UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
| ☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2017March 31, 2021
or
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number:File Number: 001-33852
VirnetX Holding Corporation
(Exact name of registrant as specified in its charter)
| Delaware | 77-0390628 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification |
| 308 Dorla Court, Suite 206 Zephyr Cove, Nevada | 89448 | |
| (Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: (775) 548-1785
Former name, former address and former fiscal year, if changed since last report: N/A
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
| Common Stock, par value $0.0001 per share | VHC | NYSE |
Indicate by check mark whether the Registrant:registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically, and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth companycompany” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐ | Accelerated filer | |||
Smaller reporting company | Non-accelerated filer ☒ | |||
Emerging growth company ☐ | ||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrantRegistrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.Act). Yes ☐ No ☒
May 7, 2021.
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
We have included or incorporated by reference in this Quarterly Report on Form 10-Q (including in the section entitled Management’s Discussion and Analysis of Financial Condition and Results of Operations), and from time to time we may make statements that may constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are based upon our current expectations, estimates, assumptions, and beliefs concerning future events and conditions and may discuss, among other things, anticipated future performance (including sales and earnings), expected growth, future business plans and costs and the impact of potential and ongoing litigation. Any statement that is not historical in nature is a forward-looking statement and may be identified by the use of words and phrases such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “projects,” “will be,” “will continue,” “will likely result in,” and similar expressions. These statements include our beliefs and statements regarding general industry and market conditions and growth rates, as well as general domestic and international economic conditions. Readers are cautioned not to place undue reliance on forward-looking statements. Forward-looking statements are necessarily subject to risks, uncertainties, and other factors, many of which are outside our control, which could cause actual results to differ materially from such statements and from our historical results and experience. These risks, uncertainties and other factors include, but are not limited to those described in Item 1A - Risk Factors of this Quarterly Report and elsewhere in this Quarterly Report and those described from time to time in our future reports filed with the Securities and Exchange Commission. Readers are cautioned that it is not possible to predict or identify all the risks, uncertainties and other factors that may affect future results and that the risks described herein should not be considered a complete list. Any forward-looking statement speaks only as of the date on which such statement is made, and we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.
Among others, the forward-looking statements appearing in this Quarterly Report that may not occur include statements that:
In the VirnetX Inc. v. Apple, Inc. (Case Nos. 6:11-cv-00563-RWS, 6:12-cv-00855-RWS) (“Apple II”) litigation, the United States Court of Appeals for the Federal Circuit (the “Federal Circuit”) in November 2019, affirmed-in-part and reversed-in-part the judgment issued by the United States District Court for the Eastern District of Texas (the “district court”) in the case awarding VirnetX damages of $595.9 million. On October 30, 2020, after a trial in the district court, a jury returned a verdict in favor of VirnetX, awarding VirnetX with over $502 million in damages. On January 15, 2021, the district court denied Apple’s motion for judgment as a matter of law and affirmed the jury findings. This may imply that VirnetX may soon receive over $500 million in cash, however, on February 4, 2021, Apple has filed a notice of appeal to the Federal Circuit with regards to this judgement from the district court. In addition, the patents in this case are being challenged in the United States Patent and Trademark Office. If those challenges are successful, the award in the case may be reduced, eliminated and/or delayed for a lengthy period. The continuation of this litigation is distracting to our management, expensive, and these distractions and expenses may continue.
We have undertaken activities to commercialize our products and patent portfolio in and outside the United States. These statements may imply that the worldwide market for our commercialized products is large and will result in significant future revenues for us. However, commercialization of products such as ours are subject to significant obstacles and risks, including but not limited to a perception by some potential partners and customers that they should await the outcome of the Apple II litigation before entering or considering to enter any agreement with us, and that or other factors may lead us to be unsuccessful in obtaining further licensing agreements or making arrangements or entering contracts which create significant future revenues for us.
EXCEPT AS REQUIRED BY LAW, WE UNDERTAKE NO OBLIGATION TO UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENT AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE.
VIRNETX HOLDING CORPORATION
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(in thousands, except share amounts)
As of September 30, 2017 | As of December 31, 2016 | As of March 31, 2021 | As of December 31, 2020 | |||||||||||||
| ASSETS | (unaudited) | (unaudited) | ||||||||||||||
| Current assets: | ||||||||||||||||
| Cash and cash equivalents | $ | 1,647 | $ | 6,627 | $ | 197,198 | $ | 192,908 | ||||||||
| Investments available for sale | 2,665 | 9,249 | 19,835 | 28,348 | ||||||||||||
| Accounts receivables | 6 | 8 | ||||||||||||||
| Prepaid income tax | 2,903 | 2,905 | ||||||||||||||
| Prepaid expenses and other current assets | 692 | 588 | 586 | 263 | ||||||||||||
| Total current assets | 5,004 | 16,464 | 220,528 | 224,432 | ||||||||||||
| Prepaid expenses, non-current | 2,086 | 2,374 | ||||||||||||||
| Prepaid expenses and other assets | 1,213 | 1,301 | ||||||||||||||
| Property and equipment, net | 12 | 33 | 10 | 11 | ||||||||||||
| Deferred tax assets | 16,245 | 9,049 | ||||||||||||||
| Total assets | $ | 7,102 | $ | 18,871 | $ | 237,996 | $ | 234,793 | ||||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||||||||
| Current liabilities: | ||||||||||||||||
| Accounts payable and accrued liabilities | $ | 802 | $ | 1,806 | $ | 532 | $ | 654 | ||||||||
| Accrued payroll and related expenses | 210 | 1,522 | 274 | 220 | ||||||||||||
| Income tax liability | 394 | 396 | ||||||||||||||
| Other current liabilities | 140 | — | ||||||||||||||
| Deferred revenue, current portion | 1,500 | 1,500 | ||||||||||||||
| Accrued licensing costs | 0 | 9,438 | ||||||||||||||
| Accrued legal expenses (Note 7) | 38,284 | 0 | ||||||||||||||
| Other liabilities, current | 31 | 44 | ||||||||||||||
| Total current liabilities | 3,046 | 5,224 | 39,121 | 10,356 | ||||||||||||
| Deferred revenue, non-current portion | 1,375 | 2,500 | ||||||||||||||
| Total liabilities | 4,421 | 7,724 | ||||||||||||||
| Commitments and contingencies (Note 4) | — | — | 0 | 0 | ||||||||||||
| Stockholders’ equity: | ||||||||||||||||
| Preferred stock, par value $0.0001 per share Authorized: 10,000,000 shares at September 30, 2017 and December 31, 2016, Issued and outstanding: 0 shares at September 30, 2017 and December 31, 2016 | — | — | ||||||||||||||
| Common stock, par value $0.0001 per share | ||||||||||||||||
| Authorized: 100,000,000 shares at September 30, 2017 and December 31, 2016, Issued and outstanding: 58,309,034 shares and 58,144,888 shares, at September 30, 2017 and December 31, 2016, respectively | 6 | 6 | ||||||||||||||
Preferred stock, par value $0.0001 per share Authorized: 10,000,000 shares at March 31, 2021 and December 31, 2020, Issued and outstanding: 0 shares at March 31, 2021 and December 31, 2020 | 0 | 0 | ||||||||||||||
Common stock, par value $0.0001 per share Authorized: 100,000,000 shares at March 31, 2021 and December 31, 2020, Issued and outstanding: 71,058,570 shares and 71,058,570 shares, at March 31, 2021 and December 31, 2020, respectively | 7 | 7 | ||||||||||||||
| Additional paid-in capital | 172,171 | 169,391 | 233,336 | 232,457 | ||||||||||||
| Accumulated deficit | (169,482 | ) | (158,238 | ) | (34,457 | ) | (8,014 | ) | ||||||||
| Accumulated other comprehensive loss | (14 | ) | (12 | ) | (11 | ) | (13 | ) | ||||||||
| Total stockholders’ equity | 2,681 | 11,147 | 198,875 | 224,437 | ||||||||||||
| Total liabilities and stockholders’ equity | $ | 7,102 | $ | 18,871 | $ | 237,996 | $ | 234,793 | ||||||||
See accompanying notes to condensed consolidated financial statements.
VIRNETX HOLDING CORPORATION
(in thousands, except per share amounts)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, 2017 | September 30, 2016 | September 30, 2017 | September 30, 2016 | |||||||||||||
| Revenue | $ | 375 | $ | 375 | $ | 1,146 | $ | 1,148 | ||||||||
| Operating expense: | ||||||||||||||||
| Royalty expense | — | 884 | — | 884 | ||||||||||||
| Research and development | 481 | 460 | 1,473 | 1,391 | ||||||||||||
| Selling, general and administrative expenses | 3,456 | 6,318 | 10,953 | 20,132 | ||||||||||||
| Total operating expense | 3,937 | 7,662 | 12,426 | 22,407 | ||||||||||||
| Loss from operations | (3,562 | ) | (7,287 | ) | (11,280 | ) | (21,259 | ) | ||||||||
| Interest and other income, net | 9 | 19 | 40 | 50 | ||||||||||||
| Loss before taxes | (3,553 | ) | (7,268 | ) | (11,240 | ) | (21,209 | ) | ||||||||
| Income tax benefit (expense) | 1 | (119 | ) | (4 | ) | (126 | ) | |||||||||
| Net loss | $ | (3,552 | ) | $ | (7,387 | ) | $ | (11,244 | ) | $ | (21,335 | ) | ||||
| Basic and diluted loss per share | $ | (0.06 | ) | $ | (0.13 | ) | $ | (0.19 | ) | $ | (0.38 | ) | ||||
| Weighted average shares outstanding basic and diluted | 58,306 | 56,651 | 58,216 | 55,503 | ||||||||||||
| Three Months Ended March 31, | ||||||||
| 2021 | 2020 | |||||||
| Revenue | $ | 5 | $ | 302,576 | ||||
| Operating expense: | ||||||||
| Licensing costs | (9,438 | ) | 90,101 | |||||
| Research and development | 1,152 | 1,905 | ||||||
| Selling, general and administrative | 41,943 | 27,376 | ||||||
| Total operating expense | 33,657 | 119,382 | ||||||
| (Loss) income from operations | (33,652 | ) | 183,194 | |||||
| Gain on settlement | 0 | 41,271 | ||||||
| Interest and other income, net | 16 | 108,239 | ||||||
| (Loss) income before taxes | (33,636 | ) | 332,704 | |||||
| Income tax benefit (expense) | 7,193 | (32,759 | ) | |||||
| Net (Loss) income | $ | (26,443 | ) | $ | 299,945 | |||
| Basic (loss) income per share | $ | (0.37 | ) | $ | 4.26 | |||
| Diluted (loss) income per share | $ | (0.37 | ) | $ | 4.20 | |||
| Weighted average shares outstanding basic | 71,059 | 70,365 | ||||||
| Weighted average shares outstanding diluted | 71,059 | 71,384 | ||||||
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, 2017 | September 30, 2016 | September 30, 2017 | September 30, 2016 | |||||||||||||
| Net loss | $ | (3,552 | ) | $ | (7,387 | ) | $ | (11,244 | ) | $ | (21,335 | ) | ||||
| Other comprehensive gain (loss), net of tax: | ||||||||||||||||
| Change in equity adjustment from foreign currency translation, net of tax | — | — | — | 4 | ||||||||||||
| Change in unrealized gain (loss) on investments, net of tax | 3 | (1 | ) | (2 | ) | 12 | ||||||||||
| 3 | (1 | ) | (2 | ) | 16 | |||||||||||
| Comprehensive loss | $ | (3,549 | ) | $ | (7,388 | ) | $ | (11,246 | ) | $ | (21,319 | ) | ||||
See accompanying notes to condensed consolidated financial statements.
VIRNETX HOLDING CORPORATION
(in thousands)
| Three Months Ended March 31, | ||||||||
| 2021 | 2020 | |||||||
| Net (loss) income | $ | (26,443 | ) | $ | 299,945 | |||
| Other comprehensive income (loss), net of tax: | ||||||||
| Change in unrealized gain, net of tax | 5 | 2 | ||||||
| Change in foreign currency translation, net of tax | (3 | ) | 1 | |||||
| Total other comprehensive income (loss), net of tax | 2 | 3 | ||||||
| Comprehensive (loss) income | $ | (26,441 | ) | $ | 299,948 | |||
See accompanying notes to condensed consolidated financial statements.
