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Item 7. Management’s Discussion and Analysis

2021-03-16 compared with 2020-03-16 · 165 added, 228 removed, 163 unchanged (71% of the section changed)

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Company Overview

We are an Internet security software and technology company with patented technology for secure communications including 5G and 4G LTE security.

Our software and technology solutions, including our Secure Domain Name Registry and GABRIEL Connection Technology™, are designed to facilitate secure communications and provide the security platform required by next-generation Internet-based applications such as instant messaging, or IM, voice over Internet protocol, or VoIP, mobile services, streaming video, file transfer, remote desktop and Machine-to-Machine, or M2M communications.

We are an Internet security software and technology company with patented technology for various types of secure network communications, including 5G and 4G LTE network security.

Our patented Secure Domain Name Registry and GABRIEL Connection Technology™, are the foundation for our GABRIEL Secure Communication Platform™ that protects communications using Zero Trust Network Access (ZTNA).

Our technology generates secure connections on a “zero-click” or “single-click” basis, significantly simplifying the deployment of secure real-time communication solutions by eliminating the need for end-users to enter any encryption information.

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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 the new initiatives like Smart City, Connected Car and Connected Home that would connect everything from social services and citizen engagement to public safety, transportation and economic development to the internet to enable more productivity, features and efficiency in our everyday lives.

The subject matter of all our U.S.

and foreign patents and pending applications relates generally to securing communication over the internet, and as such covers all our technology and other products.

Our issued U.S.

and foreign patents expire at various times during the period from 2019 to 2024.

Some of our issued patents and pending patent applications were acquired by our principal operating subsidiary;

VirnetX, Inc., from Leidos, Inc., or Leidos, (f/k/a Science Applications International Corporation, or SAIC) in 2006 and we are required to make payments to Leidos, based on cash or certain other values generated from those patents.

The amount of such payments depends upon the type of value generated, and certain categories are subject to maximums and other limitations.

Our product GABRIEL Secure Communication Platform™ includes a set of sophisticated software libraries with application interfaces available for securing third-party applications seamlessly across multiple operating system platforms.

Unlike other collaboration and communication products and services on the market today, this product

does not require access to users confidential data and reduces the threat of hacking and data mining.

Our patent portfolio is primarily focused on securing real-time communications over the Internet, and related services, and is used in all our technology and products, some of which were acquired by our principal operating subsidiary;

VirnetX, Inc., from Leidos, Inc., or Leidos, (f/k/a Science Applications International Corporation, or SAIC) in 2006.

Our product portfolio includes sophisticated technologies, products and services that are available for sale worldwide.

Our GABRIEL Secure Communication Platform™ includes a set of software libraries with application interfaces available for securing third-party applications seamlessly across multiple operating systems.

It enables individuals and organizations to maintain complete ownership and control over their personal and confidential data, secured within their own private network, while enabling authorized secure encrypted access from anywhere at any time.

Our GABRIEL Gateway product extends our Secure Communication Platform™ by allowing existing networked devices and services to seamlessly join the “GABRIEL SECURED” network without requiring any modifications.

All these devices or services, including cloud based services, can now be assigned a VirnetX Secure Domain Name and use a fully authenticated secure communication channels for its communications.

Our GABRIEL Collaboration Suite™ is a set of communication tools that use our GABRIEL Secure Communication Platform™.

It enables seamless and secure cross-platform communications between devices that are enrolled in our security fabric and have our software installed.

Our GABRIEL Collaboration Suite™ is available for download and free trial, for Android, iOS, Windows, Linux and Mac OS X platforms, at http://www.gabrielsecure.com/ .

We continue to enhance our products and add new functionality to our products.

We will provide updates to new and existing customers as they are released to the general public.

A large number of small and medium businesses have installed our GABRIEL Secure Communication Platform™ and GABRIEL Collaboration Suite™ products in their corporate networks.

All these devices or services, including on-premise or cloud-based services, can now be assigned a VirnetX Secure Domain Name and use fully authenticated, secure communication channels for its communications.

Our GABRIEL Collaboration Suite™ is a set of communication applications and tools that use our GABRIEL Secure Communication Platform™.

It enables seamless and secure cross-platform communications between devices that are enrolled in our “GABRIEL SECURED” network and have our software installed.

Our GABRIEL Collaboration Suite™ is available for download and free trial, for Android, iOS, Windows, Linux, and Mac OS X platforms, at https://virnetx.com .

We continue to enhance our products and add new functionality.

We will provide updates to new and existing customers as they are released to the public.

