VirnetX Holding Corp 10-Q

ITEM 1- FINANCIAL STATEMENTS. VIRNETX HOLDING CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share amounts) As of March 31, 2023 As of December 31, 2022 (unaudited) ASSETS Current assets: Cash and cash equivalents $ 97,050 $ 86,561 Investments available for sale 52,367 65,462 Accounts receivables 4 14 Prepaid expenses and other current assets 614 224 Total current assets 150,035 152,261 Prepaid expenses and other assets 614 703 Property and equipment, net 10 11 Total assets $ 150,659 $ 152,975 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable and accrued liabilities $ 1,692 $ 373 Accrued payroll and related expenses 365 311 Accrued dividends 71,429 — Other liabilities, current 37 47 Total current liabilities 73,523 731 Other liabilities — — Total liabilities 73,523 731 Commitments and contingencies (Note 4) Stockholders’ equity: Preferred stock, par value $ 0.0001 per share Authorized: 10,000,000 shares at March 31 , 2023 and December 31, 2022 ; Issued and outstanding: 0 shares at March 31 , 2023 and December 31, 2022 — — Common stock, par value $ 0.0001 per share Authorized: 100,000,000 shares at March 31 , 2023 and December 31, 2022 ; Issued and outstanding: 71,424,650 shares at March 31 , 2023 and 71,424,650 at December 31, 2022 7 7 Additional paid-in capital 240,428 239,746 Accumulated deficit ( 163,091 ) ( 87,195 ) Accumulated other comprehensive loss ( 208 ) ( 314 ) Total stockholders’ equity 77,136 152,244 Total liabilities and stockholders’ equity $ 150,659 $ 152,975 See accompanying notes to condensed consolidated financial statements. 2 Index VIRNETX HOLDING CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (in thousands, except per share amounts) Three Months Ended March 31, 2023 March 31, 2022 Revenue $ 2 $ 5 Operating expense: Licensing costs — ( 4 ) Research and development 1,368 1,227 Selling, general and administrative 4,548 3,185 Total operating expense 5,916 4,408 Income (loss) from operations ( 5,914 ) ( 4,403 ) Interest and other income, net 1,369 24 Income (loss) before taxes ( 4,545 ) ( 4,379 ) Income tax (expense) benefit 78 1,059 Net income (loss) $ ( 4,467 ) $ ( 3,320 ) Basic income (loss) per share $ ( 0.06 ) $ ( 0.05 ) Diluted income (loss) per share $ ( 0.06 ) $ ( 0.05 ) Weighted average shares outstanding - basic 71,425 71,233 Weighted average shares outstanding - diluted 71,425 71,233 See accompanying notes to condensed consolidated financial statements. 3 Index VIRNETX HOLDING CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited) (in thousands) Three Months Ended March 31, 2023 March 31, 2022 Net income (loss) $ ( 4,467 ) $ ( 3,320 ) Other comprehensive income (loss): Change in unrealized gain (loss) on investments, net of tax 107 ( 171 ) Change in foreign currency translation, net of tax ( 1 ) ( 3 ) Total other comprehensive income (loss) 106 ( 174 ) Comprehensive income (loss) $ ( 4,361 ) $ ( 3,494 ) See accompanying notes to condensed consolidated financial statements. 4 Index VIRNETX HOLDING CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Unaudited) (in thousands, except per share amounts) Three Months Ended March 31, 2023 2022 Total shareholders’ equity, beginning balances $ 152,244 $ 185,449 Common stock and additional paid-in capital: Beginning balances 239,753 236,452 Stock-based compensation 682 778 Ending balances 240,435 237,230 Accumulated deficit: Beginning balances ( 87,195 ) ( 50,935 ) Net (loss) income ( 4,467 ) ( 3,320 ) Dividends ( 71,429 ) — Ending balances ( 163,091 ) ( 54,255 ) Accumulated other comprehensive loss: Beginning balances ( 314 ) ( 68 ) Change in unrealized investment gain/loss, net 107 ( 171 ) Change in foreign currency translation, net ( 1 ) ( 3 ) Ending balances ( 208 ) ( 242 ) Total shareholders’ equity, ending balances $ 77,136 $ 182,733 Dividends per share $ 1.00 $ — See accompanying notes to condensed consolidated financial statements. 5 Index VIRNETX HOLDING CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (in thousands) Three Months Ended March 31, 2023 2022 Cash flows from operating activities: Net (loss) income $ ( 4,467 ) $ ( 3,320 ) Adjustments to reconcile net (loss) income to cash flows from operating activities: Depreciation 1 2 Deferred tax assets — ( 1,059 ) Bad debt 10 — Stock-based compensation 682 778 Changes in assets and liabilities: Accounts receivables — 5 Prepaid expenses and other assets ( 301 ) ( 369 ) Accounts payable 1,320 313 Accrued payroll and related expenses 54 60 Accrued licensing costs — ( 355 ) Other liabilities ( 10 ) ( 17 ) Net cash (used in) operating activities ( 2,711 ) ( 3,962 ) Cash flows from investing activities: Purchase of investments ( 16,638 ) ( 4,060 ) Proceeds from sale or maturity of investments 29,838 2,412 Net cash provided by (used in) investing activities 13,200 ( 1,648 ) Net change in cash and cash equivalents 10,489 ( 5,610 ) Cash and cash equivalents, beginning of period 86,561 142,018 Cash and cash equivalents, end of period $ 97,050 $ 136,408 Non-cash transactions Dividends approved and accrued on March 30, 2023, paid in April 2023 $ 71,429 $ — See accompanying notes to condensed consolidated financial statements. 