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 June 30, 2021.

☐

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission 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 No.)

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 (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, every Interactive Data File required to be submitted 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 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 company” 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 Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

71,232,856 shares of Registrant’s Common Stock were outstanding as of August 5, 2021.

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

We have included or incorporated by reference in this Quarterly Report on Form 10-Q (this “Quarterly Report”), 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 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 is 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

INDEX

		Page

PART I — FINANCIAL INFORMATION		2
	Item 1 — Financial Statements.	2

	Condensed Consolidated Balance Sheets at June 30, 2021 (unaudited) and December 31, 2020	2
	Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2021 and 2020 (unaudited)	3
	Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2021 and 2020 (unaudited)	4
	Condensed Consolidated Statements of Shareholders’ Equity for the three and six months ended June 30, 2021 and 2020 (unaudited)	5
	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2021 and 2020 (unaudited)	6
	Notes to Condensed Consolidated Financial Statements	7
	Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
	Item 3 — Quantitative and Qualitative Disclosures About Market Risk	19
	Item 4 —Controls and Procedures	19

PART II —OTHER INFORMATION		20
	Item 1 —Legal Proceedings	20
	Item 1A —Risk Factors	20
	Item 5 —Exhibits	32

SIGNATURES		33

Index

PART I — FINANCIAL INFORMATION

ITEM 1-FINANCIAL STATEMENTS.

VIRNETX HOLDING CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

	As of June 30, 2021			As of December 31, 2020
ASSETS	(unaudited)
Current assets:
Cash and cash equivalents	$	153,632		$	192,908
Investments available for sale		21,908			28,348
Accounts receivables		14			8
Prepaid income tax		2,903			2,905
Prepaid expenses and other current assets		451			263
Total current assets		178,908			224,432
Prepaid expenses and other assets		1,125			1,301
Property and equipment, net		9			11
Deferred tax assets		16,854			9,049
Total assets	$	196,896		$	234,793

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities	$	445		$	654
Accrued payroll and related expenses		306			220
Accrued licensing costs		—			9,438
Other liabilities, current		18			44
Total current liabilities		769			10,356

Commitments and contingencies (Note 4)

Stockholders’ equity:
Preferred stock, par value $0.0001 per share Authorized: 10,000,000 shares at June 30, 2021 and December 31, 2020, Issued and outstanding: 0 shares at June 30, 2021 and December 31, 2020		—			—
Common stock, par value $0.0001 per share Authorized: 100,000,000 shares at June 30, 2021 and December 31, 2020, Issued and outstanding: 71,232,856 shares and 71,058,570 shares, at June 30, 2021 and December 31, 2020, respectively		7			7
Additional paid-in capital		234,114			232,457
Accumulated deficit		(37,980	)		(8,014	)
Accumulated other comprehensive loss		(14	)		(13	)
Total stockholders’ equity		196,127			224,437
Total liabilities and stockholders’ equity	$	196,896		$	234,793

See accompanying notes to condensed consolidated financial statements.

Index

VIRNETX HOLDING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(in thousands, except per share amounts)

	Three Months Ended						Six Months Ended
	June 30, 2021			June 30, 2020			June 30, 2021			June 30, 2020
Revenue	$	15		$	18		$	20		$	302,594
Operating expense:
Licensing costs		—			—			(9,438	)		90,101
Research and development		1,149			3,803			2,301			5,708
Selling, general and administrative		3,008			6,701			44,951			34,077
Total operating expense		4,157			10,504			37,814			129,886
Income (loss) from operations		(4,142	)		(10,486	)		(37,794	)		172,708
Gain		—			—			—			41,271
Realized gain		—			—			—			1
Interest and other income, net		10			16			26			108,254
Income (loss) before taxes		(4,132	)		(10,470	)		(37,768	)		322,234
Income tax (expense) benefit		609			2,430			7,802			(30,329	)
Net income (loss)	$	(3,523	)	$	(8,040	)	$	(29,966	)	$	291,905
Basic income (loss) per share	$	(0.05	)	$	(0.11	)	$	(0.42	)	$	4.13
Diluted income (loss) per share	$	(0.05	)	$	(0.11	)	$	(0.42	)	$	4.05
Weighted average shares outstanding - basic		71,111			70,915			71,085			70,640
Weighted average shares outstanding - diluted		71,111			70,915			71,085			72,098

See accompanying notes to condensed consolidated financial statements.

