VirnetX Holding Corp 10-K

Item 8. Financial Statements and Supplementary Data FINANCIAL STATEMENTS Financial Statements Index Page Report of Farber Hass Hurley LLP, Independent Registered Public Accounting Firm 36 Consolidated Balance Sheets of VirnetX Holding Corporation as of December 31, 2020 and December 31, 2019 38 Consolidated Statements of Operations of VirnetX Holding Corporation for the years ended December 31, 2020 and, December 31, 2019 39 Consolidated Statements of Comprehensive Income (Loss) of VirnetX Holding Corporation for the years ended December 31, 2020 and December 31, 2019 39 Consolidated Statements of Stockholders’ Equity of VirnetX Holding Corporation for the years ended December 31, 2020 and, December 31, 2019 40 Consolidated Statements of Cash Flows of VirnetX Holding Corporation for the years ended December 31, 2020, and December 31, 2019 41 Notes to Consolidated Financial Statements of VirnetX Holding Corporation 42 35 Index REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of VirnetX Holding Corporation Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of VirnetX Holding Corporation (the “Company”) as of December 31, 2020 and 2019, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2020, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020, and 2019, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated March 16, 2021, expressed an unqualified opinion. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. 36 Index Description of the Matter Revenue Recognition As discussed in Notes 2 and 12 to the financial statements, during the year ended December 31, 2020 the Company collected a lump sum payment in the amount of $454 million from Apple Inc. on a judgement as a result of a favorable verdict relating to a patent infringement lawsuit. As disclosed by management, the process for determining the value of revenue from the basis of the award was identified in the Final Judgement which included, fixed royalty rate per device, damages for willful infringement, interest, and reimbursement for court costs and attorney’s fees. Our determination that revenue recognition pertaining to the Final Judgement is a critical audit matter results from the significant judgment exercised by management in determining the classification. Processes involving higher amounts of management judgment include the interpretation of the provisions of the Final Judgement to determine the amount of revenue to recognize and whether or not the Company is acting as a principal in the fulfillment of the identified performance obligations. Audit Procedures Our principal audit procedures related to the Company’s revenue recognition for the Final Judgement included the following: - We evaluated the Company’s internal controls related to the identification of distinct performance obligations and the determination of the timing of revenue recognition. - We evaluated management’s significant accounting policies related to the Final Judgement . - We obtained and read the Final Judgement and evaluated and tested management’s identification of the significant terms for completeness. From the terms in the Final Judgement , we evaluated the appropriateness of management’s application of their accounting principles, in their determination of revenue recognition conclusions. - We tested the mathematical accuracy of management’s calculations of the classification of the Final Judgement as well as the associated timing of revenue recognized in the financial statements. Description of the Matter Deferred Taxes As discussed in Notes 2 and 10 to the financial statements, the Company recorded a deferred tax asset, net of a valuation allowance as of December 31, 2020. In assessing the ability to realize the deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The valuation allowance is based on management’s estimates of future taxable income and application of relevant income tax law. Our determination that valuation of deferred taxes is a critical audit matter results from the significant judgment by management when assessing the ability to realize the deferred tax assets, particularly as it relates to estimates of future taxable income. This in turn led to a high degree of auditor judgment, subjectivity, and effort in performing procedures relating to management’s assessment of the realizability of deferred tax assets, as it relates to estimates of future taxable income and application of income tax law. Audit Procedures Our principal audit procedures related to the Company’s deferred taxes included the following: - We evaluated management’s assessment of the realizability of deferred tax assets on a jurisdictional basis. This included evaluating estimates of future taxable income, evaluating management's application of income tax law, and