VirnetX Holding Corporation — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; comparative period is Q1 2019. Amounts below are in U.S. dollars; financial statement amounts are in thousands unless stated otherwise. VirnetX commercializes and licenses patents and secure-communications technology. The quarter’s results were dominated by a one-time Apple litigation payment, not recurring product or licensing growth.
Financial performance and liquidity
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Revenue | $302.576 million | $8,000 |
| Operating expenses | $119.382 million | $5.642 million |
| Operating income (loss) | $183.194 million | $(5.634) million |
| Net income (loss) | $299.945 million | $(5.608) million |
| Basic / diluted EPS | $4.26 / $4.20 | $(0.08) / $(0.08) |
| Net cash from operating activities | $426.360 million | $(4.819) million |
- Q1 2020 operating and net margins were approximately 60.5% and 99.1%, respectively; results include unusual litigation-related items.
- The $454.034 million Apple payment was allocated to $302.428 million of royalty revenue, $41.271 million of willful-infringement damages, $108.221 million of interest income, and $2.114 million of reimbursed litigation costs.
- Licensing costs of $90.101 million were accrued in connection with the Apple proceeds. SG&A was $27.376 million, including increased legal costs; R&D was $1.905 million.
- Cash and cash equivalents were $435.812 million and short-term available-for-sale investments were $1.336 million at March 31, versus $3.135 million and $2.394 million, respectively, at year-end. Working capital was $301.303 million.
- Current liabilities were $136.478 million, including $90.101 million of accrued licensing costs and $41.481 million of income taxes. No borrowings are reported on the balance sheet.
Changes versus prior period
Revenue increased from $8,000 and the Company moved from a $5.608 million net loss to $299.945 million of net income, primarily because it collected the Apple judgment. Operating cash flow rose from a $4.819 million use to $426.360 million provided. SG&A increased by $22.670 million, primarily reflecting patent-litigation legal fees, partly offset by Apple’s reimbursement of litigation costs. The effective tax rate was 9.9%, aided by a $38.112 million reversal of deferred-tax valuation allowances.
Outlook, litigation, and risks
- Management said cash and short-term investments at quarter-end should 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 and technology licenses and royalties; the filing provides no numerical guidance.
- Apple is seeking relief from the Apple I judgment and has indicated it may seek restitution if successful; the court had not ruled. Apple II damages were remanded, and the district court ordered a new damages trial scheduled for August 17, 2020. Patent challenges and litigation outcomes could affect recoveries.
- McKool Smith claims an $36.3 million contingency fee (8% of the Apple payment) in arbitration; VirnetX denies the claim and says it will contest it. The outcome and any resulting payment are uncertain.
- VirnetX’s business and earnings remain exposed to costly, unpredictable patent litigation, possible patent invalidation, dependence on a limited number of licensees, and the difficulty of converting its GABRIEL products and patent portfolio into recurring revenue. Some patents expire during 2020–2024.
- The Company cited potential COVID-19 effects on customer budgets, sales cycles, partnerships, travel, and operations; it said the financial impact could not then be estimated. Employees were working remotely, and management reported no material effect on internal controls to date.
- After quarter-end, the Board approved a special cash dividend of $1.00 per share, payable on or about May 26, 2020, to holders of record May 18. The filing also reports amended bylaws adopted May 7, including exclusive-forum provisions.
Important facts for investors to verify
- Whether Apple I’s judgment remains intact or any restitution is ordered, and the potential status and damages outcome of the Apple II retrial.
- The ultimate amount and timing of Leidos-related licensing costs accrued against the Apple proceeds, and the resolution of McKool Smith’s $36.3 million fee claim.
- Whether the reported cash balance and planned dividend leave adequate resources for ongoing litigation and commercialization, and whether the dividend was paid as announced.
- Evidence of sustainable, recurring license or product revenue apart from litigation proceeds, including customer adoption and the effects of patent challenges and patent expirations.
- The realization of deferred tax assets and the effect of future tax examinations or changes in taxable income.