Index

VIRNETX HOLDING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)

(in thousands)

	Three Months Ended						Six Months Ended
	June 30, 2021			June 30, 2020			June 30, 2021			June 30, 2020
Net income (loss)	$	(3,523	)	$	(8,040	)	$	(29,966	)	$	291,905
Other comprehensive income (loss):
Change in unrealized gain (loss) on investments, net of tax		(3	)		(1	)		2			1
Change in foreign currency translation, net of tax		—			—			(3	)		1
Total other comprehensive income (loss)		(3	)		(1	)		(1	)		2
Comprehensive income (loss)	$	(3,526	)	$	(8,041	)	$	(29,967	)	$	291,907

See accompanying notes to condensed consolidated financial statements.

Index

VIRNETX HOLDING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Unaudited)

(in thousands)

	Three Months Ended June 30,						Six Months Ended June 30,
	2021			2020			2021			2020
Total shareholders’ equity, beginning balances	$	198,875		$	311,610		$	224,437		$	5,628

Common stock and additional paid-in capital:
Beginning balances		233,343			229,278			232,464			223,244
Common stock issued for cash, net		—			—			—			4,488
Common stock issued for options/RSUs, net		(196	)		(78	)		(196	)		690
Warrants issued for services		—			104			—			104
Stock-based compensation		974			953			1,853			1,731
Ending balances		234,121			230,257			234,121			230,257

Accumulated deficit (retained earnings):
Beginning balances		(34,457	)		82,343			(8,014	)		(217,602	)
Net (loss) income		(3,523	)		(8,040	)		(29,966	)		291,905
Dividends		—			(70,841	)		—			(70,841	)
Ending balances		(37,980	)		3,462			(37,980	)		3,462

Accumulated other comprehensive loss:
Beginning balances		(11	)		(11	)		(13	)		(14	)
Change in unrealized investment gain/loss, net		(3	)		(1	)		2			1
Change in foreign currency translation, net		—			—			(3	)		1
Ending balances		(14	)		(12	)		(14	)		(12	)

Total shareholders’ equity, ending balances	$	196,127		$	233,707		$	196,127		$	233,707

See accompanying notes to condensed consolidated financial statements.

Index

VIRNETX HOLDING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(in thousands)

	Six Months Ended June 30,
	2021			2020
Cash flows from operating activities:
Net (loss) income	$	(29,966	)	$	291,905
Adjustments to reconcile net (loss) income to cash flows from operating activities:
Depreciation		2			2
Deferred tax assets		(7,805	)		(8,536	)
Amortization of warrant issuance costs		34			17
Stock-based compensation		1,853			1,731
Changes in assets and liabilities:
Accounts receivables		(6	)		—
Prepaid expenses and other assets		(46	)		(28	)
Other liabilities		(26	)		(167	)
Accounts payable		(209	)		(287	)
Accrued licensing costs		(9,438	)		9,438
Accrued payroll and related expenses		86			(1	)
Income tax payable		2			38,863
Net cash (used in) provided by operating activities		(45,519	)		332,937
Cash flows from investing activities:
Purchase of investments		(7,817	)		(2,292	)
Proceeds from sale or maturity of investments		14,256			2,066
Net cash provided by (used in) investing activities		6,439			(226	)
Cash flows from financing activities:
Proceeds from exercise of options		—			1,046
Proceeds from sale of common stock		—			4,488
Dividend paid		—			(70,841	)
Payment of payroll taxes on vested restricted stock units		(196	)		(356	)
Net cash used in financing activities		(196	)		(65,663	)
Net change in cash and cash equivalents		(39,276	)		267,048
Cash and cash equivalents, beginning of period		192,908			3,135
Cash and cash equivalents, end of period	$	153,632		$	270,183

See accompanying notes to condensed consolidated financial statements.

