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EX-32.1 - CERTIFICATION - VirnetX Holding Corpvirnetx_10q-ex3201.htm
EX-31.1 - CERTIFICATION - VirnetX Holding Corpvirnetx_10q-ex3101.htm
EX-31.2 - CERTIFICATION - VirnetX Holding Corpvirnetx_10q-ex3102.htm
EX-10.1 - ENGAGEMENT LETTER - VirnetX Holding Corpvirnetx_10q-ex1001.htm
EX-32.2 - CERTIFICATION - VirnetX Holding Corpvirnetx_10q-ex3202.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q

þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the quarterly period ended March 31, 2010
   
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-33852
 
VirnetX Holding Corporation
(Exact name of registrant as specified in its charter)
 
Delaware
 
77-0390628
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
     
5615 Scotts Valley Drive, Suite 110
   
Scotts Valley, California
 
95066
(Address of Principal Executive Offices)
 
(Zip Code)

(831) 438-8200
(Registrant’s Telephone Number, Including Area Code)
 
Not applicable
(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  R  No  £
 
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  £  No  £
 
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  £
Accelerated filer  £
Non-accelerated filer  £
Smaller reporting company  R
    (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  £  No  R
 
The number of shares outstanding of the Registrant’s Common Stock as of May 3, 2010 was 43,704,663.
 


 
 
 
 
 
VIRNETX HOLDING CORPORATION
 
INDEX
 
  Page
   
 
PART I — FINANCIAL INFORMATION
   
Item 1.  Financial Statements (Unaudited) 3
   
Condensed Consolidated Balance Sheets at March 31, 2010 and December 31, 2009 3
   
Condensed Consolidated Statements Of Operations for the three months ended March 31, 2010 and 2009 4
   
Condensed Consolidated Statements Of Cash Flows for the three months ended March 31, 2010 and 2009 5
   
Notes to Condensed Consolidated Financial Statements 6
   
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations 11
   
Item 3.  Quantitative and Qualitative Disclosures About Market Risk  15
   
Item 4.  Controls and Procedures  15
   
PART II — OTHER INFORMATION
   
Item 1.  Legal Proceedings  15
   
Item 1A.  Risk Factors 16
   
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds 31
   
Item 6.  Exhibits  32
   
Signatures 33
 
 
 
 
 
2

 

PART I — FINANCIAL INFORMATION
 
ITEM 1.  — FINANCIAL STATEMENTS.
 
VIRNETX HOLDING CORPORATION
(a development stage enterprise)
CONDENSED CONSOLIDATED BALANCE SHEETS
 
   
March 31,
2010
   
December 31,
2009
 
   
(Unaudited)
       
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 4,551,737     $ 2,011,470  
Accounts receivable, net
    12,593       6,842  
Prepaid expense and other current assets
    71,043       43,863  
Total current assets
    4,635,373       2,062,175  
Property and equipment, net
    22,166       23,430  
Intangible and other assets
    144,000       156,000  
Total assets
  $ 4,801,539     $ 2,241,605  
 
 
 
       
 
           
Current liabilities:             
Accounts payable and accrued liabilities
  $ 2,165,184     $ 4,478,325  
Current portion of long-term obligation
    36,000       40,000  
Total current liabilities
    2,201,184       4,518,325  
Long-term obligation, net of current portion
    84,000       120,000  
Commitments and contingencies
               
Stockholders’ equity (deficit):
               
Preferred stock, par value $0.0001 per share
               
Authorized: 10,000,000 shares; issued and outstanding: 0 shares at March 31, 2010 and December 31, 2009, respectively
               
Common stock, par value $0.0001 per share
               
Authorized: 100,000,000 shares; issued and outstanding:
               
43,698,414 shares at March 31, 2010 and 39,750,927 at December 31, 2009, respectively
    4,370       3,975  
Additional paid-in capital
    43,098,935       33,730,217  
Deficit accumulated during the development stage
    (40,586,950 )     (36,130,912 )
Total stockholders’ equity (deficit)
    2,516,355       (2,396,720 )
Total liabilities and stockholders’ equity (deficit)
  $ 4,801,539     $ 2,241,605  
 
 
See accompanying notes to condensed consolidated financial statements
 
 
 
 
 
3

 
 
VIRNETX HOLDING CORPORATION
(a development stage enterprise)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
 
   
Three Months
Ended
March 31, 2010
   
Three Months
Ended
March 31, 2009
   
For the period
August 2, 2005
(Date of Inception)
to March 31,
2010
 
Revenue royalties
  $ 20,769     $ 3,154     $ 255,685  
Operating expense:
                       
Research and development
    522,235       221,699       3,526,120  
General and administrative
    3,955,885       3,186,690       37,436,826  
Total operating expense
    (4,478,120 )     (3,408,389 )     (40,962,946 )
Loss from operations
    (4,457,351 )     (3,405,235 )     (40,707,261 )
Interest and other income, net
    1,313       2,227       120,311  
Net loss
  $ (4,456,038 )   $ (3,403,008 )   $ (40,586,950 )
Basic and diluted loss per share
  $ (0.11 )   $ (0.09 )        
Weighted average shares outstanding
    40,095,183       37,016,763          
 
 
See accompanying notes to condensed consolidated financial statements
 
 
 
 
 
 
4

 
 
VIRNETX HOLDING CORPORATION
(a development stage enterprise)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
   
Three Months
Ended
March 31, 2010
   
Three Months
Ended
March 31, 2009
   
Cumulative Period from
August 2, 2005
(Date of Inception)
to March 31, 2010
 
Cash flows from operating activities:
                 
Net loss
  $ (4,456,038 )   $ (3,403,008 )     (40,586,950 )
Adjustments to reconcile net loss to net cash used in operating activities:
                       
Stock-based compensation
    789,401       683,784       8,334,167  
Depreciation and amortization
    14,868       15,670       172,902  
Changes in assets and liabilities:
                       
Receivables and other current assets
    (32,931 )     (5,502 )     (193,131 )
Other assets
    ----       ----       94,263  
Accounts payable and accrued liabilities
    (2,313,141 )     454,018       2,165,392  
Net cash used in operating activities
    (5,997,841 )     (2,255,038 )     (30,013,357 )
Cash flows from investing activities:
                       
Purchase of property and equipment
    (1,603 )           (86,030 )
Cash acquired in acquisition
                14,009  
Net cash used in investing activities
    (1,603 )           (72,021 )
Cash flows from financing activities:
                       
Issuance of notes payable
                250,000  
Repayment of notes payable
                (250,000 )
Proceeds from issuance of preferred stock, net of issuance costs
                1,147,625  
Proceeds from issuance of restricted stock
                2,180  
Proceeds from advance from preferred stockholders
                230,000  
Proceeds from exercise of options
                30,000  
Proceeds from convertible debt
                1,500,000  
Payment of royalty obligation less imputed interest
    (40,000 )     (44,000 )     (132,000 )
Proceeds from sale of common stock
    8,579,711       3,367,925       31,859,310  
Net cash provided by financing activities
    8,539,711       3,323,925       34,637,115  
Net increase in cash and cash equivalents
    2,540,267       1,068,887       4,551,737  
Cash and cash equivalents, beginning of period
    2,011,470       457,155        
Cash and cash equivalents, end of period
  $ 4,551,737     $ 1,526,042     $ 4,551,737  
Supplemental disclosure of cash flow information:
                       
Cash paid during the period for taxes
  $ ----     $ 2,173     $ 12,174  
Cash paid during the period for interest
  $ 10,000     $ 6,000     $ 63,252  
Supplemental disclosure of noncash investing and financing activities:
                       
Conversion of advance into preferred stock
  $     $     $ 230,000  
Royalty obligation assumed to obtain intangible assets
  $     $     $ 252,000  

See accompanying notes to condensed consolidated financial statements
 
 
 
5

 
 
VIRNETX HOLDING CORPORATION
(a development stage enterprise)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 1 — Basis of Presentation
 
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) 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 accompanying unaudited interim financial statements include all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation.  The information contained in this quarterly report on Form 10-Q should be read in conjunction with the audited financial statements and related notes for the year ended December 31, 2009 which are contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”), on March 30, 2010.
 
These financial statements are prepared on a going concern basis that contemplates the realization of assets and discharge of liabilities in the normal course of business.  We have incurred net operating losses and negative cash flows from operations.  At March 31, 2010, we had a deficit accumulated in the development stage of $40,586,950.  Management believes that the cash balance at March 31, 2010 will be insufficient to fund our operations for longer than through the end of our third quarter of 2010.  The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.
 
Note 2 — Formation and Business of the Company
 
VirnetX Holding Corporation (“we,” “us,” “our” or the “Company”) are a development stage company focused on commercializing a patent portfolio for providing solutions for secure real-time communications such as instant messaging, or “IM,” and voice over internet protocol, or “VoIP.”
 
In July 2007 we effected a merger between PASW, Inc., a company which had at the time of the merger, publicly traded common stock with limited operations, and VirnetX, Inc., which became our principal operating subsidiary. As a result of this merger, the former security holders of VirnetX, Inc. came to own a majority of our outstanding common stock.
 