testing the completeness and accuracy of underlying data used in management’s assessment. - We evaluated management’s estimates of future taxable income which involved evaluating whether the estimates used by management were reasonable considering the current and past performance of the respective entity and whether the estimates were consistent with evidence obtained in other areas of the audit. /s/ Farber Hass Hurley LLP We have served as the Company’s auditor since 2008. Chatsworth, California March 16, 2021 37 Index VIRNETX HOLDING CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands, except share amounts) As of December 31, 2020 As of December 31, 2019 ASSETS Current assets: Cash and cash equivalents $ 192,908 $ 3,135 Investments available for sale 28,348 2,394 Accounts receivables 8 5 Prepaid income tax 2,905 — Prepaid expenses and other current assets 263 237 Total current assets 224,432 5,771 Prepaid expenses and other assets 1,301 1,711 Property and equipment, net 11 16 Long term, deferred tax asset 9,049 — Total assets $ 234,793 $ 7,498 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable and accrued liabilities $ 654 $ 1,346 Accrued payroll and related expenses 220 287 Accrued licensing costs 9,438 — Other liabilities, current 44 193 Total current liabilities 10,356 1,826 Other liabilities — 44 Total liabilities 10,356 1,870 Commitments and contingencies (Note 4) Stockholders’ equity: Preferred stock, par value $ 0.0001 per share Authorized: 10,000,000 shares at December 31, 2020 and December 31, 2019, Issued and outstanding: 0 shares at December 31, 2020 and December 31, 2019 — — Common stock, par value $ 0.0001 per share Authorized: 100,000,000 shares at December 31, 2020 and December 31, 2019, Issued and outstanding: 71,058,570 shares and 69,586,764 shares, at December 31, 2020 and December 31, 2019, respectively 7 7 Additional paid-in capital 232,457 223,237 Accumulated deficit ( 8,014 ) ( 217,602 ) Accumulated other comprehensive loss ( 13 ) ( 14 ) Total stockholders’ equity 224,437 5,628 Total liabilities and stockholders’ equity $ 234,793 $ 7,498 See accompanying notes to consolidated financial statements. 38 Index VIRNETX HOLDING CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except share and per share amounts) Year Ended December 31, 2020 Year Ended December 31, 2019 Revenue $ 302,636 $ 85 Operating expense: Licensing costs 90,101 — Research and development 8,830 3,845 Selling, general and administrative expenses 45,812 15,905 Total operating expense 144,743 19,750 Income (loss) from operations 157,893 ( 19,665 ) Gain on settlement 41,271 — Interest and other income, net 108,288 92 Income (loss) before taxes 307,452 ( 19,573 ) Income tax (expense) benefit ( 27,023 ) 393 Net income (loss) $ 280,429 $ ( 19,180 ) Basic earnings (loss) per share $ 3.96 $ ( 0.28 ) Diluted earnings (loss) per share $ 3.92 $ ( 0.28 ) Weighted average shares outstanding basic 70,850,311 68,564,321 Weighted average shares outstanding diluted 71,615,843 68,564,321 VIRNETX HOLDING CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (in thousands) Year Ended December 31, 2020 Year Ended December 31, 2019 Net income (loss) $ 280,429 $ ( 19,180 ) Other comprehensive (loss), net of tax: Change in unrealized gain (loss) on investments — 3 Change in foreign currency translation 1 ( 3 ) Total other comprehensive gain (loss), net of tax 1 — Comprehensive income (loss) $ 280,430 $ ( 19,180 ) See accompanying notes to consolidated financial statements. 39 Index VirnetX Holding Corporation CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (in thousands, except share amounts) Common Stock Additional Accumulated Other Total Stockholders’ Shares Amount Paid-in Capital Accumulated Deficit Comprehensive Loss Equity Balance at December 31, 2018 66,879,847 $ 7 $ 208,317 $ ( 198,422 ) $ ( 14 ) $ 9,888 Stock issued for cash at $ 4.00 -$ 6.49 per share, net 1,860,483 10,539 10,539 Stock issued for options and RSUs, net 846,434 670 670 Stock-based compensation 3,711 3,711 Comprehensive loss: Net loss ( 19,180 ) ( 19,180 ) Change in foreign currency translation, net of tax ( 3 ) ( 3 ) Change in unrealized gains, net of tax 3 3 Comprehensive loss ( 19,180 ) Balance at December 31, 2019 69,586,764 $ 7 $ 223,237 $ ( 217,602 ) $ ( 14 ) $ 5,628 Stock issued for cash at $ 4.00 -$ 4.96 per share, net 1,049,382 4,488 4,488 Stock issued for options and RSUs, net 422,424 690 690 Stock-based compensation 3,938 3,938 Warrants issued for services 104 104 Dividends declared and paid, $ 1.00 per share ( 70,841 ) ( 70,841 ) Comprehensive income: Net income 280,429 280,429 Change in foreign currency translation, net of tax 1 1 Comprehensive income 280,430 Balance at December 31, 2020 71,058,570 $ 7 $ 232,457 $ ( 8,014 ) $ ( 13 ) $ 224,437 See accompanying notes to consolidated financial statements. 