Index

VIRNETX HOLDING CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share amounts)

(Unaudited)

Note 1 — Business Description and Basis of Presentation

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 derive revenue licensing technology, including GABRIEL Connection Technology™, to various original equipment manufacturers (“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. During 2020, we had revenues from settlement of a patent infringement dispute whereby we received consideration for past sales of licensee that utilized our technology, where there was no prior patent license agreement (see “Revenue Recognition”).

Our portfolio of intellectual property is the foundation of our business model. We currently own approximately 194 total patents and pending applications, including 70 U.S. patents/patent applications 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, M2M communications in areas of Smart City, Connected Car and Connected Home. The subject matter of all our U.S and foreign patents and pending applications relates generally to securing communications over the Internet and such covers all our technology and other products. Some of our issued U.S. and foreign patents expire at various times during the period from 2021 to 2034.

Note 2 — Summary of Significant Accounting Policies

Unaudited Interim Financial Information

The accompanying Condensed Consolidated Balance Sheet as of June 30, 2021, the Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2021 and 2020, the Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2021 and 2020, the Condensed Consolidated Statements of Shareholders’ Equity for the three and six months ended June 30, 2021 and 2020, and the Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 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 June 30, 2021, our results of operations for the three and six months ended June 30, 2021 and 2020, and our cash flows for the six months ended June 30, 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-owned subsidiaries. All intercompany balances and transactions have been eliminated.

Leases

The Company 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 Sheets. ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at the commencement date based on the present value of lease payments over the lease term (see Note 8 – Leases).

Index

Revenue Recognition

The Company derives revenue from licensing and royalty fees from contracts with customers which often span several years. We account for this revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Our revenue arrangements may consist of multiple-element arrangements, with revenue for each unit of accounting recognized as the product or service is delivered to the customer.

With the licensing of our patents, performance obligations are generally satisfied at a point in time as work is complete when our patent rights are transferred to our customers. We generally have no further obligation to our customers regarding our technology.

Certain contracts may require our customers to enter into a hosting arrangement with us and for these arrangements, revenue is recognized over time, generally over the life of the servicing contract.

The Company actively monitors and enforces its intellectual property rights, including seeking appropriate compensation from third parties that utilize the Company’s intellectual property 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 are licensing 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 such realization. Management generally considers any such gains as realized only upon the collection of cash.

Cash and Cash Equivalents

We consider all highly liquid investments purchased with original maturities of three months or less at the date of purchase to be cash equivalents. Our cash and cash equivalents are not subject to significant interest rate risk due to the short maturities of these investments.

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 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.

Property and Equipment

Property and equipment are stated at historical cost, less accumulated depreciation, and amortization. Depreciation and amortization are computed using the accelerated and straight-line methods over the estimated useful lives of the assets, which range from five to seven years. Repair and maintenance costs are charged to expense as incurred.

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. 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, or FDIC. During the six months ended June 30, 2021, we had, at times, funds that were uninsured. We do not believe that we are subject to any unusual financial risk beyond the normal risk associated with commercial banking relationships. We have not experienced any losses on our deposits of cash and cash equivalents.

Index

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 cost, 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 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, 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, which 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 a vesting term of 4 years. We recognize forfeitures, if any, when they occur. In addition, 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. See Note 5 - Stock-Based Compensation for additional information concerning our share-based compensation awards.

Index

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.

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. agency and treasury 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 June 30, 2021 and December 31, 2020.