6 Index VIRNETX HOLDING CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except per share amounts) (Unaudited) Note 1 — Business Description and Basis of Presentation VirnetX Holding Corporation (the “Company,” “we,” “us,” or “our”) is an Internet security software and technology company with patented technology for Zero Trust Network Access (“ZTNA”) based secure network communications. VirnetX’s software and technology solutions, including its Secure Domain Name Registry and Technology, VirnetX One ™, War Room™, VirnetX Matrix™, and Gabriel Connection Technology™, are designed to be device- and location-independent, and enable a secure real-time communication environment for all types of enterprise applications, services, and critical infrastructures. Our technology generates secure connections on a “single-click” basis, significantly simplifying the deployment of secure real-time communication solutions by eliminating the need for end-users to enter any encryption information . 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. Our next-generation, VirnetX One ™ 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. VirnetX One ™ is a security-as-a-service platform that protects enterprise applications, services, and infrastructure from cyber-attacks. Our platform allows businesses and other enterprises of all sizes to add a “security umbrella” as an added layer on top of their existing infrastructure to further reduce risk and bolster security against ever-growing cyberthreats to data, operating systems, other infrastructure products and gateway security controllers. Note 2 — Summary of Significant Accounting Policies Unaudited Interim Financial Information The accompanying Condensed Consolidated Balance Sheet as of March 31, 2023, the Condensed Consolidated Statements of Operations for the three months ended March 31, 2023 and 2022, the Condensed Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2023 and 2022, the Condensed Consolidated Statements of Shareholders’ Equity for the three months ended March 31, 2023 and 2022, and the Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2023 and 2022 are unaudited. These unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). In our opinion, the unaudited interim consolidated financial statements include all adjustments of a normal recurring nature necessary for the fair presentation of our financial position as of March 31, 2023, our results of operations for the three months ended March 31, 2023 and 2022, and our cash flows for the three months ended March 31, 2023 and 2022. The results of operations for interim periods are not necessarily indicative of the results to be expected for a full year. These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, filed with the SEC on March 31, 2023. 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. 7 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 expenses, and other assets on the Condensed Consolidated Balance Sheets. ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at the commencement date based on the present value of lease payments over the lease term (see Note 8 – Leases). Revenue Recognition The Company derives revenue from licensing and royalty fees from contracts with customers which can span several years. We account for this revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Our revenue arrangements may consist of multiple-element arrangements, with revenue for each unit of accounting recognized as the product or service is delivered to the customer. With the licensing of our patents, performance obligations are generally satisfied at a point in time as work is complete when our patent rights are transferred to our customers. We generally have no further obligation to our customers regarding our technology. Certain contracts may require our customers to enter into a hosting arrangement with us and for these arrangements, revenue is recognized over time, generally over the life of the servicing contract. The Company actively monitors