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 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 Name Registry and Technology 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. Our War Room™ software product provides 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 and law enforcement 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 superior security for internet-enabled enterprise applications and their connected devices, and for control systems currently deployed by those enterprises (e.g., file servers, data back-up systems, VPN/firewalls). VirnetX Matrix™ provides a true “zero-trust” access protection, “single-click” ease of use, and is a highly-effective added layer of protection that is deployed simply, without the need for changes to an enterprise’s existing, in-place infrastructure. We believe VirnetX Matrix™ is an attractive solution for all businesses, cloud and on-premise application service providers, and original equipment manufacturers (“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. Effective May 31, 2023 we have ended the support for our GABRIEL Collaboration Suite™. All the existing customers and partners have been notified of this announcement. During the first and second quarters of 2023, we actively engaged in discussions with certain third-parties to pitch the capabilities of VirnetX One™. As a result of our efforts, during the second quarter we made a series of announcements with Solution Synergy, WeSecure, Samsung, Envoy Data Corporation, and ObjectSecurity. We also announced a number of new deployments of our VirnetX Matrix™ product at City of Bridgeport, International Association of Certified ISAOs (IACI) and SkinWalker Ranch as a part of our new sales initiatives. We continue to actively pursue new opportunities as a part of these initiatives. We believe that these parties have an interest to secure devices and systems in areas such as City, County and State Governments, Healthcare, Finance, Legal, Oil and Gas, Medical, Law Enforcement, National Defense and related support industries. Although there can be no assurance in this regard, the Company believes that there are opportunities for Company products sales directly to, resale arrangements with and/or adoption as vendor standards by, one or more of these third parties. 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 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 to assist with rapid integration of these techniques into existing software implementations. Customers who want to develop their own implementation of the VirnetX patented techniques for supporting secure domain names, or other techniques that are covered by our patent portfolio for establishing secure communication links, can purchase a patent license. The number of patents licensed, and therefore the cost of the patent license to the customer, will depend upon which of the patents are used in a particular product or service. These licenses will typically include an initial license fee, as well as an ongoing royalty. We expect to continue to launch new and enhanced security platforms, software products, and services based on our GABRIEL Connection Technology™. We will 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. 16 Index 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 the 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. NYSE Deficiency On May 12, 2023, we received a written notification from the NYSE that as of May 11, 2023, we are not in compliance with the continued listing standard set forth in Section 802.01C of the NYSE Listed Company Manual because the average closing price of our common stock was less than $1.00 per share over a consecutive 30 trading-day period. Pursuant to Section 802.01C, We have a period of six months following the receipt of the notification to regain compliance with the minimum price criteria, we can regain compliance with the minimum share price requirement if, on the last trading-day of any calendar month, our common stock has a closing share price, and a 30 trading-day average closing share price, of at least $1.00. If both a $1.00 closing share price on the last trading day of the cure period and a $1.00 average closing share price over the 30 trading-day period ending on the last trading day of the cure period are not attained and we do not regain compliance by November 12, 2023, NYSE may commence suspension and delisting procedures with respect to our common stock. If shares of our common stock are delisted from the NYSE, there may be no public market for our common shares. Any over-the-counter or other public market that does develop would likely be characterized by decreased liquidity and greater volatility, which may materially and adversely affect the value of our common shares. We have notified the NYSE that we intend to cure the continued listing standard deficiency and to return to compliance with Section 802.01C. However, our common stock share price may not meet the applicable requirements during the cure period and there can be no assurances that further options to cure the deficiency that we may consider can or will be effectuated as an alternative to proceeding to delisting. There can be no assurance that we will regain compliance with the NYSE continued listing standard. Any potential delisting of our common stock from the NYSE would likely result in decreased liquidity and increased volatility for our common stock and would adversely affect our ability to raise additional capital or enter into strategic transactions. As of the date of this Quarterly Report on Form 10-Q, we have not yet regained compliance with the above-mentioned NYSE continued listing standard. Results of Operation Three and Six Months Ended June 30, 2023 Compared with the Three and Six Months Ended June 30, 2022 (in thousands, except per share amounts) Revenue We recognized revenue of $2 and $34 and $4 and $39 in the three and six months ended June 30, 2023 and June 30, 2022, respectively. Licensing Costs Licensing costs of $4 for the six months ended June 30, 2022 is a refund of licensing costs we incurred in conjunction with a favorable court decision relating to a patent infringement case. Research and Development Expenses Our research and development expenses increased by $3,500 to $4,755 for the three months ended June 30, 2023, and by $3,641 to $6,123 for the six months ended June 30, 2023. The increase was primarily due to higher engineering employee costs, which included a bonus paid in the second quarter of 2023. Selling, General and Administrative Expenses Our selling, general and administrative expenses increased by $4,320 to $7,366 for the three months ended June 30, 2023, and by $5,682 to $11,913 for the six months ended June 30, 2023. The increase is primarily due to increased legal fees, outside services, and compensation costs, which included a bonus paid in the second quarter of 2023. 17 Index Liquidity and Capital Resources As of June 30, 2023, our cash and cash equivalents totaled approximately $25,970 and our short-term investments totaled approximately $40,529, compared to cash and cash equivalents of approximately $86,561 and short-term investments of approximately $65,462 at December 31, 2022, respectively. Working capital was $65,900 at June 30, 2023, and $151,530 at December 31, 2022. We expect that our cash and cash equivalents and short-term investments as of June 30, 2023, 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. Dividends On March 30, 2023, we declared a one-time cash dividend of $1 per share of common stock, paid to shareholders of record as of the close of business on April 10, 2023. The timing and amount of future dividends, if any, will depend on market conditions, corporate business and financial considerations and regulatory requirements. Income Taxes For the three months ended June 30, 2023, we recognized no income tax on loss before taxes of $11,379, which is an effective tax rate of 0.0%. For the six months ended June 30, 2023, we recognized an income tax benefit of $78 on loss of $15,924, which is an effective tax rate of 0.49%. The effective rate is lower than the statutory federal rate primarily due to the change in valuation allowance. For the three months ended June 30, 2022, we recognized an income tax expense of $373 on loss before taxes of $4,064, an effective tax rate of 9.18%. For the six months ended June 30, 2022, we recognized an income tax benefit of $684 on loss before taxes of $8,441, which is an effective tax rate of 8.10%. The effective rate is lower than the statutory federal rate primarily due to the effect of stock-based compensation and expiring options, requiring us to reduce our deferred tax asset. Management provided a full valuation allowance against net deferred income tax assets at June 30, 2023. Contractual Obligations There have been no material changes to the contractual obligations disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022. Off-Balance Sheet Arrangements None.