NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts)
(Unaudited)
Note 1 — Business Description
VirnetX Holding Corporation, which we refer to 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. Since 2012 we had revenues from settlements of patent infringement disputes whereby we received consideration for past sales of licenses 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 49 U.S. and 69 foreign patents with approximately 50 pending patent applications worldwide. 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”) communications in areas including “Smart City,” “Connected Car” and “Connected Home.” All our U.S. and foreign patents and pending patent applications relate generally to securing communications over the Internet and as such, cover all our technology and other products. Our issued U.S. and foreign patents expire at various times during the period from 2019 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.
Note 2 — Basis of Presentation and Summary of Significant Accounting Policies
Basis of Consolidation
The consolidated financial statements include the accounts of VirnetX Holding Corporation and our wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated.
Unaudited Interim Financial Information
The accompanying Condensed Consolidated Balance Sheet as of September 30, 2017, the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2017 and 2016, the Condensed Consolidated Statements of Comprehensive Loss 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 prepared in accordance with generally accepted accounting principles 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 results to be expected for the year ending December 31, 2017.
These unaudited interim condensed 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, 2016, filed with the SEC on March 16, 2017.
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 our accounting estimates are reasonably likely to occur. 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, at the time they are made 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.
Reclassifications
Certain prior period amounts were reclassified to conform to the current year’s presentation. None of these reclassifications had an impact on reported net income for any of the periods presented.
Revenue Recognition
We derive our revenue from patent licensing. The timing and amount of revenue recognized from each licensee depends upon a variety of factors, including the specific terms of each agreement and the nature of the deliverables and obligations. Such agreements may be complex and include multiple elements. These agreements may include, without limitation, elements related to the settlement of past patent infringement liabilities, up-front and non-refundable license fees for the use of patents, patent licensing royalties on covered products sold by licensees, and the compensation structure and ownership of intellectual property rights associated with contractual technology development arrangements. Licensing agreements are accounted for under the Financial Accounting Standards Board (“FASB”) revenue recognition guidance, “Revenue Arrangements with Multiple Deliverables.” This guidance requires consideration to be allocated to each element of an agreement that has stand-alone value using the relative fair value method. In other circumstances, such as those agreements involving consideration for past and expected future patent royalty obligations, after consideration of the particular facts and circumstances, the appropriate recording of revenue between periods may require the use of judgment. In all cases, revenue is only recognized after all the following criteria are met: (1) written agreements have been executed; (2) delivery of technology or intellectual property rights has occurred or services have been rendered; (3) fees are fixed or determinable; and (4) collectability of fees is reasonably assured.
Patent License Agreements
: Upon signing a patent license agreement, including licenses entered into upon settlement of litigation, we provide the licensee permission to use our patented technology in specific applications. We account for patent license agreements in accordance with the guidance for revenue recognition for arrangements with multiple deliverables, with amounts allocated to each element based on their fair values. We have elected to utilize the leased-based model for revenue recognition with revenue being recognized over the expected period of benefit to the licensee. Under our patent license agreements, we do or expect to typically receive one or a combination of the following forms of payment as consideration for permitting our licensees to use our patented inventions in specific applications and products:
•
Consideration for Past Sales
: Consideration related to a licensee’s product sales from prior periods may result from a negotiated agreement with a licensee that utilized our patented technology prior to signing a patent license agreement with us or from the resolution of a litigation, disagreement or arbitration with a licensee over the specific terms of an existing license agreement. We may also receive royalty for past sales in connection with the settlement of patent litigation where there was no prior patent license agreement. These amounts are negotiated, typically based upon application of a royalty rate to historical sales prior to the execution of the license agreement. In each of these cases, because delivery has occurred, we record the consideration as revenue when we have obtained a signed agreement, identified a fixed or determinable price, and determined that collectability is reasonably assured.