40 Index VIRNETX HOLDING CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Year Ended December 31, 2020 Year Ended December 31, 2019 Cash flows from operating activities: Net income (loss) $ 280,429 $ ( 19,180 ) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation 5 7 Stock-based compensation 3,938 3,711 Amortization of warrant issuance costs 69 — Deferred income taxes ( 9,049 ) — Changes in assets and liabilities: Prepaid expenses and other assets 419 374 Accounts payable and accrued liabilities ( 692 ) 296 Other liabilities ( 193 ) 97 Accrued payroll and related expenses ( 67 ) 10 Accrued licensing costs 9,438 — Accounts receivable ( 3 ) 1 Prepaid income taxes ( 2,905 ) ( 396 ) Net cash provided by (used in) operating activities 281,389 ( 15,080 ) Cash flows from investing activities: Purchase of property and equipment — ( 14 ) Purchase of investments ( 33,065 ) ( 5,784 ) Proceeds from sale or maturity of investments 7,112 5,192 Net cash used in investing activities ( 25,953 ) ( 606 ) Cash flows from financing activities: Proceeds from exercise of options 1,046 816 Proceeds from sale of common stock 4,488 10,539 Payment of dividends on common stock ( 70,841 ) — Payments on payroll taxes on cashless vesting of RSUs ( 356 ) ( 145 ) Net cash (used in) provided by financing activities ( 65,663 ) 11,210 Net increase (decrease) in cash and cash equivalents 189,773 ( 4,476 ) Cash and cash equivalents, beginning of period 3,135 7,611 Cash and cash equivalents, end of period $ 192,908 $ 3,135 Cash paid for income taxes $ 38,977 $ 4 See accompanying notes to consolidated financial statements. 41 Index VirnetX Holding Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands except share, per share and per device amounts) Note 1 − Formation and Business of the Company VirnetX Holding Corporation, which we refer to as” we”, “us”, “our”, “the Company” or “VirnetX”, is engaged in the business of commercializing a portfolio of patents. We seek to license our technology, including GABRIEL Connection Technology™, to various original equipment manufacturers, or OEMs, that use our technologies in the development and manufacturing of their own products within the IP-telephony, mobility, fixed-mobile convergence, and unified communications markets. Prior to 2012 our revenue was limited to an insignificant amount of software royalties pursuant to the terms of a single license agreement. During 2012, 2013 and 2020 we had revenues from settlements of patent infringement disputes whereby we received consideration for past sales of licensees 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. Our issued U.S. and foreign patents expire at various times during the period from 2020 to 2024. Some of our issued patents and pending patent applications were acquired by our principal operating subsidiary; VirnetX, Inc., from 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. Note 2 − Summary of Significant Accounting Policies The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. The critical accounting policies we employ in the preparation of our consolidated financial statements are those which involve impairment of long-lived assets, income taxes, fair value of financial instruments and stock-based compensation. Use of Estimates We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the U.S. (“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. 42 Index 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 expense, and other assets on the 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 (see Note 13 – Leases). 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 Accounting Standards Codification 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 (“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. During the year ended December 31, 2020, the Company collected a lump sum payment of $ 454,034 from Apple, Inc., because of a favorable court decision relating to a patent infringement case. The court decision identified the following as the basis of the award: $ 302,428 for past royalties, $ 41,271 in damages for willful infringement, $ 108,221 for interest, and $ 2,114 in reimbursement for court costs and attorney’s fees (see Note 12 - Litigation). Elements of the payment were recognized in the Company’s condensed consolidated statement of operations as follows: Classification of Payment Received in the Company’s Condensed Consolidated Statement of Operations Year Ended: December 31, 2020 Revenue (royalties) $ 302,428 Operating expenses: selling, general and administrative (reimbursed litigation costs) 2,114 Other income: gain (willful infringement) 41,271 Other income: interest income (pre- and post-judgment interest) 108,221 Total cash received $ 454,034 Licensing Costs Included in operating expenses for the year ended December 31, 2020, is $ 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. Contingent Gains We recognize gain contingencies in accordance with ASC 450-30-25 which 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. 