XASE:VHC VirnetX Holding Corp Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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

 
FORM 10-Q
 
(Mark One)
 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2012
 
or
 
 
o
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 Number)
 
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:
 
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 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 x No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
 
 
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
 
The number of shares outstanding of the Registrant’s Common Stock as of May 4, 2012, was 50,862,872.
 


 
 

 

WARNING CONCERNING FORWARD LOOKING STATEMENTS
 
 
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS STATEMENTS THAT CONSTITUTE FORWARD LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 AND OTHER FEDERAL SECURITIES LAWS. ALSO, WHENEVER WE USE WORDS SUCH AS "BELIEVE", "EXPECT", "ANTICIPATE", "INTEND", "PLAN", "ESTIMATE" OR SIMILAR EXPRESSIONS, WE ARE MAKING FORWARD LOOKING STATEMENTS. THESE FORWARD LOOKING STATEMENTS ARE BASED UPON OUR PRESENT INTENT, BELIEFS OR EXPECTATIONS, BUT FORWARD LOOKING STATEMENTS ARE NOT GUARANTEED TO OCCUR AND MAY NOT OCCUR. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTAINED IN OR IMPLIED BY OUR FORWARD LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS. AMONG OTHERS, THE FORWARD LOOKING STATEMENTS WHICH APPEAR IN THIS REPORT THAT MAY NOT OCCUR INCLUDE:
 
 
THE DESCIPTION OF OUR BUSINESS INCLUDES A STATEMENT THAT WE INTEND TO MARKET OUR GABRIEL CONNECTION TECHNOLOGY™. AN IMPLICATION OF THIS STATEMENT MAY BE THAT WE WILL BE ABLE TO SUCCESSFULLY MARKET THIS TECHNOLOGY AND THAT IT WILL GENERATE REVENUE IN THE FUTURE. IN FACT, THERE ARE MANY FACTORS WHICH WILL IMPACT THE SUCCESS OF THIS TECHNOLOGY FOR US, INCLUDING SEVERAL FACTORS WHICH ARE BEYOND OUR CONTROL, SUCH AS THE DEMAND FOR THIS TECHNOLOGY BY POTENTIAL CUSTOMERS AND THE LEVEL OF COMPETITION IN OUR BUSINESS.

 
THE DESCRIPTION OF OUR BUSINESS INCLUDES STATEMENTS RELATING TO OUR INTENT TO ESTABLISH A SECURE DOMAIN NAME REGISTRY IN THE U.S. AND OTHER PARTS OF THE WORLD AND THAT WE ARE CONSIDERING MAKING APPLICATIONS TO BECOME ACCREDITED TO DO SO UNDER AUTHORITY OF THE U.S. GOVERNMENT.  THE IMPLICATION OF THOSE STATEMENTS MAY BE THAT WE WILL BE ABLE TO ESTABLISH A REGISTRY THAT WILL HAVE MARKET ACCEPTANCE AND THAT IT WILL GENERATE REVENUE FOR US IN THE FUTURE.  THERE ARE MANY FACTORS WHICH WILL IMPACT OUR ABILITY TO SUCCESSFULLY ESTABLISH A DOMAIN NAME REGISTRY, INCLUDING SEVERAL FACTORS WHICH ARE BEYOND OUR CONTROL, SUCH AS THE ACCREDITATION APPLICATION PROCESS OR THE ACCEPTANCE OF OUR REGISTRY OVER OTHERS, PARTICULARLY IF WE DETERMINE TO ESTABLISH A REGISTRY WITHOUT ACCREDITATION.

 
THE STATEMENTS THAT WE HAVE SUBMITTED A LICENSING DECLARATION TO THE 3RD GENERATION PARTNERSHIP, OR 3GPP, UPDATED SUCH DECLARATIONS AT THE REQUEST OF THE EUROPEAN TELECOMMUNICATIONS STANDARDS INSTITUTE, OR ETSI,  AND THE ALLIANCE FOR TELECOMMUNICATIONS INDUSTRY SOLUTIONS, OR ATIS, AND THAT WE BELIEVE WE  ARE POSITIONED TO LICENSE OUR PATENTS TO 3GPP MEMBERS DESIRING TO IMPLEMENT THE TECHNICAL SPECIFICATIONS IDENTIFIED BY US, MAY IMPLY THAT THE PATENTS WE HAVE IDENTIFIED TO 3GPP WILL GENERATE LICENSING REVENUE FOR US IN THE FUTURE. WE CANNOT ASSURE YOU THAT WE WILL BE SUCCESSFUL IN LICENSING OUR PATENTS OR THAT THIRD PARTIES WILL BE WILLING TO ENTER INTO LICENSES WITH US ON REASONABLE TERMS OR AT ALL.

 
OUR STATEMENT THAT WE BELIEVE WE HAVE THE FINANCIAL AND OTHER RESOURCES TO COMPLETE OUR BUSINESS PLAN MAY IMPLY THAT OUR RESOURCES WILL BE SUFFICIENT TO COMPLETE THAT PLAN SUCCESSFULLY.  HOWEVER, WE MAY NOT BE ABLE TO SUCCESSFULLY IMPLEMENT OUR BUSINESS PLAN FOR MANY REASONS, INCLUDING MANY REASONS THAT ARE BEYOND OUR CONTROL, SUCH AS THE POSSIBILITY THAT OUR FINANCIAL RESOURCES BECOME EXHAUSTED DUE TO INCREASED COSTS ASSOCIATED WITH OUR ATTEMPTS TO COMPETE WITH OTHERS WHO MAY HAVE GREATER RESOURCES, OR DUE TO OUR OTHER ACTIVITIES, INCLUDING OUR LITIGATION ACTIVITIES.

 
STATEMENTS DESCRIBING OUR LITIGATION EFFORTS MAY IMPLY THAT WE WILL PREVAIL IN SOME OR ALL OF OUR  PENDING LITIGATION. HOWEVER, WE CANNOT ASSURE YOU WE WILL PREVAIL IN OUR PENDING LITIGATION MATTERS AND ANY ADVERSE RULING MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS. ALSO, THE LEGAL AND OTHER COSTS WE MAY INCUR IN CONNECTION WITH LITIGATION MATTERS WILL DEPEND, IN PART, UPON ACTIONS TAKEN BY OTHER PARTIES, WHICH ACTIONS ARE NOT WITHIN OUR CONTROL AND THESE COSTS MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.

 
OUR REFERENCES TO THE FACTS THAT OUR CORE DEVELOPMENT TEAM HAS SPENT OVER TEN YEARS WORKING TOGETHER, AND HAS HAD PRIOR SUCCESS AT SAIC MAY IMPLY THAT OUR TEAM WILL BE SUCCESSFUL IN THE FUTURE.  HOWEVER, THIS TEAM MAY NOT BE SUCCESSFUL FOR MANY REASONS, INCLUDING MANY REASONS THAT ARE BEYOND OUR CONTROL, SUCH AS THE POSSIBILITY THAT ONE OR MORE KEY MEMBERS OF THE TEAM BECOMES INCAPACITATED, OR THAT COMPETITORS ARE SUCCESSFUL IN DEVELOPING SUPERIOR PRODUCTS.

 
OUR STATEMENT WITH RESPECT TO OUR INTENT TO MARKET AND SELL LICENSE AND SERVICES TO OTHERS MAY IMPLY THAT OUR PLANS TO DO SO ARE IMMINENT OR WILL BE SUCCESSFUL. HOWEVER, MARKETING AND SELLING OUR PRODUCT AND SERVICES WHILE SIMULTANEOUSLY PURSUING OUR LITIGATION AND OUR FURTHER DEVELOPMENT ACTIVITIES CAN PRESENT SIGNIFICANT CHALLENGES. OUR MARKETING AND SALES PLANS MAY TAKE LONGER TO IMPLEMENT THAN WE NOW EXPECT, MAY NOT BE IMPLEMENTED, OR MAY FAIL.
 
THESE AND OTHER UNEXPECTED RESULTS MAY BE CAUSED BY VARIOUS FACTORS, SOME OF WHICH ARE BEYOND OUR CONTROL, INCLUDING:
 
 
THE IMPACT OF CHANGES IN THE U.S. AND GLOBAL ECONOMIES IN GENERAL, TECHNOLOGICAL INNOVATIONS THAT AFFECT OUR INDUSTRY, OR CHANGES IN CAPITAL MARKETS ON US AND OUR INTENDED CUSTOMERS;

 
COMPLIANCE WITH, AND CHANGES TO, U.S. FEDERAL, STATE AND LOCAL LAWS AND REGULATIONS, FOREIGN LAWS AND REGULATIONS, ACCOUNTING RULES, TAX RATES AND SIMILAR MATTERS; AND

 
COMPETITION WITHIN OUR INDUSTRY.
 
 
 

 
 
WE HAVE GENERATED NET INCOME IN ONLY ONE ANNUAL REPORTING PERIOD SINCE WE BECAME PUBLICLY OWNED. ALTHOUGH OUR PLANS ARE INTENDED TO GENERATE NET INCOME, THERE CAN BE NO ASSURANCE THAT THESE PLANS WILL SUCCEED.
 