	June 30, 2021
	Adjusted Cost		Unrealized Gains		Unrealized Losses		Fair Value		Cash and Cash Equivalents		Investments Available for Sale
Cash	$	41,658	$	—	$	—	$	41,658	$	41,658	$	—
Level 1:
Mutual funds		111,974		—		—		111,974		111,974		—
U.S. agency securities		11,773		2		—		11,775		—		11,775
U.S. treasury securities		10,131		2		—		10,133		—		10,133
		133,878		4		—		133,882		111,974		21,908
Total	$	175,536	$	4	$	—	$	175,540	$	153,632	$	21,908

	December 31, 2020
	Adjusted Cost		Unrealized Gains		Unrealized Losses			Fair Value		Cash and Cash Equivalents		Investments Available for Sale
Cash	$	121,785	$	—	$	—		$	121,785	$	121,785	$	—
Level 1:
Mutual funds		70,996		—		—			70,996		70,996		—
U.S. agency securities		13,767		2		—			13,769		127		13,642
U.S. treasury securities		14,707		—		(1	)		14,706		—		14,706
		99,470		2		(1	)		99,471		71,123		28,348
Total	$	221,255	$	2	$	(1	)	$	221,256	$	192,908	$	28,348

New Accounting Pronouncements

In December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2019-12 Income Taxes (Topic 740). The amendments 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 U. S. GAAP for other areas of Topic 740 by clarifying and amending existing guidance. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. We adopted this ASU on January 1, 2021 and there was no material impact on our financial position or cash flows as a result.

Index

Note 3 — Income Taxes

For the three months ended June 30, 2021, we recognized income tax benefit of $609 on loss before income taxes of $4,132, which is an effective tax rate of 14.78%; the effective tax rate was favorably impacted by the net operating loss (“NOL”). For the six months ended June 30, 2021, we recognized income tax benefit of $7,802 on loss before income taxes of $37,768 which is an effective tax rate of 20.66%; the effective tax rate was higher than the statutory federal income tax rate primarily due to the effect of research and development tax credits.

For the three and six months ended June 30, 2020, we had an income tax benefit of $2,430 and an income tax expense of $30,329, respectively.

As of June 30, 2020, we had deferred tax assets of $8,536. As of June 30, 2021, we had net deferred tax assets of $16,854 after applying a partial valuation allowance.

A valuation allowance is provided for deferred 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, or reduce, a valuation allowance associated with 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. Due to the 2020 income, we have released the valuation allowance against federal net deferred tax assets, and we maintain a partial valuation allowance against the state NOL and credit carryovers due to there was no income in California.

Internal Revenue Code Section 382 places a limitation on the amount of NOL carryforwards that can be used to offset taxable income after a change in control (generally greater than 50% change in ownership) of a loss corporation. California, the state in which our headquarters was once located, has similar rules. Since the Company did not have a greater than 50% change of control as defined under the Internal Revenue Code, no limitation applies to the Company’s NOLs.

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 NOLs, and tax credits 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 June 30, 2021, we have no uncertain tax positions.

Our policy is to recognize interest and penalties accrued on uncertain tax positions as a component of income tax expense. As of December 31, 2020 and June 30, 2021, we had no accrued interest or 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 which expires on October 31, 2021 (see Note 8 - Leases).

We entered 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 $95 and $174 compared to $13 and $89 in fees and reimbursements to the LLC during the three and six months ended June 30, 2021 and 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. We entered into a 12-month non-exclusive agreement 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 and can be cancelled by either us or the LLC with 30 days’ notice. The agreement renews on an annual basis unless terminated by either party. 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 “2013 Plan”), which has been approved by our stockholders. To the extent that any award should expire, become un-exercisable or is otherwise forfeited, the shares subject to such award will again become available for issuance under the 2013 Plan. The 2013 Plan provides for the granting of stock options and restricted stock units purchase rights (“RSUs”) to our employees and consultants. Stock options granted under the 2013 Plan may be incentive stock options or nonqualified stock options. Incentive stock options (“ISOs”) may only be granted to our employees (including officers and directors). Nonqualified stock options (“NSOs”) and stock purchase rights may be granted to our employees and consultants. The 2013 Plan expires in 2023.

