VirnetX(VHC) - 2022 Q4 - Annual Report

Part I Business VirnetX is an internet security software and technology company specializing in Zero Trust Network Access (ZTNA) solutions, generating revenue from software sales and patent licensing based on its extensive intellectual property portfolio - The company's business model is based on its intellectual property portfolio, which includes approximately 205 total patents and pending applications (72 U.S. and 133 foreign)[20] - VirnetX's product suite includes VirnetX One™ (a security-as-a-service platform), War Room™ (secure video conferencing), and VirnetX Matrix™ (security for internet-enabled enterprise applications)[21][22][23] - The company has an ongoing licensing program for its patent portfolio and GABRIEL Connection Technology™, targeting OEMs, service providers, and system integrators[26] Projected Market Growth in Key Areas | Market | 2022 Size | Projected Size | Forecast Period | CAGR | | :--- | :--- | :--- | :--- | :--- | | Zero Trust Security | $24.8 billion | >$60 billion | by 2027 | 19.4% | | Video Conferencing | $7.69 billion | $18.1 billion | by 2027 | 18.7% | | Cloud Computing Security | $43.6 billion | >$92.7 billion | by 2028 | 13.4% | | Industrial IoT Security | $4.76 billion | $23.17 billion | by 2028 | 30.2% | Risk Factors The company faces significant risks from activist shareholders, uncertain software revenue, costly patent litigation, challenges in protecting intellectual property, and financial volatility, compounded by past financial restatements and internal control weaknesses - The business may be negatively affected by activist shareholders, which is costly, time-consuming, and diverts management attention[70] - The company is heavily involved in costly and time-consuming patent litigation with uncertain outcomes, particularly against large, well-financed companies[72] - A significant risk is the potential failure to adequately protect patent rights and trade secrets, with several patents subject to USPTO inter partes review (IPR) proceedings which could lead to invalidation[75] - The company has previously restated financial statements and identified a material weakness in internal control over financial reporting, which could affect investor confidence[142][143] - The market price of the company's common stock has been and may continue to be highly volatile, with the price ranging between $1.03 and $2.69 per share in 2022[129] Unresolved Staff Comments The company reports no unresolved staff comments - None[145] Properties The company's principal executive offices are located in a leased property of approximately 2,090 square feet in Zephyr Cove, Nevada, with the lease term ending in October 2023 - The company leases approximately 2,090 square feet of office space for its principal executive offices at 308 Dorla Court, Suite 206, Zephyr Cove, Nevada, 89448[146] Legal Proceedings The company is involved in multiple intellectual property infringement lawsuits, notably the "Apple II" case where a $502.8 million jury verdict was vacated, and is appealing several PTAB decisions, having previously paid $38.3 million in arbitration - In the "Apple II" case, a jury awarded VirnetX $502.8 million in October 2020. However, on March 31, 2023, the Federal Circuit vacated the judgment and remanded the case to the district court with instructions to dismiss it as moot. VirnetX is evaluating its options, including seeking rehearing or certiorari review[288][289] - The company is appealing multiple PTAB decisions that found claims of its U.S. Patent Nos. 6,502,135 and 7,490,151 to be unpatentable. On March 30, 2023, the USCAFC affirmed the PTAB's decisions in these cases[292][293] - An arbitration with former legal counsel McKool Smith, P.C. concluded in April 2021, with an award of approximately $36.3 million plus interest to McKool. VirnetX paid the full amount of $38.3 million, and the matter is now closed[299] Mine Safety Disclosure This item is not applicable to the company - Not applicable[148] Part II Market for Common Equity, Stockholder Matters, and Issuer Purchases VirnetX's common stock trades on the NYSE under 'VHC', with a history of special cash dividends following litigation successes, though its stock performance has underperformed market indices over the last five years - The company's common stock trades on the NYSE under the symbol "VHC"[150] - A special cash dividend of $1.00 per common share was declared on March 30, 2023, payable in April 2023. This follows a similar $1.00 per share special dividend paid in 2020[153] 5-Year Cumulative Total Shareholder Return (Indexed to $100) | Company/Index | 12/31/2017 | 12/31/2022 | | :--- | :--- | :--- | | VirnetX Holding Corp | $100.00 | $47.99 | | S&P 500 | $100.00 | $156.89 | | RDG Technology Composite | $100.00 | $169.48 | Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) The company's financial results show minimal revenue in 2022 and 2021 compared to a significant one-time patent payment in 2020, with fluctuating operating expenses driven by legal fees, resulting in net losses in 2021 and 2022, while maintaining sufficient cash and investments for current operations Revenue Comparison (in thousands) | Year | Revenue | | :--- | :--- | | 2022 | $48 | | 2021 | $35 | | 2020 | $302,636 | - The significant revenue in 2020 was from a one-time lump sum payment of $454 million from Apple, Inc. resulting from a