RESULTS THAT DIFFER FROM THOSE STATED OR IMPLIED BY OUR FORWARD LOOKING STATEMENTS MAY ALSO BE CAUSED BY VARIOUS CHANGES IN OUR BUSINESS OR MARKET CONDITIONS AS DESCRIBED MORE FULLY IN OUR ANNUAL REPORT ON FORM 10-K FILED WITH THE SECURITIES AND EXCHANGE COMMISSION AND ALSO UNDER "PART I. ITEM 1A. RISK FACTORS" AND ELSEWHERE IN THIS REPORT.
 
YOU SHOULD NOT PLACE UNDUE RELIANCE UPON FORWARD LOOKING STATEMENTS.
 
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
 
 
 
 
Page
1
 
1
 
1
 
2
 
2
 
3
 
4
 
10
 
13
 
Item 4 — Controls and Procedures
13
PART II — OTHER INFORMATION
14
 
14
 
14
 
20
 
20
 
20
 
20
 
21
22
23
 
 
 

 
ITEM 1. — FINANCIAL STATEMENTS.
 
VIRNETX HOLDING CORPORATION
(in thousands, except per share amounts)
 
 
 
March 31,
2012
 
December 31,
2011
 
 
 
(Unaudited)
 
 
 
ASSETS
         
Current assets:
 
 
 
 
 
Cash and cash equivalents
 
$
39,957
 
 
$
49,482
 
Investments available for sale
 
 
19,935
 
 
 
14,438
 
Prepaid taxes
 
 
12,639
 
 
 
10,459
 
Prepaid expense and other current assets
 
 
447
 
 
 
91
 
Total current assets
 
 
72,978
 
 
 
74,470
 
Property and equipment, net
 
 
61
 
 
 
56
 
Intangible and other assets
 
 
48
 
 
 
60
 
Deferred tax benefit
 
 
40
 
 
 
47
 
Total assets
 
$
73,127
 
 
$
74,633
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
 
 
 
 
 
 
 
 
Accounts payable and accrued liabilities
 
$
3,756
 
 
$
1,227
 
Income tax liability
 
 
430
 
 
 
430
 
Derivative liability
 
 
4,430
 
 
 
4,699
 
Total current liabilities
 
 
8,616
 
 
 
6,356
 
Stockholders’ equity:
 
 
 
 
 
 
 
 
Preferred stock, par value $0.0001 per share
 
 
 
 
 
 
 
 
Authorized: 10,000,000 shares at March 31, 2012, and December 31, 2011 Issued and outstanding: 0 shares at March 31, 2012 and December 31, 2011
 
 
 
 
 
 
Common stock, par value $0.0001 per share
 
 
 
 
 
 
 
 
Authorized: 100,000,000 shares at March 31, 2012 and December 31, 2011 Issued and outstanding: 50,697,136 shares at March 31, 2012, and 50,619,136 at December 31, 2011, respectively
 
 
5
 
 
 
5
 
Additional paid in capital
 
 
105,239
 
 
 
104,277
 
Accumulated deficit
 
 
(40,711
)
 
 
(36,001
)
Accumulated other comprehensive loss
 
 
(22
)
 
 
(4
)
Total stockholders’ equity
 
 
64,511
 
 
 
68,277
 
Total liabilities and stockholders’ equity
 
$
73,127
 
 
$
74,633
 
 
See accompanying notes to condensed consolidated financial statements.
 
 
1

 
(in thousands, except per share amounts)
 
 
 
Three Months
Ended
March 31,
2012
 
 
Three Months
Ended
March 31,
2011
 
Revenue — Royalties
 
$
 
 
$
17
 
Operating expense:
 
 
 
 
 
 
 
 
Research and development
 
 
256
 
 
 
196
 
General, selling and administrative
 
 
6,967
 
 
 
2,573
 
Total operating expense
 
 
7,223
 
 
 
2,769
 
Loss from operations
 
 
(7,223
)
 
 
(2,752
)
Gain (loss) on change in value of  derivative liability
 
 
269
 
 
 
(5,130
)
Interest income, net
 
 
74
 
 
 
60
 
Loss before taxes
 
 
(6,880
)
 
 
(7,822
)
Income tax benefit
 
 
(2,173
)
 
 
(700
)
Net loss
 
$
(4,707
)
 
$
(7,122
)
Basic and diluted loss per share:
 
$
(0.09
)
 
$
(0.14
)
Weighted average shares outstanding basic and diluted
 
 
50,658
 
 
 
49,461
 

 
 
 
VIRNETX HOLDING CORPORATION
(in thousands)
 
 
 
Three Months
Ended
March 31,
2012
 
 
Three Months
Ended
March 31,
2011
 
Net loss
 
$
(4,707
)
 
$
(7,122
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
Change in unrealized loss on investments, net of tax
 
 
(18
)
 
 
962
 
                 
Comprehensive loss
 
$
(4,725
)
 
$
(6,160
)

See accompanying notes to condensed consolidated financial statements.

 
2

 
VIRNETX HOLDING CORPORATION
(in thousands)
 
 
 
Three Months
Ended
March 31,
2012
 
 
Three Months
Ended
March 31,
2011
 
Cash flows from operating activities:
 
 
 
 
 
 
Net loss
 
$
(4,707
)
 
$
(7,122)
 
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
 
 
 
 
 
Depreciation and amortization
 
 
17
 
 
 
15
 
Stock-based compensation
 
 
873
 
 
 
643
 
Net change in deferred taxes
 
 
7
 
 
 
 3,325
 
Change in value of derivative liability
 
 
 (269
)
 
 
5,130
 
Changes in assets and liabilities:
 
 
 
 
 
 
   
Receivables and other current assets
 
 
 
 
 
(3
)
Prepaid taxes
 
 
 (2,180
)
 
 
 
Prepaid expenses and other current assets
   
(356
)
   
(216
)
Accounts payable and accrued liabilities
 
 
2,529
 
 
 
(15
)
Income tax liability
 
 
 
 
 
(13,723
)
Net cash used in operating activities
 
 
(4,086
)
 
 
(11,966
)
Cash flows from investing activities:
 
 
 
 
 
 
 
 
Purchase of property and equipment
 
 
(10
)
 
 
 —
 
Purchase of investments
   
(23,980
)
   
(10,224
)
Proceeds from sale or maturity of investments
 
 
18,461
 
 
 
30,372
 
Net cash provided by (used in) investing activities
 
 
(5,529
)
 
 
20,148
 
Cash flows from financing activities:
 
 
 
 
 
 
 
 
Proceeds from exercise of options
 
 
90
 
 
 
 
Proceeds from exercise of warrants
 
 
 
 
 
736
 
Net cash provided by financing activities
 
 
90
 
 
 
736
 
Net increase (decrease) in cash and cash equivalents
 
 
(9,525
)
 
 
8,918
 
Cash and cash equivalents, beginning of period
 
 
49,482
 
 
 
34,635
 
Cash and cash equivalents, end of period
 
$
39,957
 
 
$
43,553
 
Supplemental disclosure of cash flow information:
 
 
 
 
 
 
 
 
Cash paid during the period for taxes
 
$
 
 
$
9,600
 
Cash paid during the period for interest
 
$
 
 
$
 
 
See accompanying notes to condensed consolidated financial statements.
 
 
3

(in thousands, except share and per share amounts)
 (Unaudited)
 
Note 1 — Business Description and Basis of Presentation
 
VirnetX, Inc. (“we” or “VirnetX”) develop software and technology solutions for securing real-time communications over the Internet.  Our patented GABRIEL Connection Technology™ combines industry standard encryption protocols with our patented techniques for automated domain name system, or DNS, lookup mechanisms, and enables users to create a secure communication link using secure domain names over wired or wireless (4G/LTE) networks.
 
Our portfolio of intellectual property is the foundation of our business model.  We currently own 20 patents in the United States and 26 foreign patents, as well as several pending U.S. and foreign patent 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 operating systems and network security.  On December 1, 2009, we submitted a licensing declaration to the 3rd Generation Partnership Project, or 3GPP, identifying those of our U.S. and international patents which may be relevant to Long Term Evolution, or LTE. On March 14, 2011, we supplemented our licensing declaration to include five additional specifications. On April 28, 2011, at the request of the European Telecommunications Standards Institute, or ETSI, we agreed to update our licensing declaration to ETSI under ETSI's Intellectual Property Rights or IPR policy.  We agreed with ETSI that we will 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, as set forth in the updated licensing declaration under ETSI’s IPR policy. On June 17, 2011, in response to a request from the Alliance for Telecommunications Industry Solutions, or ATIS, the North American Organizational Partner for 3GPP, we also agreed to make available a non-exclusive patent license to 3GPP members desiring to implement the technical specifications identified by us, as set forth in the updated licensing declaration under ATIS' IPR policy.
 
Our software and technology solutions 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 and remote desktop.  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.
 
Microsoft Corporation is our first licensee and has been granted a worldwide, irrevocable, nonexclusive, non-sublicenseable fully paid up license of our patents for Microsoft products.  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 4G/LTE.
 
The accompanying interim condensed consolidated financial statements are unaudited.  These unaudited financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP, applicable for interim financial statements.  Therefore, the disclosures do not include all the information necessary for complete financial statements in accordance with GAAP.  These unaudited interim financial statements should be read in conjunction with the consolidated financial statements and notes contained in our Annual Report on Form 10-K for the year ended December 31, 2011, or our Annual Report. Interim financial reporting standards require us to make estimates that are based on assumptions regarding the outcome of future events and circumstances not known at that time. Inevitably, some assumptions will not materialize, unanticipated events or circumstances may occur which vary from those estimates and such variations may significantly affect our future results. In the opinion of our management, all adjustments, which include only normal recurring adjustments, considered necessary for a fair presentation have been included.  Our financial results have varied significantly from period to period.  For this and other reasons, our operating results for any historical periods are not necessarily indicative of the results that may be expected for any future period.
 
