Item 8. Financial Statements and Supplementary Data
Item 8.
Financial Statements and Supplementary Data
Set forth below, are the audited consolidated financial statements for our company accompanied by all reports thereon of Farber Hass Hurley LLP (PCAOB No. 223 )
FINANCIAL STATEMENTS
Financial Statements Index
Page
Report of Farber Hass Hurley LLP, Independent Registered Public Accounting Firm
26
Consolidated Balance Sheets of VirnetX Holding Corporation as of December 31, 2021 and December 31, 2020
28
Consolidated Statements of Operations of VirnetX Holding Corporation for the years ended December 31, 2021, December 31, 2020 and, December 31, 2019
29
Consolidated Statements of Comprehensive (Loss) Income of VirnetX Holding Corporation for the years ended December 31, 2021, December 31, 2020, and December 31, 2019
30
Consolidated Statements of Stockholders’ Equity of VirnetX Holding Corporation for the years ended December 31, 2021, December 31, 2020 and, December 31, 2019
31
Consolidated Statements of Cash Flows of VirnetX Holding Corporation for the years ended December 31, 2021, December 31, 2020, and December 31, 2019
32
Notes to Consolidated Financial Statements of VirnetX Holding Corporation
33
25
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, 2021
and 2020, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2021, 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, 2021, and 2020, and the results of its operations and its cash flows for
each of the years in the three-year period ended December 31, 2021, 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, 2021, 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, 2022, (May 13, 2022 as to the effects of the material weakness described in Management’s Report on Internal
Control over Financial Reporting (As Revised), which report expressed an adverse opinion on the Company’s internal control over financial reporting because of a material weakness).
Restatement of 2021 Financial Statements
As discussed in Note 2 to the consolidated financial statements, the 2021 consolidated financial statements have been restated to
correct misstatements.
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 Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was
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 the critical audit matter 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 matter below, providing a separate opinion on the critical audit
matter or on the accounts or disclosures to which it relates.
26
Index
Deferred Taxes
Description of the Matter
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, 2021. 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, 2022 (May 13, 2022 as to the effects of Note 2)
27
Index
VIRNETX HOLDING CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
As restated
As of
December 31, 2021
As of
December 31, 2020
ASSETS
Current assets:
Cash and cash equivalents
$
142,018
$
192,908
Investments available for sale
27,254
28,348
Accounts receivables
17
8
Prepaid income tax
—
2,905
Prepaid expenses and other current assets
203
263
Total current assets
169,492
224,432
Prepaid expenses and other assets
1,056
1,301
Property and equipment, net
18
11
Deferred tax asset
15,950
9,049
Total assets
$
186,516
$
234,793
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities
$
338
$
654
Accrued payroll and related expenses
270
220
Accrued licensing costs
355
9,438
Other liabilities, current
58
44
Total current liabilities
1,021
10,356
Other liabilities
46
—
Total liabilities
1,067
10,356
Commitments and contingencies (Note 4)
Stockholders’ equity:
Preferred stock, par value $ 0.0001 per share Authorized: 10,000,000 shares at December 31, 2021
and December 31, 2020, Issued and outstanding: 0 shares at December 31, 2021 and December 31, 2020
—
—
Common stock, par value $ 0.0001 per share
Authorized: 100,000,000 shares at December 31, 2021 and December 31, 2020, Issued and outstanding: 71,232,856
shares and 71,058,570 shares, at December 31, 2021 and December 31, 2020, respectively
7
7
Additional paid-in capital
236,445
232,457
Accumulated deficit
( 50,935
)
( 8,014
)
Accumulated other comprehensive loss
( 68
)
( 13
)
Total stockholders’ equity
185,449
224,437
Total liabilities and stockholders’ equity
$
186,516
$
234,793
See accompanying notes to consolidated financial statements.
28
Index
VIRNETX HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)
As restated
Year Ended
December 31, 2021
Year Ended
December 31, 2020
Year Ended
December 31, 2019
Revenue
$
35
$
302,636
$
85
Operating expense:
Licensing costs
( 9,083
)
90,101
—
Research and development
5,577
8,830
3,845
Selling, general and administrative expenses
52,715
45,812
15,905
Total operating expense
49,209
144,743
19,750
(Loss) income from operations
( 49,174
)
157,893
( 19,665
)
Gain on settlement
—
41,271
—
Interest and other income, net
48
108,288
92
(Loss) income before taxes
( 49,126
)
307,452
( 19,573
)
Income tax benefit (provision)
6,205
( 27,023
)
393
Net (loss) income
$
( 42,921
)
$
280,429
$
( 19,180
)
Basic (loss) earnings per share
$
( 0.60
)
$
3.96
$
( 0.28
)
Diluted (loss) earnings per share
$
( 0.60
)
$
3.92
$
( 0.28
)
Weighted average shares outstanding basic
71,159,458
70,850,311
68,564,321
Weighted average shares outstanding diluted
71,159,458
71,615,843
68,564,321
See accompanying notes to consolidated financial statements.
29
VIRNETX HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(in thousands)
As restated
Year Ended
December 31, 2021
Year Ended
December 31, 2020
Year Ended
December 31, 2019
Net (loss) income
$
( 42,921
)
$
280,429
$
( 19,180
)
Other comprehensive (loss) income, net of tax:
Change in unrealized (loss) gain on investments, net
( 51
)
—
3
Change in foreign currency translation, net
( 4
)
1
( 3
)
Total other comprehensive (loss) gain, net of tax
( 55
)
1
—
Comprehensive (loss) income
$
( 42,976
)
$
280,430
$
( 19,180
)
See accompanying notes to consolidated financial statements.