and enforces its intellectual property rights, including seeking appropriate compensation from third parties that utilize the Company’s intellectual property without a license. As a result, the Company may, from time to time, receive payments as part of a settlement or compensation for a patent infringement dispute. Proceeds received are allocated to each element identified in the settlement or compensation, based on the fair value of each element. Generally, settlements and compensation may include the following elements: the value of a license or royalty agreement, cost reimbursement, damages, and interest. Elements identified related to licensing and royalty are recognized as revenue. Elements identified as reimbursed costs are generally recorded as a reduction to the reported expenses. Elements identified as damages or interest are generally recorded in other income in the condensed consolidated statement of operations. Licensing Costs Included in operating expenses in 2022 is a refund of licensing costs we incurred in conjunction with 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 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 three months ended March 31, 2023, 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. 8 Index Fair Value The carrying amounts of our financial instruments, including cash equivalents, accounts payable, and accrued liabilities, approximate fair value because of their generally short maturities. Intangible Assets We record intangible assets at cost, less accumulated amortization. Amortization of intangible assets is provided over their estimated useful lives, which can range from 3 to 15 years, on either a straight-line basis or as revenue is generated by the assets. Impairment of Long-Lived Assets We identify and record impairment losses on long-lived assets used in operations when events and changes in circumstances indicate that the carrying amount of an asset might not be recoverable, but not less than annually. Recoverability is measured by comparison of the anticipated future net undiscounted cash flows to the related assets’ carrying value. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the projected discounted future net cash flows arising from the asset. Research and Development Research and development costs include expenses paid to outside development consultants and compensation related expenses for our engineering staff. Research and development costs are expensed as incurred. Income Taxes We account for income taxes using the asset and liability method. The asset and liability method requires the recognition of deferred tax assets and liabilities for expected future tax consequences of temporary differences that currently exist between the tax basis and financial reporting basis of our assets and liabilities. We calculate current and deferred tax provisions based on estimates and assumptions that could differ from actual results reflected on the income tax returns filed during the following years. Adjustments based on filed returns are recorded when identified in the subsequent years. The effect on deferred taxes for a change in tax rates is recognized in income in the period that the tax rate change is enacted. In assessing our deferred tax assets, we consider whether it is more likely than not that all or some portion of the deferred tax assets will not be realized. The 2017 U.S. Tax Cuts and Jobs Act changes IRC Section 174, regarding capitalization of book research and development (“R&D”) expenses for income tax purposes. Effective for tax years beginning in 2022, IRC Section 174 requires the capitalization of book R&D expenses which are capitalized and amortized over 5 years for domestic R&D expenses and over 15 years for foreign R&D expenses. To date there has been limited guidance from the IRS on how to quantify the amount of book R&D expenses subject to capitalization, including the indirect expenses supporting the R&D function. Due to the limited guidance, some assumptions were made in our estimates. A valuation allowance is provided for deferred income tax assets when, in our judgment, based upon currently available information and other factors, it is more likely than not that all or a portion of such deferred income tax assets will not be realized. The determination of the need for a valuation allowance is based on an on-going evaluation of current information including, among other things, historical operating results, estimates of future earnings in different taxing jurisdictions and the expected timing of the reversals of temporary differences. We believe