Index

In April 2021, the Board approved an amendment and restatement of the 2013 Plan to, among other things, increase the shares reserved under the Plan by 2,500,000 shares (the “Plan Amendment”). Our stockholders approved the Plan Amendment at the 2021 Annual Meeting of the Stockholders held on June 3, 2021. The 2013 Plan generally provides for the granting of shares of our common stock, including stock options and stock purchase rights (“RSUs”). Options may be granted under the 2013 Plan with an exercise price determined by our Board of Directors, or a duly appointed committee thereof, provided, however, that the exercise price of an option granted to any employee shall be not less than 100% of the fair market value at the date of grant in the case of ISOs or 85% of the fair market value at the date of grant in the case of an NSO. The exercise price of an ISO or NSO granted to one of our Named Executive Officers shall not be less than 100% fair market value of the shares at the date of grant and the exercise price of an ISO granted to a 10% shareholder shall not be less than 110% of the fair market value of the shares on the date of grant. Stock options granted under the 2013 Plan typically vest over four years and have a 10-year term. All RSUs are considered to be granted at the fair value of our stock on the date of grant because they have no exercise price. RSUs typically vest over four years. As of June 30, 2021, there were 2,419,049 shares available for grant under the 2013 Plan.

Stock-based compensation expense included in general and administrative expense was $463 and $475, and in research and development expense was $511 and $478, for the three months ended June 30, 2021 and 2020, respectively. Stock-based compensation expense included in general and administrative expense was $846 and $823, and in research and development expense was $1,007 and $908, for the six months ended June 30, 2021 and 2020, respectively.

During the three months ended June 30, 2021, we granted options for a total of 779,500 shares with a weighted average grant date fair value of $3.45 per option. During the three months ended June 30, 2020, we granted options for a total of 377,500 shares with a weighted average grant date fair value of $5.07 per option.

During the six months ended June 30, 2021, we granted options for a total of 779,500 shares with a weighted average grant date fair value of $3.45 per option. We estimated the fair value of the options on the date of grant utilizing the Black-Scholes valuation model with the following assumptions: (i) 0 percent dividend yield, (ii) 91 percent volatility, (iii) 1 percent risk free rate and (iv) 6 years expected term. During the six months ended June 30, 2020, we granted options for a total of 617,500 shares with a weighted average grant date fair value of $4.77 per option. We estimated the fair value of the options on the date of grant utilizing the Black-Scholes valuation model with the following assumptions: (i) 0 percent dividend yield, (ii) 94 percent volatility, (iii) 0.65 percent risk free rate and (iv) 6 years expected term.

During the three months ended June 30, 2021 and 2020, we granted 236,661 and 218,329 RSUs respectively, with weighted average fair values at the date of grant of $4.61 and $6.89, respectively. RSUs, which are subject to forfeiture if service terminates prior to the shares vesting, are expensed ratably over the vesting period. During the three months ended June 30, 2021 and 2020, we paid $196 and $356 in withholding taxes on shares issued upon conversion of RSUs, respectively. The underlying shares were cancelled. The amounts are reflected as financing costs in the accompanying statement of cash flows. No RSUs were granted during the first three months of 2021 or 2020.

As of June 30, 2021, the unrecognized stock-based compensation expense related to non-vested stock options and RSUs was $6,588 and $2,802, respectively, which will be amortized over an estimated weighted average period of approximately 2.91 and 2.88 years, respectively.

During the three and six months ended June 30, 2021, no options were exercised. During the three months ended June 30, 2020, we issued 60,000 shares as a result of the exercise of options. During the six months ended June 30, 2020, we issued 262,031 shares as a result of the exercise of options.

During the three months ended June 30, 2021 and 2020, we issued 174,285 and 160,393 shares as a result of vesting RSUs, respectively. No shares were issued during the first there months of 2021 or 2020 as a result of vesting RSUs.

Note 6 — Equity

Common Stock

On July 30, 2018 we filed a $100,000 universal shelf registration statement on SEC Form S-3 which was declared effective by the SEC on August 16, 2018. We also entered an at-the-market equity offering sales agreement (“ATM”) with Cowen & Company, LLC on August 31, 2018, under which we can offer and sell shares of our common stock having an aggregate value of up to $50,000.