30
Index
VirnetX Holding Corporation
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except share amounts)
As restated
Year Ended
December 31, 2021
Year Ended
December 31, 2020
Year Ended
December 31, 2019
Total shareholders’ equity, beginning balances
$
224,437
$
5,628
$
9,888
Common stock and additional paid-in capital:
Beginning balances
232,464
223,244
208,324
Common stock issued for cash, net
—
4,488
10,539
Common stock issued for options/RSUs, net
( 196
)
690
670
Warrants issued for services
—
104
—
Stock-based compensation
4,184
3,938
3,711
Ending balances
236,452
232,464
223,244
Accumulated deficit (retained earnings)
Beginning balances
( 8,014
)
( 217,602
)
( 198,422
)
Net (loss) income
( 42,921
)
280,429
( 19,180
)
Dividends
—
( 70,841
)
—
Ending balances
( 50,935
)
( 8,014
)
( 217,602
)
Accumulated other comprehensive loss:
Beginning balances
( 13
)
( 14
)
( 14
)
Change in unrealized investment (loss) gain, net
( 51
)
—
3
Change in foreign currency translation, net
( 4
)
1
( 3
)
Ending balances
( 68
)
( 13
)
( 14
)
Total shareholders’ equity, ending balances
$
185,449
$
224,437
$
5,628
Dividends per share
$
—
$
1.00
$
—
See accompanying notes to consolidated financial statements.
31
Index
VIRNETX HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
As restated
Year Ended
December 31, 2021
Year Ended
December 31, 2020
Year Ended
December 31, 2019
Cash flows from operating activities:
Net (loss) income
$
( 42,921
)
$
280,429
$
( 19,180
)
Adjustments to reconcile net (loss) income to
net cash from operating activities:
Depreciation
4
5
7
Stock-based compensation
4,184
3,938
3,711
Amortization of warrants issuance costs
34
69
—
Deferred income taxes
( 6,901
)
( 9,049
)
—
Changes in assets and liabilities:
Prepaid expenses and other current assets
271
419
374
Accounts payable and accrued liabilities
( 316
)
( 692
)
296
Other liabilities
60
( 193
)
97
Accrued payroll and related expenses
50
( 67
)
10
Accrued licensing costs
( 9,083
)
9,438
—
Accounts receivable
( 9
)
( 3
)
1
Prepaid income taxes
2,905
( 2,905
)
( 396
)
Net cash (used in) provided by operating activities
( 51,722
)
281,389
( 15,080
)
Cash flows from investing activities:
Purchase of property and equipment
( 11
)
—
( 14
)
Purchase of investments
( 26,332
)
( 33,065
)
( 5,784
)
Proceeds from sale or maturity of investments
27,371
7,112
5,192
Net cash provided by (used in) investing activities
1,028
( 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
Dividends paid on common stock
—
( 70,841
)
—
Taxes paid on cashless exercise of restricted stock units
( 196
)
( 356
)
( 145
)
Net cash (used in) provided by financing activities
( 196
)
( 65,663
)
11,210
Net (decrease) increase in cash and cash equivalents
( 50,890
)
189,773
( 4,476
)
Cash and cash equivalents, beginning of period
192,908
3,135
7,611
Cash and cash equivalents, end of period
$
142,018
$
192,908
$
3,135
Cash paid for income taxes
$
2
$
38,977
$
4
See accompanying notes to consolidated financial statements.
32
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 derive revenue from selling our software products and licensing our technology, including GABRIEL Connection Technology™, to various original equipment manufacturers (“OEMs”), that use our technologies in the development and
manufacturing of their own products within the IP-telephony, mobility, fixed-mobile convergence, and unified communications markets. During 2020, we had revenues from settlement of a patent infringement dispute whereby we received consideration for
past sales of licensee that utilized our technology, where there was no prior patent license agreement.
Our portfolio of intellectual property is the foundation of our business model. We currently own approximately 205 total patents and pending applications, including 72
U.S. patents/patent applications and 133 foreign patents/validations/pending applications. Our patent portfolio is primarily focused on
securing real-time communications over the Internet, as well as related services such as the establishment and maintenance of a secure domain name registry. Our patented methods also have additional applications in the key areas of device operating
systems and network security for Cloud services, M2M communications in areas of Smart City, Connected Car and Connected Home. The subject matter of all our U.S and foreign patents and pending applications relates generally to securing communications
over the Internet and such covers all our technology and other products. Some of our issued U.S. and foreign patents expire at various times during the period from 2021 to 2034.
Note 2 − Summary of Significant Accounting Policies
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.
Restatement of Previously issued Financial Statements
On March 16, 2022, the Company filed with the SEC the Original Form 10-K, together with all exhibits thereto, which included consolidated financial statements as of
December 31, 2021 and 2020 and for the years ended December 31, 2021, 2020 and 2019. On May 9, 2022, Company management concluded the December 31, 2021 consolidated financial statements included in the Original Form 10-K should no longer be relied
upon because of an error related to accounting for deferred taxes. The error was deemed material to the consolidated financial statements for the year ended December 31, 2021 and resulted in a restatement more fully described below.
