VirnetX Holding Corp Annual Report 2012

Plain-text annual report

UNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549 FORM 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, 2012or oTRANSITION REPORT PURSUANT TO SECTION 13 Or 15(d) OF THE SECURITIES EXCHANGE ACT OF1934For 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) 308 Dorla Court, Suite 206 Zephyr Cove, Nevada 89448(Address of principal executive offices) (Zip Code)Registrant’s telephone number, including area code: 775-548-1785Former name, former address and former fiscal year, if changed since last report:Securities 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 ExchangeSecurities 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 x No o 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 x 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. o Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. 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 xAccelerated filer oNon-accelerated filer oSmaller reporting company o(Do not check if a smaller reporting company) Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes o No x The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 29, 2012, was$1,483,175,933 based upon the closing price of the common shares of the Registrant on June 29, 2012. This calculation does not reflect a determination thatcertain persons are affiliates of the Registrant for any other purpose. 51,151,075 shares of Registrant’s Common Stock were outstanding as of February 22, 2013. 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 not later than 120 days after December 31, 2012 in connection with the solicitation of proxies for the Registrant’s 2013Annual Meeting of Stockholders. INDEX Page PART I Item 1.Business4Item 1A.Risk Factors11Item 1B.Unresolved Staff Comments16Item 2.Properties16Item 3.Legal Proceedings16Item 4.Mine Safety Disclosure16 PART II Item 5.Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities17Item 6.Selected Financial Data18Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations19Item 7A.Quantitative and Qualitative Disclosures about Market Risk24Item 8.Financial Statements and Supplementary Data25Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure43Item 9A.Controls and Procedures43Item 9B.Other Information43 PART III Item 10.Directors, Executive Officers and Corporate Governance44Item 11.Executive Compensation44Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matter44Item 13.Certain Relationships and Related Transactions, and Director Independence44Item 14.Principal Accountant Fees and Services44 PART IV Item 15.Exhibits and Financial Statement Schedules45 2Index WARNING CONCERNING FORWARD LOOKING STATEMENTS THIS ANNUAL REPORT ON FORM 10-K CONTAINS STATEMENTS THAT CONSTITUTE FORWARD LOOKING STATEMENTS WITHINTHE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 AND OTHER FEDERAL SECURITIES LAWS. ALSO,WHENEVER WE USE WORDS SUCH AS "BELIEVE", "EXPECT", "ANTICIPATE", "INTEND", "PLAN", "ESTIMATE" OR SIMILAREXPRESSIONS, WE ARE MAKING FORWARD LOOKING STATEMENTS. THESE FORWARD LOOKING STATEMENTS ARE BASED UPONOUR PRESENT INTENT, BELIEFS OR EXPECTATIONS, BUT FORWARD LOOKING STATEMENTS ARE NOT GUARANTEED TO OCCURAND MAY NOT OCCUR. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTAINED IN OR IMPLIED BY OUR FORWARDLOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS. AMONG OTHERS, THE FORWARD LOOKING STATEMENTS WHICHAPPEAR IN THIS REPORT THAT MAY NOT OCCUR INCLUDE: ●THE DESCIPTION OF OUR BUSINESS INCLUDES A STATEMENT THAT WE INTEND TO MARKET OUR GABRIELCONNECTION TECHNOLOGY™. AN IMPLICATION OF THIS STATEMENT MAY BE THAT WE WILL BE ABLE TOSUCCESSFULLY MARKET THIS TECHNOLOGY AND THAT IT WILL GENERATE REVENUE IN THE FUTURE. IN FACT, THEREARE MANY FACTORS WHICH WILL IMPACT THE SUCCESS OF THIS TECHNOLOGY FOR US, INCLUDING SEVERAL FACTORSWHICH ARE BEYOND OUR CONTROL, SUCH AS THE DEMAND FOR THIS TECHNOLOGY BY POTENTIAL CUSTOMERS ANDTHE LEVEL OF COMPETITION IN OUR BUSINESS. ●THE DESCRIPTION OF OUR BUSINESS INCLUDES STATEMENTS RELATING TO OUR INTENT TO ESTABLISH A SECUREDOMAIN NAME REGISTRY IN THE U.S. AND OTHER PARTS OF THE WORLD AND THAT WE ARE CONSIDERING MAKINGAPPLICATIONS