Company Quick10K Filing
VirnetX
Price5.52 EPS-0
Shares69 P/E-18
MCap381 P/FCF-32
Net Debt-3 EBIT-22
TEV378 TEV/EBIT-18
TTM 2019-09-30, in MM, except price, ratios
10-Q 2020-09-30 Filed 2020-11-06
10-Q 2020-06-30 Filed 2020-08-10
10-Q 2020-03-31 Filed 2020-05-11
10-K 2019-12-31 Filed 2020-03-16
10-Q 2019-09-30 Filed 2019-11-08
10-Q 2019-06-30 Filed 2019-08-09
10-Q 2019-03-31 Filed 2019-05-10
10-K 2018-12-31 Filed 2019-03-18
10-Q 2018-09-30 Filed 2018-11-08
10-Q 2018-06-30 Filed 2018-08-09
10-Q 2018-03-31 Filed 2018-05-10
10-K 2017-12-31 Filed 2018-03-16
10-Q 2017-09-30 Filed 2017-11-09
10-Q 2017-06-30 Filed 2017-08-09
10-Q 2017-03-31 Filed 2017-05-08
10-K 2016-12-31 Filed 2017-03-16
10-Q 2016-09-30 Filed 2016-11-09
10-Q 2016-06-30 Filed 2016-08-09
10-Q 2016-03-31 Filed 2016-05-10
10-K 2015-12-31 Filed 2016-03-15
10-Q 2015-09-30 Filed 2015-11-09
10-Q 2015-06-30 Filed 2015-08-10
10-Q 2015-03-31 Filed 2015-05-11
10-K 2014-12-31 Filed 2015-03-02
10-Q 2014-09-30 Filed 2014-11-10
10-Q 2014-06-30 Filed 2014-08-08
10-Q 2014-03-31 Filed 2014-05-09
10-K 2013-12-31 Filed 2014-03-03
10-Q 2013-09-30 Filed 2013-11-12
10-Q 2013-06-30 Filed 2013-08-09
10-Q 2013-03-31 Filed 2013-05-10
10-K 2012-12-31 Filed 2013-03-01
10-Q 2012-09-30 Filed 2012-11-09
10-Q 2012-06-30 Filed 2012-08-09
10-Q 2012-03-31 Filed 2012-05-10
10-K 2011-12-31 Filed 2012-02-29
10-Q 2011-09-30 Filed 2011-11-09
10-Q 2011-06-30 Filed 2011-08-09
10-Q 2011-03-31 Filed 2011-05-10
10-K 2010-12-31 Filed 2011-03-16
10-Q 2010-09-30 Filed 2010-11-08
10-Q 2010-06-30 Filed 2010-08-09
10-Q 2010-03-31 Filed 2010-05-07
10-K 2009-12-31 Filed 2010-03-31
8-K 2020-09-01
8-K 2020-07-17
8-K 2020-05-29
8-K 2020-05-08
8-K 2020-03-19
8-K 2020-03-13
8-K 2020-02-24
8-K 2020-02-10
8-K 2019-10-01
8-K 2019-07-08
8-K 2019-05-23
8-K 2019-01-15
8-K 2018-12-04
8-K 2018-09-24
8-K 2018-08-31
8-K 2018-05-24
8-K 2018-04-12
8-K 2018-03-08
8-K 2018-01-17

VHC 10Q Quarterly Report

Part I - Financial Information
Item 1 - Financial Statements.
Note 1 - Business Description and Basis of Presentation
Note 2 - Summary of Significant Accounting Policies
Note 3 - Income Taxes
Note 4 - Commitments and Related Party Transactions
Note 5 - Stock - Based Compensation
Note 6 - Equity
Note 7 - Litigation
Note 8 - Leases
Note 9 - Earnings (Loss) per Share
Note 10 - Subsequent Events
Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3 - Quantitative and Qualitative Disclosures About Market Risk.
Item 4 - Controls and Procedures
Part II - Other Information
Item 1 - Legal Proceedings
Item 1A - Risk Factors
Item 5 - Other Information
Item 6 - Exhibits.
EX-31.1 brhc10016205_ex31-1.htm
EX-31.2 brhc10016205_ex31-2.htm
EX-32.1 brhc10016205_ex32-1.htm
EX-32.2 brhc10016205_ex32-2.htm

VirnetX Earnings 2020-09-30

Balance SheetIncome StatementCash Flow
0.10.10.10.00.00.02012201420172020
Assets, Equity
0.10.10.0-0.0-0.1-0.12016201720182020
Rev, G Profit, Net Income
0.10.10.0-0.0-0.1-0.12012201420172020
Ops, Inv, Fin


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2020
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-33852

graphic
VirnetX Holding Corporation
(Exact name of registrant as specified in its charter)

Delaware
 
77-0390628
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)

308 Dorla Court, Suite 206 Zephyr Cove, Nevada
 
89448
(Address of principal executive offices)
 
(Zip Code)

Registrant’s telephone number, including area code: (775) 548-1785
Former name, former address and former fiscal year, if changed since last report: N/A

Securities registered pursuant to Section 12(b) of the Act:

Title of  each class
Trading Symbols
Name of each exchange on which Registered
Common Stock, par value $0.0001 per share
VHC
New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  No

Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes  No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer,  smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
Accelerated filer 
Smaller reporting company
Non-accelerated filer
 
 
 
Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No

71,058,570 shares of Registrant’s Common Stock were outstanding as of November 4, 2020.




SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

We have included or incorporated by reference in this Quarterly Report on Form 10-Q (including in the section entitled Management’s Discussion and Analysis of Financial Condition and Results of Operations), and from time to time we may make statements that may constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are based upon our current expectations, estimates, assumptions and beliefs concerning future events and conditions and may discuss, among other things, anticipated future performance (including sales and earnings), expected growth, future business plans and costs and the impact of potential and ongoing litigation. Any statement that is not historical in nature is a forward-looking statement and may be identified by the use of words and phrases such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “projects,” “will be,” “will continue,” “will likely result in,” and similar expressions. These statements include our beliefs and statements regarding general industry and market conditions and growth rates, as well as general domestic and international economic conditions. Readers are cautioned not to place undue reliance on forward-looking statements. Forward-looking statements are necessarily subject to risks, uncertainties and other factors, many of which are outside our control, which could cause actual results to differ materially from such statements and from our historical results and experience. These risks, uncertainties and other factors include, but are not limited to those described in Item 1A - Risk Factors of this Quarterly Report and elsewhere in this Quarterly Report and those described from time to time in our future reports filed with the Securities and Exchange Commission. Readers are cautioned that it is not possible to predict or identify all the risks, uncertainties and other factors that may affect future results and that the risks described herein should not be considered a complete list. Any forward-looking statement speaks only as of the date on which such statement is made, and we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

Among others, the forward-looking statements appearing in this Quarterly Report that may not occur include statements that:

          In the VirnetX Inc. v. Apple, Inc. (Case Nos. 6:11-cv-00563-RWS, 6:12-cv-00855-RWS) (“Apple II”) litigation, in November 2019, the United States Court of Appeals for the Federal Circuit (the “Federal Circuit”) affirmed-in-part and reversed-in-part the judgment issued by the United States District Court for the Eastern District of Texas (the “district court”) in the case awarding VirnetX damages of $595.9 million. The Federal Circuit affirmed the district court’s ruling that Apple Inc. (“Apple”) was precluded from challenging the validity of the asserted patents, and also affirmed the jury’s finding of infringement with respect to Apple’s VPN on Demand feature. The Federal Circuit reversed, however, the finding of infringement with respect to Apple’s FaceTime feature. The Federal Circuit remanded to the district court for an assessment of whether, given that only VPN on Demand infringed. In its order, unsealed on May 1, 2020, the district court 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 district court granted Apple’s motion for continuance and reset the jury selection and trial to October 26, 2020. On October 30, 2020, a federal jury in the U.S. District Court for the Eastern District of Texas issued a $502,848,847 verdict in favor of VirnetX. 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 March 13, 2020, VirnetX was paid a $454,033,859 judgment in a separate case against Apple. In addition, the patents in issue are being challenged in the United States Patent and Trademark Office. If those challenges are successful, they could also impact the award in the case. The continuation of this litigation is distracting to our management,  expensive, and these distractions and expenses may continue.