The error related to the carrying balance of our deferred taxes that included the fair value of nonqualified stock options (“NSO”) expensed for book purposes but the
tax impact of that expense is deferred for income tax purposes. In connection with accounting for NSOs, the Company expenses the fair value of NSOs granted over the vesting period of the NSOs. For income tax purposes, the tax impact of that
expense is deferred as part of our deferred tax asset, until the NSO holder converts the NSO to stock, at which time the deferred tax asset is reduced and income tax expense is recognized. If an NSO is never exercised, and then expires in
accordance with the terms of the contract, any amounts included in our deferred tax asset are written off and income tax expense is recognized. As of December 31, 2021, the Company incorrectly included $ 3,328 in deferred tax assets related to expired NSOs as of the end of the Affected Period, which should have reduced our income tax benefit when the NSOs expired.
The Company has restated the consolidated financial statements as of and for the year ended December 31, 2021 from amounts previously reported on the Original Form
10-K to reduce our deferred tax asset in our consolidated balance sheet and our income tax benefit in our consolidated statement of operations by $ 3,328 ;
the restatement also resulted in changes to Note 2 - Summary of Significant Accounting Policies, Restatement of Previously Issued Financial Statements ,
Note 7 – Earnings per share and Note 10 – Income Taxes.
33
The following tables present the impact of the restatement adjustment on the previously issued consolidated financial statements and footnotes as of and for the year
ended December 31, 2021:
As of and for the year ended
December 31, 2021
As Previously Reported
Restatement Adjustment
As Restated
Consolidated Balance Sheet
Deferred tax asset
$
19,278
$
( 3,328
)
$
15,950
Total assets
189,844
( 3,328
)
186,516
Accumulated deficit
( 47,607
)
( 3,328
)
( 50,935
)
Total stockholders’ equity
188,777
( 3,328
)
185,449
Total liabilities and stockholders’ equity
189,844
( 3,328
)
186,516
Consolidated Statement of Operations
Income tax benefit
$
9,533
$
( 3,328
)
$
6,205
Net loss
( 39,593
)
( 3,328
)
( 42,921
)
Basic loss per share
( 0.56
)
( 0.04
)
( 0.60
)
Diluted loss per share
( 0.56
)
( 0.04
)
( 0.60
)
Consolidated Statement of Comprehensive Loss
Net loss
$
( 39,593
)
$
( 3,328
)
$
( 42,921
)
Comprehensive loss
( 39,648
)
( 3,328
)
( 42,976
)
Consolidated Statement of Stockholders’ Equity
Net loss
$
( 39,593
)
$
( 3,328
)
$
( 42,921
)
Ending balance, accumulated deficit
( 47,607
)
( 3,328
)
( 50,935
)
Total liabilities and stockholders’ equity
188,777
( 3,328
)
185,449
Consolidated Statement of Cash Flows
Net loss
$
( 39,593
)
$
( 3,328
)
$
( 42,921
)
Deferred income taxes
( 10,229
)
3,328
( 6,901
)
Note 7 - Earnings per share
Net loss
$
( 39,593
)
$
( 3,328
)
$
( 42,921
)
Basic loss per share
( 0.56
)
( 0.04
)
( 0.60
)
Diluted loss per share
( 0.56
)
( 0.04
)
( 0.60
)
Note 10 - Income Taxes, income tax provision
Deferred income tax benefit, Federal
$
( 10,293
)
$
( 3,268
)
$
( 7,025
)
Deferred income tax benefit, State
64
60
124
Total deferred income tax benefit
( 10,229
)
( 3,208
)
( 6,901
)
Total income tax benefit
( 9,533
)
3,328
( 6,205
)
Note 10 - Income Taxes, reconciliation of income tax rate
State taxes, net of federal benefit
( 0.19
)%
( 0.12
)%
( 0.31
)%
Stock based compensation
( 0.02
)%
( 6.66
)%
( 6.68
)%
Effective income tax rate
19.41
%
( 6.78
)%
12.63
%
Note 10 - Income Taxes, deferred tax assets
Stock based compensation
$
9,615
$
( 3,328
)
$
6,287
Total deferred tax assets
19,284
( 3,328
)
15,956
Deferred tax assets after valuation allowance
19,284
( 3,328
)
15,956
Net deferred tax assets
19,278
( 3,328
)
15,950
34
Use of Estimates
We prepare our consolidated financial statements in accordance with U.S. GAAP. In doing so, we have to make estimates and assumptions that affect our
reported amounts of assets, liabilities, revenues, and expenses, as well as related disclosure of contingent assets and liabilities. In some cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in the
accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our
financial condition or results of operations will be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to
accounting estimates of this type as critical accounting policies and estimates, which we discuss further below. We have reviewed our critical accounting policies and estimates with the Audit Committee of our Board of Directors.
Basis of Consolidation
The consolidated financial statements include the accounts of VirnetX Holding Corporation and our wholly owned subsidiaries. All intercompany balances
and transactions have been eliminated.
Leases
The Company determines if an arrangement is a lease at inception in accordance with Accounting Standards Codification (“ASC”) Topic 842. Operating
lease right-of-use (“ROU”) assets are included in Prepaid expenses, and other assets on the Condensed Consolidated Balance Sheets. ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent
the Company’s obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at the commencement date based on the present value of lease payments over the lease term.
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. Elements of the payment were recognized in the Company’s condensed consolidated statement of operations as follows:
35
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 are licensing costs we incurred in conjunction with the proceeds received from Apple Inc., pursuant to a favorable court decision relating
to a patent infringement case.
Contingent Gains
ASC Topic 450-30-25, Contingent Gains, prohibits recognition of contingent gains until realized. Accordingly, we do not record contingent gains ahead
of such realization. Management generally considers any such gains as realized only upon the collection of cash.