•
Current Royalty Payments
: Ongoing royalty payments cover a licensee’s obligations to us related to its sales of covered products in the current contractual reporting period. Licensees that owe these current royalty payments are obligated to provide us with quarterly or semi-annual royalty reports that summarize their sales of covered products and their related royalty obligations to us. We expect to receive these royalty reports subsequent to the period in which our licensees’ underlying sales occurred. As a result, it is impractical for us 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.
•
Non-Refundable Up-Front Fees and Minimum Fee Contracts
: For licenses that provide for non-refundable up-front or fixed minimum fees over their term, for which we have no future obligations or performance requirements, 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 are generally presumed not to be fixed or determinable, and revenue is deferred and recognized as earned, but generally not in advance of collection.
•
Non-Royalty Elements
: Elements that are not related to royalty revenue in nature, such as settlement fees, expense reimbursement, and damages, if any, are recorded as gain from settlement which is reflected as a separate line item within the operating expenses section in the consolidated statements of operations.
Deferred revenue
In August 2013, we began receiving annual payments on a contract requiring payment to us over 4 years totaling $10,000 (“August 2013 Contract Settlement”). In accordance with our revenue recognition policy we defer and recognize revenue over the life of the contract, but not ahead of collection. We collected the final payment under the contract in 2016. During the nine months ended September 30, 2017 we recognized $1,125 of revenue related to the August 2013 Contract Settlement.
Activity under the August 2013 Contract Settlement was as follows:
Deferred Revenue, December 31, 2016
|
|
$
|
4,000
|
|
Less: Amount amortized as revenue
|
|
|
1,125
|
|
Deferred Revenue, September 30, 2017
|
|
$
|
2,875
|
|
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 are 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.
Concentration of Credit Risk and Other Risks and Uncertainties
Our cash and cash equivalents are primarily maintained at two major financial institutions in the United States. A portion of those balances are insured by the Federal Deposit Insurance Corporation. During the nine months ended September 30, 2017 we had funds which 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. We have not experienced any losses on our deposits of cash and cash equivalents.
Prepaid Expenses
Prepaid expenses at September 30, 2017 include 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.
Impairment of Long-Lived Assets
On an annual basis, we identify and record impairment losses on long-lived assets when events and changes in circumstances indicate that the carrying amount of an asset might not be recoverable. 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.
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:
Valued at the quoted net asset value of shares held.
U.S. Government and U.S. Agency 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, and December 31, 2016.
|
|
September 30, 2017
|
|
|
|
Adjusted
Cost
|
|
|
Unrealized
Gains
|
|
|
Unrealized
Losses
|
|
|
Fair
Value
|
|
|
Cash
and Cash
Equivalents
|
|
|
Investments
Available
for Sale
|
|
Cash
|
|
$
|
1,427
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
1,427
|
|
|
$
|
1,427
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mutual funds
|
|
|
220
|
|
|
|
-
|
|
|
|
-
|
|
|
|
220
|
|
|
|
220
|
|
|
|
-
|
|
U.S. agency securities
|
|
|
2,667
|
|
|
|
-
|
|
|
|
(2
|
)
|
|
|
2,665
|
|
|
|
-
|
|
|
|
2,665
|
|
|
|
|
2,887
|
|
|
|
-
|
|
|
|
(2
|
)
|
|
|
2,885
|
|
|
|
220
|
|
|
|
2,665
|
|
Total
|
|
$
|
4,314
|
|
|
$
|
-
|
|
|
$
|
(2
|
)
|
|
$
|
4,312
|
|
|
$
|
1,647
|
|
|
$
|
2,665
|
|
|
|
December 31, 2016
|
|
|
|
Adjusted
Cost
|
|
|
Unrealized
Gains
|
|
|
Unrealized
Losses
|
|
|
Fair
Value
|
|
|
Cash
and Cash
Equivalents
|
|
|
Investments
Available
for Sale
|
|
Cash
|
|
$
|
3,432
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
3,432
|
|
|
$
|
3,432
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mutual funds
|
|
|
3,195
|
|
|
|
—
|
|
|
|
—
|
|
|
|
3,195
|
|
|
|
3,195
|
|
|
|
—
|
|
U.S. government securities
|
|
|
1,254
|
|
|
|
—
|
|
|
|
—
|
|
|
|
1,254
|
|
|
|
—
|
|
|
|
1,254
|
|
U.S. agency securities
|
|
|
7,996
|
|
|
|
2
|
|
|
|
(3
|
)
|
|
|
7,995
|
|
|
|
—
|
|
|
|
7,995
|
|
|
|
|
12,445
|
|
|
|
2
|
|
|
|
(3
|
)
|
|
|
12,444
|
|
|
|
3,195
|
|
|
|
9,249
|
|
Total
|
|
$
|
15,877
|
|
|
$
|
2
|
|
|
$
|
(3
|
)
|
|
$
|
15,876
|
|
|
$
|
6,627
|
|
|
$
|
9,249
|
|
New Accounting Pronouncements
In June 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments-Credit Losses (Topic 326) “ASU 2016-13”. The purpose of 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 is effective for interim and annual reporting periods beginning after December 15, 2019. We are evaluating the impact this guidance will have on our financial position and statement of operations.