          We have undertaken activities to commercialize our products and patent portfolio in and outside the United States. These statements may imply that the worldwide market for our commercialized products is large and will result in significant future revenues for us. However, commercialization of products such as ours are subject to significant obstacles and risks, including but not limited to a perception by some potential partners and customers that they should await the outcome of the Apple II litigation before entering or considering to enter any agreement with us, and that or other factors may lead us to be unsuccessful in obtaining further licensing agreements or making arrangements or entering contracts which create significant future revenues for us.

EXCEPT AS REQUIRED BY LAW, WE UNDERTAKE NO OBLIGATION TO UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENT AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE.


VIRNETX HOLDING CORPORATION
INDEX

 
 
Page
 
 
 
2
 
2
 
 
 
 
2
 
3
 
3
 
4
 
6
 
7
 
15
 
20
 
20
 
 
 
21
 
21
 
23
 
35
 
 
 
36
37


1

PART I — FINANCIAL INFORMATION

ITEM 1-FINANCIAL STATEMENTS.
VIRNETX HOLDING CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)

 
As of
September 30,
2020
   
As of
December 31, 2019
 
ASSETS
 
(unaudited)
       
Current assets:
           
Cash and cash equivalents
 
$
225,911
   
$
3,135
 
Investments available for sale
   
22,077
     
2,394
 
Accounts receivable
   
6
     
5
 
Prepaid expenses and other current assets
   
396
     
237
 
Total current assets
   
248,390
     
5,771
 
Prepaid expenses and other assets
   
1,389
     
1,711
 
Property and equipment, net
   
12
     
16
 
Deferred tax asset
   
8,754
     
 
Total assets
 
$
258,545
   
$
7,498
 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable and accrued liabilities
 
$
583
   
$
1,346
 
Accrued licensing costs
   
9,438
     
 
Accrued payroll and related expenses
   
299
     
287
 
Other liabilities, current
   
53
     
193
 
Income taxes payable
   
17,414
     
 
Total current liabilities
   
27,787
     
1,826
 
                 
Other liabilities
   
4
     
44
 
Total liabilities
   
27,791
     
1,870
 
                 
Commitments and contingencies (Note 4)
   
     
 
                 
Stockholders’ equity:
               
Preferred stock, par value $0.0001 per share authorized: 10,000,000 shares at September 30, 2020 and December 31, 2019, issued and outstanding: 0 shares at September 30, 2020 and December 31,2019
   
     
 
Common stock, par value $0.0001 per share authorized: 100,000,000 shares at September 30, 2020 and December 31, 2019, issued and outstanding: 71,058,570 shares and 69,586,764 shares, at September 30, 2020 and December 31, 2019, respectively
   
7
     
7
 
Additional paid-in capital
   
231,322
     
223,237
 
Accumulated deficit
   
(563
)
   
(217,602
)
Accumulated other comprehensive loss
   
(12
)
   
(14
)
Total stockholders’ equity
   
230,754
     
5,628
 
Total liabilities and stockholders’ equity
 
$
258,545
   
$
7,498
 

See accompanying notes to condensed consolidated financial statements.

2


VIRNETX HOLDING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(in thousands, except per share amounts)

 
Three Months Ended
   
Nine Months Ended
 
   
September 30, 2020
   
September 30, 2019
   
September 30, 2020
   
September 30, 2019
 
Revenue
 
$
26
   
$
4
   
$
302,620
   
$
50
 
Operating expense:
                               
Licensing costs
   
     
     
90,101
     
 
Research and development
   
1,091
     
964
     
6,799
     
2,886
 
Selling, general and administrative expenses
   
4,270
     
4,016
     
38,347
     
12,326
 
Total operating expense
   
5,361
     
4,980
     
135,247
     
15,212
 
Income (loss) from operations
   
(5,335
)
   
(4,976
)
   
167,373
     
(15,162
)
Gain
   
     
     
41,271
     
 
Interest and other income, net
   
17
     
20
     
108,272
     
75
 
Income (loss) before taxes
   
(5,318
)
   
(4,956
)
   
316,916
     
(15,087
)
Income tax benefit (expense)
   
1,293
     
     
(29,036
)
   
393
 
Net income (loss)
 
$
(4,025
)
 
$
(4,956
)
 
$
287,880
   
$
(14,694
)
Basic earnings (loss) per share
 
$
(0.06
)
 
$
(0.07
)
 
$
4.07
   
$
(0.22
)
Diluted earnings (loss) per share
 
$
(0.06
)
 
$
(0.07
)
 
$
4.02
   
$
(0.22
)
Weighted average shares outstanding, basic
   
71,059
     
68,943
     
70,780
     
68,278
 
Weighted average shares outstanding, diluted
   
71,059
     
68,943
     
71,663
     
68,278
 

VIRNETX HOLDING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)
(in thousands)

 
 
Three Months Ended
   
Nine Months Ended
 
 
 
September 30, 2020
   
September 30, 2019
   
September 30, 2020
   
September 30, 2019
 
Net income (loss)
 
$
(4,025
)
 
$
(4,956
)
 
$
287,880
   
$
(14,694
)
Other comprehensive gain (loss), net of tax:
                               
Change in unrealized gain (loss) on investments, net of tax
   
     
1
     
1
     
2
 
Change in foreign currency translation, net
   
     
     
1
     
 
     
     
1
     
2
     
2
 
Comprehensive income (loss)
 
$
(4,025
)
 
$
(4,955
)
 
$
287,882
   
$
(14,692
)

See accompanying notes to condensed consolidated financial statements.

3


VIRNETX HOLDING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Unaudited)
(in thousands, except per share amounts)

 
Common Stock
   
Additional
Paid-in
   
Retained Earnings
(Accumulated
   
Accumulated
Other
Comprehensive
   
Total
Stockholders’
Equity
 
   
Shares
   
Amount
   
Capital
   
Deficit)
   
Loss
   
(Deficit)
 
Balance, December 31, 2019
   
69,586,764
   
$
7
   
$
223,237
   
$
(217,602
)
 
$
(14
)
 
$
5,628
 
Stock issued for cash, $4.00 - $4.96, net
   
1,049,382
             
4,488
                     
4,488
 
Stock-based compensation
                   
778
                     
778
 
Stock issued for options and RSUs, net
   
202,031
             
768
                     
768
 
Comprehensive income:
                                               
Net income
                           
299,945
             
299,945
 
Change in unrealized gain, net
                                   
2
     
2
 
Change in foreign currency, net
                                   
1
     
1
 
Comprehensive income
                                           
299,948
 
Balance, March 31, 2020
   
70,838,177
     
7
     
229,271
     
82,343
     
(11
)
   
311,610
 
Stock-based compensation
                   
953
                     
953
 
Warrant issued for services
                   
104
                     
104
 
Stock issued for options and RSUs, net
   
220,393
             
(78
)
                   
(78
)
Dividends paid
                           
(70,841
)
           
(70,841
)
Comprehensive loss:
                                               
Net loss
                           
(8,040
)
           
(8,040
)
Change in unrealized loss, net
                                   
(1
)
   
(1
)
Comprehensive loss
                                           
(8,041
)
Balance, June 30, 2020
   
71,058,570
   
$
7
   
$
230,250
   
$
3,462
   
$
(12
)
 
$
233,707
 
Stock-based compensation
                   
1,072
                     
1,072
 
Comprehensive loss:
                                               
Net loss
                           
(4,025
)
           
(4,025
)
Comprehensive loss
                                           
(4,025
)
Balance, September 30, 2020
   
71,058,570
   
$
7
   
$
231,322
   
$
(563
)
 
$
(12
)
 
$
230,754
 

Dividends paid in the three and nine months ended September 30, 2020 totaled $0 and $1.00 per share, respectively.

