VirnetX Holding Corp
Annual Report 2010

Plain-text annual report

UNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549FORM 10-K(Mark One) xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2010or oTRANSITION REPORT PURSUANT TO SECTION 13 Or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from _________________ to _______________________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 Number) 5615 Scotts Valley Drive, Suite 110 Scotts Valley, California 95066(Address of principal executive offices) (Zip Code) Registrant’s telephone number, including area code: (831) 438-8200Securities registered pursuant to Section 12(b) of the Act: Title of Class Name of Exchange on Which RegisteredCommon Stock, par value $0.0001 per share NYSE Amex Stock Exchange Securities registered pursuant to Section 12(g) of the Act:NoneIndicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.Yes o No x Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.Yes o No x Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during 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 filingrequirements for the past 90 days. Yes x No o Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data Filerequired to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorterperiod that the registrant was required to submit and post such files). Yes o No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not becontained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. x Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer oAccelerated filer xNon-accelerated filer oSmaller reporting company x(Do not check if a smaller reporting company) Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes o No x The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2010, was $229,626,990based upon the closing price of the common shares of the Registrant on June 30, 2010. This calculation does not reflect a determination that certain personsare affiliates of the Registrant for any other purpose. 49,547,952 shares of Registrant’s Common Stock were outstanding as of March 10, 2011.  DOCUMENTS INCORPORATED BY REFERENCE Certain portions of this Annual Report on Form 10-K incorporate by reference information from the Registrant’s Proxy Statement to be filed with theSecurities and Exchange Commission in connection with the solicitation of proxies for the Registrant’s 2011 Annual Meeting of Stockholders for the yearended December 31, 2010.  VirnetX Holding CorporationINDEX Page PART I Item 1.Business1Item 1A.Risk Factors11Item 1B.Unresolved Staff Comments25Item 2.Properties25Item 3.Legal Proceedings25Item 4.Reserved25 PART II Item 5.Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities26Item 6.Selected Financial Data29Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations30Item 7A.Quantitative and Qualitative Disclosures about Market Risk37Item 8.Financial Statements and Supplementary Data37Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure59Item 9A.Controls and Procedures59Item 9B.Other Information60 PART III Item 10.Directors, Executive Officers and Corporate Governance61Item 11.Executive Compensation61Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Equity CompensationPlan Information61Item 13.Certain Relationships and Related Transactions, and Director Independence61Item 14.Principal Accountant Fees and Services61 PART IV Item 15.Exhibits and Financial Statement Schedules62 -i-IndexStatement regarding forward-looking statementsThis Annual Report on Form 10-K includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 andSection 21E of the Securities Exchange Act of 1934. All statements other than statements of historical facts contained in this Annual Report on Form10-K, including statements regarding our current liquidity, future financial position, business strategy and plans and objectives of management forfuture operations, are forward-looking statements. The words “believe,” “may,” “estimate,” “continue,” “anticipate,” “intend,” “expect” andsimilar expressions, as they relate to us, are intended to identify forward-looking statements. We have based these forward-looking statements largelyon our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results ofoperations, business strategy and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptionsdescribed in “Risk Factors” and elsewhere in this Annual Report on Form 10-K. These risks are not exhaustive. Other sections of the Annual Reporton Form 10-K include additional factors which could adversely impact our business and financial performance. Moreover, we operate in a verycompetitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for our management to predict all riskfactors, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actualresults to differ materially from those contained in any forward-looking statements. You should not rely upon forward-looking statements aspredictions of future events. We cannot assure you that the events and circumstances reflected in the forward-looking statements will be achieved oroccur and actual results could differ materially from those projected in the forward-looking statements.As used herein, “we,” “us,” “our,” or the “Company” means VirnetX Holding Corporation and its wholly-owned subsidiaries, includingVirnetX, Inc., collectively, on a consolidated basis.PART IItem 1. Business.The CompanyWe are developing and commercializing software and technology solutions for securing real-time communications over the Internet. Our patentedGABRIEL Connection Technology™ combines industry standard encryption protocols with our patented techniques for automated domain name system, orDNS, lookup mechanisms, enabling users to create a secure communication link using secure domain names. We also intend to establish the exclusive securedomain name registry in the United States and other key markets around the world. Our software and technology solutions provide the security platformrequired by next-generation Internet-based applications such as instant messaging, or IM, voice over Internet protocol, or VoIP, mobile services, streamingvideo, file transfer and remote desktop. Our technology generates secure connections on a “zero-click” or “single-click” basis, significantly simplifying thedeployment of secure real-time communication solutions by eliminating the need for end users to enter any encryption information.We currently have twelve patents in the United States and sixteen foreign patents, as well as several pending U.S. and foreign patentapplications. Our portfolio includes a number of patents that describe unique systems and methods for 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 haveadditional applications in operating systems and network security. On December 2, 2009, we declared to the 3GPP (3rd Generation Partnership Project) thatour U.S. and foreign patents are or may be essential to Long Term Evolution (LTE) and 4G wireless specifications. We believe that we hold patents relevantfor compliance with the 3GPP Series 33 specifications that define security requirements for LTE/4G networks. Our employees include the core developmentteam behind our patent portfolio, technology and software. This team has worked together for over ten years and is the same team that invented and developedthis technology while working at Science Application International Corporation, or SAIC. SAIC is a FORTUNE 500® scientific, engineering and technologyapplications company that uses its deep domain knowledge to solve problems of vital importance to the nation and the world, in national security, energy andthe environment, critical infrastructure and health. We acquired the majority of this patent portfolio in 2006, and it now serves as the foundation of ourplanned licensing and service offerings. We expect to derive the majority of our revenue from license fees and royalties associated with this technology. Wealso intend to continue our research and development efforts to further strengthen and expand our patent portfolio. Please see Item 7 – Management’sDiscussion and Analysis of Financial Condition and Results of Operations – Operations – Research and Development Expenses for a description of ourresearch and development expenses for the past two fiscal years. Over time, we plan to leverage our patent portfolio to develop a product suite that can be soldto enterprise customers and developers. Index Our primary source of income since our inception has been from the Settlement and License Agreement we entered into with Microsoft Corporation,our first licensee, on May 14, 2010, or the Settlement and License Agreement. Pursuant to the Settlement and License Agreement, Microsoft paid us$200,000,000 in June 2010. As a result we dismissed the two patent infringement lawsuits we had initiated against Microsoft in February 2007 and March2010 and granted Microsoft a worldwide, irrevocable, nonexclusive, non-sub licensable fully paid up license for our patents. The Settlement and LicenseAgreement with Microsoft will not impact our plans to operate a secure domain name service.On August 11, 2010, we initiated a lawsuit by filing a complaint against Aastra, Apple, Cisco, NEC in the United States District Court for theEastern District of Texas, Tyler Division, pursuant to which we allege that these parties infringe on certain of our patents. We seek damages and injunctiverelief. On January 12, 2011, we initiated a lawsuit by filing a complaint against Siemens and Mitel in the United States District Court for the Eastern Districtof Texas, Tyler Division, pursuant to which we allege that these companies infringe two of our patents. We seek damages and injunctive relief.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 beta testing of our GABRIEL Connection Technology has nowbecome part of our Secure Domain Name Initiative, or SDNI, that was announced on April 13, 2010. We have been in active discussions with leading4G/LTE companies (domain infrastructure providers, chipset manufacturers, service providers, and others) to participate in a design pilot program fordelivering to end-users and consumers of the Internet and mobile devices the needed and necessary security requirements for the next generation 4G/LTEwireless networks. We expect that the design pilot program will implement our patented Secure Domain Name and our GABRIEL Connection Technology™.We also intend to license our technology and software, including our secure domain name registry service, to communication service providers aswell as to system integrators. We believe that the market opportunity for our software and technology solutions is large and expanding.Industry OverviewThe Internet is increasingly evolving into a rich medium used by individuals and businesses to conduct commerce, share information and engage inreal-time communications including email, text messaging, IM, and voice and video calls. This communications experience is richer and more complex thanever before. Session initiation protocol, or SIP, was developed to enable the convergence of voice and data networks and today is the predominant industrystandard for establishing multimedia communications over the Internet such as voice, video, instant messaging, presence information and file transfer. SIP,as well as other real-time collaboration protocols such as XMPP, use DNS lookup as its primary means of connecting Internet devices but is an openarchitecture that remains inherently unsecure.We believe that accessing a diversity of services from a single device, anytime and anywhere, and the ability to access these same services from arange of devices are emerging as key market requirements. The portions of the IP-telephony, mobility, fixed-mobile convergence and unified communicationsmarkets that could benefit from our software and technology solutions are forecasted by Infonetics to grow from approximately $59 billion of worldwiderevenues in 2006 to approximately $162 billion by 2011, representing a compound annual growth rate, or CAGR, of approximately 22%. We believe that thisgrowing trend represents a significant opportunity for VirnetX to license its technology and software, and establish its secure domain name registry. -2-Index IP TelephonyIP telephony includes technologies that use Internet Protocol’s packet-switched connections to exchange voice, fax, and other forms of informationtraditionally carried over the dedicated circuit-switched connections of the public switched telephone network, or PSTN. The adoption of IP telephony hashelped businesses significantly lower network operating costs by using a common network for voice and data. As the workforce becomes increasinglydispersed, mobile features enabled by Internet protocol-based communications such as presence, unified messaging, peer-to-peer applications, find me/followme, white-boarding and document sharing have become more commonplace. However, the development of the related security infrastructure has laggedbehind, leaving next-generation networks vulnerable to a multitude of threats including man-in-middle, eavesdropping, domain hijacking, distributed denial ofservice, or DDoS, spam over Internet telephony, or SPIT, and spam over instant messaging, or SPIM. These threats continue to highlight the need forsecuring next-generation networks. As the use of IP telephony systems extends beyond the boundaries of an organization’s private network, security is likelyto become an even bigger concern. Worldwide revenue from IP telephony products like IP-PBX including IP phones, service provider VoIP and IMSequipment, VoIP gateways and hosted VoIP services for businesses is forecasted by Infonetics to grow from approximately $15 billion in 2006 toapproximately $43 billion in 2011, representing a CAGR of approximately 23%. We believe our unique and patented solution provides the robust securityplatform required for providing on-demand secure communication links between enterprises intending to communicate securely without manually configuringthe connections. We believe a standard security solution such as ours will further accelerate the adoption of IP telephony products in the market and allowenterprises to take full advantage of these rich content applications and real-time communications over the Internet, thereby significantly increasing their returnon investment.Fixed-Mobile ConvergenceFixed-mobile convergence is an environment where wired and wireless phones work together with Internet Protocol to deliver services (voice, video,data and combinations thereof) uniformly across multiple access networks, including, among others, WiMAX, WiFi, cellular and fixed. We believe thatworldwide revenue for fixed-mobile convergence infrastructure equipment will grow from approximately $9 million in 2006 to over $406 million in 2011,representing a CAGR of approximately 114%. Additionally, according to a thought leadership paper entitled “Road to Full Convergence” published by Fixed-Mobile Convergence Alliance, or FMCA, an alliance of leading operators representing a customer base of over 850 million customers, consumers increasinglyfeel the need to be connected and have real-time access to media streams, blogs and breaking news. During the past ten years, users have become increasinglytechnologically sophisticated and are now demanding greater functionality from the Internet. Today, the Internet is used for commerce, accessing content,social networking, online dating and a number of other forms of media-rich, real-time communication and collaboration. Mobile devices like dual mode(cellular/WiFi) phones lie at the center of this transition and have become the device with the closest proximity and relationship to the user. We believe thataccessing a diversity of services from a single device, anytime and anywhere, and the ability to access the same services from a range of devices, is emergingas a key market requirement. Worldwide total dual mode cellular/WiFi phone revenue was approximately $17 billion in 2006 and is expected to grow toapproximately $76 billion in 2011, representing a CAGR of approximately 35%. The strong projected growth for converged cellular/WiFi phones and relatedservices in enterprise and consumer market segments represents a significant opportunity for VirnetX’s technology, and software to become the industrystandard for securing real-time communication.IP MobilitySmartphones are multi-functional devices that handle a wide variety of business-critical applications and support increasingly complex functionsincluding enhanced data processing, Internet access, e-mail access, calendars and scheduling, contact management and the ability to view electronicdocuments. Users have continual access to these applications while on the move making them an increasingly essential business tool for the mobileworker. These devices enable mobile workers to have similar functionality inside or outside the office thereby increasing employee efficiency. However, it iscritical that this mobile environment have the same level of security as an enterprise’s internal network. Worldwide revenue from IP mobility products likesmartphones and mobile data cards is expected to grow from approximately $26 billion in 2006 to approximately $41 billion by 2011, representing a CAGRof approximately 10%. We believe in order to realize the full functionality of IP mobility, several challenges including security must be overcome. When usersare mobile, connections and data need to cross multiple network boundaries, each of which poses a security threat. Wireless networks present unique threatsbecause rogue users can enter the enterprise network through wireless access points that may not be sufficiently protected as part of an organization’s ITsecurity protocols. Providing authenticated access to the wireless networks and enterprise applications through the wireless domain are important requirementsand represent a significant market opportunity for VirnetX’s patented technology and secure domain names to provide users fully authenticated secure accesson a “zero-click” or “single-click” basis. -3-Index Unified CommunicationsThe need to enhance productivity is putting increasing demand on instant access to, and the management of, rapidly expanding real-timeinformation. Mobile collaboration, and the ability to conduct business whether inside or outside of the office, are high priorities. Business and consumerusers are nomadic and expect instant access everywhere. The ability to establish multiple secure simultaneous network connections and provide IP sessionswith security and encryption will be critical to widespread deployment of next-generation networks. A shortcoming of this new communications environmentis that the various modes of communication operate independently from one another and do not integrate easily, if at all. As the number of devices grows,individual points of contact multiply and communication becomes more sophisticated and increasingly vulnerable.The idea behind unified communications is to organize the array of communication methodologies, integrating the various fragmented waysindividuals communicate today into a single communications experience, ultimately increasing utility and productivity. The basic components comprisingunified communications include: a directory for storing addresses, various modes of communication with each user/contact (desk phone, mobile phone, IM,etc.), message storage for all messages regardless of communication method and secure presence of a user’s status for each mode of communication (available,away, busy, etc.). Worldwide unified communications market generated approximately $377 million in revenue in 2006 and is forecasted to grow rapidly overthe next few years generating approximately $813 million in revenue in 2011, representing a CAGR of approximately 17%. We believe the growth in unifiedcommunication products may not reach its full potential due to the lack of transparent and seamless security as users hesitate to place their presenceinformation online for all to see and as organizations block access due to the lack of credentials verified by a neutral third party. Our solutions help addressthese concerns and should enable significant growth in the unified communications market.Our SolutionsOur software and technology solutions, including our secure domain name registry, our patents and our GABRIEL Connection Technology™ aredesigned to secure all types of real-time communications over the Internet. Our technology uses industry standard encryption methods with our patented DNSlookup mechanisms to create a secure communication link between users intending to communicate in real time over the Internet. Our technology can be builtinto network infrastructure, operating systems or silicon chips developed for a communication or computing device to secure real-time communications overthe Internet between numerous devices. Our technology automatically encrypts data allowing organizations and individuals to establish communities ofsecure, registered users and transmit information between multiple devices, networks and operating systems. These secure network communities, which wecall secure private domains, or SPDs, are designed to be fully-customizable and support rich content applications such as IM, VoIP, mobile services,streaming video, file transfer and remote desktop in a completely secure environment. Our approach is a unique and patented solution that provides the robustsecurity platform required by these rich content applications and real-time communications over the Internet. The key benefits and features of our technologyinclude the following: -4-Index ·Automatic and seamless to the user. After a one-time registration, users connect securely on a “zero-click” or “single-click” basis. ·Secure data communications. Users create secure networks with people they trust and communicate over a secure channel. ·Control of data at all times. Users can secure and customize their unified communication and collaboration applications such as file sharingand remote desktop with policy-based access and secure presence information. ·Authenticated users. Users know they are communicating with authenticated users with secure domain names. ·Application-agnostic technology. Our solution provides security at the IP layer of the network by using patented DNS lookup mechanisms tomake connections between secure domain names, thereby obviating the need to provide application specific security.Competitive StrengthsWe believe the following competitive strengths will enable our success in the marketplace: ·Unique patented technology. We are focused on developing innovative technology for securing real-time communications over the Internet, andestablishing the exclusive secure domain name registry in the United States and other key markets around the world. Our unique solutionscombine industry standard encryption methods and communication protocols with our patented techniques for automated DNS lookupmechanisms. Our technology and patented approach enables users to create a secure communication link by generating secure domainnames. We have a portfolio comprised of twelve patents in the United States and sixteen foreign patents, as well as several pending U.S. andforeign patent applications. Our portfolio includes patents and pending patent applications in the United States and other key markets thatsupport our secure domain name registry service for the Internet. ·Scalable licensing business model. We are actively engaged in pursuing licensing agreements with OEMs, service providers and systemintegrators within the IP-telephony, mobility, fixed-mobile convergence and unified communications end-markets. ·Highly experienced research and development team. Our research and development team is comprised of nationally recognized networksecurity and encryption technology scientists and experts that have worked together as a team for over ten years. During their careers, this teamhas developed several cutting-edge technologies for U.S. national defense, intelligence and civilian agencies, many of which remain critical to ournational security today. Prior to joining VirnetX, our team worked for SAIC during which time they invented the technology that is thefoundation of our technology, and software. Based on the collective knowledge and experience of our development team, we believe that we haveone of the most experienced and sophisticated groups of security experts researching vulnerability and threats to real-time communication overthe Internet and developing solutions to mitigate these problems.Our StrategyOur strategy is to become the market leader in securing real-time communications over the Internet and to establish our GABRIEL CommunicationsTechnology™ as the industry standard security platform. Key elements of our strategy are to: -5-Index ·Implement a technology licensing program to commercialize our intellectual property, including our GABRIEL Connection Technology™. ·Establish VirnetX as the exclusive universal registry of secure domain names and to enable our customers to act as registrars for their users andbroker secure communication between users on different registries. ·Leverage our existing technology to develop a suite of products that can be sold directly to end-user enterprises.On December 2, 2009, we declared to the 3GPP (3rd Generation Partnership Project) that we believe our U.S. and foreign patents are or may beessential to Long Term Evolution (LTE) and 4G wireless specifications. We believe that we hold the patents relevant to compliance with the 3GPP Series 33specifications that define security requirements for LTE/4G networks.License and Service OfferingsWe plan to offer a diversified portfolio of license and service offerings focused on securing real-time communications over the Internet, including: ·VirnetX technology licensing: Customers who want to develop their own implementation of the VirnetX code module for supporting securedomain names, or who want to use their own techniques that are covered by our patent portfolio for establishing secure communication links,will purchase a technology license. We anticipate that these licenses would typically include an initial license fee, as well as an ongoingroyalty. We expect that these licenses will include a one-time delivery of Gabriel software development kit including object libraries, samplecode, testing and quality assurance tools and the supporting documentation necessary for a customer to implement of the techniques we havedeveloped. ·GABRIEL Connection Technology™ Software Development Kit or SDK: OEM customers who want to adopt the GABRIEL ConnectionTechnology™ as their solution for establishing secure connections using secure domain names within their products will purchase an SDKlicense. The software development kit consists of object libraries, sample code, testing and quality assurance tools and the supportingdocumentation necessary for a customer to implement our technology. These tools are comprised of software for a secure domain nameconnection test server, a relay test server and a registration test server. We expect that customers would pay an up-front license fee to purchase anSDK license and a royalty fee for every product shipped with the embedded VirnetX code module. ·Secure domain name registrar service: Customers, including service providers, telecommunication companies, ISPs, system integrators andOEMs could purchase a license to our secure domain name registrar service. We would provide the software suite and technology support toenable such customers to provision devices with secure domain names and facilitate secure connections between registered devices. This suiteincludes the following server software modules: oRegistrar server software: We anticipate that our registrar server software would enable customers to operate as a secure domain nameregistrar that provisions devices with secure domain names. The registrar server software is designed to provide an interface for ourcustomers to register new virtual private domains and sub-domain names. This server module must be enrolled with the VirnetX securedomain name master registry to obtain its credentials before functioning as an authorized registrar. oConnection server software: We anticipate that our connection server software would allow customers to provide connection services toenrolled devices. The connection services include registration of presence information for authenticated users and devices, presenceinformation query request services, enforcement of policies and support for communication with peers behind firewalls. -6-Index oRelay server software: We anticipate that our relay server software would allow customers to dynamically maintain connections and relaydata to private IP addresses for network devices that reside behind firewalls. Secure domain name registrar service customers will enter intoa technology licensing and revenue sharing agreement with VirnetX whereby we will typically receive an up-front licensing fee for the securedomain name registrar technology, as well as ongoing annual royalties for each secure domain name issued by the customer. ·Secure domain name master registry and connection service: As part of enabling the secure domain name registrar service, we expect thatwe will maintain and manage the secure domain name master registry. This service is expected to enroll all secure domain name registrarcustomers and generate the credentials required to function as an authorized registrar. It also is expected to provide connection services anduniversal name resolution, presence information and secure connections between authorized devices with secure domain names. ·Technical support services: We intend to provide high-quality technical support services to licensees and customers for the rapid customizationand deployment of GABRIEL Connection Technology™ in an individual customer’s products and services.Our research and development team was the team responsible for inventing the claimed subject matter of the patents that form the foundation of ourtechnology. This team has worked together for over ten years. We intend to leverage this experience and continue investing in research and development and,over time, expect to strengthen and expand our patent portfolio, technology, and software. While we are currently focused on securing real-timecommunications over the Internet and establishing the first and only secure domain name registry, we believe our existing and future intellectual propertyportfolio will extend to additional areas including, among others, network security and operating systems for fixed and mobile devices.CustomersOur primary source of revenue since inception has been from the Settlement and License Agreement we entered into with Microsoft Corporation, ourfirst licensee, on May 14, 2010, or the Settlement and License Agreement. Pursuant to the Settlement and License Agreement, Microsoft paid us $200,000,000in June 2010. As a consequence, we dismissed the two patent infringement lawsuits we initiated against Microsoft in February 2007 and March 2010 andgranted Microsoft a worldwide, irrevocable, nonexclusive, non-sub licensable fully paid up license under our patents. The Settlement and License Agreementwith Microsoft will not impact our plans to operate a secure domain name service.We are currently focused on commercializing our technology and are actively offering our GABRIEL Connection Technology™ to original equipmentmanufacturers, or OEMs, within the IP-telephony, mobility, fixed-mobile convergence and unified communications markets.We also intend to provide technology licenses and software offerings, including our secure domain name registry service, to communication serviceproviders as well as to system integrators.Marketing and SalesWe plan to employ a leveraged, partner-oriented, marketing strategy for our technology licenses and software offerings. We expect the marketingstrategy will primarily be focused on OEMs.We plan to directly market our domain name registry services to our service provider and system integrator customers. We hope to leverage ourrelationship with SAIC to extend our offering to departments and agencies within the federal government. 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 nationalsecurity, energy and the environment, critical infrastructure, and health. -7-Index We intend to build a sales force that will be responsible for managing accounts and pursuing technology licensing and sales opportunities with newcustomers.CompetitionWe believe our technology and solutions will compete primarily against various proprietary security solutions. We group these solutions into threemain categories: ·Proprietary or home-grown application specific security solutions have been developed by vendors and integrated directly into their products forour target markets including IP-telephony, mobility, fixed-mobile convergence, and unified communications. These proprietary solutions havebeen developed due to the lack of standardized approaches to securing real-time communications. This approach has led to corporate networksthat are isolated and, as a result, restrict enterprises to using these next-generation networks within the boundaries of their privatenetwork. These solutions generally do not provide security for communications over the Internet or require network administrators to manuallyexchange keys and other security parameters with each destination network outside their corporate network boundary. The cost-savings andother benefits of IP-based real-time communications are significantly limited by this approach to securing real-time communications. ·A session border controller, or SBC, is a device used in networks to exert control over the signaling and media streams involved in establishing,conducting and terminating VoIP calls. A traditional firewall or network address translation, or NAT, device typically block information likeendpoint IP addresses and port numbers required by signaling protocols, such as SIP and XMPP, to reach and communicate with their intendeddestination. SBCs are used in physical networks to address these limitations and enable real-time session traffic to cross the boundaries createdby firewalls and other NAT devices and enable VoIP calls to be established successfully. However, SBCs must decrypt and analyze everysingle data packet for the information to be transmitted successfully, thereby preventing end-to-end encryption. This network design results inSBCs becoming a single point of congestion on the network, as well as a single point of failure. SBCs are also limited to the physical networkthey secure. ·SIP firewalls, or SIP-aware firewalls, and application layer gateways, manage and protect the traffic, flow and quality of VoIP and other SIP-related communications. They perform real-time network address translation, dynamic firewall functions, support multiple signaling protocols,and media functionality, allowing secure interconnection and the flow of IP media streams across multiple networks. While SIP firewalls assistin analyzing SIP traffic transmitted over the corporate network to filter out various threats, they do not necessarily encrypt the traffic. As aresult, this traffic is not entirely secure from end-to-end nor is it protected against threats like man-in-middle and eavesdropping.Intellectual Property and Patent RightsOur intellectual property is primarily comprised of trade secrets, patented know-how, issued and pending patents, copyrights and technologicalinnovation.We have a portfolio comprised of twelve patents in the United States and sixteen foreign patents, as well as several pending U.S. and foreign patentapplications. Our portfolio includes a number of patents that describe unique systems and methods for 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 haveadditional applications relating to operating systems and network security. -8-Index We have included a list of our U.S. patents below. Each patent below is publicly accessible on the Internet website of the U.S. Patent and TrademarkOffice at www.uspto.gov. The term of each of our issued U.S. and foreign patents will expire during the period from 2019 to 2024.U.S. Patent Number Link toPatent Title of Patent6,502,135 Agile network protocol for secure communications with assured system availability6,618,761 Agile network protocol for secure communications with assured system availability6,826,616 Method for establishing secure communication link between computers of virtual private network6,834,310 Preventing packet flooding of a computer on a computer network6,839,759 Method for establishing secure communication link between computers of virtual private network without user entering anycryptographic information6,907,473 Agile network protocol for secure communications with assured system availability7,010,604 Agile network protocol for secure communications with assured system availability7,133,930 Agile network protocol for secure communications with assured system availability7,188,180 Method for establishing secure communication link between computers of virtual private network7,209,479 Third party VPN certification7,418,504 Agile network protocol for secure communications using secure domain names7,490,151 Establishment of a secure communication link based on a domain name service (DNS) requestNotwithstanding anything to the contrary set forth in any of the Company’s filings under the Securities Act of 1933 or the Securities ExchangeAct of 1934 that might incorporate future filings, the information set forth on the United States Patent and Trademark Office, or the USPTO Website,shall not be deemed to be a part of or incorporated by reference into any such filings. The Company does not warrant the accuracy, or completenessor adequacy of the USPTO Website, and expressly disclaims liability for errors or omissions on such website.Assignment of PatentsMost 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, asamended on November 2, 2006, including documents prepared pursuant to the November amendment, and as further amended on March 12, 2008. We arerequired to make payments to SAIC based on the revenue generated from our ownership or use of the patents we acquired from SAIC. Royalty amounts varydepending upon the type of revenue generating activities, and certain royalty categories are subject to maximums and other limitations. With respect to revenue-generating activities within our field of use, minimum annual royalty payments of $50,000 were due beginning in 2008 but as of June 30, 2010 we have metour maximum royalty payment. Under certain circumstances, SAIC is entitled to receive a portion of the proceeds from revenues, monies or any form ofconsideration paid to VirnetX for certain acquisitions of VirnetX or from the settlement of certain patent infringement claims we assert on others.Government RegulationThe laws governing online secure communications remain largely unsettled, even in areas where there has been legislative action. It may take years todetermine whether and how existing laws governing intellectual property, privacy and libel apply to online communications and media. Such legislation mayinterfere with the growth in use of online secure communications and decrease the acceptance of online secure communications as a viable solution, whichcould adversely affect our business.Due to the Internet’s popularity and increasing use, new laws regulating secure communications may be adopted. These laws and regulations maycover, among other things, issues relating to privacy, pricing, taxation, telecommunications over the Internet, content, copyrights, distribution and quality ofproducts and services. We intend to comply with all new laws and regulations as they are adopted. -9-Index The U.S. government has 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 thatincreases 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 InternetCorporation for Assigned Names and Numbers, or ICANN, a California non-profit corporation headquartered in Marina Del Rey, California. ICANN isresponsible for managing the accreditation of registry providers and registrars that manage the assignment of top level domain names associated with theauthoritative DNS root directory. Although it is possible to create and manage other DNS root directories privately without accreditation from ICANN, thepossibility of conflicting name and number assignments makes it less likely that users would widely adopt a top level domain name associated with analternative DNS root directory provided by a non-ICANN-accredited registry service.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 withICANN and we cannot assure you that we will be successful in obtaining ICANN accreditation for our registry service on terms acceptable to us or atall. 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’sresponsibilities for the domain name system to the U.S. Department of Commerce and ICANN and the evolving government regulatory environment withrespect to domain name registry services.EmployeesAs of December 31, 2010, we had 11 full-time employees.Corporate Overview and HistoryPASW, Inc. was incorporated in the State of California in November 1992. PASW, Inc. reincorporated in the State of Delaware in March2007. From inception until January 2003, PASW, Inc. was engaged in the business of developing and licensing software that enabled Internet and web basedcommunications. In January 2003, PASW, Inc. sold all of its operating assets and became a publicly traded company with limited operations.VirnetX, Inc., which we refer to throughout this Annual Report on Form 10-K as VirnetX, was incorporated in the State of Delaware in August2005. In November 2006, VirnetX acquired certain patents from SAIC. In July 2007, we effected a reverse merger between PASW, Inc. and VirnetX, whichbecame our principal operating subsidiary. As a result of this merger, the former security holders of VirnetX came to own a majority of our outstandingcommon stock. On October 29, 2007, we changed our name from PASW, Inc. to VirnetX Holding Corporation.Available InformationWe file or furnish various reports, such as registration statements, periodic and current reports, proxy statements and other materials with theSEC. Our Internet website address is www.virnetx.com. You may obtain, free of charge on our Internet website, copies of our annual report on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of theExchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information we post is intendedfor reference purposes only; none of the information posted on our website is part of this report or incorporated by reference herein.In addition to the materials that are posted on our website, you may read and copy any materials we file with the SEC at the SEC’s Public ReferenceRoom at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and other information statements, and other information regarding issuers,including us, that file electronically with the SEC. The Internet address of the SEC’s Internet site is http://www.sec.gov. -10-Index Item 1A. Risk Factors.You should carefully consider the following material risks in addition to the other information set forth in the Annual Report on this Form 10-K before making any investment in the offered securities. The risks and uncertainties described below are not the only ones we face. Additional risksand uncertainties not presently known to us or that we currently believe to be immaterial may also adversely affect our business. If any of these riskfactors occurs, you could lose substantial value or your entire investment in the offered securities.Risks Related To Existing and Future LitigationOur litigation against Aastra, Apple, Cisco, NEC, Siemens and Mitel is ongoing, and we expect such litigation and the appeals process to betime-consuming and costly, which may adversely affect our financial condition and our ability to operate our business.On August 11, 2010, we initiated a lawsuit by filing a complaint against Aastra, Apple, Cisco, NEC in the United States District Court for theEastern District of Texas, Tyler Division, pursuant to which we allege that these parties infringe on certain of our patents. We seek damages and injunctiverelief. On January 12, 2011, we initiated a lawsuit by filing a complaint against Siemens and Mitel in the United States District Court for the Eastern Districtof Texas, Tyler Division, pursuant to which we allege that these companies infringe two of our patents. We seek damages and injunctive relief.We cannot assure you that any of these lawsuits will result in a final outcome that is favorable to our company or our stockholders.We expect to allocate a significant amount of our existing cash on hand towards the fees and expenses associated these litigation matters. Weanticipate that these legal proceedings could continue for several years and may require significant expenditures for legal fees and other expenses. In the eventwe are not successful through appeal and do not subsequently obtain monetary and injunctive relief, these litigation matters may significantly reduce ourfinancial resources and have a material impact on our ability to continue our operations. The time and effort required of our management to effectively pursuethese litigation matters may adversely affect our ability to operate our business, since time spent on matters related to the lawsuits will take away from the timespent on managing and operating our business.While we believe Aastra, Apple, Cisco, NEC, Siemens and Mitel infringe our patents, we can provide no assurance that we will be successfulin our lawsuit through appeal.We believe that Aastra, Apple, Cisco, NEC, Siemens and Mitel infringe on certain of our patents, but obtaining and collecting a judgment againstthese parties may be difficult or impossible. Patent litigation is inherently risky and the outcome is uncertain. Aastra, Apple, Cisco, NEC, Siemens andMitel are all large, well-financed companies with substantially greater resources than us. We believe that these parties will devote a substantial amount ofresources 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, wecannot predict the final outcome of these litigation matters.We may commence additional legal proceedings against third parties who we believe are infringing on our intellectual property rights, and ifwe are forced to litigate to defend our intellectual property rights, or to defend claims by third parties against us relating to intellectual propertyrights, 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 infringementclaims against other parties in addition to our claims against Aastra, Apple Inc., Cisco, NEC, Siemens and Mitel. If we commence actions against additionalparties, we may incur significant expense and commit significant management time, which may adversely affect our financial condition and results ofoperations. Moreover, there can be no assurance that we would be successful in any additional legal proceedings and the existence and outcome of any suchlitigation could harm our business. In addition, commencing lawsuits may lead to potential counterclaims which may preclude our ability to develop andcommercialize products. -11-Index Risks Related to Our Business and Our IndustryWe may or may not be able to capitalize on potential market opportunities related to our licensing strategy or our patent portfolio.In order to capitalize on our patent portfolio, our business strategy calls for us to enter into licensing relationships with the leading companies in ourtarget market in order to reach a larger end-user base than we could reach through direct sales and marketing efforts. Although we entered into a Settlement andLicense Agreement with Microsoft Corporation, there can be no assurance that we will be able to continue to capitalize on our patent portfolio or any potentialmarket opportunity in the foreseeable future. Our inability to generate licensing revenues associated with the potential market opportunity could result from anumber of factors, including, but not limited to: ·we may not be successful in entering into licensing relationships with our targeted customers on commercially acceptable terms; and ·challenges to the validity of certain of our patents underlying our licensing opportunities.We can provide no assurance that we will be successful in pursuing our business plan of commercializing our technology.We expect to depend on our intellectual property licensing fees and royalties for the majority of our revenues. Our ability to generate licensing fees androyalties is dependent on mainstream market adoption of real-time communications based on Session Initiation Protocol or using DNS lookup protocols aswell as customer adoption of our GABRIEL Communication Technology™ and our secure domain name registry. We cannot assure you that we will succeedin building a profitable business based on our business plan.There has been increased competition for security solutions in the real-time communications industry, as more companies seek to provideproducts and services similar to our proposed products and services, and because larger and better-financed competitors may affect our ability tooperate 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 securityproducts and services that will compete directly with our proposed products and services. We also expect that we will compete against established vendorswithin the IP-telephony, mobility, fixed-mobile convergence and unified communications markets. These companies may incorporate other competitivetechnologies into their product offerings, whether developed internally or by third parties. For the foreseeable future, substantially all of our competitors arelikely to be larger, better-financed companies that may develop products superior to our proposed products, which could create significant competitiveadvantages for those companies. Our future success depends on our ability to compete effectively with our competitors. As a result, we may have difficultycompeting with larger, established competitors. Generally, these competitors have: ·substantially greater financial, technical and marketing resources; ·a larger customer base; ·better name recognition; and -12-Index ·more expansive product offerings.