VirnetX Holding Corporation — FY2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The filing also provides quarterly results; “2017 Q4” is not the reporting period of this annual report. Amounts below are in U.S. dollars; financial statement figures are generally in thousands unless noted.
Business context and reporting period
VirnetX develops and licenses patented technology for securing real-time Internet communications, including its GABRIEL products and secure-domain-name technology. Its business is centered on patent licensing; management expects license fees and royalties to provide most future revenue. The company reported approximately 185 patents and pending applications. GABRIEL had been installed by more than 80 small and medium-sized businesses, but the filing says the product was not yet generating revenue.
Financial performance and liquidity
| Metric | FY2017 | FY2016 |
|---|---|---|
| Revenue | $1.547 million | $1.550 million |
| Operating expenses | $18.868 million | $30.055 million |
| Operating loss | $17.321 million | $28.505 million |
| Net loss | $17.278 million | $28.569 million |
| Loss per share | $0.30 | $0.51 |
| Cash used in operations | $14.944 million | $21.922 million |
| Cash and cash equivalents | $3.135 million | $6.627 million |
| Available-for-sale investments | $1.453 million | $9.249 million |
| Total liabilities | $5.622 million | $7.724 million |
| Stockholders’ equity | $1.553 million | $11.147 million |
- Revenue was largely from a 2013 contract settlement: $1.5 million recognized in FY2017, with $2.5 million of deferred revenue remaining at year-end. The filing attributes another $47,000 to royalties from other licensees.
- SG&A declined to $16.194 million from $26.672 million, primarily because legal fees fell to $3.657 million from $13.002 million. R&D increased to $2.674 million from $2.499 million. No Leidos royalty expense was recorded in 2017, compared with $884,000 in 2016.
- Operating cash outflow remained substantial. Financing provided $3.657 million, mainly from stock sales; investing activities provided $7.795 million, largely from maturities or sales of investments. The company reported no off-balance-sheet arrangements and no debt balance in the presented balance sheet.
- At year-end, current assets were $5.179 million and current liabilities were $4.482 million. Management said available cash and investments, together with subsequent ATM proceeds, should fund current spending for the foreseeable future.
- FY2017 Q4 revenue was $401,000 and net loss was $6.034 million, compared with revenue of $402,000 and net loss of $7.235 million in Q4 2016.
Material changes versus the prior comparable period
- Net loss improved by $11.291 million year over year, principally as lower legal expenses and the absence of Leidos royalty expense more than offset modestly higher R&D costs. Revenue was essentially flat.
- Cash plus investments declined to $4.588 million from $15.876 million, while total assets fell to $7.175 million from $18.871 million. Equity decreased as accumulated losses continued.
- The company sold 730,444 shares through its ATM in 2017 for gross proceeds of $3.790 million. It reported $6.821 million in net proceeds from additional ATM sales after year-end through March 14, 2018; the filing separately reports $7.032 million gross proceeds for those sales.
Outlook, commentary, risks and unusual items
- No specific earnings or revenue guidance is provided. Management plans to pursue licensing, GABRIEL sales through partners and direct marketing, and development of a secure-domain-name registry. It cautions that licensing and product adoption may not succeed.
- VirnetX reported an Apple I final judgment totaling $439.7 million, including damages, interest, costs and attorneys’ fees. Apple appealed; the amount is not presented as FY2017 revenue or cash received. A separate Apple II retrial was scheduled for April 2, 2018 as of the filing, and numerous patent-validity appeals and proceedings remained pending.
- The company said its Japan arrangements with Public Intelligence Technology Associates had produced no meaningful results and were terminated in March 2018. It warned PITA may dispute termination and that alternative expansion strategies may fail.
- Key risks include litigation costs and uncertain outcomes, patent challenges and potential expirations from 2019 to 2024, reliance on a small number of licensing sources, continuing operating losses, potential dilution or difficulty raising capital, and lengthy or unpredictable sales cycles.
- Related-party aircraft lease costs were approximately $1.240 million in 2017; the company’s CEO and Chief Administrative Officer control the lessor. The Tax Cuts and Jobs Act reduced the federal corporate rate to 21%; the company maintained a full valuation allowance on deferred tax assets.
- VirnetX disclosed adoption of the new revenue standard in 2018. The filing gives conflicting directions for the expected approximately $2.5 million accumulated-deficit adjustment, while consistently describing a $2.5 million reduction in deferred revenue; the direction is unclear in the filing text.
- The auditor issued an unqualified opinion on the financial statements and internal controls; management and the auditor reported effective internal control over financial reporting at December 31, 2017.
Important facts for investors to verify
- Whether the Apple I judgment survives appeal, and the eventual outcome and timing of Apple II and the patent-validity proceedings.
- How much of the reported post-year-end ATM proceeds was net of fees, remaining ATM capacity, and the resulting dilution.
- The sustainability and composition of licensing revenue, especially the run-off of the 2013 settlement and the company’s ability to secure new licensees.
- The company’s cash runway against continuing operating cash outflows and any further need for external financing.
- The final accounting transition adjustment under the new revenue standard, given the inconsistent accumulated-deficit description in the filing.