We use the ATM proceeds for GABRIEL product development, marketing, and general corporate purposes, which may include working capital, capital expenditures, other corporate expenses, and acquisitions of complementary products, technologies, or businesses. As of June 30, 2021, common stock with an aggregate value of up to $21,964 remained available for offer and sale under the ATM agreement.

We sold no shares under the ATM during the three and six months ended June 30, 2021.

Index

We sold no shares under the ATM during the three months ended June 30, 2020. We sold 1,049,382 shares under the ATM during the six months ended June 30, 2020, with an average sales price per common share of $4.41 and the aggregate proceeds from the sales totaled $4,627. Sales commissions, fees and other costs associated with the ATM totaled $139.

We issued no shares for options during the three and six months ended June 30, 2021. We issued 202,031 and 262,031 shares of common stock for options during the three and six months ended June 30, 2020, respectively.

We issued 174,285 and 160,393 shares as a result of vesting RSUs during the three months ended June 30, 2020 and 2021, respectively. No shares were issued as a result of vesting RSUs during the first three months of 2021 or 2020.

Warrants

In 2020, we issued warrants for the purchase of 25,000 shares of common stock at an exercise price of $5.75 per share, exercisable on the date of grant expiring in April 2025. The weighted average fair value at the grant date was $4.16 per warrant. The fair value at the grant date was estimated utilizing the Black-Scholes valuation model with the following 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 (iv) and expected option term of 5 years.

Warrants Issued				Exercise Price				Outstanding and Exercisable December 31, 2020				Issued				Exercised				Terminated / Cancelled				Outstanding and Exercisable June 30, 2021			Expiration Date
	25,000			$	5.75				25,000				—				—				—				25,000		April 30, 2025

Note 7 — Litigation

We have several 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”) and the Supreme Court of the United States (“SCOTUS”).

VirnetX Inc. v. Apple, Inc. (Case 6:12-CV-00855-LED) (“Apple II”)

This case began on November 6, 2012, when we had filed a complaint against Apple in USDC in which we alleged that Apple infringed on certain of our 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 accused products include the iPhone 5, iPod Touch 5th Generation, iPad 4th Generation, iPad mini, and the latest Macintosh computers; these products were not included in the Apple I case because they were released after the Apple I case was initiated. Post-trial motions hearing was held on July 18, 2018. On August 31, 2018, the USDC entered a Final Judgment and issued its Memorandum Opinion and Order regarding post-trial motions, affirming the jury’s verdict of $502,600 and granting VirnetX motions for supplemental damages, a sunset royalty, and the royalty rate of $1.20 per infringing iPhone, iPad and Mac products, pre-judgment and post-judgment interest and costs. Apple filed a notice of appeal with the USCAFC in the Apple II case.

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 heard 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 proceedings 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 scheduling order for the parties to brief the court about the need for a new trial for recalculating the damages. We filed our motion for entry of judgment on February 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 a new judgment based on the prior jury verdict and ordered a new jury trial on damages. On August 10, 2020, the USDC granted Apple’s motion for continuance and reset the date to October 26, 2020. On October 30, 2020, a jury returned a $502,800 verdict in favor of VirnetX based on Apple’s infringement of two network security patents: VirnetX US Patents No. 6,502,135 and No. 7,490,151. The jury verdict called for damages of $0.84 per accused device since the 2013 launch of Apple’s iOS 7 operating system and represents 598,629,580 infringing units from US sales only. On January 15, 2021, the district court denied Apple’s motion for judgment as a matter of law, and on February 4, 2021, Apple filed a notice of appeal to the USCAFC. Apple’s opening brief was filed on June 2, 2021. VirnetX filed its responsive brief on July 26, 2021. On July 29, 2021 Apple filed an unopposed motion for 28-day extension of time to file its reply brief, upon which the Court has not yet made a ruling.