43 Index 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 year ended December 31, 2020 and 2019, 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. 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. 44 Index 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. 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. If and when we believe it is more likely than not that we will recover our deferred tax assets, we will reverse the valuation allowance as an income tax benefit in our statements of operations. We account for our uncertain tax positions in accordance with U.S. GAAP. The U.S. GAAP method of accounting for uncertain tax positions utilizes a two-step approach to evaluate tax positions. Step one, recognition, requires evaluation of the tax position to determine if based solely on technical merits it is more likely than not to be sustained upon examination. Step two, measurement, is addressed only if a position is more likely than not to be sustained. In step two, the tax benefit is measured as the largest amount of benefit, determined on a cumulative probability basis, which is more likely than not to be realized upon ultimate settlement with tax authorities. If a position does not meet the more likely than not threshold for recognition in step one, no benefit is recorded until the first subsequent period in which the more likely than not standard is met, the issue is resolved with the taxing authority, or the statute of limitations expires. Positions previously recognized are derecognized when we subsequently determine the position no longer is more likely than not to be sustained. Evaluation of tax positions, their technical merits, and measurements using cumulative probability are highly subjective management estimates. Actual results could differ materially from these estimates. Stock-Based Compensation We account for stock-based compensation using the fair value recognition method in accordance with U.S. GAAP. We recognize these compensation costs on a straight-line basis over the requisite service period of the award, which is generally the vesting term of 4 years. We do not estimate the forfeiture rate and recognize forfeitures, if any, when they occur. See Note 6 - Stock-Based Compensation below for additional information concerning our share-based compensation awards. In addition, as required we record stock-based compensation expense for awards granted to non-employees at fair value of the consideration received or the fair value of the equity instruments issued as they vest over the performance period. Earnings per Share Basic earnings per share are computed by dividing earnings available to common stockholders by the weighted average number of outstanding common shares during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of shares outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. During 2019 we incurred losses; therefore, the effect of any common stock equivalent would be anti-dilutive during the year. 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 are currently evaluating the impact, if any this ASU will have on our consolidated financial statements and related disclosures . 45 Index In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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 . Note 3 − Property and Equipment Our major classes of property and equipment were as follows: December 31 2020 2019 Office furniture $ 79 $ 79 Computer equipment 81 81 Total 160 160 Less accumulated depreciation ( 149 ) ( 144 ) Total property and equipment, net $ 11 $ 16 Depreciation expense for the years ended December 31, 2020 and 2019 was $ 5 , and $ 7 , respectively. Note 4 − Commitments, Contingencies and Related Party Transactions We lease our offices under an operating lease with a third party expiring in October 2021 . We recognize rent expense on a straight-line basis over the term of the lease. Rent expense was $ 56 , for each of the years ended December 31, 2020, and 2019. Future minimum rents due under the lease total $ 46 in 2021, when the lease expires. 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 $ 324 and $ 1,790 in rental fees and reimbursements to the LLC during the years ended December 31, 2020 and 2019, 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 normal in such transactions 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 Plan 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 will expire in 2023. 