the determination to record a valuation allowance to reduce a deferred income tax asset is a significant accounting estimate because it is based, among other things, on an estimate of future taxable income in the United States and certain other jurisdictions, which is susceptible to change and may or may not occur, and because the impact of adjusting a valuation allowance may be material. In determining when to release the valuation allowance established against our net deferred income tax assets, we consider all available evidence, both positive and negative. We continually assess our ability to generate sufficient taxable income during future periods in which our deferred tax assets may be realized. If and when we believe it is more likely than not that we will recover our deferred tax assets, we will reverse the valuation allowance as an income tax benefit in our statements of operations. We account for our uncertain tax positions in accordance with U.S. GAAP, which utilizes a two-step approach to evaluate tax positions. Step one, recognition, requires evaluation of the tax position to determine if based solely on technical merits it is more likely than not to be sustained upon examination. Step two, measurement, is addressed only if a position is more likely than not to be sustained. In step two, the tax benefit is measured as the largest amount of benefit, determined on a cumulative probability basis, which is more likely than not to be realized upon ultimate settlement with tax authorities. If a position does not meet the more likely than not threshold for recognition in step one, no benefit is recorded until the first subsequent period in which the more likely than not standard is met, the issue is resolved with the taxing authority, or the statute of limitations expires. Positions previously recognized are reversed if and 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. 9 Index Stock-Based Compensation We account for stock-based compensation using the fair value recognition method in accordance with U.S. GAAP. We recognize these compensation costs on a straight-line basis over the requisite service period of the award, which is generally a vesting term of 4 years. We recognize forfeitures, if any, when they occur. In addition, we record stock-based compensation expense for awards granted to non-employees at fair value of the consideration received or the fair value of the equity instruments issued, as they vest, over the performance period (See Note 5 - Stock-Based Compensation). Earnings per Share Basic earnings per share are computed by dividing earnings available to common stockholders by the weighted average number of outstanding common shares during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of shares outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. Fair Value of Financial Instruments Fair value is the price that would result from an orderly transaction between market participants at the measurement date. A fair value hierarchy prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). Level 2 measurements utilize either directly or indirectly observable inputs in markets other than quoted prices in active markets. Our financial instruments are stated at amounts that equal, or approximate, fair value. When we estimate fair value, we utilize market data or assumptions that we believe market participants would use in pricing the financial instrument, including assumptions about risk and inputs to the valuation technique. We use valuation techniques, primarily the income and market approach, which maximizes the use of observable inputs and minimize the use of unobservable inputs for recurring fair value measurements. Mutual funds: Valued at the quoted net asset value of shares held. U.S. agency and treasury securities : Fair value measured at the closing price reported on the active market on which the individual securities are traded. The following tables show the adjusted cost, gross unrealized gains, gross unrealized losses, and fair value of our securities by significant investment category as of March 31, 2023 and December 31, 2022. March 31, 2023 Adjusted Cost Unrealized Gains Unrealized Losses Fair Value Cash and Cash Equivalents Investments Available for Sale Cash $ 12,867 $ — $ — $ 12,867 $ 12,867 $ — Level 1: Mutual funds 67,667 — — 67,667 67,667 — U.S. agency and treasury securities 69,071 25 ( 213 ) 68,883 16,516 52,367 136,738 25 ( 213 ) 136,550 84,183 52,367 Total $ 149,605 $ 25 $ (213 ) $ 149,417 $ 97,050 $ 52,367 December 31, 2022 Adjusted Cost Unrealized Gains Unrealized Losses Fair