patent infringement case[183] Operating Expense Comparison (in thousands) | Expense Category | 2022 | 2021 | 2020 | | :--- | :--- | :--- | :--- | | Licensing Costs | $(4) | $(9,083) | $90,101 | | Research and Development | $6,406 | $5,577 | $8,830 | | Selling, General & Administrative | $15,722 | $52,715 | $45,812 | - Volatility in SG&A expenses was primarily due to legal fees, which were $3.3 million in 2022, $41.8 million in 2021, and $30.7 million in 2020[189] - As of December 31, 2022, cash and cash equivalents were $86.6 million and short-term investments were $65.5 million[194] Quantitative and Qualitative Disclosures about Market Risk As a "smaller reporting company," the company has omitted the information required by this item - Information required by Item 7A has been omitted as permitted for "smaller reporting companies"[197] Financial Statements and Supplementary Data The audited consolidated financial statements for 2020-2022 present a net loss in 2021 and 2022 following a net income in 2020, with the auditor issuing an unqualified opinion while highlighting deferred tax valuation as a critical audit matter, and total assets decreasing in 2022 - The independent auditor, Farber Hass Hurley LLP, issued an unqualified opinion on the financial statements[201] - The auditor identified the valuation of deferred taxes as a critical audit matter due to the significant management judgment involved in assessing the realizability of deferred tax assets[204][207] Consolidated Financial Highlights (in thousands) | Metric | Dec 31, 2022 | Dec 31, 2021 | | :--- | :--- | :--- | | Cash and cash equivalents | $86,561 | $142,018 | | Total Assets | $152,975 | $186,516 | | Total Liabilities | $731 | $1,067 | | Total Stockholders' Equity | $152,244 | $185,449 | Consolidated Statement of Operations Highlights (in thousands, except per share data) | Metric | 2022 | 2021 | 2020 | | :--- | :--- | :--- | :--- | | Revenue | $48 | $35 | $302,636 | | Total operating expense | $22,124 | $49,209 | $144,743 | | Net (loss) income | $(36,260) | $(42,921) | $280,429 | | Diluted (loss) earnings per share | $(0.51) | $(0.60) | $3.92 | Consolidated Cash Flow Highlights (in thousands) | Cash Flow Activity | 2022 | 2021 | 2020 | | :--- | :--- | :--- | :--- | | Net cash (used in) provided by operating activities | $(16,893) | $(51,722) | $281,389 | | Net cash (used in) provided by investing activities | $(38,535) | $1,028 | $(25,953) | | Net cash used in financing activities | $(29) | $(196) | $(65,663) | Changes in and Disagreements with Accountants The company reports no disagreements with its accountants on accounting and financial disclosure - None[305] Controls and Procedures Management concluded that the company's disclosure controls and internal control over financial reporting were effective as of December 31, 2022, following enhancements to supervisory review procedures for deferred tax accounting - The CEO and CFO concluded that disclosure controls and procedures were effective as of December 31, 2022[308] - Changes were made to internal controls over financial reporting, specifically modifying supervisory review procedures over deferred tax accounting to address a prior material weakness. These enhanced controls are believed to be operating effectively[309] - Management concluded that the company's internal control over financial reporting was effective as of December 31, 2022, based on the COSO 2013 framework[312] Other Information The company reports no other information - None[313] Part III Directors, Executive Officers and Corporate Governance Information required by this item is incorporated by reference from the company's definitive proxy statement - Information will be contained in the definitive proxy statement and is incorporated by reference[316] Executive Compensation Information required by this item is incorporated by reference from the company's definitive proxy statement - Information will be set forth in the Proxy Statement and is incorporated by reference[317] Security Ownership and Related Stockholder Matters Information regarding security ownership is incorporated by reference from the proxy statement, detailing outstanding securities and available shares under equity compensation plans as of December 31, 2022 Equity Compensation Plan Information as of December 31, 2022 | Plan Category | Securities to be Issued Upon Exercise | Weighted-Average Exercise Price | Securities Remaining Available for Future Issuance | | :--- | :--- | :--- | :--- | | Equity compensation plans approved by security holders | 7,368,130 | $5.21 | 1,563,345 | Certain Relationships, Related Transactions, and Director Independence Information required by this item is incorporated by reference from the company's definitive proxy statement - Information will be set forth in the Proxy Statement and is incorporated by reference[323] Principal Accountant Fees and Services Information required by this item is incorporated by reference from the company's definitive proxy statement - Information will be set forth in the Proxy Statement and is incorporated by reference[324] Part IV Exhibits and Financial Statement Schedules This section lists the documents filed as part of the Annual Report on Form 10-K, including financial statements and an exhibit index - This section contains the index to consolidated financial statements and a list of all exhibits filed with the report[328]