See accompanying notes to condensed consolidated financial statements.
4


 
Common Stock
   
Additional
Paid-in
   
Retained Earnings
(Accumulated
   
Accumulated
Other
Comprehensive
   
Total
Stockholders’
Equity
 
   
Shares
   
Amount
   
Capital
   
Deficit)
   
Loss
   
(Deficit)
 
Balance, December 31, 2018
   
66,879,847
   
$
7
   
$
208,317
   
$
(198,422
)
 
$
(14
)
 
$
9,888
 
Stock issued for cash, $5.05 - $5.42, net
   
560,338
             
2,848
                     
2,848
 
Stock-based compensation
                   
785
                     
785
 
Stock issued for options and RSUs, net
   
663,816
             
816
                     
816
 
Comprehensive loss:
                                               
Net loss
                           
(5,608
)
           
(5,608
)
Change in unrealized gain, net
                                   
1
     
1
 
Comprehensive loss
                                           
(5,607
)
Balance, March 31, 2019
   
68,104,001
     
7
     
212,766
     
(204,030
)
   
(13
)
   
8,730
 
Stock issued for cash, $6.02 - $6.49, net
   
467,928
             
2,849
                     
2,849
 
Stock-based compensation
                   
928
                     
928
 
Stock issued for options and RSUs, net
   
182,618
                                     
 
Comprehensive loss:
                                               
Net loss
                           
(4,130
)
           
(4,130
)
Comprehensive loss
                                           
(4,130
)
Balance, June 30, 2019
   
68,754,547
   
$
7
   
$
216,543
   
$
(208,160
)
 
$
(13
)
 
$
8,377
 
Stock issued for cash, $5.53 - $6.49, net
   
203,754
             
1,219
                     
1,219
 
Stock-based compensation
                   
999
                     
999
 
Comprehensive loss:
                                               
Net loss
                           
(4,956
)
           
(4,956
)
Change in unrealized gain, net
                                   
1
     
1
 
Comprehensive loss
                                           
(4,955
)
Balance, September 30, 2019
   
68,958,301
   
$
7
   
$
218,761
   
$
(213,116
)
 
$
(12
)
 
$
5,640
 

No dividends declared or paid in 2019.
See accompanying notes to condensed consolidated financial statements.

5


VIRNETX HOLDING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in thousands)

 
Nine Months Ended
 
   
September 30,
2020
   
September 30,
2019
 
Cash flows from operating activities:
           
Net income (loss)
 
$
287,880
   
$
(14,694
)
Adjustments to reconcile net loss to net cash from operating activities:
               
Depreciation
   
4
     
4
 
Stock-based compensation
   
2,803
     
2,712
 
Amortization of warrant issued for services
   
43
     
 
Deferred income taxes
   
(8,754
)
   
 
Changes in assets and liabilities:
               
Prepaid expenses and other assets
   
224
     
286
 
Accounts payable and accrued liabilities
   
(763
)
   
118
 
Accrued licensing costs
   
9,438
     
 
Accrued payroll and related expenses
   
12
     
62
 
Other liabilities
   
(180
)
   
 
Accounts receivable
   
(1
)
   
 
Income taxes payable
   
17,414
     
(396
)
Net cash provided by (used in) operating activities
   
308,120
     
(11,908
)
Cash flows from investing activities:
               
Purchase of investments
   
(22,519
)
   
(5,319
)
Proceeds from sale or maturity of investments
   
2,838
     
4,503
 
Net cash used in investing activities
   
(19,681
)
   
(816
)
Cash flows from financing activities:
               
Proceeds from exercise of options
   
1,046
     
816
 
Proceeds from sale of common stock
   
4,488
     
6,916
 
Dividends paid
   
(70,841
)
   
 
Payments of taxes on cashless exercise of restricted stock units
   
(356
)
   
(47
)
Net cash (used in) provided by financing activities
   
(65,663
)
   
7,685
 
Net increase (decrease) in cash and cash equivalents
   
222,776
     
(5,039
)
Cash and cash equivalents, beginning of period
   
3,135
     
7,611
 
Cash and cash equivalents, end of period
 
$
225,911
   
$
2,572
 
Supplemental cash flow information:
               
Cash paid for income taxes
 
$
20,377
     
 

See accompanying notes to condensed consolidated financial statements.

6


VIRNETX HOLDING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share amounts)
(Unaudited)

Note 1 — Business Description and Basis of Presentation

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 seek to license our technology, including GABRIEL Connection Technology™, to various original equipment manufacturers, or 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. Since 2012 we had revenues from settlements of patent infringement disputes whereby, we received consideration for past sales of licensees that utilized our technology, where there was no prior patent license agreement, as well as license agreement revenues from settlements providing licensing for the continued use of our technology (see “Revenue Recognition”).

Our portfolio of intellectual property is the foundation of our business model. We currently own approximately 194 total patents and pending applications, including 70 U.S. patents/patent applications and 124 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, Machine-to-Machine (“M2M”), communications in areas including “Smart City,” “Connected Car” and “Connected Home.” All our U.S. and foreign patents and pending patent applications relate generally to securing communications over the internet and as such, cover all our technology and other products. Our issued U.S. and foreign patents expire at various times during the period from 2020 to 2024. Some of our issued patents and pending patent applications were acquired by our principal operating subsidiary, VirnetX, Inc., from Leidos, Inc. (“Leidos”) (f/k/a Science Applications International Corporation, or SAIC) in 2006 and we are required to make payments to Leidos based on cash or certain other values generated from those patents in certain circumstances. The amount of such payments depends upon the type of value generated and certain categories are subject to maximums and other limitations.

Note 2 — Summary of Significant Accounting Policies

Unaudited Interim Financial Information

The accompanying Condensed Consolidated Balance Sheet as of September 30, 2020, the Condensed Consolidated Statements of Operations, the Condensed Consolidated Statements of Comprehensive Income (Loss), the Condensed Consolidated Statements of Shareholders’ Equity (Deficit) for the three and nine months ended September 30, 2020 and 2019, and the Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2020 and 2019 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 September 30, 2020, our results of operations for the three and nine months ended September 30, 2020 and 2019, and our cash flows for the nine months ended September 30, 2020 and 2019. 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, 2019, filed with the SEC on March 16, 2020.

Use of Estimates

We prepare our consolidated financial statements in accordance with U.S. GAAP. In doing so, we must 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 our accounting estimates are reasonably likely to occur. 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 experience and other assumptions that we believe are reasonable under the circumstances, at the time they are made, 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.

7

Reclassifications

Certain prior period amounts were reclassified to conform to the current year’s presentation. None of these reclassifications had an impact on reported operating expenses, operating income or net income for any of the periods presented.

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, giving the Company a right-of-use (“ROU”) asset, is a lease at inception. Operating lease ROU assets are included in other assets on the Condensed Consolidated Balance Sheet. 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 of the arrangement based on the present value of lease payments over the lease term. Other assets at September 30, 2020, includes a ROU asset related to a facility lease for corporate promotional and marketing purposes. The facility lease was paid in full at inception and the ROU is being amortized over the  term of the lease. Other assets also include an ROU related to our office operating lease which expires in October 2021 (See Note 8 - Leases).

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 (“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 (“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 nine months ended September 30, 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 (see Note 7 - Litigation). Elements of the payment were recognized in the Company’s condensed consolidated statement of operations as follows:

Classification of Payment Received in the Company’s Condensed Consolidated Statement of Operations
Nine Months Ended

 
September 30,
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 for the nine months ended September 30, 2020, is $90,101 in 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.

8

Earnings (Loss) Per Share

Basic earnings (loss) per share are computed by dividing earnings (loss) available to common stockholders by the weighted average number of outstanding common shares during the period. Diluted earnings per share are 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.

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. A portion of those balances are insured by the Federal Deposit Insurance Corporation. During the nine months ended September 30, 2020, we had funds which were uninsured. We do not believe that we are subject to any unusual financial risk beyond the normal risk associated with commercial banking relationships with major financial institutions. We have not experienced any losses on our deposits of cash and cash equivalents.

Impairment of Long-Lived Assets

On an annual basis, we identify and record impairment losses on long-lived assets when events and changes in circumstances indicate that the carrying amount of an asset might not be recoverable. Recoverability is measured by comparison of the anticipated future net undiscounted cash flows to the related assets’ carrying value. If such assets are 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.

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. Government and U.S. Agency 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 September 30, 2020 and December 31, 2019.