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 . At December 31, 2020, there were 545,210 shares available for grant under the 2013 Plan. 46 Index Note 6 − Stock-Based Compensation The following tables summarize information about stock options and RSUs outstanding at December 31, 2020: Options Outstanding Options Vested and Exercisable Range of Exercise Prices Number Outstanding Weighted Average Remaining Contractual Life (Years) Weighted Average Exercise Price Number Exercisable Weighted Average Remaining Contractual Life (Years) Weighted Average Exercise Price $ 2.35 -   6.95   4,558,896 7.04 $ 4.53 3,147,625 6.47 $ 4.26 $ 14.52 -  35.25   1,253,625 1.71 $ 23.16 1,253,625 1.71 $ 23.16 5,812,521 5.89 $ 8.62 4,401,250 5.11 $ 9.64 The following tables summarize activity under the Plan for the indicated periods: Options Number of Shares Weighted Average Exercise Price Weighted Average Remaining Contractual Life (Years) Aggregate Intrinsic Value Outstanding at December 31, 2018 5,998,837 $ 7.72 — $ — Options granted 345,000 6.06 — — Options exercised ( 663,816 ) 1.23 — — Options cancelled ( 50,000 ) 4.95 — — Outstanding at December 31, 2019 5,630,021 $ 8.49 6.11 $ 516 Options granted 747,500 6.07 — — Options exercised ( 262,031 ) 3.99 — — Options cancelled ( 302,969 ) 5.30 — — Outstanding at December 31, 2020 5,812,521 $ 8.55 5.89 $ 3,650 Options exercisable at December 31, 2020 4,401,250 $ 9.64 5.11 $ 2,927 RSUs Number of RSUs Weighted Average Grant Date Fair Value Aggregate Intrinsic Value Outstanding at December 31, 2018 504,994 $ 3.83 $ — RSUs granted 229,996 6.06 — RSUs vested ( 207,334 ) 4.07 — RSUs cancelled ( 29,167 ) 4.65 Outstanding at December 31, 2019 498,489 $ 4.71 $ 86 RSUs granted 218,329 6.89 — RSUs vested ( 212,495 ) 4.63 — Outstanding at December 31, 2020 504,323 $ 5.69 $ 230 Intrinsic value is calculated as the difference between the per-share market price of our common stock on the last trading day of 2020, which was $ 5.04 and the exercise price of the options. For options exercised, the intrinsic value is the difference between market price and the exercise price on the date of exercise. We received cash proceeds of $ 1,046 and $ 816 from stock options exercised in 2020 and 2019, respectively. The total intrinsic value of options exercised was $ 151 and $ 2,473 during the years ended December 31, 2020 and 2019, respectively. Stock-based compensation expense is included in operating expense for each period as follows: Stock-Based Compensation by Type of Award Year Ended December 31, 2020 Year Ended December 31, 2019 Stock options $ 2,872 $ 2,756 RSUs 1,066 955 Total stock-based compensation expense $ 3,938 $ 3,711 47 Index As of December 31, 2020, there was $ 5,249 of unrecognized stock-based compensation expense related to unvested employee stock options and $ 2,215 of unrecognized stock-based compensation expense related to unvested RSUs. These costs are expected to be recognized over a weighted-average period of 2.24 and 2.33 years, respectively. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model using the following weighted average assumptions: Year Ended December 31, 2020 Year Ended December 31, 2019 Expected stock price volatility 93.45 % 92.34 % Risk-free interest rate 0.63 % 2.09 % Expected life term 6.21 years 6.14 years Expected dividends 0 % 0 % Based on the Black-Scholes option pricing model, the weighted average estimated fair value of employee stock options granted was $ 4.62 and $ 4.63 per share during the years ended December 31, 2020 and 2019, respectively. The expected life was determined using the simplified method outlined in ASC 718, “Compensation - Stock Compensation” . Expected volatility of the stock options was based upon historical data and other relevant factors. We have not provided an estimate for forfeitures because we have had nominal forfeited options and RSUs and believed that all outstanding options and RSUs at December 31, 2020, would vest. Note 7 − Earnings Per Share Basic earnings per share are based on the weighted average number of shares outstanding for a period. Diluted earnings per share are based upon the weighted average number of shares and potentially dilutive common shares outstanding. Potential common shares outstanding principally include stock options and RSUs under our stock plan and warrants. During 2019, we incurred losses; therefore, the effect of any common stock equivalent would be anti-dilutive during the year. The table below sets forth the basic and diluted loss per share calculations: 2020 2019 Net income (loss) $ 280,429 $ ( 19,180 ) Basic weighted average number of shares outstanding 70,850 68,564 Effect of dilutive securities 766 — Diluted weighted average number of shares outstanding 71,616 68,564 Basic earnings (loss) per share $ 3.96 $ ( 0.28 ) Diluted earnings (loss) per share $ 3.92 $ ( 0.28 ) Note 8 − Common Stock Each share