Under GAAP, the accompanying financial statements  have been prepared as if VirnetX, Inc., a company whose inception date was August 2, 2005, who is our predecessor for accounting purposes, had acquired PASW, Inc. on July 5, 2007.  Accordingly, the accompanying statement of operations includes the operations of VirnetX, Inc. from August 2, 2005 to December 31, 2009 and the operations of PASW, Inc. from July 5, 2007 to December 31, 2009.  The historical share activity of VirnetX, Inc. has been retroactively restated to account for the 12.454788 to one exchange rate which was applicable to certain convertible instruments as explained in Note 10 and Note 11 and for our one for three reverse stock split which was implemented on October 29, 2007.
 
Our principal business activities to date are our efforts to commercialize our patent portfolio.  We also conduct the remaining activities of PASW, Inc., which are generally limited to the collection of royalties on certain internet-based communications by a wholly owned Japanese subsidiary of PASW pursuant to the terms of a single license agreement.  The revenue generated by this agreement is not significant and we expect the revenue from this license to decrease substantially in the future.
 
Although we believe we may derive revenues in the future from our principal patent portfolio and are currently endeavoring to develop certain of those patents into marketable products, we have not done so to date.  As such, we are in the development stage and consequently are subject to the risks associated with development stage companies, including the need for additional financings, the uncertainty that our licensing program development efforts will produce revenue-bearing licenses for us, the uncertainty that our development initiatives will produce successful commercial products as well as the uncertainty of marketing and customer acceptance of such products.
 
These financial statements have been prepared on the basis that the Company will continue as a going concern. The going concern assumption contemplates the realization of assets and discharge of liabilities in the normal course of business.  We have incurred net operating losses and negative cash flows from operations.  At March 31, 2010, we had a deficit accumulated in the development stage of approximately $40,586,950. Management is anticipates incurring net losses, continued negative cash flows from operations and a continued working capital deficit during 2010.  These conditions and the uncertainty of the Microsoft litigation raise substantial doubt as to our ability to continue as a going concern. These consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary if we are unable to continue as a going concern.
 
 
6

 

Note 3 — Earnings Per Share
 
Basic earnings per share is based on the weighted average number of shares outstanding for a period.  Diluted earnings per share is based upon the weighted average number of shares and potentially dilutive common shares outstanding.  Potential common shares outstanding principally include warrants, restricted stock and stock options under our stock plan.  Since the Company has incurred losses, the effect of any common stock equivalent would be anti-dilutive.

Note 4 — Patent Portfolio
 
As of March 31, 2010, we had 12 issued U.S. and eight issued foreign technology related patents, in addition to pending U.S. and foreign patent applications.  The terms of our issued U.S. and foreign patents run through the period 2019 to 2024.  Most of our issued patents were acquired by our principal operating subsidiary, VirnetX, Inc., from Science Applications International Corporation, or SAIC, pursuant to an Assignment Agreement dated December 21, 2006, and a Patent License and Assignment Agreement dated August 12, 2005, as amended on November 2, 2006, including documents prepared pursuant to the November amendment, and as further amended on March 12, 2008.  We are required to make payments to SAIC based on the revenue generated from our ownership or use of the patents assigned to us by SAIC.  Minimum annual royalty payments of $50,000 began  in 2008 and are current as of March 31, 2010.  Royalty amounts vary depending upon the type of revenue generating activities, and certain royalty categories are subject to maximums and other limitations.  SAIC is entitled to receive a portion of the proceeds from revenues, monies or any form of consideration paid for the acquisition of VirnetX or from the settlement of certain patent infringement claims of ours.  We have granted SAIC a security interest in some of our intellectual property, including the patents and patent applications we obtained from SAIC, to secure these payment obligations.  Generally upon our default of our agreement with SAIC and certain other events, we are required to convey to SAIC our interests in the patents and patent applications acquired from SAIC without consideration.

Note 5 — Commitments
 
We lease our office facility under a non-cancelable operating lease that was amended in 2008 and ends in 2012.  We recognize rent expense on a straight-line basis over the term of the lease.
 
For the Year
 
Minimum Required Lease Payments in Period
 
       
April 1 through December 31, 2010                                                                                                  
 
$
41,817
 
2011                                                                                                  
   
59,242
 
2012                                                                                                  
   
30,202
 
   
$
131,261
 
 
 
 
 

 
 
7

 
 
Note 6 — Stock Plan
 
In 2005, VirnetX, Inc. adopted the 2005 Stock Plan, which was assumed by us upon the closing of the transaction between VirnetX Holding Corporation and VirnetX, Inc. on July 5, 2007.  Our Board of Directors renamed this plan the “VirnetX Holding Corporation 2007 Stock Plan (“the Plan”) and our stockholders approved the Plan at our 2008 annual stockholders’ meeting. The Plan provides for the issuance of up to 11,624,469 shares of our common stock.  To the extent that any award should expire, become unexercisable or is otherwise forfeited, the shares subject to such award will again become available for issuance under the Plan.  The Plan provides for the granting of stock options and stock purchase rights to our employees and consultants.  Stock options granted under the Plan may be incentive stock options or nonqualified stock options.  Incentive stock options (“ISO”) may only be granted to our employees (including officers and directors).  Nonqualified stock options (“NSO”) and stock purchase rights may be granted to our employees and consultants.
 
Options may be granted under the Plan with an exercise price determined by our Board of Directors, provided, however, that the exercise price of an ISO or NSO granted to one of our Named Executive Officers shall not be less than 100% fair market value of the shares at the date of grant and the exercise price of an ISO granted to a 10% shareholder shall not be less than 110% of the fair market value of the shares on the date of grant

       There were 6,101,040 options outstanding at March 31, 2010 and 5,785,790 at December 31, 2009 with an average exercise price of $2.73 at March 31, 2010 and $2.57 at December 31, 2010.  As of March 31, 2010, there were 1,101,979 shares available to be granted under the Plan.
 
During the period January 1, 2010 through March 31, 2010, no options were exercised.
 
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 is included in general and administrative expense for each period ended March 31, 2010.  Total stock-based compensation expense was $789,401 and $683,784 for the three months ended March 31, 2010 and 2009, respectively.
 
As of March 31, 2010, the unrecorded deferred stock-based compensation balance related to stock options was $6,472,482, which will be amortized as expense over an estimated weighted average vesting amortization period of approximately 1.6 years.
 
The fair value of each option grant was estimated on the date of grant using the following weighted average assumptions:
 
   
Period Ended March 31,
2010
   
Year Ended December 31,
2009
 
Volatility
  110%     120%  
Risk-free interest rate
  3.70%     2.93%  
Expected life
 
7.0 years
   
6.6 years
 
Expected dividends
  0%     0%  
 
The expected life was determined using the simplified method outlined in Staff Accounting Bulletin 110, 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.  We have not provided an estimate for forfeitures because we have no history of forfeited options and believe that all outstanding options at March 31, 2010 will vest.  In the future, the Company may change this estimate based on actual and expected future forfeiture rates.
 
 
8

 
 
Note 8 — Warrants
 
In 2007 and 2009, we issued warrants to purchase our common stock in connection with various transactions.  As of and for the three month period ended March 31, 2010:
 
           
Number of Warrants
       
           
Activity For The Three Months Ended March 31, 2010
       
Original
Number of Warrants
Issued
   
Exercise
Price per
Common
Share
   
Exercisable
at
December 31,
2009
   
Became Exercisable
   
Exercised
   
Terminated / Cancelled /
Expired
   
Exercisable at March 31,
2010
   
Termination
 
                                             
  266,667     $ 0.75       33,896       --       --       --       33,896     2012  
  300,000     $ 4.80       300,000       --       --       --       300,000     2012  
  1,235,000     $ 2.00       1,235,000       --       (1,233,741 )     (1,259 )     --     n/a  
  1,235,000     $ 3.00       1,235,000       --       (120,193 )     --       1,114,807    
July 2010 (1)
 
  1,235,000     $ 4.00       1,235,000       --       (12,000 )     --       1,223,000    
July 2010 (1)
 
  200,000     $ 1.80       220,000       --       (169,000 )     --       51,000    
January 2014
 
  2,380,942     $ 3.93 (2)     --       2,380,942       (31,610 )     --       2,349,332    
March 2015
 
  2,419,023     $ 0.01       --       --       --       --       --     (3)  
  2,380,942     $ 2.52       2,380,942       --       2,380,942       --       --     n/a  
                                                           
Total
              6,639,838       2,380,942       (3,947,486 )     (1,259 )     5,072,035        

(1)  
Subject to earlier call by the Company under certain conditions.
(2)  
Subject to adjustment.
(3)  
These warrants were to become exercisable under certain conditions, if those conditions existed prior to January 14, 2010.
These conditions did not exist prior to that date and, as such, these warrants expired unexercisable.

During the three months ended March 31, 2010, we received aggregate proceeds from the exercise of warrants of approximately $8,579,000.
 