In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718) (“ASU 2016-09”), which simplified certain aspects of the accounting for share-based payment transactions, including income taxes, classification of awards and classification in the statement of cash flows. We adopted this ASU in 2017 with the following affects:
• ASU 2016-9 requires excess tax benefits to be recognized regardless of whether the benefit reduces taxes payable. We had zero excess tax benefits recognized for the nine months ended September 30, 2017.
• Certain prior period amounts were reclassified to conform to the current year’s presentation. None of these reclassifications had an impact on reported net income for any of the periods presented. As a result of the implementation of ASU 2016-09, our condensed consolidated statements of cash flow for the nine months ended September 30, 2016 has been restated to reflect the reclassification of $93 for payments of taxes on cashless exercise of restricted stock units, previously reported in cash flows from operation activities to the current presentation in cash flows from financing activities.
• The Company has elected to not estimate forfeitures expected to occur to determine the amount of stock-based compensation cost to be recognized in each period. The guidance relating to forfeitures did not have an impact on our accumulated deficit as of January 1, 2017.
In February 2016, FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 requires an entity to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. For public companies, ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period, and requires a modified retrospective adoption, with early adoption permitted. We are evaluating the impact this guidance will have on our financial position and statement of operations.
In May 2014, the FASB issued ASU No. 2014-09 Revenue from Contracts with Customers (Topic 606) “ASU 2014-09”. ASU 2014-09 was subsequently amended by ASU No. 2016-10 and 2016-12. As amended, Topic 606 supersedes the revenue recognition requirements in Topic 605, Revenue Recognition including most industry-specific revenue recognition guidance throughout the Industry Topics of the Codification. In addition, the amendments create a new Subtopic 340-40, Other Assets and Deferred Costs—Contracts with Customers
.
In summary, the core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. For a public entity, the amendments to ASU 2014-09 are effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. We will adopt the new revenue standards in our first quarter of 2018 utilizing the full retrospective transition method. The new revenue standards are not expected to have a material impact on the amount and timing of revenue recognized in our consolidated financial statements.
Note 3 - Income Taxes
We had $1 income tax benefit for the three months ended September 30, 2017 and $4 of income tax expense for the nine months ended September 30, 2017. During the three and nine-month period ended September 30, 2017, we had net operating losses (“NOLs”) which generated deferred tax assets for NOL carryforwards. 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.
We had $119 income tax expense for the three months ended September 30, 2016 and $126 of income tax expense for the nine months ended September 30, 2016. During the three and nine-month periods ended September 30, 2016, we had NOLs which generated deferred tax assets for NOL carryforwards. We provided valuation allowances against the net deferred tax assets including the deferred tax assets for NOL carry-forwards. Valuation allowances provided for our net deferred tax assets increased by $2,707 and $7,942 for the three and nine months ended September 30, 2016, respectively.