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 userpreferences and to devote greater resources to developing and operating networks of affinity websites. These competitors may develop products or services thatare 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 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 intellectualproperty rights, we rely on a combination of patent, trademark, copyright and trade secret laws, confidentiality agreements with our employees and thirdparties, and protective contractual provisions. Further, we can give no assurances that infringement or invalidity claims (or claims for indemnificationresulting from infringement claims) will not be asserted or prosecuted against us or that any such assertions or prosecutions will not materially adverselyaffect our business.Regardless of whether these or any future claims are valid or can be successfully asserted, defending against such claims could cause us to incursignificant costs, could jeopardize or substantially delay a successful outcome in any future litigation, and could divert resources away from our otheractivities. In addition, assertion of infringement claims could result in injunctions that prevent us from distributing our products. In addition to challengesagainst 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 orinvalidated; ·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 thosewe 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 thefuture or from which competitors may operate. While we have numerous pending foreign patents, obtaining such patents will not necessarily protect ourtechnology or prevent our international competitors from developing similar products or technologies. Our inability to adequately protect our patented rightswould have a negative impact on our operations and revenues.In addition, legal standards relating to the validity, enforceability, and scope of protection of intellectual property rights in Internet-related businessesare uncertain and still evolving. Because of the growth of the Internet and Internet related businesses, patent applications are continuously and simultaneouslybeing filed in connection with Internet-related technology. There are a significant number of U.S. and foreign patents and patent applications in our areas ofinterest, and we believe that there has been, and is likely to continue to be, significant litigation in the industry regarding patent and other intellectual propertyrights.The burdens of being a public company may adversely affect our ability to pursue litigation.As a public company, our management must devote substantial time, attention and financial resources to comply with U.S. securities laws. Thismay have a material adverse effect on management’s ability to effectively and efficiently pursue 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 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 ourlitigation opponents to develop effective litigation strategies that are contrary to our interests. -13-Index When we attempt to implement our secure domain name registry services business, we may be subject to government and industry regulationand 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. OnJuly 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 mannerthat 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 InternetCorporation for Assigned Names and Numbers, or ICANN, a California non-profit corporation headquartered in Marina Del Rey, California. ICANN isresponsible for managing the accreditation of registry providers and registrars that manage the assignment of top level domain names associated with theauthoritative DNS root directory. Although other DNS root directories are possible to create and manage privately without accreditation from ICANN, thepossibility of conflicting name and number assignments makes it less likely that users would widely adopt a top level domain name associated with analternative DNS root directory provided by a non-ICANN-accredited registry service.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 withICANN and we cannot assure you that we will be successful in obtaining ICANN accreditation for our registry service on terms acceptable to us or atall. 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’sresponsibilities for the domain name system to the U.S. Department of Commerce and ICANN and the evolving government regulatory environment withrespect to domain name registry services. -14-Index The laws governing online secure communications are largely unsettled, and if we become subject to various government regulations, costsassociated 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 incompliance 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 orthat 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 CommunicationsCommission has imposed some traditional telephony requirements on VoIP such as disability access requirements and other obligations. It is possible thatfederal and state legislatures may seek to impose increased fees and administrative burdens on VoIP, data and video providers. Such regulations could resultin substantial costs depending on the technical changes required to accommodate the requirements, and any increased costs could erode the pricing advantageover 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 relativelyrecent development. Although the provisioning of such services is currently permitted by U.S. law and is largely unregulated within the United States, severalforeign governments have adopted laws and/or regulations that could restrict or prohibit the provisioning of voice communications services over the Internet orprivate 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 ofgovernments 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 affectour 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 wouldprohibit 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 theInternet generally.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 businessstrategy that our facilities and infrastructure remain secure and are perceived by the marketplace to be secure. Our secure domain name registry operations willalso depend on our ability to maintain our computer and telecommunications equipment in effective working order and to reasonably protect our systemsagainst interruption, and potentially depend on protection by other registrars in the shared registration system. The secure domain name servers that we willoperate will be critical hardware to our registry services operations. Therefore, we expect to have to expend significant time and money to maintain or increasethe security of our facilities and infrastructure.Security technologies are constantly being tested by computer professionals, academics and “hackers.” Advances in the techniques for attackingsecurity solutions could make some or all of our products obsolete or unmarketable. Likewise, if any of our products are found to have significant securityvulnerabilities, then we may need to dedicate engineering and other resources to eliminate the vulnerabilities and to repair or replace products already sold orlicensed to our customers. Despite our security measures, our infrastructure may be vulnerable to physical break-ins, computer viruses, attacks by hackersor similar disruptive problems. It is possible that we may have to expend additional financial and other resources to address such problems. Any physical orelectronic break-in or other security breach or compromise of the information stored at our secure data centers and domain name registration systems mayjeopardize the security of information stored on our premises or in the computer systems and networks of our customers. In such an event, we could facesignificant liability and customers could be reluctant to use our services. Such an occurrence could also result in adverse publicity and therefore adverselyaffect the market’s perception of the security of electronic commerce and communications over IP networks as well as of the security or reliability of ourservices. -15-Index 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.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 may not continue to gain widespread market acceptance. The Internet may ultimately prove not to be a viable commercialmarketplace 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.If the market for IM, VoIP, mobile services, streaming video, file transfer and remote desktop does not grow as anticipated, our businesswould be adversely affected.The success of our products that secure IM, VoIP, mobile services, streaming video, file transfer and remote desktop, among other real-timecommunications applications, depends on the growth in the number of users, which in turn depends on the Internet gaining more widespread acceptance as thebasis for these real-time communications applications. These real-time communications applications are still in early stages of market acceptance and wecannot assure you that they will continue to develop a broader audience. For example, potential new users may view VoIP as unattractive relative to traditionaltelephone services for a number of reasons, including the need to purchase computer headsets or the perception that the price advantage for VoIP is insufficientto 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 beno 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 personaland professional users of IM and other next-generation Internet-based solutions do not want to pay for the security solutions, we will have difficulty marketingand selling our products and technologies. -16-Index We expect that we will experience long and unpredictable sales cycles, which may impact our operating results.We expect that our sales cycles will be long and unpredictable due to a number of uncertainties such as: ·the need to educate potential customers about our patent rights and our product and service capabilities; ·customers’ willingness to invest potentially substantial resources and modify their network infrastructures to take advantage of our products; ·customers’ budgetary constraints; ·the timing of customers’ budget cycles; and ·delays caused by customers’ internal review processes.We expect that we will be substantially dependent on a concentrated number of customers. If we are unable to establish, maintain or replaceour relationships with customers and develop a diversified customer base, our revenues may fluctuate and our growth may be limited.We expect that in the future, a significant portion of our revenues will be generated from a limited number of customers. Substantially all of ourincome during fiscal year 2010 was from the payments to us resulting from the Settlement and License Agreement we entered into with Microsoft. There can beno guarantee that we will be able to obtain additional customers, or if we do so, to sustain our revenue levels from these prospective customers. If we are notable to establish, maintain or replace the limited group of prospective customers that we anticipate may generate a substantial majority of our revenues in thefuture, 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 evolvingmarket 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 needsand frequent new service and product introductions. We are currently focused on developing products to provide security solutions for real-timecommunications. Our future success will depend, in part, on our ability to use new technologies effectively, to continue to develop our technical expertise, toenhance 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 adaptquickly enough to changing technology, customer requirements and industry standards. If we fail to use new technologies effectively, to develop our technicalexpertise and new services, or to enhance existing services on a timely basis, either internally or through arrangements with third parties, our product andservice offerings may fail to meet customer needs, which would adversely affect our revenues and prospects for growth.In addition, if we are unable, for technological, legal, financial or other reasons, to adapt in a timely manner to changing market conditions orcustomer 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 renderour existing products, services and systems obsolete. The emerging nature of products and services in the technology and communications industry and theirrapid evolution will require that we continually improve the performance, features and reliability of our products and services. Our success will depend, inpart, on our ability to: ·design, develop, launch and/or license our planned products, services and technologies that address the increasingly sophisticated and variedneeds of our prospective customers; and -17-Index ·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 andrequires substantial expenditures and lead time. We may be unable to use new technologies effectively. Updating our technology internally and licensing newtechnology 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, amongothers: ·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 oursales and marketing efforts for our current products, which inability would have a material adverse effect on our business, financial condition and operatingresults.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 claimagainst us could harm our operating results and financial condition. In addition, any actual or perceived breach of our security solution, whether or notcaused by the failure of one of our products, could hurt our reputation and cause potential customers to turn to our competitors’ products.Our products are highly technical and may contain undetected errors, which could cause harm to our reputation and adversely affect ourbusiness.Our products are highly technical and complex and, when deployed, may contain errors or defects. Despite testing, some errors in our products mayonly be discovered after a product has been installed and used by customers. Any errors or defects discovered in our products after commercial release couldresult in failure to achieve market acceptance, loss of revenue or delay in revenue recognition, loss of customers and increased service and warranty cost, anyof which could adversely affect our business, operating results and financial condition. In addition, we could face claims for product liability, tort or breachof warranty, including claims relating to changes to our products made by our channel partners. The performance of our products could have unforeseen orunknown adverse effects on the networks over which they are delivered as well as on third-party applications and services that utilize our services, whichcould result in legal claims against us, harming our business. Furthermore, we expect to provide implementation, consulting and other technical services inconnection with the implementation and ongoing maintenance of our products, which typically involves working with sophisticated software, computing andcommunications 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’sperception of us and our products. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptableterms or at all, our business, operating results and financial condition could be adversely impacted. -18-Index Malfunctions of third-party communications infrastructure, hardware and software expose 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 todeploy our offerings. We have no control over the operation, quality or maintenance of a significant portion of that infrastructure or whether or not those thirdparties will upgrade or improve their equipment. We depend on these companies to maintain the operational integrity of our connections. If one or more ofthese 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 theextent the number of users of networks utilizing our future products suddenly increases, the technology platform and secure hosting services which will berequired to accommodate a higher volume of traffic may result in slower response times or service interruptions. System interruptions or increases in responsetime 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, usersdepend on real-time communications; outages caused by increased traffic could result in delays and system failures. These types of occurrences could causeusers to perceive that our solution does not function properly and could therefore adversely affect our ability to attract and retain licensees, strategic partnersand 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 othercomputer and communication networks that we establish. To the extent the number of users of networks utilizing our future products suddenly increases, thetechnology platform and hosting services which will be required to accommodate a higher volume of traffic may result in slower response times, serviceinterruptions 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 orrepeated, could reduce the appeal of the networks to users. These types of occurrences could cause users to perceive that our solution does not functionproperly 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 theoperation of our secure domain name registration system could result in the inability of one or more registrars to register and maintain secure domain names fora 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 assignedsecure 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 ourcustomer support service and our ability to process registration requests in a timely manner. -19-Index Our ability to sell our solutions will be dependent on the quality of our technical support, and our failure to deliver high-quality technicalsupport 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 issuesand 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 wouldbe adversely affected, and our reputation with potential customers could be harmed. In addition, as we expand our operations internationally, our technicalsupport team will face additional challenges, including those associated with delivering support, training and documentation in languages other thanEnglish. As a result, our failure to deliver and maintain high-quality technical support services to our customers could result in customers choosing to use ourcompetitors’ products instead of ours in the future.Telephone carriers have petitioned governmental agencies to enforce regulatory tariffs, which, if granted, would increase the cost of onlinecommunication, and such increase in cost may impede the growth of online communication and adversely affect our business.Use of the Internet has over-burdened existing telecommunications infrastructures, and many high traffic areas have begun to experience interruptionsin service. As a result, certain local telephone carriers have petitioned governmental agencies to enforce regulatory tariffs on IP telephony traffic that crossesover the traditional telephone networks. If any of these petitions or the relief that they seek is granted, the costs of communicating via online could increasesubstantially, potentially adversely affecting the growth in the use of online secure communications. Any of these developments could have an adverse effecton our business.The departure of Kendall Larsen, our Chief Executive Officer and President, and/or other key personnel could compromise our ability toexecute 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 andPresident. 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 maintainkey 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 ourability to execute our strategic plan and materially harm our business.We will need to recruit and retain additional qualified personnel to successfully grow our business.Our future success will depend in part on our ability to attract and retain qualified operations, marketing and sales personnel as well asengineers. Inability to attract and retain such personnel could adversely affect our business. Competition for engineering, sales, marketing and executivepersonnel is intense, particularly in the technology and Internet sectors and in the regions where our facilities are located. We can provide no assurance that wewill attract or retain such personnel.Growth of internal operations and business may strain our financial resources.We may need to significantly expand the scope of our operating and financial systems in order to build our business. Our growth rate may place asignificant 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; -20-Index ·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, may also strain ourmanagement resources. We cannot give you any assurance that we will adequately address these risks and, if we do not, our ability to successfully expandour business could be adversely affected.Failing to maintain effective internal control over financial reporting could cause our costs to increase and could cause our stock price todecline.On January 25, 2011 the Audit Committee of our Board of Directors determined that the previously filed financial statements for the fiscal quarterended September 30, 2009, the fiscal year ended December 31, 2009, the fiscal quarter ended March 31, 2010, the fiscal quarter ended June 30, 2010 and thefiscal quarter ended September 30, 2010 should no longer be relied upon and needed to be restated to adjust the accounting for certain derivative instruments(the Series I Warrants issued by the Company in a private placement transaction in September 2009). We also determined that we did not maintain effectivecontrol over our accounting for the Series I Warrants and that a material weakness existed with respect to our reporting of complex, non-routine transactions(the Series I Warrants), as of the end of the periods covered by the Form 10-K and Form 10-Qs that included the financial statements referenced above and asof the end of the period covered by this Form 10-K. Although we subsequently restated all such financial statements, we do not believe that we are currentlymaintaining effective control over our disclosure controls and procedures and internal control over financial reporting as regards this issue, and we may in thefuture identify deficiencies regarding the design and effectiveness of our system of internal control over financial reporting that we engage in pursuant toSection 404 of the Sarbanes-Oxley Act, or Section 404, as part of our periodic reporting obligations. Such deficiencies could include those arising from ourlack of technical accounting expertise in the interpretation of complex, non-routine transactions, which we may not be able to remediate in time to meet thecontinuing reporting deadlines imposed by Section 404 and the costs of which may harm our results of operations. In addition, if we continue to fail tomaintain 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 thatour management can conclude in the future that we have effective internal controls. We also may not be able to retain an independent registered publicaccounting firm with sufficient resources to attest to and report on our internal controls in a timely manner. Moreover, our registered public accounting firmmay 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 thefuture we continue to be unable to assert that we maintain effective internal controls, our investors could lose confidence in the accuracy and completeness ofour financial reports which could cause our stock price to decline.If we expand into international markets, our inexperience outside the United States would increase the risk that our international expansionefforts 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 attentionand 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; The Company may not be able to successfully manage the rapid growth of the Company’s business. The Company experienced significant growth during fiscal 2010 primarily as a result of the income it recognized pursuant to the Settlement andLicense Agreement with Microsoft. This growth places additional demands on the Company’s managerial, administrative and operational resources. Failure tomanage growth effectively could have a material adverse effect on the Company’s prospects and the Company’s business, results of operations and financialcondition.We are subject to financial reporting and other requirements for which our accounting, internal audit and other management systems andresources may not be adequately prepared.Beginning with our annual report on this Form 10-K for the fiscal year ending December 31, 2010, we were required by SEC rules to include a reportof management on the Company’s internal control over financial reporting in our annual reports. In addition, our independent registered public accounting firmauditing our financial statements was required to provide an attestation report on our internal control for fiscal 2010.The Company was not an accelerated filer prior to fiscal 2011 and therefore was not required to have an attestation report from our independentregistered public accounting firm on our internal controls. We expect that these reporting and other obligations will increase for the Company in fiscal 2011 andgoing forward as a result of our change in status from a smaller reporting company to an accelerated filer for the 2011 fiscal year. We expect that theseexpanded reporting and other obligations, specifically the requirements as an “accelerated filer,” will place significant demands on our management,administrative, operational, internal audit and accounting resources and cause us to incur significant expenses. If we are unable to accomplish these objectivesin a timely and effective fashion, our ability to comply with the financial reporting requirements and other rules that apply to reporting companies could beimpaired. -21-Index ·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.Our business and ability to grow are subject to risks associated with the ongoing financial crisis and weak global economy.The continuing turmoil in the financial markets and weak global economy impacts our ability to enter into licensing and other customeragreements. Further, these conditions and uncertainty about future economic conditions make it challenging for us to forecast our operating results, makebusiness decisions and identify the risks that may affect our business, financial condition and results of operations. If we are not able to timely andappropriately adapt to changes resulting from the difficult macroeconomic environment, our business, financial condition, and results of operations may besignificantly negatively affected.Risks Related to Our StockWe do not intend to pay regular future dividends on our common stock and thus stockholders must look to appreciation of our common stockto realize a gain on their investments.Although we paid a special cash dividend to holders of our common stock with a record date of July 1, 2010, we do not have any plans to continuepaying dividends in the foreseeable future. Instead, we currently intend to retain any future earnings for funding growth. Our future dividend policy is withinthe discretion of our board of directors and will depend upon various factors, including our business, financial condition, results of operations, capitalrequirements, and investment opportunities. Accordingly, stockholders must look solely to appreciation of our common stock to realize a gain on theirinvestment. This appreciation may not occur.The exercise of our outstanding warrants or stock options may result in a dilution of our current stockholders’ voting power and an increasein 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 ofDecember 31, 2010, we had outstanding warrants to purchase an aggregate of 1,090,444 shares of common stock. To the extent outstanding warrants areexercised, additional shares of common stock will be issued, and such issuance may dilute existing stockholders and increase the number of shares eligiblefor resale in the public market. Additionally, the issuance of up to 3,326,897 shares of common stock issuable upon exercise of vested stock options andother stock awards outstanding as of December 31, 2010 pursuant to our stock incentive plan may further dilute our existing stockholders’ voting interest.