TO BECOME ACCREDITED TO DO SO UNDER AUTHORITY OF THE U.S. GOVERNMENT. THE IMPLICATIONOF THOSE STATEMENTS MAY BE THAT WE WILL BE ABLE TO ESTABLISH A REGISTRY THAT WILL HAVE MARKETACCEPTANCE AND THAT IT WILL GENERATE REVENUE FOR US IN THE FUTURE. THERE ARE MANY FACTORS WHICHWILL IMPACT OUR ABILITY TO SUCCESSFULLY ESTABLISH A DOMAIN NAME REGISTRY, INCLUDING SEVERAL FACTORSWHICH ARE BEYOND OUR CONTROL, SUCH AS THE ACCREDITATION APPLICATION PROCESS OR THE ACCEPTANCE OFOUR REGISTRY OVER OTHERS IN THE MARKET, PARTICULARLY IF WE DETERMINE TO ESTABLISH A REGISTRY WITHOUTACCREDITATION. ●THE STATEMENTS THAT WE HAVE SUBMITTED A LICENSING DECLARATION TO THE 3RD GENERATION PARTNERSHIP, OR3GPP, UPDATED SUCH DECLARATIONS AT THE REQUEST OF THE EUROPEAN TELECOMMUNICATIONS STANDARDSINSTITUTE, OR ETSI, AND THE ALLIANCE FOR TELECOMMUNICATIONS INDUSTRY SOLUTIONS, OR ATIS, AND THAT WEBELIEVE WE ARE POSITIONED TO LICENSE OUR PATENTS TO 3GPP MEMBERS DESIRING TO IMPLEMENT THE TECHNICALSPECIFICATIONS IDENTIFIED BY US, MAY IMPLY THAT THE PATENTS WE HAVE IDENTIFIED TO 3GPP WILL GENERATELICENSING REVENUE FOR US IN THE FUTURE. WE CANNOT ASSURE YOU THAT WE WILL BE SUCCESSFUL IN LICENSINGOUR PATENTS OR THAT THIRD PARTIES WILL BE WILLING TO ENTER INTO LICENSES WITH US ON REASONABLE TERMSOR AT ALL. ●OUR STATEMENT THAT WE BELIEVE WE HAVE THE FINANCIAL AND OTHER RESOURCES TO COMPLETE OUR BUSINESSPLAN MAY IMPLY THAT OUR RESOURCES WILL BE SUFFICIENT TO COMPLETE THAT PLAN SUCCESSFULLY. HOWEVER,WE MAY NOT BE ABLE TO SUCCESSFULLY IMPLEMENT OUR BUSINESS PLAN FOR MANY REASONS, INCLUDING MANYREASONS THAT ARE BEYOND OUR CONTROL, SUCH AS THE POSSIBILITY THAT OUR FINANCIAL RESOURCES BECOMEEXHAUSTED DUE TO INCREASED COSTS ASSOCIATED WITH OUR ATTEMPTS TO COMPETE WITH OTHERS WHO MAYHAVE GREATER RESOURCES, OR DUE TO OUR OTHER ACTIVITIES, INCLUDING OUR LITIGATION ACTIVITIES. ●STATEMENTS DESCRIBING OUR CONTINUED LITIGATION EFFORTS MAY IMPLY THAT WE WILL PREVAIL IN SOME OR ALLOF OUR LITIGATION. HOWEVER, WE CANNOT ASSURE YOU WE WILL PREVAIL IN OUR PENDING LITIGATION MATTERSAND ANY ADVERSE RULING MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS. ALSO, THE LEGAL AND OTHERCOSTS WE MAY INCUR IN CONNECTION WITH LITIGATION MATTERS WILL DEPEND, IN PART, UPON ACTIONS TAKEN BYOTHER PARTIES, WHICH ACTIONS ARE NOT WITHIN OUR CONTROL AND THESE COSTS MAY HAVE A MATERIAL ADVERSEEFFECT ON OUR BUSINESS. ●OUR REFERENCES TO THE FACTS THAT OUR CORE DEVELOPMENT TEAM HAS SPENT OVER TEN YEARS WORKINGTOGETHER, AND HAS HAD PRIOR SUCCESS AT SAIC MAY IMPLY THAT OUR TEAM WILL BE SUCCESSFUL IN THEFUTURE. HOWEVER, THIS TEAM MAY NOT BE SUCCESSFUL FOR MANY REASONS, INCLUDING MANY REASONS THATARE BEYOND OUR CONTROL, SUCH AS THE POSSIBILITY THAT ONE OR MORE KEY MEMBERS OF THE TEAM BECOMESINCAPACITATED, OR THAT COMPETITORS ARE SUCCESSFUL IN DEVELOPING SUPERIOR PRODUCTS. ●OUR STATEMENT WITH RESPECT TO OUR INTENT TO MARKET AND SELL LICENSE AND SERVICES TO OTHERS MAYIMPLY THAT OUR PLANS TO DO SO ARE IMMINENT OR WILL BE SUCCESSFUL. HOWEVER, MARKETING AND SELLING OURPRODUCT AND SERVICES WHILE SIMULTANEOUSLY PURSUING OUR LITIGATION AND OUR FURTHER DEVELOPMENTACTIVITIES CAN PRESENT SIGNIFICANT CHALLENGES. OUR MARKETING AND SALES PLANS MAY TAKE LONGER TOIMPLEMENT THAN WE NOW EXPECT, MAY NOT BE IMPLEMENTED, OR MAY FAIL.THESE AND OTHER UNEXPECTED RESULTS MAY BE CAUSED BY VARIOUS FACTORS, SOME OF WHICH ARE BEYOND OURCONTROL, INCLUDING: ●THE IMPACT OF CHANGES IN THE US AND GLOBAL ECONOMIES IN GENERAL AND THE CAPITAL MARKETS ON US ANDOUR INTENDED CUSTOMERS; ●COMPLIANCE WITH, AND CHANGES TO, U.S. FEDERAL, STATE AND LOCAL LAWS AND REGULATIONS, FOREIGN LAWSAND REGULATIONS, ACCOUNTING RULES, TAX RATES AND SIMILAR MATTERS; AND ●COMPETITION WITHIN OUR INDUSTRY. WE HAVE GENERATED NET INCOME IN ONLY ONE ANNUAL REPORTING PERIOD SINCE WE BECAME PUBLICLY OWNED. ALTHOUGHOUR PLANS ARE INTENDED TO GENERATE NET INCOME, THERE CAN BE NO ASSURANCE THAT THESE PLANS WILL SUCCEED. RESULTS THAT DIFFER FROM THOSE STATED OR IMPLIED BY OUR FORWARD LOOKING STATEMENTS MAY ALSO BE CAUSED BYVARIOUS CHANGES IN OUR BUSINESS OR MARKET CONDITIONS AS DESCRIBED MORE FULLY UNDER "PART I. ITEM 1A. RISKFACTORS" AND ELSEWHERE IN THIS REPORT. YOU SHOULD NOT PLACE UNDUE RELIANCE UPON FORWARD LOOKING STATEMENTS. EXCEPT AS REQUIRED BY LAW, WE UNDERTAKE NO OBLIGATION TO UPDATE OR REVISE ANY FORWARD LOOKINGSTATEMENT AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. 