In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all deferred assets will not be realized. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Based on the available objective evidence, including our history of operating losses and the uncertainty of generating future taxable income, management believes it is more likely than not that the net deferred tax assets at September 30, 2017 will not be fully realizable. Accordingly, management has maintained a valuation allowance against our net deferred tax assets at September 30, 2017. The valuation allowance provided against our net deferred tax assets was approximately $50,000 and $44,000 at September 30, 2017 and December 31, 2016, respectively.
At September 30, 2017, we have federal and state NOL carry-forwards of approximately $85,000 and $69,000, respectively, with the federal NOL carry-forwards expiring beginning in 2027. The state NOL carry-forward began expiring in 2016.
We have adopted accounting guidance for income taxes, which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold and measurement attribute for the financial statements recognition and measurement of a tax position taken or expected to be taken in a tax return. We are required to recognize in the financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position.
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 losses and tax credits remaining unutilized from such years.
Our policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. As of September 30, 2017, we had accrued immaterial amounts of interest and penalties related to uncertain tax positions.
Note 4 — Commitments and Related Party Transactions
We lease our offices under an operating lease with a third party expiring in October 2019. We recognize rent expense on a straight-line basis over the term of the lease.
We lease the use of an aircraft from K2 Investment Fund LLC (“LLC”) for business travel for employees of the Company. We incurred approximately $218 and $690 compared to $228 and $596 in rental fees and reimbursements to the LLC during the three and nine months ended September 30, 2017 and 2016, respectively. Our Chief Executive Officer and Chief Administrative Officer are the managing partners and control the equity interests of the LLC. On January 31, 2015, we entered a 12-month non-exclusive lease with 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 LLC with 30 days’ notice. The lease renews on an annual basis unless terminated by the lessor or lessee. Neither party has exercised their termination rights.
Note 5 — Stock-Based Compensation
We have a stock incentive plan for employees and others called the VirnetX Holding Corporation 2013 Equity Incentive 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 provides for grants of 16,624,469 shares of our common stock, including stock options and restricted stock units (“RSUs”), and will expire in 2023. As of September 30, 2017, 2,244,631 shares remained available for grant under the Plan.
During the three months ended September 30, 2017, we granted options for a total of 1,377,500 shares with a weighted average grant date fair value of $3.01 During the three months ended September 30, 2016, no options were granted.
During the nine months ended September 30, 2017, we granted options for a total of 1,733,500 shares. The weighted average fair values at the grant dates for options issued during the nine months ended September 30, 2017 was $2.93 per option. 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, 2017 (i) dividend yield on our common stock of 0 percent (ii) expected stock price volatility of 85 percent (iii) a risk-free interest rate of 1.93 percent and (iv) and expected option term of 6 years.
During the nine months ended September 30, 2016, we granted options for a total of 429,000 shares with a weighted average 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.
During the three months ended September 30,
2017
and
2016,
we granted no RSUs.
During the nine months ended September 30, 2017 and 2016, we granted 220,664 and 219,331 RSUs, respectively. The weighted average fair values of at the grant dates for RSUs issued during the nine months
ended September 30, 2017 and 2016 were $3.83 and $4.75 per RSU, respectively. RSUs, which are subject to
forfeiture if service terminates prior to the shares vesting, are expensed ratably over the vesting period.
Stock-based compensation expense included in general and administrative expense was $1,064 and $2,780 for the three and nine months ended September 30, 2017, respectively, and $1,423 and $3,979 for the three and nine months ended September 30, 2016, respectively.
As of September 30, 2017, the unrecognized stock-based compensation expense related to non-vested stock options and RSUs was
$7,180
and
$2,241
, respectively, which will be amortized over an estimated weighted average period of approximately 3.34 and 2.68 years, respectively.
During the nine-month period ended September 30, 2017 we issued 164,146 new shares of common stock as a result of vesting RSUs.