Many small and medium businesses have installed our GABRIEL Secure Communication Platform™ and GABRIEL Collaboration Suite™ products in their corporate networks.

We intend to continue to expand our customer base with targeted promotions and direct sales initiatives.

We are actively recruiting partners in various vertical markets including, healthcare, finance, government, etc., to help us rapidly expand our enterprise customer base.

A number of International Association of Certified ISAO (IACI) including ISAOs for Maritime & Ports ISAO, Credit Union ISAO, City of Chicago ISAO, Human Trafficking ISAO, have chosen to deploy our software as private and secure e-technology to protect their communications.

Several other ISAOs are completing their evaluations before deploying our products within their networks.

We have executed a number of patent and technology licenses and intend to seek further licensees for our technology, including our GABRIEL Connection Technology™ to original equipment manufacturers, or OEMs, of chips, servers, smart phones, tablets, e-Readers, laptops, net books and other devices, within the IP-telephony, mobility, fixed-mobile convergence and unified communications markets including 5G and 4G/LTE Advanced.

We have submitted a declaration with the 3 rd Generation Partnership Project, or 3GPP, identifying a group of our patents and patent applications that we believe are or may become essential to certain developing specifications in the 3GPP LTE, Systems Architecture Evolution, or SAE project.

We have agreed to make available a non-exclusive patent license under fair, reasonable and non-discriminatory terms and conditions, with compensation, or FRAND, to 3GPP members desiring to implement the technical specifications identified by us.

We believe that we are positioned to license our essential security patents to 3GPP members as they move into deploying 5G and 4G/LTE Advanced devices and solutions.

We have an ongoing GABRIEL Licensing Program under which we offer licenses to a portion of our patent portfolio, technology, and software, including our secure domain name registry service, to domain infrastructure providers, communication service providers as well as to system integrators.

Our GABRIEL Connection Technology™ License is offered to OEM customers who want to adopt the GABRIEL Connection Technology™ as their solution for establishing secure connections using secure domain names within their products.

We have developed GABRIEL Connection Technology™ Software Development Kit (SDK) to assist with rapid integration of these techniques into existing software implementations with minimal code changes and include object libraries, sample code, testing and quality assurance tools and the supporting documentation necessary for a customer to implement our technology.

Customers who want to develop their own implementation of our patented techniques for supporting secure domain names, or other techniques that are covered by our patent portfolio for establishing secure communication links, can purchase a patent license.

We have developed GABRIEL Connection Technology™ Software Development Kit (SDK) to assist with rapid integration of these techniques into existing software implementations.

Customers who want to develop their own implementation of the VirnetX patented techniques for supporting secure domain names, or other techniques that are covered by our patent portfolio for establishing secure communication links, can purchase a patent license.

The number of patents licensed, and therefore the cost of the patent license to the customer, will depend upon which of the patents are used in a particular product or service.

These licenses will typically include an initial license fee, as well as an ongoing royalty.

We have signed Patent License Agreements with Avaya Inc., Aastra USA, Inc., Microsoft Corporation, Mitel Networks Corporation, NEC Corporation and NEC Corporation of America, Siemens Enterprise Communications GmbH & Co.

KG, and Siemens Enterprise Communications Inc.

to license certain of our patents, for a one-time payment and/or an ongoing royalty for all future sales through the expiration of the licensed patents with respect to certain current and future IP-encrypted products.

We believe that the market opportunity for our software and technology solutions is large and expanding as secure domain names are now an integral part of securing the next generation 5G and 4G/LTE Advanced wireless networks and M2M communications in areas including Smart City, Connected Car and Connected Home.

We also believe that all 5G and 4G/LTE Advanced mobile devices will require unique secure domain names and become part of a secure domain name registry.

We intend to continue to license our patent portfolio, technology and software, including our secure domain name registry service, to domain infrastructure providers, communication service providers as well as to system integrators.

We intend to seek further license of our technology, including our GABRIEL Connection Technology™ to enterprise customers, developers and original equipment manufacturers, or OEMs, of chips, servers, smart phones, tablets, e-Readers, laptops, net books and other devices, within the IP-telephony, mobility, fixed-mobile convergence and unified communications markets including 5G and 4G/LTE.

Our employees include the core development team behind our patent portfolio, technology, and software.

This team has worked together for over ten years and is the same team that invented and developed this technology while working at Leidos, Inc.

Leidos is a FORTUNE 500® scientific, engineering and technology applications company that uses its deep domain knowledge to solve problems of vital importance to the nation and the world, in national security, energy and the environment, critical infrastructure and health.