Cash and Cash Equivalents
We consider all highly liquid investments purchased with original maturities of three months or less at the date of purchase to be cash equivalents.
Our cash and cash equivalents are not subject to significant interest rate risk due to the short maturities of these investments.
Investments
Investments are classified as available-for-sale and are recorded at fair market value. Unrealized gains and losses are reported as other
comprehensive income. Realized gains and losses are recorded in income in the period they are realized using specific identification of each security’s cost basis. We invest our excess cash primarily in highly liquid debt instruments including
corporate, government and federal agency securities, with contractual maturities less than two years . By policy, we limit the amount of
credit exposure to any one issuer.
Property and Equipment
Property and equipment are stated at historical cost, less accumulated depreciation, and amortization. Depreciation and amortization are computed
using the accelerated and straight-line methods over the estimated useful lives of the assets, which range from five to seven years . Repair and maintenance costs are charged to expense as incurred.
36
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. In 2021, we had, at times, funds that were uninsured. We do not believe that we are subject to any unusual financial risk beyond the normal risk associated with commercial banking
relationships. We have not experienced any losses on our deposits of cash and cash equivalents.
Fair Value
The carrying amounts of our financial instruments, including cash equivalents, accounts payable, and accrued liabilities, approximate fair value
because of their generally short maturities.
Intangible Assets
We record intangible assets at cost, less accumulated amortization. Amortization of intangible assets is provided over their estimated useful lives,
which can range from 3 to 15 years ,
on either a straight-line basis or as revenue is generated by the assets.
Impairment of Long-Lived Assets
We identify and record impairment losses on long-lived assets used in operations when events and changes in circumstances indicate that the carrying
amount of an asset might not be recoverable, but not less than annually. Recoverability is measured by comparison of the anticipated future net undiscounted cash flows to the related assets’ carrying value. If such assets are considered to be impaired,
the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the projected discounted future net cash flows arising from the asset.
Research and Development
Research and development costs include expenses paid to outside development consultants and compensation related expenses for our engineering staff.
Research and development costs are expensed as incurred.
Income Taxes
We account for income taxes using the asset and liability method. The asset and liability method requires the recognition of deferred tax assets and
liabilities for expected future tax consequences of temporary differences that currently exist between the tax basis and financial reporting basis of our assets and liabilities. We calculate current and deferred tax provisions based on estimates and
assumptions that could differ from actual results reflected on the income tax returns filed during the following years. Adjustments based on filed returns are recorded when identified in the subsequent years. The effect on deferred taxes for a change
in tax rates is recognized in income in the period that the tax rate change is enacted. In assessing our deferred tax assets, we consider whether it is more likely than not that all or some portion of the deferred tax assets will not be realized.
A valuation allowance is provided for deferred income tax assets when, in our judgment, based upon currently available information and other factors,
it is more likely than not that all or a portion of such deferred income tax assets will not be realized. The determination of the need for a valuation allowance is based on an on-going evaluation of current information including, among other things,
historical operating results, estimates of future earnings in different taxing jurisdictions and the expected timing of the reversals of temporary differences. We believe the determination to record a valuation allowance to reduce a deferred income tax
asset is a significant accounting estimate because it is based, among other things, on an estimate of future taxable income in the United States and certain other jurisdictions, which is susceptible to change and may or may not occur, and because the
impact of adjusting a valuation allowance may be material. In determining when to release the valuation allowance established against our net deferred income tax assets, we consider all available evidence, both positive and negative. We continually
assess our ability to generate sufficient taxable income during future periods in which our deferred tax assets may be realized. If and when we believe it is more likely than not that we will recover our deferred tax assets, we will reverse the
valuation allowance as an income tax benefit in our statements of operations.
37
Index
We account for our uncertain tax positions in accordance with U.S. GAAP, which utilizes a two-step approach to evaluate tax positions. Step one,
recognition, requires evaluation of the tax position to determine if based solely on technical merits it is more likely than not to be sustained upon examination. Step two, measurement, is addressed only if a position is more likely than not to be
sustained. In step two, the tax benefit is measured as the largest amount of benefit, determined on a cumulative probability basis, which is more likely than not to be realized upon ultimate settlement with tax authorities. If a position does not meet
the more likely than not threshold for recognition in step one, no benefit is recorded until the first subsequent period in which the more likely than not standard is met, the issue is resolved with the taxing authority, or the statute of limitations
expires. Positions previously recognized are derecognized when we subsequently determine the position no longer is more likely than not to be sustained. Evaluation of tax positions, their technical merits, and measurements using cumulative probability
are highly subjective management estimates. Actual results could differ materially from these estimates.
Stock-Based Compensation
We account for stock-based compensation using the fair value recognition method in accordance with U.S. GAAP. We recognize these compensation costs on
a straight-line basis over the requisite service period of the award, which is generally a vesting term of 4 years. We recognize
forfeitures, if any, when they occur. In addition, we record stock-based compensation expense for awards granted to non-employees at fair value of the consideration received or the fair value of the equity instruments issued, as they vest, over the
performance period (See Note 6 - Stock-Based Compensation).
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.
New Accounting Pronouncements
In December 2019, the Financial Accounting Standards Board (“FASB”) issued
Accounting Standards Update (“ASU”) 2019-12 Income Taxes (Topic 740). The amendments in this ASU simplify the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent
application of and simplify U. S. GAAP for other areas of Topic 740 by clarifying and amending existing guidance. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15,
2020. We adopted this ASU on January 1, 2021 and there was no material impact on our financial position or cash flows as a result.