of common stock has the right to one vote . The holders of common stock are entitled to receive dividends whenever funds are legally available and when declared by our Board of Directors, subject to the prior rights of holders of all classes of stock outstanding having priority rights as to dividends. Our restated articles of incorporation authorize us to issue up to 100,000,000 shares of $ 0.0001 par value common stock. On July 30, 2018 we filed a $ 100,000 universal shelf registration statement on SEC Form S-3. This replacement registration statement was declared effective by the SEC on August 16, 2018. We also entered a new ATM with Cowen on August 31, 2018, under which we could 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 and 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 December 31, 2020, common stock with an aggregate value of up to $ 21,964 remained available for offer and sale under the ATM agreement. 48 Index We sold 1,049,382 and 1,860,483 shares of common stock under the ATM program during the years ended December 31, 2020 and 2019, respectively. The average sales price per common share sold during the year ended December 31, 2020 was $ 4.41 and the aggregate proceeds from the sales totaled $ 4,627 during the period. Sales commissions, fees and other costs associated with the ATM transactions totaled $ 139 for 2020. The average sales price per common share sold during the year ended December 31, 2019 was $ 5.84 and the aggregate proceeds from the sales totaled $ 10,866 during the period. Sales commissions, fees and other costs associated with the ATM transactions totaled $ 326 for 2019. Dividends On May 8, 2020 , we declared a one-time cash dividend to shareholders of record as of the close of business on May 18, 2020 of $ 1 per share of common stock, payable on May 26, 2020 . The timing and amounts of future dividends, if any, will depend on market conditions, corporate business and financial considerations and regulatory requirements. 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, 2019 Issued Exercised Terminated / Cancelled Outstanding and Exercisable December 31, 2020 Expiration Date 25,000 $ 7.00 25,000 — — ( 25,000 ) — April 30, 2020 25,000 $ 5.75 — 25,000 — — 25,000 April 30, 2025 — 25,000 25,000 — ( 25,000 ) 25,000 — Note 9 − Employee Benefit Plan We sponsor a defined contribution 401k plan covering substantially all our employees. Our matching contribution to the plan was approximately $ 112 and $ 101 in 2020 and 2019, respectively. Note 10 − Income Taxes The income tax provision (benefit) is comprised of the following: Year Ended December 31, 2020 Year Ended December 31, 2019 Current: Federal $ 35,122 $ — State 950 ( 393 ) 36,072 ( 393 ) Deferred: Federal ( 8,816 ) — State ( 233 ) — ( 9,049 ) — Total income tax provision (benefit) $ 27,023 $ ( 393 ) A reconciliation of the United States federal statutory income tax rate to our effective income tax rate is as follows: Year Ended December 31, 2020 Year Ended December 31, 2019 United States federal statutory rate 21.00 % 21.00 % State taxes, net of federal benefit 0.17 % 1.99 % Valuation allowance ( 12.22 )% ( 21.96 )% Stock based compensation ( 0.01 )% — R&D Credit ( 0.21 )% 1.34 % Other 0.06 % ( 0.38 )% Effective income tax rate 8.79 % 1.99 % 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 of valuation allowance. Due to the income in 2020, our valuation allowance against federal net deferred tax assets was fully released in 2020. We continue to provide partial valuation allowance against California net operating loss and research credit carryovers due to the fact that we have no income in California. 49 Index Deferred tax assets (liabilities) consist of the following: As of December 31, 2020 As of December 31, 2019 Deferred tax assets: Reserves and accruals $ 48 $ 62 Research and development credits and other credits 13 1,730 Net operating loss carry forward 598 27,907 Stock based compensation 8,998 8,402 Other 3 11 Total deferred tax assets $ 9,660 $ 38,112 Valuation allowance ( 611 ) ( 38,112 ) Deferred tax assets after valuation allowance 9,049 — Total deferred tax liability — — Net deferred tax assets $ 9,049 $ — In 2020 and 2019, we had pre-tax income of $ 307,452 and pre-tax losses of $ 19,573 , respectively. At December 31, 2020, we had federal and state net operating loss carryforwards of approximately $ 0 and $ 107,989 , respectively. All of the federal net operating loss carryforwards has been utilized to offset taxable income in 2020. The state net operating loss carryforward will be expiring beginning in 2029 . 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. Internal Revenue Code Section 382 places a limitation on the amount of net operating loss 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 Net Operating Losses. 