VIRNETX HOLDING CORPORATION
(in thousands)
| Three Months Ended March 31, | ||||||||
| 2021 | 2020 | |||||||
| Total shareholders' equity, beginning balances | $ | 224,437 | $ | 5,628 | ||||
| Common stock and additional paid-in capital: | ||||||||
| Beginning balances | 232,464 | 223,244 | ||||||
| Common stock issued for cash, net | 0 | 4,488 | ||||||
| Common stock issued for options/RSUs, net | 0 | 768 | ||||||
| Stock-based compensation | 879 | 778 | ||||||
| Ending balances | 233,343 | 229,278 | ||||||
| Accumulated deficit (retained earnings): | ||||||||
| Beginning balances | (8,014 | ) | (217,602 | ) | ||||
| Net (loss) income | (26,443 | ) | 299,945 | |||||
| Ending balances | (34,457 | ) | 82,343 | |||||
| Accumulated other comprehensive loss: | ||||||||
| Beginning balances | (13 | ) | (14 | ) | ||||
| Change in unrealized investment gain/loss, net | 5 | 2 | ||||||
| Change in foreign currency translation, net | (3 | ) | 1 | |||||
| Ending balances | (11 | ) | (11 | ) | ||||
| Total shareholders' equity, ending balances | $ | 198,875 | $ | 311,610 | ||||
See accompanying notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in thousands)
| Three Months Ended March 31, | ||||||||||||||||
Nine Months Ended September 30, 2017 | Nine Months Ended September 30, 2016 | 2021 | 2020 | |||||||||||||
| Cash flows from operating activities: | ||||||||||||||||
| Net loss | $ | (11,244 | ) | $ | (21,335 | ) | ||||||||||
| Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||||||||||
| Net (loss) income | $ | (26,443 | ) | $ | 299,945 | |||||||||||
| Adjustments to reconcile net (loss) income to cash flows from operating activities: | ||||||||||||||||
| Depreciation | 21 | 22 | 1 | 1 | ||||||||||||
| Deferred tax assets | (7,196 | ) | (8,722 | ) | ||||||||||||
| Amortization of warrant issuance costs | — | 30 | 26 | 0 | ||||||||||||
| Stock-based compensation | 2,780 | 3,979 | 879 | 778 | ||||||||||||
| Changes in assets and liabilities: | ||||||||||||||||
| Accounts receivables | 2 | 0 | ||||||||||||||
| Prepaid expenses and other assets | 184 | 238 | (261 | ) | (281 | ) | ||||||||||
| Accounts payable and accrued liabilities | (1,004 | ) | 549 | |||||||||||||
| Other liabilities | (13 | ) | (153 | ) | ||||||||||||
| Accounts payable | (122 | ) | 3,274 | |||||||||||||
| Accrued licensing costs | (9,438 | ) | 90,101 | |||||||||||||
| Accrued payroll and related expenses | (1,270 | ) | (1,290 | ) | 54 | (64 | ) | |||||||||
| Other current liabilities | 140 | — | ||||||||||||||
| Royalty payable | — | 884 | ||||||||||||||
| Related-party payable | — | 83 | ||||||||||||||
| Income tax liability | (2 | ) | — | |||||||||||||
| Deferred revenue | (1,125 | ) | 1,375 | |||||||||||||
| Net cash used in operating activities | (11,520 | ) | (15,465 | ) | ||||||||||||
| Income tax payable | 2 | 41,481 | ||||||||||||||
| Accrued legal expenses | 38,284 | 0 | ||||||||||||||
| Net cash (used in) provided by operating activities | (4,225 | ) | 426,360 | |||||||||||||
| Cash flows from investing activities: | ||||||||||||||||
| Purchase of property and equipment | — | (14 | ) | |||||||||||||
| Purchase of investments | (756 | ) | (7,888 | ) | (2,476 | ) | (200 | ) | ||||||||
| Proceeds from sale or maturity of investments | 7,338 | 8,615 | 10,991 | 1,261 | ||||||||||||
| Net cash provided by investing activities | 6,582 | 713 | 8,515 | 1,061 | ||||||||||||
| Cash flows from financing activities: | ||||||||||||||||
| Proceeds from exercise of options | — | 20 | 0 | 768 | ||||||||||||
| Proceeds from sale of common stock | — | 14,626 | 0 | 4,488 | ||||||||||||
| Payments of taxes on cashless exercise of restricted stock units | (42 | ) | (93 | ) | ||||||||||||
| Net cash (used in) provided by financing activities | (42 | ) | 14,553 | |||||||||||||
| Net decrease in cash and cash equivalents | (4,980 | ) | (199 | ) | ||||||||||||
| Net cash provided by financing activities | 0 | 5,256 | ||||||||||||||
| Net increase in cash and cash equivalents | 4,290 | 432,677 | ||||||||||||||
| Cash and cash equivalents, beginning of period | 6,627 | 8,726 | 192,908 | 3,135 | ||||||||||||
| Cash and cash equivalents, end of period | $ | 1,647 | $ | 8,527 | $ | 197,198 | $ | 435,812 | ||||||||
| Cash paid for income taxes | $ | — | $ | 126 | ||||||||||||
See accompanying notes to condensed consolidated financial statements.
(in thousands, except litigation, patent, share and per share amounts)
(Unaudited)
Note 1 — Business Description and Basis of Presentation
VirnetX Holding Corporation, which we refer to as “we,” “us,” “our,”as” we”, “us”, “our”, “the Company” or “VirnetX”, is engaged in the business of commercializing a portfolio of patents. We seek to license our technology, including GABRIEL Connection Technology™, to various original equipment manufacturers, or OEMs, that use our technologies in the development and manufacturing of their own products within the IP-telephony, mobility, fixed-mobile convergence, and unified communications markets. Prior to 2012, our revenue was limited to an insignificant amount of software royalties pursuant to the terms of a single license agreement. SinceDuring 2012, 2013 and 2020 we had revenues from settlements of patent infringement disputes whereby we received consideration for past sales of licenseslicensees that utilized our technology, where there was no prior patent license agreement as well as license agreement revenues from settlements providing licensing for the continued use of our technology (see “Revenue Recognition”).
Our portfolio of intellectual property is the foundation of our business model. We currently own approximately 49194 total patents and pending applications, including 70 U.S. and 69 foreign patents with approximately 50 pending patents/patent applications worldwide.and 124 foreign patents/validations/pending applications. Our patent portfolio is primarily focused on securing real-time communications over the Internet, as well as related services such as the establishment and maintenance of a secure domain name registry. Our patented methods also have additional applications in the key areas of device operating systems and network security for Cloud services, Machine-to-Machine (“M2M”)M2M communications in areas including “Smartof Smart City,” “Connected Car” Connected Car and “ConnectedConnected Home.” All The subject matter of all our U.S.U.S and foreign patents and pending patent applications relaterelates generally to securing communications over the Internet and as such covercovers all our technology and other products. OurSome of our issued U.S. and foreign patents expire at various times during the period from 20192021 to 2024. Some of our issued patents and pending patent applications were acquired by our principal operating subsidiary, VirnetX, Inc., from Leidos, Inc. (“Leidos”) (f/k/a Science Applications International Corporation or SAIC) in 2006 and we are required to make payments to Leidos, in certain cases that result in cash or certain other values generated from those patents. The amount of such payments depends upon the type of value generated, and certain categories are subject to maximums and other limitations.2034.
Note 2 — Basis of Presentation and Summary of Significant Accounting Policies
Unaudited Interim Financial Information
The accompanying Condensed Consolidated Balance Sheet as of March 31, 2021, the Condensed Consolidated Statements of Operations for the three months ended March 31, 2021 and 2020, the Condensed Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2021 and 2020, the Condensed Consolidated Statements of Shareholders’ Equity for the three months ended March 31, 2021 and 2020, and the Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2021 and 2020 are unaudited. These unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). In our opinion, the unaudited interim consolidated financial statements include all adjustments of a normal recurring nature necessary for the fair presentation of our financial position as of March 31, 2021, our results of operations for the three months ended March 31, 2021 and 2020, and our cash flows for the three months ended March 31, 2021 and 2020. The results of operations for interim periods are not necessarily indicative of the results to be expected for a full year. These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, filed with the SEC on March 16, 2021.
Use of Estimates
We prepare our consolidated financial statements in accordance with U.S. GAAP. In doing so, we have to make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues, and expenses, as well as related disclosure of contingent assets and liabilities. In some cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss further below. We have reviewed our critical accounting policies and estimates with the audit committee of our board of directors.
Basis of Consolidation
The consolidated financial statements include the accounts of VirnetX Holding Corporation and our wholly-ownedwholly owned subsidiaries. All intercompany balances and transactions have been eliminated.
The accompanyingCompany determines if an arrangement is a lease at inception in accordance with Accounting Standards Codification (“ASC”) Topic 842. Operating lease right-of-use (“ROU”) assets are included in Prepaid expenses, and other assets on the Condensed Consolidated Balance Sheet as of September 30, 2017,Sheets. ROU assets represent the Condensed Consolidated Statements of OperationsCompany’s right to use an underlying asset for the threelease term and nine months ended September 30, 2017lease liabilities represent the Company’s obligation to make lease payments arising from the lease. ROU assets and 2016,lease liabilities are recognized at the Condensed Consolidated Statementscommencement date based on the present value of Comprehensive Losslease payments over the lease term (see Note 8 – Leases).
Revenue Recognition
The Company derives revenue from licensing and royalty fees from contracts with customers which often span several years. We account for the three and nine months ended September 30, 2017 and 2016, and the Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2017 and 2016 are unaudited. These unaudited interim condensed consolidated financial statements have been preparedthis revenue in accordance with generally accepted accounting principlesASC Topic 606, Revenue from Contracts with Customers. A performance obligation is a promise in the United States (“U.S. GAAP”). In our opinion, the unaudited interim condensed consolidated financial statements include all adjustments of a normal recurring nature necessary for the fair presentation of our financial position as of September 30, 2017, our results of operations for the three and nine months ended September 30, 2017 and 2016, and our cash flows for the nine months ended September 30, 2017 and 2016. The results of operations for the three and nine months ended September 30, 2017 are not necessarily indicative of the resultscontract to be expected for the year ending December 31, 2017.
With thelicensing of our patents, performance obligations are generally satisfied at a point in whichtime as work is complete when our licensees’ underlying sales occurred. As a result, it is impractical for uspatent rights are transferred to recognize revenue in the period in which the underlying sales occur, and, in most cases, we will recognize revenue in the period in which the royalty report is received and other revenue recognition criteria are met due to the fact that without royalty reports from our licensees, our visibility into our licensees’ sales is limited.
Certain contracts may require our customers to enter into a hosting arrangement with us and for these arrangements, revenue is generally recognized over the license term. For licenses that provide for fees that are not fixed or determinable, including licenses that provide for extended payment terms and/or payment of a significant portion of the fee after expiration of the license or more than 12 months after delivery, the fees aretime, generally presumed not to be fixed or determinable, and revenue is deferred and recognized as earned, but generally not in advance of collection.
The Company actively monitors and enforces its intellectual property (“IP”) rights, including seeking appropriate compensation from third parties that utilize the Company’s IP without a license. As a result, the Company may, from time to time, receive payments as part of a settlement or compensation for a patent infringement dispute. Proceeds received are allocated to each element identified in the settlement or compensation, based on the fair value of each element. Generally, settlements and compensation may include the following elements: the value of a license or royalty agreement, cost reimbursement, damages and interest. Elements identified related to licensing and royalty are recognized as revenue. Elements identified as reimbursed costs are generally recorded as a reduction to the reported expenses. Elements identified as damages or interest are generally recorded in other income in the condensed consolidated statement of operations.
Licensing Costs
Included in operating expenses licensing are costs we incurred in conjunction with the proceeds received from Apple Inc., pursuant to a favorable court decision relating to a patent infringement case.
Contingent Gains
ASC Topic 450-30-25, Contingent Gains, prohibits recognition of contingent gains until realized. Accordingly, we do not record contingent gains ahead of collection. such realization. Management generally considers any such gains as realized only upon the collection of cash.
Cash and Cash Equivalents
We collectedconsider all highly liquid investments purchased with original maturities of three months or less at the final payment under the contract in 2016. During the nine months ended September 30, 2017 we recognized $1,125date of revenue relatedpurchase to be cash equivalents. Our cash and cash equivalents are not subject to significant interest rate risk due to the August 2013 Contract Settlement.short maturities of these investments.
Investments are classified as available-for-sale and are recorded at fair market value. Unrealized gains and losses are reported as other comprehensive income. Realized gains and losses are recorded in income in the August 2013 Contract Settlement was as follows:period they are realized using specific identification of each security’s cost basis. We invest our excess cash primarily in highly liquid debt instruments including corporate, government and federal agency securities, with contractual maturities less than two years. By policy, we limit the amount of credit exposure to any one issuer.
| Deferred Revenue, December 31, 2016 | $ | 4,000 | ||
| Less: Amount amortized as revenue | 1,125 | |||
| Deferred Revenue, September 30, 2017 | $ | 2,875 |
Property and Equipment
Property and equipment are stated at historical cost, less accumulated depreciation, and amortization. Depreciation and amortization are computed by dividing earnings availableusing the accelerated and straight-line methods over the estimated useful lives of the assets, which range from five to common stockholders by the weighted average number of outstanding common shares during the period. Diluted earnings per shareseven years. Repair and maintenance costs are computed by dividing net income by the weighted average number of shares outstanding during the period increasedcharged to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued.expense as incurred.
Concentration of Credit Risk and Other Risks and Uncertainties
Our cash and cash equivalents are primarily maintained at two2 major financial institutions in the United States. Deposits held with these financial institutions may exceed the amount of insurance provided on such deposits. A portion of those balances are insured by the Federal Deposit Insurance Corporation.Corporation, or FDIC. During the ninethree months ended September 30, 2017March 31, 2021 and 2020, we had, at times, funds whichthat were uninsured. We do not believe that we are subject to any unusual financial risk beyond the normal risk associated with commercial banking relationships with major financial institutions.relationships. We have not experienced any losses on our deposits of cash and cash equivalents.
Fair Value
The carrying amounts of our financial instruments, including cash equivalents, accounts payable, and accrued liabilities, approximate fair value because of their generally short maturities.
Intangible Assets
We record intangible assets at September 30, 2017 includecost, less accumulated amortization. Amortization of intangible assets is provided over their estimated useful lives, which can range from 3 to 15 years, on either a straight-line basis or as revenue is generated by the current portion of prepaid rent for a facility lease for corporate promotional and marketing purposes. From inception, the prepayment totaling $4,000 is being amortized over the 10-year term of the lease. The unamortized non-current portion of the prepayment is included in Prepaid expenses, non-current on the consolidated balance sheet.assets.
Impairment of Long-Lived Assets
We identify and record impairment losses on long-lived assets used in operations when events and changes in circumstances indicate that the carrying amount of an asset might not be recoverable.recoverable, but not less than annually. Recoverability is measured by comparison of the anticipated future net undiscounted cash flows to the related assets’ carrying value. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the projected discounted future net cash flows arising from the asset.
Research and Development
Research and development costs include expenses paid to outside development consultants and compensation related expenses for our engineering staff. Research and development costs are expensed as incurred.
Income Taxes
We account for income taxes using the asset and liability method. The asset and liability method requires the recognition of deferred tax assets and liabilities for expected future tax consequences of temporary differences that currently exist between the tax basis and financial reporting basis of our assets and liabilities. We calculate current and deferred tax provisions based on estimates and assumptions that could differ from actual results reflected on the income tax returns filed during the following years. Adjustments based on filed returns are recorded when identified in the subsequent years. The effect on deferred taxes for a change in tax rates is recognized in income in the period that the tax rate change is enacted. In assessing our deferred tax assets, we consider whether it is more likely than not that all or some portion of the deferred tax assets will not be realized.