 
September 30, 2020
 
   
Adjusted Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair Value
   
Cash and Cash
Equivalents
   
Investments
Available for
Sale
 
Cash
 
$
144,133
   
$
   
$
   
$
144,133
   
$
144,133
   
$
 
Level 1:
                                               
Mutual funds
   
71,061
     
     
     
71,061
     
71,061
     
 
U. S. government securities
   
15,020
     
1
             
15,021
     
3,400
     
11,621
 
U.S. agency securities
   
17,772
     
1
     
     
17,773
     
7,317
     
10,456
 
Total investments
   
103,853
     
2
     
     
103,855
     
81,778
     
22,077
 
Total
 
$
247,986
   
$
2
   
$
   
$
247,988
   
$
225,911
   
$
22,077
 

 
December 31, 2019
 
   
Adjusted Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair Value
   
Cash and Cash
Equivalents
   
Investments
Available for
Sale
 
Cash
 
$
2,076
   
$
   
$
   
$
2,076
   
$
2,076
   
$
 
Level 1:
                                               
Mutual funds
   
613
     
     
     
613
     
613
     
 
U.S. agency securities
   
2,837
     
3
     
     
2,840
     
446
     
2,394
 
Total investments
   
3,450
     
3
     
     
3,453
     
1,059
     
2,394
 
Total
 
$
5,526
   
$
3
   
$
   
$
5,529
   
$
3,135
   
$
2,394
 

9

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 are currently evaluating the impact, if any this ASU will have on our consolidated financial statements and related disclosures.

In June 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-13, Measurement of Credit Losses on Financial Instruments, and issued subsequent amendments to the initial guidance within ASU 2019-04 and ASU 2019-05 (collectively, "ASU 2016-13"). The amendments in ASU 2016-13 replace the incurred loss impairment methodology with the current expected credit loss model, which requires consideration of a broader range of reasonable and supportable information to estimate credit losses. The Company adopted this ASU effective January 1, 2020 and the adoption did not have a material impact on the Company's financial position, results of operations or cash flows.

Note 3 — Income Taxes

For the three months ended September 30, 2020, we recognized an income tax benefit of $1,293 on a loss before income taxes of $5,318, which is an effective tax rate of a 24.3%. For the nine months ended September 30, 2020, we recognized income tax expense of $29,036 on income before income taxes of $316,916 which is an effective tax rate of 9.2%. For the three and nine months ended September 30, 2019, we had an income tax benefit of zero and $393, respectively, due to a release of a state reserve as the statute of limitation for the tax return expired. The effective tax rate for the 2020 nine-month period was favorably impacted by the reversal of valuation allowance reserves totaling $37,585, which were established in prior years on our deferred tax assets primarily associated with net operating loss (“NOL”) carryforwards. For the three and nine months ended September 30, 2019, we had NOLs which generated deferred tax assets for NOL carryforwards. During 2019, we provided valuation allowances against the net deferred tax assets including the deferred tax assets for NOL carryforwards. At September 30, 2020, we had deferred tax assets of $8,754.

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.  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, or reduce, a valuation allowance associated with 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.
 
As a result of the significant taxable income recognized in the nine months ended September 30, 2020, we determined that it was more likely than not that we will recover our deferred tax assets and accordingly the valuation allowances were reduced during the period.  During 2019, consistent with our policy, and because of our history of operating losses, we did not recognize the benefit of our deferred tax assets, including NOL carryforwards, that may have been used to offset future taxable income.  We continually assess our ability to generate sufficient taxable income during future periods in which our deferred tax assets may be realized.
 
Internal Revenue Code Section 382 places a limitation (the ‘‘IRC Section 382 Limitation’’) on the amount of net operating loss carryforwards that can be used to offset taxable income after a change in control (generally greater than 50% change in ownership) of a loss corporation. California, the state in which our headquarters was once located, has similar rules. Generally, after a control change, a loss corporation cannot deduct net operating loss carryforwards generated in years prior to the deemed change of control under IRC Section 382 in excess of the Section 382 Limitation. Because we have concluded that the Company has not experienced a change in control under Section 382, all NOL carryforwards were utilized to offset taxable income generated in the period.
 
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 to be utilized from such years.

Our policy is to recognize interest and penalties accrued on uncertain tax positions as a component of income tax expense. As of September 30, 2020, we had accrued immaterial amounts of interest and penalties related to the uncertain tax positions. 

10


Note 4 — Commitments and Related Party Transactions

We lease our offices under an operating lease with a third party which expires in October 2021 (see “Note 8 - Leases”).

We entered into a service agreement for the use of an aircraft from K2 Investment Fund LLC (the “LLC”) for business travel for employees of the Company. We incurred approximately $67, and $157 compared to $442, and $1,327 in rental fees and reimbursements to the LLC during the three and nine months ended September 30, 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 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

We have a stock incentive plan for employees and others called the VirnetX Holding Corporation 2013 Equity Incentive Plan (the “Plan”), which has been approved by our stockholders. In April 2017, the Board approved an amendment and restatement of the Plan to, among other things, increase the shares reserved under the Plan by 2,500,000 shares (the “Plan Amendment”). Our stockholders approved of the Plan Amendment at the 2017 Annual Meeting of Stockholders held on June 1, 2017. The Plan provides for grants of 16,624,469 shares of our common stock, including stock options and restricted stock units (“RSUs”), and will expire in 2023. As of September 30, 2020, 675,210 shares remained available for grant under the Plan.

During the three months ended September 30, 2020 and 2019, we did not grant options or RSUs.

During the nine months ended September 30, 2020, we granted options for a total of 617,500 shares. The weighted average fair value at the grant dates was $4.77 per option. The fair values of options at the grant date were 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 94 percent (iii) a risk-free interest rate of 0.65 percent and (iv) and expected option term of 6 years.

During the nine months ended September 30, 2019, we granted options for a total of 345,000 shares. The weighted average fair value at the grant dates was $4.63 per option. The fair values of options at the grant date were 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 92 percent (iii) a risk-free interest rate of 2.09 percent and (iv) and expected option term of 6 years.

During the nine months ended September 30, 2020 and 2019, we granted 218,329 and 229,996 RSUs, respectively. The weighted average fair values at the grant dates for RSUs issued during the nine months ended September 30, 2020 and 2019 were $6.89 and $6.06 per RSU, respectively. RSUs, which are subject to forfeiture if service terminates prior to the shares vesting, are expensed ratably over the vesting period.

Stock-based compensation expense included in general and administrative expense was $576 and $1,399 and in research and development expense was $496 and $1,404 for the three and nine months ended September 30, 2020, respectively.  Stock-based compensation expense included in general and administrative expense was $565 and $1,437 and in research and development expense was $434 and $1,275 for the three and nine months ended September 30, 2019, respectively.

As of September 30, 2020, the unrecognized stock-based compensation expense related to non-vested stock options and RSUs was $5,571 and $2,522, respectively, which will be amortized over an estimated weighted average period of approximately 2.2 and 2.6 years, respectively.

During the three months ended September 30, 2020 and 2019, no shares were issued as a result of exercised options or vested RSUs.  During the nine months ended September 30, 2020, we issued 262,031 shares of common stock as a result of the exercise of options and 160,393 shares of common stock as a result of vesting RSUs. During the nine months ended September 30, 2019, we issued 663,816 shares of common stock as a result of the exercise of options and 182,618 shares of commons stock as a result of vesting RSUs.


11


Note 6 — Equity

Common Stock

On July 30, 2018 we filed a $100,000 universal shelf registration statement on SEC Form S-3 which was declared effective by the SEC on August 16, 2018. We also entered an at-the-market equity offering sales agreement (“ATM”) with Cowen & Company, LLC on August 31, 2018, under which we can offer and sell shares of our common stock having an aggregate value of up to $50,000.

We use the ATM proceeds for GABRIEL product development, marketing and general corporate purposes, which may include working capital, capital expenditures, other corporate expenses and acquisitions of complementary products, technologies or businesses. As of September 30, 2020, common stock with an aggregate value of up to $21,964 remained available for offer and sale under the ATM agreement.

We did not sell any shares under the ATM during the three months ended September 30, 2020.  During the nine months ended September 30, 2020, we sold 1,049,382 shares under the ATM. The average price per common share was $4.41 and the aggregate proceeds from the sales totaled $4,627. Sales commissions, fees and other costs associated with the ATM totaled $139.

During the three months ended September 30, 2019, we sold 203,754 shares under the ATM. The average sales price per common share was $6.17 and the aggregate proceeds from the sales totaled $1,257 during the period. Sales commissions, fees and other costs associated with the ATM totaled $38. During the nine months ended September 30, 2019, we sold 1,232,020 shares under the ATM. The average sales price per common share was $5.79 and the aggregate proceeds from the sales totaled $7,131 during the period. Sales commissions, fees and other costs associated with the ATM totaled $214.