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 forresale in the public market. Sales of substantial numbers of such shares in the public market could adversely affect the market price of our shares.The fair value of accounting for our Series I Warrants as derivative liabilities may materially impact our results of our operations in futureperiods.In connection with the restatement of our financial results to correct the accounting for the Series I Warrants, we recorded the Series I Warrants as aderivative liability in accordance with ASC 815-40, “Derivatives and Hedging – Contracts in Entity’s Own Equity.” These derivative liabilities are reported atfair value each reporting period with changes in the fair value recognized as gain or loss during each reporting period. An increase in our stock price ormeasure of our stock price volatility, for example, will generally result in an increase in the fair value of our warrant liability and a non-cash charge during theperiod of such increase, and could materially and negatively impact our results of operations in future periods. -22-Index Trading in our common stock is limited and the price of our common stock may be subject to substantial volatility, particularly in light of theinstability in the financial and capital markets.Our common stock is listed on NYSE Amex, but its daily trading volume has been limited, sporadic and volatile. Over the past years the marketprice of our common stock has experienced significant fluctuations. Between December 31, 2009 and December 31, 2010, the reported last sale price for ourcommon stock has ranged between $2.94 and $18.65 per share. The price of our common stock may continue to be volatile as a result of a number offactors, including, but not limited to, the following: ·developments in any then-outstanding litigation; ·quarterly variations in our operating results; ·large purchases or sales of common stock; ·actual or anticipated announcements of new products or services by us or competitors; ·general conditions in the markets in which we compete; and ·economic and financial conditions.Because ownership of our common shares is concentrated, investors may have limited influence on stockholder decisions.As of December 31, 2010, our executive officers and directors beneficially owned approximately 20% of our then outstanding common stock. Inaddition, 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 ourBoard 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 othermatters submitted to the stockholders for a vote. However, we cannot be certain how many shares of our common stock this group of stockholders currentlyowns. Because of their beneficial ownership interest, our officers and directors could significantly influence stockholder actions of which you disapprove orthat are contrary to your interests. This ability to exercise significant influence could prevent or significantly delay another company from acquiring ormerging with us.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 donot have any control over these analysts. There is no guarantee that securities analysts will cover our common stock. If securities analysts do not cover ourcommon stock, the lack of research coverage may adversely affect our common stock’s market price. If we are covered by securities analysts, and our stockis 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 couldlose or fail to gain visibility in the financial markets, which could cause our stock price or trading volume to decline. -23-Index 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 ofour 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 forelection 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 wouldtake 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 10,000,000authorized, but unissued, shares of preferred stock. Therefore, this stock may be issued at the discretion of our Board of Directors withpreferences over your shares of our common stock in a manner that is materially dilutive to existing stockholders. In addition, blank checkpreferred stock can be used to create a “poison pill” which is designed to deter a hostile bidder from buying a controlling interest in our stockwithout 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 inthe future, very rapidly and without stockholder approval. ·Advance notice requirements for director nominations and for new business to be brought up at stockholder meetings: Stockholderswishing to submit director nominations or raise matters to a vote of the stockholders must provide notice to us within very specific datewindows 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 ofDirectors and management more time to react to stockholder proposals generally and could also have the effect of disregarding a stockholderproposal 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 ourBoard of Directors and management or to the minority stockholders. Along with the advance notice requirements described above, thisprovision 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 adoptnew By-laws can only be approved by the affirmative vote of at least 66 2/3% of the outstanding shares. ·Elimination of the ability of stockholders to call a special meeting of the stockholders: Only the Board of Directors or management can callspecial meetings of the stockholders. This could mean that stockholders, even those who represent a significant block of our shares, may needto wait for the annual meeting before nominating directors or raising other business proposals to be voted on by the stockholders.In addition, the provisions of Section 203 of the Delaware General Corporate Law govern us. These provisions may prohibit large stockholders, inparticular those owning 15% or more of our outstanding voting stock, from merging or combining with us for a certain period of time.These and other provisions in our amended and restated certificate of incorporation, our By-laws and under Delaware law could discourage potentialtakeover attempts, reduce the price that investors might be willing to pay for shares of our common stock in the future and result in the market price beinglower than it would be without these provisions. -24-Index Item 1B. Unresolved Staff Comments.None.Item 2. Properties.Our principal executive offices are located at 5615 Scotts Valley Drive, Suite 110, Scotts Valley, California 95066. We lease this property from athird party for a term that ends in 2012. We have no other properties and believe that our office facility is suitable and appropriately supports our currentbusiness needs.Item 3. Legal Proceedings.On August 11, 2010, we filed a complaint against Aastra USA, Inc., Aastra Technologies Ltd., Apple Inc., Cisco Systems, Inc., NEC Corporation,and NEC Corporation of America in the United States District Court for the Eastern District of Texas, Tyler Division. The complaint includes allegations ofpatent infringement regarding five patents owned by VirnetX. In this complaint we are seeking both damages and injunctive relief.On January 12, 2011, we filed a complaint against Siemens AG, Siemens Corporation, Siemens Communications, Inc., Siemens EnterpriseCommunications, Inc., Mitel Networks Corporation and Mitel Networks, Inc., in the United States District Court for the Eastern District of Texas, TylerDivision. The complaint includes allegations of patent infringement regarding two patents owned by VirnetX, U.S. Patent Nos. 6,502,135 and7,418,504. In this complaint we are seeking both damages and injunctive relief.One or more potential intellectual property infringement claims may also be available to us against certain other companies who have the resources todefend 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 maypreclude 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 byany governmental authority or other party.Item 4. Reserved. -25-IndexPART IIItem 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.Market InformationOur common stock currently trades under the symbol “VHC” on the NYSE Amex Stock Exchange. Before the New York Stock Exchange acquiredthe American Stock Exchange in 2008, our common stock had traded under the “VHC” symbol on the American Stock Exchange since December 26,2007. Before then our common stock traded in the over-the-counter market on the Nasdaq OTC Bulletin Board under the symbols “VNXH,” and “PASW.”Those common stock warrants that we issued in our January 2009 public offering that are still outstanding trade under the symbols “VHCOZ” and“VHCOL” on the OTC Bulletin Board.The following table shows the price range of our common stock, as reported on the NYSE Amex Stock Exchange, for each quarter ended during thelast two fiscal years.Quarter Ended High Low 3/31/09 $1.49 $1.06 6/30/09 $1.79 $1.10 9/30/09 $3.52 $1.22 12/31/09 $3.90 $1.95 3/31/10 $7.99 $2.94 6/30/10 $7.09 $4.03 9/30/10 $15.05 $5.42 12/31/10 $20.00 $11.61 The closing price of our common stock on the NYSE Amex Stock Exchange on March 10, 2011 was $12.46 per share.HoldersAs of March 10, 2011, we had 64 stockholders of record.DividendsOn June 15, 2010, the Company’s Board of Directors declared a special cash dividend of $0.50 per share of the Company’s common stock toholders of record on July 1, 2010. We currently intend to retain all available funds and any future earnings to support the operation of and to finance thegrowth and development of our business. We do not anticipate paying any cash dividends in the foreseeable future. Any future determination to declare cashdividends will be made at the discretion of our board of directors and will depend on our financial condition, operating results, capital requirements, generalbusiness conditions and other factors that our board of directors may deem relevant.Securities Authorized for Issuance Under Equity Compensation PlansOn April 17, 1998, when we operated under the name PASW, Inc., we adopted an equity incentive program. Under this program, we may grantincentive stock options, non-statutory stock options, stock appreciation rights, stock bonuses and rights to acquire restricted stock to employees, directorsand consultants (except for incentive stock options which may only be granted to employees). The number of shares of common stock initially reserved forissuance under this program was 150,580 shares post-split. As of December 31, 2010, there were no outstanding options or rights under this program and wedo not intend to grant any equity incentives in the future under this plan. -26-Index In connection with the merger between VirnetX Holding Corporation and VirnetX, our Board of Directors approved our adoption of the VirnetX 2005Stock Plan, as amended, to cover grants of stock options and stock purchase rights to our employees and consultants. Our Board of Directors renamed thisstock plan the VirnetX Holding Corporation 2007 Stock Plan. The total number of shares of our common stock reserved for issuance under the VirnetXHolding Corporation 2007 Stock Plan is 11,624,469, of which as of December 31, 2010, there were 1,103,478 shares remaining available for futuregrants. To the extent that any award granted under the 2007 Stock Plan should expire, become unexercisable or is otherwise forfeited, the shares subject tosuch award will again become available for issuance under the 2007 Plan.Plan Category Number of Securities to beIssued Upon Exercise ofOutstanding Options,Warrants and Rights (a) Weighted-Average ExercisePrice of Outstanding Options,Warrants and Rights (b) Number of SecuritiesRemaining Available forFuture Issuance UnderEquity Compensation PlansExcluding SecuritiesReflected in Column (a) (c) Equity compensation plans approved by securityholders 5,920,835 3.23 1,103,478 Equity compensation plans not approved bysecurity holders — — Total 5,920,835 3.23 1,103,478 On February 24, 2010 the Compensation Committee granted an additional 345,250 options to the employees of VirnetX Inc. In September 2009, weclosed a private placement of 2,380,942 shares of our common stock at a purchase price of $3.17 per share. In addition to shares of common stock, we alsoissued (i) Series I warrants to purchase an additional 3,246,959 shares of our common stock with an exercise price of $3.93 per share (subject to adjustmentand including (x) 627,923 shares of our common stock issuable pursuant to the anti-dilution protections in the Series I Warrants, and (y) 238,094 shares ofour common stock issuable to the placement agent of the September 2009 transaction) (the “Series I Warrants”), (ii) Series II warrants to purchase up to anadditional 2,419,045 shares of our common stock, subject to adjustment as described below, on an automatic cashless exercise basis with an exercise price of$0.01 per share (the “Series II Warrants”) and (iii) Series III warrants to purchase approximately an additional 2,380,942 shares of common stock with anexercise price of $2.52 per share (the “Series III Warrants” and together with the Series I Warrants and the Series II Warrants, the “Warrants”). We filed aregistration statement on Form S-1 (File No. 333-162145) to cover the common stock issued and the shares of common stock issuable upon exercise of theWarrants.The Series I Warrants are rights to purchase an aggregate of approximately 3,246,959 shares of the Company’s common stock over a 5-year term atan exercise price equal to 125% of the price per share paid in the private placement (i.e., $3.93 per share), subject to antidilution protection that could reducethe exercise price to 100% of the closing price on September 2, 2009 (i.e., $3.17 per share) if the Company completes other financings while the Series IWarrants are outstanding at a price per share less than the exercise price per share of the Series I Warrants. The Series I Warrants were not exercisable until sixmonths following the closing of the private placement and expire on fifth anniversary of the closing of the private placement. Aside from the antidilutionadjustment associated with the exercise price premium, the Series I Warrants are not subject to any further adjustments with respect to the exercise price ornumber of shares covered. In connection with the September 2009 private placement, we issued one of the Series I Warrants to purchase 238,094 shares ofour common stock with an exercise price of $3.93 per share to the placement agent in the private placement. The warrant issued to the placement agent inSeptember 2009 will expire 5 years after issuance. -27-Index The Series II Warrants provided the investors pricing protection for the private placement with a floor price of $1.25 per share. In the event themarket price of our common stock declined between the closing of the private placement and the earlier of (i) the date the registration statement was declaredeffective and (ii) the date Rule 144 became available for resale of the Shares (i.e., generally 6 months after the closing of the private placement) (such date thatis the earlier of clause (i) and (ii) above is referred to in this registration statement as the “Warrant Exercise Date”), the Series II warrants would beautomatically exercised on a cashless exercise basis and a number of additional shares would be issued to the investors who participated in the privateplacement in order to effectively reduce the per share purchase price paid in the private placement to the greater of (i) 80% of the 15-day volume weightedaverage trading price per share of the Company’s common stock immediately following the Warrant Exercise Date and (ii) $1.25 per share. As such, thegreatest number of shares that could be issued pursuant to the Series II Warrants was approximately 2,419,045 shares. At the Warrant Exercise Date, theSeries II Warrants would either be automatically exercised on a cashless exercise basis if the Company’s stock price was lower at the Warrant Exercise Date asdescribed above, or they would expire unexercised. The adjustment associated with the Series II Warrants did not affect either the exercise price or number ofshares covered by either the Series I Warrants or the Series III Warrants. On January 14, 2010 the Series II Warrants expired unexercised and terminatedwithout any additional shares being issued to the private placement investors.At the Warrant Exercise Date, the Series III Warrants provided the investors a 60-day right to purchase an additional $6.0 million of common stockfrom the Company at $2.52 per share. The Series III Warrants were not subject to any adjustments with respect to the exercise price or number of sharescovered. As of February 20, 2010, all Series III Warrants have been exercised in full.The foregoing descriptions of the Series I Warrant, the Series II Warrant, the Series III Warrant, and the placement agent warrant are summaries onlyand are qualified in their entirety by reference to Exhibits 4.1, 4.2, and 4.3 filed as exhibits to our Current Report on Form 8-K filed with the Securities andExchange Commission on September 3, 2009. -28-Index Performance Graph The stock price performance reflected on this graph is not necessarily indicative of future stock price performance. 12/05 12/06 12/07 12/08 12/09 12/10 VirnetX Holding Corp $100.00 $241.67 $1,633.33 $411.11 $816.67 $4471.64 S&P 500 $100.00 $115.80 $122.16 $76.96 $97.33 $111.99 RDG Technology Composite $100.00 $109.07 $125.31 $71.12 $114.36 $129.26 Item 6. Selected Financial Data.You should read the selected consolidated financial data set forth below in conjunction with our consolidated financial statements, the notes to ourconsolidated financial statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained elsewhere in thisAnnual Report on Form 10-K. Our historical results are not necessarily indicative of results to be expected for future periods. -29-Index For the yearendedDecember 31,2010 For the yearendedDecember 31,2009 For the yearendedDecember 31,2008 For the yearendedDecember 31,2007 For the yearendedDecember 31,2006 Consolidated Statement of Operations Data: Revenue $68,185 $26,306 $133,744 $74,866 $— Gain on settlement (200,000,000) — — — — Other operating expenses 95,383,105 13,114,131 12,355,332 8,725,210 1,407,675 Net operating expenses (104,616,895) 13,114,131 12,355,332 8,725,210 1,407,675 Income tax expense 34,062,436 — — — — Net (loss) income 41,416,893 (12,524,373) (12,072,180) (8,692,164) (1,401,339)Earnings (loss) per share $0.91 $(0.33) $(0.35) $(0.36) $(0.08)Dividends declared per common share $0.50 $0.00 $0.00 $0.00 $0.00 Consolidated Balance Sheet Data Cash and cash equivalents $34,634,533 $2,011,470 $457,155 $8,589,447 139,997 Investments available for sale 43,456,803 — — — — Total assets $81,694,120 $2,241,605 $978,982 $9,279,166 195,123 Long-term obligation — 120,000 160,000 204,000 — Stockholders’ equity (deficit) $59,452,966 $(8,707,812) $(894,351) $8,495,376 $107,737 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.This Annual Report on Form 10-K, including this Management’s Discussion and Analysis of Financial Condition and Results of Operationscontains “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995, which provides a “safe harbor” forstatements about future events, products and future financial performance that are based on the beliefs of, estimates made by and informationcurrently 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 discussionshould be read in conjunction with and is qualified in its entirety by reference to our consolidated financial statements and accompanying notesincluded elsewhere in this Annual Report on Form 10-K. Actual results and the outcome or timing of certain events may differ significantly from thosestated or implied by these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, thosediscussed in Item 1A of Part I “Risk Factors” and other factors from time to time described in our other filings with the Securities and ExchangeCommission, or SEC. For this purpose, using the terms “believe,” “expect,” “expectation,” “anticipate,” “can,” “should,” “would,” “could,”“estimate,” “appear,” “based on,””hope”, “may,” “intended,” “potential,” “indicate,” “are emerging” and “possible” or similar statements areforward-looking statements that involve risks and uncertainties that could cause our actual results and the outcome and timing of certain events todiffer materially from those stated or implied by these forward-looking statements. By making forward-looking statements, we have not assumed anyobligation to, and you should not expect us to, update or revise those statements because of new information, future events or otherwise.Company OverviewWe are an internet security software and technology company. Our software and technology solutions, including our secure domain name registryand GABRIEL Connection Technology(TM), are designed to facilitate secure communications and to create a secure environment for real-time communicationapplications such as instant messaging, VoIP, smart phones, eReaders and video conferencing. We acquired several patents through our principal operatingsubsidiary, VirnetX, from Science Applications International Corporation, or SAIC. SAIC is a FORTUNE 500® scientific, engineering and technologyapplications company that uses its deep domain knowledge to solve problems of vital importance to the nation and the world, in national security, energy andthe environment, critical infrastructure, and health. -30-Index To date, our primary source of significant income has been from the Settlement and License Agreement we entered into with Microsoft Corporation,our first licensee, on May 14, 2010, or the Settlement and License Agreement. Pursuant to the Settlement and License Agreement, Microsoft paid us$200,000,000 in June 2010 and we dismissed the two patent infringement lawsuits we initiated against Microsoft in February 2007 and March 2010 andgranted Microsoft a worldwide, irrevocable, nonexclusive, non-sub licensable fully paid up license under our patents. We are currently involved in litigationagainst Aastra, Apple, Cisco, NEC, Siemens and Mitel with respect to our allegations that these companies infringes on certain of our patents and are seekingboth damages and injunctive relief. We expect to use a significant portion of the proceeds we received from the Settlement and License Agreement to fund thecosts and expenses of these litigation matters and if we are not successful, we may substantially deplete our capital resources and our ability to fund futureoperations. Although we believe these potential claims are worth pursuing, commencing a lawsuit can be expensive and time-consuming, and there is noassurance that we will prevail on such potential claims. In addition, bringing a lawsuit may lead to potential counterclaims which may preclude our ability tocommercialize our initial products, which are currently in development. We also believe that we may derive revenues in the future from licensing our softwareand technology solutions and we are currently endeavoring to develop certain marketable products. We expect to continue to incur significant expenses,including but not limited to those we expect to incur in our patent infringement litigation matters against Aastra, Apple, Cisco, NEC, Siemens and Mitel, andwe do not currently have any sources of revenue from our continuing operations. If we are