A valuation allowance is provided for deferred income tax assets when, in our judgment, based upon currently available information and other factors, it is more likely than not that all or a portion of such deferred income tax assets will not be realized. The determination of the need for a valuation allowance is based on an on-going evaluation of current information including, among other things, historical operating results, estimates of future earnings in different taxing jurisdictions and the expected timing of the reversals of temporary differences. We believe the determination to record a valuation allowance to reduce a deferred income tax asset is a significant accounting estimate because it is based, among other things, on an estimate of future taxable income in the United States and certain other jurisdictions, which is susceptible to change and may or may not occur, and because the impact of adjusting a valuation allowance may be material. In determining when to release the valuation allowance established against our net deferred income tax assets, we consider all available evidence, both positive and negative. We continually assess our ability to generate sufficient taxable income during future periods in which our deferred tax assets may be realized. If and when we believe it is more likely than not that we will recover our deferred tax assets, we will reverse the valuation allowance as an income tax benefit in our statements of operations.
We account for our uncertain tax positions in accordance with U.S. GAAP. The U.S. GAAP method of accounting for uncertain tax positions utilizes a two-step approach to evaluate tax positions. Step one, recognition, requires evaluation of the tax position to determine if based solely on technical merits it is more likely than not to be sustained upon examination. Step two, measurement, is addressed only if a position is more likely than not to be sustained. In step two, the tax benefit is measured as the largest amount of benefit, determined on a cumulative probability basis, which is more likely than not to be realized upon ultimate settlement with tax authorities. If a position does not meet the more likely than not threshold for recognition in step one, no benefit is recorded until the first subsequent period in which the more likely than not standard is met, the issue is resolved with the taxing authority, or the statute of limitations expires. Positions previously recognized are derecognized when we subsequently determine the position no longer is more likely than not to be sustained. Evaluation of tax positions, their technical merits, and measurements using cumulative probability are highly subjective management estimates. Actual results could differ materially from these estimates.
Stock-Based Compensation
We account for stock-based compensation using the fair value recognition method in accordance with U.S. GAAP. We recognize these compensation costs on a straight-line basis over the requisite service period of the award, which is generally the vesting term of 4 years. We do not estimate the forfeiture rate and recognize forfeitures, if any, when they occur. See Note 5 - Stock-Based Compensation below for additional information concerning our share-based compensation awards. In addition, as required we record stock-based compensation expense for awards granted to non-employees at fair value of the consideration received or the fair value of the equity instruments issued as they vest over the performance period.
Earnings per Share
Basic earnings per share are computed by dividing earnings available to common stockholders by the weighted average number of outstanding common shares during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of shares outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. During the three months ended March 31, 2021 we incurred losses; therefore, the effect of any common stock equivalent would be anti-dilutive.
Fair Value of Financial Instruments
Fair value is the price that would result from an orderly transaction between market participants at the measurement date. A fair value hierarchy prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). Level 2 measurements utilize either directly or indirectly observable inputs in markets other than quoted prices in active markets.
Our financial instruments are stated at amounts that equal, or approximate, fair value. When we estimate fair value, we utilize market data or assumptions that we believe market participants would use in pricing the financial instrument, including assumptions about risk and inputs to the valuation technique. We use valuation techniques, primarily the income and market approach, which maximizes the use of observable inputs and minimize the use of unobservable inputs for recurring fair value measurements.
Mutual Funds:funds: Valued at the quoted net asset value of shares held.
U.S. Governmentagency and U.S. Agency Securitiestreasury securities: Fair value measured at the closing price reported on the active market on which the individual securities are traded.
The following tables show the adjusted cost, gross unrealized gains, gross unrealized losses and fair value of our securities by significant investment category as of September 30, 2017,March 31, 2021 and December 31, 2016.2020.
| September 30, 2017 | March 31, 2021 | |||||||||||||||||||||||||||||||||||||||||||||||
Adjusted Cost | Unrealized Gains | Unrealized Losses | Fair Value | Cash and Cash Equivalents | Investments Available for Sale | Adjusted Cost | Unrealized Gains | Unrealized Losses | Fair Value | Cash and Cash Equivalents | Investments Available for Sale | |||||||||||||||||||||||||||||||||||||
| Cash | $ | 1,427 | $ | - | $ | - | $ | 1,427 | $ | 1,427 | $ | - | $ | 83,156 | $ | — | $ | — | $ | 83,156 | $ | 83,156 | $ | — | ||||||||||||||||||||||||
| Level 1: | ||||||||||||||||||||||||||||||||||||||||||||||||
| Mutual funds | 220 | - | - | 220 | 220 | - | 114,042 | 0 | 0 | 114,042 | 114,042 | 0 | ||||||||||||||||||||||||||||||||||||
| U.S. agency securities | 2,667 | - | (2 | ) | 2,665 | - | 2,665 | 12,718 | 4 | 0 | 12,722 | 0 | 12,722 | |||||||||||||||||||||||||||||||||||
| U.S. treasury securities | 7,110 | 3 | 0 | 7,113 | 0 | 7,113 | ||||||||||||||||||||||||||||||||||||||||||
| 2,887 | - | (2 | ) | 2,885 | 220 | 2,665 | 133,870 | 7 | 0 | 133,877 | 114,042 | 19,835 | ||||||||||||||||||||||||||||||||||||
| Total | $ | 4,314 | $ | - | $ | (2 | ) | $ | 4,312 | $ | 1,647 | $ | 2,665 | $ | 217,026 | $ | 7 | $ | — | $ | 217,033 | $ | 197,198 | $ | 19,835 | |||||||||||||||||||||||
| December 31, 2016 | December 31, 2020 | |||||||||||||||||||||||||||||||||||||||||||||||
Adjusted Cost | Unrealized Gains | Unrealized Losses | Fair Value | Cash and Cash Equivalents | Investments Available for Sale | Adjusted Cost | Unrealized Gains | Unrealized Losses | Fair Value | Cash and Cash Equivalents | Investments Available for Sale | |||||||||||||||||||||||||||||||||||||
| Cash | $ | 3,432 | $ | — | $ | — | $ | 3,432 | $ | 3,432 | $ | — | $ | 121,785 | $ | — | $ | — | $ | 121,785 | $ | 121,785 | $ | — | ||||||||||||||||||||||||
| Level 1: | ||||||||||||||||||||||||||||||||||||||||||||||||
| Mutual funds | 3,195 | — | — | 3,195 | 3,195 | — | 70,996 | 0 | 0 | 70,996 | 70,996 | 0 | ||||||||||||||||||||||||||||||||||||
| U.S. government securities | 1,254 | — | — | 1,254 | — | 1,254 | ||||||||||||||||||||||||||||||||||||||||||
| U.S. agency securities | 7,996 | 2 | (3 | ) | 7,995 | — | 7,995 | 13,767 | 2 | 0 | 13,769 | 127 | 13,642 | |||||||||||||||||||||||||||||||||||
| U.S. treasury securities | 14,707 | 0 | (1 | ) | 14,706 | 0 | 14,706 | |||||||||||||||||||||||||||||||||||||||||
| 12,445 | 2 | (3 | ) | 12,444 | 3,195 | 9,249 | 99,470 | 2 | (1 | ) | 99,471 | 71,123 | 28,348 | |||||||||||||||||||||||||||||||||||
| Total | $ | 15,877 | $ | 2 | $ | (3 | ) | $ | 15,876 | $ | 6,627 | $ | 9,249 | $ | 221,255 | $ | 2 | $ | (1 | ) | $ | 221,256 | $ | 192,908 | $ | 28,348 | ||||||||||||||||||||||
New Accounting Pronouncements
In June 2016,December 2019, the FASBFinancial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments-Credit Losses2019-12 Income Taxes (Topic 326) “ASU 2016-13”740). The purposeamendments in this ASU simplify the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. The amendments in this ASU 2016-13 is to require a financial asset measured at amortized cost basis to be presented at the net amount expected to be collected. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses. ASU 2016-13 isare effective for fiscal years, and interim and annual reporting periods within those fiscal years, beginning after December 15, 2019.2020. We are evaluating theadopted this ASU on January 1, 2021 and there was no material impact this guidance will have on our financial position and statement of operations.
11
Note 3 -— Income Taxes
For the three months ended September 30, 2017 and $4 ofMarch 31, 2021, we recognized income tax expense forbenefit of $7,193on a loss before income taxes of $33,636, which is an effective tax rate of 21.38%. The effective tax rate was higher than the nine months ended September 30, 2017.statutory federal income tax rate primarily due to the effect of research and development tax credits. During the three and nine-monththree-month period ended September 30, 2017,March 31, 2021 we had net operating losses (“NOLs”) which generatedincreased our deferred tax assets by $7,196 to $16,245 for NOL carryforwards. We continue to provide a partial allowance against California net operating loss and research credit carryovers due to the fact that we have provided valuation allowances against the net deferred tax assets including the deferred tax assets for NOL carryforwards. Valuation allowances provided for our net deferred tax assets increased by $1,404 and $5,152 for the three and nine months ended September 30, 2017, respectively.no income in California.
A valuation allowance is provided valuation allowances against the netfor deferred tax assets including the deferred tax assets for NOL carry-forwards. Valuation allowances provided forwhen, in our net deferred tax assets increased by $2,707judgment, based upon currently available information and $7,942 for the three and nine months ended September 30, 2016, respectively.
Internal Revenue Code Section 382 places a limitation on the amount of net deferred tax assets was approximately $50,000 and $44,000 at September 30, 2017 and December 31, 2016, respectively.
Our tax years for 2005 and forward are subject to examination by the U.S. tax authority and various state tax authorities. These years are open due to net operating lossesNOLs and tax credits remaining unutilized from such years.generated in these years were utilized in 2020. The statute of limitation for these years shall expire three years after the date of filing 2020 income tax returns.
We are required to recognize the financial statement effects of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. In 2019, we released all ASC 740-10 uncertain tax positions due to the expiring of the statute of limitation. At December 31, 2020 and March 31, 2021, we have 0 uncertain tax positions.
Our policy is to recognize interest and penalties accrued on any unrecognizeduncertain tax benefitspositions as a component of income tax expense. As of September 30, 2017,At December 31, 2020 and March 31, 2021, we had 0 accrued immaterial amounts of interest andor penalties related to the uncertain tax positions.
Note 4 — Commitments and Related Party Transactions
We lease our offices under an operating lease with a third party expiring inwhich expires on October 2019. We recognize rent expense on a straight-line basis over the term of the lease.31, 2021 (see Note 8 - Leases).
We leaseentered into a service agreement for the use of an aircraft from K2 Investment Fund LLC (“LLC”) for business travel for employees of the Company. We incurred approximately $218$79 and $690 compared to $228 and $596$76 in rental fees and reimbursements to the LLC during the three and nine months ended September 30, 2017March 31, 2021 and 2016,2020, respectively. We pay for the Company’s usage of the aircraft and have no rights to purchase. Our Chief Executive Officer and Chief Administrative Officer are the managing partners of the LLC and control the equity interests of the LLC. On January 31, 2015, weWe entered into a 12-month non-exclusive leaseagreement with the LLC for use of the plane at a rate of $8 per flight hour, with no minimum usage requirement. The agreement contains other terms and conditions normal in such transactions and can be cancelled by either us or the LLC with 30 days’ notice. The leaseagreement renews on an annual basis unless terminated by the lessor or lessee.either party. Neither party has exercised their termination rights.rights.
Note 5 — Stock-BasedStock Based Compensation
We have a stock incentive plan for employees and others called the VirnetX“VirnetX Holding Corporation 2013 Equity Incentive Plan”, or the Plan, (the “Plan”), which has been approved by our stockholders. In May 2017, the Board approved an amendment and restatement of the Plan to, among other things, increase the shares reserved under the Plan by 2,500,000 shares (the “Plan Amendment”). Our stockholders approved of the Plan Amendment at the 2017 Annual Meeting of Stockholders held on June 1, 2017. The Plan generally provides for grantsthe granting of up to 16,624,469 shares of our common stock, including stock options and restricted stock unitspurchase rights (“RSUs”), and will expire in 2023.2024. As of September 30, 2017, 2,244,631March 31, 2021, 545,210 shares remained available for grant under the Plan.
Stock-based compensation expense included in general and administrative expense was $383 and $348, and in research and development expense was $496 and $430, for the three months ended March 31, 2021 and 2020, respectively.
We did 0t grant options during the three months ended March 31, 2021. During the three months ended September 30, 2017,March 31, 2020, we granted options for a total of 1,377,500240,000 shares with a weighted average grant date fair value of $3.01 During the three months ended September 30, 2016, no options were granted.
We did 0t grant date fair value of $3.25. The fair values of options at the grant date were estimated utilizing the Black-Scholes valuation model with the following weighted average assumptions for the nine months ended September 30, 2016 (i) dividend yield on our common stock of 0 percent (ii) expected stock price volatility of 80 percent (iii) a risk-free interest rate of 1.84 percent and (iv) an expected option term of 6 years.
As of September 30, 2017,March 31, 2021, the unrecognized stock-based compensation expense related to non-vested stock options and RSUs was $7,180$4,602 and $2,241,$1,983, respectively, which will be amortized over an estimated weighted average period of approximately 3.342.17 and 2.682.08 years, respectively.
Note 6 — Equity
Common Stock
On August 21, 2015,July 30, 2018 we filed a $100,000 universal shelf registration statement withon SEC Form S-3 which was declared effective by the SEC enabling us to offer and sell from time to time up to $100 million of equity, debt or other types of securities.on August 16, 2018. We also entered an at-the-market (“ATM”) equity offering sales agreement (“ATM”) with Cowen & Company, LLC on August 20, 2015,31, 2018, under which we maycan offer and sell shares of our common stock having an aggregate value of up to $35 million. $50,000.
We have and expect to use the ATM proceeds from this offering for GABRIEL product development, and marketing and general corporate purposes, which may include working capital, capital expenditures, other corporate expenses and acquisitions of complementary products, technologies or businesses. From August 20, 2015 through December 30, 2016, weAs of March 31, 2021, common stock with an aggregate value of up to $21,964 remained available for offer and sale under the ATM agreement.
We sold 5,595,6500 shares under the ATM. TheATM during the three months ended March 31, 2021. We sold 1,049,382 shares under the ATM during the three months ended March 31, 2020, with an average sales price per common share was $4.14of $4.41 and the aggregate proceeds from the sales totaled $23,169 during the period.$4,627. Sales commissions, fees and other costs associated with the ATM totaled $695. During$139.
We issued 0 shares for options during the ninethree months ended September 30, 2017 noMarch 31, 2021. We issued 202,031 shares were sold underof common stock for options during the ATM. At September 30, 2017 $65 million remains available for sale under the shelf offering, with $11.8 million remaining in the ATM. (see “Note 8 - Subsequent Events”) three months ended March 31, 2020.