Note 3 − Property and Equipment
Our major classes of property and equipment were as follows:
December 31
2021
2020
Office furniture
$
79
$
79
Computer equipment
92
81
Total
171
160
Less accumulated depreciation
( 153
)
( 149
)
Total property and equipment, net
$
18
$
11
Depreciation expense for 2021, 2020 and 2019 was $ 4 ,
$ 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 2023 . We recognize rent expense on a straight-line basis over the term of the lease. Rent expense was $ 56 , for each of the years 2021, 2020 and 2019. Future minimum rents due under the lease total $ 56
in 2022 and $ 46 in 2023 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 $ 791 , $ 324 ,
and $ 1,790 in rental fees and reimbursements to the LLC during the years 2021, 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.
38
Index
Note 5 − Stock Plan
We have an equity incentive plan for employees and others called the VirnetX Holding Corporation 2013 Equity Incentive Plan (the “2013 Plan”), which
has been approved by our stockholders. To the extent that any award should expire, become un-exercisable or is otherwise forfeited, the shares subject to such award will again become available for issuance under the 2013 Plan. The 2013 Plan provides
for the granting of stock options and restricted stock units purchase rights (“RSUs”) to our employees and consultants. Stock options granted under the 2013 Plan may be incentive stock options or nonqualified stock options. Incentive stock options
(“ISOs”) may only be granted to our employees (including officers and directors). Nonqualified stock options (“NSOs”) and stock purchase rights may be granted to our employees and consultants. The 2013 Plan expires in 2023.
In April 2021, the Board approved an amendment and restatement of the 2013 Plan to, among other things, increase the shares reserved under the Plan
by 2,500,000 shares (the “Plan Amendment”). Our stockholders approved the Plan Amendment at the 2021 Annual Meeting of the Stockholders
held on June 3, 2021. The 2013 Plan generally provides for the granting of shares of our common stock, including stock options and RSUs. Options may be granted under the 2013 Plan with an exercise price determined by our Board of Directors, or a duly
appointed committee thereof, provided, however, that the exercise price of an option granted to any employee shall be not less than 100 %
of the fair market value at the date of grant in the case of ISOs or 85 % of the fair market value at the date of grant in the case of an
NSO. The exercise price of an ISO or NSO granted to one of our Named Executive Officers shall not be less than 100 % fair market value of
the shares at the date of grant and the exercise price of an ISO granted to a 10% shareholder shall not be less than 110 % of the fair
market value of the shares on the date of grant. Stock options granted under the 2013 Plan typically vest over four years and have a 10 -year term. All RSUs are considered to be granted at the fair value of our stock on the date of grant because they have no exercise price. RSUs
typically vest over four years . As of December 31, 2021, there were 2,240,296 shares available for grant under the 2013 Plan.
Note 6 − Stock-Based Compensation
The following tables summarize information about stock options and RSUs outstanding at December 31, 2021:
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
$ 2.88
- 6.95
5,533,812
6.66
$
4.50
4,050,084
5.82
$
4.34
$ 14.52
- 35.25
863,625
1.31
$
22.95
863,625
1.32
$
22.95
6,397,437
5.94
$
6.99
4,913,709
5.03
$
7.61
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
—
$
—
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
—
$
—
Options granted
999,500
4.43
—
—
Options exercised
—
—
—
—
Options cancelled
( 414,584
)
22.54
—
—
Outstanding at December 31, 2021
6,397,437
$
6.99
5.94
$
6
Options exercisable at December 31, 2021
4,913,709
$
7.61
5.03
$
6
39
Index
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
$
—
RSUs granted
218,329
6.89
—
RSUs vested
( 212,495
)
4.63
—
RSUs cancelled
—
—
—
Outstanding at December 31, 2020
504,323
$
5.69
$
—
RSUs granted
236,661
4.61
—
RSUs vested
( 215,165
)
5.23
—
RSUs cancelled
( 16,664
)
5.45
—
Outstanding at December 31, 2021
509,155
$
5.38
$
—
Intrinsic value is calculated as the difference between the per-share market price of our common stock on the last trading day of 2021, which was $ 2.60 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. In 2021, no options were exercised. In 2020 and 2019, we received cash proceeds of $ 1,046 and $ 816 from stock options
exercised, respectively. The total intrinsic value of options exercised was $ 151 and $ 2,473 in 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, 2021
Year Ended
December 31, 2020
Year Ended
December 31, 2019
Stock options
$
3,067
$
2,872
$
2,756
RSUs
1,117
1,066
955
Total stock-based compensation expense
$
4,184
$
3,938
$
3,711
As of December 31, 2021, there was $ 5,403
of unrecognized stock-based compensation expense related to unvested stock options and $ 2,098 of unrecognized stock-based compensation
expense related to unvested RSUs. These costs are expected to be recognized over a weighted-average period of 2.86 and 2.37 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, 2021
Year Ended
December 31, 2020
Year Ended
December 31, 2019
Expected stock price volatility
90.58
%
93.45
%
92.34
%
Risk-free interest rate
1.06
%
0.63
%
2.09
%
Expected life term
6.22 years
6.21 years
6.14
years
Expected dividends
0
%
0
%
0
%
Based on the Black-Scholes option pricing
model, the weighted average estimated fair value of employee stock options granted was $ 3.32 , $ 4.62 and $ 4.63 per share during 2021, 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.
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 2021 and 2019, we incurred losses;
therefore, the effect of any common stock equivalent would be anti-dilutive during the years.
