
- Other stated risks include litigation costs and uncertain outcomes, limited recurring licensing revenue, customer concentration, COVID-19 effects on sales and business development, cybersecurity and privacy exposure, and volatility in the common stock. Management said disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Investor verification priorities
- Confirm the status and final outcome of the October 2020 Apple II verdict, including post-trial motions, any appeal, and whether any award is ultimately collectible.
- Assess the collectability and potential restitution exposure associated with the Apple I payment, as well as the status and amount of the McKool arbitration claim.
- Separate recurring licensing and product revenue from litigation-related proceeds when evaluating earnings, cash flow, and valuation.
- Monitor accrued licensing costs, income taxes payable, legal spending, and the company’s stated outlook for operating losses.
- Evaluate patent validity proceedings, remaining patent terms, and VirnetX’s ability to secure licenses beyond litigation settlements.
- Verify future dividend policy and potential dilution from ATM issuance, outstanding equity awards, and other share-based compensation.