Warrants
In 2015,2020, we issued warrants (“Advisor Warrants”) for the purchase of 25,000 shares of common stock at an exercise price of $7$5.75 per share, which expireexercisable on the date of grant expiring in April 2020.2025. The Advisor Warrants were issued for advisory services provided by a third party. Our Advisor Warrants were recorded atweighted average fair value onat the issuancegrant date and included in Additional Paid in Capital on our Condensed Consolidated Balance Sheet. The Advisor Warrants are exercisable by the holder, in whole or in part, until expiration, and may also be net-share-settled. Terms of the warrant agreement include no registration requirements for the underlying common stock and there are no anti-dilution provisions.was $4.16 per warrant. The fair value at issuance of the warrants of $121grant date was recorded in Prepaid Expenses and Other Current Assets, and was amortized overestimated utilizing the twelve-month life of the service contract,Black-Scholes valuation model with the expense included in Selling, Generalfollowing weighted average assumptions (i) dividend yield on our common stock of 0 percent (ii) expected stock price volatility of 97 percent (iii) a risk-free interest rate of 0.27 percent and Administrative Expense in our Condensed Consolidated Statements(iv) and expected option term of Operations.5 years.
| Warrants Issued | Exercise Price | Outstanding and Exercisable December 31, 2020 | Issued | Exercised | Terminated / Cancelled | Outstanding and Exercisable March 31, 2021 | Expiration Date | ||||||||||||||||||||
| 25,000 | $ | 5.75 | 25,000 | 0 | 0 | 0 | 25,000 | April 30, 2025 | |||||||||||||||||||
Original Number of Warrants Issued | Exercise Price per Common Share | Exercisable at December 31, 2016 | Became Exercisable | Exercised | Terminated / Cancelled / Expired | Exercisable at September 30, 2017 | Expiration Date | ||||||||||||||||||||
| 25,000 | $ | 7.00 | 25,000 | — | — | — | 25,000 | April 2020 | |||||||||||||||||||
| 25,000 | — | — | — | 25,000 | |||||||||||||||||||||||
Note 7 — Litigation
We have elevenseveral intellectual property infringement lawsuits pending in the United States District Court for the Eastern District of Texas, Tyler Division (“USDC”), and United States Court of Appeals for the Federal Circuit (“USCAFC”).
VirnetX Inc. v. Cisco Systems, Inc. et al. (Case 6:10-CV-00417-LED) (“Apple I”)
On August 11, 2010, we initiated a lawsuit by filingfiled a complaint against Aastra USA. Inc. (“Aastra”), Apple Inc. (“Apple”), Cisco Systems, Inc. (“Cisco”), and NEC Corporation (“NEC”) in the United States District Court for the Eastern District of Texas, Tyler Division, pursuant toUSDC in which we alleged that these parties infringe on certain of our patents.patents (U.S. Patent Nos. 6,502,135, 7,418,504, 7,921,211 and 7,490,151). We sought damages and injunctive relief. The cases against each defendant were separated by the judge. Aastra and NEC agreed to sign license agreements with us, and we agreed to dropdropped all the accusations of infringement against them. At the pre-trial hearing, the judgeA jury in USDC decided to conduct separate jury trial for each defendant,that our patents were not invalid and try only the case against Apple on the scheduled trial date. The jury trialrendered a verdict of our case againstnon-infringement by Cisco was held on March 4, 2013. The jury in our case against Cisco came back with a verdict of non-infringement also determined that all our patents-in-suit patents are not invalid. Our motionsmotion for a new Cisco trial and Cisco’s infringement of certain VirnetX patents werewas denied and the case against Cisco was closed.
4 of our patents. On September 29, 2017, the United States District Court for the Eastern District of Texas, Tyler Division,USDC entered Final Judgement and issued its Memorandum Opinion and Order regarding post-trial motions resulting from the prior $302.4 million jury verdict for VirnetX in the Apple I case.
On October 13,27, 2017 having met and conferred and having reached agreementsApple appealed the final judgment entered on all amounts, parties jointlySeptember 29, 2017 to the USCAFC. Oral arguments in this case were held on January 8, 2019. On January 15, 2019, the Court issued a Rule 36 order affirming the district court’s final judgment. Apple filed a petition for panel rehearing and rehearing en-banc in this matter on February 21, 2019. On October 1, 2019, USCAFC issued an order denying Apple’s petition. Apple filed a petition for a writ of certiorari with the SCOTUS, which was denied on February 24, 2020. Prior to the SCOTUS decision denying Apple’s petition for a writ of certiorari, on February 20, 2020, Apple filed a Rule 60(b) motion askingfor relief from judgment with the Court to grant VirnetX an additional sum in the amount of $96,028 in agreed Bill of Costs, Attorneys’ Fees, and Prejudgment Interest. The Final Judgement is only subject to appeal stemming from new issues unresolved in the Apple I case, remanded backUSDC, seeking relief from the United States Courtdistrict court’s September 29, 2017 final judgment. VirnetX filed a responsive brief in opposition on March 5, 2020.
On March 13, 2020, the Company received payment of Appeals$454,034 from Apple, representing the previously announced final judgment with interest in this case. Apple sought payment relief by filing a motion under rule 60(b). On September 1, 2020 USDC issued an order denying Apple’s motion for the Federal Circuit. The total Final Judgement amount including Jury Verdict, Willful Infringement, Interest, Costs and Attorney Feesrelief of judgement. This case is $439,727. (see “Note 8 - Subsequent Events”).now closed.
VirnetX Inc. v. Apple, Inc. (Case 6:12-CV-00855-LED) (“Apple II”)
On October 9, 2018, USCAFC docketed the appeal as Case No. 19-1050 - VirnetX Inc. v. Apple Inc . On January 24, 2019 Apple filed its opening brief. We filed our response brief on March 1, 2019. Apple filed its reply brief on April 5, 2019. The oral arguments were invalidheard on October 4, 2019. On November 22, 2019, the USCAFC issued an opinion affirming the district court’s findings that Apple is precluded from making certain invalidity arguments and that Apple infringed the ’135 and ’151 patents; reversing the USDC’s finding that Apple infringed the ’504 and ’211 patents; and remanding the case for indefiniteness. Inproceedings on damages. Apple sought panel and en banc rehearing, which the USCAFC denied on February 10, 2020.
On February 22, 2020, the USDC issued a separatescheduling order for the parties to brief the court granted in part and denied in partabout the need for a new trial for recalculating the damages. We filed our motion for partial summaryentry of judgment on Apple’s invalidity counterclaims, precluding Apple from asserting invalidity as a defense against infringementFebruary 28, 2020. The arguments on this matter were heard on April 14, 2020. In its order, unsealed on May 1, 2020, the USDC denied VirnetX’s motion for entry of the claims that were tried before a jury in our prior litigation against Apple (VirnetX vs. Cisco et. al., Case 6:10-CV-00417-LED). The jury trial in this case was scheduled for October 13, 2015. On March 30, 2015, the court issued an order finding substantial overlap between this case and the remanded portions of Case 6:10-CV-00417-LED (VirnetX vs. Cisco et. al.). The court consolidated the two civil actions under Civil Action Case 6:12-CV-00855-LED (VirnetX Inc. v. Apple, Inc.) and designated it as the lead case. On July 29, 2016, the court issued a new order, vacating its previous orders consolidating the cases Apple I case and Apple II case, ordering that the two cases be retried separately, and setting the retrial date for Apple I case with jury selection to begin on September 26, 2016. The court also ordered that the issue of willfulness in both cases is bifurcated and that the Apple II will be retried after Apple I case.
VirnetX Inc. v. Mangrove Partners Master Fund, Ltd., Apple Inc. (Case 15-1934)(USCAFC Case 20-2271) and VirnetX Inc. v. Mangrove Partners Master Fund, Ltd., Apple Inc., and Black Swamp, LLC (USAFC Case 20-2272)
On July 10, 2015,September 15, 2020, we filed appeals with the USCAFC appealing the invalidity findings by the United States Patent and Trademark Office, Patent Trial and Appeal Board (“PTAB”) in IPR2014-00237 and IPR2014-00238, related to U.S. Patent No. 8,504,697. The oral arguments in this case were heard on November 7, 2016. On December 9, 2016, the USCAFC affirmed the PTAB based on the grounds discussed in IPR2014-00238. We are currently evaluating our options in this case.
On September 22, 2017, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in IPR2016-00693 and IPR2016-00957 involving our U.S. Patent Nos. 7,418,504 and 7,921,211. These appeals have been consolidated. The briefing in these appeals is ongoing. The entity that initiated the IPRs, Black Swamp IP, LLC, indicated on October 18, 2017, that it would not participate in the appeals. On October 20, 2017, the USCAFC orderedJuly 23, 2020, the United States and the USPTO (collectively, “the United States”) filed a petition for a writ of certiorari from several decisions by the USAFC, including decisions in VirnetX Inc. v. Cisco Systems, Inc., Nos. 2019-1671, and VirnetX Inc. v. Iancu, Nos. 2017-2593, -2594. In those cases, the USAFC granted VirnetX’s motions to vacate the underlying decisions of the PTAB on the basis of Arthrex, Inc. v. Smith & Nephew, Inc., 941 F.3d 1320 (Fed. Cir. 2019), and remanded for further proceedings. The United States requested that the SCOTUS hold its certiorari petition pending the disposition of the United States’ separate petition in United States v. Arthrex, Inc., No. 19-1434 (filed June 25, 2020). On August 26, 2020, VirnetX filed a response, agreeing that the United States’ certiorari petition should be held pending the disposition of the petition for a writ of certiorari in No. 19-1434 (and related petitions filed by private parties in Nos. 19-1452 and 19-1458), and any further SCOTUS proceedings.
On October 13, 2020, SCOTUS granted the United States’ petition for a writ of certiorari in No. 19-1434 as to USAFC Case No. 2018-2140, and the petitions for writs of certiorari in Nos. 19-1452 and 19-1458, all limited to Questions 1 and 2 as set forth in the July 22, 2020 Memorandum for the United States filed in No. 19-1434. The consolidated petition is seeking review of decisions by the USCAFC holding that administrative patent judges (“APJ”) of the Patent Trial and Appeal Board of the U.S. Patent and Trademark Office must be appointed by the President and confirmed by the Senate; and, whether the remedy imposed by USCAFC that federal laws that place restrictions on when officials can be removed from office cannot apply to informAPJ, was the appropriate one. SCOTUS heard oral argument in these consolidated cases on March 1, 2021. We are waiting for SCOTUS to rule in this matter.
McKool Smith P.C. v. VirnetX, Inc., AAA Case No. 01-20-0003-7975
On March 23, 2020, the law firm of McKool Smith, P.C. (“McKool”) filed a Demand for Arbitration against VirnetX, Inc. with the American Arbitration Association (“AAA”). In its demand, McKool claimed that a retention agreement it within 30 days whetherentered into in 2010 with VirnetX entitled it wishes to participatea contingency fee arising from the recent 2020 payment made in the appeals.Apple I case. McKool claimed it was owed approximately $36,300 (or 8% of the Apple I payment). We filed a general response with the AAA denying McKool’s claim and contested the matter vigorously. An evidentiary hearing was held on the matter during the week of February 22, 2021 and the parties submitted additional briefings. On April 19, 2021, the arbitrator awarded McKool $36,323 in damages, plus pre-judgment interest in the amount of 5% simple interest from March 23, 2020 to April 18, 2021, and post-judgment interest in the amount of 5%, compounded annually, until payment of the award. We accrued the resulting $38,284 as of March 31, 2021 and paid that amount to McKool on April 20, 2021. This matter is now closed.
Neal Hurwitz v. Kendall Larsen et al. (Case 2020-0425-JRS)
On June 2, 2020, stockholder Neal Hurwitz filed a verified derivative complaint in the Delaware Court of Chancery against Kendall Larsen, Robert D. Short Ill, Gary Feiner, Michael F. Angelo, and Thomas M. O’Brien and naming the Company as nominal defendant. The lawsuit alleges breaches of fiduciary duty, corporate waste, and unjust enrichment arising out of a series of previously-disclosed transactions and compensation awards and seeks an award of monetary damages and equitable relief. On July 1, 2020, the defendants filed a motion to dismiss the complaint based on a failure to plead demand futility and a failure to state a claim on which relief can be granted and, on August 19, 2020, the defendants filed an opening brief in support of their motion to dismiss. On October 16, 2020, plaintiff amended his complaint rather than respond to the arguments in the defendants’ opening brief. On October 23, 2020, the defendants filed a renewed motion to dismiss plaintiff’s amended complaint based on a failure to plead demand futility and a failure to state a claim on which relief can be granted. On January 12, 2021, Hurwitz voluntarily dismissed his suit without prejudice.
Other Legal Matters
One or more potential intellectual property infringement claims may also be available to us against certain other companies who have the resources to defend against any such claims. Although we believe these potential claims are worth pursuing,likely valid, commencing a lawsuit can be expensive and time-consuming, and there is no assurance that we willcould prevail on such potential claims.claims if we made them. In addition, bringing a lawsuit may lead to potential counterclaims which may precludedistract our abilitymanagement and our other resources, including capital resources, from efforts to successfully commercialize our initial products, which are currently in development. products.
Currently, we are not a party to any other pending legal proceedings and are not aware of any proceeding threatened or contemplated against us by any governmental authority or other party.us.
Note 8 — Subsequent EventsLeases
We lease office space under an operating lease which expires on October 31, 2021. On October 16, 2017, we receivedMarch 31, 2021, the underlying ROU asset and lease liability totaled $31. On December 31, 2020, the underlying ROU asset and lease liability totaled $44. For the three months ended March 31, 2021 and 2020, lease expense totaled $14 and $13, respectively.
We also lease a final judgment affirming a jury’s verdict of $1.20 per iPhone royaltyfacility for corporate promotional and marketing purposes which was prepaid at inception and expires in 2025, as amended. On March 31, 2021 and December 31, 2020, the United States CourtROU asset totaled $1,173 and $1,248, respectively; lease expense totaled $75 and $96, for the Eastern Districtthree months ended March 31, 2021 and 2020, respectively.