The team has continued its research and development work started at Leidos and expanded the set of patents we acquired in 2006 from Leidos, into a larger portfolio of approximately 194 total patents and pending applications, including 70 U.S.

patents/patent applications and 124 foreign patents/validations/pending applications This portfolio now serves as the foundation of our licensing business and planned service offerings and is expected to generate the majority of our future revenue in license fees and royalties.

We intend to continue our research and development efforts to further strengthen and expand our patent portfolio.

We intend to continue using a primarily outsourced and leveraged model to maintain efficiency and manage costs as we grow our licensing business by, for example, offering incentives to early licensing targets or asserting our rights for use of our patents.

We also intend to expand our design pilot in participation with leading 5G and 4G/LTE companies (domain infrastructure providers, chipset manufacturers, service providers and others) and build our secure domain name registry.

Some members of this team have worked together for over twenty years and were on same team that invented and developed this technology while working at Leidos, Inc.

The team has continued its research and development work and expanded the set of patents we acquired in 2006 from Leidos, into a larger patent portfolio.

This portfolio now serves as the foundation of our products, services, and our licensing business.

It is expected to generate most of our future revenue in license fees and royalties.

We intend to continue our efforts to develop new products and technologies and further strengthen and expand our patent portfolio.

We intend to continue using an outsourced and leveraged model to maintain efficiency and manage costs as we grow our licensing business by, for example, offering incentives to early licensing targets or asserting our rights for use of our patents.

Litigation (all dollar amounts in this section are expressed in thousands except for rates per device)

We have multiple 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).

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”).

Cisco Systems, Inc.

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On September 30, 2016, pursuant to the 2014 remand from the USCAFC, a jury in the USDC awarded us $302,400 for Apple’s infringement of four of our patents.

On September 29, 2017, the USDC entered its final judgement,

denied all of Apples post-trial motions, granted all our post-trial motions, including our motion for willful infringement and enhanced the royalty rate during the willfulness period from $1.20 to $1.80 per device, and awarded us costs, certain attorneys fees, and prejudgment interest.

The total amount in the final judgement was $439,700, including $302,400 (jury verdict), $41,300 (enhanced damages) and $96,000 (costs, fees and interest).

On October 27, 2017 Apple filed its notice of appeal of this final judgement to the USCAFC.

Apple filed its opening brief on March 19, 2018.

We filed our response on April 4, 2018.

On April 11, 2018, USCAFC designated Cases 18-1197-CB, Case 17-1368 and Case 17-1591 as companion cases and assigned to the same merits panel.

Events and developments after this order are described below under VirnetX Inc.

The Mangrove Partners (USCAFC Case 17-1368) (Consolidated Appeal) .

On September 29, 2017, the USDC entered its final judgment, denied all of Apple’s post-trial motions, granted all our post-trial motions, including our motion for willful infringement and enhanced the royalty rate during the willfulness period from $1.20 to $1.80 per device, and awarded us costs, certain attorneys’ fees, and prejudgment interest.

The total amount in the final judgment was $439,700, including $302,400 (jury verdict), $41,300 (enhanced damages) and $96,000 (costs, fees, and interest).

On October 27, 2017 Apple appealed the final judgment entered on September 29, 2017 to the USCAFC.

Oral arguments in this case were held on January 8, 2019.

On January 15, 2019, the Court issued a Rule 36 order affirming the district court’s final judgment.

Apple filed a petition for panel rehearing and rehearing en-banc in this matter on February 21, 2019.

On October 1, 2019, USCAFC issued an order denying Apple’s petition.

Apple filed a petition for a writ of certiorari with the SCOTUS , which was denied on February 24, 2020.

Prior to the SCOTUS decision denying Apple’s petition for a writ of certiorari, on February 20, 2020, Apple filed a Rule 60(b) motion for relief from judgment with the USDC, seeking relief from the district court’s September 29, 2017 final judgment.

VirnetX filed a responsive brief in opposition on March 5, 2020.

On March 13, 2020, the Company received payment of $454,034 from Apple, representing the previously announced final judgment with interest in this case.

Apple sought payment relief by filing a motion under Rule 60(b).

On September 1, 2020 USDC issued an order denying Apple’s motion for relief of judgement.

This case is now closed.

(Case 6:12-CV-00855-LED) (“Apple II”)

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We sought damages and injunctive relief.

The accused products include the iPhone 5, iPod Touch 5th Generation, iPad 4 th 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.