 
4

 
Note 2 – Summary of Significant Accounting Policies

Revenue Recognition
 
We defer recognition of revenue in accordance with ASC Topic 605 until such time as all of the criteria below have been met:
 
 
persuasive evidence of sales arrangements;

 
delivery has occurred or services have been rendered;

 
the buyer’s price is fixed or determinable; and

 
collection is reasonably assured.
 
We expect that some or all of our future licensing agreements will provide for payments to us over an extended period of time. For a licensing agreement with fixed royalty payments, we expect to recognize revenue as amounts become due. For a licensing agreement with variable royalty payments we expect to recognize royalty revenue at the time that the licensees' sales occur; however, because we expect that a licensee may report sales information to us on a delayed basis, we expect our revenue recognition criterion may also be met on a delayed basis.
 
Complex revenue arrangements may require us to make significant judgments, assumptions and estimates about when substantial delivery of contract elements will occur, whether any significant ongoing obligations exist subsequent to contract execution, whether amounts due are collectible and the appropriate period  in which the completion of the earning process occurs. If new information subsequently becomes known to us which causes us to make different judgments, assumptions or estimates regarding material contracts, our financial results may be materially affected.
 
Earnings Per Share
 
Basic earnings per share are computed by dividing earnings available to common stockholders by the weighted average number of outstanding common shares during the period.  Diluted earnings per share is computed by dividing net income by the weighted average number of shares outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. During the three months ended March 31, 2012 and 2011, we incurred losses; therefore, the effect of any Common Stock equivalents was anti-dilutive during those periods.
 
Concentration of Credit Risk and Other Risks and Uncertainties
 
Our cash and cash equivalents are primarily maintained at two major financial institutions in the United States.  Deposits held with these financial institutions may exceed the amount of insurance provided on such deposits.  A portion of those balances are insured by the Federal Deposit Insurance Corporation, or FDIC.  During the period ended March 31, 2012 and 2011, we had, at times, funds that were uninsured.  The uninsured balance at March 31, 2012, was approximately $18,715 compared to $29,185 at December 31, 2011.  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.

Derivative Instruments
 
Our Series I Warrants contain an anti-dilution provision which precludes them from being considered indexed to our stock. As a result, the warrants are required to be accounted for as derivative instruments.
 
We recognize derivative instruments as either assets or liabilities on the accompanying Condensed Consolidated Balance Sheets at fair value. We record changes in the fair value (i.e., gains or losses) of the derivatives in the accompanying Condensed Consolidated Statements of Operations.

Impairment of Long-Lived Assets
 
On an annual basis we identify and record impairment losses on long-lived assets used in operations when events and changes in circumstances indicate that the carrying amount of an asset might not be recoverable.  Recoverability is measured by comparison of the anticipated future net undiscounted cash flows to the related assets’ carrying value.  If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the projected discounted future net cash flows arising from the asset.
 
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 observable inputs in markets other than active markets.
 
Our financial instruments are stated at amounts that equal to, or approximate, fair value.  When we approximate 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 quoted valuation techniques, primarily the income and market approach, that maximize the use of observable inputs and minimize the use of unobservable inputs for recurring fair value measurements.
 
 
5

 
Certificate of deposits: Fair value measured at face value plus accrued interest.
 
Corporate bonds:  Fair value measured at the closing price reported on the active market on which the individual securities are traded.
 
Series I Warrants: Fair value measured by using a Binomial valuation model.  As of March 31, 2012 and December 31, 2011, the assumptions used to measure fair value of our outstanding Series I Warrants carried as derivative liabilities on our condensed consolidated balance sheet for March 31, 2012 included a warrant exercise price of $3.59 per share, a common share price of $23.93, a discount rate of 1.04%, and a volatility of 115%. The assumptions used for December 31, 2011 was a warrant exercise price of $3.59 per share, a common share price of $24.97, a discount rate of 0.83%, and a volatility of 123%.
 
The following tables show our securities’ adjusted cost, gross unrealized gains, gross unrealized losses and fair value by significant investment category  as of March 31, 2012 and December 31, 2011.
                                                                                                
      March 31, 2012  
Level 1:
 
 
Adjusted Cost
 
 
Unrealized Gains
 
 
Unrealized Losses
 
 
Fair Value
 
Certificates of deposit
 
 
$
3,332
 
 
$
3
 
 
$
 
 
$
3,335
 
   
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate Bonds:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
AA
 
 
 
4,185
 
 
 
13
 
 
 
 
 
 
4,198
 
    A  
 
 
7,261
 
 
 
 
 
 
(7
)
 
 
7,254
 
BAA
 
 
 
5,179
 
 
 
 
 
 
(31
)
 
 
5,148
 
Total Corporate Bonds
 
 
 
16,625
 
 
 
13
 
 
 
(38
)
 
 
16,600
 
                                   
Total Investments at Fair Value
 
 
$
19,957
 
 
$
16
 
 
$
(38
)
 
$
19,935
 
 
      December 31, 2011  
Level 1:
 
 
Adjusted Cost
 
 
Unrealized Gains
 
 
Unrealized Losses
 
 
Fair Value
 
Certificates of deposit
 
 
$
2,582
 
 
$
2
 
 
$
 
 
$
2,584
 
   
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate Bonds:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
AA
 
 
 
2,014
 
 
 
 
 
 
(3
)
 
 
2,011
 
       A  
 
 
9,846
 
 
 
 
 
 
(3
)
 
 
9,843
 
Total Corporate Bonds
 
 
 
11,860
 
 
 
 
 
 
(6
)
 
 
11,854
 
     
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Investments at Fair Value
 
 
$
14,442
 
 
$
2
 
 
$
(6
)
 
$
14,438
 

The following tables set forth by level within the fair value hierarchy, our financial instrument liabilities as of March 31, 2012 and December 31, 2011.

 
    March 31, 2012  
 
 
Quoted
Prices in
Active
Markets for
Identical
Assets
 
 
Significant
Other
Observable
Inputs
 
 
Significant
Unobservable
Inputs
 
 
 
 
 
 
(Level 1)
 
 
(Level 2)
 
 
(Level 3)
 
 
Total
 
Series l Warrants
 
$
 
 
$
 
 
$
4,430
 
 
$
4,430
 
Total
 
$
 
 
$
 
 
$
4,430
 
 
$
4,430
 
 
   
December 31, 2011
 
 
 
Quoted
Prices in
Active
Markets for
Identical
Assets
 
 
Significant
Other
Observable
Inputs
 
 
Significant
Unobservable
Inputs
 
 
 
 
 
 
(Level 1)
 
 
(Level 2)
 
 
(Level 3)
 
 
Total
 
Series l Warrants
 
$
 
 
$
 
 
$
4,699
 
 
$
4,699
 
Total
 
$
 
 
$
 
 
$
4,699
 
 
$
4,699
 
 
 
6

 
The following table sets forth a summary of changes in the fair value of our Level 3 financial instrument liability for the period ended March 31, 2012 and year ended December 31, 2011:
                                                                                                                    
    March 31, 2012       December 31, 2011  
   
Fair Value
Measurements
Using
Significant
Unobservable
Inputs (Level 3)
     
Fair Value
Measurements
Using
Significant
Unobservable
Inputs (Level 3)
 
Balance December 31, 2011
  $ 4,699  
Balance December 31, 2010
  $ 14,364  
Net gain included in loss
    (269 )
Net loss included in earnings
    5,595  
Settlements
     
Settlements
    (15,260 )
Balance March 31, 2012
  $ 4,430  
Balance December 31, 2011
  $ 4,699  
 
Note 3 — Patent Portfolio
 
As of March 31, 2012, we own 20 issued U.S. and 26 issued foreign patents, in addition to several pending U.S. and foreign patent applications.  Our issued U.S. and foreign patents expire at various times during the period from 2019 to 2024.  Some of our issued patents and pending patent applications were acquired by our principal operating subsidiary, VirnetX, Inc., from Science Applications International Corporation, or SAIC, in 2006 and we are required to make payments to SAIC 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. As of June 30, 2010, we met our maximum royalty payment requirement; however, SAIC is also entitled under certain circumstances to receive a portion of the proceeds paid to us for certain acquisitions of VirnetX or from the settlement of certain patent infringement claims of ours.
 
Note 4 — Income Taxes
 
The components of the income tax expense for the period ended March 31, 2012 and 2011 respectively are as follows:
 
 
 
March 31, 2012
 
 
March 31, 2011
 
Current:
 
 
 
 
 
 
Federal
 
$
(2,177
)
 
$
(4,007)
 
State
 
 
-
 
 
 
                       3
 
Foreign
 
 
(3
)
 
 
                      4
 
 
 
 
(2,180
)
 
 
(4,000)
 
Deferred:
 
 
 
 
 
 
 
 
Federal
 
 
1
 
 
 
3,300
 
State
 
 
6
 
 
 
-
 
Foreign
 
 
-
 
 
 
-
 
 
 
 
7
 
 
 
3,300
 
Total provision for income taxes
 
$
(2,173
)
 
$
(700)
 
 
In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of deferred assets will not be realized.  The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible.
 