Note 9 — Earnings Per Share
Basic earnings per share are based on the weighted average number of Texas, Tyler Division in the case VirnetX, Inc. et al. v. Apple Inc., No. 6:10-cv-00417-RWS (Apple I), awarding the Company a total of $439.8 million including jury verdict, willful infringement, interest, costs and attorney fees, following the previously disclosed jury trial and verdict in the amount of $302.4 million. The Final Judgement is subject to appeal stemming from new issues unresolved in the Apple I case, remanded back from the United States Court of Appealscommon shares outstanding for the Federal Circuit. On October 27, 2017 Apple filed its noticeperiod. Diluted earnings per share are based on the weighted average number of appealcommon shares and potentially dilutive common shares outstanding. Potential common shares outstanding principally include stock options, RSUs and warrants, excluding any potentially dilutive shares convertible at a price higher than the closing price of our stock at the Final Judgment entered on September 29, 2017 toend of each reporting period.
The following table shows the United States Courtcomputation of Appealsbasic and diluted earnings per share for the Federal Circuit. (See “Note 7 – Litigation”).three months ended March 31, 2021 and 2020 (in thousands, except per share amounts):
| Three Months Ended March 31, | ||||||||
| 2021 | 2020 | |||||||
| Numerator: | ||||||||
| Net (loss) income | $ | (26,443 | ) | $ | 299,945 | |||
| Denominator: | ||||||||
| Weighted-average basic shares outstanding | 71,059 | 70,365 | ||||||
| Effect of dilutive securities | 0 | 1,019 | ||||||
| Weighted-average diluted shares | 71,059 | 71,384 | ||||||
| Basic (loss) earnings per share | $ | (0.37 | ) | $ | 4.26 | |||
| Diluted (loss) earnings per share | $ | (0.37 | ) | $ | 4.20 | |||
We incurred a net loss for the three months ended March 31, 2021; therefore, all 6,341,844 potentially dilutive securities representing shares of common stock under the ATM. The average sales price per common share was $5.49 and the aggregate proceedswere excluded from the sales totaled $2,806 duringcomputation of diluted earnings per share, because their effect would have been antidilutive. For the period. Sales commissions, and other costs associated withthree months ended March 31, 2020, potentially dilutive securities representing 2,161,955 shares of common stock were excluded from the ATM totaled $87.computation of diluted earnings per share, because their effect would have been antidilutive.
Note 10 — Subsequent Events
See Note 7 - Litigation McKool Smith P.C. v. VirnetX, Inc., AAA Case No. 01-20-0003-7975.
ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSOPERATIONS.
Company Overview
We are an Internet security software and technology company with patented technology for various types of secure network communications, including 5G and 4G Long Term Evolution (“LTE”),LTE network security. Our software and technology solutions, including ourpatented Secure Domain Name Registry and GABRIEL Connection Technology™, are designed to facilitate securethe foundation for our GABRIEL Secure Communication Platform™ that protects communications and provide the security platform required by next-generation Internet-based applications such as instant messaging, or IM, voice over Internet Protocol, (“VoIP”), mobile services, streaming video, file transfer, remote desktop and Machine-to-Machine (“M2M”) communications.using Zero Trust Network Access (ZTNA). Our technology generates secure connections on a ‘‘zero-click’’“zero-click” or ‘‘single-click’’“single-click” basis, significantly simplifying the deployment of secure real-time communication solutions by eliminating the need for end-users to enter any encryption information. Our portfolio of intellectual property is the foundation of our business model. We currently own approximately 49194 total patents and pending applications, including 70 U.S. and 69 foreign patents with approximately 50 pending patents/patent applications worldwide.and 124 foreign patents/validations/pending applications. Our patent portfolio is primarily focused on securing real-time communications over the Internet, as well asand related services, such as the establishment and maintenance of a secure domain name registry. Our patented methods also have additional applicationsis used in the key areas of device operating systems and network security for Cloud services, M2M communications in new initiatives including ‘‘Smart City’’, ‘‘Connected Car’’ and ‘‘Connected Home’’ that would connect everything from social services and citizen engagement to public safety, transportation and economic development to the internet to enable more productivity, features and efficiency in our everyday lives. The subject matter of all our U.S. and foreign patents and pending applications relates generally to securing communication over the internet, and as such covers all our technology and other products. Our issued U.S. and foreign patents expire at various times during the period from 2019 to 2024. Someproducts, some of our issued patents and pending patent applicationswhich were acquired by our principal operating subsidiary; VirnetX, Inc., from Leidos, Inc. (“Leidos”), or Leidos, (f/k/a Science Applications International Corporation, or SAIC) in 2006 and we are required to make payments to Leidos, based on cash or certain other values generated from those patents. The amount of such payments depends upon the type of value generated, and certain categories are subject to maximums and other limitations.2006.
Our product Gabrielportfolio includes sophisticated technologies, products and services that are available for sale worldwide. Our GABRIEL Secure Communication Platform™, unlike other collaboration and communication products and services on the market today, does not require access to user’s confidential data and reduces the threat includes a set of hacking and data mining.software libraries with application interfaces available for securing third-party applications seamlessly across multiple operating systems. It enables individuals and organizations to maintain complete ownership and control over their personal and confidential data, secured within their own private network, while enabling authorized secure encrypted access from anywhere at any time.
Our GabrielGABRIEL Gateway product extends our Secure Communication Platform™ by allowing existing networked devices and services to seamlessly join the “GABRIEL SECURED” network without requiring any modifications. All these devices or services, including on-premise or cloud-based services, can now be assigned a VirnetX Secure Domain Name and use fully authenticated, secure communication channels for its communications.
Our GABRIEL Collaboration Suite™ is a set of communication applications and tools that run-on top ofuse our GabrielGABRIEL Secure Communication Platform™. It enables seamless and secure cross-platform communications between user’s devices that are enrolled in our “GABRIEL SECURED” network and have our software installed. Our GabrielGABRIEL Collaboration Suite™ is available for download and free trial, for Android, iOS, Windows, Linux, and Mac OS X platforms, at http:https://www.gabrielsecure.com/virnetx.com.
We continue to enhance our products and add new functionality to our products.functionality. We will provide updates to new and existing customers as they are released to the public. Over 80Many small and medium businesses have installed our GabrielGABRIEL Secure Communication Platform™ and GabrielGABRIEL Collaboration Suite™ products in their corporate networks. We seekintend to continue to expand our customer base with targeted promotions and direct sales initiatives.
We have an ongoing GabrielGABRIEL Licensing Program under which we offer licenses to a portion of our patent portfolio, technology, and software, including our secure domain name registry service, to domain infrastructure providers, communication service providers as well as to system integrators. Our GABRIEL Connection Technology™ License is offered to OEM customers who want to adopt the GABRIEL Connection Technology™ as their solution for establishing secure connections using secure domain names within their products. We have developed GABRIEL Connection Technology™ Software Development Kit (SDK) to assist with rapid integration of these techniques into existing software implementations with minimal code changes and include object libraries, sample code, testing and quality assurance tools and the supporting documentation necessary for a customer to implement our technology.implementations. Customers who want to develop their own implementation of the VirnetX patented techniques for supporting secure domain names, or other techniques that are covered by our patent portfolio for establishing secure communication links, can purchase a patent license. The number of patents licensed, and therefore the cost of the patent license to the customer, will depend upon which of the patents are used in a particular product or service. These licenses will typically include an initial license fee, as well as an ongoing royalty.
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Our employees include the core development team behind our patent portfolio, technology, and software. ThisSome members of this team hashave worked together for over tentwenty years and is thewere on same team that invented and developed this technology while working at Leidos, Inc. (‘‘Leidos’’). Leidos is a FORTUNE 500® scientific, engineering and technology applications company that uses its deep domain knowledge to solve problems of vital importance to the nation and the world, in national security, energy and the environment, critical infrastructure and health.Leidos. The team has continued its research and development work started at Leidos, and expanded the set of patents we acquired in 2006 from Leidos, into a larger portfolio of over 110 U.S. and international patents and with over 75 pending applications.patent portfolio. This portfolio now serves as the foundation of our products, services, and our licensing business and planned service offerings andbusiness. It is expected to generate the majoritymost of our future revenue in license fees and royalties. We intend to continue our researchefforts to develop new products and development efforts totechnologies and further strengthen and expand our patent portfolio.
We intend to continue using an outsourced and leveraged model to maintain efficiency and manage costs as we grow our licensing business by, for example, offering incentives to early licensing targets or asserting our rights for use of our patents. We also intend to expand our design pilot in participation with leading 4G/LTE companies (domain infrastructure providers, chipset manufacturers, service providers and others) and build our secure domain name registry.
New Accounting Pronouncements
In June 2016,December 2019 the FASBFinancial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments-Credit Losses2019-12 Income Taxes (Topic 326) “ASU 2016-13”740). The purposeamendments in this ASU simplify the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. The amendments in this ASU 2016-13 is to require a financial asset measured at amortized cost basis to be presented at the net amount expected to be collected. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses. ASU 2016-13 isare effective for fiscal years, and interim and annual reporting periods within those fiscal years, beginning after December 15, 2019.2020. We are evaluating theadopted this ASU on January 1, 2021 with no material impact this guidance will have on our financial position, and statementresults of operations.
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Results of OperationsOperation
Three and Nine Months Ended September 30, 2017March 31, 2021
Compared with the Three and Nine Months Ended September 30, 2016March 31, 2020
(in thousands, except per share amounts)
Revenue
Classification in the Company’s Condensed Consolidated Statement of Operations for the Three Months Ended March 31, 2020 | ||||
| Revenue (royalties) | $ | 302,428 | ||
| Operating expenses: selling, general and administrative (reimbursed litigation costs) | 2,114 | |||
| Other income: gain (willful infringement) | 41,271 | |||
| Other income: interest income (pre and post judgment interest) | 108,221 | |||
| Total cash received | $ | 454,034 | ||
Licensing Costs
Included in operating expenses for the three and nine months ended September 30, 2017, respectively, and revenuesMarch 31, 2020, is $90,101 in licensing costs accrued in conjunction with the proceeds received from Apple, Inc., pursuant to the favorable court decision relating to a patent infringement case. Accrued licensing costs of $375 and $1,148 for$9,438 were reversed during the three and nine months ended September 30, 2016, respectively.March 31, 2021, as a result of the McKool award (See Note 7 - Litigation).
Research and Development Expenses
Selling, General and Administrative Expenses
Our selling, general and administrative expenses increased by $14,567 to $41,943 for the three months ended September 30, 2017 compared to September 30, 2016 decreased by $2,862 to $3,456. The change is primarily due to a decrease in legal fees associated with our patent infringement actions. For the nine months ended September 30, 2017 our selling, general and administrative expenses decreased by $9,179 to $10,953 compared to the nine months ended September 30, 2016. The change was primarily due to an $8,200 decrease in legal fees associated with our patent infringement actions. We expect to incur the same or increased levels of legal fees over the next two quarters and expect to report lossesMarch 31, 2021, from operations as a result. (See “Legal Proceedings” for additional information regarding these infringement actions.)
Interest and September 30, 2016 was $3,552 and $7,387, respectively. Net loss forother income, net
For the ninethree months ended September 30, 2017 and September 30, 2016 was $11,244 and $21,335, respectively. The changes are primarily dueMarch 31, 2020, we recognized interest income of $108,221 pursuant to decreases in legal fees associated with our patent infringement actions and reported in our selling, general and administrative expenses.the favorable ruling against Apple, Inc. discussed above.
Liquidity and Capital Resources
As of September 30, 2017,March 31, 2021, our cash and cash equivalents totaled approximately $1,647$197,198 and our short-term investments totaled approximately $2,665,$19,835, compared to cash and cash equivalents of approximately $6,627$192,908 and short-term investments of approximately $9,249$28,348 at December 31, 2016.2020, respectively. Working capital was $1,958$181,405 at September 30, 2017,March 31, 2021, and $11,240$214,076 at December 31, 2016.2020. The decrease in cash and investments during the ninethree months ended September 30, 2017March 31, 2021 was primarily attributed to costs incurred for legal expenses in defense of our patent infringement actions and the loss incurred during the period.operating expenses.
We expect that our cash and cash equivalents and short-term investments as of September 30, 2017, the $2,806 in proceeds subsequent to September 30, 2017, from sales of common shares under the ATM, as well as the possibility of future sales of common shares under the ATM and the universal shelf registration statement, described below,March 31, 2021, will be sufficient to fund our current level of selling, general and administration costs, including legal expenses and provide related working capital for the foreseeable future. Over the longer term, we expect to derive the majority of our future revenue from license fees and royalties associated with our patent portfolio, technology, software and secure domain name registry in the United States and other markets around the world.
Universal Shelf Registration Statement and ATM Offering
On August 21, 2015,July 30, 2018 we filed a $100,000 universal shelf registration statement withon SEC Form S-3 which was declared effective by the U.S. Securities and Exchange Commission (the “SEC”) enabling us to offer and sell from time to time up to $100 million of equity, debt or other types of securities.SEC on August 16, 2018. We also entered into an at-the-market (“ATM”) equity offering sales agreement (“ATM”) with Cowen & Company, LLC on August 20, 2015,31, 2018, under which we maycan offer and sell shares of our common stock having an aggregate value of up to $35 million. $50,000.
We expect to use the ATM proceeds from this offering for GABRIEL product development, and marketing and general corporate purposes, which may include working capital, capital expenditures, other corporate expenses and acquisitions of complementary products, technologies or businesses. At September 30, 2017 $65 million remainsAs of March 31, 2021, common stock with an aggregate value of up to $21,964 remained available for offer and sale under the shelf offering, with $11.8 million remaining in the ATM. Subsequent to September 30, 2017, weATM agreement.
We sold 527,039no shares of common stock under the ATM.ATM for the three months ended March 31, 2021 and 1,049,382 shares during the three months ended March 31, 2020. The average sales price per common share was $5.49$4.41 and the aggregate proceeds from the sales totaled $2,806$4,627 during the period. Sales commissions, fees and other costs associated with the ATM totaled $87.$139.
Income Taxes
no income in California.
Contractual Obligations
There have been no material changes to the contractual obligations disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.2020.
Off-Balance Sheet Arrangements
Interest Rate Risk
We invest our excess cash primarily in highly liquid instruments including time deposits, money market, mutual funds and U.S. government and U.S. agency and treasury securities. We seek to limit the amount of our credit exposure to any one issuer.
Investments in fixed rate instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates. Due in part to these factors, our income from investments may decrease in the future.