40
Index
The table below sets forth the basic and diluted loss per share calculations:
As restated
Year Ended
December 31, 2021
Year Ended
December 31, 2020
Year Ended
December 31, 2019
Net (loss) income
$
( 42,921
)
$
280,429
$
( 19,180
)
Basic weighted average number of shares outstanding
71,159
70,850
68,564
Effect of dilutive securities
—
766
—
Diluted weighted average number of shares outstanding
71,159
71,616
68,564
Basic (loss) earnings per share
$
( 0.60
)
$
3.96
$
( 0.28
)
Diluted (loss) earnings per share
$
( 0.60
)
$
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 development and marketing of our software product and services , and general corporate purposes, which may include working capital, capital expenditures, other corporate expenses and acquisitions of complementary products, technologies, or businesses. As of August 16, 2021, the
universal shelf registration expired.
We sold zero
shares of common stock under the ATM program during 2021. In 2020, we sold 1,049,382 shares of common stock under the ATM program. 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. In 2019, we sold 1,860,483
shares under the ATM. The average sales priced during the year ended December 31, 2019 per common share 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 totaled $ 327 .
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, 2020
Issued
Exercised
Terminated /
Cancelled
Outstanding and
Exercisable
December 31, 2021
Expiration Date
25,000
$ 5.75
25,000
—
—
—
25,000
April 30, 2025
In April 2020, 25,000 warrants with an exercise price of $ 7.00 per share expired.
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 $ 145 , $ 112 , and $ 101 in 2021, 2020 and 2019, respectively.
41
Index
Note 10 − Income Taxes
The income tax provision (benefit) is comprised of the following:
As restated
Year Ended
December 31, 2021
Year Ended
December 31, 2020
Year Ended
December 31, 2019
Current:
Federal
$
661
$
35,122
$
—
State
35
950
( 393
)
Foreign
—
—
—
696
36,072
( 393
)
Deferred:
Federal
( 7,025
)
( 8,816
)
—
State
124
( 233
)
—
( 6,901
)
( 9,049
)
—
Total income tax (benefit) provision
$
( 6,205
)
$
27,023
$
( 393
)
A reconciliation of the United States federal statutory income tax rate to our effective income tax rate is as follows:
As restated
Year Ended
December 31, 2021
Year Ended
December 31, 2020
Year Ended
December 31, 2019
United States federal statutory rate
21.00
%
21.00
%
21.00
%
State taxes, net of federal benefit
( 0.31
)%
0.17
%
1.99
%
Valuation allowance
—
( 12.22
)%
( 21.96
)%
Stock based compensation
( 6.68
)%
( 0.01
)%
—
R&D Credit
0.19
%
( 0.21
)%
1.34
%
Other
( 1.57
)%
0.06
%
( 0.38
)%
Effective income tax rate
12.63
%
8.79
%
1.99
%
The Company’s effective tax rate for 2021 was substantially lower than the
statutory Federal income tax rate primarily due to stock-based compensation and expiring stock options requiring us to reduce our deferred tax asset. The Company’s effective tax rate for both 2020 and 2019 was significantly 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.
42
Deferred tax assets (liabilities) consist of the following:
As restated
As of
December 31, 2021
As of
December 31, 2020
Deferred tax assets:
Reserves and accruals
$
58
$
48
Research and development credits and other credits
92
13
Net operating loss carry forward
9,519
598
Stock based compensation
6,287
8,998
Other
—
3
Total deferred tax assets
$
15,956
$
9,660
Valuation allowance
—
( 611
)
Deferred tax assets after valuation allowance
15,956
9,049
Total deferred tax liability – depreciation
( 6
)
—
Net deferred tax assets
$
15,950
$
9,049
In 2021, 2020 and 2019, we had pre-tax losses of $ 49,126 ,
pre-tax income of $ 307,452 , and pre-tax losses of $ 19,573 , respectively. At December 31, 2021, we had federal and state net operating loss carryforwards of approximately $ 45,326 and $ 107,989 , respectively. However, none of the state net operating loss
carryover is apportioned to a deferred tax asset, because currently we do not have operations in the state where losses accumulated. 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;
management determined no valuation allowance is necessary for 2021.
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. At December 31, 2021, we have no uncertain tax positions.
43
Index
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 2021 and 2020.
Note 11 − Fair Value Measurement
Fair value is the price that would result from an orderly transaction between market participants at the measurement date. A fair value hierarchy prioritizes the inputs used to
measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). Level 2
measurements utilize either directly or indirectly observable inputs in markets other than quoted prices in active markets.
Our
financial instruments are stated at amounts that equal, or approximate, fair value. When we estimate fair value, we utilize market data or assumptions that we believe market participants would use in pricing the financial instrument, including
assumptions about risk and inputs to the valuation technique. We use valuation techniques, primarily the income and market approach, which maximizes the use of observable inputs and minimize the use of unobservable inputs for recurring fair value
measurements.
Mutual funds: Valued at the quoted net asset value (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, 2021 and 2020 (in thousands):
December 31, 2021
Adjusted
Cost
Unrealized
Gains
Unrealized
Losses
Fair
Value
Cash
and Cash
Equivalents
Investments
Available
for Sale
Cash
$
35,428
$
—
$
—
$
35,428
$
35,428
$
—
Level 1:
Mutual funds
106,590
—
—
106,590
106,590
—
U.S. agency securities
16,658
—
( 26
)
16,632
—
16,632
U.S. treasury securities
10,646
—
( 24
)
10,622
—
10,622
133,894
—
( 50
)
133,844
106,590
27,254
Total
$
169,322
$
—
$
(50
)
$
169,272
$
142,018
$
27,254
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
The maturities of our investments generally range from within one to two years . Actual maturities could differ from contractual maturities due
to call or prepayment provisions.
