The Company
We are an Internet security software and technology company with patented
technology for various types of secure network communications, including 5G and
4G LTE network security. Our patented Secure Domain Names and GABRIEL Connection
Technology™, are the foundation for our new VirnetX One platform that protects
communications using Zero Trust Network Access ("ZTNA"). 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 205 total patents and pending
applications, including 72 U.S. patents/patent applications and 133 foreign
patents/validations/pending applications. Our patent portfolio is primarily
focused on securing real-time communications over the Internet, and related
services, and is used in all our technology and products, some of which were
acquired by our principal operating subsidiary? VirnetX, Inc. , from Leidos,
Inc., or Leidos, (f/k/a Science Applications International Corporation, or SAIC)
in 2006.
Our product portfolio includes sophisticated technologies, products and services
that are available for sale worldwide. On March 1, 2022 , we launched War Room™
software, the first product on our next-generation, VirnetX One platform. This
new platform builds upon our patented Secure Domain Names and GABRIEL Connection
Technology™ to further enhance the security and efficiency of our patented
secure communication links. Our VirnetX One platform is a security-as-a-service
platform that protects enterprise applications, services, and infrastructure
from cyber-attacks.
Our new War Room™ software product provides an industry leading, safe, and
secure video conferencing meeting environment where sensitive communications and
data is invisible to those not authorized to view it. War Room™ validates
permissions of all the users, and devices requesting access to any secure
meeting room prior to granting access. We believe our War Room™ will be an
attractive solution for government agencies as well as all professional sectors
such as legal, financial, and medical where limiting access to confidential data
is a critical requirement.
Our GABRIEL Collaboration Suite™ is a set of communication applications and
tools that use our GABRIEL Secure Communication Platform™. It enables seamless
and secure cross platform communications between devices that are enrolled in
our "VIRNETX SECURED" network and have our software installed. Our GABRIEL
Collaboration Suite™ is available for download and free trial, for Android, iOS,
Windows, Linux, and Mac OS X platforms, at https://virnetx.com.
We have an ongoing licensing program under which we offer licenses to a portion
of our patent portfolio, technology, and software, including our secure domain
name registry service, to domain infrastructure providers, communication service
providers as well as to system integrators. Our GABRIEL Connection Technology™
License is offered to original equipment manufacturer ("OEM") customers who want
to adopt the GABRIEL Connection Technology™ as their solution for establishing
secure connections using secure domain names within their products. We have
developed GABRIEL Connection Technology™ Software Development Kit ("SDK") to
assist with rapid integration of these techniques into existing software
implementations. Customers who want to develop their own implementation of the
VirnetX patented techniques for supporting secure domain names, or other
techniques that are covered by our patent portfolio for establishing secure
communication links, can purchase a patent license. The number of patents
licensed, and therefore the cost of the patent license to the customer, will
depend upon which of the patents are used in a particular product or service.
These licenses will typically include an initial license fee, as well as an
ongoing royalty.
We expect to continue to launch new and enhanced security platforms, software
products, and services based on our GABRIEL Connection Technology™. We will
provide updates to new and existing customers as they are released to the
public. Many small and medium businesses have installed our software products in
their corporate networks. We intend to continue to expand our customer base with
targeted promotions and direct sales initiatives.
Our employees include the core development team behind our patent portfolio,
technology, and software. Some members of this team have worked together for
over twenty years and were on same team that invented and developed this
technology while working at Leidos. The team has continued its research and
development work and expanded the set of patents we acquired in 2006 from
Leidos, into a larger patent portfolio. This portfolio now serves as the
foundation of our products, services, and our licensing business. It is expected
to generate most of our future revenue in license fees and royalties. We intend
to continue our efforts to develop new products and technologies and further
strengthen and expand our patent portfolio. We intend to continue using an
outsourced and leveraged model to maintain efficiency and manage costs as we
grow our licensing business by, for example, offering incentives to early
licensing targets or asserting our rights for use of our patents.
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Litigation
We are subject to various legal proceedings, the outcomes of which are inherently uncertain. We record any potential gains related to legal proceedings only after cash is collected. We record a liability when it is probable that a loss has been incurred and the amount is reasonably estimable, the determination of which requires significant judgment. Resolution of legal matters in a manner inconsistent with management's expectations could have a material impact on our financial condition and operating results. See Note 12 in the notes to our consolidated financial statements for more information.