Note 6 — Equity
Common Stock
On August 21, 2015, we filed a universal shelf registration statement with the SEC enabling us to offer and sell from time to time up to $100 million of equity, debt or other types of securities. We also entered an at-the-market (“ATM”) equity offering sales agreement with Cowen & Company, LLC on August 20, 2015, under which we may offer and sell shares of our common stock having an aggregate value of up to $35 million. We have and expect to use 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, we sold 5,595,650 shares under the ATM. The average sales price per common share was $4.14 and the aggregate proceeds from the sales totaled $23,169 during the period. Sales commissions, fees and other costs associated with the ATM totaled $695. During the nine months ended September 30, 2017 no shares were sold under 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”)
Warrants
In 2015, we issued warrants (“Advisor Warrants”) for the purchase of 25,000 shares of common stock at an exercise price of $7 per share, which expire in April 2020. The Advisor Warrants were issued for advisory services provided by a third party. Our Advisor Warrants were recorded at fair value on the issuance 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. The fair value at issuance of the warrants of $121 was recorded in Prepaid Expenses and Other Current Assets, and was amortized over the twelve-month life of the service contract, with the expense included in Selling, General and Administrative Expense in our Condensed Consolidated Statements of Operations.
Information about warrants outstanding during the nine months ended September 30, 2017 follows:
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
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
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25,000
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Stock Purchase and Revenue Sharing Agreement
As previously disclosed in the Company’s public filings, on May 31, 2017, the Company entered into a Stock Purchase Agreement (the “Purchase Agreement”) with Public Intelligence Technology Associates kk (“PITA”), (Japanese Corporation), pursuant to which the Company would issue and sell to PITA 5,494,505 shares of Common Stock (the “Shares”) as promptly as practicable following the satisfaction or waiver of certain closing conditions (the “Share Purchase”). The Share Purchase did not close and the Purchase Agreement was terminated effective as of October 18, 2017.
Concurrently with the termination of the Purchase Agreement, the Company and PITA amended and restated the Revenue Sharing Agreement (the “Amended and Restated Revenue Sharing Agreement”) to have it survive the termination of the Purchase Agreement.
Note 7 — Litigation
We have eleven intellectual property infringement lawsuits pending in the United States District Court for the Eastern District of Texas, Tyler Division, and United States Court of Appeals for the Federal Circuit (“USCAFC”).
VirnetX Inc. v. Apple, Inc. (Case 6:12-CV-00855-LED)
On March 30, 2015, the United States Court for the Eastern District of Texas, Tyler Division, issued an order finding substantial overlap between the remanded portions of the Civil Action Case 6:10-CV-00417-LED (VirnetX vs. Cisco et. al.), and the ongoing Civil Action Case 6:12-CV-00855-LED (VirnetX Inc. v. Apple, Inc.). 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. The jury trial in this case was held on January 25, 2016. On February 4, 2016, a jury in the United States Court for the Eastern District of Texas, Tyler Division, awarded us $625.6 million in a verdict against Apple Inc. for infringing four of our US patents, marking it the second time a federal jury has found Apple liable for infringing VirnetX’s patented technology. The verdict includes royalties awarded to us based on an earlier patent infringement finding
(Case 6:10-CV-00417-LED)
against Apple. The jury found that Apple’s modified VPN On-Demand, iMessage and FaceTime services infringed VirnetX’s patents and that Apple’s infringement was willful. In addition to determining the royalty owed by Apple for its prior infringement, this verdict also includes an award based on the jury’s finding that Apple’s modified VPN On Demand, iMessage and FaceTime services have continued to infringe VirnetX’s patents. The post-trial hearing was held on May 25, 2016 in the United States Court for the Eastern District of Texas, Texarkana Division. On July 29, 2016, the court issued a new order, vacating its previous orders consolidating the cases (Case No. 6:10-cv-417, Docket No. 878 (“Apple I case”); Case No. 6:12-cv-855, Docket No. 220 (“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 case will be retried after Apple I case. Events and developments subsequent to the order from the court are described to support Apple I and Apple II matters.