unsuccessful in these matters or in developing certain marketableproducts, we may be unable to successfully complete our business plans, our business may fail and you could lose some or all of your investment in oursecurities.We are subject to numerous risks including: the uncertainty that our technology licensing program development efforts will produce revenue bearinglicenses for us; the uncertainty that our development initiatives will produce successful commercial products as well as the marketing and customeracceptance of such products; competition from larger, better funded organizations; dependence on key personnel; uncertain patent protection; and dependenceon corporate partners and collaborators. See “Risk Factors” for additional information.Developments from the Year Ended December 31, 2010WarrantsOn January 14, 2010, the Series II Warrants expired unexercised and terminated without any additional shares of common stock being issued toprivate placement investors.As of February 24, 2010, all Series III Warrants issued had been exercised in full and we issued 2,380,942 shares of our common stock. Theaggregate cash exercise proceeds from the Series III Warrants totaled $6,000,000. After payment of fees and commissions, we received net proceeds ofapproximately $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. As ofMarch 12, 2010, we had received proceeds in the amount of $2,000,000.LitigationOn March 16, 2010, a jury awarded us a $105,750,000 verdict against Microsoft for infringing two of our patents. The jury also found thatMicrosoft’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 byMicrosoft’s Windows 7 and Windows Server 2008 R2 software products.On May 14, 2010 we announced that our wholly-owned VirnetX, Inc. (“VirnetX”), entered into a Settlement and License Agreement with MicrosoftCorporation (“Microsoft”) to settle all claims asserted by VirnetX against Microsoft in two lawsuits filed by VirnetX in the United States District Court for theEastern District of Texas, Tyler Division. Under the Settlement and License Agreement, Microsoft has agreed to pay VirnetX $200,000,000 in cash inexchange for dismissing both lawsuits and a worldwide, irrevocable, nonexclusive, non-sublicensable fully paid up license under VirnetX’s patents. TheSettlement and License Agreement will not impact VirnetX’s plans to operate a universal Secure Domain Name Service. -31-Index On May 25, 2010 and June 1, 2010, the United States District Court for the Eastern District of Texas, Tyler Division entered two Orders ofDismissal (the “Dismissals”) whereby all claims asserted by VirnetX, Inc. (the “Company”), the wholly-owned operating subsidiary of VirnetX HoldingCorporation, against Microsoft Corporation (“Microsoft”) with respect to the lawsuits filed by the Company against Microsoft were dismissed with prejudice.On May 18, 2010, Microsoft filed Notices of Non-Participation with the United States Patent and Trademark Office, whereby Microsoft stated thatit would not participate further in the Inter Partes Reexamination of certain of the Company’s patents, which Microsoft previously filed on November 25,2009. The United States Patent and Trademark Office issued an Office action on June 16, 2010 confirming the patentability of the claims of the patentssubject to reexamination, and closing prosecution of the reexamination procedures.On August 11, 2010, we filed a complaint against Aastra USA, Inc., Aastra Technologies Ltd., Apple Inc., Cisco Systems, Inc., NEC Corporation,and NEC Corporation of America in the United States District Court for the Eastern District of Texas, Tyler Division. The complaint includes allegations ofpatent infringement regarding five patents owned by VirnetX. In its complaint, VirnetX seeks both damages and injunctive relief.Special DividendOn June 15, 2010, the Board approved the declaration of a special cash dividend of $0.50 per share of the Company’s common stock (the“Dividend”) payable on or about July 15, 2010 to stockholders of record on July 1, 2010. In connection with the Dividend, the Board of Directors of theCompany also approved a cash distribution to holders of stock options under the Company’s 2007 Stock Plan. The Company’s principal executive officerand principal financial officer received gross payments of approximately $438,000 and $196,000, respectively, in connection with the cash distribution tostock option holders.Holders of warrants to purchase shares of the Company’s common stock did not receive any cash payment pursuant to the Dividend unless anduntil such holders exercise their warrants. Holders of the Company’s Series I Warrants pursuant to the Company’s private placement transaction that closedon September 11, 2009 received notice of the Dividend and the related adjustment to each Series I Warrant’s exercise price. Holders of the Company’s $3.00and $4.00 warrants to purchase shares of the Company’s common stock issued pursuant to the Company’s public offering that closed on January 30, 2009also received notice of the Dividend, but, pursuant to the terms of the $3.00 and $4.00 warrants, there was no adjustment to each such warrant’s exerciseprice. The $3.00 and $4.00 warrants expired, if not earlier exercised, on July 30, 2010.Board of DirectorsOn June 16, 2010, Edmund “Gif” Munger resigned from the Board and formally retired from active service with the Company, effective July 9,2010.Effective July 9, 2010, the Board elected Dr. Robert Short III to fill the vacancy on the Board left by Mr. Munger’s resignation. Dr. Short has beenthe Chief Scientist for the Company since May 2006.Recent DevelopmentsOn January 12, 2011, VirnetX Holding Corporation filed a complaint against Siemens AG, Siemens Corporation, Siemens Communications, Inc.,Siemens Enterprise Communications, Inc., Mitel Networks Corporation and Mitel Networks, Inc., in the United States District Court for the Eastern Districtof Texas, Tyler Division. The complaint includes allegations of patent infringement regarding two patents owned by VirnetX, U.S. Patent Nos. 6,502,135and 7,418,504. In its complaint, VirnetX seeks both damages and injunctive relief. -32-Index On January 25, 2011, the Audit Committee determined that the previously filed financial statements for the following periods should no longer berelied upon: ·the fiscal quarter ended September 30, 2009 included in its quarterly report on Form 10-Q as filed with the Securities and ExchangeCommission (“SEC”) on November 9, 2009 (the “2009 Form 10-Q”); ·the fiscal year ended December 31, 2009 included in its annual report on Form 10-K as filed with the SEC on March 31, 2010 (the “Form 10-K”) along with the related audit report from its independent registered public accounting firm; ·the fiscal quarter ended March 31, 2010 included in its quarterly report on Form 10-Q as filed with the SEC on May 7, 2010 (the “1Q 2010Form 10-Q”); ·the fiscal quarter ended June 30, 2010 included in its quarterly report on Form 10-Q as filed with the SEC on August 9, 2010 (the “2Q 2010Form 10-Q”); and ·the fiscal quarter ended September 30, 2010 included in its quarterly report on Form 10-Q as filed with the SEC on November 8, 2010 (the “3Q2010 Form 10-Q” and, collectively with the 2009 Form 10-Q, the 1Q 2010 Form 10-Q and the 2Q 2010 Form 10-Q, the “Form 10-Qs”).VirnetX restated the Form 10-K and Form 10-Qs, which were filed with the Securities and Exchange Commission on January 31, 2011, to adjust theaccounting for certain derivative instruments (the Series I Warrants issued by the Company in a private placement transaction in September 2009) in suchfinancial statements, which were previously recorded as equity instruments (the “Restatements”).In connection with the Restatements, we performed a re-assessment of the Series I Warrants to purchase 2,619,036 shares of common stock thatwere issued in connection with its September 2009 private placement and has concluded that the Series I Warrants are liabilities within the scope of AccountingStandards Codification Topic 815-40, “Derivatives and Hedging – Contracts in Entity’s Own Equity” (“ASC 815-40”), because the Series I Warrantscontain a provision requiring a weighted average adjustment to the exercise price of the Series I Warrants in the event the Company issues common stock, orsecurities convertible into or exercisable for common stock, at a price per share lower than such exercise price. Accordingly, the Series I Warrants should havebeen accounted for as a derivative liability, measured at fair value, with changes in fair value recognized as gain or loss for each reporting period thereafter.The Restatement did not impact the Company's previously reported cash, cash equivalents, short-term investments or cash flows.In connection with the Restatements, the Company’s Chief Executive Officer and Chief Financial Officer re-evaluated, with the participation ofmanagement, the effectiveness of the Company’s disclosure controls and procedures and internal control over financial reporting, and concluded that theCompany did not maintain effective disclosure controls and procedures or internal controls over financial reporting for the reasons discussed in Part II, Item9A “Disclosure Controls and Procedures” of this Form 10-K.Critical Accounting PoliciesThe preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to makeestimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during the reported period. The critical accounting policies we employ in the preparation of ourconsolidated financial statements are those which involve impairment of long-lived assets, income taxes, fair value of financial instruments and stock-basedcompensation. Revenue RecognitionWe recognize revenue when persuasive evidence of an arrangement exists, we have delivered the product or performed the service, the fee is fixed ordeterminable and collection is reasonably assured. If any of these criteria are not met, we defer recognizing the revenue until such time as all criteria are met.Depending on the complexity of the underlying revenue arrangement and related terms and conditions, significant judgments, assumptions andestimates may be required to determine when substantial delivery of contract elements will occur, whether any significant ongoing obligations exist subsequentto contract execution, whether amounts due are collectible and the appropriate period or periods in which, or during which, the completion of the earningprocess occurs. Depending on the magnitude of specific revenue arrangements, if different judgments, assumptions and estimates are made regardingcontracts executed in any specific period, our periodic financial results may be materially affected. -33-Index Impairment of Long-Lived AssetsWe identify and record impairment losses on long-lived assets used in operations when events and changes in circumstances indicate that thecarrying amount of an asset might not be recoverable, but not less than annually. Recoverability is measured by comparison of the anticipated future netundiscounted cash flows to the related assets’ carrying value. If such assets are considered to be impaired, the impairment to be recognized is measured by theamount by which the carrying amount of the assets exceeds the projected discounted future net cash flows arising from the asset.Income TaxesIncome tax expense is computed using an asset and liability method and using expected annual effective tax rates. Under this method, deferredincome tax assets and liabilities result from temporary differences in the financial reporting bases and the income tax reporting bases of assets andliabilities. The measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefit that, based on available evidence, is not expectedto be realized. When it appears more likely than not that deferred taxes will not be realized, a valuation allowance is recorded to reduce the deferred tax asset toits estimated realizable value. For net deferred tax assets we consider estimates of future taxable income, including tax planning strategies in determiningwhether our net deferred tax assets are more likely than not to be realized.Effective January 1, 2007, we have adopted, Accounting for Uncertainty in Income Taxes using the prospective method. The adoption did not havea material impact on our financial statements. Implementation of FASB ASC 815-40-15 "Derivatives and Hedging-Contracts in Entity's Own Equity-Scope and Scope Exceptions"In June 2008, the FASB ratified guidance included in ASC 815-40-15 "Derivatives and Hedging-Contracts in Entity's Own Equity-Scope and ScopeExceptions," which provides that an entity should use a two-step approach to evaluate whether an equity-linked financial instrument (or embedded feature) isindexed to its own stock, including evaluating the instrument's contingent exercise and settlement provisions. ASC 815-40-15 contains provisions describingconditions when an instrument or embedded feature would be considered indexed to an entity's own stock for purposes of evaluating the instrument orembedded feature under FASB ASC Topic 815 "Derivatives and Hedging," which establishes accounting and reporting standards for derivative instruments,including certain derivative instruments embedded in other contracts. Under the provisions of ASC 815-40-15 the embedded Series I Warrants are notconsidered indexed to our stock. As a result of the antidilution protection in the Series I Warrants and the application of ASC 815-40-15, effective September,2009, the Warrants were required to be accounted for as derivative instruments. Accordingly, effective September 2009, Company's Series I WarrantConversion Feature and Investor Warrants are recognized as liabilities in our consolidated balance sheet.Stock-Based CompensationWe account for share-based compensation in accordance with the fair value method, which requires the measurement and recognition ofcompensation expense in the statement of operations for all share-based payment awards made to employees and directors including employee stock optionsbased on estimated fair values. Using the modified retrospective transition method of adopting this standard, the financial statements presented herein reflectcompensation expense for stock-based awards as if the provisions of this standard had been applied from the date of our inception.In addition, we record stock and options granted to non-employees at fair value of the consideration received or the fair value of the equityinvestments issued as they vest over the performance period.New Accounting PronouncementsIn September 2006, the FASB established a framework for measuring fair value in accordance with United States Generally Accepted AccountingPrinciples (“GAAP”) and expanded disclosure about fair value measurements including valuing securities in markets that are not active. The Companyadopted the framework for measuring fair value effective January 1, 2009 with the exception of the application of the framework to non-recurring, non-financial assets and non-financial liabilities. The adoption of the framework for measuring fair value did not have a significant impact on the Company’sresults of operations or financial position.In June 2008, the FASB issued guidance requiring that unvested instruments granted in share-based payment transactions that contain non-forfeitable rights to dividends or dividend equivalents are participating securities subject to the two-class method of computing earnings per share. Thisguidance is effective for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning on or after December 15,2008. The adoption did not have a material effect on the Company’s consolidated financial statements.In April 2009, the FASB required disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies aswell as in annual financial statements, effective for interim reporting periods ending after June 15, 2009, and required those disclosures in summarizedfinancial information at interim reporting periods. The Company adopted the new disclosure guidance over fair value of financial instruments, and adoptiondid not have a material effect on the Company’s consolidated financial statements. -34-Index In June 2009, the FASB established the Accounting Standards Codification (“Codification”) as the single source of authoritative GAAP to be appliedby nongovernmental entities, except for the rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under authority of federalsecurities laws, which are sources of authoritative GAAP for SEC registrants. While not intended to change GAAP, the Codification significantly changes theway in which the accounting literature is referenced and organized. The codification was adopted as of August 31, 2009. Adoption did not have a materialeffect on the Company’s consolidated financial statements.In January 2010, the FASB required new disclosures about fair value of financial instruments for interim and annual reporting periods. These newdisclosures were effective for interim and annual reporting periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuanceand settlement of Level 3 financial instruments, which are effective for interim and annual reporting periods in fiscal years beginning after December 15,2010. Adoption is not expected to have a material effect on the Company’s consolidated financial statements.OperationsRevenue - RoyaltiesRevenue generated for the twelve months ended December 31, 2010 was $68,185 compared to $26,306 for the twelve months ended December 31,2009. Our revenue was solely limited to the royalties earned under our single license agreement through our Japanese subsidiary. We expect the revenue fromthis license to decrease substantially in the future. We do not intend to seek additional licenses or other revenue through our Japanese subsidiary.Gain on SettlementIn May 2010, we entered into a Settlement and License Agreement with Microsoft. Pursuant to the Settlement and License Agreement, Microsoft paidus $200,000,000 in June 2010 and we dismissed the two patent infringement lawsuits we initiated against Microsoft in February 2007 and March 2010 andgranted Microsoft a worldwide, irrevocable, nonexclusive, non-sub licensable fully paid up license under our patents.We recorded the $200,000,000 lump sum payment as gain on settlement as a result of litigation. We originally classified this payment as revenue.Upon further analysis, the Company could not practically and objectively separate any settlement portion from the revenue element as discussed under theguidance of ASC Topic 605. As a result, the Company now classifies the amount as a gain on settlement. This settlement satisfies all past litigation anddisputes between the Company and Microsoft and there are no future obligations that the Company would need to perform to earn this settlementpayment. That is, the license and settlement agreement represents fully paid up licenses by both the Company and Microsoft for which no future payment ordelivery is required. Accordingly, the Company recognized the entire settlement amount in its 2010 operating results.Research and Development ExpensesResearch and development costs include expenses paid to outside development consultants and compensation-related expenses for our engineeringstaff. Research and development costs are expensed as incurred.Our research and development expenses increased from $864,058 for the twelve months ended December 31, 2009 to $2,412,109 for the twelvemonths ended December 31, 2010. This increase is primarily due to increased costs related to engineering activities for product development, salary increasesfor all of our employees and the bonuses that were paid to our employees in 2010. -35-Index Selling, General and Administrative ExpensesSelling, general and administrative expenses include management and administrative personnel, as well as outside legal, accounting, and consultingservices.Our selling, general and administrative expenses increased by $21,514,149 to $33,764,222 for 2010 from $12,250,073 for the year endedDecember 31, 2009. The increase was primarily due to increased legal fees, approximately $16,000,000 for the contingent fees on the Microsoft settlement andan increase of $2,000,000 in other legal fees in 2010 over 2009. A bonus of approximately $2,000,000 was paid to the employees and directors after the licenseagreement was signed account for most of the rest of the increased expenses. Legal fees represent approximately 76% of general and administrative expensesfor 2010 compared to 55% in 2009.Royalty expense was $59,206,774 for 2010, compared to no royalty expenses in 2009, all due to the amounts paid to SAIC in royalty paymentsfollowing the execution of the settlement and license agreement was signed with Microsoft. The royalty expense has hit its maximum under the settlement andlicense agreement and will be paid in future periods only in certain circumstances.Other Income/ExpensesThe company recognized $30,515,799 in non-cash loss related to the periodic revaluation of its Series I Warrants in fiscal 2010. This loss is aresult of the Company’s stock price increasing and making the outstanding warrants more valuable. There were no derivative instruments in the prioryear. We recognized $1,310,048 in interest in 2010 compared to $5,074 in 2009.Liquidity and Capital Resources As of December 31, 2010, our cash and cash equivalents totaled $34,634,533 and our short-term investments totaled $43,456,803 compared to$2,011,470 and zero, respectively, as of December 31, 2009. The increase in our cash and cash equivalents and short-term investments for the fiscal yearended December 31, 2010 over the fiscal year ended December 31, 2009 is primarily due to the cash we received from the payments under the Settlement andLicense Agreement with Microsoft discussed below and our investments of such amounts. We recognized an unrealized loss on our investments of $984,266 for the fiscal year ended December 31, 2010 compared to no gain or loss on ourinvestments for the fiscal year ended December 31, 2009 because we did not have any investments available for sale as of December 31, 2009. We havedetermined that this loss is temporary because the fair value of our investment securities is below the carrying value primarily due to changes in interest ratesand we anticipate that this loss will be reversed over the securities' remaining lives, as demonstrated by improved valuations in fiscal 2011. Before entering into the Microsoft Settlement, we allocated a large part of our cash and cash equivalents to the fees and expenses associated with theMicrosoft litigation. We expect that our cash and cash equivalents as of December 31, 2010 to be sufficient to fund our operations and provide workingcapital for general corporate purposes and legal expenses, including the expenses for the new complaints against Aastra USA, Inc., Aastra Technologies Ltd.,Apple Inc., Cisco Systems, Inc., NEC Corporation, NEC Corporation of America, Siemens and Mitel for at least the next 36 months. Other than theanticipated expenses associated with the new complaints, the Company does not currently have any material commitments for capital expenditures.While we do not expect a significant increase in income in the near term similar to that associated with the gain on settlement recognized during thetwelve months ended December 31, 2010 as a result of the Settlement and License Agreement, we do expect to derive the majority of our future income fromlicense fees and royalties associated with our technology, software and Secure domain name registry in the United States and other markets around the worldover the long term.Investors should not expect the Company to receive settlements/income for the new complaints unless and until the new complaints are resolved in theCompany’s favor and there is no assurance that the Company will prevail on such potential claims.Off-Balance Sheet ArrangementsAs of December 31, 2010, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K. -36-Index Item 7A. Quantitative and Qualitative Disclosures about Market RiskOur exposure to market risk due to changes in interest rates relates primarily to the increase or decrease in the value of the $43,456,803 investmentsavailable for sale in our investment portfolio. Our risk associated with fluctuating interest rates is limited to our investments in interest rate sensitive financialinstruments. Under our current investment policy, we do not use interest rate derivative instruments to manage exposure to interest rate changes. We attempt toincrease the safety and preservation of our invested principal funds by limiting the percentage of funds invested in any one instrument and investing in shortterm debt securities that generally have a maturity of less than six months. We mitigate default risk by investing primarily in investment grade securities. A100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our interest sensitive financialinstruments. Changes in interest rates over time will increase or decrease our interest income.Item 8. Financial Statements and Supplementary Data.FINANCIAL STATEMENTSFinancial Statements Index PageReport of Farber Hass Hurley LLP, Independent Registered Public Accounting Firm38Consolidated Balance Sheets of VirnetX Holding Corporation as of December 31, 2010 and December 31, 200939Consolidated Statements of Operations of VirnetX Holding Corporation for the years ended December 31, 2010 and December 31, 200940Consolidated Statements