Based on the available objective evidence, management believes it is more likely than not that the net deferred tax assets will not be fully realizable for the three months ended March 31, 2012.  Accordingly, management has maintained partial valuation allowance against its net deferred tax assets at March 31, 2012.  The net change in the total valuation allowance for the period ended March 31, 2012 was a decrease of $208.
 
At March 31, 2012, the Company has federal and state net operating loss carryforwards of approximately $912 and $44,277 respectively, expiring beginning in 2027 and 2012, respectively.
 
 
7

 
Note 5 — Commitments
 
We lease our offices under an operating lease with a third party that requires minimum payments monthly until it ends in June 2013.  We recognize rent expense on a straight-line basis over the term of the lease.
 
For the Year
 
Minimum Required Lease
Payments in Period
 
2012
 
$
42
 
2013
 
 
28
 
Total
 
$
70
 
 
Note 6 — Stock Plan
 
We have a stock incentive plan for employees and others called the “VirnetX Holding Corporation 2007 Stock Plan”, or the Plan, which has been approved by our stockholders. On April 31, 2012, our Compensation Committee approved amendments to the Plan to allow us to grant restricted stock units awards. The Plan provides for the granting of up to 11,624,469 shares of our common stock, including stock options, stock purchase rights and restricted stock units and will expire in 2018.  As of March 31, 2012, there were 628,478 shares available to be granted under the Plan.
 
We had 4,828,998 and 4,906,998 options outstanding at March 31, 2012, and December 31, 2011, respectively, with an average exercise price of $5.20 and $5.12, respectively.
 
Note 7 — Stock-Based Compensation

We account for equity instruments issued to employees in accordance with the fair value method which requires that such issuances be recorded at their fair value on the grant date.  The recognition of the expense is subject to periodic adjustment as the underlying equity instrument vests.

Stock-based compensation expense included in general and administrative expenses was $873 and $643 for the three months ended March 31, 2012 and 2011, respectively.

As of March 31, 2012, the unrecognized stock-based compensation expense related to non-vested stock options was $8,673 which will be amortized as expense over an estimated weighted average vesting amortization period of approximately 0.6 years, as compared to $3,384 and 1 year for 2011.
 
Note 8 — Warrants
 
Information about warrants outstanding during the three months ended March 31, 2012 follows:
 
Original Number of
Warrants Issued
 
 
 
Exercise
Price per Common
Share
 
 
Exercisable at
December 31,
2011
 
 
Became
Exercisable
 
 
Exercised
 
 
Terminated /
Cancelled /
Expired
 
 
Exercisable
at March 31, 2012
 
Expiration
Date
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  2,619,036 (1)
 
 
$
3.59
 
 
 
204,908
 
 
 
 
 
 
 
 
 
 
 
 
204,908
 
March 2015
Total
 
 
 
 
 
 
 
 
204,908
 
 
 
 
 
 
 
 
 
 
 
 
 
204,908
 
 
 
 
(1)
Referred to as our Series I Warrants.
 
Note 9 — Litigation
 
We have three intellectual property infringement lawsuits pending against multiple parties in the United States District Court for the Eastern District of Texas, Tyler Division, pursuant to which we allege that these parties infringe on certain of our patents. We seek damages and injunctive relief in all the complaints. We have one complaint with the United States International Trade Commission (ITC) alleging that Apple, Inc. has engaged in unfair trade practices by the importation, sale for importation, and sale after importation of certain devices with secure communication capabilities that infringe one or more claims of our U.S. Patent No. 8,051,181.
 
On August 11, 2010, we initiated a lawsuit by filing a complaint against Aastra Technologies, Inc., Apple, Inc., Cisco Systems, Inc., and NEC Corporation.
 
On January 12, 2011, we initiated a new lawsuit by filing a complaint against Siemens Enterprise Communications and Mitel Networks Corp. On April 12, 2011, we amended this complaint to add Avaya, Inc., as a defendant.
 
 
8

 
We believe that Aastra, Apple, Cisco, NEC, Siemens, Mitel and Avaya infringe on certain of our patents, but obtaining and collecting a judgment against these parties may be difficult or impossible.  Patent litigation is inherently risky and the outcome is uncertain.  Aastra, Apple, Cisco, NEC, Siemens, Mitel and Avaya are all large, well-financed companies with substantially greater resources than us.  We believe that these parties will devote a substantial amount of resources in an attempt to prove that either their products do not infringe our patents or that our patents are invalid and unenforceable.  At this time, we cannot predict the final outcome of these litigation matters.
 
On November 1, 2011, we initiated a lawsuit against Apple in the United States District Court, Tyler Division, pursuant to which we allege that Apple infringes an additional patent of ours.  We seek damages and injunctive relief.  No hearing or trial dates have been set.
 
On November 4, 2011, we filed a complaint with the United States International Trade Commission (ITC) alleging that Apple has engaged in unfair trade practices by the importation, sale for importation, and sale after importation of certain devices with secure communication capabilities that infringe one or more claims of our U.S. Patent No. 8,051,181. The accused products include the latest iPhones, iPads, iPods and Macintosh computers. We have requested that the ITC institute an investigation into Apple’s allegedly infringing imports and ultimately bar Apple from importing those Apple products or further selling the infringing Apple products that have already been imported.

On January 5, 2012, a claims construction hearing was held in our case against Aastra, Apple, Cisco and NEC in the United States District Court for the Eastern District of Texas, Tyler Division. On April 25, 2012 the United States District Court for the Eastern District of Texas, Tyler Division, issued its Markman Order on the claim terms that were in dispute in the  Aastra, Apple, Cisco and NEC litigation and adopted certain interpretations that we believe are favorable to us. The trial in connection with the Aastra, Apple, Cisco and NEC litigation is scheduled to start on November 5, 2012.
 
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 worth pursuing, commencing a lawsuit can be expensive and time-consuming, and there is no assurance that we will prevail on such potential claims.  In addition, bringing a lawsuit may lead to potential counterclaims which may preclude our ability to commercialize our initial products, which are currently in development.
 
Note 10 — Subsequent Events
 
On January 5, 2012, a claims construction hearing was held in our case against Aastra, Apple, Cisco and NEC in the United States District Court for the Eastern District of Texas, Tyler Division. On April 25, 2012 the United States District Court for the Eastern District of Texas, Tyler Division, issued its Markman Order on the claim terms that were in dispute in the  Aastra, Apple, Cisco and NEC litigation and adopted certain interpretations that we believe are favorable to us. The trial in connection with the Aastra, Apple, Cisco and NEC litigation is scheduled to start on November 5, 2012.

On April 13, 2012, our Compensation Committee approved changes to the compensation for our Board of Directors, approved amendments to the Plan to allow us to grant restricted stock unit awards and authorized the issuance of 240,000 options and 126,667 RSUs (restricted stock units), at a price of $24.

On May 3, 2012 – VirnetX Holding Corp. (AMEX:VHC) and Aastra USA, Inc. (the “Parties”) today announced that on May 3 2012, they signed a Patent License Agreement (the “Agreement”).  Under the terms of the Agreement, VirnetX has agreed to license certain of its patents to Aastra USA, Inc., for a one-time payment to VirnetX and an ongoing reasonable royalty for all future sales through the expiration of the licensed patents as outlined in the Agreement with respect to certain current and future IP-encrypted products.
 
 
9

Company Overview
 
We develop software and technology solutions for securing real-time communications over the Internet.  Our patented GABRIEL Connection Technology™ combines industry standard encryption protocols with our patented techniques for automated domain name system, or DNS, lookup mechanisms, and enables users to create a secure communication link using secure domain names over wired or wireless (4G/LTE) networks. We are currently beta testing our GABRIEL Connection Technology™ as part of our Secure Domain Name Initiative, or (SDNI), on various platforms including PCs, smart phones and tablets. We also intend to establish the exclusive secure domain name registry in the United States and other key markets around the world.
 
Our portfolio of intellectual property is the foundation of our business model.  We currently own 20 patents in the United States and 26 foreign patents, as well as several pending U.S. and foreign patent 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 operating systems and network security.  On December 2, 2009, we submitted a licensing declaration to the 3rd Generation Partnership Project, or 3GPP, identifying those of our U.S. and international patents which may be relevant to Long Term Evolution, or LTE. On March 14, 2011, we supplemented our licensing declaration to include five additional specifications. On April 28, 2011, at the request of the European Telecommunications Standards Institute, or ETSI, we agreed to update our licensing declaration to ETSI under ETSI's Intellectual Property Rights or IPR policy.  We agreed with ETSI that we will 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, as set forth in the updated licensing declaration under ETSI’s IPR policy. On June 17, 2011, in response to a request from the Alliance for Telecommunications Industry Solutions, or ATIS, the North American Organizational Partner for 3GPP, we also agreed to make available a non-exclusive patent license to 3GPP members desiring to implement the technical specifications identified by us, as set forth in the updated licensing declaration under ATIS' IPR policy. We believe that we are positioned to license our essential security patents to 3GPP members as they move into 4G.
 
We intend 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 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 4G/LTE wireless networks. We also believe that all 4G mobile devices will require unique secure domain names and become part of a secure domain name registry.
 
Our software and technology solutions 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 and remote desktop.  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.
 