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.

On September 20, 2018, pursuant to a Courts order, attorneys from VirnetX and Apple conferred and agreed, without dispute, to add an amount totaling $93,300 for Bill of Costs and Prejudgment Interest to the $502,600 jury verdict.

The total amount in the final judgement in the Apple II case is now $595,900.

Apple has filed a notice of appeal with the USCAFC in the Apple II case.

On October 9, 2018, USCAFC accepted the notice and docketed it as Case No.

19-1050 - VirnetX Inc.

All subsequent events and developments in this case are described below under VirnetX Inc.

(USCAFC Case 19-1050) (Apple II Appeal).

The Mangrove Partners (USCAFC Case 17-1368) (Consolidated Appeal)

On April 11, 2018, the USCAFC in an order designated the following appeals as companion cases and assigned to the same merits panel;

• VirnetX Inc.

The Mangrove Partners (USCAFC Case 17-1368)

On December 16, 2016, we filed appeals with the USCAFC, appealing the invalidity findings by the Patent Trial and Appeal Board (PTAB) in IPR2015-01046, and on December 20, 2016 for IPR2015-1047, involving our U.S.

6,502,135, and 7,490,151.

These appeals also involve Apple, and one of them involves Black Swamp IP, LLC.

Oral arguments in this case were argued on January 8, 2019.

On July 8, 2019, the USCAFC issued its opinion vacating and remanding both decisions.

The court agreed with us that the PTAB misconstrued the patent claims, that many of the PTABs invalidity findings lacked substantial evidence, and that the PTAB Board abused its discretion in denying us the opportunity to file a motion for additional discovery as to the real party-in-interest issues.

The underlying inter partes review (IPR) proceedings are currently pending before the PTAB.

• VirnetX Inc.

Cisco Systems, Inc.

(USCAFC Case 18-1197-CB) (Appeal of Apple I Case)

On October 27, 2017 Apple appealed the Final Judgment entered on September 29, 2017 to the USCAFC.

Oral arguments in this case were held on January 8, 2019.

On January 15, 2019 the Court issued a Rule 36 order affirming the District Court Judgement.

Apple filed a request for panel rehearing and rehearing en-banc in this matter on February 21, 2019.

On March 12, 2019, the Court invited us to respond to Apples petition on or before March 26, 2019.

We filed our response on March 22, 2019.

On July 1, 2019 Apple filed a motion for leave to file a supplemental brief regarding the impact of the USCAFCs decision in VirnetX Inc.

Cisco Systems, Inc.

(USCAFC Case 18-1751) , issued on June 28, 2019 (described below).

We filed a response to Apples motion and a contingent motion for leave to file a responsive supplemental brief on July 11, 2019.

On July 17, 2019, the USCAFC granted both motions and ordered Apples and our supplemental briefs filed.

On August 1, 2019, USCAFC issued an order

denying Apples petition for panel and en banc rehearing.

On August 7, 2019, Apple filed a motion to vacate the August 1, 2019 order and for leave to file a second request for panel rehearing and rehearing en-banc.

On October 1, 2019, USCAFC issued an order denying Apples motion.

Apple subsequently requested an extension for its deadline to petition for a writ of certiorari, and that deadline was extended until December 29, 2019.

Apple filed a petition for a writ of certiorari with the U.S.

Supreme Court, which was denied on February 24, 2020.

Prior to the Supreme Court decision denying Apples Petition for Writ of Certiorari, on Ferbuary 20, 2020, Apple filed a Rule 60(b) Motion for Relief from Judgement in the U.S.

District Court (VirnetX Inc.

Apple, 6:10-cv-00417) seeking relief from the Courts September 29, 2017 Final Judgment.

VirnetX filed a responsive brief in opposition on March 5, 2020.

On March 13, 2020, the Company received payment of $454,034 from Apple, representing the previously announced final judgment with interest in this case.

Apple has filed a motion in the USDC seeking to vacate the USDCs final judgment and has indicated that it will seek restitution of the payment if relief is awarded.

The USDC has not ruled in this matter.

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.

Apple Inc., Cisco Systems, Inc.

(USCAFC Case 17-1591)

On February 7, 2017, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in inter-parties reexamination nos.

95/001,788, 95/001,789, and 95/001,856 related to our U.S.

7,921,211 and 7,418,504.

Oral arguments in this case were argued on January 8, 2019.

On July 1, 2019 Apple filed a motion for leave to file a supplemental brief regarding the impact of the USCAFCs decision in VirnetX Inc.