Value Cash and Cash Equivalents Investments Available for Sale Cash $ 16,949 $ — $ — $ 16,949 $ 16,949 $ — Level 1: Mutual funds 66,493 — — 66,493 66,493 — U.S. agency and treasury securities 68,958 9 ( 386 ) 68,581 3,119 65,462 135,451 9 ( 386 ) 135,074 69,612 65,462 Total $ 152,400 $ 9 $ (386 ) $ 152,023 $ 86,561 $ 65,462 10 Index New Accounting Pronouncements In September 2022, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“Update”) 2022-04, “Liabilities – Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations”, which requires entities to disclose the key terms of supplier finance programs used in connection with the purchase of goods and services along with information about their obligations under these programs. This Update does not affect the recognition, measurement or financial statement presentation of supplier finance program obligations. The Update is effective for all entities for fiscal years beginning after December 15, 2022 and interim periods within those fiscal years, except for the rollforward requirement, which is effective for fiscal years beginning after December 15, 2023. We do not have a supplier finance program currently in place, and, therefore, there was no impact on our financial position or cash flows as a result. Note 3 — Income Taxes For the three months ended March 31, 2023, we recognized an income tax benefit of $ 78 on loss before taxes of $ 4,545 , which is an effective tax rate of 1.71 %. The effective rate is lower than the statutory federal rate primarily due to the change in valuation allowance. For the three months ended March 31, 2022, we recognized an income tax benefit of $ 1,059 on loss before taxes of $ 4,379 , an effective tax rate of 24.45 %. The effective rate is higher than the statutory federal rate primarily due to the effect of research and development tax credits. Management determined that a full valuation allowance should be provided against net deferred income tax assets at March 31, 2023. Our tax years for 2005 and forward are subject to examination by the U.S. tax authority and various state tax authorities because we utilized the NOLs and tax credits generated in those years in 2020. The statute of limitation for those years shall expire three years after the date of filing 2020 income tax returns. We are required to recognize the financial statement effects of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. At December 31, 2022 and March 31, 2023, we have no uncertain tax positions. Our policy is to recognize interest and penalties accrued on uncertain tax positions as a component of income tax expense. We had no accrued interest or penalties related to uncertain tax positions at March 31, 2023. Note 4 — Commitments and Related Party Transactions We lease our office under an operating lease with a third party which expires on October 31, 2023 (see Note 8 - Leases). We entered into a service agreement for the use of an aircraft from K2 Investment Fund LLC (“LLC”) for business travel for employees of the Company. We incurred approximately $ 287 compared to $ 265 in fees and reimbursements to the LLC during the three months ended March 31, 2023 and 2022, respectively. We pay for the Company’s usage of the aircraft and have no rights to purchase. Our Chief Executive Officer and Chief Administrative Officer are the managing partners of the LLC and control the equity interests of the LLC. We entered into a 12 -month non-exclusive agreement with the LLC for use of the plane at a rate of $ 8 per flight hour, with no minimum usage requirement. The agreement contains other terms and conditions and can be cancelled by either us or the LLC with 30 days’ notice. The agreement renews on an annual basis unless terminated by either party. Neither party has exercised their termination rights. Note 5 — Stock Based Compensation Our stockholders are being asked to approve the Amended and Restated Equity Incentive Plan (the “Amended 2013 Plan”) at our annual shareholders’ meeting in June 2023. Our shareholder-approved 2013 Equity Incentive Plan (the “Prior Plan”) expired March 29, 2023; no further awards will be made under the Prior Plan, but the Amended 2013 Plan will govern awards granted under the Prior Plan. Stock-based compensation expense included in general and administrative expense was $ 371 and $ 466 , and in research and development expense was $ 311 and $ 312 , for the three months ended March 31, 2023 and 2022, respectively. During the three months ended March 31, 2023 and 2022, we did no t grant any options or RSUs. As of March 31, 2023, the unrecognized stock-based compensation expense related to unvested stock options and RSUs was $ 3,484 and $ 1,256 , respectively, which will be amortized over an estimated weighted average period of approximately 2.47 and 2.18 years, respectively. Note 6 — Equity Common Stock We issued no shares for options exercised during the three months ended March 31, 2023 or 2022, respectively. We issued no shares as a result of vesting RSUs during the three months ended March 31, 2023 or 2022. 