3Index PART I Item 1. Business. The Company Our portfolio of intellectual property is the foundation of our business model. We currently own 20 patents in the United States and 32 foreign patents, as wellas several pending U.S. and foreign patent applications. Our patent portfolio is primarily focused on securing real-time communications over the Internet, aswell as related services such as the establishment and maintenance of a secure domain name registry. Our patented methods also have additional applicationsin operating systems and network security. We have submitted a declaration with the 3rd Generation Partnership Project, or 3GPP, identifying a group of ourpatents and patent applications that we believe are or may become essential to certain developing specifications in the 3GPP LTE, SAE project. We have agreedto make available a non-exclusive patent license under fair, reasonable and non-discriminatory terms and conditions, with compensation, or FRAND, to 3GPPmembers desiring to implement the technical specifications identified by us. We believe that we are positioned to license our essential security patents to 3GPPmembers as they move into 4G. We have an ongoing Gabriel Licensing Program under which we offer licenses to our patent portfolio, technology and software, including our secure domainname registry service, to domain infrastructure providers, communication service providers as well as to system integrators. Our Gabriel ConnectionTechnologyTM License is offered to OEM customers who want to adopt the GABRIEL Connection Technology™ as their solution for establishing secureconnections using secure domain names within their products. We have developed GABRIEL Connection Technology™ Software Development Kit (SDK) toassist with rapid integration of these techniques into existing software implementations with minimal code changes and include object libraries, sample code,testing and quality assurance tools and the supporting documentation necessary for a customer to implement our technology. Customers who want to developtheir own implementation of the VirnetX patented techniques for supporting secure domain names, or other techniques that are covered by our patent portfoliofor establishing secure communication links, can purchase a patent license. The number of patents licensed, and therefore the cost of the patent license to thecustomer, will depend upon which of the patents are used in a particular product or service. These licenses will typically include an initial license fee, as wellas an ongoing royalty. We intend to license our patent portfolio, technology and software, including our secure domain name registry service, to domain infrastructure providers,communication service providers as well as to system integrators. We believe that the market opportunity for our software and technology solutions is largeand expanding as secure domain names are now an integral part of securing the next generation 4G/LTE wireless networks. We also believe that all 4G mobiledevices will require unique secure domain names and become part of a secure domain name registry. In connection with the settlement of our lawsuit against Microsoft Corporation in 2010, Microsoft became our first licensee. Pursuant to the Settlement andLicense Agreement between ourselves and Microsoft, Microsoft paid us $200 million, which has been recognized as gain on settlement and Microsoft wasgranted a worldwide, irrevocable, nonexclusive, non-sub licensable fully paid up license for our patents for Microsoft products. We have also signed PatentLicense Agreements with Aastra USA, Inc. Mitel Networks Corporation, NEC Corporation and NEC Corporation of America, Siemens EnterpriseCommunications GmbH & Co. KG, and Siemens Enterprise Communications Inc. to license certain of our US patents, for a one-time payment and anongoing royalty for all future sales through the expiration of the licensed patents with respect to certain current and future