In connection with the settlement of our lawsuit against Microsoft Corporation in 2010, Microsoft became our first licensee.  Pursuant to the Settlement and License Agreement between us and Microsoft, Microsoft paid us $200 million, which has been recognized as gain on settlement and Microsoft was granted a worldwide, irrevocable, nonexclusive, non-sublicenseable fully paid up license for our patents for Microsoft products.  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 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 Science Application International Corporation, or SAIC.  SAIC 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 SAIC and expanded the set of patents we acquired in 2006 from SAIC into a larger portfolio with 46 issued U.S. and foreign patents and numerous pending U.S. and foreign patent 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 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 4G/LTE companies (domain infrastructure providers, chipset manufacturers, service providers, and others) and build our secure domain name registry.
 
Competition
 
We believe our technology and solutions will compete primarily against various proprietary security solutions.  We group these solutions into three main categories:
 
 
Proprietary or home-grown application specific security solutions have been developed by vendors and integrated directly into their products for our target markets including IP-telephony, mobility, fixed-mobile convergence, and unified communications.  These proprietary solutions have been developed due to the lack of standardized approaches to securing real-time communications.  This approach has led to corporate networks that are isolated and, as a result, restrict enterprises to using these next-generation networks within the boundaries of their private network.  These solutions generally do not provide security for communications over the Internet or require network administrators to manually exchange keys and other security parameters with each destination network outside their corporate network boundary.  The cost-savings and other benefits of IP-based real-time communications are significantly limited by this approach to securing real-time communications.
 
 
10

 
 
A session border controller, or SBC, is a device used in networks to exert control over the signaling and media streams involved in establishing, conducting and terminating VoIP calls.  A traditional firewall or network address translation, or NAT, device typically block information like endpoint IP addresses and port numbers required by signaling protocols, such as SIP and XMPP, to reach and communicate with their intended destination.  SBCs are used in physical networks to address these limitations and enable real-time session traffic to cross the boundaries created by firewalls and other NAT devices and enable VoIP calls to be established successfully.  However, SBCs must decrypt and analyze every single data packet for the information to be transmitted successfully, thereby preventing end-to-end encryption.  This network design results in SBCs becoming a single point of congestion on the network, as well as a single point of failure.  SBCs are also limited to the physical network they secure.
 
 
SIP firewalls, or SIP-aware firewalls, and application layer gateways, manage and protect the traffic, flow and quality of VoIP and other SIP-related communications.  They perform real-time network address translation, dynamic firewall functions; support multiple signaling protocols, and media functionality, allowing secure interconnection and the flow of IP media streams across multiple networks.  While SIP firewalls assist in analyzing SIP traffic transmitted over the corporate network to filter out various threats, they do not necessarily encrypt the traffic.  As a result, this traffic is not entirely secure from end-to-end nor is it protected against threats like man-in-middle and eavesdropping.
 
New Accounting Pronouncements
 
In May 2011, the FASB issued a new accounting standard update, which amends the fair value measurement guidance and includes some enhanced disclosure requirements.  The most significant change in disclosures is an expansion of the information required for Level 3 measurements based on unobservable inputs. The standard is effective for fiscal years beginning after December 15, 2011. This standard did not have an impact on our results of operations and financial position, when adopted on January 1, 2012.
 
In June 2011, the FASB modified the presentation of comprehensive income in the financial statements.  The revised standard requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements and must be applied retrospectively.  This standard eliminates the current option to report other comprehensive income and its components in the statement of changes in equity.  The revised standard does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.  Our adoption of modification of the standard did not have an effect on our consolidated results of operations and financial position.
 
In September 2011, the FASB issued an amendment to an existing accounting standard, which provides entities an option to perform a qualitative assessment to determine whether further impairment testing on goodwill is necessary.  Specifically, an entity has the option to first assess qualitative factors to determine whether it is necessary to perform the current two-step test.  If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required.  Otherwise, no further testing is required.  This standard is effective for annual and interim goodwill impairment test performed for fiscal years beginning after December 15, 2011. Our adoption did not have a material impact on our consolidated financial statements.
 
 
11

 
Results of Operations
 
Three Months Ended March 31, 2012
Compared with Three Months Ended March 31, 2011
(in thousands, except per share amounts)
 
Revenue — Royalties
 
We had no revenue for the three months ended March 31, 2012, compared to $17 for the comparable 2011 period. Our revenue in 2011 was solely limited to the royalties earned under a single license agreement through our Japanese subsidiary.  We expect the revenue from this license will continue to be insignificant in the future.  We do not intend to seek additional licenses or other revenue through our Japanese subsidiary.
 
Research and Development Expenses
 
Our research and development expenses increased by $60  to $256 for the three months ended March 31, 2012, from $196 for comparable 2011 period. This increase was primarily due to the increase in wages and medical costs.
 
Selling, General and Administrative Expenses
 
Selling, general and administrative expenses include management and administrative personnel, as well as outside legal, accounting, and consulting services.
 
Our selling, general and administrative expenses increased by $4,394 to $6,967 for the three months ended March 31, 2012, from $2,753 for the comparable 2011 period. This increase is primarily due to an increase in legal fees of $4,174, totaling $5,103 for the three months ended March 31, 2012 compared to $929.
 
For the comparable 2011 period while wages and medical costs also increased in the 2012 period, the increase is primarily due to the increase in legal fees associated with the current patent infringement actions taken against companies previously discussed.
 
Other Income and Expenses
 
During the three months ended March 31, 2012, the non-cash gain related to the periodic revaluation of our Series I Warrants liability was $269, which compares to a non-cash loss of $5,130 for the comparable period in 2011. The balance of the liability for the Series I Warrants decreased to $4,430 at March 31, 2012, from $4,699 at December 31, 2011.  The gains and losses from the revaluations of the warrant liability in the first quarter of 2012 and 2011 were primarily the result of changes in our common share price during the periods.

Interest income increased by $14 to $74 for the three months ended March 31, 2012, from $60 for the comparable 2011 period.
 
Liquidity and Capital Resources
 
As of March 31, 2012, our cash and cash equivalents totaled approximately $39,957 and our short-term investments totaled approximately $19,935, compared to cash equivalents of approximately $49,482 and short-term investments of approximately $14,438 at December 31, 2011. Working capital was $64,362 at March 31, 2012 and $68,114 at December 31, 2011.
 
We expect that our cash and cash equivalents and short-term investments as of March 31, 2012, will be sufficient to fund our operations and provide working capital for general corporate purposes and legal expenses including the expenses for our ongoing complaints against Aastra, Apple, Cisco, NEC, Siemens, Mitel and Avaya in the United States District Court of the Eastern District of Texas, Tyler Division, as well as our filed complaint with the U.S. International Trade Commission, for at least the next 36 months.  While we do not expect to generate net income in the near term,  we do 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 over the long term.  However, there is no guarantee that our patent infringement claims will be resolved in our favor or receive any proceeds from these claims unless and until they may be resolved in our favor, and we expect to continue to incur substantial legal and other costs associated with pursuit of our claims.
 
Off-Balance Sheet Arrangements
 
None.

 
12

 
Interest Rate Risk
 
We invest our excess cash primarily in highly liquid instruments including time deposits, money market, and corporate debt 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 six months of March 31, 2012.
 
Other Market Risks

We have no obligation to settle our Series I Warrant obligations in cash. However, these derivative instruments are accounted for as liabilities on our consolidated balance sheets and are marked-to-market each period based on their estimated fair value. The non-cash gains or losses from the decreases and increases in the estimated fair value of the warrant liability are recognized in earnings each period. The estimated fair value is determined in large part by reference to our assumptions and estimates of various factors. Our liability will increase by approximately $200 and we may recognize significant non-cash losses, if all other factors being constant, the market price of our common shares increases by $1.  Conversely, our liability will decrease by approximately $200 and we may recognize significant non-cash gains, if all other factors being constant, if the market price of our common shares decreases by $1.
 
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 substantially in the near term and could have a material impact to our consolidated balance sheets and statement of operations.
 
 
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, March 31, 2012.
 
The purpose of this evaluation was to determine whether as of March 31, 2012 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 March 31, 2012, 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 March 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
 
13

 
PART II — OTHER INFORMATION
 
 
We have three intellectual property infringement lawsuits pending against multiple parties in the United States District Court for the Eastern District of Texas, Tyler Division, pursuant to which we allege that these parties infringe on certain of our patents. We seek damages and injunctive relief in all the complaints. We have one complaint with the United States International Trade Commission (ITC) alleging that Apple Inc has engaged in unfair trade practices by the importation, sale for importation, and sale after importation of certain devices with secure communication capabilities that infringe one or more claims of our U.S. Patent No. 8,051,181.
 
On August 11, 2010, we initiated a lawsuit by filing a complaint against Aastra Technologies, Inc., Apple, Inc., Cisco Systems, Inc., and NEC Corporation.
 
On January 12, 2011, we initiated a new lawsuit by filing a complaint against Siemens Enterprise Communications and Mitel Networks Corp. On April 12, 2011, we amended this complaint to add Avaya, Inc., as a defendant.
 
We believe that Aastra, Apple, Cisco, NEC, Siemens, Mitel and Avaya infringe on certain of our patents, but obtaining and collecting a judgment against these parties may be difficult or impossible.  Patent litigation is inherently risky and the outcome is uncertain.  Aastra, Apple, Cisco, NEC, Siemens, Mitel and Avaya are all large, well-financed companies with substantially greater resources than us.  We believe that these parties will devote a substantial amount of resources in an attempt to prove that either their products do not infringe our patents or that our patents are invalid and unenforceable.  At this time, we cannot predict the final outcome of these litigation matters.
 