We considered the historical volatility of short-term interest rates and determined that it was reasonably possible that an adverse change of 100 basis points could be experienced in the near term but would have an immaterial impact in the fair value of our marketable securities, which generally mature within one year of September 30, 2017.March 31, 2021.
Other Market Risks
We considered the historical volatility of our stock prices and determined that it was reasonably possible that the fair market value of our stock price could increase or decrease substantially in the near term and could have a material impact to our consolidated balance sheets and statement of operations.operations with respect to future stock-based compensation costs and other equity transactions.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of September 30, 2017,March 31, 2021.
The purpose of this evaluation was to determine whether as of September 30, 2017March 31, 2021 our disclosure controls and procedures were effective to provide reasonable assurance that the information we are required to disclose in our filings with the SEC, (i) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of September 30, 2017,March 31, 2021, our disclosure controls and procedures were effective.
Changes in Internal Control Over Financial ReportingReporting.
There were no changes in our internal control over financial reporting during the quarter ended September 30, 2017March 31, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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Our operations and financial results are subject to various risks and uncertainties, including those described below, which could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common and capital stock. You should carefully consider the following material risks and uncertainties described below in addition to the other information set forth in this Quarterly Report on Form 10-Q, as well asincluding the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Annual Form 10-K filed March 16, 2017consolidated financial statements and related notes, before making any investment in our common stock. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also adversely affect our business. If any of these risk factors occur, you could lose substantial value or your entire investment in our shares.shares.
Risks Related to Our Business and Our Financial Reporting
We are involved and will continue to be involved in litigation defending our patent portfolio, which can be time-consuming and costly, and we cannot anticipate the results.
We spend a significant amount of our financial and management resources to pursue our current litigation. We believe that this litigation and others that we may pursue in the future could continue for years and consume significant financial and management resources. The counterpartcounterparties to our litigation includesinclude large, well-financed companies with substantially greater resources than us. WePatent litigation is risky, and the outcome is uncertain, and we cannot assure you that any of our current or future litigation matters will result in a favorable outcome for us. In addition, even if we obtain favorable interim rulings or verdicts, they may be inconsistent with the ultimate resolution of the dispute. Furthermore, any awards we receive may be subject to obligations to Leidos and fee arrangements with outside counsel. Also, we cannot assure you that we will not be exposed to claims or sanctions against us which may be costly or impossible for us to defend. Unfavorable or adverse outcomes may result in losses, exhaustion of financial resources or other adverse effects, which could encumber our ability to develop and commercialize our products.
We may not be able to capitalize on market opportunities related to our licensing strategy or our patent portfolio.
Our business strategy includes licensing our patents and technology to other companies in order to reach a larger end-user base than we could reach through direct sales and marketing efforts; as such, our business strategy and revenues willmay depend on intellectual property licensing fees and royalties for the majority of our revenues. We currently derive minimal revenue from licensing activities, and royalties, and we cannot assure you that we will successfully capitalize on our market opportunities or that our current business strategy will succeed. Factors that may affect our ability to execute our current business strategy include, but are not limited to, the following:
Although to date we have entered into a limited number of settlement and license agreements, we may not be successful in entering into further licensing relationships, or if we are successful in entering into such relationships, the acquisition of them may be expensive, and they, as well as our existing settlement and our existing and pending license agreements may not generate the financial results, we expect;
expect.Factors that may affect our ability to execute our current business strategy include, but are not limited to, the following:
Third parties may challenge the validity of our patents;
The pendency of our various litigations may cause potential licensees not to do business with us;
Our patents may expire before we can make our business strategy successful;
We face, and we expect to continue to face, intense competition from new and established competitors who may have superior products and services or better marketing, financial or other capacities than we do; and
It is possible that one or more of our potential customers or licensees develops or otherwise sources products or technologies similar to, competitive with or superior to ours.
If we are not able to adequately protect our patent rights, our business would be negatively impacted.
We believe our patents are valid, enforceable, and valuable. Notwithstanding this belief, third parties may make claims of infringement or invalidity claims with respect to our patents and such claims could give rise to material cost for defense or settlement or both, jeopardize or substantially delay a successful outcome of litigation we are or may become involved in, divert resources away from our other activities, limit or cease our revenues related to such patents, or otherwise materially and adversely affect our business. Similar challenges could also prevent us from obtaining additional patents in the future. Additionally, several of our patents are currently, and other patents may in the future be, subject to United States Patent and Trademark Office (“USPTO”) post-grant inter partes review proceedings (“IPR”) which may result in all or part of these patents being invalidated, or the claims of our patents being limited. Unfavorable or adverse outcomes in our litigation or IPRs may result in losses, exhaustion of financial resources, reduction in our ability to enforce our intellectual property rights, or other adverse effects, which could encumber our ability to develop and commercialize our products. Even if we are successful in enforcing our intellectual property rights, our patents may not ultimately provide us with any competitive advantages and may be less valuable than we currently expect. These risks may be heightened in countries other than the United States where laws regarding patent protection are less developed, and may be negatively affected by the fact that legal standards in the United States and elsewhere for protection of intellectual property rights in Internet-related businesses are uncertain and still evolving. In addition, there are a significant number of United States and foreign patents and patent applications in our areas of interest, and we expect that significant litigation in these areas will continue and will add uncertainty to the value of certain patents and other intellectual property rights in our areas of interest. If we are unable to protect our intellectual property rights or otherwise realize value from them, our business would be negatively affected.
We can provide no assurances that the licensing of our essential security patents under FRAND will be successful.
At the request of the European Telecommunications Standards Institute (“ETSI”), and the Alliance for Telecommunications Industry Solutions (“ATIS”), we agreed to update our licensing declaration to ETSI and ATIS under their respective Intellectual Property Rights policies. This was in response to our Statement of Patent Holder identifying a group of our patents and patent applications that we believe are or may become essential to certain developing specifications in the 3rd3rd Generation Partnership Project (3GPP) Long Term Evolution (“LTE”), Systems Architecture Evolution (“SAE”) project. We will make available a non-exclusive patent license under FRAND (fair, reasonable and non-discriminatory terms, and conditions, with compensation) for the patents identified by us that are or become essential to applicants desiring to implement the Technical Specifications identified by us, as set forth in the updated licensing declaration under the ATIS and ETSI Intellectual Property Rights policies. Our licensing declarations under the ATIS and ETSI Intellectual Property Rights policies may limit our flexibility in determining royalties and license terms for certain of our patents. Consequently, we cannot assure you that the licensing of the essential security patents will be successful or that third parties will be willing to enter into licenses with us on reasonable terms or at all, which could have an adverse effect on our business and harm our competitive position.
Because our business is conducted or expected to be conducted in an environment that is subject to rapid change, we may be subject to various developments in regulation, law, and consumer preferences to which we may not be able to adapt successfully.
The current regulatory environment for our products and services remains unclear. We can give no assurance that our planned product offerings will be in compliance with laws and regulations of local, state, United States federal or foreign authorities. Further, we can give no assurance that we will not unintentionally violate such laws or regulations or that such laws or regulations will not be modified, or that new laws or regulations will be enacted in the future which would cause us to be in violation of such laws or regulations. For example, Voice-Over-Internet Protocol o(VoIP”(“VoIP”) services are not currently subject to all the same regulations that apply to traditional telephony, but it is possible that similar regulations may be applied to VoIP in the future and that these could result in substantial costs to us which could adversely affect the marketability of our products and planned products related to VoIP. For further example, the use of the Internet and private Internet Protocol (“IP”) networks for communication is largely unregulated within the United States, but may become regulated in the future; Additionally,additionally, several foreign governments have enacted measures that could restrict or prohibit voice communications services over the Internet or private IP networks.
Our business depends on the growth of instant messaging, VoIP, mobile services, streaming video, file transfer and remote desktop and other next-generation Internet-based applications. A decline in the use of these applications due to complexity or cost of these applications relative to alternate traditional or newly developed communications channels, or development of alternative technologies, could cause a material decline in the number of users in these areas.
More aggressive domestic or international regulation of the Internet in general, and Internet telephony providers and services specifically may materially and adversely affect our business, financial condition, operating results, and future prospects.prospects.
Our exposure to outside influences beyond our control, including new legislation, court rulings or actions by the United States Patent and Trademark Office, could adversely affect our licensing and enforcement activities and results of operations.
Our licensing and enforcement activities are subject to numerous risks from outside influences, including the following:
New legislation, regulations or rules related to obtaining patents or enforcing patents could significantly increase our operating costs and decrease our revenue. For instance, the United States Supreme Court has recently modified some tests used by the USPTO in granting patents during the past 20 years which may decrease the likelihood that we will be able to obtain patents and increase the likelihood of challenge of any patents we obtain or license. In addition, in 2012 the United States recently enacted sweeping changes to the United States patent system under the Leahy-Smith America Invents Act, including changes that transition the United States from a “first-to-invent” system to a “first to file” system and alter the processes for challenging issued patents.
patents;More patent applications are filed each year resulting in longer delays in getting patents issued by the USPTO.
USPTO;Federal courts are becoming more crowded, and as a result, patent enforcement litigation is taking longer.
longer; andAs patent enforcement becomes more prevalent, it may become more difficult for us to voluntarily license our patents.
New legislation, regulations or court rulings related to enforcing patents could harm our business and operating results.
Intellectual property is the subject of intense scrutiny by the courts, legislatures, and executive branches of governments around the world. Various patent offices, governments or intergovernmental bodies may implement new legislation, regulations or rulings that impact the patent enforcement process, or the rights of patent holders and such changes could negatively affect licensing efforts and/or litigations. For example, limitations on the ability to bring patent enforcement claims, limitations on potential liability for patent infringement, lower evidentiary standards for invalidating patents, increases in the cost to resolve patent disputes and other similar developments could negatively affect our ability to assert our patent or other intellectual property rights.
It is impossible to determine the extent of the impact of any new laws, regulations or initiatives that may be proposed, or whether any of the proposals will become enacted as laws. Compliance with any new or existing laws or regulations could be difficult and expensive, affect the manner in which we conduct our business and negatively impact our business, prospects, financial condition, and results of operations.
We may need to raise additional capital to support our business growth, and this capital will be dilutive, may cause our stock price to drop or may not be available on acceptable terms, if at all.
We may need to raise additional capital, which may not be available to us when needed or may not be available on terms acceptable to us, to support our business growth or to respond to business opportunities, challenges, or unforeseen circumstances, including sales under our ATM or our universal shelf registration statement. Our ability to obtain additional capital, if and when required, will depend on our business plans, investor demand, our operating performance, the condition of the capital markets, the terms of our current contractual obligations and other factors.
If we raise additional funds through the issuance of equity, equity-linked or debt securities, including those under our ATM or our Universal Shelf Registration Statement, those securities may have rights, preferences, or privileges senior to the rights of our common stock, and our existing stockholders may experience dilution. Additionally, we are unable to predict the future success of our ATM or any other offering. Sales of a substantial number of shares of our common stock in the public market, or the perception that these sales or other financings might occur, could depress the market price of our common stock, and could also impair our ability to raise capital through the sale of additional equity securities. If we issue debt securities or incur indebtedness, we could experience increased future payment obligations and a need to comply with restrictive covenants, such as limitations on our ability to incur additional debt, limitations on our ability to acquire, sell or license intellectual property rights and other operating restrictions that could adversely impact our ability to conduct our business. If we are unable to obtain additional capital or are unable to obtain additional capital on satisfactory terms, our ability to continue to support our business growth or to respond to business opportunities, challenges, or other circumstances could be adversely affected, and our business may be harmed.
If we experience security breaches, we could be exposed to liability and our reputation and business could suffer.
We expect to retain certain confidential and proprietary customer information in our secure data centers and secure domain name registry, as well as personal data and other confidential and proprietary information relating to our business. It will be critical to our business strategy that our facilities and infrastructure remain secure and are perceived by the marketplace to be secure. Our secure domain name registry operations will also depend on our ability to maintain our computer and telecommunications equipment in effective working order and to reasonably protect our systems against interruption, and potentially depend on protection by other registrars in the shared registration system. The secure domain name servers that we will operate will be critical hardware to our registry services operations. Therefore, we expect to have to expend significant time and money to maintain or increase the security of our products, facilities, and infrastructure. Security technologies are constantly being tested by computer professionals, academics and “hackers.” Advances in computer capabilities and the techniques for attacking security solutions, new discoveries in the field of cryptography or other events or developments could result in compromises or breaches of our security measures and could make some or all our products obsolete or unmarketable. Likewise, if any of our products are found to have significant security vulnerabilities, then we may need to dedicate engineering and other resources to eliminate the vulnerabilities and to repair or replace products already sold or licensed to our customers. Despite ourthe security measures that we and our service providers utilize, our infrastructure and that of our service providers may be vulnerable to physical break-ins, computer viruses, attacks by hackers, phishing attacks, social engineering, or similar disruptive problems. It is possible that we may have to expend additional financial and other resources to address such problems. The COVID-19 pandemic is increasing vulnerability to cyber-attacks, as more individuals and companies work online, which increases these risks. As a provider of Internet security software and technology, we may be the target of dedicated efforts by hackers and other third parties to overcome or defeat our security measures. Any physical or electronic break-in or other security breach or compromise of the information stored at our secure data centers and domain name registration systems, including any compromise due to human error or employee or contractor malfeasance, may jeopardize the security of information stored on our premises or in the computer systems and networks of our customers. In such an event, we could face significant liability and current or potential customers could be reluctant to use our services. Additionally, any such data security incident, or the perception that one has occurred could also result in adverse publicity, harm to our reputation and competitive position, and therefore adversely affect the market’s perception of the security of electronic commerce and communications over IP networks as well as the security or reliability of our services.
A security breach or other security incident could require a substantial level of financial resources to rectify and otherwise respond to, may be difficult to identify or address in a timely manner, and could result in a claimclaims, investigations, and investigationinquires by private parties or governmental entities that may divert management’s attention and require the expenditure of significant time and resources, and which may cause us to incur substantial fines, penalties, or other liability and related legal and other costs. Any actual or perceived security breach or other security incident may also harm our reputation and make it more difficult or impossible for us to successfully market to others. Any of the foregoing matters could harm our operating results and financial condition.
Privacy and data security concerns, and data collection and transfer restrictions and related domestic or foreign regulations may limit the use and adoption of our solutions and adversely affect our business.