44
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 Court of Appeals for the Federal Circuit (“USCAFC”).
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 United States District Court (“USDC”) in which we alleged that Apple infringed on certain of our patents, (U.S. Patent Nos. 6,502,135, 7,418,504, 7,921,211 and 7,490,151). We sought damages and injunctive
relief. The accused products include the iPhone 5, iPod Touch 5th Generation, iPad 4th Generation, iPad mini, and the latest Macintosh computers. Post-trial motions hearing was held on July 18, 2018. On August 31, 2018, the USDC entered a Final
Judgment and issued its Memorandum Opinion and Order regarding post-trial motions, affirming the jury’s verdict of $ 502,600 and granting
VirnetX motions for supplemental damages, a sunset royalty, and the royalty rate of $ 1.20 per infringing iPhone, iPad and Mac products,
pre-judgment and post-judgment interest and costs. Apple filed a notice of appeal with the USCAFC in the Apple II case.
On October 9, 2018, USCAFC docketed the appeal as Case No. 19-1050 - VirnetX Inc. v. Apple Inc. On January 24, 2019 Apple filed its opening brief. We filed our response brief on March 1, 2019. Apple
filed its reply brief on April 5, 2019. The oral arguments were heard on October 4, 2019. On November 22, 2019, the USCAFC issued an opinion affirming the district court’s findings that Apple is precluded from making certain invalidity arguments
and that Apple infringed the ’135 and ’151 patents; reversing the USDC’s finding that Apple infringed the ’504 and ’211 patents; and remanding the case for proceedings on damages. Apple sought panel and en banc rehearing, which the USCAFC denied
on February 10, 2020.
On February 22, 2020, the USDC issued a scheduling order for the parties to brief the court about the need for a new trial for recalculating the damages. We filed our motion for entry of judgment on
February 28, 2020. The arguments on this matter were heard on April 14, 2020. In its order, unsealed on May 1, 2020, the USDC denied VirnetX’s motion for entry of a new judgment based on the prior jury verdict and ordered a new jury trial on
damages. On August 10, 2020, the USDC granted Apple’s motion for continuance and reset the date to October 26, 2020. On October 30, 2020, a jury returned a $ 502,800 verdict in favor of VirnetX based on Apple’s infringement of two network security patents:
VirnetX US Patents No. 6,502,135 and No. 7,490,151. The jury verdict called for damages of $ 0.84 per accused device since the 2013
launch of Apple’s iOS 7 operating system and represents 598,629,580 infringing units from US sales only. On January 15, 2021, the
district court denied Apple’s motion for judgment as a matter of law, and on February 4, 2021, Apple filed a notice of appeal to the USCAFC.
On February 22, 2021, USCAFC docketed the
appeal as Case No. 19-1672. Apple’s opening brief was filed on June 2, 2021. VirnetX filed its responsive brief on July 26, 2021. Apple filed its reply brief on September 13, 2021. The briefing is complete, and we are awaiting the court order with
the schedule for oral arguments in this matter.
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 (USCAFC Case 20-2272)
On September 15, 2020,
we filed with the USCAFC an appeal of the invalidity findings by the Patent Trial and Appeal Board (“PTAB”) in inter-partes review proceedings IPR2015-01046 and IPR2016-00062 involving our U.S. Patent No. 6,502,135, and an appeal of the invalidity
findings by the PTAB in inter partes review proceedings IPR2015-1047, IPR2016- 00063, and IPR2016-00167 involving our U.S. Patent No. 7,490,151. On September 25, 2020, the USCAFC issued an order consolidating the two appeals. On December 15, 2020,
we filed a motion to vacate the PTAB decisions below and to remand these appeals to the PTAB. On March 16, 2021, the USCAFC denied the motion without prejudice to us raising the challenges made in the motion in our opening brief. Our opening brief
was filed on June 7, 2021.
On June 23, 2021, the USCAFC entered an order directing us (and parties in other appeals that raised Appointments Clause challenges) to file a brief explaining how they believe their cases should proceed in light of
the Supreme Court’s decision in United States v. Arthrex, Inc., 141 S. Ct. 1970 (2021). On July 7, 2021, we filed a brief in response to the court’s order. Other parties, including the U.S. Patent and Trademark Office (“PTO”) filed their
responses on July 21, 2021. On August 19, 2021, USCAFC issued an order remanding these appeals for the limited purpose of allowing VirnetX the opportunity to request rehearing of the PTAB’s final written decisions by the Director of the USPTO.
The USCAFC retained jurisdiction over the appeals in the meantime. On September 20, 2021, we filed our requests for Director rehearing with the PTO. On October 29, 2021, our requests for Director rehearing were denied. We subsequently filed an
amended opening brief to the USCAFC on December 10, 2021, the other parties filed response briefs on February 2, 2022, and we filed a reply brief on February 22, 2022. All the briefings have been completed. We are awaiting the court order with
the schedule for oral arguments in this matter.