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, which will expire 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
Exercisable at
December 31, 2019
Newly Exercisable
Exercised
Terminated /
Cancelled
Exercisable at
September 30, 2020
Expiration Date
25,000
$
7.00
25,000
(25,000)
April 30, 2020
25,000
$
5.75
25,000
25,000
April 30, 2025
 
_
25,000
25,000
(25,000)
25,000
_

Note 7 — Litigation

We have several intellectual property infringement lawsuits pending in the United States District Court for the Eastern District of Texas, Tyler Division (“USDC”), and United States Court of Appeals for the Federal Circuit (“USCAFC”) and the Supreme Court of the United States (“SCOTUS”).

VirnetX Inc. v. Cisco Systems, Inc. et al. (Case 6:10-CV-00417-LED) (“Apple I”)

On August 11, 2010, we filed a complaint against Aastra USA. Inc. (“Aastra”), Apple Inc. (“Apple”), Cisco Systems, Inc. (“Cisco”), and NEC Corporation (“NEC”) the USDC in which we alleged that these parties infringe 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 cases against each defendant were separated by the judge. Aastra and NEC agreed to sign license agreements with us, and we dropped all accusations of infringement against them. A jury in USDC decided that our patents were not invalid and rendered a verdict of non-infringement by Cisco on March 4, 2013. Our motion for a new Cisco trial was denied and the case against Cisco was closed.

On November 6, 2012, a jury in the USDC awarded us over $368,000 for Apple’s infringement of four of our patents, plus daily interest up to the final judgment.

12

Apple filed an appeal of the judgment to the USCAFC. On September 16, 2014, USCAFC affirmed the USDC jury’s finding that all four of our patents at issue are valid and confirmed the USDC jury’s finding of infringement of VPN on Demand under many of the asserted claims of our ‘135 and ‘151 patents, and the USDC’s decision to allow evidence about our license and royalty rates regarding the determination of damages. However, the USCAFC vacated the USDC jury’s damages award and some of the USDC’s claim construction with respect to parts of our ‘504 and ‘211 patents and remanded the damages award and determination of infringement with respect to FaceTime back to the USDC for further proceedings.

On September 30, 2016, pursuant to the 2014 remand from the USCAFC, a jury in the USDC awarded us $302,400 for Apple’s infringement of four of our patents. On September 29, 2017, the USDC entered its final judgment, denied all of Apple’s post-trial motions, granted all our post-trial motions, including our motion for willful infringement and enhanced the royalty rate during the willfulness period from $1.20 to $1.80 per device, and awarded us costs, certain attorneys’ fees, and prejudgment interest. The total amount in the final judgment was $439,700, including $302,400 (jury verdict), $41,300 (enhanced damages) and $96,000 (costs, fees and interest).

On October 27, 2017 Apple appealed the final judgment entered on September 29, 2017 to the USCAFC. Oral arguments in this case were held on January 8, 2019. On January 15, 2019 the Court issued a Rule 36 order affirming the district court’s final judgment. Apple filed a petition for panel rehearing and rehearing en-banc in this matter on February 21, 2019. On October 1, 2019, USCAFC issued an order denying Apple’s petition. Apple filed a petition for a writ of certiorari with the SCOTUS, which was denied on February 24, 2020. Prior to the SCOTUS decision denying Apple’s petition for a writ of certiorari, on February 20, 2020, Apple filed a Rule 60(b) motion for relief from judgment with the USDC, seeking relief from the district court’s September 29, 2017 final judgment. VirnetX filed a responsive brief in opposition on March 5, 2020.

On March 13, 2020, the Company received payment of $454,034 from Apple, representing the previously announced final judgment with interest in this case. Apple has indicated that it will seek restitution of the payment if relief sought in its Rule 60(b) motion is awarded. On April 16, 2020, the USDC ordered Apple to file a supplemental brief with respect to its Rule 60(b) motion within 7 days. On September 1, 2020 USDC issued an order denying Apple’s motion for relief of judgement. This case is now closed.

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 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; these products were not included in the Apple I case because they were released after the Apple I case was initiated. 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 trial date to October 26, 2020. On October 30, 2020, a federal jury in the U.S. District Court for the Eastern District of Texas issued 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. We are currently awaiting court order scheduling the hearing for the judgement as a matter of law (JMOL) motions filed by both parties.

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 (USAFC Case 20-2272)

On September 15, 2020, we filed with the USCAFC an appeal of the invalidity findings by the 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. Our initial briefs are due by December 21, 2020.

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Iancu v. Luoma (SCOTUS Case 20-74)

On July 23, 2020, the United States and the USPTO (collectively, “the United States”) filed a petition for a writ of certiorari from several decisions by the USAFC, including decisions in VirnetX Inc. v. Cisco Systems, Inc., Nos. 2019-1671, and VirnetX Inc. v. Iancu, Nos. 2017-2593, -2594.  In those cases, the USAFC granted VirnetX’s motions to vacate the underlying decisions of the PTAB on the basis of Arthrex, Inc. v. Smith & Nephew, Inc., 941 F.3d 1320 (Fed. Cir. 2019), and remanded for further proceedings.  The United States requested that the SCOTUS hold its certiorari petition pending the disposition of the United States’ separate petition in United States v. Arthrex, Inc., No. 19-1434 (filed June 25, 2020).  On August 26, 2020, VirnetX filed a response, agreeing that the United States’ certiorari petition should be held pending the disposition of the petition for a writ of certiorari in No. 19-1434 (and related petitions filed by private parties in Nos. 19-1452 and 19-1458), and any further SCOTUS proceedings.

On October 13, 2020, SCOTUS granted the United States’ petition for a writ of certiorari in No. 19-1434 as to USAFC Case No. 2018-2140, and the petitions for writs of certiorari in Nos. 19-1452 and 19-1458, all limited to Questions 1 and 2 as set forth in the July 22, 2020 Memorandum for the United States filed in No. 19-1434. The consolidated petition is seeking review of decisions by the USCAFC holding that administrative patent judges (APJ) of the Patent Trial and Appeal Board of the U.S. Patent and Trademark Office must be appointed by the president and confirmed by the Senate; and, whether the remedy imposed by USCAFC that federal laws that place restrictions on when officials can be removed from office cannot apply to APJ, was the appropriate one.

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 claims that a retention agreement it entered into in 2010 with VirnetX entitles it to a contingency fee arising from the recent 2020 payment made by Apple. McKool claims it is owed $36,300 (or 8% of the payment). We have filed a general response with AAA denying McKool’s claim and intend to vigorously contest the matter.

Neal Hurwitz v. Kendall Larsen et al. (Case 2020-0425-JRS)

On June 2, 2020, stockholder Neal Hurwitz filed a verified derivative complaint in the Delaware Court of Chancery against Kendall Larsen, Robert D. Short Ill, Gary Feiner, Michael F. Angelo, and Thomas M. O'Brien and naming the Company as nominal defendant. The lawsuit alleges breaches of fiduciary duty, corporate waste, and unjust enrichment arising out of a series of previously-disclosed transactions and compensation awards and seeks an award of monetary damages and equitable relief. On July 1, 2020, the defendants filed a motion to dismiss the complaint based on a failure to plead demand futility and a failure to state a claim on which relief can be granted and, on August 19, 2020, the defendants filed an opening brief in support of their motion to dismiss. On October 16, 2020, plaintiff amended his complaint rather than respond to the arguments in the defendants' opening brief. On October 23, 2020, the defendants filed a renewed motion to dismiss plaintiff's amended complaint based on a failure to plead demand futility and a failure to state a claim on which relief can be granted.

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 in October 2021; at September 30, 2020, the underlying ROU asset and lease liability totaled $57. For the three and nine months ended September 30, 2020, we recorded lease expense of $14 and $42.  For the three and nine months ended September 30, 2019, we recorded lease expense of $14 and $42.

We also entered into an operating lease for a facility used for corporate promotional and marketing purposes which was prepaid at inception and would have originally expired in 2024.  In September 2020, this lease was extended for one year to 2025, due to COVID use-restrictions in 2020.  No other terms of the original contract were affected and there was no impact on cash flow.   At September 30, 2020, the ROU totaled $1,323For the three and nine months ended September 30, 2020, we recorded promotional and marketing lease expense of $89 and $282For the three and nine months ended September 30, 2019, we recorded lease expense of $96 and $289.