11 Index 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, 2022 Issued Exercised Terminated / Cancelled Outstanding and Exercisable March 31, 2023 Expiration Date 25,000 $ 5.75 25,000 — — — 25,000 April 30, 2025 Note 7 — 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 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. 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 United States Court of Appeals for the Federal Circuit (“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 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 USDC 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, the 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. Oral arguments were held on September 8, 2022. On March 31, 2023, the USCAFC issued its decision vacating the USDC’s judgement in this matter and remanding it back to the USDC with instructions to dismiss the case as moot. On April 20, 2023, VirnetX filed a motion to extend the time to file a petition for rehearing from May 1, 2023, until June 5, 2023, and remains pending. 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. 12 Index On June 23, 2021, the USCAFC entered an order directing us (and parties in other appeals that raised Appointments Clause challenges) to file a brief explaining how they believe their cases should proceed in light of the Supreme Court’s decision in United States v. Arthrex, Inc., 141 S. Ct. 1970 (2021). On July 7, 2021, we filed a brief in response to the court’s order. Other parties, including the U.S. Patent and Trademark Office (“USPTO”) 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 USPTO. 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. The oral arguments in this matter were held on September 8, 2022. On March 30, 2023, the USCAFC issued its decision affirming PTAB’s decisions finding certain claims of the ‘135 patent and the ‘151 patent to be unpatentable. On April 19, 2023, VirnetX filed a motion to extend the time to file a petition for rehearing from May 15, 2023, until June 5, 2023. That motion was granted on April 20, 2023. 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 USPTO. The USCAFC retained jurisdiction over the appeals in the meantime. On October 18, 2021, we filed our requests for Director rehearing with the USPTO. 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 April 4, 2022, the USCAFC vacated the PTAB’s decision in IPR2016-00957 and remanded Appeal No. 17-2594 with instructions to dismiss. In the April 4, 2022 order, the USCAFC further set a briefing schedule, in Appeal No. 17-2593. VirnetX filed its opening brief on September 12, 2022. The USPTO filed its response brief on December 20, 2022. VirnetX filed its reply brief on February 14, 2023, and we currently await scheduling of oral arguments. VirnetX has filed a motion to hold this appeal in abeyance pending the disposition of any petition for rehearing in the No. 20-2271, -2272 appeal, and pending the Supreme Court’s disposition of a pending petition for a writ of certiorari in Arthrex, Inc. v. Smith & Nephew, Inc. , No. 22-639. That motion, filed on April 18, 2023, and remains pending. 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 re-examination 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. VirnetX’s opening brief was filed on June 23, 2022. The USPTO’s response brief was filed on August 2, 2022, and Cisco’s response brief was filed on September 2, 2022. VirnetX filed its reply brief on October 7, 2022, and we currently await scheduling of oral arguments. VirnetX Inc. v. Apple Inc. (USCAFC Case 22-1523) (“Apple Reexam I”) On March 10, 2022, we filed with the USCAFC an appeal of the invalidity findings by the PTAB in inter-partes re-examination proceeding 95/001,682 involving our U.S. Patent No. 6,502,135. Our opening brief was filed on August 22, 2022. Apple and USPTO each filed a response brief on December 28, 2022. VirnetX filed its reply brief on February 8, 2023, and we currently await scheduling of oral arguments. VirnetX has, however, filed a motion to hold this appeal in abeyance pending the disposition of any petition for rehearing in the No. 20-2271, -2272 appeal, and