Cisco Systems, Inc.

(USCAFC Case 18-1751) , issued on June 28, 2019 (described below).

On August 1, 2019, the USCAFC issued an opinion in this case agreeing with us that the PTAB could not maintain two of those reexaminations (initiated by Apple) with respect to claims as to which there has been a prior final decision on patent validity entered by a federal court.

The court instructed PTAB to terminate those reexamination proceedings with respect to claims 1-35 of the ‘504 patent and claims 36-59 of the ‘211 patent.

The court affirmed PTABs invalidity findings with respect to the remaining patent claims.

Apple filed a request for panel rehearing and rehearing en-banc in this matter on August 26, 2019.

We filed a separate request for panel rehearing on September 3, 2019.

Our request was denied on September 19, 2019, and Apples request was denied on October 11, 2019.

All decisions are final in the case.

(USCAFC Case 19-1050) (Apple II Appeal)

On January 24, 2019 Apple filed its opening brief.

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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 district courts finding that Apple infringed the 504 and 211 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, 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 initial brief on February 28, 2020.

All briefings have been completed.

Courts decision in the matter is awaited.

(USCAFC Case 17-2593)

On September 22, 2017, we filed with the USCAFC appeals of the invalidity findings by the PTAB in IPR2016-00693 and IPR2016-00957 involving our U.S.

7,418,504 and 7,921,211.

The briefing in these appeals has not taken place.

The entity that initiated the IPRs, Black Swamp IP, LLC, indicated on October 18, 2017, that it would not participate in the appeals.

On November 27, 2017, the USPTO indicated that it would intervene in the appeals.

On January 19, 2018, the USCAFC stayed these appeals pending the USCAFCs decision in Case 17-1591.

On October 25, 2019, we and the USPTO filed a joint request that the deadline to inform the USCAFC how these appeals should proceed be extended until November 1, 2019.

On November 15, 2019, we and the USPTO requested that the USCAFC stay this appeal pending resolution of any petition for rehearing in Arthrex, Inc.

Smith & Nephew, Inc., No.

The USCAFC denied the stay request on November 27, 2019.

On January 6, 2020, we filed a motion to vacate and remand in light of Arthrex, Inc.

Smith & Nephew, Inc., 941 F.3d 1320 (Fed.

2019), which was granted on February 27, 2020.

Cisco Systems, Inc.

(USCAFC Case 18-1751)

On March 30, 2018, we filed with the USCAFC an appeal of the invalidity findings by the PTAB in inter-partes reexamination no.

95/001,851 involving our U.S.

Oral arguments in this case were held on June 4, 2019.

On June 28, 2019, the USCAFC issued its opinion vacating the PTABs invalidity findings with respect to claims 5, 12, and 13 and remanding to the PTAB for further proceedings.

The court affirmed the PTABs invalidity findings with respect to the remaining patent claims.

Cisco filed a request for panel rehearing and rehearing en-banc in this matter on August 12, 2019.

Ciscos request was denied on October 1, 2019.

Cisco Systems, Inc.

(USCAFC Case 19-1043)

On October 1, 2018, we filed with the USCAFC an appeal of the invalidity findings by the PTAB in inter-partes reexamination no.

95/001,746 involving our U.S.

We filed our opening brief on March 15, 2019.

Cisco filed its response brief on June 19, 2019.

We filed our reply brief on August 14, 2019.

Cisco filed a motion to submit a sur-reply brief on August 26, 2019, which we opposed.

On September 27, 2019, the USCAFC issued an order deferring resolution of Ciscos motion for the merits panel.

Oral argument was held on January 8, 2020.

On January 21, 2020, the USCAFC issued a Rule 36 judgment affirming the PTABs decision.

Cisco Systems, Inc.

(USCAFC Case 19-1671)

On March 18, 2018, we filed with the USCAFC an appeal of the invalidity findings by the PTAB in inter-partes reexamination no.

95/001,679 involving our U.S.

We filed a motion to remand on August 23, 2019, which the USCAFC denied on October 1, 2019, directing the parties to address the issues in the merits briefs.

Our opening brief is currently due on November 12, 2019.

On November 7, 2019, we filed another motion to vacate and remand in light of Arthrex .

The USPTO intervened and opposed the remand.

The USCAFC granted our motion on January 24, 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.

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.

Mangrove Partners Master Fund, Ltd., Apple Inc.

(USCAFC Case 20-2271) and VirnetX Inc.

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.

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.

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, which remains pending.

In view of our motion to remand, our deadline to file an initial brief is currently stayed.