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 filing a complaint against Aastra USA. Inc. (“Aastra”), Apple, Cisco Systems, Inc. (“Cisco”), and NEC Corporation (“NEC”) in the United States District Court for the Eastern District of Texas, Tyler Division, pursuant to which we alleged that these parties infringe on certain of our patents. We sought damages and injunctive relief. Aastra and NEC agreed to sign license agreements with us and we agreed to drop all the accusations of infringement against them. At the pre-trial hearing, the judge decided to conduct separate jury trial for each defendant, and try only the case against Apple on the scheduled trial date. The jury trial of our case against 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 motions for a new trial and Cisco’s infringement of certain VirnetX patents were denied and the case against Cisco was closed.
The jury trial of our case against Apple was held on October 31, 2012. On November 6, 2012, a jury in the United States Court for the Eastern District of Texas, Tyler Division, awarded us over $368 million in a verdict against Apple for infringing four of our patents. On February 26, 2013, the court issued its Memorandum Opinion and Order regarding post-trial motions resulting from the prior jury verdict denying Apple’s motion to reduce the damages awarded by the jury for past infringement. The Court further denied Apple’s request for a new trial on the liability and damages portions of the verdict and granted our motions for pre-judgment interest, post-judgment interest, and post-verdict damages to date. The Court ordered that Apple pay $34 thousand in daily interest up to final judgment and $330 thousand in daily damages for infringement up to final judgment for certain Apple devices included in the verdict. The Court denied our request for a permanent injunction and severed the future infringement portion into its own separate proceedings under Case 6:13-CV-00211-LED.
On July 3, 2013, Apple filed an appeal of the judgment dated February 27, 2013 and order dated June 4, 2013 denying Apple’s motion to alter or amend the judgment to the USCAFC. On September 16, 2014, USCAFC issued their opinion, affirming the jury’s finding that all 4 of our patents are valid, confirming the jury’s finding of infringement of VPN on Demand under many of the asserted claims of our ‘135 and ‘151 patents, and confirming the district’s court’s decision to allow evidence concerning our licenses and royalty rates in connection with the determination of damages. In its opinion, the USCAFC also vacated the jury’s damages award and the district court’s claim construction with respect to parts of our ‘504 and ‘211 patents and remanded the damages award and determination of infringement with respect to FaceTime –for further proceedings consistent with its opinion. On October 16, 2014, we filed a petition with the USCAFC, requesting a rehearing and rehearing en banc of the Federal Circuit’s September 14, 2014, decision concerning VirnetX’s litigation against Apple Inc. On December 16, 2014, USCAFC denied our petition requesting a rehearing and rehearing en banc of the Federal Circuit’s September 14, 2014, decision and remanded the case back to the Eastern District of Texas, Tyler Division, for further proceedings consistent with its opinion. On February 25, 2015, USCAFC granted Apple’s motions to lift stay of proceedings and vacate Case 6:13-CV-00211-LED. On March 30, 2015, the court issued an order finding substantial overlap between the remanded portions of this case and the ongoing Civil Action Case 6:12-CV-00855-LED (VirnetX Inc. v. Apple, Inc.). 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. The jury trial in this case was held on September 26, 2016. On September 30, 2016, a Jury in the United States Court for the Eastern District of Texas, Tyler Division, in the case VirnetX Inc., et al. v. Apple Inc., No. Apple I, awarded VirnetX $302.4 million in a verdict against Apple for infringing four VirnetX patents, marking the third time a federal jury has found Apple liable for infringing VirnetX’s patented technology.
The verdict includes royalties awarded to VirnetX, for unresolved issues in the Apple I case, remanded back from the USCAFC, related to (1) damages owed to VirnetX for infringement by Apple’s original VPN-on-Demand (VOD) and (2) the alleged infringement by Apple’s original FaceTime product, under the new claim construction of “secure communication link” pertaining to the ’504 and ’211 patents by the USCAFC, and the damages associated with that infringement. The hearing on all the post-trial motions was held on November 22, 2016.