of Stockholders’ Equity (Deficit) of VirnetX Holding Corporation for the years ended December 31, 2010 andDecember 31, 200941Consolidated Statements of Cash Flows of VirnetX Holding Corporation for the years ended December 31, 2010 and December 31, 200942Notes to Financial Statements of VirnetX Holding Corporation43 -37-IndexREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMBoard of Directors and ShareholdersVirnetX Holding CorporationWe have audited the accompanying consolidated balance sheets of VirnetX Holding Corporation (the “Company”) as of December 31, 2010 and2009, and the related consolidated statements of operations, stockholders’ equity (deficit) and comprehensive income (loss), and cash flows for the yearsended December 31, 2010 and 2009. VirnetX Holding Corporation’s management is responsible for these consolidated financial statements. Ourresponsibility is to express an opinion on these consolidated financial statements based on our audits.We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe thatour audits provide a reasonable basis for our opinion.In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of VirnetX HoldingCorporation, Inc. as of December 31, 2010 and 2009, and the consolidated results of their operations, stockholders’ equity (deficit) and comprehensiveincome (loss) and cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), VirnetX HoldingCorporation’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issuedby the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 15, 2011 expressed an adverse opinion. /s/ Farber Hass Hurley LLP Granada Hills, California March 15, 2011 -38-IndexVirnetX Holding Corporation CONSOLIDATED BALANCE SHEETS As ofDecember 31,2010 As ofDecember 31,2009 ASSETS Current assets: Cash and cash equivalents $34,634,533 $2,011,470 Investments available for sale 43,456,803 — Accounts receivable, net 2,691 6,842 Current deferred tax benefit 1,734,570 — Prepaid expenses and other current assets 87,215 43,863 Total current assets 79,915,812 2,062,175 Property and equipment, net 25,464 23,430 Intangible and other assets 108,000 156,000 Long term deferred tax benefit 1,644,844 — Total assets $81,694,120 $2,241,605 LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable and accrued liabilities $518,976 $4,478,325 Income tax liability 7,357,830 — Current portion of long-term obligation — 40,000 Derivative liability 14,364,350 6,311,091 Total current liabilities 22,241,156 10,829,416 Long-term obligation, net of current portion — 120,000 Commitments and contingencies — — Stockholders' equity (deficit): Preferred stock, par value $0.0001 per share Authorized: 10,000,000 shares at December 31, 2010 and 2009, respectively Issued and outstanding: 0 shares at December 31, 2010 and 2009, respectively Common stock, par value $0.0001 per share Authorized: 100,000,000 shares at December 31, 2010 and 2009, respectively Issued and outstanding: 49,341,028 shares and 39,750,927 shares, at December 31, 2010 and 2009, respectively 4,934 3,975 Additional paid-in capital 78,187,376 26,860,747 Accumulated deficit (17,755,080) (35,572,534)Accumulated other comprehensive loss (984,266) — Total stockholders' equity (deficit) 59,452,964 (8,707,812)Total liabilities and stockholders' equity $81,694,120 $2,241,605 The accompanying notes are an integral part of these consolidated financial statements -39-IndexVirnetX Holding Corporation CONSOLIDATED STATEMENTS OF OPERATIONS Year EndedDecember 31,2010 Year EndedDecember 31,2009 Revenue - Royalties $68,185 $26,306 Operating expenses: Royalty expense 59,206,774 – Research and development 2,412,109 864,058 General, selling and administrative 33,764,222 12,250,073 Gain on settlement (200,000,000) – Total operating expenses (104,616,895) 13,114,131 Income (loss) from operations 104,685,080 (13,087,825)Gain (loss) on change in value of embedded derivative and warrants (30,515,799) 558,378 Interest income, net 1,310,048 5,074 Income (loss) before taxes 75,479,329 (12,524,373)Income taxes 34,062,436 – Net Income (loss) $41,416,893 $(12,524,373)Basic earnings (loss) per share: $0.91 $(0.33)Diluted earnings (loss) per share: $0.84 $(0.33)Weighted average shares outstanding basic 45,452,550 37,911,340 Weighted average shares outstanding dilutive 49,066,704 37,911,340 Dividends declared per common share $0.50 – The accompanying notes are an integral part of these consolidated financial statements -40-IndexVirnetX Holding Corporation CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)AND COMPREHENSIVE INCOME (LOSS) Series A PreferredStock Common Stock AdditionalPaid-in Accumulated OtherComprehensiveIncome TotalStockholders'Equity Shares Amount Shares Amount Capital Deficit (Expense) (Deficit) Balance atDecember 31, 2008 — — 34,899,985 $3,489 $22,150,321 $(23,048,161) — $(894,351)Stock issued for cash at$1.50 per share, net — — 2,470,000 247 3,273,416 — — 3,273,663 Stock issued for cash at$2.52 per share, net — — 2,380,942 239 5,400,001 — — 5,400,240 Deferred offering costs — — — — (125,238) — — (125,238)Stock-based compensation — — — — 3,031,717 — — 3,031,717 Derivative liability — — — — (6,869,470) — — (6,869,470)Net loss — — — — — (12,524,373) — (12,524,373)Balance at December 31,2009 — — 39,750,927 $3,975 $26,860,747 $(35,572,534) $(8,707,812)Stock issued on cashexercise of warrants at$2.52 per share, net — — 2,380,943 238 5,394,985 — — 5,394,985 Stock issued on cashexercise of warrants at$2.00 per share, net — — 1,233,741 123 2,354,026 — — 2,354,026 Stock issued on cashexercise of warrants at$3.00 per share, net — — 1,235,000 123 3,750,590 — — 3,750,590 Stock issued on cashexercise of warrants at$4.00 per share, net — — 1,235,000 123 4,944,800 — — 4,944,800 Stock issued on cashexercise of warrants at$1.80 per share, net — — 220,000 22 396,000 — — 396,000 Stock issued on cashexercise of warrants at$4.80 per share, net — — 228,648 23 1,097,510 — — 1,097,510 Stock issued on cashexercise of warrants at$3.93-$3.59 per share,net — — 1,787,620 179 6,593,133 — — 6,593,133 Stock issued for cashexercise of options, net — — 1,269,149 128 1,403,900 — — 1,404,859 Stock-based compensation — — — — 3,380,876 — — 3,380,876 Deferred tax benefit relatedto stock-basedcompensation 527,951 — 527,951 Fees and commissions — — — — (979,682) — — (979,682)Derivative liability — — — — 22,462,540 — — 22,462,540 Unrealized loss onavailable for saleinvestments, net (984,266) (984,266)Dividend — — — — (23,599,439) — (23,599,439)Net Income — — — 41,416,893 — 41,416,893 Balance at December 31,2010 49,341,028 4,934 78,187,376 (17,755,080) (984,266) 59,452,964 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Year Ended December 31, December 31, 2010 2009 Net income/(loss) $41,416,893 $(12,524,373)Unrealized loss on investments, net (984,266) - Comprehensive income/(loss) $40,432,627 $(12,524,373) The accompanying notes are an integral part of these consolidated financial statements -41-IndexVirnetX Holding Corporation CONSOLIDATED STATEMENTS OF CASH FLOWS Year EndedDecember 31,2010 Year EndedDecember 31,2009 Cash flows from operating activities: Net Income (loss) $41,416,893 $(12,524,373)Adjustments to reconcile net loss to net cash used in operating activities: Unrealized loss on investments (984,266) — Stock-based compensation 3,380,876 3,031,717 Change in value of derivative liability 30,515,799 (558,378)Depreciation and amortization 59,066 63,113 Deferred tax benefit (2,851,462) — Changes in assets and liabilities: Receivables and other current assets (39,200) 140,296 Other assets — 94,263 Accounts payable and accrued liabilities 3,398,479 2,808,992 Net cash provided by (used in) operating activities 74,896,185 (6,944,370)Cash flows from investing activities: Purchase of property and equipment (13,100) (5,980)Purchase of investments (43,456,803) — Net cash used in investing activities (43,469,903) (5,980)Cash flows from financing activities: Payment of dividend (23,599,439) — Payment of royalty obligation less imputed interest (160,000) (44,000)Proceeds from exercise of options 1,341,432 — Proceeds from exercise of warrants 23,614,788 — Proceeds from sales of common stock — 8,548,665 Net cash provided by financing activities 1,196,781 8,504,665 Net increase in cash and cash equivalents 32,623,063 1,554,315 Cash and cash equivalents, beginning of period 2,011,470 457,155 Cash and cash equivalents, end of period $34,634,533 $2,011,470 Supplemental disclosure of cash flow information: Cash paid during the year for taxes $29,556,069 $2,173 Cash paid during the year for interest $10,000 $6,000 The accompanying notes are an integral part of these consolidated financial statements -42-IndexVirnetX Holding CorporationNOTES TO FINANCIAL STATEMENTS Note 1 Formation and Business of the Company VirnetX Holding Corporation ("we," "us," "our" or the "Company") is a company focused on commercializing a patent portfolio for providingsolutions 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 limitedoperations, and VirnetX, Inc., which became our principal operating subsidiary. As a result of this merger, the former security holders of VirnetX, Inc. cameto own a majority of our outstanding common stock. 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 PASWpursuant to the terms of a single license agreement. The revenue generated by this agreement is not significant. The company is no longer considered to be in the development stage as principal operations have commenced and significant income has beenrecognized. As such, the cumulative amounts and other disclosure required for development stage companies are omitted in the December 31, 2010 statements. Note 2 Summary of Significant Accounting Policies Basis of Presentation The consolidated financial statements include the accounts of VirnetX Holding Corporation and all wholly-owned subsidiaries. All materialintercompany accounts and transactions have been eliminated. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities atthe date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from thoseestimates. Revenue Recognition The Company recognizes revenue when (i) persuasive evidence of an arrangement exists, (ii) all obligations have been performed pursuant to theterms of the agreement, (iii) amounts are fixed or determinable and (iv) collectability of amounts is reasonably assured. If any of these criteria are not met, theCompany defers recognizing the revenue until such time as all criteria are met. Determination of whether or not these criteria have been met may require theCompany to make judgments, assumptions and estimates based upon current information and historical experience. The Company expects future royalty revenues from technology license agreements with original equipment manufacturers, or OEMs, within the IP-telephony, mobility, fixed-mobile convergence and unified communications markets. The Company will recognize royalty revenues upon notification by itslicensees and when deemed collectible. The terms of the royalty agreements generally require licensees to give the Company notification. The Company is planning to license its technology, including Gabriel Connection Technology to various original equipment manufacturers, orOEMs, within the IP-telephony, mobility, fixed-mobile convergence and unified communications markets, who use these technologies in the development andmanufacturing of their own products. Such licensing agreements may cover the license of part, or all, of our patent portfolio, with or without our technologysoftware components. The contractual terms of the agreements generally will provide for payments over an extended period of time. For the licensingagreements with fixed royalty payments, the Company will generally recognize revenue from these arrangements as amounts become due. For the licensingagreements with variable royalty payments which can be based on either a percentage of sales or number of units sold, the Company will recognize royaltyrevenue at the time that the licensees' sales occur. The Company's licensees, however, do not report and pay royalties owed for sales in any given quarter untilafter the conclusion of that quarter. As the Company is unable to estimate the licensees' sales in any given quarter to determine the royalties due to theCompany, it will recognize royalty revenues based on royalties reported by licensees during the quarter and when other revenue recognition criteria are met. -43-Index Depending on the complexity of the underlying revenue arrangement and related terms and conditions, significant judgments, assumptions andestimates may be required to determine when substantial delivery of contract elements will occur, whether any significant ongoing obligations exist subsequentto contract execution, whether amounts due are collectible and the appropriate period or periods in which, or during which, the completion of the earningprocess occurs. Depending on the magnitude of specific revenue arrangements, if different judgments, assumptions and estimates are made regardingcontracts executed in any specific period, our periodic financial results may be materially affected. Gain and Loss from Derivative Liability In accordance with FASB ASC 815-40-15 "Derivatives and Hedging-Contracts in Entity's Own Equity-Scope and Scope Exceptions", theCompany is required to account for the Series I Warrants as derivative liabilities. The Company is required to mark to market in each reporting quarter thevalue of the embedded derivative and Series I Warrants. The Company revalues these derivative liabilities at the end of each reporting period. The periodicchange in value of the derivative liabilities is recorded as either non-cash derivative gain (if the value of the embedded derivative and Series I Warrantsdecrease) or as non-cash derivative loss (if the value of the embedded derivative and Series I Warrants increase). Although the values of the embeddedderivative and Series I warrants are affected by interest rates, the remaining contractual exercise period and the Company's stock volatility, the primary causeof the change in the values will be the price of the Company's Common Stock. If the stock price goes up, derivative liability will generally increase and if thestock price goes down derivative liability will generally decrease. Cash and Cash Equivalents We consider all highly liquid investments purchased with original maturities of three months or less at the date of purchase to be cash equivalents. Investments Investments are classified as held-for-sale and are recorded at fair market value. Unrealized gain and losses are reported as other comprehensiveincome. Realized gains and losses are included in income in the period they are realized. The Company's investments consist of debt securities with maturitydates primarily less than nine months. Property and Equipment Property and equipment are stated at historical cost, less accumulated depreciation and amortization. Depreciation and amortization are computedusing the accelerated and straight line methods over the estimated useful lives of the assets, which range from five to seven years. Repair and maintenancecosts are charged to expense as incurred. -44-Index Concentration of Credit Risk and Other Risks and Uncertainties Our cash and cash equivalents are primarily maintained at two financial institutions in the United States. Our investements available for sale areprimarily held at one financial institution, but no one of the debt instruments exceed five percent of the total investments. Deposits held with these financialinstitutions may exceed the amount of insurance provided on such deposits. The interest earning cash balances are insured by the Federal Deposit InsuranceCorporation as of the date of this report up to $250,000. During the year ended December 31, 2010 we had, at times, funds that were uninsured. Theuninsured balance at December 31, 2010 was in excess of $9,900,000. We have not experienced any losses on our deposits of cash and cash equivalents. Intangible Assets We record intangible assets at cost, less accumulated amortization. Amortization of intangible assets is provided over their estimated useful lives,which can range from 3 to 15 years, on either a straight line basis or as revenue is generated by the assets. Impairment of Long-Lived Assets We identify and record impairment losses on intangible and other long-lived assets used in operations when events and changes in circumstancesindicate that the carrying amount of an asset might not be recoverable. Recoverability is measured by comparison of the anticipated future net undiscountedcash flows to the related assets' carrying value. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount bywhich the carrying amount of the assets exceeds the projected discounted future net cash flows arising from the asset. Research and Development Research and development costs include expenses paid to outside development consultants and compensation related expenses for our engineeringstaff. Research and development costs are expensed as incurred. Income Taxes Income tax expense is computed using an asset and liability method and using expected annual effective tax rates. Under this method, deferredincome tax assets and liabilities result from temporary differences in the financial reporting bases and the income tax reporting bases of assets andliabilities. The measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefit that, based on available evidence, is not expectedto be realized. When it appears more likely than not that deferred taxes will not be realized, a valuation allowance is recorded to reduce the deferred tax asset toits estimated realizable value. For net deferred tax assets we consider estimates of future taxable income, including tax planning strategies in determiningwhether our net deferred tax assets are more likely than not to be realized. Effective January 1, 2007, we have adopted, Accounting for Uncertainty in Income Taxes using the prospective method. The adoption did not havea material impact on our financial statements. Implementation of FASB ASC 815-40-15 "Derivatives and Hedging-Contracts in Entity's Own Equity-Scope and Scope Exceptions" In June 2008, the FASB ratified guidance included in ASC 815-40-15 "Derivatives and Hedging-Contracts in Entity's Own Equity-Scope and ScopeExceptions," which provides that an entity should use a two-step approach to evaluate whether an equity-linked financial instrument (or embedded feature) isindexed to its own stock, including evaluating the instrument's contingent exercise and settlement provisions. ASC 815-40-15 contains provisions describingconditions when an instrument or embedded feature would be considered indexed to an entity's own stock for purposes of evaluating the instrument orembedded feature under FASB ASC Topic 815 "Derivatives and Hedging," which establishes accounting and reporting standards for derivative instruments,including certain derivative instruments embedded in other contracts. -45-Index Under the provisions of ASC 815-40-15 the embedded Series I Warrants are not considered indexed to our stock. As a result of the antidilutionprotection in the Series I Warrants and the application of ASC 815-40-15, effective September, 2009, the Warrants were required to be accounted for asderivative instruments. Accordingly, effective September 2009, Company's Series I Warrant Conversion Feature and Investor Warrants are recognized asliabilities in our consolidated balance sheet. Fair Value of Financial Instruments Carrying amounts of our financial instruments, including cash and cash equivalents, accounts payable, notes payable and accrued liabilitiesapproximate their fair values due to their short maturities. The carrying amount of our minimum royalty payment obligation approximates fair value becauseit is recorded at a discounted calculation. Stock-Based Compensation Our accounting for share-based compensation is in accordance with the fair value method which requires the measurement and recognition ofcompensation expense in the statement of operations for all share-based payment awards made to employees and directors including employee stock-optionsbased on estimated fair values. Using the modified retrospective transition method of adopting this standard, the financial statements presented herein reflectcompensation expense for stock-based awards as if the provisions of this standard had been applied from the date of inception. In addition, as required we record stock and options granted to non-employees at fair value of the consideration received or the fair value of the equityinstruments issued as they vest over the performance period. Earnings Per Share Basic earnings per share is computed by dividing earnings available to common stockholders by the weighted average number of outstandingcommon shares during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of shares outstandingincluding potentially dilutive securities such as options, warrants and convertible debt. Since we incurred a loss in the prior period, any common stockequivalents have been excluded in 2009 because their effect would be anti-dilutive. New Accounting Pronouncements In September 2006, the FASB established a framework for measuring fair value in accordance with United States Generally Accepted AccountingPrinciples ("GAAP") and expanded disclosure about fair value measurements including valuing securities in markets that are not active. The Companyadopted the framework for measuring fair value effective January 1, 2009 with the exception of the application of the framework to non-recurring, non-financial assets and non-financial liabilities. The adoption of the framework for measuring fair value did not have a significant impact on the Company'sresults of operations or financial position. In June 2008, the FASB issued guidance requiring that unvested instruments granted in share-based payment transactions that contain nonforfeitablerights to dividends or dividend equivalents are participating securities subject to the two-class method of computing earnings per share. This guidance iseffective for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Theadoption did not have a material effect on the Company's consolidated financial statements. In April 2009, the FASB required disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies aswell as in annual financial statements, effective for interim reporting periods ending after June 15, 2009, and required those disclosures in summarizedfinancial information at interim reporting periods. The Company adopted the new disclosure guidance over fair value of financial instruments, and adoptiondid not have a material effect on the Company's consolidated financial statements. -46-Index In June 2009, the FASB established the Accounting Standards Codification ("Codification") as the single source of authoritative GAAP to be appliedby nongovernmental entities, except for the rules and interpretive releases of the Securities and Exchange Commission ("SEC") under authority of federalsecurities laws, which are sources of authoritative GAAP for SEC registrants. While not intended to change GAAP, the Codification significantly changes theway in which the accounting literature is referenced and organized. The codification was adopted as of August 31, 2009. Adoption did not have a materialeffect on the Company's consolidated financial statements. In January 2010, the FASB required new disclosures about fair value of financial instruments for interim and annual reporting periods. These newdisclosures were effective for interim and annual reporting periods beginning after December 15, 2009, except for disclosures about purchases, sales,issuances and settlements of Level 3 financial instruments, which are effective for interim and annual reporting periods in fiscal years beginning afterDecember 15, 2010. Adoption is not expected to have a material effect on the Company's consolidated financial statements. Reclassifications The Company has reclassified certain amounts in its financial statements for fiscal year 2009 to conform to the fiscal year 2010 presentation. Note 3 Gain on SettlementIn June 2010, the Company received $200,000,000 from Microsoft related to a licensing agreement that granted Microsoft a worldwide, irrevocable,nonexclusive, non-sub licensable fully paid up license. Pursuant to the agreement, the Company also agreed to dismiss the lawsuits and any damages. Thisamount was originally classified as revenue. Upon further analysis, the Company could not practically and objectively separate any settlement portion fromthe revenue element as discussed under the guidance of ASC Topic 605. As a result, the Company now classifies the amount as a gain on settlement. Note 4 Property Our major classes of property and equipment were as follows: December 31 2010 2009 Office furniture $21,810 $21,810 Computer Equipment 75,716 62,616 Total 97,526 84,426 Less accumulated depreciation (72,062) (60,996) $25,464 $23,430 Depreciation expense for the years ended December 31, 2010 and 2009 was $11,066 and $15,113, respectively. Note 5 Patent Portfolio As of December 31, 2010, we had twelve issued U.S. and sixteen issued foreign technology related patents, in addition to pending U.S. and foreignpatent applications. The term of our issued U.S. and foreign patents runs through the period 2019 to 2024. Most of our issued patents were acquired by ourprincipal operating subsidiary, VirnetX, Inc., from Science Applications International Corporation, or SAIC, pursuant to an Assignment Agreement datedDecember 21, 2006, and a Patent License and Assignment Agreement dated August 12, 2005, as amended on November 2, 2006, including documentsprepared pursuant to the November amendment, and as further amended on March 12, 2008. We are required to make payments to SAIC based on therevenue generated from our ownership or use of the patents we acquired from SAIC. Royalty amounts vary depending upon the type of revenue generatingactivities, and certain royalty categories are subject to maximums and other limitations. With respect to revenue-generating activities within our field of use,minimum annual royalty payments of $50,000 were due beginning in 2008 but as of June 30, 2010 we have met our maximum royalty payment. Undercertain circumstances, SAIC is entitled to receive a portion of the proceeds from revenues, monies or any form of consideration paid to VirnetX for certainacquisitions of VirnetX or from the settlement of certain patent infringement claims of ours. We recorded a related asset equal in amount to the liability as an intangible asset which will be amortized over the expected revenue generating periodof our agreement with SAIC. Amortization expense was $48,000 in 2010 and 2009. As of December 31, 2010, the expected amortization of the intangible assets is as follows:2011 $48,000 2012 48,000 Thereafter 12,000 Total $108,000 -47-Index Note 6 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 astraight-line basis over the term of the lease. Rent expense for the years ended December 31, 2010 and 2009 were $51,807.For the Year MinimumRequiredLeasePayments inPeriod 2011 $59,242 2012 30,202 Total $89,444 Note 7 Stock Plan In 2005, VirnetX, Inc. adopted the 2005 Stock Plan (the "Plan"), which was assumed by us upon the closing of the transaction between VirnetXHolding Corporation and VirnetX, Inc. on July 5, 2007. Our Board of Directors renamed this Plan the VirnetX Holding Corporation 2007 Stock Plan and ourstockholders approved the Plan at our 2008 annual stockholders' meeting. The Plan provides for the issuance of up to 11,624,469 shares of our commonstock. To the extent that any award should expire, become unexercisable or is otherwise forfeited, the shares subject to such award will again become availablefor issuance under the Plan. The Plan provides for the granting of stock options and stock purchase rights to our employees and consultants. Stock optionsgranted 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. The Plan will expire 10 years after it was approved by our Board of Directors. Options may be granted under the Plan with an exercise pricedetermined 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 notbe 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. Activity under the Plan is as follows: Options Outstanding SharesAvailable forGrant Number ofShares WeightedAverageExercise Price Balance at December 31, 2008 2,651,392 4,468,595 $2.98 Restricted stock granted — — — Options granted (1,317,195) 1,317,195 1.18 Options exercised — — — Options cancelled 83,032 — — Balance at December 31, 2009 1,417,229 5,785,790 $2.57 Restricted stock granted — — — Options granted (345,250) 345,250 5.53 Options exercised (1,269,149) 1.11 Options cancelled 31,500 (31,500) 5.48 Balance at December 31, 2010 1,103,478 4,830,391 $3.14 -48-Index Note 8 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 attheir 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 as follows:Stock-Based Compensation by Type of Award Year EndedDecember 31,2010 Year EndedDecember 31,2009 Restricted stock $— $— Employee stock options 3,380,876 3,031,717 Total stock-based compensation $3,380,876 $3,031,717 As of December 31, 2010, the unrecorded deferred stock-based compensation balance related to stock options was $4,026,507, which will beamortized as expense over an estimated weighted average vesting amortization period of approximately 1.2 years. The fair value of each option grant was estimated on the date of grant using the following weighted average assumptions: Year EndedDecember 31,2010 Year EndedDecember 31,2009Volatility 110 % 120 %Risk-free interest rate 3.66 % 2.93 %Expected life 7.0 years 6.6 yearsExpected dividends 0 % 0 % Based on the Black-Scholes option pricing model, the weighted average estimated fair value of employee stock options granted was $4.83 and $1.06during the year ended December 31, 2010 and 2009, respectively. The expected life was determined using the simplified method outlined in FASB codification topic 718, taking the average of the vesting term and thecontractual term of the option. Expected volatility of the stock options was based upon historical data and other relevant factors, such as the volatility ofcomparable publicly-traded companies at a similar stage of life cycle. We have not provided an estimate for forfeitures because we have no history of forfeitedoptions and believe that all outstanding options at December 31, 2010 will vest. In the future, the Company may change this estimate based on actual andexpected future forfeiture rates. The following table summarizes activity under the equity incentive plans for the indicated periods: Number ofShares WeightedAverageExercise Price WeightedAverageRemainingContractualLife (Years) AggregateIntrinsicValue Outstanding at December 31, 2008 4,468,595 2.98 — — Options granted 1,317,195 1.18 — — Options exercised — — — — Options cancelled — — — — Outstanding at December 31, 2009 5,785,790 2.57 — — Options granted 345,250 5.53 — — Options exercised (1,269,149) 1.11 — — Options cancelled (31,500) 5.48 — — Outstanding at December 31, 2010 4,830,391 $3.14 7.15 $56,566,634 -49-Index Intrinsic value is calculated at the difference between the market price of the Company's stock on the last trading day of the year ($14.85) and theexercise price of the options. For options exercised, the intrinsic value is the difference between market price and the exercise price on the date of exercise. The following table summarizes information about stock options outstanding at December 31, 2010:Options Outstanding Options Vested and Exercisable Range of Exercise Price NumberOutstanding WeightedAverageRemainingContractualLife (Years) WeightedAverageExercise Price NumberExercisable WeightedAverageRemainingContractualLife (Years) WeightedAverageExercise Price $0.24 705,772 5.22 $0.24 705,772 5.22 $0.24 4.20 1,327,899 6.56 4.20 1,177,493 6.56 4.20 5.88-6.47 797,026 7.00 6.04 575,270 7.00 6.04 1.74-6.20 371,250 7.56 3.62 215,417 7.50 4.06 1.15- 1.58 1,314,694 8.26 1.18 563,831 8.27 1.19 5.48-6.03 313,750 9.18 5.54 89,115 9.25 5.55 4,830,391 7.15 $3.14 3,326,898 6.77 $3.20 Note 9 Warrants In 2007 and 2009 we issued warrants to purchase shares of our common stock in public and private securities offerings. Warrant Activity as of the Year Ended December 31, 2010Original Number ofWarrants Issued ExercisePrice perCommonShare Exercisable atDecember 31,2009 BecameExercisable Exercised Terminated/ Cancelled /Expired Adjustment ExercisableatDecember 31,2010 Termination 300,000 $4.80 300,000 — (270,000) — — 30,000 December2012 1,235,000 $2.00(1) 1,235,000 — (1,233,741) (1,259) — — n/a 1,235,000 $3.00(1) 1,235,000 — (1,235,000) — — — n/a 1,235,000 $4.00(1) 1,235,000 — (1,235,000) — — — n/a 220,000 $1.80 220,000 — (220,000) — — — n/a 2,619,036 $3.93(2) — 2,619,036(2) (212,926) — (2,406,110) — n/a $3.59(2) — 2,406,110 (1,586,695) — 241,029 1,060,444 March 2015 2,419,023(2) $0.01(3) — — — (3) — — n/a 2,380,942 $2.52 2,380,942 — (2,380,942) — — — n/a Total 6,605,942 5,025,146 (8,374,304) (1259) (2,165,081) 1,090,444 (1)Subject to call by us under certain conditions.(2)Represents the exercise price and number of shares of common stock issuable as adjusted to reflect the impact of the Company's payment of a specialcash dividend to stockholders of record on July 1, 2010.(3)These warrants were exercisable under certain conditions. Those conditions were not met, and accordingly, these warrants terminated. -50-Index Note 10 Earnings Per Share Basic earnings per share are based on the weighted average number of shares outstanding for a period. Diluted earnings per share are based upon theweighted average number of shares and potentially dilutive common shares outstanding. Potential common shares outstanding principally include stockoptions, warrants, restricted stock and other equity awards under our stock plan. During 2009, the Company has incurred losses; therefore the effect of anycommon stock equivalent would be anti-dilutive during that period. The table below sets forth the basic loss per share calculations (in 000s, except per share information). Period Ended December 31, 2010 2009 Net income (loss) $41,417 $(12,524)Weighted average number of shares outstanding 45,453 37,911 Diluted weighted average number of shares outstanding 49,067 — Basic earnings (loss) per share $0.91 $(0.33)Diluted earnings (loss) per share $0.84 $(0.33) For the years ended December 31, 2010 and 2009, there were the following stock equivalents: 2010 2009 Options 4,830,391 5,785,790 Warrants 1,090,444 12,271,946 Note 11 Preferred Stock Our Amended and Restated Certificate of Incorporation, as amended in October 2007, authorizes us to issue 10,000,000 shares of $0.0001 par valueper share preferred stock having rights, preferences and privileges to be designated by our Board of Directors. There were no shares of preferred stockoutstanding at December 31, 2010. Note 12 Common Stock Each share of common stock has the right to one vote. The holders of common stock are entitled to receive dividends whenever funds are legallyavailable and when declared by our Board of Directors, subject to the prior rights of holders of all classes of stock outstanding having priority rights as todividends. On June 15, 2010, the Company's Board of Directors declared a special cash dividend of $0.50 per share of the Company's common stock toholders of record on July 1, 2010. Our restated articles of incorporation authorize us to issue up to 100,000,000 shares of $.0001 par value common stock. Note 13 Employee Benefit Plan We sponsor a defined contribution, 401k plan, covering substantially all our employees. The Company's matching contribution to the plan in 2010was approximately $36,400 and $36,000 in 2009. -51-Index Note 14 Income Taxes The Company had pre-tax income during the twelve months ended December 31, 2010 for the first time since inception. The components of incometax expense for the periods ended December 31, 2010 and 2009 are as follows: December 31,2010 December 31,2009 Current: Federal $27,822,487 $— State 9,608,862 — Foreign 10,502 — 37,441,851 — Deferred: Federal (3,379,415) — State — — Foreign — — (3,379,415) — Total provision for income taxes $34,062,436 $— A reconciliation of the United States federal statutory income tax rate to the Company's effective income tax rate is as follows: December 31,2010 December 31,2009 United States federal statutory rate 35% 35%State taxes, net of federal benefit 8.28% — Valuation allowance (9.69)% (33.96)%Warrants 14.15% (2.07)%Other (3.64)% 1.03%Total 44.10% 0.00% Deferred tax assets (liabilities) consist of the following: December 31,2010 December 31,2009 Deferred Tax Assets: Reserves and accruals $53,009 $— State tax 3,326,406 — R&D credits and other credits 225,068 500,000 Net operating loss carry forward 371,615 10,500,000 Stock Based Compensation 3,109,253 — Gross Deferred Tax Assets 7,085,351 11,000,000 Deferred Tax Asset Valuation Allowance (3,687,657) (11,000,000)Total Deferred Tax Asset 3,397,694 — Deferred Tax Liability Depreciation & Amortization (18,280) — Total Deferred Tax Liability (18,280) — Total $3,379,414 $— In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of deferred assetswill not be realized. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income during the periods in whichthose temporary differences become deductible. Based on the available objective evidence, management believes it is more likely than not that the net deferred tax assets will not be fully realizable forthe year ended December 31, 2010. Accordingly, management has released a partial valuation allowance against its net deferred tax assets at December 31,2010. The net change in the total valuation allowance for the year ended December 31, 2010 was a decrease of $7,312,343. -52-Index At December 31, 2010, the Company has federal and state net operating loss carryforwards of approximately $912,000 and $912,000, respectively,expiring beginning in 2026 and 2012, respectively. At December 31, 2010, the Company has federal research and development credit carryforwards of approximately $225,000 expiring beginning in2023. Internal Revenue Code section 382 places a limitation (the "Section 382 Limitation") on the amount of taxable income can be offset by net operating("NOL") carryforwards after a change in control (generally greater than 50% change in ownership) of a loss corporation. California has similar rules. TheCompany's capitalization described herein may have resulted in such a change. Generally, after a control change, a loss corporation cannot deduct NOLcarryforwards in excess of the Section 382 Limitation. Management has done a high level analysis on the utilization of its NOL carryforwards against taxableincome in future periods and determined on a more likely than not basis it will be able to use all of its NOLs before they expire. Effective January 1, 2009, the Company adopted new accounting guidance for income taxes, which clarifies the accounting for uncertainty inincome taxes recognized in an enterprise's financial statements and prescribes a recognition threshold and measurement attribute for the financial statementsrecognition and measurement of a tax position taken or expected to be taken in a tax return. The Company is now required to recognize in the financialstatements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. Theadoption of the new accounting guidance did not impact the Company's financial condition, results of operations, or cash flows. The Company's tax years for 2005 and forward are subject to examination by the U.S. tax authorities and various state tax authorities. These yearsare open due to net operating losses and tax credit unutilized from such years. We are required to recognize the financial statement effects of a tax position when it is more likely than not, based on the technical merits, that theposition will be sustained upon examination. As a result, we have reduced our gross deferred tax assets by $128,000 and $0 at December 31, 2010 and 2009,respectively for certain tax benefits which we judge may not be sustained upon examination, and we have provided an offset through equal reduction in thevaluation allowance. The Company's policy is to recognize interest and penalties accrued on any unrecognized tax benefit as a component of income tax expense. TheCompany did not have associated accrued interest or penalties nor was any interest expense or penalties recognized during the 12 months ended December 31,2010. A reconciliation of the beginning and ending amounts of unrecognized tax benefits are as follows: December 31,2010 December 31,2009 Balance at the beginning of the year $— $— Additions based on tax positions related to the current year — — Additions (reductions) for tax positions of prior years 128,000 — Settlements — — Lapse of applicable statute of limitations — — Balance at the end of the year $128,000 $— -53-Index Note 15 Fair Value Measurement All investments are stated at fair value or amounts that closely approximate fair value. Fair value is the price that would be received to sell an asset orpaid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The Company utilizes market data or assumptions that the Company believes market participants would use in pricing the asset or liability,including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroboratedor generally unobservable. The Company primarily applies the income and market approach for recurring fair value measurements and endeavors to utilize the best availableinformation. Accordingly, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservableinputs. The Company is able to classify fair value balances based on the observability of those inputs. A fair value hierarchy prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in activemarkets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). Level 2 measurementsutilize observable inputs in markets other than active markets. Certificate of deposits: Valued at face value plus accrued interest Corporate bonds: Valued at the closing price reported on the active market on which the individual securities are traded. Warrants: Beginning September 2009, the Company carried its embedded Series I Warrants on its balance sheet as liabilities carried at fair valuedetermined by using the Binomial valuation model. As of December 31, 2010, the assumptions used in the valuation of the embedded derivation of the Series IWarrants with an exercise price of $3.59, as well as the Company's stock price of $14.85, discount rate of 2.01%, and volatility of 123%. As of December31, 2009, the assumptions used in the calculation of the embedded derivation of the Series I Warrants with an exercise price of $3.93, as well as theCompany's stock price of $2.94, discount rate of 2.69%, and volatility of 121%. The following tables set forth by level, within the fair value hierarchy, the financial instruments at fair value as of December 31, 2010: Assets at Fair Value as of December 31, 2010 Level 1 Level 2 Level 3 Total Certificates of deposit $3,971,472 — — $3,971,472 Corporate Bonds: Domestic 32,538,282 — — 32,538,282 Foreign 6,947,049 — — 6,947,049 Total Corporate Bonds 39,485,331 — — 39,485,331 Total Investments at Fair Value $43,456,803 — — $43,456,803 -54-Index The following table presents the derivative instrument related to warrants that are carried at fair value as of December 31, 2010 and December 31,2009: Fair Value Measurements at December 31, 2010 Quoted Pricesin ActiveMarkets forIdentical Assets Significant OtherObservableInputs SignificantUnobservableInputs Total (Level 1) (Level 2) (Level 3) Warrants $14,364,350 $— $— $14,364,350 Total $14,364,350 $— $— $14,364,350 The following table sets forth a summary of changes in the fair value of the Company’s Level 3 derivative instrument for the year ended December31, 2010: Fair ValuesMeasurementsUsingSignificantUnobservableInputs (Level3) Balance December 31, 2009 $6,311,091 Net loss included in earnings 30,515,799 Settlements (22,462,540)Balance December 31, 2010 $14,364,350 Fair Value Measurements at December 31, 2009 Quoted Pricesin ActiveMarkets forIdentical Assets Significant OtherObservableInputs SignificantUnobservableInputs Total (Level 1) (Level 2) (Level 3) Warrants $6,311,091 $— $— $6,311,091 Total $6,311,091 $— $— $6,311,091 The following table sets forth a summary of changes in the fair value of the Company’s Level 3 derivative for the year ended December 31, 2009: Fair ValuesMeasurementsUsingSignificantUnobservableInputs (Level3) Balance December 31, 2008 $— Net effect of implementing liability accounting for warrants 6,869,470 Net gain included in earnings (558,379) Settlements 0 Balance December 31, 2009 $6,311,091 Note 16 Litigation We believe that Aastra, Apple, Cisco, NEC, Siemens and Mitel infringe on certain of our patents, but obtaining and collecting a judgment againstthese parties may be difficult or impossible. Patent litigation is inherently risky and the outcome is uncertain. Aastra, Apple, Cisco, NEC, Siemens andMitel are all large, well-financed companies with substantially greater resources than us. We believe that these parties will devote a substantial amount ofresources 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, wecannot predict the final outcome of these litigation matters. -55-Index On August 11, 2010, we initiated a lawsuit by filing a complaint against Aastra, Apple, Cisco, NEC in the United States District Court for theEastern District of Texas, Tyler Division, pursuant to which we allege that these parties infringe on certain of our patents. We seek damages and injunctiverelief. On January 12, 2011, we initiated a lawsuit by filing a complaint against Siemens and Mitel in the United States District Court for the Eastern Districtof Texas, Tyler Division, pursuant to which we allege that these companies infringe two of our patents. We seek damages and injunctive relief. We cannot assure you that any of these lawsuits will result in a final outcome that is favorable to our company or our stockholders. We expect to allocate a significant amount of our existing cash hand towards the fees and expenses associated with these litigation matters. Weanticipate that these legal proceedings could continue for several years and may require significant expenditures for legal fees and other expenses. In the eventwe are not successful through appeal and do not subsequently obtain monetary and injunctive relief, these litigation matters may significantly reduce ourfinancial resources and have a material impact on our ability to continue our operations. The time and effort required of our management to effectively pursuethese litigation matters may adversely affect our ability to operate our business, since time spent on matters related to the lawsuits will take away from the timespent on managing and operating our business. -56-Index Note 17 Quarterly Financial Information (unaudited) First Second1 Third Fourth (amounts in thousands except per share) 2010 Revenue $21 $23 $16 $8 Income (loss) from operations (4,457) 115,101 (2,434) (3,525)Net (loss) / income (8,900) 78,575 (25,420) (2,838)Basic earnings (loss) per common share $(0.23) $1.77 $(0.54) $(0.06)Diluted earnings (loss) per common share $(0.23) $1.67 $(0.54) $(0.06) SecondQuarterJune 30, 2010(As originallyreported) SecondQuarterJune 30, 2010(Asreclassified) (amounts in thousands exceptper share) 2010 Revenue $200,023 $23 Gain on settlement - 200,000 Income from operations 115,101 115,101 Net loss 78,575 78,575 Basic earnings per common share $1.77 $1.77 Diluted earnings per common share 1.67 1.67 1 In June 2010, the Company received $200,000,000 from Microsoft related to a licensing agreement that granted Microsoft a worldwide, irrevocable,nonexclusive, non-sub licensable fully paid up license. Pursuant to the agreement, the Company also agreed to dismiss the lawsuits and any damages. Thisamount was originally classified as revenue. Upon further analysis, the Company could not practically and objectively separate any settlement portion from the revenue element as discussed underthe guidance of ASC Topic 605. As a result, the Company now classifies the amount as a gain on settlement. First Second Third Fourth (amounts in thousands except per share) 2009 Revenue $3 $7 $3 $13 Loss from operations (3,405) (3,928) (2,624) (3,131)Net loss (3,403) (3,927) (2,623) (2,572)Net loss per common share $(0.09) $(0.11) $(0.07) $(0.07) -57-IndexReport of Independent Registered Public Accounting Firm To the Board of Directors andStockholders of VirnetX Holding Corporation We have audited VirnetX Holding Corporation's internal control over financial reporting as of December, 2010, based on criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). VirnetX HoldingCorporation's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibilityis to express an opinion on the company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in allmaterial respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting,assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessedrisk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internalcontrol over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately andfairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary topermit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate. A material weakness is a control deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonablepossibility that a material misstatement of the Company's annual or interim financial statements will not be prevented or detected on a timely basis. Thefollowing material weakness has been identified and included in management's assessment. The Company did not maintain effective controls over itsaccounting for certain derivative instruments (the Series I Warrants). Specifically, the Company's controls were not designed or operating effectively to ensurethat Series I Warrants were completely and accurately recorded as a derivative liability, measured at fair value, with changes in fair value recognized as gain orloss for each reporting period thereafter. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in ouraudit of the 2010 financial statements, and this report does not affect our report dated March 15, 2011 on those financial statements. In our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, VirnetXHolding Corporation has not maintained effective internal control over financial reporting as of December 31, 2010, based on criteria established in InternalControl—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the balance sheets andthe related statements of operations, stockholders' equity (deficit) and comprehensive income, and cash flows of VirnetX Holding Corporation, and our reportdated March 15, 2011 expressed an unqualified opinion. /s/ Farber Hass Hurley LLP Granada Hills, CaliforniaMarch 15, 2011 -58-Index Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None. Item 9A. Controls and Procedures. Evaluation of Disclosure Controls and Procedures The Company maintains disclosure controls and procedures (as such terms are defined in Rule 13a-15 and Rule 15d-15(e) under the SecuritiesExchange Act of 1934, as amended or the Securities Exchange Act) that are designed to ensure that the information we are required to disclose in the reportsthat we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rulesand forms, and accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate toallow timely decisions regarding the required disclosure. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer,evaluated the design and operating effectiveness of our disclosure controls and procedures as of the end of the period covered by this Annual Report on Form10-K (the "Evaluation Date"). Based on this evaluation, as of the Evaluation Date, our Chief Executive Officer and Chief Financial Officer concluded that amaterial weakness existed with respect to the Company's reporting of complex, non-routine transactions (the Series I Warrants) and therefore our disclosurecontrols and procedures were not effective as of the end of the period covered by this report. In connection with the filing of this annual report on Form 10-K, the Company's Chief Executive Officer and Chief Financial Officer re-evaluated,with the participation of management, the effectiveness of the Company's disclosure controls and procedures for the following periods: (i) the fiscal quarterended September 30, 2009, (ii) the fiscal year ended December 31, 2009, (iii) the fiscal quarter ended March 31, 2010, (iv) the fiscal quarter ended June 30,2010 and (v) the fiscal quarter ended September 30, 2010, and concluded that the Company's disclosure controls and procedures were not effective as of theend of each of these periods due to the material weakness that existed with respect to the Company's reporting of complex, non-routine transactions (the Series IWarrants). As previously reported, the Company restated its financial statements for each of these periods. This material weakness was a result of our lackof technical accounting expertise in the interpretation of the guidance in ASC 815-40, "Derivative and Hedging – Contracts in an Entity's own Equity", withrespect to its application to the Series I Warrants, which required us to restate our financial results for each of these periods. Management's Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining an adequate system of internal control over our financial reporting, as such term isdefined in Securities Exchange Act Rules 13a-15(f) and 15d-15(f). This system is intended to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the UnitedStates. A company's internal control over financial reporting includes policies and procedures that: (i) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company, (ii) provide reasonable assurance thattransactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the UnitedStates, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company,and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets thatcould have a material effect on the financial statements. In 2007, our management selected the framework in Internal Control — Integrated Framework, issued by the Committee of SponsoringOrganizations of the Treadway Commission or COSO, to conduct an evaluation of the effectiveness of the Company's internal control over financialreporting. The COSO framework summarizes each of the components of a company's internal control system, including the: (i) control environment, (ii)risk assessment, (iii) information and communication, and (iv) monitoring or collectively, the entity-level controls, as well as a company's control activities orprocess-level controls. In addition to utilizing substantial internal resources, management also engaged an outside consulting firm to assist in various aspectsof its evaluation and compliance efforts. -59-Index Our management, including our Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of our internal control over financialreporting as of December 31, 2010. In performing this assessment, management used the criteria established by COSO. Based upon this assessment,management has concluded that the Company did not maintain effective internal control over financial reporting as of December 31, 2010 based on the criteriaset forth in COSO because the Company did not maintain effective controls over its accounting for certain derivative instruments (the Series IWarrants). Specifically, the Company's controls were not designed or operating effectively to ensure that Series I Warrants were completely and accuratelyrecorded as a derivative liability, measured at fair value, with changes in fair value recognized as gain or loss for each reporting period thereafter. This controldeficiency resulted in the restatement of the financial statements for: (i) the fiscal quarter ended September 30, 2009 included in the Form 10-Q filed with theSEC on November 9, 2009, (ii) the fiscal year ended December 31, 2009 included the Form 10-K filed with the SEC on March 31, 2010, (iii) the fiscalquarter ended March 31, 2010 included in the Form 10-Q filed with the SEC on May 7, 2010, (iv) the fiscal quarter ended June 30, 2010 included in the Form10-Q filed with the SEC on August 9, 2010 and (v) the fiscal quarter ended September 30, 2010 included in the Form 10-Q filed with the SEC on November8, 2010. Our independent registered public accounting firm, Farber Hass Hurley LLP, which audited the consolidated financial statements included in thisannual report on Form 10-K, has issued an attestation report, included elsewhere herein, which expresses an adverse opinion on the effectiveness of ourinternal control over financial reporting. Changes in Internal Control There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule13a-15 or Rule 15d-15 of the Securities Exchange Act that occurred during our fourth fiscal quarter of 2010 that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting. Management's Remediation Initiatives Subsequent to the end of the period covered by this report, and in light of the material weakness described above, management is in the process ofdesigning and implementing improvements in our internal control over financial reporting and we currently plan to hire third party consultants to assist us inidentifying and analyzing complex non-routine transactions and with valuing and determining the appropriate accounting treatment for any such complex non-routine transactions, including the Series I Warrants. Item 9B. Other Information. Not applicable. -60-IndexPART III Certain information required by Part III is omitted from this report because we will file a definitive proxy statement within 120 days after the end ofits fiscal year pursuant to Regulation 14A or the Proxy Statement for our annual meeting of stockholders for the year ended December 31, 2010, and theinformation included in the Proxy Statement is incorporated herein by reference. Item 10. Directors, Executive Officers and Corporate Governance. The information required by this item is incorporated by reference to the information set forth in our Definitive Proxy Statement, expected to be filedwithin 120 days of our fiscal year end. Item 11. Executive Compensation. The information required by this item is incorporated by reference to the information set forth in our Definitive Proxy Statement, expected to be filedwithin 120 days of our fiscal year end. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Equity Compensation PlanInformation. The information required by this item is incorporated by reference to the information set forth in our Definitive Proxy Statement, expected to be filedwithin 120 days of our fiscal year end. Item 13. Certain Relationships and Related Transactions, and Director Independence. The information required by this item is incorporated by reference to the information set forth in our Definitive Proxy Statement, expected to be filedwithin 120 days of our fiscal year end. Item 14. Principal Accountant Fees and Services. The information required by this item is incorporated by reference to the information set forth in our Definitive Proxy Statement, expected to be filedwithin 120 days of our fiscal year end. -61-IndexPART IV Item 15. Exhibits and Financial Statement Schedules. (a)The following documents are filed as part of this Annual Report on Form 10-K: (1)Financial Statements: ·Report of Independent Registered Public Accounting Firm ·Consolidated Balance Sheets as of December 31, 2010 and 2009 ·Consolidated Statements of Operations for the years Ended December 31, 2010 and 2009 ·Consolidated Statements of Changes in Stockholders' Equity (Deficit) and comprehensive income (loss) for the years Ended December31, 2010 and 2009 ·Consolidated Statements of Cash Flows for years Ended December 31, 2010 and 2009 ·Notes to Financial Statements (2)Financial Statement Schedule: Financial statement schedules are omitted because they are not applicable or the required information is shown in the financial statements or notesthereto. All other schedules are omitted because of the absence of conditions under which they are required or because the required information is given in thefinancial statements or the notes thereto. (3)Exhibits:ExhibitNumber Description3.1 Certificate of Incorporation of the Company. (1)3.2 By-Laws of the Company. (1)4.1 Form of Warrant Issued to Gilford Securities Incorporated. (2)4.2 Form of Warrant Agency Agreement by and between the Company and Corporate Stock Transfer, Inc. as Warrant Agent. (2)4.3 Form of Underwriter's Warrant. (2)4.4 Form of Series I Warrant. (3)4.5 Amended Form of Stock Option Agreement - 2007 Stock Plan. (9)10.1 Form of Indemnification Agreement by and between the Company and each of Kendall Larsen, Robert D. Short III, Scott C. Taylor, Michael F.Angelo, Thomas M. O'Brien and William E. Sliney. (1)10.2 Voting Agreement among the Company and certain of its stockholders, dated as of December 12, 2007. (5)10.3 2007 Stock Plan and related agreements. (4)10.4 Securities Purchase Agreement, dated as of September 2, 2009, by and between the Company and the Purchasers. (3)10.5 Form of Registration Rights Agreement by and between the Company and the Purchasers. (3)10.6 Form of Underwriting Agreement between VirnetX Holding Corporation and Gilford Securities Incorporated. (2)10.7 Patent License and Assignment Agreement by and between the Company and Science Applications International Corporation, dated as ofAugust 12, 2005. (6)10.8 Security Agreement by and between the Company and Science Applications International Corporation, dated as of August 12, 2005. (6) -62-Index ExhibitNumber Description10.9 Amendment No. 1 to Patent License and Assignment Agreement by and between the Company and Science Applications InternationalCorporation, dated as of November 2, 2006. (6)10.10 Assignment Agreement between the Company and Science Applications International Corporation, dated as of December 21, 2006. (6)10.11 Professional Services Agreement by and between the Company and Science Applications International Corporation, dated as of August 12,2005. (6)10.12 Voting Agreement among the Company and certain of its stockholders, dated as of December 12, 2007. (5)10.13 Amendment No. 2 to Patent License and Assignment Agreement by and between VirnetX, Inc. and Science Applications InternationalCorporation, dated as of March 12, 2008. (7)10.14 IP Brokerage Agreement by and between ipCapital Group, Inc. and VirnetX, Inc., effective as of March 13, 2008. (7)10.15 Engagement Letter by and between VirnetX Holding Corporation and ipCapital Group, Inc. dated March 12, 2008. (7)10.16 Lease Agreement by and between the Company and Granite Creek Business Center, dated as of March 15, 2006, as amended in April 2007and April 2008. (8)10.17 Engagement Letter dated June 9, 2009, by and between McKool Smith, a professional corporation, and the Company. (9)10.18 Engagement Letter dated April 15, 2010, by and between McKool Smith, a professional corporation, and the Company. (10)10.19 Settlement and License Agreement, by and between Microsoft Corporation, a Washington corporation, and VirnetX, Inc., a Delawarecorporation. (11)21.1 Subsidiaries of VirnetX Holding Corporation.23.1 Consent of Farber Hass Hurley LLP, Independent Registered Public Accounting Firm.31.1 Chief Executive Officer Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act.31.2 Chief Financial Officer Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act.32.1 Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of2002.32.2 Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of2002.(1)Incorporated herein by reference to the Company's Current Report on Form 8-K filed with the Securities and Exchange Commission on November 1,2007.(2)Incorporated herein by reference to the Company's Registration Statement on Form S-1/A filed with the Securities and Exchange Commission onJanuary 16, 2009.(3)Incorporated herein by reference to the Company's Form 8-K filed with the Securities and Exchange Commission on September 3, 2009.(4)Incorporated herein by reference to the Company's Registration Statement on Form S-8 filed with the Securities and Exchange Commission on March25, 2008.(5)Incorporated herein by reference to the Company's Form 10-K filed with the Securities and Exchange Commission on March 31, 2008.(6)Incorporated by reference to the Company's Form 8-K (Commission File No. 001-33852) filed with the Securities and Exchange Commission on July12, 2007.(7)Incorporated by reference to the Company's Form 8-K (Commission File No. 001-33852) filed with the Securities and Exchange Commission on March18, 2008.(8)Incorporated by reference to the Company's Form 10-K (Commission File No. 001-33852) filed with the Securities and Exchange Commission onMarch 31, 2009.(9)Incorporated by reference to the Company's Form 10-Q (Commission File No. 001-33852) filed with the Securities and Exchange Commission onAugust 10, 2009. Portions of this exhibit have been omitted pursuant to a request for confidential treatment.(10)Incorporated by reference to the Company's Form 10-Q (Commission File No. 001-33852) filed with the Securities and Exchange Commission on May7, 2010.(11)Incorporated by reference to the Company's Form 10-Q/A (Commission File No. 001-33852) for the period ended June 30, 2010, filed with theSecurities and Exchange Commission on January 31, 2011. Pursuant to a request for confidential treatment, portions of Exhibit 10.19 have beenredacted and have been provided separately to the U.S. Securities and Exchange Commission, and a revised redacted copy was re-filed with the Form10-Q/A for the period ended June 30, 2010. -63-Index SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report onForm 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. VirnetX Holding Corporation By: /s/ Kendall Larsen Name: Kendall Larsen Title: Chief Executive Officer and President Dated: March 16, 2011 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Kendall Larsen his orher attorney-in-fact, with full power of substitution, for him or her in any and all capacities, to sign any amendments to this Report on Form 10-K, and to filethe same, with exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, hereby ratifying and confirmingall that said attorney-in-fact, or his or her substitute or substitutes may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below by the followingpersons on behalf of the registrant and in the capacities indicated.Name Capacity Date /s/ Kendall Larsen Director, Chief Executive Officer and President March 16, 2011Kendall Larsen (Principal Executive Officer) /s/ William E. Sliney Chief Financial Officer March 16, 2011William E. Sliney (Principal Financial Officer and PrincipalAccounting Officer) /s/ Robert D. Short III Director March 16, 2011Robert D. Short III /s/ Scott C. Taylor Director March 16, 2011Scott C. Taylor /s/ Michael F. Angelo Director March 16, 2011Michael F. Angelo /s/ Thomas M. O'Brien Director March 16, 2011Thomas M. O'Brien -64-Index EXHIBIT INDEXExhibitNumber Description3.1 Certificate of Incorporation of the Company. (1)3.2 By-Laws of the Company. (1)4.1 Form of Warrant Issued to Gilford Securities Incorporated. (2)4.2 Form of Warrant Agency Agreement by and between the Company and Corporate Stock Transfer, Inc. as Warrant Agent. (2)4.3 Form of Underwriter's Warrant. (2)4.4 Form of Series I Warrant. (3)4.5 Amended Form of Stock Option Agreement - 2007 Stock Plan. (9)10.1 Form of Indemnification Agreement by and between the Company and each of Kendall Larsen, Robert D. Short III, Scott C. Taylor, Michael F.Angelo, Thomas M. O'Brien and William E. Sliney. (1)10.2 Voting Agreement among the Company and certain of its stockholders, dated as of December 12, 2007. (5)10.3 2007 Stock Plan and related agreements. (4)10.4 Securities Purchase Agreement, dated as of September 2, 2009, by and between the Company and the Purchasers. (3)10.5 Form of Registration Rights Agreement by and between the Company and the Purchasers. (3)10.6 Form of Underwriting Agreement between VirnetX Holding Corporation and Gilford Securities Incorporated. (2)10.7 Patent License and Assignment Agreement by and between the Company and Science Applications International Corporation, dated as ofAugust 12, 2005. (6)10.8 Security Agreement by and between the Company and Science Applications International Corporation, dated as of August 12, 2005. (6)10.9 Amendment No. 1 to Patent License and Assignment Agreement by and between the Company and Science Applications InternationalCorporation, dated as of November 2, 2006. (6)10.10 Assignment Agreement between the Company and Science Applications International Corporation, dated as of December 21, 2006. (6)10.11 Professional Services Agreement by and between the Company and Science Applications International Corporation, dated as of August 12,2005. (6)10.12 Voting Agreement among the Company and certain of its stockholders, dated as of December 12, 2007. (5)10.13 Amendment No. 2 to Patent License and Assignment Agreement by and between VirnetX, Inc. and Science Applications InternationalCorporation, dated as of March 12, 2008. (7)10.14 IP Brokerage Agreement by and between ipCapital Group, Inc. and VirnetX, Inc., effective as of March 13, 2008. (7)10.15 Engagement Letter by and between VirnetX Holding Corporation and ipCapital Group, Inc. dated March 12, 2008. (7)10.16 Lease Agreement by and between the Company and Granite Creek Business Center, dated as of March 15, 2006, as amended in April 2007and April 2008. (8)10.17 Engagement Letter dated June 9, 2009, by and between McKool Smith, a professional corporation, and the Company. (9)10.18 Engagement Letter dated April 15, 2010, by and between McKool Smith, a professional corporation, and the Company. (10)10.19 Settlement and License Agreement, by and between Microsoft Corporation, a Washington corporation, and VirnetX, Inc., a Delawarecorporation. (11)21.1 Subsidiaries of VirnetX Holding Corporation.23.1 Consent of Farber Hass Hurley LLP, Independent Registered Public Accounting Firm.31.1 Chief Executive Officer Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act.31.2 Chief Financial Officer Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act.32.1 Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of2002.32.2 Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of2002.(1)Incorporated herein by reference to the Company's Current Report on Form 8-K filed with the Securities and Exchange Commission on November 1,2007.(2)Incorporated herein by reference to the Company's Registration Statement on Form S-1/A filed with the Securities and Exchange Commission onJanuary 16, 2009.(3)Incorporated herein by reference to the Company's Form 8-K filed with the Securities and Exchange Commission on September 3, 2009.(4)Incorporated herein by reference to the Company's Registration Statement on Form S-8 filed with the Securities and Exchange Commission on March25, 2008.(5)Incorporated herein by reference to the Company's Form 10-K filed with the Securities and Exchange Commission on March 31, 2008.(6)Incorporated by reference to the Company's Form 8-K (Commission File No. 001-33852) filed with the Securities and Exchange Commission on July12, 2007.(7)Incorporated by reference to the Company's Form 8-K (Commission File No. 001-33852) filed with the Securities and Exchange Commission on March18, 2008.(8)Incorporated by reference to the Company's Form 10-K (Commission File No. 001-33852) filed with the Securities and Exchange Commission onMarch 31, 2009.(9)Incorporated by reference to the Company's Form 10-Q (Commission File No. 001-33852) filed with the Securities and Exchange Commission onAugust 10, 2009. Portions of this exhibit have been omitted pursuant to a request for confidential treatment.(10)Incorporated by reference to the Company's Form 10-Q (Commission File No. 001-33852) filed with the Securities and Exchange Commission on May7, 2010.(11)Incorporated by reference to the Company's Form 10-Q/A (Commission File No. 001-33852) for the period ended June 30, 2010, filed with theSecurities and Exchange Commission on January 31, 2011. Pursuant to a request for confidential treatment, portions of Exhibit 10.19 have beenredacted and have been provided separately to the U.S. Securities and Exchange Commission, and a revised redacted copy was re-filed with the Form10-Q/A for the period ended June 30, 2010. -65-EXHIBIT 21.1 Subsidiaries of Registrant Name of EntityJurisdiction ofIncorporation orOrganization Network Research Corporation Japan Ltd.Japan (known as Network Research Corporation Japan Kabushiki Kaisha in Japan) VirnetX Inc.Delaware EXHIBIT 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (Nos. 333-149884, 333-153645 and 333-162145) andForm S-8 (No. 333-149883) of VirnetX Holding Corporation of our report dated March 15, 2011 relating to the consolidated financial statements as ofDecember 31, 2010 and 2009 and for the years then ended (which report expresses an unqualified opinion), financial statement schedule and the effectivenessof internal control over financial reporting as of December 31, 2010 (which report expresses an adverse opinion), which appear in this Form 10-K. /s/ Farber Hass Hurley LLP Granada Hills, CA March 15, 2011 EXHIBIT 31.1 CERTIFICATIONS I, Kendall Larsen, certify that: 1. I have reviewed this Annual Report on Form 10-K of VirnetX Holding Corporation for the fiscal year ended December 31, 2010; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary tomake the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by thisreport; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all materialrespects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as definedin Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) forthe registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within thoseentities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's mostrecent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting,to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internalcontrol over financial reporting. /s/ Kendall Larsen Kendall Larsen President and Chief Executive Officer (Principal Executive Officer)Date: March 16, 2011 EXHIBIT 31.2 CERTIFICATIONS I, William E. Sliney, certify that: 1. I have reviewed this Annual Report on Form 10-K of VirnetX Holding Corporation for the fiscal year ended December 31, 2010; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary tomake the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by thisreport; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all materialrespects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as definedin Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) forthe registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within thoseentities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's mostrecent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting,to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internalcontrol over financial reporting. /s/ William E. Sliney William E. Sliney Chief Financial Officer (Principal Accounting and Financial Officer)Date: March 16, 2011 EXHIBIT 32.1 CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of VirnetX Holding Corporation (the "Company") on Form 10-K for the fiscal year ended December 31, 2010as filed with the Securities and Exchange Commission on March 16, 2011 (the "Report"), I, Kendall Larsen, President and Chief Executive Officer of theCompany, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of theCompany. /s/ Kendall Larsen Kendall Larsen President and Chief Executive Officer (Principal Executive Officer) Date: March 16, 2011 EXHIBIT 32.2 CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of VirnetX Holding Corporation (the "Company") on Form 10-K for the fiscal year ended December 31, 2010as filed with the Securities and Exchange Commission on March 16, 2011 (the "Report"), I, William E. Sliney, Chief Financial Officer of the Company,certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of theCompany. /s/ William E. Sliney William E. Sliney Chief Financial Officer (Principal Accounting and Financial Officer) Date: March 16, 2011 

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