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, we have no uncertain tax positions. 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. Our policy is to recognize interest and penalties, if any, accrued on any unrecognized tax benefits, as a component of income tax expense. We had no interest or penalties accrued for the year ended December 31, 2020 or 2019. 50 Index Reconciliation of provision for uncertain tax position discussed above: Year Ended December 31, 2020 Year Ended December 31, 2019 Balance at the beginning of the year $ — $ 316 Additions based on tax positions related to the current year — — Additions for tax positions of prior years — — Settlements — — Lapse of applicable statute of limitations — ( 316 ) Balance at the end of the year $ — $ — Note 11 − Fair Value Measurement We apply fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement: Level 1 – Quoted prices in active markets for identical assets or liabilities. Level 2 – Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 – Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset or liability. The carrying amounts for cash and cash equivalents, investments in certificates of deposit, accounts payable and accrued expenses approximate their fair values due to the short period of time until maturity. Mutual funds : Valued at the quoted net asset value (NAV) 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 table shows the adjusted cost, gross unrealized gains, gross unrealized losses, and fair value of our financial assets as of December 31, 2020 and 2019 (in thousands): 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 December 31, 2019 Adjusted Cost Unrealized Gains Unrealized Losses Fair Value Cash and Cash Equivalents Investments Available for Sale Cash $ 2,076 $ — $ — $ 2,076 $ 2,076 $ — Level 1: Mutual funds 613 — — 613 613 — U.S. agency securities 2,837 3 — 2,840 446 2,394 3,450 3 — 3,453 1,059 2,394 Total $ 5,526 $ 3 $ — $ 5,529 $ 3,135 $ 2,394 The maturities of our marketable securities generally range from within one to two years . Actual maturities could differ from contractual maturities due to call or prepayment provisions. 51 Index Note 12 – Litigation (all dollar amounts in this section are expressed in thousands except for rates per device) 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. Cisco Systems, Inc. et al. (Case 6:10-CV-00417-LED) (“Apple I”) On August 11, 2010, we filed a complaint against Aastra USA. Inc. (“Aastra”), Apple Inc. (“Apple”), Cisco Systems, Inc. (“Cisco”), and NEC Corporation (“NEC”) the USDC in which we alleged that these parties infringe 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 cases against each defendant were separated by the judge. Aastra and NEC agreed to sign license agreements with us, and we dropped all accusations of infringement against them. A jury in USDC decided that our patents were not invalid and rendered a verdict of non-infringement by Cisco on March 4, 2013. Our motion for a new Cisco trial was denied and the case against Cisco was closed. On November 6, 2012, a jury in the USDC awarded us over $ 368,000 for Apple’s infringement of four of our patents, plus daily interest up to the final judgment. Apple filed an appeal of the judgment to the USCAFC. On September 16, 2014, USCAFC affirmed the USDC jury’s finding that all four of our patents at issue are valid and confirmed the USDC jury’s finding of infringement of VPN on Demand under many of the asserted claims of our ‘135 and ‘151 patents, and the USDC’s decision to allow evidence about our license and royalty rates regarding the determination of damages. However, the USCAFC vacated the USDC jury’s damages award and some of the USDC’s claim construction with respect to parts of our ‘504 and ‘211 patents and remanded the damages award and determination of infringement with respect to FaceTime back to the USDC for further proceedings. 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 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. 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 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. 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. 52 Index 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. 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 IPR 2015-01046 and IPR 2016-00062 involving our U.S. Patent No . 6,502,135 , and an appeal of the invalidity findings by the PTAB in inter partes review proceedings IPR 2015-1047 , IPR 2016 - 00063 , and IPR 2016-00167 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, which remains pending. In view of our motion to remand, our deadline to file an initial brief is currently stayed. 