VirnetX Holding Corp 10-Q

ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Company Overview We are an Internet security software and technology company with industry-leading, patented technology for Zero Trust Network Access (“ZTNA”) based secure network communications. VirnetX’s patented Secure Domain Name Registry and GABRIEL Connection Technology™, are the foundation for its VirnetX One TM , software-as-a-services (SaaS) platform. VirnetX’s technology generates secure connections on a “zero-click” or “single-click” basis, significantly simplifying the deployment network security solutions by eliminating the need for end-users to enter any encryption information. 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, and related services, and is used in all our technology and products, some of which were acquired by our principal operating subsidiary; VirnetX, Inc., from Leidos, Inc., or Leidos, (f/k/a Science Applications International Corporation, or SAIC) in 2006. Our product portfolio includes sophisticated technologies, products and services that are available for sale worldwide. On March 1, 2022, we launched War Room™ software, and on April 7, 2022, we launched VirnetX Matrix™ software on our next-generation, VirnetX One™ platform. This new platform builds upon our patented Secure Domain Names and GABRIEL Connection Technology™ to further enhance the security and efficiency of our patented secure communication links. Our VirnetX One™ platform is a security-as-a-service platform that protects enterprise applications, services, and infrastructure from cyber-attacks. Our new War Room™ software product provides an industry leading, safe, and secure video conferencing meeting environment where sensitive communications and data is invisible to those not authorized to view it. War Room™ validates permissions of all the users, and devices requesting access to any secure meeting room prior to granting access. We believe our War Room™ will be an attractive solution for government agencies as well as all professional sectors such as legal, financial, and medical where limiting access to confidential data is a critical requirement. Our VirnetX Matrix™ product provides industry's best safeguards for applications and contemporary remote workforce from sophisticated hackers and mitigates threats by enabling corporate applications to be invisible from unauthorized users. We believe our VirnetX Matrix™ software will be an attractive solution for all businesses, cloud and on-premise application service providers, and OEMs, looking to improve visibility and management of their networks to mitigate morphing attacks on their networks and for real time access and control of their users. Our GABRIEL Collaboration Suite™ is a set of communication applications and tools that use our GABRIEL Secure Communication Platform™. It enables seamless and secure cross platform communications between devices that are enrolled in our “VIRNETX SECURED” network and have our software installed. Our GABRIEL Collaboration Suite™ is available for download and free trial, for Android, iOS, Windows, Linux, and Mac OS X platforms, at https://virnetx.com. We have an ongoing licensing program under which we offer licenses to a portion of our patent portfolio, technology, and software, including our secure domain name registry service, to domain infrastructure providers, communication service providers as well as to system integrators. Our GABRIEL Connection Technology™ License is offered to original equipment manufacturer (“OEM”) customers who want to adopt the GABRIEL Connection Technology™ as their solution for establishing secure connections using secure domain names within their products. We have developed GABRIEL Connection Technology™ Software Development Kit (“SDK”) to assist with rapid integration of these techniques into existing software implementations. Customers who want to develop their own implementation of the VirnetX patented techniques for supporting secure domain names, or other techniques that are covered by our patent portfolio for establishing secure communication links, can purchase a patent license. The number of patents licensed, and therefore the cost of the patent license to the customer, will depend upon which of the patents are used in a particular product or service. These licenses will typically include an initial license fee, as well as an ongoing royalty. 18 Index We expect to continue to launch new and enhanced security platforms, software products, and services based on our GABRIEL Connection Technology™. We expect to provide updates to new and existing customers as they are released to the public. Many small and medium businesses have installed our software products in their corporate networks. We intend to continue to expand our customer base with targeted promotions and direct sales initiatives. Our employees include the core development team behind our patent portfolio, technology, and software. Some members of this team have worked together for over twenty years and were on same team that invented and developed this technology while working at Leidos. The team has continued its research and development work and expanded the set of patents we acquired in 2006 from Leidos, into a larger patent portfolio. This portfolio now serves as the foundation of our products, services, and our licensing business. It is expected to generate most of our future revenue in license fees and royalties. We intend to continue our efforts to develop new products and technologies and further strengthen and expand our patent portfolio. We intend to continue using an outsourced and leveraged model to maintain efficiency and manage costs as we grow our licensing business by, for example, offering incentives to early licensing targets or asserting our rights for use of our patents. 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 with no material impact on our financial position, results of operations or cash flows. 19 Index Results of Operation Three and Nine Months Ended September 30, 2022 Compared with the Three and Nine Months Ended September 30, 2021 (in thousands, except per share amounts) Revenue We recognized revenue of $4 and $4, and $43 and $24 in the three and nine months ended September 30, 2022 and 2021 respectively. Licensing Costs Accrued licensing costs of $9,438 were reversed during the nine months ended September 30, 2021, as a result of the McKool award; these licensing costs were reduced an additional $4, during the nine months ended September 30, 2022. (See Note 7 — Litigation). Research and Development Expenses Our research and development expenses increased by $65 to $1,216 for the three months ended September 30, 2022. And increased by $246 for the nine months ended September 30, 2022. Our research and development expenses were $3,698 and $3,452 for the nine months ended September 30, 2022 and 2021, respectively. The increase in 2022 was primarily due to the addition of staff and higher engineering employee benefits. Selling, General and Administrative Expenses Our selling, general and administrative expenses increased by $1,054 to $4,143 for the three months ended September 30, 2022, and decreased by $37,666 from $48,040 for the nine months ended September 30, 2021, respectively. The decrease is primarily due to $38,284 disputed legal fees accrued to McKool in 2021 (See Note — 7 Litigation). Liquidity and Capital Resources As of September 30, 2022, our cash and cash equivalents totaled approximately $105,805 and our short-term investments totaled approximately $53,195, compared to cash and cash equivalents of approximately $142,018 and short-term investments of approximately $27,254 at December 31, 2021, respectively. Working capital was $157,490 at September 30, 2022, and $168,471 at December 31, 2021. We expect that our cash and cash equivalents and short-term investments as of September 30, 2022, will be sufficient to fund our current level of operating expense, including legal expenses and provide related working capital for the foreseeable future. Over the longer term, we expect to derive the majority of our future revenue from license fees and royalties associated with our patent portfolio, technology, software and secure domain name registry in the United States and other markets around the world. Income Taxes For the three months ended September 30, 2022, we recognized an income tax benefit of $486 on loss before taxes of $4,766, which is an effective tax rate of 10.3%. For the nine months ended September 30, 2022, we recognized an income tax benefit of $1,171 on loss before taxes of $13,208, which is an effective rate of 8.3%. The effective tax rate was lower than the statutory federal income tax rate primarily due to the effect of stock-based compensation and expiring options, requiring us to reduce our deferred tax asset. During the nine months ended September 30, 2022, our deferred tax asset increased to $17,122. For the three and nine months ended September 30, 2021, we recognized an income tax benefit of $895 and $5,369. For the three months, income tax was primarily affected by net operating loss for the period; for the nine months, income tax was primarily affected by expiring options and research and development credits. 20 Index Contractual Obligations There have been no material changes to the contractual obligations disclosed in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2021. Off-Balance Sheet Arrangements None. 21 Index