 
 
9

 
 
Note 9 — Litigation
 
We believe Microsoft Corporation is infringing certain of our patents.  Accordingly, we commenced a lawsuit against Microsoft on February 15, 2007, the February 2007 lawsuit, by filing a complaint in the United States District Court for the Eastern District of Texas, Tyler Division.  Pursuant to the complaint, we allege that Microsoft infringes two of our U.S. patents:  U.S. Patent No. 6,502,135 B1, entitled “Agile Network Protocol for Secure Communications with Assured System Availability,” and U.S. Patent No. 6,839,759 B2, entitled “Method for Establishing Secure Communication Link Between Computers of Virtual Private Network Without User Entering Any Cryptographic Information.” On April 5, 2007, we filed an amended complaint specifying certain accused products at issue and alleging infringement of a third, recently issued U.S. patent:  U.S. Patent No. 7,188,180 B2, entitled “Method for Establishing Secure Communication Link Between Computers of Virtual Private Network.” We are seeking both damages and injunctive relief.  Microsoft answered the amended complaint and asserted counterclaims against us on May 4, 2007.  Microsoft counterclaimed for declarations that our patents are not infringed, are invalid and are unenforceable.  Microsoft seeks an award of its attorneys’ fees and costs.  We filed a reply to Microsoft’s counterclaims on May 24, 2007. We have served our infringement contentions directed to certain of Microsoft’s operating system and unified messaging and collaboration applications.  On March 31, 2008, Microsoft filed a motion to dismiss for lack of standing, which was denied by the court pursuant to an order dated June 3, 2008.  Also pursuant to that court decision, on June 10, 2008, SAIC joined us in our lawsuit as a plaintiff.  On November 19, 2008, the court granted our motion to amend our infringement contentions, permitting us to provide increased specificity and citations to Microsoft’s proprietary documents and source code to support our infringement case against Microsoft’s accused products, including, among other things, Windows XP, Vista, Server 2003, Server 2008, Live Communication Server, Office Communication Server and Office Communicator.  
  
On July 30, 2009, the United States District Court for the Eastern District of Texas, Tyler Division, issued its Markman Order in the Microsoft litigation. On March 16, 2010, the jury awarded us a $105,750,000 verdict against Microsoft for infringing two of our patents.  The jury also found that Microsoft’s patent infringement was willful. We have requested injunctive relief and the Court has scheduled a hearing on June 2, 2010 to hear evidence on that issue.  We expect Microsoft to appeal this decision and will vigorously defend our rights in any appeal.
  
On March 17, 2010, we filed a new complaint against Microsoft, or the March 2010 lawsuit, alleging infringement of U.S. Patent Nos. 6,502,135 and 7,188,180 by Microsoft's Windows 7 and Windows Server 2008 R2 software products. We refer to the February 2007 lawsuit and the March 2010 lawsuit collectivity as the Microsoft litigation.

In addition to the legal proceedings discussed above, in December 2009, Microsoft submitted a reexamination request to the USPTO to challenge the validity of certain claims on certain of our patents at issue in connection with the Microsoft litigation.  In January 2010, the USPTO confirmed the validity of certain claims, while taking “non-final action” on other of Microsoft’s claims.  We are in the process of responding to the non-final action, and the process is ongoing.
  
Because we have determined that Microsoft’s alleged unauthorized use of our patents would cause us severe economic harm and the failure to cause Microsoft to discontinue its use of such patents could result in the termination of our business, we have dedicated a significant portion of our economic resources, to date, to the prosecution of the Microsoft litigation and expect to continue to do so for the foreseeable future.
 
Although we believe Microsoft infringes certain of our patents and we intend to vigorously prosecute the Microsoft litigation, at this stage of the litigation the final outcome cannot be predicted in either the February 2007 lawsuit or the March 2010 lawsuit with any degree of reasonable certainty.  Additionally, the Microsoft litigation and appeals process will be costly and time-consuming, and we can provide no assurance that we will ultimately collect in any judgment we may receive against Microsoft for damages and/or obtain injunctive relief. 
 
Because the final outcome of this litigation cannot be estimated at this time, we have made no provision for gain or expenses in the accompanying financial statements.
 
 
 
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ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 
This Quarterly Report on Form 10-Q, including this Management’s Discussion and Analysis of Financial Condition and Results of Operations contains “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995, which provides a “safe harbor” for statements about future events, products and future financial performance that are based on the beliefs of, estimates made by and information currently available to our management.  Except for the historical information contained herein, the outcome of the events described in these forward-looking statements is subject to risks and uncertainties.  See “Risk Factors” for a discussion of these risks and uncertainties.  The following discussion should be read in conjunction with and is qualified in its entirety by reference to our consolidated financial statements included elsewhere in this report.  Actual results and the outcome or timing of certain events may differ significantly from those stated or implied by these forward-looking statements due to the factors listed under “Risk Factors,” and from time to time in our other filings with the Securities and Exchange Commission (“SEC”.)  For this purpose, using the terms “believe,” “expect,” “expectation,” “anticipate,” “can,” “should,” “would,” “could,” “estimate,” “appear,” “based on,” “may,” “intended,” “potential,” “indicate,” “are emerging” and “possible” or similar statements are forward-looking statements that involve risks and uncertainties that could cause our actual results and the outcome and timing of certain events to differ materially from those stated or implied by these forward-looking statements.  By making forward-looking statements, we have not assumed any obligation to, and you should not expect us to, update or revise those statements because of new information, future events or otherwise.
 
As used herein, “we,” “us,” “our,” or the “Company” means VirnetX Holding Corporation, together with its consolidated subsidiaries where applicable.
 
Company Overview
 
We are developing and commercializing 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, enabling users to create a secure communication link using secure domain names.  We also intend to establish the exclusive secure domain name registry in the United States and other key markets around the world. 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.
 
Our portfolio of intellectual property is the foundation of our business model.  We currently have 12 patents in the United States and eight international 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 software and technology solutions also have additional applications in operating systems and network security.  On December 2, 2009, we declared to the 3GPP (3rd Generation Partnership Project) that our U.S. and international patents are or may be essential to Long Term Evolution (LTE) and 4G wireless specifications. We believe that we will hold the majority of 4G essential patents related to Series 33 specifications that define security standards for LTE/4G and are prepared to license the use of our patents for incorporation into 4G related products such as chips, servers, smartphones, laptop computers, etc. 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.  We acquired this patent portfolio in 2006, and it now serves as the foundation of our planned licensing and service offerings.  We expect to derive the majority of our revenue from license fees and royalties associated with these patents.  We also intend to continue our research and development efforts to further strengthen and expand our patent portfolio, and over time, we plan to leverage this portfolio to develop a product suite that can be sold to enterprise customers and developers.

We intend to license our patents and our GABRIEL Connection Technology™ to original equipment manufacturers, or OEMs, within the IP-telephony, mobility, fixed-mobile convergence and unified communications markets.  The leaders in these markets include Alcatel-Lucent, Avaya Inc., Cisco Systems, Inc., Juniper Networks, Inc., LM Ericsson Telephone Company, Motorola, Inc., NEC Corporation, Nokia Corporation, Nortel Networks Corporation, Samsung Electronics Co. Ltd. and Sony Ericsson Mobile Communications AB, among others.  On December 9, 2009, we announced the start of beta testing of our GABRIEL Connection Technology™. In this testing we intend to include invited beta users from outside the company. This phase of beta testing is expected to be completed in 2010.
 
 
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We also intend to license our patent portfolio, technology and software, including our secure domain name registry service, to 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 part of our licensing strategy, in March 2008, we hired ipCapital Group, a leading advisor on licensing technology and intellectual property, to initiate discussions with several major potential licensees.  Since its founding in 1998, ipCapital Group has supported the licensing efforts of clients across a variety of technologies and markets, resulting in transactions representing several hundred million dollars of value.  On December 23, 2009, we signed a letter of intent with VeriSign, Inc. or VeriSign, under which VirnetX and VeriSign will collaborate to assess and evaluate the technical, market and commercial viability to jointly develop and provide mobile directory services and solutions using secure domain names or “PKI” certificate infrastructure consistent with VirnetX intellectual property. The letter of intent also provided for a “no shop” period until March 23, 2010, during which period the parties have agreed not to solicit or encourage proposals from any other person or entity regarding a similar strategic relationship. On March 24, 2010, we entered into an agreement with VeriSign to extend the binding exclusively period under the letter of intent until June 4, 2010. We continue to have discussions with other prospective customers/partners in our target markets outside the scope of the potential strategic relationship with VeriSign.

Key Developments in the Three Months Ended March 31, 2010
 
On January 14, 2010, the Series II Warrants issued in our September 2009 private placement transaction expired unexercised and terminated without any additional shares of common stock being issued to private placement investors.
 
On February 24, 2010, we announced that all Series III Warrants issued in our September 2009 private placement transaction had been exercised in full and we issued 2,380,942 shares of our common stock. The aggregate cash exercise proceeds from the Series III Warrants totaled $6,000,000.  After payment of fees and commissions, we received net proceeds of approximately $5,400,000.
  
On February 24, 2010, we exercised in full our rights to call the $2.00 warrants issued by us in connection with our 2009 public offering. Those warrants expired in their entirety unless they were earlier exercised on March 11, 2010. The aggregate cash exercise proceeds from the $2.00 warrants if exercised in full would total $2,470,000. After payment of fees and commissions, we receive net proceeds of approximately $2,354,000.
  
On March 16, 2010, a jury awarded us a $105,750,000 verdict against Microsoft for infringing two of our patents. The jury also found that Microsoft's patent infringement was willful.
  
On March 17, 2010, we filed a new complaint against Microsoft alleging infringement of our U.S. Patent Nos. 6,502,135 and 7,188,180 by Microsoft's Windows 7 and Windows Server 2008 R2 software products.
 
On March 24, 2010, we entered into an agreement to extend a letter of intent with VeriSign, under which VirnetX intends to work with VeriSign to create a technical pilot for providing services that could include VirnetX’s exclusive secure domain name registry and managed connection and relay services along with providing a complete PKI solution for VirnetX’s secure domain name initiative.  This falls under the original December 23, 2009, letter of intent objectives to collaborate in the development of mobile directory services and solutions using secure domain names and PKI certificate infrastructure.  The strategic relationship contemplated by the letter of intent remains subject to, among other things, the negotiation, execution and delivery of definitive agreements.  The letter of intent also provides for a binding exclusivity period until June 4, 2010, during which period the parties have agreed not to solicit or encourage proposals from any other person or entity regarding a strategic relationship, the primary purpose thereof is to assess and evaluate the technical, market and commercial viability to jointly develop and provide the services contemplated by the letter of intent.

 
 
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Recent Developments

       On April 27, 2010, we entered into an engagement letter with McKool Smith, a professional corporation, or McKool, confirming McKool as our lead counsel in our lawsuit filed in March 2010 against Microsoft, or the March 2010 Litigation. In the event of a judgment or settlement of the March 2010 Litigation, we have agreed to pay McKool a portion of the total proceeds of the March 2010 Litigation, and a portion of any judgment or settlement paid in our litigation against Microsoft filed in February 2007, or the February 2007 Litigation. Under the April 2010 engagement letter, McKool has agreed to represent us in the March 2010 Litigation at McKool’s standard hourly rates subject to a cap of $7.5 million, plus either (1) a contingency fee of 8% of the litigation proceeds from the March 2010 Litigation, if the March 2010 Litigation is settled independently of the February 2007 Litigation, or (2) if the March 2010 Litigation and February 2007 Litigation are settled together, a total of 10% of the settlement proceeds would be payable to McKool pursuant to the two outstanding engagement letters that we have entered into with McKool. McKool’s out-of-pocket expenses are not capped pursuant to the April 2010 engagement letter but are estimated to be approximately $1.5 million. A copy of the April 2010 engagement letter with McKool is attached to this Quarterly Report on Form 10-Q for the quarter ended March 31, 2010. We have submitted a request for confidential treatment for certain portions of the engagement letter. Those portions have been redacted and have been provided separately to the SEC.

Critical Accounting Policies
 
There were no material changes in the application of the Company’s critical accounting policies since the end of the most recent fiscal year.  For further information, see the “Critical Accounting Policies” section of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 30, 2010.
 
Recent Accounting Pronouncements
 
There were no material updates to recent accounting pronouncements since the end of the most recent fiscal year.  For further information, see the “Recent Accounting Pronouncements” section of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 30, 2010.
 
Results of Operations
 
Three Months Ended March 31, 2010
Compared with Three Months Ended March 31, 2009
 
Revenue — Royalties
 
Revenue generated increased to $20,769 for the three months ended March 31, 2010 from $3,154 for the three months ended March 31, 2009.  Our revenue in 2009 was solely limited to the royalties earned under our single license agreement through our Japanese subsidiary.  We expect the revenue from this license to decrease substantially in the future.  We do not intend to seek additional licenses or other revenue through our Japanese subsidiary.
 
Research and Development Expenses
 
Research and development costs include expenses paid to outside development consultants and compensation related expenses for our engineering staff.  Research and development costs are expensed as incurred.
 
Our research and development expenses increased by $300,536 to $522,235 for the three months ended March 31, 2010, from $221,699 for the three months ended March 31, 2009.  This increase is primarily due to increased engineering activities for product development, salary increase and bonuses paid in March 2010.  We expect research and development expenses to increase as employees are hired to provide in-house research and development.  While we expect to use outside contractors for additional product development on a limited basis, we expect those costs to remain level or decline.
 
 
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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 $769,195 to $3,955,885 for the three months ended March 31, 2010 from $3,186,690 for the three month period ended March 31, 2009. The increase was primarily due to salary increases,  bonuses paid in March 2010 and increased legal fees.
 
Within selling, general and administrative expenses, legal fees increased by $348,938 to $2,121,521 for the three months ended March 31, 2010 from $1,772,583 for the three months ended March 31, 2009.  The increase in fees incurred was due primarily to our patent infringement litigation against Microsoft and preparation for our annual meeting and 2010 proxy statement.
 
In addition, during the three months ended March 31, 2010, we made our third minimum annual royalty payment of $50,000 to SAIC pursuant to the patent license and assignment agreement, as amended, by and between VirnetX and SAIC.  As of March 31, 2010, we had not received any royalty revenue on the patents.
 
Also within selling, general and administrative expenses, expenses increased by $420,257 for the three months ended March 31, 2009.  The increase was primarily due to salary increases and bonuses paid in March 2010.
 
Once we begin to generate royalty revenues, we expect that our selling expenses will increase significantly as we must make payments to ipCapital Group and SAIC with respect to such revenues and as we begin to expand our sales force.
 
Liquidity and Capital Resources
 
We are in the development stage and have raised capital since our inception through the issuance of our equity securities. We have used the net proceeds to fund our operations and provide working capital for general corporate purposes, and as of March 31, 2010, we had approximately $4,550,000 in cash.

During 2009, cash used in operations was $6,944,000, or an average of approximately $579,000 per month. During the first quarter of 2010, our cash used in operations was $5,998,000, or an average of approximately $1,999,000 per month. The increase for the first quarter of 2010 over the 2009 monthly average was primarily due to our reduction of our working capital deficit, and the impacts of certain costs paid in the first quarter in connection with the Microsoft litigation. We expect this increase to carry over into the beginning of our 2010 second quarter, after which we expect our average monthly cash flow used in operations for the third and fourth quarters of 2010 will be modestly greater than in 2009.

We expect to finance future cash needs primarily through proceeds from equity or debt financings, loans, joint ventures, and/or collaborative agreements with corporate and strategic partners. We also intend to license our patent portfolio, technology and software, including our secure domain name registry service.
 
We expect to derive the majority of our revenue from license fees and royalties associated with our patent portfolio, technology and software.
 
 
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Off-Balance Sheet Arrangements
 
On June 9, 2009, we entered into an engagement letter with McKool Smith, confirming McKool as our lead counsel in the February 2007 lawsuit against Microsoft Corporation. McKool has agreed to represent us in the Microsoft litigation for a fixed fee of $3 million and a contingency fee of 8% of the litigation proceeds. In the event of a judgment or settlement below an agreed upon amount (designed to approximate the total legal fees associated with the matter), McKool’s fixed fee will be limited to the actual time spent by McKool, up to a maximum of $3 million, plus the contingency fee of 8% of the litigation proceeds. McKool’s out-of-pocket expenses are not capped pursuant to the engagement letter but are estimated to be approximately $1 million.  A copy of the engagement letter with McKool is attached as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2009.  We submitted a request for confidential treatment for certain portions of the engagement letter.  Those portions have been redacted and have been provided separately to the Securities and Exchange Commission.
 
On April 27, 2010, we entered into an engagement letter McKool Smith, confirming McKool as our lead counsel in our lawsuit filed in March 2010 against Microsoft, or the March 2010 Litigation. In the event of a judgment or settlement of the March 2010 Litigation, we have agreed to pay McKool a portion of the total proceeds of the March 2010 Litigation, and a portion of any judgment or settlement paid in the February 2007 Litigation. Under the April 2010 engagement letter, McKool has agreed to represent us in the March 2010 Litigation at McKool’s standard hourly rates subject to a cap of $7.5 million, plus either (1) a contingency fee of 8% of the litigation proceeds from the March 2010 Litigation, if the March 2010 Litigation is settled independently of the February 2007 Litigation, or (2) if the March 2010 Litigation and February 2007 Litigation are settled together, a total of 10% of the settlement proceeds would be payable to McKool. McKool’s out-of-pocket expenses are not capped pursuant to the April 2010 engagement letter but are estimated to be approximately $1.5 million. A copy of the April 2010 engagement letter with McKool is attached to this Quarterly Report on Form 10-Q for the quarter ended March 31, 2010. We have submitted a request for confidential treatment for certain portions of the engagement letter. Those portions have been redacted and have been provided separately to the Securities and Exchange Commission.

ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
Not Applicable.
 
ITEM 4 — CONTROLS AND PROCEDURES.
 
(a)      Disclosure controls and procedures.  Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such items are defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures as of the end of the period covered by this Quarterly Report are effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure, and that such information is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
 
(b)      Changes in internal control over financial reporting.  There was no change in our internal control over financial reporting during the quarter ended March 31, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
PART II — OTHER INFORMATION
 
ITEM 1 — LEGAL PROCEEDINGS.
 
We believe Microsoft Corporation is infringing certain of our patents.  Accordingly, we commenced a lawsuit against Microsoft on February 15, 2007, the February 2007 lawsuit, by filing a complaint in the United States District Court of the Eastern District of Texas, Tyler Division.  Pursuant to the complaint, we allege that Microsoft infringes two of our U.S. patents:  U.S. Patent No. 6,502,135 B1, entitled “Agile Network Protocol for Secure Communications with Assured System Availability,” and U.S. Patent No. 6,839,759 B2, entitled “Method for Establishing Secure Communication Link Between Computers of Virtual Private Network Without User Entering Any Cryptographic Information.”  On April 5, 2007, we filed an amended complaint specifying certain accused products at issue and alleging infringement of a third, recently issued U.S. patent:  U.S. Patent No. 7,188,180 B2, entitled “Method for Establishing Secure Communication Link Between Computers of Virtual Private Network.”  We are seeking both damages and injunctive relief.  Microsoft answered the amended complaint and asserted counterclaims against us on May 4, 2007.  Microsoft counterclaimed for declarations that our patents are not infringed, are invalid and are unenforceable.  Microsoft seeks an award of its attorneys’ fees and costs.  We filed a reply to Microsoft’s counterclaims on May 24, 2007. We have served our infringement
 
 
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contentions directed to certain of Microsoft’s operating system and unified messaging and collaboration applications.  On March 31, 2008, Microsoft filed a motion to dismiss for lack of standing, which was denied by the court pursuant to an order dated June 3, 2008.  Also pursuant to that court decision, on June 10, 2008, SAIC joined us in our lawsuit as a plaintiff.  On November 19, 2008, the court granted our motion to amend our infringement contentions, permitting us to provide increased specificity and citations to Microsoft’s proprietary documents and source code to support our infringement case against Microsoft’s accused products, including, among other things, Windows XP, Vista, Server 2003, Server 2008, Live Communication Server, Office Communication Server and Office Communicator.  A Markman hearing on claim construction was conducted on February 17, 2009.  We then removed one of our patents from the case. On March 16, 2010, the jury awarded us a $105,750,000 verdict against Microsoft for infringing two of our patents.  The jury also found that Microsoft’s patent infringement was willful. We have requested injunctive relief and the Court has scheduled a hearing on June 2, 2010 to hear evidence on that issue.  We expect Microsoft to appeal this decision and will vigorously defend our rights in any appeal.  
  
In addition to the February 2007 lawsuit, we filed a new complaint on March 17, 2010, or the March 2010 lawsuit, alleging infringement by Microsoft of U.S. Patent Nos. 6,502,135 and 7,188,180 by Microsoft Windows 7 and Windows Server 2008 R2 software products. We refer to the March 2010 lawsuit and the February 2007 lawsuit collectively as the Microsoft litigation, or the litigation against Microsoft.  
  
Because we have determined that Microsoft’s alleged unauthorized use of our patents would cause us severe economic harm and the failure to cause Microsoft to discontinue its use of such patents could result in the termination of our business, we have dedicated a significant portion of our economic resources, to date, to the prosecution of the Microsoft litigation and expect to continue to do so for the foreseeable future.
 
Although we believe Microsoft infringes certain of our patents and have received a favorable verdict from the jury on March 16, 2010, and we intend to continue to vigorously prosecute the Microsoft litigation, we cannot predict the final outcome of the Microsoft litigation with any degree of reasonable certainty.  Additionally, the Microsoft litigation and appeals process will be costly and time-consuming, and we can provide no assurance that we will ultimately collect on any judgment against Microsoft for damages and/or obtain injunctive relief.  
 
In the near term, we will dedicate significant time and resources to the Microsoft litigation.  The risks associated with such dedication of time and resources are set forth in the “Risk Factors” section of this Quarterly Report on Form 10-Q.
 
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.
 
Currently, we are not a party to any other pending legal proceedings, and are not aware of any proceeding threatened or contemplated against us by any governmental authority or other party.
  
ITEM 1A — RISK FACTORS.
 
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 the offered securities.
 
 
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Risks Related To Existing and Future Litigation
 
Our litigation against Microsoft is ongoing, and we expect such litigation and the appeals process to be time-consuming and costly, which may adversely affect our financial condition and our ability to operate our business.
 
We have initiated two lawsuits against Microsoft: one in February 2007 and one in March 2010. On February 15, 2007, we initiated a lawsuit by filing a complaint against Microsoft in the United States District Court for the Eastern District of Texas, Tyler Division, pursuant to which we allege that Microsoft infringes two of our patents regarding the creation of virtual private networks, or VPNs.  We seek damages and injunctive relief.  On April 5, 2007, we filed an amended complaint, pursuant to which we allege that Microsoft infringes a third patent. We subsequently removed one of our patents from the case. On March 16, 2010, the jury awarded us a $105,750,000 verdict against Microsoft for infringing two of our patents.  The jury also found that Microsoft’s patent infringement was willful.  We have requested injunctive relief and the Court has scheduled a hearing on June 2, 1010 to hear evidence on that issue. We expect Microsoft to appeal this decision and we will vigorously defend our rights in any appeal, but we cannot assure you that the litigation will result in a final outcome that is favorable to our company or our stockholders.

On March 17, 2010, we filed a new complaint against Microsoft alleging that Microsoft's Windows 7 and Windows Server 2008 R2 software products infringe two of our patents. We refer to the February 2007 and March 2010 lawsuits collectively in this Quarterly Report on Form 10-Q as the Microsoft litigation. Similar to the lawsuit we filed against Microsoft in February 2007, we cannot assure you that the March 2010 lawsuit will result in a final outcome that is favorable to our company or our stockholders.

In addition to pursuing the commercialization of our GABRIEL Connection Technology™ and our portfolio of intellectual property, given the scope and importance of the Microsoft litigation to us, we expect to allocate a majority of our existing cash and any proceeds we may receive from the cash exercise of warrants issued in our January 2009 public offering and our September 2009 private placement transaction towards the fees and expenses associated with the Microsoft litigation.  Although we have entered into a fixed fee engagement with McKool Smith on June 9, 2009 to act as our lead counsel in connection with the Microsoft lawsuit filed in February 2007, and a capped fee engagement with McKool Smith on April 27, 2010 to act as our lead counsel in connection with the Microsoft lawsuit filed March 2010, we anticipate that the legal proceedings against Microsoft may continue for several years and may require significant expenditures for legal fees and other expenses. Although we view the McKool Smith arrangements as positive and ones that will help us manage our expenses in connection with the litigation, we anticipate that our legal fees and other expenses associated with this litigation will be material and will negatively impact our financial condition and results of operations.  Such impact may result in our inability to continue our business or to pursue other business initiatives not associated with the Microsoft litigation.
 
The time and effort required of our management to effectively pursue the Microsoft litigation may adversely affect our ability to operate our business, since time spent on matters related to the lawsuit will take away from the time spent on managing and operating our business.  Microsoft has counterclaimed for declarations that the two patents are not infringed, are invalid and are unenforceable.  If Microsoft’s counterclaims are successful on appeal, or if they prevail in the lawsuit filed in March 2010, such outcomes may preclude our ability to commercialize our initial products.

While we believe Microsoft infringes our patents, we can provide no assurance that we will be successful in our lawsuits through appeal.
 
We believe that Microsoft infringes on certain of our patents, but obtaining and collecting a judgment against Microsoft may be difficult or impossible.  Patent litigation is inherently risky and the outcome is uncertain.  Microsoft is a large, well-financed company with substantially greater resources than us.  We believe that Microsoft 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 not valid and are unenforceable.  At this time, we cannot predict the final outcome of the Microsoft litigation.
 
 
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We are devoting a substantial amount of our financial and management resources to the Microsoft litigation, and if we are unsuccessful in this lawsuit, our financial condition may be adversely affected, and we may not survive.
 
Currently, we are devoting substantial time, effort and financial resources to the Microsoft litigation.  We are a development stage company with no finished product, and, although our business strategy is focused primarily on bringing patented products to market, our business strategy also depends greatly on collecting on our judgment before our financial resources are depleted.  In the event we are not successful through appeal and do not subsequently obtain monetary and injunctive relief, we may not have enough financial resources to continue our operations.
 
The burdens of being a public company may adversely affect our ability to pursue the Microsoft litigation.
 
As a public company, our management must devote substantial time, attention and financial resources to comply with U.S. securities laws.  This may have a material adverse affect on management’s ability to effectively pursue the Microsoft litigation as well as our other business initiatives.  In addition, our disclosure obligations under U.S. securities laws require us to disclose information publicly that will be available to Microsoft as well as any other future litigation opponents.  We may, from time to time, be required to disclose information that will have a material adverse affect on our litigation strategies.  This information may enable our litigation opponents to develop effective litigation strategies that are contrary to our interests.
 
We may commence additional legal proceedings against third parties who we believe are infringing on our intellectual property rights, and if we are forced to litigate to defend our intellectual property rights, or to defend claims by third parties against us relating to intellectual property rights, legal fees and court injunctions could adversely affect our financial condition or end our business.
 
Disputes regarding the ownership of technologies and intellectual property rights are common and we may have intellectual property infringement claims against other parties in addition to our claims against Microsoft. If we decide to commence actions against any additional parties, doing so may be expensive and time-consuming, which may adversely affect our financial condition and results of operations.  Moreover, there can be no assurance that we would be successful in these additional legal proceedings and the existence and outcome of any such litigation could harm our business.  In addition, commencing lawsuits may lead to potential counterclaims which may preclude our ability to develop and commercialize our initial products.
 
Risks Related to Our Business and Our Industry
 
We are a development stage company with virtually no revenues.
 
We are a development stage company with a very small amount of revenue and do not expect to generate additional revenues unless and until our patent portfolio, or part of it, is commercialized. We may need to raise additional capital to fund our operations and our litigation against Microsoft and there can be no assurance that we will be successful in doing so on acceptable terms or at all.  Our inability to generate sufficient cash flow or raise other funds to meet our expenses, obligations and sustain our operations raises substantial doubt about our ability to continue as a going concern. As reported in this Quarterly Report on Form 10-Q, our management believes that the cash balance at March 31, 2010 will be insufficient to fund operations for longer than the third quarter 2010.
 
We anticipate incurring operating losses and negative cash flows for the foreseeable future resulting in uncertainty of future profitability and limitations on our operations.
 
We anticipate that we will incur operating losses and negative cash flows in the foreseeable future, and we will accumulate increasing deficits as we increase our expenditures for:
 
 
the Microsoft litigation;
 
 
infrastructure;

 
sales and marketing;
 
 
research and development;
 
 
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personnel; and

 
general business enhancements.
 
We need to significantly increase our revenue if we are to attain profitability and there is no assurance that we will be able to do so. In the event that we are unable to achieve profitability or raise sufficient funding to cover our losses in the near term, we will be unable to meet our expenses and obligations as they come due, and this raises substantial doubts as to our ability to continue as a going concern.  The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 
Our business plan for commercializing our patents and technology is new and unproven, and therefore we can provide no assurance that we will be successful in pursuing it.
 
We intend to develop products to provide a security platform for real-time communications; however, this is not a defined market.  We expect to depend on our intellectual property licensing fees for the majority of our revenues.  Our ability to generate licensing fees is highly dependent on mainstream market adoption of real-time communications based on SIP or using DNS lookup protocols as well as customer adoption of our GABRIEL Communication Technology™ and our secure domain name registry.  We cannot assure you that customers will adopt our products and services, or that we will succeed in building a profitable business based on our business plan.
 
If we are not able to adequately protect our patented rights, our operations would be negatively impacted.
  
Our ability to compete largely depends on the superiority, uniqueness and value of our technology and intellectual property.  To protect our intellectual property rights, we rely on a combination of patent, trademark, copyright and trade secret laws, confidentiality agreements with our employees and third parties, and protective contractual provisions.  Further, we can give no assurances that infringement or invalidity claims (or claims for indemnification resulting from infringement claims) will not be asserted or prosecuted against us or that any such assertions or prosecutions will not materially adversely affect our business.
  
In December 2009, Microsoft submitted a reexamination request to the USPTO to challenge the validity of two of our patents at issue in connection with the Microsoft litigation. In January 2010, the USPTO confirmed the validity of certain claims, while taking "non-final action" on other of Microsoft's claims. We are in the process of responding to the non-final action, and the process is ongoing. 
 
Regardless of whether these or any future claims are valid or can be successfully asserted, defending against such claims could cause us to incur significant costs, could jeopardize or substantially delay a successful outcome in our Microsoft litigation or any future litigation, and could divert resources away from our other activities.  In addition, assertion of infringement claims could result in injunctions that prevent us from distributing our products.  In addition to challenges against our existing patents, any of the following could also reduce the value of our intellectual property now, or in the future:
  
 
our applications for patents, trademarks and copyrights relating to our business may not be granted and, if granted, may be challenged or invalidated;

 
issued trademarks, copyrights, or patents may not provide us with any competitive advantages;

 
our efforts to protect our intellectual property rights may not be effective in preventing misappropriation of our technology; or

 
our efforts may not prevent the development and design by others of products or technologies similar to or competitive with, or superior to those we develop.
 
In addition, we may not be able to effectively protect our intellectual property rights in certain foreign countries where we may do business in the future or from which competitors may operate.  While we have numerous pending international patents, obtaining such patents will not necessarily protect our technology or prevent our international competitors from developing similar products or technologies.  Our inability to adequately protect our patented rights would have a negative impact on our operations and revenues.
 
 
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In addition, legal standards relating to the validity, enforceability, and scope of protection of intellectual property rights in Internet-related businesses are uncertain and still evolving.  Because of the growth of the Internet and Internet related businesses, patent applications are continuously and simultaneously being filed in connection with Internet-related technology.  There are a significant number of U.S. and foreign patents and patent applications in our areas of interest, and we believe that there has been, and is likely to continue to be, significant litigation in the industry regarding patent and other intellectual property rights.
 
We may or may not be able to capitalize on potential market opportunities related to our licensing strategy or our patent portfolio.
 
Our business strategy calls for us to enter into licensing relationships with the leading companies in our target market in order to reach a larger end-user base than we could reach through direct sales and marketing efforts.  We have engaged ipCapital Group to help develop our licensing strategy and to introduce us to five potential strategic licensees of our technology.  In connection with this engagement, we agreed to pay ipCapital Group 10% of the royalties of each resulting licensing arrangement, up to an aggregate maximum of $2 million per licensee, or $10 million in the aggregate.  There can be no assurance that we will be able to capitalize on the potential market opportunity.  Our inability to generate licensing revenues associated with the potential market opportunity could result from a number of factors, including, but not limited to:
 
 
our capital resources may be insufficient;

 
our management team may not have sufficient bandwidth to successfully capitalize on all of the opportunities identified by ipCapital Group;
 
 
we may not be successful in entering into licensing relationships with our targeted customers on commercially acceptable terms; and

 
the validity of certain claims of certain of our patents underlying our licensing opportunity currently being challenged in our litigation against Microsoft, and by Microsoft, through the USPTO reexamination process.
 
Our business greatly depends on the growth of IM, VoIP, mobile services, streaming video, file transfer and remote desktop and other next-generation Internet-based applications.
 
We cannot assure you that 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 will continue to gain widespread market acceptance.  The Internet may ultimately prove not to be a viable commercial marketplace for such applications for a number of reasons, including:
 
 
unwillingness of consumers to shift to VoIP and use other such next-generation Internet-based applications;

 
refusal to purchase security products to secure information transmitted through such applications;

 
perception by the licensees of unsecure communication and data transfer;

 
lack of concern for privacy by licensees and users;

 
limitations on access and ease of use;

 
congestion leading to delayed or extended response times;

 
inadequate development of Internet infrastructure to keep pace with increased levels of use; and

 
increased government regulations.
 
 
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If the market for IM, VoIP, mobile services, streaming video, file transfer and remote desktop does not grow as anticipated, our business would be adversely affected.
 
The success of our products that secure IM, VoIP, mobile services, streaming video, file transfer and remote desktop, among other real-time communications applications, depends on the growth in the number of users, which in turn depends on the Internet gaining more widespread acceptance as the basis for these real-time communications applications.  These real-time communications applications are still in early stages of market acceptance and we cannot assure you that they will continue to develop a broader audience.  For example, potential new users may view VoIP as unattractive relative to traditional telephone services for a number of reasons, including the need to purchase computer headsets or the perception that the price advantage for VoIP is insufficient to justify the perceived inconvenience.
 
While the use of IM and other next-generation Internet-based applications has grown rapidly in personal and professional use, there can be no assurance that users will pay to secure their use of such applications.
 
Many services such as Microsoft, Yahoo! and America Online offer IM free of charge.  However, security solutions for these services are not free, and OEMs may not want to adopt such security solutions if users of IM do not see the value and do not want to pay for such security solutions.  If personal and professional users of IM and other next-generation Internet-based solutions do not want to pay for the security solutions, we will have difficulty marketing and selling our products and technologies.
  
We expect that we will experience long and unpredictable sales cycles, which may impact our quarterly 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.

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 for the foreseeable future, a significant portion of our revenues will be generated from a limited number of customers.  There can be no guarantee that we will be able to obtain such customers, or if we do so, to sustain our revenue levels from these customers.  If we cannot establish, maintain or replace the limited group of customers that we anticipate will generate a substantial majority revenues, 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.
 
If we do not successfully develop our planned products and services in a cost-effective manner to customer demand in the rapidly evolving market for Internet and IP-based communications services, our business may fail.
 
The market for communications services is characterized by rapidly changing technology, evolving industry standards, changes in customer needs and frequent new service and product introductions.  We are currently focused on developing products to provide security solutions for real-time communications.  Our future success will depend, in part, on our ability to use new technologies effectively, to continue to develop our technical expertise, to enhance our existing services and to develop new services that meet changing customer needs on a timely and cost-effective basis.  We may not be able to adapt quickly enough to changing technology, customer requirements and industry standards.  If we fail to use new technologies effectively, to develop our technical expertise and new services, or to enhance existing services on a timely basis, either internally or through arrangements with third parties, our product and service offerings may fail to meet customer needs, which would adversely affect our revenues and prospects for growth.
 
 
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In addition, if we are unable, for technological, legal, financial or other reasons, to adapt in a timely manner to changing market conditions or customer requirements, we could lose customers, strategic alliances and market share.  Sudden changes in user and customer requirements and preferences, the frequent introduction of new products and services embodying new technologies and the emergence of new industry standards and practices could render our existing products, services and systems obsolete.  The emerging nature of products and services in the technology and communications industry and their rapid evolution will require that we continually improve the performance, features and reliability of our products and services.  Our success will depend, in part, on our ability to:
 
 
design, develop, launch and/or license our planned products, services and technologies that address the increasingly sophisticated and varied needs of our prospective customers; and

 
respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis.
 
The development of our planned products and services and other patented technology involves significant technological and business risks and requires substantial expenditures and lead time.  We may be unable to use new technologies effectively.  Updating our technology internally and licensing new technology from third-parties may also require us to incur significant additional expenditures.
 
If our products do not gain market acceptance, we may not be able to fund future operations.
 
A number of factors may affect the market acceptance of our planned products or any other products we develop or acquire, including, among others:
 
 
the price of our products relative to other products that seek to secure real-time communication;

 
the perception by users of the effectiveness of our products;

 
our ability to fund our sales and marketing efforts; and

 
the effectiveness of our sales and marketing efforts.
 
If our products do not gain market acceptance, we may not be able to fund future operations, including the development of new products and/or our sales and marketing efforts for our current products, which inability would have a material adverse effect on our business, financial condition and operating results.
 
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.  In addition, we rely on third parties for software development and technology services, and there may be errors in the development processes used by our third party counterparts that may adversely affect our end products.  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.
 
 
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Malfunctions of third-party communications infrastructure, hardware and software exposes us to a variety of risks we cannot control.
 
In addition, 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.
 
If we experience security breaches, we could be exposed to liability and our reputation and business could suffer.
 
We will 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.
 
 
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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 of the security or reliability of our services.
 
We may incur significant expenses and damages because of liability claims.
 
An actual or perceived breach of our security solutions could result in a product liability claim against us.  A substantial product liability claim against us could harm our operating results and financial condition.  In addition, any actual or perceived breach of our security solution, whether or not caused by the failure of one of our products, could hurt our reputation and cause potential customers to turn to our competitors’ products.
 
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.  As a result, 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.
 
There has been increased competition for security solutions in the real-time communications industry, as more companies seek to provide products and services similar to our proposed products and services, and because larger and better-financed competitors may affect our ability to operate our business and achieve profitability, our business may fail.
 
We expect competition for our products and services to be intense.  We expect to compete directly against other companies offering similar security products and services that will compete directly with our proposed products and services.  We also expect that we will compete against established vendors within the IP-telephony, mobility, fixed-mobile convergence and unified communications markets.  These companies may incorporate other competitive technologies into their product offerings, whether developed internally or by third parties.  For the foreseeable future, substantially all of our competitors are likely to be larger, better-financed companies that may develop products superior to our proposed products, which could create significant competitive advantages for those companies.  Our future success depends on our ability to compete effectively with our competitors.  As a result, we may have difficulty competing with larger, established competitor companies.  Generally, these competitors have:
 
 
substantially greater financial, technical and marketing resources;

 
a larger customer base;

 
better name recognition; and

 
more expansive product offerings.
 
 
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These competitors are likely to command a larger market share than us, which may enable them to establish a stronger competitive position, in part, through greater marketing opportunities.  Further, our competitors may be able to respond more quickly to new or emerging technologies and changes in user preferences and to devote greater resources to developing and operating networks of affinity websites.  These competitors may develop products or services that are comparable or superior.  If we fail to address competitive developments quickly and effectively, we may not be able to remain a viable entity.
  
If we fail to meet our obligations to SAIC, we may lose our rights to key technologies on which our business depends.
 
Our business depends on our rights to and under the patents we obtained from SAIC.  Our agreements with SAIC impose various obligations on us, including payment obligations and minimum royalties that we must pay to SAIC.  If SAIC believes that we have 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 our rights in these patents.  During the period of any such litigation, our ability to carry out the development and commercialization of potential products could be significantly and negatively affected.  The loss or restriction of our rights in our patents would result in our inability to continue our business.

When we attempt to implement our secure domain name registry services business, we may be subject to government and industry regulation and oversight which may impede our ability to achieve our business strategy.
 
The U.S. government has historically controlled the authoritative domain name system, or DNS, root server since the inception of the Internet.  On July 1, 1997, the President of the United States directed the U.S. Secretary of Commerce to privatize the management of the domain name system in a manner that increases competition and facilitates international participation in its management.
 
On September 29, 2006, the U.S. Department of Commerce extended its delegation of authority by entering into a new agreement with the Internet Corporation for Assigned Names and Numbers, or ICANN, a California non-profit corporation headquartered in Marina Del Rey, California.  ICANN is responsible for managing the accreditation of registry providers and registrars that manage the assignment of top level domain names associated with the authoritative DNS root directory.  Although other DNS root directories are possible to create and manage privately without accreditation from ICANN, the possibility of conflicting name and number assignments makes it less likely that users would widely adopt a top level domain name associated with an alternative DNS root directory provided by a non-ICANN-accredited registry service.
 
On June 26, 2008, ICANN announced that it will be relaxing its prior position and will begin to issue generic top level domain names, or gTLDs, more broadly than it had previously.  ICANN expects to begin to take applications for gTLDs in April or May of 2009 with an application fee of $100,000 or more per application.  ICANN expects the first of these customized gTLDs to be issued in the fourth quarter of 2009.
 
We are currently evaluating whether we will apply to become an ICANN-accredited registry provider with respect to one or more customized gTLDs, or create our own alternative DNS root directory to manage the assignment of non-standard secure domain names.  We have not yet begun discussions with ICANN and we cannot assure you that we will be successful in obtaining ICANN accreditation for our registry service on terms acceptable to us or at all.  Whether or not we obtain accreditation from ICANN, we will be subject to the ongoing risks arising out of the delegation of the U.S. government’s responsibilities for the domain name system to the U.S. Department of Commerce and ICANN and the evolving government regulatory environment with respect to domain name registry services.
 
 
 
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The laws governing online secure communications are largely unsettled, and if we become subject to various government regulations, costs associated with those regulations may materially adversely affect our business.
 
The current regulatory environment for our services remains unclear.  We can give no assurance that our planned product offerings will be in compliance with local, state and/or U.S. federal laws or other laws.  Further, we can give no assurance that we will not unintentionally violate such laws or that such laws will not be modified, or that new laws will be enacted in the future which would cause us to be in violation of such laws.
 
VoIP services are not currently subject to all of the same regulations that apply to traditional telephony.  The U.S. Federal Communications Commission has imposed some traditional telephony requirements on VoIP such as disability access requirements and other obligations.  It is possible that federal and state legislatures may seek to impose increased fees and administrative burdens on VoIP, data and video providers.  Such regulations could result in substantial costs depending on the technical changes required to accommodate the requirements, and any increased costs could erode the pricing advantage over competing forms of communication and adversely affect consumer adoption of VoIP products generally.
 
The use of the Internet and private IP networks to provide voice, video and other forms of real-time, two-way communications services is a relatively recent development.  Although the provisioning of such services is currently permitted by U.S. law and is largely unregulated within the United States, several foreign governments have adopted laws and/or regulations that could restrict or prohibit the provisioning of voice communications services over the Internet or private IP networks.  More aggressive domestic or international regulation of the Internet in general, and Internet telephony providers and services specifically, may materially and adversely affect our business, financial condition, operating results and future prospects, particularly if increased numbers of governments impose regulations restricting the use and sale of IP telephony services.
 
In addition to regulations addressing Internet telephony and broadband services, other regulatory issues relating to the Internet in general could affect our ability to provide our planned security solutions.  Congress has adopted legislation that regulates certain aspects of the Internet, including online content, user privacy, taxation, liability for third-party activities and jurisdiction.  In addition, a number of initiatives pending in Congress and state legislatures would prohibit or restrict advertising or sale of certain products and services on the Internet, which may have the effect of raising the cost of doing business on the Internet generally.
 
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.
 
The growing popularity and use of the Internet has burdened the 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 the traditional telephone networks.  If any of these petitions or the relief that they seek 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.
 
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.
 
 
 
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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.
 
Growth of internal operations and business may strain our financial resources.
 
We intend to significantly expand the scope of our operating and financial systems in order to build our business.  Our growth rate may place a significant strain on our financial resources for a number of reasons, including, but not limited to, the following:
 
 
the need for continued development of the financial and information management systems;

 
the need to manage relationships with future licensees, resellers, distributors and strategic partners;

 
the need to hire and retain skilled management, technical and other personnel necessary to support and manage our business; and

 
the need to train and manage our employee base.
 
The addition of new infrastructure services, networks, vertical categories and affinity websites and the attention they demand, on top of the attention demanded by our pending litigation with Microsoft, may also strain our management resources.  We cannot give you any assurance that we will adequately address these risks and, if we do not, our ability to successfully expand our business could be adversely affected.
 
If we expand into international markets, our inexperience outside the United States would increase the risk that our international expansion efforts will not be successful, which would in turn limit our prospects for growth.
 
We may explore expanding our business to outside the United States.  Expansion into international markets requires significant management attention and financial resources.  In addition, we may face the following risks associated with any expansion outside the United States:
 
 
challenges caused by distance, language and cultural differences;

 
legal, legislative and regulatory restrictions;

 
currency exchange rate fluctuations;

 
economic instability;

 
longer payment cycles in some countries;
 
 
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credit risk and higher levels of payment fraud;

 
potentially adverse tax consequences; and

 
other higher costs associated with doing business internationally.
 
These risks could harm our international expansion efforts, which would in turn harm our business prospects.
 
We will continue to incur significant costs as a result of being a public company.
 
As a public company, we will continue to incur significant legal, accounting and other expenses that VirnetX did not incur as a private company.  The laws, rules and regulations governing public companies to increase our legal and financial compliance costs and make some activities more time-consuming and costly, and these costs could be material to us.
 
Failing to maintain the effectiveness of our internal control over financial reporting could cause the cost related to remediation to increase and could cause our stock price to decline.
 
In the future, our management may identify deficiencies regarding the design and effectiveness of our system of internal control over financial reporting that we engage in pursuant to Section 404 of the Sarbanes-Oxley Act, or Section 404, as part of our periodic reporting obligations. Such deficiencies could include those arising from turnover of qualified personnel or arising as a result of acquisitions, which we may not be able to remediate in time to meet the continuing reporting deadlines imposed by Section 404 and the costs of which may harm our results of operations. In addition, if we fail to maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that our management can conclude on an ongoing basis that we have effective internal controls. We also may not be able to retain an independent registered public accounting firm with sufficient resources to attest to and report on our internal controls in a timely manner. Moreover, our registered public accounting firm may not agree with our management’s future assessments and may deem our controls ineffective if we are unable to remediate on a timely basis. If in the future we are unable to assert that we maintain effective internal controls, our investors could lose confidence in the accuracy and completeness of our financial reports which could cause our stock price to decline.
  
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 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.  As a result, 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.
 
Risks Related to Our Stock
 
The exercise of our outstanding warrants may 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 some or all of our outstanding warrants could significantly dilute the ownership interests of our existing stockholders. As of March 31, 2010, we had outstanding warrants to purchase an aggregate of 13,723,661 shares of common stock, including (i) the warrant to purchase 300,000 shares of common stock issued to the underwriter of our December 2007 sale of common shares and warrants, (ii) the warrants to purchase 1,114,807 shares of common stock at an exercise price of $3.00 per share issued pursuant to our January 2009 sale of common shares and warrants, (iii) the warrants to purchase 1,223,000 shares of common stock at an exercise price of $4.00 per share issued pursuant to our January 2009 sale of common shares and warrants, (iv) the warrant to purchase 51,000 shares of common stock at an exercise price of $1.80 per share issued to the underwriter of our January 2009 sale of common shares and warrants, (v) the warrants to purchase 3,215,349 shares of common stock underlying the Series I Warrants issued pursuant to our September 2009 private placement transaction.  To the extent outstanding warrants are exercised, additional shares of common stock will be issued, and such issuance may dilute existing stockholders and increase the number of shares eligible for resale in the public market.  Additionally, the issuance of up to 3,366,999 shares of common stock issuable upon exercise of vested stock options and other awards outstanding as of March 31, 2010 pursuant to our incentive plan will further dilute our existing stockholders’ voting interest.
 
 
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In addition to the dilutive effects described above, the exercise of those securities would lead to a potential increase in the number of shares eligible for resale in the public market. Sales of substantial numbers of such shares in the public market could adversely affect the market price of our shares.

We may seek to raise additional funds, finance acquisitions or develop strategic relationships by issuing capital stock that would dilute your ownership.
 
We have financed our operations, and we expect to continue to finance our operations, acquisitions and develop strategic relationships, by issuing equity or convertible debt securities, which could significantly reduce the percentage ownership of our existing stockholders.  Furthermore, any newly issued securities could have rights, preferences and privileges senior to those of our existing stock.  Moreover, any issuances by us of equity securities may be at or below the prevailing market price of our stock and in any event may have a dilutive impact on your ownership interest, which could cause the market price of stock to decline.  We may also raise additional funds through the incurrence of debt or the issuance or sale of other securities or instruments senior to our common shares.  The holders of any debt securities or instruments we may issue would have rights superior to the rights of our common stockholders.
 
Trading in our common stock is limited and the price of our common stock 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 year the market price of our common stock has experienced significant fluctuations.  Between December 31, 2008 and March 31, 2010, the reported last sale price for our common stock has ranged from $7.00 to $1.06 per share.  With such volatility, there can be no assurance that we will remain qualified to be listed on NYSE Amex.
 
In April 2009, we received a letter from the NYSE Amex stating that, based on the NYSE Amex’s review of publicly available information, we were considered to be below the NYSE Amex’s continued listing standards.  After submitting a plan of compliance to the NYSE Amex and additional evaluation by the Exchange, we were informed in October 2009 that we had resolved the continued listing deficiencies.  We cannot assure you that we will not receive additional deficiency letters in the future, or that we will continue to satisfy the continued listing standards in order to remain listed on the Exchange.
  
If our securities were delisted from trading on NYSE Amex and we are unable to list our securities on another securities exchange, our securities may be able to be listed on the OTC Bulletin Board or the “Pink Sheets,” which may adversely affect the liquidity and price of our common stock.  In addition, we expect the price of our common stock to continue to be volatile as a result of a number of factors, including, but not limited to, the following:
 
 
developments in our litigation against Microsoft;

 
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.
 
 
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Because ownership of our common shares is concentrated, you and other investors will have minimal influence on stockholder decisions.
 
As of April 15, 2010, our executive officers and directors beneficially owned an aggregate of 10,616,811 shares, or approximately 24% 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. As a result, our existing 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 shares 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 since it would take two annual meetings to effectively replace at least three directors which represents 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 existing stockholders.  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.
 
 
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Elimination of the 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 block of our shares, may need to wait for the annual meeting before nominating directors or raising other business proposals to be voted on by the stockholders.
 
Securities analysts may not cover our common stock and this may have a negative impact on our common stock’s market price.
  
The trading market for our common stock may depend on the research and reports that securities analysts publish about us or our business. We do not have any control over these analysts. There is no guarantee that securities analysts will cover our common stock. If securities analysts do not cover our common stock, the lack of research coverage may adversely affect our common stock’s market price. If we are covered by securities analysts, and our stock is downgraded, our stock price would likely decline. If one or more of these analysts ceases to cover us or fails to publish regularly reports on us, we could lose or fail to gain visibility in the financial markets, which could cause our stock price or trading volume to decline.
  
Our business is subject to risks associated with the ongoing financial crisis and weakening global economy.
  
The recent severe tightening of the credit markets, turmoil in the financial markets, and weakening global economy impacts our ability to raise needed capital and enter into customer agreements. These slowdowns are expected to worsen if these economic conditions are prolonged or deteriorate further.  Further, these conditions and uncertainty about future economic conditions make it challenging for us to forecast our operating results, make business decisions and identify the risks that may affect our business, financial condition and results of operations.  If we are not able to timely and appropriately adapt to changes resulting from the difficult macroeconomic environment, our business, financial condition, and results of operations may be significantly negatively affected.
  
We have no current intention of declaring or paying any cash dividends on our common stock.
  
We do not plan to declare or pay any cash dividends on our common stock.  Our current policy is to use all funds and any earnings in the operation and expansion of our business.
 
ITEM 2 — UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
 
We had no issuance of unregistered securities during the three months ended March 31, 2010.
 
 
 
 
 
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ITEM 6 — EXHIBITS.
 
Exhibit
Number
 
Description
     
10.1
 
Engagement Letter effective as of April 27, 2010, by and between McKool Smith, a professional corporation and the Company* (1)
     
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.**
 
_____________________________
(1)
Pursuant to a request for confidential treatment, portions of the Exhibit have been redacted and have been provided separately to the U.S. Securities and Exchange Commission.
 
*
Filed herewith.
 
**
Furnished herewith.

 
 
 
 
 
 
 
 
 
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SIGNATURES
 
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  
    Kendall Larsen  
    Chief Executive Officer (Principal Executive Officer)  
       
 
 
By:
/s/ William E. Sliney  
   
William E. Sliney
 
   
Chief Financial Officer (Principal Accounting and
 
    Financial Officer)  
 
Date: May 7, 2010
 
 
 
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EXHIBIT INDEX
 
 
Exhibit
Number
 
Description
     
10.1
 
Engagement Letter effective as of April 27, 2010, by and between McKool Smith, a professional corporation and the Company* (1)
     
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.**
 
_____________________________
(1)
Pursuant to a request for confidential treatment, portions of the Exhibit have been redacted and have been provided separately to the U.S. Securities and Exchange Commission.
 
*
Filed herewith.
 
**
Furnished herewith.

 
 
 
 
 

 
 
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