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 USAFC, including decisions in VirnetX Inc.

Cisco Systems, Inc.

(USCAFC Case 19-1725)

On March 29, 2019, we filed with the USCAFC an appeal of the invalidity findings by the PTAB in inter-partes reexamination no.

95/001,792 involving our U.S.

We filed a motion to remand on September 10, 2019.

We filed a supplemental motion to remand in light of Arthrex on November 22, 2019, which the USCAFC granted on January 24, 2020.

Cisco filed a petition for panel and en banc rehearing on February 24, 2020, which remains pending.

2019-1671, and VirnetX Inc.

2017-2593, -2594.

In those cases, the USAFC granted VirnetX’s motions to vacate the underlying decisions of the PTAB on the basis of Arthrex, Inc.

Smith & Nephew, Inc.

, 941 F.3d 1320 (Fed.

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.

19-1434 (filed June 25, 2020).

On August 26, 2020, VirnetX filed a response, agreeing that the United States’ certiorari petition should be held pending the disposition of the petition for a writ of certiorari in No.

19-1434 (and related petitions filed by private parties in Nos.

19-1452 and 19-1458), and any further SCOTUS proceedings.

On October 13, 2020, SCOTUS granted the United States’ petition for a writ of certiorari in No.

19-1434 as to USAFC Case No.

2018-2140, and the petitions for writs of certiorari in Nos.

19-1452 and 19-1458, all limited to Questions 1 and 2 as set forth in the July 22, 2020 Memorandum for the United States filed in No.

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.

McKool Smith P.C.

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 claims that a retention agreement it entered into in 2010 with VirnetX entitles it to a contingency fee arising from the recent 2020 payment made by Apple.

McKool claims it is owed approximately $36,300 (or 8% of the Apple I payment).

We have filed a general response with the AAA denying McKool’s claim and are contesting the matter vigorously.

An evidentiary hearing was held on the matter during the week of February 22, 2021 and the parties will be submitting additional briefing.

A ruling is expected sometime thereafter.

Neal Hurwitz v.

Kendall Larsen et al.

(Case 2020-0425-JRS)

On June 2, 2020, stockholder Neal Hurwitz filed a verified derivative complaint in the Delaware Court of Chancery against Kendall Larsen, Robert D.

Short Ill, Gary Feiner, Michael F.

Angelo, and Thomas M.

O’Brien and naming the Company as nominal defendant.

The lawsuit alleges breaches of fiduciary duty, corporate waste, and unjust enrichment arising out of a series of previously-disclosed transactions and compensation awards and seeks an award of monetary damages and equitable relief.

On July 1, 2020, the defendants filed a motion to dismiss the complaint based on a failure to plead demand futility and a failure to state a claim on which relief can be granted and, on August 19, 2020, the defendants filed an opening brief in support of their motion to dismiss.

On October 16, 2020, plaintiff amended his complaint rather than respond to the arguments in the defendants’ opening brief.

On October 23, 2020, the defendants filed a renewed motion to dismiss plaintiff’s amended complaint based on a failure to plead demand futility and a failure to state a claim on which relief can be granted.

On January 12, 2021, Hurwitz voluntarily dismissed his suit without prejudice.

Other Legal Matters

One or more potential intellectual property infringement claims may also be available to us against certain other companies who have the resources to defend against any such claims.

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We prepare our consolidated financial statements in accordance with U.S.

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 doing so, we must 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.

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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 base our estimates on 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.

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 other assets on the Consolidated Balance Sheet.

The Company determines if an arrangement, giving the Company a right-of-use (“ROU”) asset, is a lease at inception.

Operating lease ROU assets are included in other assets on the Condensed Consolidated Balance Sheet.

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.

ROU assets and lease liabilities are recognized at the commencement date of the arrangement based on the present value of lease payments over the lease term.

Other assets at December 31 , 2020, include a ROU asset related to a facility lease for corporate promotional and marketing purposes.

The facility lease was paid in full at inception and the ROU is being amortized over the term of the lease.

Other assets also include an ROU related to our office operating lease which expires in October 2021 (See Note 13 - Leases).

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.

We account for revenue in accordance with Accounting Standards Update (ASU) No.2014-09, Revenue from Contracts with Customers (Topic 606), which we adopted on January 1, 2018 using the modified-retrospective method.

Under Topic 606 a performance obligation is a promise in a contract to transfer a distinct good or service to the customer.

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 Accounting Standards Codification (“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 and our patent rights are transferred to our customers.