Note 9 — Earnings (Loss) Per Share
 
Basic earnings (loss) per are share based on the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share are based on the weighted average number of common shares and potentially dilutive securities which for the Company include stock options, RSUs and warrants.
 
The following table shows the computation of basic and diluted earnings (loss) per share for the three and nine months ended September 30, 2020 and 2019 (shares in thousands):

 
Three Months Ended
   
Nine Months Ended
 
   
September 30,
2020
   
September 30,
2019
   
September 30,
2020
   
September 30,
2019
 
Weighted-average basic shares outstanding
   
71,059
     
68,943
     
70,780
     
68,278
 
Effect of dilutive securities
   
     
     
883
     
 
Weighted-average diluted shares outstanding
   
71,059
     
68,943
     
71,663
     
68,278
 
                                 
Basic earnings (loss) per share
 
$
(0.06
)
 
$
(0.07
)
 
$
4.07
   
$
(0.22
)
Diluted earnings (loss) per share
 
$
(0.06
)
 
$
(0.07
)
 
$
4.02
   
$
(0.22
)


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Potentially dilutive securities representing 2,814,179 shares of common stock were excluded from the computation of diluted earnings per share for the nine months ended September 30, 2020, because their effect would have been antidilutive. We incurred a net loss for the three months ended September 30, 2020, and the three and nine months ended September 30, 2019;  therefore, all potentially dilutive securities representing shares of common stock were excluded from the computation of diluted loss per share for those periods, because their effect would have been antidilutive.

Note 10 — Subsequent Events

On October 30, 2020, a federal jury in the U.S. District Court for the Eastern District of Texas issued a $502,800 verdict in favor of VirnetX based on Apples infringement of two network security patents. The verdict calls for damages of $0.84 per accused device since the 2013 launch of Apples iOS 7 operating system (see "Note 7 - Litigation").

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 secure communications including 5G and 4G LTE security. Our software and technology solutions, including our Secure Domain Name Registry and GABRIEL Connection Technology™, are designed to facilitate secure communications and provide the security platform required by next- generation Internet-based applications such as instant messaging, or IM, voice over Internet protocol, or VoIP, mobile services, streaming video, file transfer, remote desktop and Machine-to-Machine, or M2M communications. Our technology generates secure connections on a “zero-click” or “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 194 total patents and pending applications, including 70 U.S. patents/patent applications and 124 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 the new initiatives like “Smart City”, “Connected Car” and “Connected Home” that would connect everything from social services and citizen engagement to public safety, transportation and economic development to the internet to enable more productivity, features and efficiency in our everyday lives. The subject matter of all our U.S. and foreign patents and pending applications relates generally to securing communication over the internet, and as such covers all our technology and other products. Our issued U.S. and foreign patents expire at various times during the period from 2020 to 2024. Some of our issued patents and pending patent applications 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 and we are required to make payments to Leidos, based on cash or certain other values generated from those patents. The amount of such payments depends upon the type of value generated, and certain categories are subject to maximums and other limitations.

Our product GABRIEL Secure Communication Platform™ includes a set of sophisticated software libraries with application interfaces available for securing third-party applications seamlessly across multiple operating system platforms. Unlike other collaboration and communication products and services on the market today, this product does not require access to user’s confidential data and reduces the threat of hacking and data mining. It enables individuals and organizations to maintain complete ownership and control over their personal and confidential data, secured within their own private network, while enabling authorized secure encrypted access from anywhere at any time.

Our GABRIEL Gateway product extends our Secure Communication Platform™ by allowing existing Networked Devices and Services to seamlessly join the “GABRIEL SECURED” network without requiring any modifications. All these devices or services, including cloud-based services, can now be assigned a VirnetX Secure Domain Name and use a fully authenticated secure communication channels for its communications.

Our GABRIEL Collaboration Suite™ is a set of communication tools that use our GABRIEL Secure Communication Platform™. It enables seamless and secure cross-platform communications between devices that are enrolled in our security fabric 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 http://www.gabrielsecure.com/. We continue to enhance our products and add new functionality to our products. We will provide updates to new and existing customers as they are released to the general public. A large number of small and medium businesses have installed our GABRIEL Secure Communication Platform™ and GABRIEL Collaboration Suite™ products in their corporate networks. We intend to continue to expand our customer base with targeted promotions and direct sales initiatives.

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We are actively recruiting partners in various vertical markets including, healthcare, finance, government, etc., to help us rapidly expand our enterprise customer base. A number of International Association of Certified ISAO (IACI) including ISAO’s for Maritime & Ports ISAO, Credit Union ISAO, City of Chicago ISAO, Human Trafficking ISAO, have chosen to deploy our software as private and secure e-technology to protect their communications. Several other ISAOs are completing their evaluations before deploying our products within their networks.

We have executed a number of patent and technology licenses and intend to seek further licensees for our technology, including our GABRIEL Connection Technology™ to original equipment manufacturers, or OEMs, of chips, servers, smart phones, tablets, e-Readers, laptops, net books and other devices, within the IP-telephony, mobility, fixed-mobile convergence and unified communications markets including 5G and 4G/LTE Advanced.

We have submitted a declaration with the 3rd Generation Partnership Project, or 3GPP, identifying a group of our patents and patent applications that we believe are or may become essential to certain developing specifications in the 3GPP LTE, Systems Architecture Evolution, or SAE project. We have agreed to make available a non-exclusive patent license under fair, reasonable and non-discriminatory terms and conditions, with compensation, or FRAND, to 3GPP members desiring to implement the technical specifications identified by us. We believe that we are positioned to license our essential security patents to 3GPP members as they move into deploying 5G and 4G/LTE Advanced devices and solutions.

We have an ongoing GABRIEL 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 (SDK) to assist with rapid integration of these techniques into existing software implementations with minimal code changes and include object libraries, sample code, testing and quality assurance tools and the supporting documentation necessary for a customer to implement our technology. 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 have signed Patent License Agreements with Avaya Inc., Aastra USA, Inc., Microsoft Corporation, Mitel Networks Corporation, NEC Corporation and NEC Corporation of America, Siemens Enterprise Communications GmbH & Co. KG, and Siemens Enterprise Communications Inc. to license certain of our patents, for a one-time payment and/or an ongoing royalty for all future sales through the expiration of the licensed patents with respect to certain current and future IP-encrypted products.

We believe that the market opportunity for our software and technology solutions is large and expanding as secure domain names are now an integral part of securing the next generation 5G and 4G/LTE Advanced wireless networks and M2M communications in areas including Smart City, Connected Car and Connected Home. We also believe that all 5G and 4G/LTE Advanced mobile devices will require unique secure domain names and become part of a secure domain name registry.

We intend to continue to license 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. We intend to seek further license of our technology, including our GABRIEL Connection Technology™ to enterprise customers, developers and original equipment manufacturers, or OEMs, of chips, servers, smart phones, tablets, e-Readers, laptops, net books and other devices, within the IP-telephony, mobility, fixed-mobile convergence and unified communications markets including 5G and 4G/LTE.

Our employees include the core development team behind our patent portfolio, technology and software. This team has worked together for over ten years and is the same team that invented and developed this technology while working at Leidos, Inc. (“Leidos”). Leidos is a FORTUNE 500® scientific, engineering and technology applications company that uses its deep domain knowledge to solve problems of vital importance to the nation and the world, in national security, energy and the environment, critical infrastructure and health. The team has continued its research and development work started at Leidos and expanded the set of patents we acquired in 2006 from Leidos, into a larger portfolio of approximately 194 U.S. and foreign patents, patent validations and pending applications. This portfolio now serves as the foundation of our licensing business and planned service offerings and is expected to generate the majority of our future revenue in license fees and royalties. We intend to continue our research and development efforts to 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. We also intend to expand our design pilot in participation with leading 5G and 4G/LTE companies (domain infrastructure providers, chipset manufacturers, service providers and others) and build our secure domain name registry.

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 are currently evaluating the impact, if any this ASU will have on our consolidated financial statements and related disclosures.

