VirnetX Holding Corporation — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; balance-sheet comparisons are with December 31, 2013. Unless noted otherwise, amounts are in thousands of dollars.
Business context
VirnetX develops secure communications technology and derives revenue primarily from patent licensing. It was beta testing its GABRIEL Connection Technology and Secure Domain Name Initiative products. The company reported more than 80 U.S. and foreign patents in its business description and said it expects licensing fees and royalties to provide most future revenue.
Financial performance and liquidity
| Metric | Q1 2014 | Q1 2013 / comparison |
|---|---|---|
| Revenue | $250 | $293 |
| Operating expenses | $7,203 | $9,822 |
| Operating loss | $(6,953) | $(9,529) |
| Gain on derivative liability | $838 | $1,606 |
| Net loss | $(6,087); $(0.12) per share | $(7,891); $(0.15) per share |
| Cash used in operating activities | $(8,103) | $(7,493) |
Revenue declined about 15%. General, selling and administrative expense fell $2,662, primarily because legal fees declined $3,082; research and development expense rose $43. The smaller net loss reflects lower operating expenses, partly offset by a smaller non-cash warrant revaluation gain. Revenue in 2014 came from recognition of prepaid fees; 2013 revenue included royalties related to past sales under settlements.
At March 31, cash and cash equivalents were $13,456 and available-for-sale investments were $17,486, totaling $30,942, versus $38,988 at year-end. Working capital was $26,174, down from $33,971. Total assets were $35,370 and total liabilities $5,549; no interest-bearing debt is presented in the balance sheet. Operating cash outflow exceeded net loss, including a $3,600 increase in non-current prepaid expenses. Management said cash and short-term investments should fund operations, working capital and legal expenses for the foreseeable future.
Material developments, outlook and risks
- Apple litigation: A court awarded an ongoing royalty of 0.98% on specified adjudicated products and qualifying products with FaceTime or VPN on Demand features. Apple appealed; the earlier jury damages award and royalties have not been recognized in the financial statements, and collection is uncertain. VirnetX says it would owe Leidos 25% of proceeds from that lawsuit after attorneys’ fees and costs.
- Cisco litigation: The jury found non-infringement; the court denied VirnetX’s motions for a new trial and judgment as a matter of law on March 28, 2014. The company said it was reviewing its options.
- Other cases: Patent actions against Microsoft and Apple remained pending, with hearings and trials scheduled in 2014 and 2015. Outcomes, timing and any proceeds are uncertain.
- Business and financial risks: Revenue remains minimal and dependent on licensing activity and litigation outcomes. Patent disputes are costly and unpredictable; licensing success, patent validity and enforceability, FRAND terms, product adoption and the development of a customer base are uncertain. The company also identified potential stock-price volatility and non-cash earnings effects from revaluing its Series I warrant liability.
- Guidance: No numerical revenue or earnings guidance was provided. Management described the quarter’s results as not necessarily indicative of full-year results.
Important facts for investors to verify
- Current status and appeal outcomes for the Apple verdict and ongoing royalty award, including timing and likelihood of any collection.
- Cash burn, legal spending and the assumptions behind management’s “foreseeable future” liquidity assessment.
- How much of the $10,000 five-year license contract has been collected, and the timing and terms of future payments; $2,500 had been received by March 31, 2014.
- The nature and accounting of the $3,750 non-cancellable lease obligation included in prepaid expenses.
- Future licensing revenue, customer concentration, and the impact of patent challenges or FRAND commitments.