pending the Supreme Court’s disposition of a pending petition for a writ of certiorari in Arthrex, Inc. v. Smith & Nephew, Inc. , No. 22-639. That motion, filed on April 18, 2023, and remains pending. VirnetX Inc. v. Apple Inc. (USCAFC C ase 22 - 1997 ) (“Apple Reexam II”) On July 6, 2022, we filed with the USCAFC an appeal of the invalidity findings by the PTAB in inter-partes re-examination proceeding 95/001,697 involving our U.S. Patent No. 7,490,151. On October 17, 2022, we filed a motion to remand the appeal in light of the PTAB’s refusal to permit Director rehearing. On January 23, 2023, the USCAFC denied that motion without prejudice to the parties raising their arguments in the merits briefs. VirnetX’s opening brief was filed on May 10, 2023, and remains pending. 13 Index VirnetX Inc. v. Cisco Systems, Inc. (USCAFC Case 22-2234) On September 16, 2022, we filed with the USCAFC an appeal of the invalidity findings by the PTAB in inter-partes re-examination proceeding 95/001,851 involving our U.S. Patent No. 7,418,504. We filed our opening brief on February 28, 2023, and remains pending. VirnetX Inc. v. Cisco Systems, Inc. (USCAFC Case 23-1765) On April 7, 2023, we filed with the USCAFC an appeal of the invalidity findings by the PTAB in inter-partes re-examination proceeding 95/001,714 involving our U.S. Patent No. 7,490,151. The certified list is due to be filed by the USPTO by May 30, 2023, and our opening brief will be due 60 days thereafter. In addition, on April 21, 2023, Cisco filed a cross-appeal. Cisco’s response brief was filed on May 10, 2023. Other Legal Matters One or more potential intellectual property infringement claims may also be available to us against certain other companies who have the resources to defend against any such claims. Although we believe these potential claims are likely valid, commencing a lawsuit can be expensive and time-consuming, and there is no assurance that we could prevail on such potential claims if we made them. In addition, bringing a lawsuit may lead to potential counterclaims which may distract our management and our other resources, including capital resources, from efforts to successfully commercialize our products. Currently, we are not a party to any other pending legal proceedings and are not aware of any proceeding threatened or contemplated against us. Note 8 — Leases We lease office space under an operating lease which expires on October 31, 2023. On March 31, 2023, the underlying ROU asset and lease liability totaled $ 31 . On December 31, 2022, the underlying ROU asset and lease liability totaled $ 45 . For the three months ended March 31, 2023 and 2022, lease expense totaled $ 14 and $ 13 , respectively. We also lease a facility for corporate promotional and marketing purposes which was prepaid at inception and expires in 2025, as amended. On March 31, 2023 and December 31, 2022, the ROU asset totaled $ 573 and $ 648 , respectively. For the three months ended March 31, 2023 and 2022, lease expense totaled $ 75 and $ 75 , respectively. Note 9 — Earnings Per Share Basic earnings per share are based on the weighted average number of common shares outstanding for the period. Diluted earnings per share are based on the weighted average number of common shares and potentially dilutive common shares outstanding. Potential common shares outstanding principally include stock options, RSUs and warrants, excluding any potentially dilutive shares convertible at a price higher than the closing price of our stock at the end of each reporting period. The following table shows the computation of basic and diluted earnings per share for the three months ended March 31, 2023 and 2022 (in thousands, except per share amounts): Three Months Ended March 31, 2023 2022 Numerator: Net (loss) income $ ( 4,467 ) $ ( 3,320 ) Denominator: Weighted-average basic shares outstanding 71,425 71,233 Effect of dilutive securities — — Weighted-average diluted shares 71,425 71,233 Basic (loss) earnings per share $ ( 0.06 ) $ ( 0.05 ) Diluted (loss) earnings per share $ ( 0.06 ) $ ( 0.05 ) We incurred a net loss for the three months ended March 31, 2023 and 2022; therefore, all potentially dilutive securities representing shares of common stock ( 7,353,129 in 2023 and 6,931,592 in 2022) were excluded from the computation of diluted earnings per share, because their effect would have been antidilutive. Note 10 — Subsequent Events In April 2023, the Company paid $ 71,429 for a special dividend of $ 1 per share. Additionally in April 2023, the Company paid $ 7,245 for a special bonus to employees. 14 Index