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 and revenues from these contracts are recognized over time, generally over the life of the servicing contract.

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.

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 (“IP”) rights, including seeking appropriate compensation from third parties that utilize the Company’s IP without a license.

As a result, the Company may, from time to time, receive payments as part of a settlement or compensation for a patent infringement dispute.

Proceeds received are allocated to each element identified in the settlement or compensation, based on the fair value of each element.

Generally, settlements and compensation may include the following elements:

the value of a license or royalty agreement, cost reimbursement, damages, and interest.

Elements identified related to licensing and royalty are recognized as revenue.

Elements identified as reimbursed costs are generally recorded as a reduction to the reported expenses.

Elements identified as damages or interest are generally recorded in other income in the condensed consolidated statement of operations.

Licensing Costs

Licensing costs are incurred pursuant to favorable court decisions relating to patent infringement cases and are included in operating expenses in the Company’s consolidated statement of operations.

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.

Earnings (Loss) Per Share

Basic earnings (loss) per share are computed by dividing earnings (loss) 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.

During the years ended 2019 and 2018, we incurred losses.

Therefore, the effects of any common stock equivalents were anti-dilutive during those periods.

Concentration of Credit Risk and Other Risks and Uncertainties

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A portion of those balances are insured by the Federal Deposit Insurance Corporation.

During the year ended December 31, 2019, and 2018 we had, at times, funds which were uninsured.

During the year ended December 31 , 2020, 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.

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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.

Consistent with our policy, and because of our history of operating losses, we do not currently recognize the benefit of all our deferred tax assets, including tax loss carry forwards, that may be used to offset future taxable income.

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 net operating loss and credit carryovers due to lack of income in California.

We continually assess our ability to generate sufficient taxable income during future periods in which our deferred tax assets may be realized.

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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.

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.

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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 GAAP for other areas of Topic 740 by clarifying and amending existing guidance.

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 are currently evaluating the impact, if any this ASU will have on our consolidated financial statements and related disclosures .

In August 2018 the FASB issued ASU 2018-13 - Fair Value Measurement (Topic 820).

The FASB is issuing the amendments in this ASU as part of the disclosure framework project.

On March 4, 2014, the Board issued a proposed FASB Concepts Statement, Conceptual Framework for Financial Reporting—Chapter 8:

Notes to Financial Statements, which the Board finalized on August 28, 2018.

The disclosure framework projects objective and primary focus are to improve the effectiveness of disclosures in the notes to financial statements by facilitating clear communication of the information required by GAAP that is most important to users of each entitys financial statements.

The amendments in this ASU are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019.

We will adopt this guidance on January 1, 2020 and expect this guidance will have no material impact on our financial position and statement of operations.

In June 2016, the FASB issued ASU No.

2016-13, Financial Instruments-Credit Losses (Topic 326).

The purpose of this ASU 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.

This ASU is effective for interim and annual reporting periods beginning after December 15, 2019.

We will adopt this guidance on January 1, 2020 and expect this guidance will have no material impact on our financial position and statement of operations.

In February 2016, FASB issued ASU No.

2016-02, Leases (Topic 842) as amended and supplemented by subsequent ASUs, (ASU 2016-02).

ASU 2016-02 requires an entity to recognize ROU 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 adopted this ASU on January 1, 2019 which had no impact on our consolidated statements of operations.

In May 2014, the FASB issued ASU No.

2014-09 Revenue from Contracts with Customers (Topic 606).

As amended, Topic 606 supersedes prior revenue recognition requirements including most industry-specific revenue recognition guidance.

On January 1, 2018 we adopted this standard using the modified retrospective method which resulted in a $2,500 decrease in accumulated deficit and a $2,500 decrease in deferred revenue in our consolidated balance sheet.

In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments, and issued subsequent amendments to the initial guidance within ASU 2019-04 and ASU 2019-05 (collectively, “ASU 2016-13”).

The amendments in ASU 2016-13 replace the incurred loss impairment methodology with the current expected credit loss model, which requires consideration of a broader range of reasonable and supportable information to estimate credit losses.

The Company adopted this ASU effective January 1, 2020 and the adoption did not have a material impact on the Company’s financial position, results of operations or cash flows .

Results of Operations (all amounts in this section are expressed in thousands)

Revenue generated for the year ended December 31, 2020 was $302,636 compared to revenue for the year ended December 31, 2019 of $85.

The increase was largely attributable to sales as part of our license agreements.

During the year ended December 31, 2020, the Company collected a lump sum payment of $454,034 from Apple, Inc.