IP-encrypted products. We intend toseek further license of our technology, including our GABRIEL Connection Technology™ to enterprise customers, developers and original equipmentmanufacturers, or OEMs, of chips, servers, smart phones, tablets, e-Readers, laptops, net books and other devices, within the IP-telephony, mobility, fixed-mobile convergence and unified communications markets including 4G/LTE. We have published our royalty rates and guidelines on our website. All existinglicenses have adhered to these guidelines and have met or exceeded these rates and we will use these rates and guidelines in all future license negotiations. Our employees include the core development team behind our patent portfolio, technology and software. This team has worked together for over ten years andis the same team that invented and developed this technology while working at Science Application International Corporation, or SAIC. SAIC is a FORTUNE500® scientific, engineering and technology applications company that uses its deep domain knowledge to solve problems of vital importance to the nation andthe world, in national security, energy and the environment, critical infrastructure and health. The team has continued its research and development workstarted at SAIC and expanded the set of patents we acquired in 2006 from SAIC into a larger portfolio with 52 issued U.S. and foreign patents and numerouspending U.S. and foreign patents applications. This portfolio now serves as the foundation of our licensing business and planned service offerings and isexpected to generate the majority of our future revenue in license fees and royalties. We intend to continue our research and development efforts to furtherstrengthen and expand our patent portfolio. Please see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations –Operations – Research and Development Expenses for a description of our research and development expenses for the past three fiscal years. We intend to continue using an outsourced and leveraged model to maintain efficiency and manage costs as we grow our licensing business by offeringincentives to early licensing targets or asserting our rights for use of our patents. We also intend to expand our design pilot in participation with leading4G/LTE companies (domain infrastructure providers, chipset manufacturers, service providers and others) and build our secure domain name registry. 4Index Industry Overview We believe that the Internet is an evolving, rich and complex medium used by individuals and businesses to conduct commerce, share information and engagein real-time communications including email, text messaging, IM, and voice and video calls. We believe that users have grown accustomed to havingbroadband access wherever they go, and not just at home or in the office. Users can browse the Internet or send e-mails using their mobile broadband enablednotebooks, replace their fixed DSL modems with mobile broadband modems or other devices, and send and receive video or music using 3G phones. Webelieve that Long Term Evolution, or LTE, will further advance a transition from the cellular 3G services to an all internet packet, or "IP", based network thatcan provide mobile data access speeds closer to fixed DSL speeds and allow for more bandwidth intensive applications like interactive TV, mobile videoblogging, advanced games or professional services. Session initiation protocol, or SIP, was developed to enable the convergence of voice and data networks andtoday is the predominant industry standard for establishing multimedia communications over the Internet such as voice, video, instant messaging, presenceinformation and file transfer. SIP, XMPP and other real-time collaboration protocols use DNS lookup as the primary means of connecting Internet devices.However, because these protocols use "open architecture", we believe that they are inherently unsecure. We also believe that many enterprises have concluded that security provided to communication by way of an optional add-on solution is less secure thansecurity that can be provided by upgrading core information technology, or "IT", infrastructure (systems, networks, and