Commitments and Related Party Transactions
We lease our offices under an operating lease with a third party expiring inOctober 2023 . We recognize rent expense on a straight-line basis over the term of the lease. We entered into a service agreement for the use of an aircraft fromK2 Investment Fund LLC ("LLC") for business travel for our employees. We incurred approximately$791 ,$324 , and$1,790 in rental fees and reimbursements to the LLC in 2021, 2020 and 2019, respectively. We pay for the Company's business usage of the aircraft and have no right 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 normal in such transactions 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.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity withU.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. The critical accounting policies we employ in the preparation of our consolidated financial statements are those which involve income taxes, fair value of financial instruments and stock-based compensation.
Use of Estimates
We prepare our consolidated financial statements in accordance withU.S. GAAP. In doing so, we have to make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues, and expenses, as well as related disclosure of contingent assets and liabilities. In some cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss further below. We have reviewed our critical accounting policies and estimates with the Audit Committee of our Board of Directors.
Income Taxes
We account for income taxes using the asset and liability method. The asset and liability method require the recognition of deferred tax assets and liabilities for expected future tax consequences of temporary differences that currently exist between the tax basis and financial reporting basis of our assets and liabilities. We calculate current and deferred tax provisions based on estimates and assumptions that could differ from actual results reflected on the income tax returns filed during the following years. Adjustments based on filed returns are recorded when identified in the subsequent years. The effect on deferred taxes for a change in tax rates is recognized in income in the period that the tax rate change is enacted. In assessing our deferred tax assets, we consider whether it is more likely than not that all or some portion of the deferred tax assets will not be realized. A valuation allowance is provided for deferred income tax assets when, in our judgment, based upon currently available information and other factors, it is more likely than not that all or a portion of such deferred income tax assets will not be realized. The determination of the need for a valuation allowance is based on an on-going evaluation of current information including, among other things, historical operating results, estimates of future earnings in different taxing jurisdictions and the expected timing of the reversals of temporary differences. We believe the determination to record a valuation allowance to reduce a deferred income tax asset is a significant accounting estimate because it is based, among other things, on an estimate of future taxable income inthe United States and certain other jurisdictions, which is susceptible to change and may or may not occur, and because the impact of adjusting a valuation allowance may be material. In determining when to release the valuation allowance established against our net deferred income tax assets, we consider all available evidence, both positive and negative. We continually assess our ability to generate sufficient taxable income during future periods in which our deferred tax assets may be realized. If and when we believe it is more likely than not that we will recover our deferred tax assets, we will reverse the valuation allowance if any, as an income tax benefit in our statements of operations. 25
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We account for our uncertain tax positions in accordance withU.S. GAAP. TheU.S. GAAP method of accounting for uncertain tax positions utilizes a two-step approach to evaluate tax positions. Step one, recognition, requires evaluation of the tax position to determine if based solely on technical merits it is more likely than not to be sustained upon examination. Step two, measurement, is addressed only if a position is more likely than not to be sustained. In step two, the tax benefit is measured as the largest amount of benefit, determined on a cumulative probability basis, which is more likely than not to be realized upon ultimate settlement with tax authorities. If a position does not meet the more likely than not threshold for recognition in step one, no benefit is recorded until the first subsequent period in which the more likely than not standard is met, the issue is resolved with the taxing authority, or the statute of limitations expires. Positions previously recognized are derecognized when we subsequently determine the position no longer is more likely than not to be sustained. Evaluation of tax positions, their technical merits, and measurements using cumulative probability are highly subjective management estimates. Actual results could differ materially from these estimates.
Fair Value
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.
Stock-based Compensation
We account for stock-based compensation using the fair value recognition method in accordance withU.S. GAAP. We recognize these compensation costs on a straight-line basis over the requisite service period of the award, which is generally a vesting term of 4 years. We recognize forfeitures, if any, when they occur. In addition, we record stock-based compensation expense for awards granted to non-employees at fair value of the consideration received or the fair value of the equity instruments issued, as they vest, over the performance period. See Note 6 in the notes to our consolidated financial statements for more information. Results of Operations (all amounts in this section are expressed in thousands) Revenue 2021 2020 2019 Revenue$ 35 $ 302,636 $ 85 Revenue generated in 2021 was$35 , compared to$302,636 in 2020 and$85 in 2019. In 2020, we collected a lump sum payment of$454,034 from Apple, Inc., as a result of a favorable court decision relating to a patent infringement case. The one-time payment included past royalties, damages for willful infringement, interest, court costs and attorneys' fees. See Note 2 in the notes to our consolidated financial statements for more information. We recognized royalty revenue as part of license agreements entered into with customers during the patent infringement actions (see "Litigation"). These revenues relate to payment for use of our patented technology prior to the signing of a license agreement, and royalty payments after the execution of the license agreements. Licensing Costs 2021 2020 2019 Licensing costs$ (9,083 ) $ 90,101 $ - Included in operating expenses for 2020 was$90,101 in licensing costs we incurred in conjunction with the proceeds received in the case regarding Apple, Inc. discussed above. Accrued licensing costs of$9,083 were reversed in the year endedDecember 31, 2021 , as a result of litigation. See Note 12 in the notes to our consolidated financial statements for more information. 26
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Research and Development Expenses
2021 2020 2019
Research and Development $ 5,557 $ 8,830 $ 3,845
Research and development costs include expenses paid to outside development
consultants and compensation-related expenses for our engineering staff.