(see “Legal Proceedings”), as a result of a favorable court decision relating to a patent infringement case.

The one-time payment includes past royalties, damages for willful infringement, interest, court costs and attorneys’ fees.

(See “Revenue Recognition” in Note 2 - Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements.)

We recognized royalty revenue as part of license agreements entered into with customers during the patent infringement actions (see “Litigation”).

These revenues relate to payment for use of our patented technology prior to the signing of a license agreement, and royalty payments after the execution of the license agreements.

No amounts were allocable to settlement fees, expense reimbursement, damages or any other amounts other than historical and future sales as no such amounts were requested or received.

Licensing Costs

Included in operating expenses for the year ended December 31, 2020, were $90,101 in 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.

Research and Development Expenses

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Our research and development expenses for the year ended December 31, 2020 were $8,830 compared to December 31, 2019 of $3,845.

The decrease in 2019 compared to 2018 was primarily due to the decrease in compensation.

The increase in 2020 compared to 2019 was primarily due to increased compensation expense.

Selling, General and Administrative Expenses

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Selling, general and administrative expenses include compensation expense for management and administrative personnel, as well as expenses for outside legal, accounting, and consulting services.

Our selling, general and administrative expenses for the year ended December 31, 2019 was $15,905 compared to December 31, 2018 of $20,705.

Our selling, general and administrative expenses for the year ended December 31, 2020 were $45,812 compared to December 31, 2019 of $15,905.

The volatility within selling, general and administrative expenses was primarily due to legal fees related to cases involving the defense of our patents.

Legal fees were $30,699 and $5,898 in 2020 and 2019, respectively and represent approximately 67% of selling, general and administrative expenses for 2020 compared to 37% for 2019.

Gain on Settlement

For the year ended December 31, 2020, we recorded a gain of $41,271 pursuant to a favorable court ruling in the case regarding Apple, Inc.

discussed above.

(See “Revenue Recognition” in Note 2 - Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements.)

Interest and Other Income, net

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Interest and other income for the year ended December 31, 2020 was $108,288 compared to December 31, 2019 of $92.

During 2020 we received interest of $108,221 pursuant to a favorable court ruling in the case with Apple, Inc.

discussed above.

(See “Revenue Recognition” in Note 2 - Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements.)

Effective Income Tax Rate

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Valuation allowance

Cumulative effect of accounting change

Stock based compensation

Effective income tax rate

In 2019 and 2018 we had pre-tax losses of $19,573 and $25,403, respectively, which are available for carry forward to offset future taxable income.

We made determinations to provide full valuation allowances for our net deferred tax assets at the end of 2019 and 2018, including NOL carryforwards generated during the years, based on our evaluation of positive and negative evidence, including our history of operating losses and the uncertainty of generating future taxable income that would enable us to realize our deferred tax.

The Company’s effective tax rate for both 2020 and 2019 was lower than the statutory Federal income tax rate primarily due to the change in valuation allowance.

In 2020 we had pre-tax income of $307,452 and in 2019 we had pre-tax losses of $19,573.

At December 31, 2020, we had state net operating loss carryforwards of $107,989.

All of the Federal net operating loss (NOL) carryforwards have been utilized to offset the taxable income in 2020.

The state NOL carryforwards begin expiring in 2029.

Liquidity and Capital Resources

For the year ended December 31, 2020, our cash and cash equivalents totaled $192,908 and our short-term investments totaled $28,348 compared to $3,135 and $2,394, respectively, for the year ended December 31, 2019.

We expect that our cash and cash equivalents and short-term investments as of December 31, 2019, and the $4,489 in proceeds subsequent to December 31, 2019, from sales of our common shares under the ATM, as well as the possibility of future sales of common shares under the ATM and the universal shelf registration statement, described below, will be sufficient to fund our current level of selling, general and administration costs, including legal expenses and provide related working capital for the foreseeable future.

We expect that our cash and cash equivalents and short-term investments as of December 31, 2020, will be sufficient to fund our current level of selling, general and administration costs, including legal expenses and provide related working capital for the foreseeable future.

Over the longer term, we expect to derive the majority of our future revenue from license fees and royalties associated with our patent portfolio, technology, software and secure domain name registry in the United States and other markets around the world.

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Sales commissions, fees and other costs associated with the ATM totaled $139.

Contractual Commitments

Off-Balance Sheet Arrangements

As of December 31, 2019, we had no off-balance sheet arrangements.

Quantitative and Qualitative Disclosures about Market Risk

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis