Item 1. FINANCIAL STATEMENTS |
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Pasw, Inc - Recent Material Event
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PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VirnetX Holding Corporation
(a development stage enterprise) CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
The accompanying notes are an integral part of these financial statements.
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VirnetX Holding Corporation
(a development stage enterprise) CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
The accompanying notes are an integral part of these financial statements.
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VirnetX Holding Corporation
(a development stage enterprise) CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
((Unaudited)
The accompanying notes are an integral part of these financial statements.
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VirnetX Holding Corporation
(a development stage enterprise) CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
The accompanying notes are an integral part of these financial statements.
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1. General
Certain information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the United States have been
condensed or omitted. Results of operations for the interim periods presented are not necessarily
indicative of results which may be expected for any other interim period or for the year as a
whole. The information contained in this Form 10-QSB should be read in conjunction with audited
financial statements and related notes for the year ended 2006 which are contained in the Company’s
Annual Report on Form 10-KSB filed with the Securities and Exchange Commission (the “SEC”) on April
2, 2007.
The accompanying unaudited interim financial statements include all adjustments (consisting or
normal recurring accruals) which are, in the opinion of management, necessary to a fair statement
of the results for the interim periods presented. These financial statements should be read in
conjunction with the financial statements and related notes thereto on our Annual Report on Form
10-KSB for the year ended December 31, 2006.
These financial statements have been prepared under the assumption that we will be able to
continue as a going concern. In the event that we are unable to achieve or sustain profitability
or are otherwise unable to secure external financing, we may not be able to meet our obligations as
they come due, raising substantial doubts as to our ability to continue as a going concern. Any
such inability to continue as a going concern may result in our security holders losing their
entire investment. Our financial statements, which have been prepared in accordance with generally
accepted accounting principles, contemplate that we will continue as a going concern and do not
contain any adjustments that might result if we were unable to continue as a going concern. Our
historical net losses and our 2007 cash flow from operations deficiency raise substantial doubt as
to our ability to continue as a going concern. Also, changes in our operating plans, our existing
and anticipated working capital needs, the acceleration or modification of our expansion plans,
lower than anticipated revenues, increased expenses, potential acquisitions or other events will
all affect our ability to continue as a going concern.
2. Formation and Business of the Company
VirnetX Holding Corporation (“We” “Our” or the “Company”), formerly PASW, Inc., which was
formerly Pacific Softworks, Inc., was incorporated in California in November 1992. We were
reincorporated in Delaware in May 2007. Prior to ceasing the last of our operations in January
2003, the Company was engaged in developing and licensing software that enabled internet- and
web-based communications. As of January 31, 2003, we had sold all of our operating assets, and
since such time our only source of revenue has been nominal royalties payable to us through our
wholly-owned Japanese subsidiary, Network Research Corp. Japan, Ltd. (“NRCJ”) pursuant to the terms
of a single license agreement. On July 5, 2007, the company consummated a merger transaction with
VirnetX, Inc. pursuant to which VirnetX, Inc. became a wholly owned subsidiary of the company.
VirnetX, Inc. is a development-stage company that is engaged in developing products for “real-time”
communications such as instant messaging and Voice over Internet Protocol, commercializing its
patent portfolio and providing contract research, prototyping, systems integration and technical
services.
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As of September 30, 2007 the Company had eight full-time employees and one part-time employee.
The Company’s issued and pending patents were acquired from SAIC, a systems, solutions and
technical services company based in San Diego, California, in 2005. VirnetX has granted SAIC a
limited license under these patents, but retains all right title and interest within the field of
secure communications in the following areas: Virtual Private Networks; Secure Voice Over Internet
Protocol; Electronic Mail (E-mail); Video Conferencing; Communications Logging; Dynamic Uniform
Resource Locators; Denial of Service; Prevention of Functional Intrusions; IP Hopping; Voice
Messaging and Unified Messaging; Live Voice and IP PBXs; Voice Web Video Conferencing and
Collaboration; Instant Messaging; Minimized Impact of Viruses; and Secure Session Initiation
Protocol. The Field of Use is not limited by any predefined transport mode or medium of
communication (e.g., wire, fiber, wireless, or mixed medium).
The Company is in the development stage and consequently, the Company is subject to the risks
associated with development stage companies, including the need for additional financings; the
uncertainty of the Company’s intellectual property resulting in successful commercial products as
well as the marketing and customer acceptance of such products; competition from larger
organizations; dependence on key personnel; uncertain patent protection; and dependence on
corporate partners and collaborators. To achieve successful operations, the Company may require
additional capital to continue research and development and marketing efforts. No assurance can be
given as to the timing or ultimate success of obtaining future funding.
These financial statements are prepared on a going concern basis that contemplates the
realization of assets and discharged liabilities in the normal course of business. The Company has
incurred net operating losses and negative cash flows from operations. At September 30, 2007, the
Company had a deficit accumulated in the development stage of $6,862,013. In order to continue its
operations, the Company must achieve profitable operations or obtain additional financing.
Management is currently pursuing financing alternatives, including private equity or debt
financing, collaborative or other arrangements with corporate partners or other sources. There can
be no assurance, however, that such a financing will be successfully completed on terms acceptable
to the Company. The financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
3. Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reported period. Actual results could differ from those estimates.
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Principles of Consolidation
The condensed consolidated financial statements include the accounts of the VirnetX Holding
Company and its wholly owned subsidiaries, VirtnetX, Inc., Alera and National Research Corporation,
Japan (NCRJ). All intercompany transactions have been eliminated.
These financial statements reflect the historical results of VirnetX, Inc. and subsequent to
the merger date of July 5, 2007, the operations of VirnetX Holding Corporation.
Revenue Recognition
We are a licensor of software and generate revenue primarily from the one-time sales of
licensed software. Generally, revenue is recognized upon shipment of the licensed software. For
multiple element license arrangements, the license fee is allocated to the various elements based
on fair value. When a multiple element arrangement includes rights to a post-contract customer
support, the portion of the license fee allocated to each function is recognized ratably over the
term of the arrangement.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with original maturities of
three months or less to be cash equivalents.
Property and Equipment
Property and equipment are stated at historical cost, less accumulated depreciation and
amortization. Depreciation and amortization are computed using the straight line method over the
estimated useful lives of the assets, which range from five to seven years. Repair and maintenance
costs are charged to expense as incurred.
Concentration of Credit Risk and Other Risks and Uncertainties
The Company’s cash and cash equivalents are primarily maintained at one financial institution
in the United States. Deposits held with this financial institution may exceed the amount of
insurance provided on such deposits. The balances are insured by the Federal Deposit Insurance
Corporation up to $100,000. During the nine months ended September 30, 2007 the Company had, at
times, funds that were uninsured. The Company has not experienced any losses on its deposits of
cash and cash equivalents.
Impairment of Long-Lived Assets
The Company identifies and records 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.
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Comprehensive Income (Loss)
The Company reports comprehensive income (loss) in accordance with the provisions of Statement
of Financial Accounting Standards No. 130, Reporting Comprehensive Income, which establishes
standards for reporting comprehensive income (loss) and its components in the financial statements.
Comprehensive income consists primarily of foreign currency gains or losses on assets denominated
in Japanese yen.
Research and Development
Research and development costs include expenses paid to outside development consultants and
compensation related expenses for our engineering staff. Research and development costs are
expensed as incurred.
Income Taxes
The Company accounts for income taxes under the liability method. Under this method, deferred
tax assets and liabilities are determined based on the difference between the financial statement
and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the
differences are expected to affect taxable income. Valuation allowances are established when
necessary to reduce deferred tax assets to the amounts expected to be realized.
Effective January 1,2007, the Company has adopted FASB Interpretation No. 48 (“FIN 48”), Accounting
for Uncertainty in Income Taxes. (see note 6)
Fair Value of Financial Instruments
Carrying amounts of the Company’s financial instruments, including cash and cash equivalents,
accounts payable, notes payable, accrued liabilities and approximate their fair values due to their
short maturities.
Stock-Based Compensation
The Company accounts for share-based compensation in accordance with Statement of Financial
Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which requires
the measurement and recognition of compensation expense in the statement of operations for all
share-based payment awards made to employees and directors including employee stock-options based
on estimated fair values. Using the modified retrospective transition method of adopting SFAS
123(R), the herein financial statements presented reflect compensation expense for stock-based
awards as if the provisions of SFAS 123R had been applied from the date of inception.
Earnings Per Share
SFAS No. 128, “Earnings Per Share” requires presentation of basic earnings per share (“Basic EPS”)
and diluted earnings per share (“Diluted EPS”). Basic earnings per share is 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
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dividing net income by the weighted average number of share outstanding including potentially
dilutive securities such as options, warrants and convertible debt. Since we incurred a loss for
the period, any common stock equivalents have been excluded, because their effect would be
anti-dilutive.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157 “Fair Value Measurements” (“SFAS 157”), which
defines fair value, establishes a framework for measuring fair value in generally accepted
accounting principles, and expands disclosures about fair value measurements. SFAS 157 is effective
in fiscal years beginning after November 15, 2007.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The
Fair Value Option for Financial Assets and Liabilities” (“SFAS 159”). SFAS 159 provides entities
with the option to report selected financial assets and liabilities at fair value. Business
entities adopting SFAS 159 will report unrealized gains and losses in earnings at each subsequent
reporting date on items for which fair value option has been elected. SFAS 159 establishes
presentation and disclosure requirements designed to facilitate comparisons between entities that
choose different measurement attributes for similar types of assets and liabilities. SFAS 159
requires additional information that will help investors and other financial statement users to
understand the effect of an entity’s choice to use fair value on its earnings. SFAS 159 is
effective for fiscal years beginning after November 15, 2007, with earlier adoption permitted. The
Company is currently assessing the impact that the adoption of SFAS 159 may have on our financial
position, results of operations or cash flows.
4. Property and Equipment, net
Depreciation and amortization expense was $12,425, and $1,590 for the nine months ended
September 30, 2007 and September 30, 2006, respectively.
5. Convertible Notes Payable
During February 2007 the Company obtained bridge financing in the form of notes payable
convertible into common stock upon the merger between VirnetX Holding Corporation and VirnetX, Inc.
In February 2007, VirnetX, Inc. received a loan of $500,000 from several of its Series A
preferred stock shareholders. The notes had an annual interest rate of 6% and the principal and
accrued interest thereon converted into shares of the Company’s common stock at $0.25 per share
upon the closing of the merger between VirnetX Holding Corporation and VirnetX, Inc.
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In February 2007, VirnetX, Inc. received another loan from a new investor for $1,000,000.
This note had an annual interest rate of 10% payable monthly. Of the $1,000,000 proceeds, the
Company was obligated to use $350,000 to be deposited as a retainer for legal counsel. This
$350,000 is classified as prepaid expenses and other current assets on the Company’s September 30,
2007 balance sheet. The interest on this note was paid in cash and the principal was converted
into shares of the Company’s common stock at $0.25 per share upon the closing of the merger between
VirnetX Holding Corporation and VirnetX, Inc. This investor purchased an additional $3,000,000 of
the Company’s common stock at $0.25 per share upon the closing of the merger between VirnetX
Holding Corporation and VirnetX, Inc. This $3,000,000 was placed into escrow and subsequently
remitted to the Company upon the close of the merger.
On June 28, 2007, VirnetX, Inc. borrowed $50,000 on a short-term note from the same investor
who loaned VirnetX, Inc. the $1,000,000 mentioned above. This note has an annual interest rate of
10% payable monthly. This loan plus accrued interest was repaid on July 10, 2007.
6. Income Taxes
As discussed in note 3, the Company adopted FIN 48 effective January 1, 2007. FIN 48 requires
that companies recognize in their financial statements, the impact of a tax position, if that
position is more likely than not of being sustained on audit. We do not believe that the Company
has any material uncertain positions that require measurement or recognition in the financial
statements.
The Company has had significant net operating loss carryforwards from both VirnetX and VirnetX
Holding Coporation (formerly PASW) Upon the merger, the net operating losses will be limited to
realized income from the subsidiary. As of September 30, 2007, all net operating loss
carryforwards have been fully reserved due to doubtful realization.
7. Commitments
Operating Lease Agreements
The Company leases its office space under a noncancelable operating lease that expires in
April 2008. The Company recognizes rent expenses on a straight-line basis over the lease period.
Future minimum facility lease payments at September 30, 2007 are as follows:
Rent expense was $11,194, and $4,478 for the nine months ended September 30, 2007 and
September 30, 2006, respectively.
Patent Assignment Agreement with SAIC
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The Company’s patents are based on patents originally acquired from SAIC. VirnetX, Inc.
acquired these patents from SAIC pursuant to the Assignment Agreement by and between VirnetX, Inc.
and SAIC, dated December 21, 2006, and certain other related agreements. Under the terms of these
agreements, the Company will pay SAIC a minimum guaranteed royalty of $50,000 annually beginning in
July, 2008. In addition, the Company will pay to SAIC royalties in the amount of 15% of gross
revenues up to a maximum amount of $35,000,000 less any amounts already paid by the Company to
SAIC. As of September 30, 2007 no payments had been made to SAIC under the terms of these
agreements.
Our business depends on the Company’s rights to and under the patents, which were assigned to
VirentX, Inc. by SAIC. The Company’s agreements with SAIC impose obligations on them, such as
payment obligations. If SAIC believes that the Company has failed to meet these obligations, SAIC
could seek to limit or reacquire the assigned patent rights, which could lead to costly and
time-consuming litigation and, potentially, a loss of the Company’s rights in the patents. During
the period of any such litigation, the Company’s ability to carry out the development and
commercialization of potential products could be significantly and negatively affected. If the
Company’s rights in their patents were restricted or ultimately lost, their ability to continue the
business based on the affected technology platform could be severely, adversely affected.
The Company granted SAIC a security interest in the Company’s intellectual property, including
their patents to secure their payment obligations to SAIC described above.
8. Preferred Stock
The Company’s Amended and Restated Certificate of Incorporation, as amended in October 2007,
authorizes the Company to issue 10,000,000 shares of $0.0001 par value per share preferred stock
having rights, preferences and privileges to be designated by the Board of Directors of the
Company. There were no shares of preferred stock outstanding at September 30, 2007. All of the
VirnetX, Inc. preferred stock converted into VirnetX, Inc. common stock on a 1-for-1 basis
immediately prior to the merger between VirnetX Holding Corporation and VirnetX, Inc. The VirnetX,
Inc. preferred stock outstanding at December 31, 2006 consisted of the following:
9. Common Stock
Each share of common stock has the right to one vote. The holders of common stock are also
entitled to receive dividends whenever funds are legally available and when declared by the Board
of Directors, subject to the prior rights of holders of all classes of stock outstanding having
priority rights as to dividends. No dividends have been declared by the Board from inception
through September 30, 2007. The Company’s Amended and Restated Certificate of Incorporation, as
amended in October 2007, authorizes the Company to issue 100,000,000 shares
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of $0.0001 par value per share common stock.. All share amounts have been restated to reflect
a 1 for 3 reverse stock split effective October 29, 2007.
In August 2005, the Company issued 1,066,667 shares of common stock to founders at $0.0001875
per share for aggregate proceeds of $200.
The Company has also issued Restricted Stock Units (“RSUs”) to employees and consultants as
discussed in Note 10.