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VirnetX Inc. v. Hirshfeld
(USCAFC Case 17-2593, -2594)
On September 22, 2017,
we filed with the USCAFC an appeal of the invalidity findings by the PTAB in inter-partes review proceeding IPR2016-00693 involving our U.S. Patent No. 7,418,504, and an appeal of the invalidity findings by the PTAB in inter partes review
proceeding IPR2016-00957 involving our U.S. Patent No. 7,921,211. On September 16, 2021, USCAFC issued an order remanding these appeals for the limited purpose of allowing VirnetX the opportunity to request rehearing of the PTAB’s final written
decisions by the Director of the PTO. The USCAFC retained jurisdiction over the appeals in the meantime. On October 18, 2021, we filed our requests for Director rehearing with the PTO. On January 7, 2022, our requests for Director rehearing were
denied. On January 21, 2022, we informed the USCAFC about the denial of Director rehearing and requested that the court dismiss the appeal involving IPR2016-00957 as moot and vacate the PTAB’s underlying decision. On February 15, 2022, the USCAFC
directed the PTO to respond to our request. The PTO’s response is due on March 8, 2022.
VirnetX Inc. v. Cisco Systems, Inc. (USCAFC
Case 19-1671)
On March 18, 2019, we filed
with the USCAFC an appeal of the invalidity findings by the PTAB in inter-partes reexamination proceeding 95/001,679 involving our U.S. Patent No. 6,502,135. On October 5, 2021, USCAFC issued an order remanding these appeals for the limited purpose
of allowing VirnetX the opportunity to request rehearing of the PTAB’s final written decisions by the Director of the PTO. The USCAFC retained jurisdiction over the appeals in the meantime. Our request for Director rehearing with the PTO was filed
on November 5, 2021. On January 10, 2022, our request for Director rehearing was denied. We informed the USCAFC about the denial of Director rehearing and are awaiting the court order with a schedule for briefings in this matter.
McKool Smith P.C. v. VirnetX, Inc., AAA Case No. 01-20-0003-7975
On March 23, 2020, the law firm of McKool
Smith, P.C. (“McKool”) filed a Demand for Arbitration against VirnetX, Inc. with the American Arbitration Association (“AAA”). In its demand, McKool claimed that a retention agreement it entered into in 2010 with VirnetX entitled it to a
contingency fee arising from the recent 2020 payment made in the Apple I case. McKool claimed it was owed approximately $ 36,300 (or 8 % of the Apple I payment). We filed a general response with the AAA denying McKool’s claim and contested the matter vigorously. An evidentiary hearing
was held on the matter during the week of February 22, 2021 and the parties submitted additional briefings. On April 19, 2021, the arbitrator awarded McKool $ 36,323 in damages, plus pre-judgment interest in the amount of 5 % simple interest from March 23, 2020
to April 18, 2021, and post-judgment interest in the amount of 5 %, compounded annually, until payment of the award. We accrued the
resulting $ 38,284 as of March 31, 2021 and paid that amount to McKool on April 20, 2021. This
matter is now closed.
Other Legal Matters
One or more potential intellectual property
infringement claims may also be available to us against certain other companies who have the resources to defend against any such claims. Although we believe these potential claims are likely valid, commencing a lawsuit can be expensive and
time-consuming, and there is no assurance that we could prevail on such potential claims if we made them. In addition, bringing a lawsuit may lead to potential counterclaims which may distract our management and our other resources, including capital
resources, from efforts to successfully commercialize our products.
Currently, we are not a party to any other
pending legal proceedings and are not aware of any proceeding threatened or contemplated against us.
Note 13 – Leases
We lease office space under an operating lease which expires on October 31, 2023. At December 31, 2021, the underlying ROU asset and lease
liability totaled $ 98 . At December 31, 2020, the underlying ROU asset and lease liability totaled $ 44 . Lease expense totaled $ 56 in
2021, 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. No other terms of the original agreement were affected and there was no impact on cash flow. At December 31, 2021 and 2020, the ROU asset totaled $ 948 and $ 1,248 , respectively; lease expense totaled $ 300 , $ 356 and $ 385 , during 2021, 2020 and 2019, respectively.
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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, 2021, 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, because of the effect of the material weakness identified below on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as
of December 31, 2021, based on criteria established in Internal Control—Integrated Framework (2013) issued by COSO (“COSO Framework”).
In our report dated March 16, 2022, we expressed an unqualified opinion that the Company maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2021, based on the criteria established by the COSO Framework. Management has subsequently identified a deficiency in controls related to the effectiveness of supervisory review of tax
professionals to provide the necessary assurance that transactions affecting the accounting for infrequent transactions affecting deferred taxes, and has further concluded that the deficiency represented a material weakness as of December 31, 2021.
As a result, management has revised its assessment, as presented in the accompanying Management’s Report on Internal Control over Financial reporting; to conclude that the Company’s internal control over financial reporting was not effective as of
December 31, 2021. Accordingly, our present opinion on the effectiveness of December 31, 2021’s internal control over financial reporting as of December 31, 2021, as expressed herein, is different from that expressed in our previous report.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a
reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management’s
assessment: Management identified a material weakness in its internal control over financial reporting related to the effectiveness of its supervisory review of tax professionals to provide the necessary assurance that transactions affecting the
accounting for infrequent transactions affecting deferred taxes.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the
consolidated balance sheets as of December 31, 2021 and 2020, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31,
2021 and the related notes of the Company. The material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2021 consolidated financial statements, and this report does not affect our
report dated March 16, 2022, except for the error correction discussed in Note 2, as to which the date is May 13, 2022, which expressed an unqualified opinion on those financial statements.
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, 2022 (May 13, 2022 as to the effects of t he material weakness described in “Management’s Report on Internal Control over Financial
Reporting”)
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.