On November 1, 2011, we initiated a lawsuit against Apple in the United States District Court, Tyler Division, pursuant to which we allege that Apple infringes an additional patent of ours.  We seek damages and injunctive relief.  No hearing or trial dates have been set.
 
On November 4, 2011,We filed a complaint with the United States International Trade Commission (ITC) alleging that Apple Inc has engaged in unfair trade practices by the importation, sale for importation, and sale after importation of certain devices with secure communication capabilities that infringe one or more claims of our U.S. Patent No. 8,051,181. The accused products include the latest iPhones, iPads, iPods and Macintosh computers. We have requested that the ITC institute an investigation into Apple’s allegedly infringing imports and ultimately bar Apple from importing those Apple products or further selling the infringing Apple products that have already been imported
 
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 worth pursuing, commencing a lawsuit can be expensive and time-consuming, and there is no assurance that we will prevail on such potential claims.  In addition, bringing a lawsuit may lead to potential counterclaims which may preclude our ability to commercialize our initial products, which are currently in development.
 

You should carefully consider the following material risks in addition to the other information set forth in this Quarterly Report on Form 10-Q before making any investment in the offered securities.  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 occurs, you could lose substantial value or your entire investment in our shares.
 
Risks Related to Financial Reporting Obligations
 
Our 2009 and 2010 consolidated financial statements were restated in 2011 in connection with our identification of a material weakness in our internal control over financial reporting; we may identify future material weakness which  may result in late filings, increased costs or declines in our share price.
 
In early 2011, we restated our previously filed financial statements for the fiscal quarter ended September 30, 2010, each of the then previous five fiscal quarters and the fiscal year ended December 31, 2009, to adjust our accounting for our Series I Warrants.  In connection with these restatements, we determined that we had not maintained effective control over our accounting for these Series I Warrants and, as a result, that a material weakness existed with respect to our reporting of complex, non-routine transactions as of the end of the periods covered by the Form 10-K and Form 10-Qs that included the financial statements referenced above. Although we believe that we currently maintain effective control over our disclosure controls and procedures and internal control over financial reporting as regards this issue, we may in the future identify deficiencies regarding the design and effectiveness of our system of internal control over financial reporting.  In addition, we expect that we will continue to be required to provide a management report in our Form 10-K regarding our internal control over financial reporting and that our independent registered public accounting firm will continue to be required to attest to our internal control matters.  If we experience any material weaknesses in our internal control over financial reporting in the future or are unable to provide unqualified management or attestation reports about our internal controls, we may be unable to meet financial and other reporting deadlines and may incur costs associated with remediation, and any of which could cause our share price to decline.
 
Our litigation can be time-consuming, costly and we cannot anticipate the results.
 
We spend a significant amount of our financial and management resources to pursue our current litigation matters.  We believe that these litigation matters and others that we may in the future determine to pursue could continue for years and continue to consume significant financial and management resources.  The counterparties to our litigation are all large, well-financed companies with substantially greater resources than us.  We cannot assure you that any of our current or future litigation matters will result in a favorable outcome for us.  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 affect our ability to develop and commercialize products.

 
14

 
Risks Related to Our Business and Our Industry
 
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 we cannot assure you that we will successfully capitalize on our market opportunities or that our current business strategy will succeed.  Factors on-going that may affect our ability to execute our current business strategy including, but are not limited to:
 
 
Although we entered into a Settlement and License Agreement with Microsoft Corporation, we may not be successful in entering into further licensing relationships;

 
Third parties may challenge the validity of certain of our patents;

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

 
We expect that we will face intense competition 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 patented 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 other activities, or otherwise materially and adversely affect our business.  Similar challenges could also prevent us from obtaining additional patents in the future.  Even if we are successful in enforcing our rights, our patents may not ultimately provide us with any competitive advantages and may be less valuable than we currently expect.  These risks may be heightened in countries other than the U.S., and may be negatively affected by the fact that legal standards in the U.S. and elsewhere for protection of intellectual property rights in Internet-related businesses are uncertain and still evolving.  In addition, there are a significant number of U.S. and foreign patents and patent applications in our areas of interest, and we expect that significant litigation in these areas will continue, and will add uncertainty to the value of certain patents and other intellectual property rights in our areas of interest.  If we are unable to protect our intellectual property rights or otherwise realize value from them, our business would be negatively affected.
 
We can provide no assurances that the licensing of our essential security patents under FRAND will be successful.
 
At the request of the European Telecommunications Standards Institute (ETSI), and the Alliance for Telecommunications Industry Solutions (ATIS), we agreed to update our licensing declaration to ETSI and ATIS under their respective Intellectual Property Rights (IRP) policies.  This was in response to our Statement of Patent Holder identifying a group of our patents and patent applications that we believe are or may become essential to certain developing specifications in the 3rd Generation Partnership Project (3GPP) Long Term Evolution (LTE), Systems Architecture Evolution (SAE) project.  We will make available a non-exclusive patent license under FRAND (fair, reasonable and non-discriminatory terms and conditions, with compensation) for the patents identified by VirnetX that are or become essential, to applicants desiring to implement the Technical Specifications identified by VirnetX, as set forth in the updated licensing declaration under the ATIS and ETSI IPR policies. While we believe that our FRAND commitment positions us to license our essential security patents for the Technical Specifications identified by VirnetX, our licensing declarations under the ATIS and ETSI IPR policies may limit our flexibility in determining royalties and license terms for certain of our patents.  Consequently, we cannot assure you that the licensing of the essential security patents will be successful or that third parties will be willing to enter into licenses with VirnetX on reasonable terms or at all, which could have an adverse effect on our business and harm our competitive position.
 
Because our business is conducted or expected to be conducted in an environment that is subject to rapid change, we may be subjected to various developments in regulation, law and consumer preferences that we may not be able to adapt to successfully.
 
The current regulatory environment for our products and services remains unclear.  We can give no assurance that our planned product offerings will be in compliance with laws and regulations of local, state, U.S. federal or foreign authorities.  Further, we can give no assurance that we will not unintentionally violate such laws or regulations or that such laws or regulations will not be modified, or that new laws or regulations will be enacted in the future which would cause us to be in violation of such laws or regulations.  For example, VoIP services are not currently subject to all of the same regulations that apply to traditional telephony, but it is possible that similar regulations may be applied to VoIP in the future and that these could result in substantial costs and adversely affect of the marketability of our products and planned products related to VoIP.  For further example, the use of the Internet and private IP networks for communication is largely unregulated within the United States, but may become regulated in the future; also several foreign governments have enacted measures that could restrict or prohibit voice communications services over the Internet or private IP networks.
 
Our business depends on the growth of IM, VoIP, mobile services, streaming video, file transfer and remote desktop and other next-generation Internet-based applications which are relatively new.  The Internet may ultimately prove not to be a viable commercial marketplace which could cease growth or cause material decline in the number of users in these areas due to complexity or cost of these applications relative to alternate traditional or newly developed communications channels.
 
 
15

 
More aggressive domestic or international regulation of the Internet in general, and Internet telephony providers and services specifically or a lack of growth in acceptance of the Internet as a long term viable marketplace for communications services may materially and adversely affect our business, financial condition, operating results and future prospects.
 
Our exposure to outside influences beyond our control, including new legislation, court rulings or actions by the United States Patent and Trademark Office, could adversely affect our licensing and enforcement activities and results of operations.
 
Our licensing and enforcement activities are subject to numerous risks from outside influences, including the following:
 
 
New legislation, regulations or rules related to obtaining patents or enforcing patents could significantly increase our operating costs and decrease our revenue. .  For instance, the U.S. Supreme Court has recently modified some tests used by the U.S. Patent and Trademark Office in granting patents during the past 20 years which may decrease the likelihood that we will be able to obtain patents and increase the likelihood of challenge of any patents we obtain or license.  In addition, the U.S. recently enacted sweeping changes to the U.S. patent system under the Leahy-Smith America Invents Act (“AIA”), including changes that would transition the U.S. from a “first-to-invent” system to a “first to file” system and alter the processes for challenging issued patents
 
 
More patent applications are filed each year resulting in longer delays in getting patents issued by the USPTO.
 
 
Federal courts are becoming more crowded, and as a result, patent enforcement litigation is taking longer.
 
 
As patent enforcement becomes more prevalent, it may become more difficult for us to voluntarily license our patents.
 
If we experience security breaches, we could be exposed to liability and our reputation and business could suffer.
 
We expect to retain certain confidential customer information in our secure data centers and secure domain name registry.  It will be critical to our business strategy that our facilities and infrastructure remain secure and are perceived by the marketplace to be secure.  Our secure domain name registry operations will also depend on our ability to maintain our computer and telecommunications equipment in effective working order and to reasonably protect our systems against interruption, and potentially depend on protection by other registrars in the shared registration system.  The secure domain name servers that we will operate will be critical hardware to our registry services operations.  Therefore, we expect to have to expend significant time and money to maintain or increase the security of our facilities and infrastructure. Security technologies are constantly being tested by computer professionals, academics and “hackers.” Advances in the techniques for attacking security solutions could make some or all of our products obsolete or unmarketable.  Likewise, if any of our products are found to have significant security vulnerabilities, then we may need to dedicate engineering and other resources to eliminate the vulnerabilities and to repair or replace products already sold or licensed to our customers.  Despite our security measures, our infrastructure may be vulnerable to physical break-ins, computer viruses, attacks by hackers or similar disruptive problems.  It is possible that we may have to expend additional financial and other resources to address such problems.  Any physical or electronic break-in or other security breach or compromise of the information stored at our secure data centers and domain name registration systems may jeopardize the security of information stored on our premises or in the computer systems and networks of our customers.  In such an event, we could face significant liability and customers could be reluctant to use our services.  Such an occurrence could also result in adverse publicity and therefore adversely affect the market’s perception of the security of electronic commerce and communications over IP networks as well as the security or reliability of our services.
 