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 USAFC, including decisions in VirnetX Inc. v. Cisco Systems, Inc. , Nos. 2019-1671 , and VirnetX Inc. v. Iancu, Nos. 2017-2593 , -2594 . In those cases, the USAFC granted VirnetX’s motions to vacate the underlying decisions of the PTAB on the basis of Arthrex, Inc. v. Smith & Nephew, Inc. , 941 F .3 d 1320 (Fed. Cir. 2019 ), and remanded for further proceedings. The United States requested that the SCOTUS hold its certiorari petition pending the disposition of the United States’ separate petition in United States v. Arthrex, Inc. , No . 19-1434 (filed June 25, 2020 ). On August 26, 2020 , VirnetX filed a response, agreeing that the United States’ certiorari petition should be held pending the disposition of the petition for a writ of certiorari in No . 19-1434 (and related petitions filed by private parties in Nos. 19-1452 and 19-1458 ), and any further SCOTUS proceedings. On October 13, 2020 , SCOTUS granted the United States’ petition for a writ of certiorari in No . 19-1434 as to USAFC Case No . 2018-2140 , and the petitions for writs of certiorari in Nos. 19-1452 and 19-1458 , all limited to Questions 1 and 2 as set forth in the July 22, 2020 Memorandum for the United States filed in No . 19-1434 . The consolidated petition is seeking review of decisions by the USCAFC holding that administrative patent judges (“APJ”) of the Patent Trial and Appeal Board of the U.S. Patent and Trademark Office must be appointed by the President and confirmed by the Senate; and, whether the remedy imposed by USCAFC that federal laws that place restrictions on when officials can be removed from office cannot apply to APJ, was the appropriate one . SCOTUS heard oral argument in these consolidated cases on March 1, 2021 . 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 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. 53 Index Neal Hurwitz v. Kendall Larsen et al. (Case 2020-0425 -JRS) On June 2, 2020 , stockholder Neal Hurwitz filed a verified derivative complaint in the Delaware Court of Chancery against Kendall Larsen, Robert D. Short Ill, Gary Feiner, Michael F. Angelo, and Thomas M. O’Brien and naming the Company as nominal defendant. The lawsuit alleges breaches of fiduciary duty, corporate waste, and unjust enrichment arising out of a series of previously-disclosed transactions and compensation awards and seeks an award of monetary damages and equitable relief. On July 1, 2020 , the defendants filed a motion to dismiss the complaint based on a failure to plead demand futility and a failure to state a claim on which relief can be granted and, on August 19, 2020 , the defendants filed an opening brief in support of their motion to dismiss. On October 16, 2020 , plaintiff amended his complaint rather than respond to the arguments in the defendants’ opening brief. On October 23, 2020 , the defendants filed a renewed motion to dismiss plaintiff’s amended complaint based on a failure to plead demand futility and a failure to state a claim on which relief can be granted. On January 12, 2021 , Hurwitz voluntarily dismissed his suit without prejudice. Other Legal Matters One or more potential intellectual property infringement claims may also be available to us against certain other companies who have the resources to defend against any such claims. Although we believe these potential claims are 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 13 – Leases We lease office space under an operating lease which expires on October 31, 2021 . At December 31, 2020, the underlying ROU asset and lease liability totaled $ 44 . At December 31, 2019, the underlying ROU asset and lease liability totaled $ 97 . Lease expense totaled $ 56 in both 2020 and 2019. We also lease a facility for corporate promotional and marketing purposes which was prepaid at inception and originally expired in 2024 . In September 2020, the lease was extended for one year to 2025, due to COVID use-restrictions in 2020. No other terms of the original agreement were affected and there was no impact on cash flow. At December 31, 2020 and 2019, the ROU asset totaled $ 1,248 and $ 1,604 , respectively; lease expense totaled $ 356 and $ 385 , during 2020 and 2019, respectively. 54 Index REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of VirnetX Holding Corporation Opinion on Internal Control over Financial Reporting We have audited VirnetX Holding Corporation’s (the Company’s) internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control—Integrated Framework (2013) issued by COSO. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows of the Company, and our report dated March 16, 2021, expressed an unqualified opinion. Basis for Opinion The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Farber Hass Hurley LLP Chatsworth, California March 16, 2021 55 Index Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None.