management) with integratedsecurity. We believe that, because of the complexity of today's networks and the requirement to connect users from any location at any time on any device,enterprises are reevaluating numerous parts of their technology systems, including but not limited to software solutions for smartphones, routers and switcheswith integrated security, massive security appliances for data centers, cloud-based security services and security solutions for virtualized environments andpublic and private clouds. The portions of the IP-telephony, mobility, fixed-mobile convergence and unified communications markets that could benefit fromour software and technology solutions are forecasted by Infonetics and our internal estimates to grow from approximately $128 billion of worldwide revenuesin 2010 to approximately $226 billion by 2015, representing a compound annual growth rate, or CAGR, of approximately 12%. We believe that this growingtrend represents a significant opportunity for us to license our technology and software, and establish our secure domain name registry. We also believe that various enterprises have concluded that optional add-on solution, and enterprises everywhere are currently upgrading core ITinfrastructure (systems, networks, and management) to integrate security into everything. Because of the complexity of today’s networks, and the requirementto connect users from any location at any time on any device, enterprise IT is having to reevaluate everything from software solutions for smartphones torouters and switches with integrated security, massive security appliances for data centers, cloud-based security services, and security solutions forvirtualized environments and public and private clouds. 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 and our internal estimates to grow from approximately$128 billion of worldwide revenues in 2010 to approximately $226 billion by 2015, representing a compound annual growth rate, or CAGR, ofapproximately 12%. We believe that this growing trend represents a significant opportunity for VirnetX to license its technology and software, and establish itssecure domain name registry. IP Telephony – VoIP, Telepresence and Video Conferencing IP telephony includes technologies that use Internet Protocol’s packet-switched connections to exchange voice, fax, and other forms of information traditionallycarried over the dedicated circuit-switched connections of the public switched telephone network, or PSTN. The adoption of IP telephony has helpedbusinesses significantly lower network operating costs by using a common network for voice and data. As the workforce becomes increasingly dispersed,mobile features enabled by Internet protocol-based communications such as presence, unified messaging, peer-to-peer applications, find me/follow me, white-boarding and document sharing have become more commonplace. However, the development of the related security infrastructure has lagged behind, leavingnext-generation networks vulnerable to a multitude of threats including man-in-middle, eavesdropping, domain hijacking, distributed denial of service, orDDoS, spam over Internet telephony, or SPIT, and spam over instant messaging, or SPIM. These threats continue to highlight the need for securing next-generation networks. As the use of IP telephony systems extends beyond the boundaries of an organization’s private network, security is likely to become aneven bigger concern. Worldwide revenue from IP telephony products like IP-PBX including IP phones, service provider VoIP and IMS equipment, VoIPgateways, Enterprise Telepresence and Video Conferencing for businesses is forecasted by Infonetics and our internal estimates to grow from approximately$30 billion in 2010 to approximately $59 billion in 2015, representing a CAGR of approximately 15%. We believe our unique and patented solution providesthe robust security platform required for providing on-demand secure communication links between enterprises intending to communicate securely withoutmanually configuring the connections. We believe a standard security solution such as ours will further accelerate the adoption of IP telephony