A security breach could require a substantial amount of expense to rectify and could result in a product liability claim that causes us to incur substantial liability and related legal and other costs.  A security breach may also harm our reputation and make it more difficult or impossible for us to successfully market to others.  These matters could harm our operating results and financial condition.
 
We expect that we will experience long and unpredictable sales cycles, which may impact our operating results.
 
We expect that our sales cycles will be long and unpredictable due to a number of uncertainties such as:
 
 
The need to educate potential customers about our patent rights and our product and service capabilities;
 
 
Customers’ willingness to invest potentially substantial resources and modify their network infrastructures to take advantage of our products;
 
 
Customers’ budgetary constraints;
 
 
The timing of customers’ budget cycles; and
 
 
Delays caused by customers’ internal review processes.
 
 
Long sales cycles may increase the risk that our financial resources are exhausted before we are able to generate significant revenue.
 
We expect that we will be substantially dependent on a concentrated number of customers.  If we are unable to establish, maintain or replace our relationships with customers and develop a diversified customer base, our revenues may fluctuate and our growth may be limited.
 
We expect that in the future, a significant portion of our revenues will be generated from a limited number of customers.  Substantially all of our income during 2010 was from the payments to us resulting from the Settlement and License Agreement we entered into with Microsoft. There can be no guarantee that we will be able to obtain additional customers, or if we do so, to sustain our revenue levels from these prospective customers.  If we are not able to establish, maintain or replace the limited group of prospective customers that we anticipate may generate a substantial majority of our revenues in the future, or if they do not generate revenues at the levels or at the times that we anticipate, our ability to maintain or grow our revenues will be adversely affected.
 
 
16

 
Our products are highly technical and may contain undetected errors, which could cause harm to our reputation and adversely affect our business.
 
Our products are highly technical and complex and, when deployed, may contain errors or defects.  Despite testing, some errors in our products may only be discovered after a product has been installed and used by customers.  Any errors or defects discovered in our products after commercial release could result in failure to achieve market acceptance, loss of revenue or delay in revenue recognition, loss of customers and increased service and warranty cost, any of which could adversely affect our business, operating results and financial condition.  In addition, we could face claims for product liability, tort or breach of warranty, including claims relating to changes to our products made by our channel partners.  The performance of our products could have unforeseen or unknown adverse effects on the networks over which they are delivered as well as on third-party applications and services that utilize our services, which could result in legal claims against us, harming our business.  Furthermore, we expect to provide implementation, consulting and other technical services in connection with the implementation and ongoing maintenance of our products, which typically involves working with sophisticated software, computing and communications systems.  We expect that our contracts with customers will contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld.  Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and adversely affect the market’s perception of us and our products.  In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all, our business, operating results and financial condition could be adversely impacted.
 
Malfunctions of third-party communications infrastructure, hardware and software expose us to a variety of risks we cannot control.
 
Our business will also depend upon the capacity, reliability and security of the infrastructure owned by third parties that we will use to deploy our offerings.  We have no control over the operation, quality or maintenance of a significant portion of that infrastructure or whether or not those third parties will upgrade or improve their equipment.  We depend on these companies to maintain the operational integrity of our connections.  If one or more of these companies is unable or unwilling to supply or expand its levels of service to us in the future, our operations could be severely interrupted.  Also, to the extent the number of users of networks utilizing our future products suddenly increases, the technology platform and secure hosting services which will be required to accommodate a higher volume of traffic may result in slower response times or service interruptions.  System interruptions or increases in response time could result in a loss of potential or existing users and, if sustained or repeated, could reduce the appeal of the networks to users.  In addition, users depend on real-time communications; outages caused by increased traffic could result in delays and system failures.  These types of occurrences could cause users to perceive that our solution does not function properly and could therefore adversely affect our ability to attract and retain licensees, strategic partners and customers.
 
System failure or interruption or our failure to meet increasing demands on our systems could harm our business.
 
The success of our license and service offerings will depend on the uninterrupted operation of various systems, secure data centers and other computer and communication networks that we establish.  To the extent the number of users of networks utilizing our future products suddenly increases, the technology platform and hosting services which will be required to accommodate a higher volume of traffic may result in slower response times, service interruptions or delays or system failures.  Our systems and operations will also be vulnerable to damage or interruption from:

 
power loss, transmission cable cuts and other telecommunications failures;
 
 
damage or interruption caused by fire, earthquake, and other natural disasters;
 
 
computer viruses or software defects; and
 
 
physical or electronic break-ins, sabotage, intentional acts of vandalism, terrorist attacks and other events beyond our control.
 
System interruptions or failures and increases or delays in response time could result in a loss of potential or existing users and, if sustained or repeated, could reduce the appeal of the networks to users.  These types of occurrences could cause users to perceive that our solution does not function properly and could therefore adversely affect our ability to attract and retain licensees, strategic partners and customers.
 
Any significant problem with our systems or operations could result in lost revenue, customer dissatisfaction or lawsuits against us.  A failure in the operation of our secure domain name registration system could result in the inability of one or more registrars to register and maintain secure domain names for a period of time.  A failure in the operation or update of the master directory that we plan to maintain could result in deletion or discontinuation of assigned secure domain names for a period of time.  The inability of the registrar systems we establish, including our back office billing and collections infrastructure, and telecommunications systems to meet the demands of an increasing number of secure domain name requests could result in substantial degradation in our customer support service and our ability to process registration requests in a timely manner.
 
Our ability to sell our solutions will be dependent on the quality of our technical support, and our failure to deliver high-quality technical support services could have a material adverse effect on our sales and results of operations.
 
If we do not effectively assist our customers in deploying our products, succeed in helping our customers quickly resolve post-deployment issues and provide effective ongoing support, or if potential customers perceive that we may not be able achieve to the foregoing, our ability to sell our products would be adversely affected, and our reputation with potential customers could be harmed.  In addition, as we expand our operations internationally, our technical support team will face additional challenges, including those associated with delivering support, training and documentation in languages other than English.  Our failure to deliver and maintain high-quality technical support services to our customers could result in customers choosing to use our competitors’ products instead of ours in the future.
 
Telephone carriers have petitioned governmental agencies to enforce regulatory tariffs, which, if granted, would increase the cost of online communication, and such increase in cost may impede the growth of online communication and adversely affect our business.
 
Use of the Internet has over-burdened existing telecommunications infrastructures, and many high traffic areas have begun to experience interruptions in service.  As a result, certain local telephone carriers have petitioned governmental agencies to enforce regulatory tariffs on IP telephony traffic that crosses over their traditional telephone networks.  If the relief sought in these petitions is granted, the costs of communicating via online could increase substantially, potentially adversely affecting the growth in the use of online secure communications.  Any of these developments could have an adverse effect on our business.
 
 
17

 
The departure of Kendall Larsen, our Chief Executive Officer and President, and/or other key personnel could compromise our ability to execute our strategic plan and may result in additional severance costs to us.
 
Our success largely depends on the skills, experience and efforts of our key personnel, including Kendall Larsen, our Chief Executive Officer and President.  We have no employment agreements with any of our key executives that prevent them from leaving us at any time.  In addition, we do not maintain key person life insurance for any of our officers or key employees.  The loss of Mr. Larsen, or our failure to retain other key personnel, would jeopardize our ability to execute our strategic plan and materially harm our business.
 
We will need to recruit and retain additional qualified personnel to successfully grow our business.
 
Our future success will depend in part on our ability to attract and retain qualified operations, marketing and sales personnel as well as engineers.  Inability to attract and retain such personnel could adversely affect our business.  Competition for engineering, sales, marketing and executive personnel is intense, particularly in the technology and Internet sectors and in the regions where our facilities are located.  We can provide no assurance that we will attract or retain such personnel.
 
Risks Related to Our Stock
 
We do not intend to pay regular future dividends on our common stock and thus stockholders must look to appreciation of our common stock to realize a gain on their investments.
 
Although we paid a special cash dividend to holders of our common stock with a record date of July 1, 2010, we do not have any plans to pay regular dividends in the foreseeable future.  Instead, we generally intend to retain future earnings to fund our business plan.  Our future dividend policy is within the discretion of our Board of Directors and will depend upon various factors, including our business, financial condition, results of operations, capital requirements, and investment opportunities.  Accordingly, stockholders must generally look to appreciation of our common stock to realize a gain on their investment.  This appreciation may not occur.
 
The exercise of our outstanding stock options would result in a dilution of our current stockholders' voting power and an increase in the number of shares eligible for future resale in the public market which may negatively impact the market price of our stock.
 