In June 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-13, Measurement of Credit Losses on Financial Instruments, and issued subsequent amendments to the initial guidance within ASU 2019-04 and ASU 2019-05 (collectively, "ASU 2016-13"). The amendments in ASU 2016-13 replace the incurred loss impairment methodology with the current expected credit loss model, which requires consideration of a broader range of reasonable and supportable information to estimate credit losses. The Company adopted this ASU effective January 1, 2020 and the adoption did not have a material impact. on the Company's financial position, results of operations or cash flows.

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Results of Operations

Three and Nine Months Ended September 30, 2020
Compared with Three and Nine Months Ended September 30, 2019
(in thousands, except per share amounts)

Revenue

For the three and nine months ended September 30, 2020 we recognized revenue of $26 and $302,620, respectively compared to the three and nine months ended September 30, 2019 of $4 and $50, respectively.  During the nine months ended September 30, 2020, the Company collected a lump sum payment of $454,034 from Apple, Inc. (see “Legal Proceedings”), as a result of a favorable court decision relating to a patent infringement case. The one-time payment includes past royalties, damages for willful infringement, interest, court costs and attorneys’ fees. The elements of the payment were recognized in the Company’s condensed consolidated statement of operations as follow (see Note 2 in the Condensed Consolidated Financial Statements):

Classification of Payment Received in the Company’s Condensed Consolidated Statement of Operations for the Nine Months Ended September 30, 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 for the nine months ended September 30, 2020, is $90,101 in licensing costs we have incurred in conjunction with the proceeds received from Apple, Inc., pursuant to a favorable court decision relating to a patent infringement case.

Research and Development Expenses

Research and development expenses were $1,091 and $964 for the three months ended September 30, 2020 and 2019, respectively, representing an increase of $127 due primarily to an increase in staff expense. Research and development expenses were $6,799 and $2,886 for the nine months ended September 30, 2020 and 2019, respectively, representing an increase of $3,913 due primarily to an increase in staff expense.

Selling, General and Administrative Expenses

Selling, general and administrative expenses includes wages and benefits of management and administrative personnel, as well as outside legal, accounting, and consulting services.

Our selling, general and administrative expenses for the three months ended September 30, 2020 compared to September 30, 2019 increased by $254 to $4,270. The change is primarily due to an increase in staff expenses. For the nine months ended September 30, 2020 our selling, general and administrative expenses increased by $26,021 to $38,347 compared to the nine months ended September 30, 2019. The change was primarily due to a $22,445 increase in legal fees associated with our patent infringement actions, after reflecting reimbursement of $2,114, pursuant to a judgment collected from Apple.  We expect to incur the same levels or decreased levels of legal fees over the next two quarters and expect to report losses from operations as a result. (See “Legal Proceedings” for additional information regarding these infringement actions.)

Other Income and Expenses

For the nine months ended September 30, 2020, we recognized a gain of $41,271 and interest and other income of $108,272 which included interest received of $108,221 pursuant to a judgment collected from Apple.

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Income Taxes

For the three months ended September 30, 2020, we recognized an income tax benefit of $1,293 on loss before income taxes of $5,318, which is an effective tax rate of a 24.3%. For the nine months ended September 30, 2020, we recognized income tax expense of $29,036 on income before income taxes of $316,916 which is an effective tax rate of 9.2%. For the three and nine months ended September 30, 2019, we had an income tax benefit of zero and $393, respectively, due to a release of a state reserve as the statute of limitation for the tax return expired. The effective tax rate for the 2020 nine-month period was favorably impacted by the reversal of valuation allowance reserves totaling $37,585, which were established in prior years on our deferred tax assets primarily associated with net operating loss (“NOL”) carryforwards. For the three and nine months ended September 30, 2019, we had NOLs which generated deferred tax assets for NOL carryforwards. During 2019, we provided valuation allowances against the net deferred tax assets including the deferred tax assets for NOL carryforwards. At September 30, 2020, we had deferred tax assets of $8,754. (see Note 3 in the Condensed Consolidated Financial Statements for a further discussion of income taxes)

Net Income (Loss)

Net (loss) income for the three and nine months ended September 30, 2020 was ($4,025) and $287,880, respectively. Net losses for the three and nine months ended September 30, 2019 were ($4,956) and ($14,694), respectively. The change is primarily due to the judgment collected from Apple associated with our patent infringement action.

Liquidity and Capital Resources

As of September 30, 2020, our cash and cash equivalents totaled approximately $225,911 and our short-term investments totaled approximately $22,077, compared to cash and cash equivalents of approximately $3,135 and short-term investments of approximately $2,394 at December 31, 2019, respectively. Working capital was $220,603 at September 30, 2020, and $3,945 at December 31, 2019. The increase in cash and investments during the nine months September 30, 2020, will be sufficient to fund our current level of selling, general and administration costs, 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 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.

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Universal Shelf Registration Statement and ATM Offering

On July 30, 2018 we filed a $100,000 universal shelf registration statement on SEC Form S-3 which was declared effective by the SEC on August 16, 2018. We also entered an at-the-market equity offering sales agreement (“ATM”) with Cowen & Company, LLC on August 31, 2018, under which we can offer and sell shares of our common stock having an aggregate value of up to $50,000.

We use the ATM proceeds for GABRIEL product development, marketing and general corporate purposes, which may include working capital, capital expenditures, other corporate expenses and acquisitions of complementary products, technologies or businesses. As of September 30, 2020, common stock with an aggregate value of up to $21,964 remained available for offer and sale under the ATM agreement.

During the nine months ended September 30, 2020, we sold 1,049,382 shares under the ATM. The average sales price per common share 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 totaled $139.  No sales were made under the ATM during the three months ended September 30, 2020.

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, 2019.

Off-Balance Sheet Arrangements

None.

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ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Interest Rate Risk

We invest our excess cash primarily in highly liquid instruments including money market, mutual funds and U.S. government and U.S. agency securities. We seek to limit the amount of our credit exposure to any one issuer.

Investments in fixed rate instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates. Due in part to these factors, our income from investments may decrease in the future.

We considered the historical volatility of short-term interest rates and determined that it was reasonably possible that an adverse change of 100 basis points could be experienced in the near term but would have an immaterial impact in the fair value of our marketable securities, which generally mature within one year of September 30, 2020.

Other Market Risks

We considered the historical volatility of our stock prices and determined that it was reasonably possible that the fair market value of our stock price could increase or decrease substantially in the near term and could have a material impact to our condensed consolidated balance sheets and statement of operations.

ITEM 4 — CONTROLS AND PROCEDURES

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of September 30, 2020.

The purpose of this evaluation was to determine whether as of September 30, 2020 our disclosure controls and procedures were effective to provide reasonable assurance that the information we are required to disclose in our filings with the SEC, (i) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of September 30, 2020, our disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended September 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

ITEM 1 — LEGAL PROCEEDINGS

We have several intellectual property infringement lawsuits pending in the United States District Court for the Eastern District of Texas, Tyler Division (“USDC”), and United States Court of Appeals for the Federal Circuit (“USCAFC”) and the Supreme Court of the United States (“SCOTUS”).

VirnetX Inc. v. Cisco Systems, Inc. et al. (Case 6:10-CV-00417-LED) (“Apple I”)

On August 11, 2010, we filed a complaint against Aastra USA. Inc. (“Aastra”), Apple Inc. (“Apple”), Cisco Systems, Inc. (“Cisco”), and NEC Corporation (“NEC”) the USDC in which we alleged that these parties infringe 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 cases against each defendant were separated by the judge. Aastra and NEC agreed to sign license agreements with us, and we dropped all accusations of infringement against them. A jury in USDC decided that our patents were not invalid and rendered a verdict of non-infringement by Cisco on March 4, 2013. Our motion for a new Cisco trial was denied and the case against Cisco was closed.

On November 6, 2012, a jury in the USDC awarded us over $368,000 for Apple’s infringement of four of our patents, plus daily interest up to the final judgment.

Apple filed an appeal of the judgment to the USCAFC. On September 16, 2014, USCAFC affirmed the USDC jury’s finding that all four of our patents at issue are valid and confirmed the USDC jury’s finding of infringement of VPN on Demand under many of the asserted claims of our ‘135 and ‘151 patents, and the USDC’s decision to allow evidence about our license and royalty rates regarding the determination of damages. However, the USCAFC vacated the USDC jury’s damages award and some of the USDC’s claim construction with respect to parts of our ‘504 and ‘211 patents and remanded the damages award and determination of infringement with respect to FaceTime back to the USDC for further proceedings.