Personal privacy, information security, and data protection are significant issues in the United States, Europe, and many other jurisdictions where we have operations or offer our products. The regulatory framework governing the collection, processing, storage and use of confidential and proprietary business information and personal data is rapidly evolving. The United States.States federal and various state and foreign governments have adopted or proposed requirements regarding the collection, distribution, use, security and storage of personally identifiable information and other data relating to individuals, and federal and state consumer protection laws are being applied to enforce regulations related to the online collection, use and dissemination of data.
Further, many foreign countries and governmental bodies, including the European Union (EU”(“EU”), where we conduct business, have laws and regulations concerning the collection and use of personal data obtained from their residents or by businesses operating within their jurisdiction. These laws and regulations often are more restrictive than those in the United States. Laws and regulations in these jurisdictions apply broadly to the collection, use, storage, disclosure, and security of data that identifies or may be used to identify or locate an individual, such as names, email addresses and, in some jurisdictions, IP addresses.
We also expect that there will continue to be new proposed laws, regulations and industry standards concerning privacy, data protection and information security in the United States, the EU, and other jurisdictions. For example, the European Commission recently adopted a General Data Protection Regulation (the “GDPR”) that became fully effective inon May 25, 2018, that will supersede currentsuperseding prior EU data protection legislation, imposeimposing more stringent EU data protection requirements, and provideproviding for greater penalties for noncompliance. The United Kingdom has enacted a Data Protection Act and legislation referred to as the UK GDPR that substantially implements the GDPR. We are evaluating obligations imposed on us by the GDPR and we may be required to incur substantial expense in order to make significant changes to our product and business operations in connection with obtaining and maintaining compliance with the GDPR and similar legislation, such as the UK GDPR and UK Data Protection Act, all of which may adversely affect our revenue and product sales. Additionally, California recently enacted legislation, the California Consumer Privacy Act (the “CCPA”) that, among other things, requires covered companies to provide new disclosures to California consumers, and afford such consumers new abilities to opt-out of certain sales of personal information. Additionally, a new privacy law, the California Privacy Rights Act (the “CPRA”), was approved by California voters in the November 2020 election. The CPRA significantly modifies the CCPA, creating obligations relating to consumer data beginning on January 1, 2022, with implementing regulations expected on or before July 1, 2022, and enforcement beginning July 1, 2023. We cannot yet fully determine the impact suchthese or future laws, regulations and standards may have on our business. Suchbusiness, but they may require us to modify our data processing practices and policies and to incur substantial costs and expenses in an effort to comply. Privacy, data protection and information security laws and regulations are often subject to differing interpretations, may be inconsistent among jurisdictions, and may be alleged to be inconsistent with our current or future practices. Additionally, we may be bound by contractual requirements applicable to our collection, use, processing, and disclosure of various types of data, including personal data, and may be bound by, or voluntarily comply with, self-regulatory or other industry standards relating to these matters. These and other requirements could reduce demand for our products, increase our costs, impair our ability to grow our business, or restrict our ability to store and process data or, in some cases, impact our ability to offer our service in some locations and may subject us to liability. Any failure or perceived failure to comply with applicable laws, regulations, industry standards, and contractual obligations may adversely affect our business. Further, in view of new or modified federal, state, or foreign laws and regulations, industry standards, contractual obligations and other legal obligations, or any changes in their interpretation, we may find it necessary or desirable to fundamentally change our business activities and practices or to expend significant resources to modify our product and otherwise adapt to these changes. We may be unable to make such changes and modifications in a commercially reasonable manner or at all, and our ability to develop new products and features could be limited.
The costs of compliance with and other burdens imposed by laws, regulations and standards may limit the use and adoption of our service and reduce overall demand for it, or lead to significant fines, penalties, or liabilities for any noncompliance. Privacy, information security, and data protection concerns, whether valid or not valid, may inhibit market adoption of our platform, particularly in certain industries and foreign countries.countries.
We expect that we will experience long and unpredictable sales cycles, which may impact our operating results.
The sales cycle between initial customer contact and execution of a contract or license agreement with a customer or purchaser of our products can vary widely. We expect that our sales cycles will be long and unpredictable due to several factors, including but not limited to:
The need to educate potential customers about our patent rights and our product and service capabilities;
The impact of the COVID-19 pandemic on our potential customers and their business operations, including their budgetary constraints and resources devoted to adopting new products.
Our customers’ willingness to invest potentially substantial resources and modify their network infrastructures to take advantage of our products;
Our customers’ budgetary constraints;
The timing of our customers’ budget cycles;
Delays caused by customers’ internal review processes; and
Long sales cycles that may increase the risk that our financial resources are exhausted before we are able to generate significant revenue.
In addition, potential customers of our products include local, state, federal and foreign government authorities. Sales to government authorities can be extended and unpredictable. Government authorities generally have complex budgeting, purchasing, and regulatory processes that govern their capital spending, and their spending is likely to be adversely impacted by economic conditions, including impacts from the COVID-19 pandemic. In addition, in many instances, sales to government authorities may require field trials and may be delayed by the time it takes for government officials to evaluate multiple competing bids, negotiate terms, and award contracts.
For these reasons, the sales cycle associated with our products is subject to a number of significant risks that are beyond our control. Consequently, if our forecasted customer orders are not realized or delayed, our revenues and results of operations could be materially and adversely affected.
If we are unable to expand our revenue sources or establish, sustain, grow, or replace relationships with a diversified customer base, our revenues may be limited.
We currently generate revenue from a limited number of customers that have entered Settlementsettlement and License Agreements. Although ourlicense agreements. Our GABRIEL Collaboration SuiteSuite™ is not currently generating limited revenue, and it will take time for us to grow our installed user base and generate new customers. Additionally, there is no guarantee that we will be able to derive revenue from new customers, sustain or increase revenue from existing customers or replace customers from whom we currently generate revenue. As a result, our revenue may be limited or static.
We have limited technical resources and are at an early stage in the development and commercialization of our GABRIEL Collaboration Suite.products.
In addition, a high percentage of our expenses are and will continue to be fixed. Accordingly, if we do not generate revenue as and when anticipated, our losses may be greater than expected and our operating results will suffer.
Our products are highly technical and may contain undetected errors, which could cause harm to our reputation and adversely affect our business.
Our products are highly technical and complex and, when deployed, may contain errors or defects. Despite testing, some errors in our products may only be discovered after a product has been installed and used by customers. Any errors or defects discovered in our products after commercial release could result in failure to achieve market acceptance, loss of revenue or delay in revenue recognition, loss of customers and increased service and warranty cost, any of which could adversely affect our business, operating results, and financial condition. In addition, we could face claims for product liability, tort, or breach of warranty, including claims relating to changes to our products made by our channel partners. The performance of our products could have unforeseen or unknown adverse effects on the networks over which they are delivered as well as on third-party applications and services that utilize our services, which could result in legal claims against us, harming our business. Furthermore, we expect to provide implementation, consulting, and other technical services in connection with the implementation and ongoing maintenance of our products, which typically involves working with sophisticated software, computing, and communications systems. We expect that our contracts with customers will contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and adversely affect the market’s perception of us and our products. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all, our business, operating results, and financial condition could be adversely impacted.
Malfunctions of third-party communications infrastructure, hardware and software expose us to a variety of risks that we cannot control.
Our business will depend upon, among other things, the capacity, reliability, security, and securityunimpeded access of the infrastructure owned by third parties that we will use to deploy our offerings. We have no control over the operation, quality, or maintenance of a significant portion of that infrastructure or whether or not those third parties will upgrade or improve their equipment. We depend on these companies to maintain the operational integrity of our connections. If one or more of these companies is unable or unwilling to supply or expand its levels of service to us in the future, our operations could be severely interrupted. Also, to the extent that the number of users of networks utilizing our current or future products suddenly increases, the technology platform and secure hosting services which will be required to accommodate a higher volume of traffic may result in slower response times or service interruptions. System interruptions or increases in response time could result in a loss of potential or existing users and, if sustained or repeated, could reduce the appeal of the networks to users. In addition, users depend on real-time communications; outages caused by increased traffic could result in delays and system failures. These types of occurrences could cause users to perceive that our solution does not function properly and could therefore adversely affect our ability to attract and retain licensees, strategic partners, and customers.
System failure or interruption or our failure to meet increasing demands on our systems could harm our business.
The success of our license and service offerings will depend on the uninterrupted operation of various systems, secure data centers and other computer and communication networks that we establish. To the extent, the number of users of networks utilizing our future products suddenly increases, the technology platform and hosting services which will be required to accommodate a higher volume of traffic may result in slower response times, service interruptions or delays or system failures. Our systems and operations will also be vulnerable to damage or interruption from, among other things:
System interruptions or failures and increases or delays in response time could result in a loss of potential or existing users and, if sustained or repeated, could reduce the appeal of the networks to users. These types of occurrences could cause users to perceive that our solution does not function properly and could therefore adversely affect our ability to attract and retain licensees, strategic partners, and customers.
Any significant problem with our systems or operations could result in lost revenue, customer dissatisfaction or lawsuits against us. A failure in the operation of our secure domain name registration system could result in the inability of one or more registrars to register and maintain secure domain names for a period of time. A failure in the operation or update of the master directory that we plan to maintain could result in deletion or discontinuation of assigned secure domain names for a period of time. The inability of the registrar systems we establish, including our back-office billing and collections infrastructure, and telecommunications systems to meet the demands of an increasing number of secure domain name requests could result in substantial degradation in our customer support service and our ability to process registration requests in a timely manner.
Our ability to sell our solutions will be dependent on the quality of our technical support, and our failure to deliver high-quality technical support services could have a material adverse effect on our sales and results of operations.
If we do not effectively assist our customers in deploying our products, succeed in helping our customers quickly resolve post-deploymentpost- deployment issues and provide effective ongoing support, or if potential customers perceive that we may not be able achieve to the foregoing, our ability to sell our products would be adversely affected, and our reputation with current and potential customers could be harmed. In addition, as we expand our operations internationally, our technical support team will face additional challenges, including those associated with delivering support, training, and documentation in languages other than English. Our failure to deliver and maintain high-quality technical support services to our customers could result in customers choosing to use our competitors’ products and support services instead of ours in the future.future.
Telephone carriers have petitioned governmental agencies to enforce regulatory tariffs, which, if granted, would increase the cost of online communication, and such increase in cost may impede the growth of online communication and adversely affect our business.
Use of the Internet has over-burdened existing telecommunications infrastructures, and many high traffic areas have begun to experience interruptions in service. As a result, certain local telephone carriers have petitioned governmental agencies to enforce regulatory tariffs on IP telephony traffic that crosses over their traditional telephone networks. If the relief sought in these petitions is granted, the costs of communicating via online could increase substantially, potentially adversely affecting the growth in the use of online secure communications. Any of these developments could have an adverse effect on our business.
The departure of Kendall Larsen, our Chief Executive Officer and President, and/or other key personnel could compromise our ability to execute our strategic plan and may result in additional severance costs to us.materially harm our business.
Our success largely depends on the skills, experience, and effortsperformance of our key personnel, includingpersonnel. Due to the specialized nature of our business and limited staff, we are particularly dependent on Kendall Larsen, our Chief Executive Officer and President. We have no employment agreements with any of our key executives that prevent them from leaving us at any time. In addition, we do not maintain key person life insurance for any of our officers or key employees. The loss of Mr. Larsen, or our failure to retain other key personnel or adequately plan for the succession of key personnel, would jeopardize our ability to execute our strategic plan and materially harm our business.
We will need to recruit and retain additional qualified personnel to successfully grow our business.
Our future success will depend, in part, on our ability to attract and retain qualified engineering, operations, marketing, sales and executive personnel. Inability to attract and retain such personnel could adversely affect our business. Competition for engineering, operations, marketing, sales, and executive personnel is intense, particularly in the technology and Internet sectors and in the regions where we conduct our business. We may need to invest significant amounts of cash and equity to attract and retain employees and expend significant time and resources to identify, recruit, train and integrate such employees, and we may never realize returns on these investments. Additionally, we can provide no assurance that we will attract or retain such personnel.
Our international expansion will subject us to additional costs and risks, and our plans may not be successful.
We expect to expand our presence internationally in Japan and elsewhere through third party arrangements such as international partnerships, joint ventures and potentially establishing international subsidiaries and offices. Our international expansion may present challenges and risks, including those inherent in international operations, to us and may require significant attention from management. For example, the COVID-19 pandemic has and could continue to disrupt and slow our international expansion and partnership efforts, as our international partners’ businesses could continue to be disrupted. We may identify future material weakness whichnot be successful in our international partnerships, expansion efforts, and we may resultincur significant operating expenses in late filings,our efforts to expand internationally.
We have incurred and will continue to incur significant increased costs or declinesas a result of operating as a public company, and our management will be required to continue to devote substantial time to various compliance initiatives.
The Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, as well as other rules implemented by the SEC and the New York Stock Exchange (“NYSE”), impose various requirements on public companies, including requiring changes in corporate governance practices. These and proposed corporate governance laws and regulations under consideration may further increase our compliance costs. If compliance with these various legal and regulatory requirements diverts our management’s attention from other business concerns, it could have a material adverse effect on our business, financial condition, and operating results. The Sarbanes-Oxley Act requires, among other things, that we assess the effectiveness of our internal control over financial reporting annually and disclosure controls and procedures quarterly. If we are unable to assert in any future reporting periods that our internal control over financial reporting is effective (or if our independent registered public accounting firm is unable to express an opinion on the effectiveness of our internal controls), we could lose investor confidence in the accuracy and completeness of our financial reports, which would have an adverse effect on our share price.
Although we believe that we currently maintain effective control over our disclosures and procedures and internal control over financial reporting, we may in the future identify deficiencies regarding the design and effectiveness of our system of internal control over financial reporting. If we experience any material weaknesses in our internal control over financial reporting in the future or are unable to provide unqualified management or attestation reports about our internal controls, we may be unable to meet financial and other reporting deadlines and may incur costs associated with remediation, and any of which could cause our share price to decline. Moreover, if we identify deficiencies in our internal control over financial reporting that are deemed to be material weaknesses in future periods, the market price of our common stock could decline, and we could be subject to potential delisting by the NYSE and review by the NYSE, the SEC, or other regulatory authorities, which would require the expenditure by us of additional financial and management resources. As a result, our shareholders could lose confidence in our financial reporting, which would harm our business and the market price of our common stock.