On September 29, 2017, the United States District Court for the Eastern District of Texas, Tyler Division, 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.
In the Order, the Court denied all of Apple’s post-trial motions including motion for judgment as a matter of law of non-infringement, motion for judgment as a matter of law on damages, motion for a new trial on infringement, and motion for a new trial on damages. The Court granted all VirnetX’s post-trial motions including motion for willful infringement and enhanced the royalty rate during the willfulness period by 50 percent, from $1.20 to $1.80 per device, awarding VirnetX, enhanced damages in the amount of $41,271 against Apple thereby, granting VirnetX a total sum of $343,699 in pre-interest damages. The Court also awarded costs, certain attorneys’ fees, and prejudgment interest to VirnetX, and directed the parties to meet and confer regarding these amounts. On October 13, 2017, having met and conferred and having reached agreements on all amounts, parties jointly filed a motion asking 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 back from the United States Court of Appeals for the Federal Circuit. The total Final Judgement amount including Jury Verdict, Willful Infringement, Interest, Costs and Attorney Fees is $439,727. (see “Note 8 - Subsequent Events”).
VirnetX Inc. v. Apple, Inc. (Case 6:12-CV-00855-LED) (“Apple II”)
On November 6, 2012, we filed a complaint against Apple in the United States District Court for the Eastern District of Texas, Tyler Division for willfully infringing four of our patents, U.S. Patent Nos. 6,502,135, 7,418,504, 7,921,211 and 7,490,151, and seeking both an unspecified amount of damages and injunctive relief. The accused products include the iPhone 5, iPod Touch 5th Generation, iPad 4th Generation, iPad mini, and the latest Macintosh computers. Due to their release dates, these products were not included in the previous lawsuit that concluded with a Jury verdict on November 6, 2012 that was subsequently upheld by the United States District Court for the Eastern District of Texas, Tyler Division, on February 26, 2013. On July 1, 2013, we filed a consolidated and amended complaint to include U.S. Patent No. 8,051,181 and consolidate Civil Action No. 6:11-cv-00563-LED. On August 27, 2013, we filed an amended complaint including allegations of willful infringement related to U.S. Patent No. 8,504,697 seeking both damages and injunctive relief. The Markman hearing in this case was held on May 20, 2014 and on August 8, 2014, issued its Markman Order, denying Apple’s motion for summary judgment of indefiniteness, in which Apple alleged that some of the disputed claims terms in the patents asserted by us were invalid for indefiniteness. In a separate order, the court granted in part and denied in part our motion for partial summary judgment on Apple’s invalidity counterclaims, precluding Apple from asserting invalidity as a defense against infringement 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.
On September 29, 2017, the Court issued an order denying Apple’s Motion to Stay. The Court ordered the parties to meet and confer and file a joint motion with a proposed trial date by October 13, 2017. The parties have met, conferred and filed a joint motion on the proposed trial dates. We are awaiting court order setting the date for a new jury trial in Apple II case.
VirnetX Inc. v. Apple, Inc. (Case 15-1934)
On July 10, 2015, 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.
VirnetX Inc. v. Apple, Inc. (Case 16-1211)
On September 28, 2015, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in IPR2014-00403 and IPR2014-00404 and on October 22, 2015 for IPR2014-00481 and IPR2014-00482 involving our U.S. Patent Nos. 7,188,180, and 7,987,274. 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 IPR2014-00403 and IPR2014-00481. We are currently evaluating our options in this case.
VirnetX Inc. v. Apple, Inc. (Case 16-1480)
On November 30, 2015, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in inter-partes reexamination no. 95/001,949 related to U.S. Patent No. 8,051,181. The oral arguments in this case were heard on November 7, 2016. On December 9, 2016, the USCAFC affirmed the PTAB based on certain grounds. We are currently evaluating our options in this case.