On September 30, 2016, pursuant to the 2014 remand from the USCAFC, a jury in the USDC awarded us $302,400 for Apple’s infringement of four of our patents. On September 29, 2017, the USDC entered its final judgment, denied all of Apple’s post-trial motions, granted all our post-trial motions, including our motion for willful infringement and enhanced the royalty rate during the willfulness period from $1.20 to $1.80 per device, and awarded us costs, certain attorneys’ fees, and prejudgment interest. The total amount in the final judgment was $439,700, including $302,400 (jury verdict), $41,300 (enhanced damages) and $96,000 (costs, fees and interest).

On October 27, 2017 Apple appealed the final judgment entered on September 29, 2017 to the USCAFC. Oral arguments in this case were held on January 8, 2019. On January 15, 2019 the Court issued a Rule 36 order affirming the district court’s final judgment. Apple filed a petition for panel rehearing and rehearing en-banc in this matter on February 21, 2019. On October 1, 2019, USCAFC issued an order denying Apple’s petition. Apple filed a petition for a writ of certiorari with the SCOTUS, which was denied on February 24, 2020. Prior to the SCOTUS decision denying Apple’s petition for a writ of certiorari, on February 20, 2020, Apple filed a Rule 60(b) motion for relief from judgment with the USDC, seeking relief from the district court’s September 29, 2017 final judgment. VirnetX filed a responsive brief in opposition on March 5, 2020.

On March 13, 2020, the Company received payment of $454,034 from Apple, representing the previously announced final judgment with interest in this case. Apple has indicated that it will seek restitution of the payment if relief sought in its Rule 60(b) motion is awarded. On April 16, 2020, the USDC ordered Apple to file a supplemental brief with respect to its Rule 60(b) motion within 7 days. On September 1, 2020 USDC issued an order denying Apple’s motion for relief of judgement. This case is now closed.

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 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; these products were not included in the Apple I case because they were released after the Apple I case was initiated. 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.

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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 federal jury in the U.S. District Court for the Eastern District of Texas issued 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. We are currently awaiting court order scheduling the hearing for the judgement as a matter of law (JMOL) motions filed by both parties.

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 (USAFC Case 20-2272)

On September 15, 2020, we filed with the USCAFC an appeal of the invalidity findings by the 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. Our initial briefs are due by December 21, 2020.

Iancu v. Luoma (SCOTUS Case 20-74)

On July 23, 2020, the United States and the USPTO (collectively, “the United States”) filed a petition for a writ of certiorari from several decisions by the USAFC, including decisions in VirnetX Inc. v. Cisco Systems, Inc., Nos. 2019-1671, and VirnetX Inc. v. Iancu, Nos. 2017-2593, -2594.  In those cases, the USAFC granted VirnetX’s motions to vacate the underlying decisions of the PTAB on the basis of Arthrex, Inc. v. Smith & Nephew, Inc., 941 F.3d 1320 (Fed. Cir. 2019), and remanded for further proceedings.  The United States requested that the SCOTUS hold its certiorari petition pending the disposition of the United States’ separate petition in United States v. Arthrex, Inc., No. 19-1434 (filed June 25, 2020).  On August 26, 2020, VirnetX filed a response, agreeing that the United States’ certiorari petition should be held pending the disposition of the petition for a writ of certiorari in No. 19-1434 (and related petitions filed by private parties in Nos. 19-1452 and 19-1458), and any further SCOTUS proceedings.

On October 13, 2020, SCOTUS granted the United States’ petition for a writ of certiorari in No. 19-1434 as to USAFC Case No. 2018-2140, and the petitions for writs of certiorari in Nos. 19-1452 and 19-1458, all limited to Questions 1 and 2 as set forth in the July 22, 2020 Memorandum for the United States filed in No. 19-1434. The consolidated petition is seeking review of decisions by the USCAFC holding that administrative patent judges (APJ) of the Patent Trial and Appeal Board of the U.S. Patent and Trademark Office must be appointed by the president and confirmed by the Senate; and, whether the remedy imposed by USCAFC that federal laws that place restrictions on when officials can be removed from office cannot apply to APJ, was the appropriate one.

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 claims that a retention agreement it entered into in 2010 with VirnetX entitles it to a contingency fee arising from the recent 2020 payment made by Apple. McKool claims it is owed $36,200 (or 8% of the payment). We have filed a general response with AAA denying McKool’s claim and intend to vigorously contest the matter.

Neal Hurwitz v. Kendall Larsen et al. (Case 2020-0425-JRS)

On June 2, 2020, stockholder Neal Hurwitz filed a verified derivative complaint in the Delaware Court of Chancery against Kendall Larsen, Robert D. Short Ill, Gary Feiner, Michael F. Angelo, and Thomas M. O'Brien and naming the Company as nominal defendant. The lawsuit alleges breaches of fiduciary duty, corporate waste, and unjust enrichment arising out of a series of previously-disclosed transactions and compensation awards and seeks an award of monetary damages and equitable relief. On July 1, 2020, the defendants filed a motion to dismiss the complaint based on a failure to plead demand futility and a failure to state a claim on which relief can be granted and, on August 19, 2020, the defendants filed an opening brief in support of their motion to dismiss. On October 16, 2020, plaintiff amended his complaint rather than respond to the arguments in the defendants' opening brief. On October 23, 2020, the defendants filed a renewed motion to dismiss plaintiff's amended complaint based on a failure to plead demand futility and a failure to state a claim on which relief can be granted.

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.

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ITEM 1A — RISK FACTORS

Our operations and financial results are subject to various risks and uncertainties, including those described below, which could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common and capital stock. You should carefully consider the risks and uncertainties described below in addition to the other information set forth in this Quarterly Report on Form 10-Q, including the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes, before making any investment in our common stock. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also adversely affect our business. If any of these risk factors occur, you could lose substantial value or your entire investment in our shares.

Risks Related to Our Business and Our Financial Reporting

We are involved and will continue to be involved in litigation defending our patent portfolio, which can be time-consuming and costly, and we cannot anticipate the results.

We spend a significant amount of our financial and management resources to pursue our current litigation. We believe that this litigation and others that we may pursue in the future could continue for years and consume significant financial and management resources. The counterparties to our litigation include large, well-financed companies with substantially greater resources than us. Patent litigation is risky, and the outcome is uncertain, and we cannot assure you that any of our current or future litigation matters will result in a favorable outcome for us. In addition, even if we obtain favorable interim rulings or verdicts, they may be inconsistent with the ultimate resolution of the dispute. Also, we cannot assure you that we will not be exposed to claims or sanctions against us which may be costly or impossible for us to defend. Unfavorable or adverse outcomes may result in losses, exhaustion of financial resources or other adverse effects, which could encumber our ability to develop and commercialize our products.

We may not be able to capitalize on market opportunities related to our licensing strategy or our patent portfolio.

Our business strategy includes licensing our patents and technology to other companies in order to reach a larger end-user base than we could reach through direct sales and marketing efforts; as such, our business strategy and revenues will depend on intellectual property licensing fees and royalties for the majority of our revenues. We currently derive minimal revenue from licensing activities, and royalties, and we cannot assure you that we will successfully capitalize on our market opportunities or that our current business strategy will succeed. Factors that may affect our ability to execute our current business strategy include, but are not limited to, the following:

Although to date we have entered into a limited number of settlement and license agreements, we may not be successful in entering into further licensing relationships, or if we are successful in entering into such relationships, the acquisition of them may be expensive, and they, as well as our existing settlement and our existing and pending license agreements may not generate the financial results we expect;

Third parties may challenge the validity of our patents;

The pendency of our various litigations may cause potential licensees not to do business with us;

We face, and we expect to continue to face, intense competition from new and established competitors who may have superior products and services or better marketing, financial or other capacities than we do; and

It is possible that one or more of our potential customers or licensees develops or otherwise sources products or technologies similar to, competitive with or superior to ours.

If we are not able to adequately protect our patent rights, our business would be negatively impacted.

We believe our patents are valid, enforceable and valuable. Notwithstanding this belief, third parties may make claims of infringement or invalidity claims with respect to our patents and such claims could give rise to material cost for defense or settlement or both, jeopardize or substantially delay a successful outcome of litigation we are or may become involved in, divert resources away from our o