10. Stock Plan
In 2005, VirnetX, Inc. adopted the 2005 Stock Plan (the “Plan”), which was assumed by the
Company upon the closing of the merger between VirnetX Holding Corporation and VirnetX, Inc. on
July 5, 2007. The Plan provides for the granting of stock options and restricted stock units to
employees and consultants of the Company. Stock options granted under the Plan may be either
incentive stock options or nonqualified stock options. Incentive stock options (“ISO”) may be
granted only to Company employees (including officers and directors who are also employees).
Nonqualified stock options (“NSO”) may be granted to Company employees and consultants. The
Company has reserved 933,333 shares of common stock for issuance under the Plan. The Company
received proceeds of $80 and $24 from the issuance of 266,667 and 78,333 shares of restricted stock
units during the years ended December 31, 2006 and 2005, respectively.
Options under the Plan may be granted for periods of up to ten years and at prices no less
than 85% of the estimated fair value of the shares on the date of grant as determined by the Board
of Directors, provided, however, that the exercise price of an ISO and NSO shall not be less than
100% and 85% of the estimated fair value of the shares on the date of grant, respectively, and the
exercise price of an ISO and NSO granted to a 10% stockholder shall not be less than 110% of the
estimated fair value of the shares on the date of grant.
The Company had during the year ended December 31, 2006 restricted stock units granted for
6,667 shares that had been approved by the Board of Directors, but not signed by the restricted
stock holders. Accordingly, these shares have been reflected to reduce shares available for grant.
The unamortized stock based compensation expense related to restricted stock units at September
30, 2007 was $102,739 which will be recognized over approximately the next three years.
During May 2007, options were exercised to purchase 6,667 shares of common stock for proceeds
to the Company of $20,000.
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Activity under the Plan is as follows:
11. Stock-Based Compensation
The Company accounts for equity instruments issued to employees in accordance with the
provisions of SFAS 123R which requires that such equity instruments are recorded at their fair
value on the grant date. The future expensing of stock-based compensation is subject to periodic
adjustments as the underlying equity instruments vest.
At September 30, 2007, September 30, 2006 and December 31, 2006, the fair value of common
stock was $4.53 per share, $3.00 per share and $3.00 per share, respectively. The Company has
recorded $348,572, $191,414, and $1,360,321 in employee stock-based compensation expense for the
nine months ended September 30, 2007 and September 30, 2006 and for the period from August 2, 2005
(date of inception) to September 30, 2007, respectively.
The Company elected to adopt the modified retrospective application method as provided by SFAS
No. 123(R) and accordingly, financial statement amounts for the periods presented herein reflect
results as if the fair value method of expensing equity awards had been applied from the date of
inception. The effect of recording stock-based compensation was as follows:
As the Company has provided for a full valuation allowance against deferred tax assets, there
is no anticipated tax effect of stock-based compensation expense.
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As of September 30, 2007, the unrecorded deferred stock-based compensation balance related to
stock options was $4,517,813, which will be recognized over an estimate weighted average
amortization period of approximately 3.5 years.
The fair value of each option grant was estimated on the date of grant using the following
assumptions:
An aggregate of 1,347,899 options have been granted from January 1, 2007 to September 30,
2007.
The expected life was determined using the simplified method outlined in Staff Accounting
Bulletin No. 107 (“SAB 107”), taking the average of the vesting term and the contractual term of
the option. Expected volatility of the stock options was based upon historical data and other
relevant factors, such as the volatility of comparable publicly-traded companies at a similar stage
of life cycle. The Company has not provided an estimate for forfeitures because the Company has no
history of forfeited options and believes that all outstanding options at September 30, 2007 will
vest. In the future, the Company may change this estimate based on actual and expected future
forfeiture rates. An aggregate of 1,347,899 options have been granted in 2007.
The following table summarizes activity under the equity incentive plans for the indicated
periods:
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