Research and development costs are expensed as incurred.
Our research and development expenses in 2021 were$5,557 compared to$8,830 in 2020 and$3,845 in 2019. The fluctuation in 2021 compared to 2020 and 2019 was primarily due to changes in engineering staff compensation costs.
Selling, General and Administrative Expenses
2021 2020 2019
Selling, General and Administrative
Selling, general and administrative expenses include compensation costs for
management and administrative personnel, as well as expenses for outside legal,
accounting, and consulting services.
Our selling, general and administrative expenses in 2021 were$52,715 compared to$45,812 in 2020 and$15,905 in 2019. The volatility within selling, general and administrative expenses was primarily due to legal fees related to cases involving the defense of our patents. Legal fees were$41,828 ,$30,699 , and$5,898 in 2021, 2020 and 2019, respectively and represented approximately 80% of selling, general and administrative expenses for 2021 compared to 67% for 2020 and 37% for 2019. Gain on Settlement In 2020, we recorded a gain of$41,271 pursuant to a favorable court ruling in the case regarding Apple, Inc. discussed above. See Note 2 in the notes to our consolidated financial statements for more information.
Interest and Other Income, net
2021 2020 2019
Interest and Other Income
Interest and other income in 2021 was$48 compared to$108,288 in 2020 and$92 in 2019. During 2020 we received interest of$108,221 pursuant to a favorable court ruling in the case with Apple, Inc. discussed above. See Note 2 in the notes to our consolidated financial statements for more information.
Effective Income Tax Rate
A reconciliation of
effective income tax rate is as follows:
Year Ended Year Ended Year Ended
December 31, 2021 December 31, 2020 December 31, 2019
United States federal statutory rate 21.00 % 21.00 % 21.00 %
State taxes, net of federal benefit (0.19 )% 0.17 % 1.99 %
Valuation allowance - (12.22 )% (21.96 )%
Stock based compensation (0.02 )% (0.01 )% -
R&D Credit 0.19 % (0.21 )% 1.34 %
Other (1.57 )% 0.06 % (0.38 )%
Effective income tax rate 19.41 % 8.79 % 1.99 %
The Company’s effective tax rate for both 2020 and 2019 was substantially lower
than the statutory Federal income tax rate primarily due to the change in
valuation allowance.
Liquidity and Capital Resources
As of
short-term investments totaled
respectively, as of
We expect that our cash and cash equivalents and short-term investments as ofDecember 31, 2021 , 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 and product sales inthe United States and other markets around the world.
Universal Shelf Registration and ATM Offering
OnJuly 30, 2018 we filed a$100,000 universal shelf registration statement on Form S-3 which was declared effective by theSEC onAugust 16, 2018 . We also entered an at-the-market equity offering sales agreement ("ATM") withCowen & Company, LLC onAugust 31, 2018 , under which we were able to sell shares of our common stock having an aggregate value of up to$50,000 . 27
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We used the ATM proceeds for development, marketing of our software products and services, and general corporate purposes, such as working capital, capital expenditures, other corporate expenses and potential acquisitions of complementary products, technologies, or businesses. As ofAugust 16, 2021 , the universal shelf registration had expired. We sold zero shares of common stock under the ATM program during 2021. In 2020, we sold 1,049,382 shares of common stock under the ATM program. The average sales price per common share sold during 2020 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 transactions totaled$139 for 2020. In 2019, we sold 1,860,483 shares under the ATM. The average sales price per common share during 2019 was$5.84 , and the aggregate proceeds from the sales totaled$10,866 during the period. Sales commissions, fees and other costs associated with the ATM totaled$327 for 2019.
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