VirnetX Inc. v. Apple, Inc. (Case 16-119)
On March 4, 2016, we filed a petition for writ of mandamus with the USCAFC, requesting the USCAFC’s intervention to revoke the PTAB’s decision joining Apple to IPR2015-01046 and IPR2015-01047, related to U.S. Patent Nos. 6,502,135 and 7,490,151. On March 18, 2016, the USCAFC denied the petition without prejudice to us raising the arguments on appeal after the PTAB’s final decisions. We are currently evaluating our options in this case.
VirnetX Inc. v. Apple, Inc. (Case 17-1131)
On October 31, 2016, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in IPR2015-00810 and IPR2015-00812, on November 9, 2016 for IPR2015-00811, and on November 28, 2016 for IPR2015-00866, IPR2015-00868, IPR2015-00870 and IPR2015-00871 involving our U.S. Patent Nos.8,868,705, 8,850,009, 8,458,341, 8,516,131, and 8,560,705. These appeals have been consolidated. The briefing in these appeals has been concluded; oral arguments have not yet been scheduled.
VirnetX Inc. v. The Mangrove Partners (Case 17-1368)
On December 16, 2016, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in IPR2015-01046, and on December 20, 2016 for IPR2015-1047, involving our U.S. Patent Nos. 6,502,135, and 7,490,151. These appeals also involve Apple, Inc. and one of them involves Black Swamp IP, LLC. On April 27, 2017, the USCAFC stayed these appeals pending the USCAFC’s en banc decision in
Wi-Fi One, LLC v. Broadcom Corporation,
No. 2015-1944.
VirnetX Inc. v. Apple Inc., Cisco Systems, Inc. (Case 17-1591)
On February 7, 2017, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in inter-partes reexamination nos. 95/001,788, 95/001,789, and 95/001,856 related to our U.S. Patent Nos. 7,921,211 and 7,418,504. These appeals have been consolidated. The briefing in these appeals is ongoing.
VirnetX Inc. v. Apple Inc. (Case 17-2490)
On August 23, 2017, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in IPR2016-00331 and IPR2016-00332 involving our U.S. Patent No. 8,504,696. These appeals have been consolidated. The briefing in these appeals is ongoing.
In re VirnetX Inc. (Case 17-2593)
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 ordered the United States Patent and Trademark Office to inform it within 30 days whether it wishes to participate in the appeals.
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, commencing a lawsuit can be expensive and time-consuming, and there is no assurance that we will prevail on such potential claims. In addition, bringing a lawsuit may lead to potential counterclaims which may preclude our ability to commercialize our initial products, which are currently in development. 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.
Note 8 — Subsequent Events
On October 16, 2017, we received a final judgment affirming a jury’s verdict of $1.20 per iPhone royalty in the United States Court for the Eastern District 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 Appeals for the Federal Circuit. On October 27, 2017 Apple filed its notice of appeal of the Final Judgment entered on September 29, 2017 to the United States Court of Appeals for the Federal Circuit. (See “Note 7 – Litigation”).
Subsequent to September 30, 2017, we sold 527,039 shares of common stock under the ATM. The average sales price per common share was $5.49 and the aggregate proceeds from the sales totaled $2,806 during the period. Sales commissions, and other costs associated with the ATM totaled $87.
On October
26th,
2017, we signed a Strategic Service Provider (SSP) Agreement with Benefit One Solutions, Inc., Japan, a company which provides welfare services to employees of over 3,000 government, and corporate organizations in Japan. Benefit One Solutions will be a Strategic Service Provider and a non-exclusive reseller of VirnetX's Gabriel Collaboration Suite of Products in Japan. Under the terms of the agreement, Benefit One will adopt the use of VirnetX Gabriel products within its own organization of approximately 1,300 employees for intra-company communication, and will integrate Gabriel Collaboration Suite of Products into its benefits application platform and offer VirnetX Secure Domain Names and Gabriel Client as a value-added service to its outside businesses. Under the terms of agreement with Benefit One Solutions, public notification of this agreement, in the form of public event(s) and/or press releases, will occur by both parties simultaneously.