There are inherent uncertainties involved in estimates, judgments and assumptions used in the preparation of financial statements in accordance with U.S. GAAP. Any changes in estimates, judgments and assumptions could have a material adverse effect on our business, financial condition, and operating results.
The preparation of financial statements in accordance with U.S. GAAP involves making estimates, judgments and assumptions that affect reported amounts of assets (including intangible assets), liabilities and related reserves, revenues, expenses, and income. Estimates, judgments and assumptions are inherently subject to change in the future, and any such changes could result in corresponding changes to the amounts of assets, liabilities, revenues, expenses, and income. Any such changes could have a material adverse effect on our business, financial condition, and operating results.
Our results of operations and financial condition could be materially affected by the enactment of legislation implementing changes in the U.S. or foreign taxation of international business activities or the adoption of other tax reform policies.
As we expand the scale of our international business activities, any changes in the U.S. or foreign taxation of such activities may increase our worldwide effective tax rate and harm our business, results of operations, and financial condition. For example, in December 2017, the legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”) was enacted, which contained significant changes to U.S. tax law, including, but not limited to, a reduction in the corporate tax rate and a transition to a new territorial system of taxation. The impact of future changes to U.S. and foreign tax law on our business is uncertain and could be adverse, and we will continue to monitor and assess the impact of any such changes.
War, terrorism, other acts of violence, or natural or manmade disasters may affect the markets in which we operate, our clients and our service delivery.
Our business may be adversely affected by instability, disruption, or destruction in a geographic region in which we operate, regardless of cause, including war, terrorism, riot, civil insurrection, or social unrest, and natural or manmade disasters, including famine, flood, fire, earthquake, storm, or pandemic events and spread of disease, such as the COVID-19 pandemic. Such events may cause our customers to delay their decisions on spending for the services we provide and give rise to sudden significant changes in regional and global economic conditions and cycles. These events may also pose risks to our personnel and to physical facilities and operations, which could adversely affect our financial results.
The global COVID-19 pandemic may harm our business, financial condition, and results of operations.
In December 2019, a novel coronavirus, COVID-19 was reported in China and in March 2020, the World Health Organization declared it a pandemic. This contagious disease outbreak has continued to spread across the globe and is impacting worldwide economic activity and financial markets. In light of the uncertain and rapidly evolving situation relating to the spread of COVID-19, we have taken precautionary measures intended to minimize the risk of the virus to our employees, our customers, and other third parties with whom we interact. We are requiring all employees to work remotely and have also suspended all non-essential travel worldwide for our employees. While we have a distributed workforce and our employees are accustomed to working remotely or working with other remote employees, our workforce is not fully remote. Our employees and consultants travel frequently to establish and maintain relationships with one another, our customers and prospective customers, partners, and investors. Although we continue to monitor the situation and may adjust our current policies as more information and public health guidance becomes available, temporarily suspending travel and restricting the ability to do business in person could negatively affect our customer success efforts, sales and marketing efforts, challenge our ability to enter into customer contracts in a timely manner, slow down our recruiting efforts, or create operational or other challenges, any of which could harm our business, financial condition and results of operations. Furthermore, if a natural disaster, power outage, connectivity issue, or other event occurred that impacted our employees’ ability to work remotely, it may be difficult or, in certain cases, not possible, for us to continue our business for a substantial period of time. The increase in remote working may also result in consumer privacy, IT security and fraud concerns as well as increase our exposure to potential wage and hour issues. In addition, the COVID-19 pandemic may disrupt the operations of our customers, partners, suppliers, and other third-party providers for an indefinite period of time, including as a result of travel restrictions, adverse effects on budget planning processes, and/or business shutdowns, all of which could negatively impact our business, financial condition, and results of operations. More generally, the COVID-19 pandemic could continue to adversely affect economies and financial markets globally, potentially leading to an economic downturn, which could decrease technology spending and adversely affect our business.
Risks Related to Our Common Stock
Trading in our common stock is limited and the price of our common shares may be subject to substantial volatility.
Our common stock is currently listed on the NYSE MKT.and was previously listed on the NYSE American LLC (formerly the NYSE MKT LLC). Over the past years, the market price of our common stock has experienced significant fluctuations. Between OctoberApril 1, 2016,2020, and September 30, 2017,March 31, 2021, the reported last adjusted closing price on the NYSE MKTAmerican LLC, and now NYSE, for our common stock ranged between $1.85$4.29 and $5.30$8.17 per share. The price of our common stock may continue to be volatile as a result of several factors, some of which are beyond our control. These factors include, but not limited to, the following:
Developments or lack thereof in any then-outstanding litigation;
In addition, we believe there has been and may continue to be substantial trading in derivatives of our stock, including short selling activity or related similar activities, which are beyond our control and which may be beyond the full control of the SEC and Financial Institutions Regulatory Authority or “FINRA”. While the SEC and FINRA rules prohibit some forms of short selling and other activities that may result in stock price manipulation, such activity may nonetheless occur without detection or enforcement. We have held conversations with regulators concerning trading activity in our stock; however, there can be no assurance that should there be any illegal manipulation in the trading of our stock, it will be detected, prosecuted, or successfully eradicated. Significant short selling or other types of market manipulation could cause our stock trading price to decline, to become more volatile, or both.
The market price of our common stock has been and may continue to be volatile, and you could lose all or part of your investment.
The trading price of our common stock has been volatile since our initial public offering and is likely to continue to be volatile. Factors that could cause fluctuations in the market price of our common stock include, but are not limited to the following:
Changes in accounting standards, policies, guidelines, interpretations, or principles;
Further, in recent years the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. In addition, the stock prices of many technology companies have experienced wide fluctuations that have often been unrelated to the operating performance of those companies. These broad market and industry fluctuations, as well as general economic, political and market conditions such as recessions, government shutdowns, global pandemics (such as the COVID-19 pandemic), interest rate changes the stability of the EU and the exit of the United Kingdom or international currency fluctuations, may cause the market price of our common stock to decline. In the past, following periods of volatility in the overall market and the market price of a particular company’s securities, securities class action litigation has often been instituted against these companies.
We have broad discretion in how we apply our funds, and we may not use these funds effectively, which could affect our results of operations and cause our stock price to decline.
Our management will have broad discretion in the application of our existing cash, cash equivalents and marketable securities and could spend these funds in ways that do not improve our results of operations or enhance the value of our common stock. Pending their use, we may invest our available funds in a manner that does not produce income or that loses value. The failure by our management to apply our available funds effectively could result in financial losses that could cause the price of our common stock to decline and delay the development of our products.
In addition, an entity that, among other things, is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, owning, trading, or holding certain types of securities would be deemed an Investment Company under the Investment Company Act of 1940 (the “1940 Act”). If we do not manage our investments and business in a manner that meets the requirements for an exemption under the 1940 Act, we may be deemed to be an investment company under the 1940 Act and subject to additional limitations on operating our business including limitations on the issuance of securities, which may make it difficult for us to raise capital.
We do not regularly pay dividends on our common stock and thus stockholders must look to appreciation of our common stock to realize a gain on their investments.
Our dividend policy is within the discretion of our Board of Directors and will depend upon various factors, including our business, financial condition, results of operations, capital requirements, and investment opportunities. We therefore cannot make assurances that our Board of Directors will determine to pay regular or special dividends in the future. Accordingly, unless our Board of Directors determines to pay dividends, stockholders will be required to look to appreciation of our common stock to realize a gain on their investment, which may not occur.
The exercise of our outstanding stock options, warrants and RSUs and issuance of new shares would result in a dilution of our current stockholders’ voting power and an increase in the number of shares eligible for future resale in the public market which may negatively impact the market price of our stock.
The exercise of our outstanding vested stock options, warrants and RSUs would dilute the ownership interests of our existing stockholders. As of March 31, 2021, we had outstanding options, warrants and RSUs to purchase an aggregate of 6,341,844 shares of common stock representing approximately 9% of our total shares outstanding of which 4,674,542 were vested and therefore exercisable. To the extent outstanding stock options are exercised, additional shares of common stock will be issued, existing stockholders’ percentage voting interests will decline and the number of shares eligible for resale in the public market will increase. Such increase may have a negative effect on the value or market trading price of our common stock.
The market price of our common stock may decline because our operating results may not be consistent and may be difficult to predict.
Our reported net income has fluctuated in the past due to several factors. We expect that our future operating results may also fluctuate due to the same or similar factors. While we had net income of $280.4 million for the year ended December 31, 2020, we had net losses of $19.2 million for the year ended December 31, 2019, and $26.4 million for the quarter ended March 31, 2021. As of March 31, 2021, we had accumulated deficits of $34.5 million. The following include some of the factors that may cause our operating results to fluctuate:
The outcome of actions to enforce our intellectual property rights currently in progress or that we may undertake in the future, and the timing thereof;
The impact of the COVID-19 pandemic on our sales cycle and results;
The amount and timing of receipt of license fees from potential infringers, licensees, or customers;
The rate of adoption of our patented technologies;
The number of new license arrangements we may execute, or that may expire, within a particular period and the scope of those licenses, including the number of our patents which are licensed, the extent of prior infringement of our patent rights, royalty rates, timing of payment obligations, expiration date etc.;
The success of a licensee in selling products that use our patented technologies; and
The amount and timing of expenses related to our patent filings and enforcement proceedings, including litigation, related to our intellectual property rights.
These fluctuations may make our business particularly difficult to manage, adversely affect our business and operating results, make our operating results difficult for investors to predict and, further, cause our results to fall below investor’s expectations and adversely affect the market price of our common stock.
Because ownership of our common stock is concentrated, investors may have limited influence on stockholder decisions.
As of September 30, 2017,March 31, 2021, our executive officers and directors beneficially owned approximately 18%14% of our outstanding common stock. In addition, a group of stockholders that, as of December 31, 2007, held 4,766,666 shares, or approximately 8%7% of our outstanding common stock, have entered into a voting agreement with us that requires them to vote all of their shares of our voting stock in favor of the director nominees approved by our Board of Directors at each director election going forward, and in a manner that is proportional to the votes cast by all other voting shares as to any other matters submitted to the stockholders for a vote. However, we cannot be certain how many shares of our common stock this group of stockholders currently owns. Because of their beneficial ownership interest, our officers and directors could significantly influence stockholder actions of which you disapprove or that are contrary to your interests. This ability to exercise significant influence could prevent or significantly delay another company from acquiring or merging with us.us.
Our protective provisions in our amended and restated certificate of incorporation and bylaws could make it difficult for a third party to successfully acquire us even if you would like to sell your stock to them.
We have a number of protective provisions in our amended and restated certificate of incorporation and bylaws that could delay, discourage, or prevent a third party from acquiring control of us without the approval of our Board of Directors. These protective provisions include:
| • | A staggered Board of Directors: This means that only one or two directors (since we have a five-person Board of Directors) will be up for election at any given annual meeting. This has the effect of delaying the ability of stockholders to affect a change in control of us because it would take two annual meetings to effectively replace a majority of the Board of Directors. |
| • | Blank check preferred stock: Our Board of Directors has the authority to establish the rights, preferences, and privileges of our 10,000,000 authorized, but unissued, shares of preferred stock. Therefore, this stock may be issued at the discretion of our Board of Directors with preferences over your shares of our common stock in a manner that is materially dilutive to you. In addition, blank check preferred stock can be used to create a “poison pill” which is designed to deter a hostile bidder from buying a controlling interest in our stock without the approval of our Board of Directors. We have not adopted such a “poison pill;” but our Board of Directors has the ability to do so in the future, very rapidly and without stockholder approval. |
| • | Advance notice requirements for director nominations and for new business to be brought up at stockholder |
| • | No stockholder actions by written consent: No stockholder or group of stockholders may take actions rapidly and without prior notice to our Board of Directors and management or to the minority stockholders. Along with the advance notice requirements described above, this provision also gives our Board of Directors and management more time to react to proposed stockholder actions. |
| • | Super majority requirement for stockholder amendments to the bylaws: Stockholder proposals to alter or amend our bylaws or to adopt new bylaws can only be approved by the affirmative vote of at least 66 2/3% of the outstanding shares of our common stock. |
| • | No ability of stockholders to call a special meeting of the stockholders: Only the Board of Directors or management can call special meetings of the stockholders. This could mean that stockholders, even those who represent a significant percentage of our shares of common stock, may need to wait for the annual meeting before nominating directors or raising other business proposals to be voted on by the stockholders. |
In addition, the provisions of Section 203 of the Delaware General CorporateCorporation Law govern us. These provisions may prohibit large stockholders, in particularparticularly those owning 15% or more of our outstanding voting stock, from merging or combining with us for a certain period of time.
These and other provisions in our amended and restated certificate of incorporation, our bylaws and under Delaware law could discourage potential takeover attempts, reduce the price that investors might be willing to pay for shares of our common stock in the future and result in the market price being lower than it would be without these provisions.
However, notwithstanding the exclusive forum provisions, our amended and restated bylaws explicitly state that they would not preclude the filing of claims brought to enforce any liability or duty created under federal securities laws, including the Securities Act of 1933 or the Securities Exchange Act of 1934, the registrant has duly caused1934.
Any person or entity purchasing or otherwise acquiring any interest in any of our securities shall be deemed to have notice of and consented to this reportprovision. This exclusive-forum provision may limit a stockholder’s ability to bring a claim in a judicial forum of its choosing for disputes with us or our directors, officers, or other employees, which may discourage lawsuits against us and our directors, officers, and other employees. If a court were to find this exclusive-forum provision in our amended and restated bylaws to be signed on its behalf byinapplicable or unenforceable in an action, we may incur additional costs associated with resolving the undersigned thereunto duly authorized.dispute in other jurisdictions, which could harm our results of operations.
Exhibit Number | Description |
| Certification of the President and Chief Executive Officer | |
| Certification of the Chief Financial Officer | |
| Certification of the President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 101 | Interactive Data Files |
| * |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| VIRNETX HOLDING CORPORATION | |||
| By: | /s/ Kendall Larsen | ||
| Name | Kendall Larsen | ||
| Chief Executive Officer (Principal Executive Officer) | |||
| By: | /s/ Richard H. Nance | ||
| Name | Richard H. Nance | ||
| Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) | |||
| Date: May 10, 2021 | |||
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