VirnetX Inc. v. Mangrove Partners Master Fund, Ltd., Apple Inc. (USCAFC Case 20-2271) and VirnetX Inc. v. Mangrove Partners Master Fund, Ltd., Apple Inc., and Black Swamp, LLC (USAFC Case 20-2272)

On September 15, 2020, we filed with the USCAFC an appeal of the invalidity findings by the PTAB in inter-partes review proceedings IPR2015-01046 and IPR2016-00062 involving our U.S. Patent No. 6,502,135, and an appeal of the invalidity findings by the PTAB in inter partes review proceedings IPR2015-1047, IPR2016- 00063, and IPR2016-00167 involving our U.S. Patent No. 7,490,151. On September 25, 2020, the USCAFC issued an order consolidating the two appeals. On December 15, 2020, we filed a motion to vacate the PTAB decisions below and to remand these appeals to the PTAB. On March 16, 2021, the USCAFC denied the motion without prejudice to us raising the challenges made in the motion in our opening brief. Our opening brief was filed on June 7, 2021.

Index

On June 23, 2021, the USCAFC entered an order directing us (and parties in other appeals that raised Appointments Clause challenges) to file a brief explaining how they believe their cases should proceed in light of the Supreme Court’s decision in United States v. Arthrex, Inc., 141 S. Ct. 1970 (2021). On July 7, 2021, we filed a brief in response to the court’s order. Other parties, including the USPTO have filed their responses. The USCAFC has stayed all deadlines and proceedings, in this case, until this matter is resolved. We are waiting for USCAFC to issue their decision in this matter.

Iancu v. Luoma (SCOTUS Case 20-74)

On July 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 USCAFC, 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 USCAFC 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 USCAFC 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 APJ, was the appropriate one. SCOTUS heard oral argument in these consolidated cases on March 1, 2021, and issued a decision on June 21, 2021. In that decision, the Supreme Court ruled that the unreviewable authority wielded by APJs during inter partes review is incompatible with the manner of their appointment, and held that the proper remedy is to enable the Director of the USPTO to review and rehear final decisions issued by APJs. On June 28, 2021, following its decision in Arthrex, the Supreme Court granted the United States’ certiorari petition in lancu v. Luoma, No. 20-74, vacated all the USCAFC’s underlying remand orders, and remanded to the USCAFC for further consideration in light of Arthrex. The Supreme Court issued its judgment on July 30, 2021, and the case is now closed.

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 entered into in 2010 with VirnetX entitled it to a contingency fee arising from the recent 2020 payment made in the 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.

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 likely valid, commencing a lawsuit can be expensive and time-consuming, and there is no assurance that we could prevail on such potential claims if we made them. In addition, bringing a lawsuit may lead to potential counterclaims which may distract our management and our other resources, including capital resources, from efforts to successfully commercialize our 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.

Note 8 — Leases

We lease office space under an operating lease which expires on October 31, 2021. On June 30, 2021, the underlying ROU asset and lease liability totaled $18. On December 31, 2020, the underlying ROU asset and lease liability totaled $44. For the three and six months ended June 30, 2021, lease expense totaled $14 and $28, respectively. For the three and six months ended June 30, 2020, the lease expense totaled $13 and $26, respectively.

We also lease a facility for corporate promotional and marketing purposes which was prepaid at inception and expires in 2025, as amended. On June 30, 2021 and December 31, 2020, the ROU asset totaled $1,098 and $1,248, respectively. For the three and six months ended June 30, 2021, lease expense totaled $75 and $150, respectively. For the three and six months ended June 30, 2020, lease expense totaled $96 and $193, respectively.

Index

Note 9 — Earnings Per Share

Basic earnings per share are based on the weighted average number of common shares outstanding for the period. Diluted earnings per share are based on the weighted average number of common 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 end of each reporting period. The following table shows the computation of basic and diluted earnings per share for the three and six months ended June 30, 2021 and 2020 (in thousands, except per share amounts):

SEC Form 10-Q filed by VirnetX Holding Corp