The exercise of our outstanding vested stock options would dilute the ownership interests of our existing stockholders. As of March 31, 2012, we had outstanding options to purchase an aggregate of 4,828,998 shares of common stock (representing 9.7% of our total shares outstanding as of March 31, 2012) of which 3,926,896 are vested and therefore exercisable. To the extent outstanding stock options are exercised, additional shares of common stock will be issued, and such issuance would dilute non-exercising stockholders' percentage voting interests and increase the number of shares eligible for resale in the public market.
 
The fair value of accounting for our Series I Warrants as derivative liabilities may materially impact our results of our operations in future periods.
 
We record the Series I Warrants as a derivative liability in accordance with ASC 815-40, “Derivatives and Hedging – Contracts in Entity’s Own Equity.”  These derivative liabilities are reported at fair value each reporting period with changes in the fair value recognized as gain or loss during each reporting period.  An increase in our share price or measure of our share price volatility, for example, will generally result in an increase in the fair value of our warrant liability and a non-cash charge during the period of such increase, which could materially and negatively impact our results of operations in future periods.
 
Trading in our common shares is limited and the price of our common shares may be subject to substantial volatility, particularly in light of the instability in the financial and capital markets.
 
Our common stock is listed on NYSE Amex, but its daily trading volume has been limited, sporadic and volatile.  Over the past years the market price of our common stock has experienced significant fluctuations.  Between April 1, 2011, and March 31, 2012, the reported last sale price for our common stock ranged between $12.38 and $39.88 per share.  The price of our common stock may continue to be volatile as a result of a number of factors, some of which are beyond our control. These factors include, but not limited to, the following:
 
 
developments in any then-outstanding litigation;
 
 
quarterly variations in our operating results;
 
 
large purchases or sales of common stock;
 
 
actual or anticipated announcements of new products or services by us or competitors;
 
 
general conditions in the markets in which we compete; and
 
 
economic and financial conditions.
 
 
18

 
The market price of our common stock may decline because our operating results may not be consistent and may be difficult to predict.
 
Our reported net income has fluctuated in the past due to several factors. We expect that our future operating results may also fluctuate due to the same or similar factors.  We had a net loss of $12.5 million for the year ended December 31, 2009, a net income of $41.4 million for the year ended December 31, 2010, and we have had a net loss of $17.3 million for the year ended December 31, 2011.  The following include some of the factors that may cause our operating results to fluctuate:
 
 
the outcome of enforcement actions currently in progress or that we may undertake in the future, and the timing thereof;
 
the amount and timing of receipt of license fees from potential infringers, licensees or customers;
 
the outcome of actions we have taken and may take in the future to enforce our intellectual property rights;
 
the rate of adoption of our patented technologies;
 
the number of new license arrangements we may execute, or that may expire, within a particular period and the scope of those licenses, including the number of our patents which are licensed, the extent of prior infringement of our patent rights, royalty rates, timing of payment obligations, expiration date etc;
 
the success of a licensee in selling products that use our patented technologies; and
 
the amount and timing of expenses related to our patent filings and enforcement proceedings, including litigation, related to our intellectual property rights.
 
These fluctuations may make our business particularly difficult to manage, adversely affect our business and operating results, make our operating results difficult for investors to predict and, further, cause our results to fall below investor’s expectations and adversely affect the market price of our common stock.
 
Because ownership of our common stock is concentrated, investors may have limited influence on stockholder decisions.
 
As of March 31, 2012, our executive officers and directors beneficially owned approximately 21% of our then outstanding common stock.  In addition, a group of stockholders that, as of December 31, 2007, held 4,766,666 shares, or approximately 12%, of our then outstanding common stock, have entered into a voting agreement with us that requires them to vote all of their shares of our voting stock in favor of the director nominees approved by our Board of Directors at each director election going forward, and in a manner that is proportional to the votes cast by all other voting shares as to any other matters submitted to the stockholders for a vote.  However, we cannot be certain how many shares of our common stock this group of stockholders currently owns.  Because of their beneficial ownership interest, our officers and directors could significantly influence stockholder actions of which you disapprove or that are contrary to your interests.  This ability to exercise significant influence could prevent or significantly delay another company from acquiring or merging with us.
 
Our protective provisions could make it difficult for a third party to successfully acquire us even if you would like to sell your stock to them.
 
We have a number of protective provisions that could delay, discourage or prevent a third party from acquiring control of us without the approval of our Board of Directors.  Our protective provisions include:
 
 
A staggered Board of Directors: This means that only one or two directors (since we have a five-person Board of Directors) will be up for election at any given annual meeting.  This has the effect of delaying the ability of stockholders to effect a change in control of us because it would take two annual meetings to effectively replace a majority of the Board of Directors.
 
 
Blank check preferred stock: Our Board of Directors has the authority to establish the rights, preferences and privileges of our 10,000,000 authorized, but unissued, shares of preferred stock.  Therefore, this stock may be issued at the discretion of our Board of Directors with preferences over your shares of our common stock in a manner that is materially dilutive to you.  In addition, blank check preferred stock can be used to create a “poison pill” which is designed to deter a hostile bidder from buying a controlling interest in our stock without the approval of our Board of Directors.  We have not adopted such a “poison pill;” but our Board of Directors has the ability to do so in the future, very rapidly and without stockholder approval.
 
 
Advance notice requirements for director nominations and for new business to be brought up at stockholder meetings: Stockholders wishing to submit director nominations or raise matters to a vote of the stockholders must provide notice to us within very specific date windows and in very specific form in order to have the matter voted on at a stockholder meeting.  This has the effect of giving our Board of Directors and management more time to react to stockholder proposals generally and could also have the effect of disregarding a stockholder proposal or deferring it to a subsequent meeting to the extent such proposal is not raised properly.
 
 
No stockholder actions by written consent: No stockholder or group of stockholders may take actions rapidly and without prior notice to our Board of Directors and management or to the minority stockholders.  Along with the advance notice requirements described above, this provision also gives our Board of Directors and management more time to react to proposed stockholder actions.
 
 
Super majority requirement for stockholder amendments to the By-laws: Stockholder proposals to alter or amend our By-laws or to adopt new By-laws can only be approved by the affirmative vote of at least 66 2/3% of the outstanding shares of our common stock.
 
 
No ability of stockholders to call a special meeting of the stockholders: Only the Board of Directors or management can call special meetings of the stockholders.  This could mean that stockholders, even those who represent a significant percentage of our shares of common stock, may need to wait for the annual meeting before nominating directors or raising other business proposals to be voted on by the stockholders.
 
In addition, the provisions of Section 203 of the Delaware General Corporate Law govern us.  These provisions may prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us for a certain period of time.
 
These and other provisions in our amended and restated certificate of incorporation, our By-laws and under Delaware law could discourage potential takeover attempts, reduce the price that investors might be willing to pay for shares of our common stock in the future and result in the market price being lower than it would be without these provisions.
 
 
 
19

 

There were no sales of unregistered securities during the three months ended March 31, 2012.


None.


Not applicable.


None.
 
 
20

 
 
 
Exhibit Number
 
Description
10.1+
 
VirnetX Holding Corporation Fiscal 2012 Director Compensation Program.
10.2+
 
VirnetX Holding Corporation 2007 Stock Plan.
10.3+
 
Form of VirnetX Holding Corporation 2007 Stock Plan Restricted Stock Unit Award Agreement.
10.4+
 
Employment Offer Letter from VirnetX, Inc. to Richard H. Nance.
31.1
 
Certification of the President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
 
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*
 
Certification of the President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*
 
Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101**
 
Interactive Data Files
 
+
Denotes a management contract or compensatory plan or arrangement.
*
This exhibit is furnished herewith, but not deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability under that section. Such certifications will not be deemed to be incorporated by reference in any filing under the Securities Act or the Exchange Act, except to the extent that we explicitly incorporate them by reference.
 
 
21

 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
VIRNETX HOLDING CORPORATION
 
 
 
 
 
By:
  /s/ Kendall Larsen
 
 
Name
Kendall Larsen
       
 
 
Title
Chief Executive Officer (Principal Executive Officer)
 
 
 
 
 
By:
  /s/ Richard Nance
 
 
Name
Richard H. Nance
       
 
 
Title
Chief Financial Officer (Principal Financial Officer and
 
 
 
Principal Accounting Officer)
Date: May 10, 2012
 
 
 
 
 
22

 
 
Exhibit Number
 
Description
 
VirnetX Holding Corporation Fiscal 2012 Director Compensation Program.
 
VirnetX Holding Corporation 2007 Stock Plan.
 
Form of VirnetX Holding Corporation 2007 Stock Plan Restricted Stock Unit Award Agreement.
 
Employment Offer Letter from VirnetX, Inc. to Richard H. Nance.
 
Certification of the President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
Certification of the President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101**
 
Interactive Data Files
 
+
Denotes a management contract or compensatory plan or arrangement.
*
This exhibit is furnished herewith, but not deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability under that section. Such certifications will not be deemed to be incorporated by reference in any filing under the Securities Act or the Exchange Act, except to the extent that we explicitly incorporate them by reference.
 
 
 23

XASE:VHC VirnetX Holding Corp Quarterly Report 10-Q Filling

VirnetX Holding Corp XASE:VHC Stock - Get Quarterly Report SEC Filing of VirnetX Holding Corp XASE:VHC stocks, including company profile, shares outstanding, strategy, business segments, operations, officers, consolidated financial statements, financial notes and ownership information.

XASE:VHC VirnetX Holding Corp Quarterly Report 10-Q Filing - 3/31/2012
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