products in themarket and allow enterprises to take full advantage of these rich content applications and real-time communications over the Internet, thereby significantlyincreasing their return on investment. Unified Communications We believe that the need to enhance productivity is rapidly increasing demand for the management of and instant access to real-time information. We believethat mobile collaboration, instant Internet access and the ability to conduct business whether inside or outside of the office, are high priorities. We also believethat the ability to establish multiple secure simultaneous network connections and provide IP sessions with security and encryption will be critical towidespread deployment of next-generation networks. However, one possible shortcoming of this new communications environment is that the various modes ofcommunication operate independently from one another and do not integrate easily, if at all. We believe that the number of individual points of contact in theseenvironments will grow and that as a result, communication will become more sophisticated and increasingly vulnerable. An array of communication methodologies integrated into a single communications experience is often referred to as unified communications. We believe thatunified communications have higher utility and can increase productivity for users. The basic components of unified communications include: a directory forstoring addresses, various modes of communication with each user/contact (desk phone, mobile phone, 1M, etc.), message storage for all messages regardlessof communication method and secure presence of a user's status for each mode of communication (available, away, busy, etc.). Worldwide unifiedcommunications market generated approximately $462 million in revenue in 2010 and is forecasted to grow rapidly over the next few years generatingapproximately $1.04 billion in revenue in 2015, representing a CAGR of approximately 11%. We believe the growth in unified communication products maynot reach its full potential due to the lack of transparent and seamless security as users hesitate to place their presence information online for all to see and asorganizations block access due to the lack of credentials verified by a neutral third party. We believe that our solutions help address these concerns and shouldenable significant growth in the unified communications market. IP Mobility-LTE, Fixed-Mobile Convergence We believe that telecommunication markets are rapidly changing and presenting new challenges to the equipment and service providers, including but notlimited to increasing user demand for mobile, always-on connections with multiple devices. We also believe that traffic growth, video acceleration, cloudservices and a rapidly growing number of subscribers challenge currently available network architectures and that, because of this, service providers andcarriers will eventually use a single network for fixed and mobile communications, private/premium communications and Internet access, in spite of thedifficulties involved challenging their business models and forcing the consideration of new network architectures. We believe that LTE technology will deliverusers the benefits of faster data speeds and new services by creating a new radio access technology that's optimized for IP-based traffic and offers operators asimple upgrade path from 3G networks. Smartphones are multi-functional devices that handle a wide variety of business-critical applications and supportincreasingly complex functions including enhanced data processing, Internet access, e-mail access, calendars and scheduling, contact management and theability to view electronic documents. Users have continual access to these applications while on the move making them an increasingly essential business toolfor the mobile worker. These devices enable mobile workers to have similar functionality inside or outside the office thereby increasing employee efficiency.However, it is critical that this mobile environment have the same level of security as an enterprise's internal network. Fixed-mobile convergence is anenvironment where wired and wireless phones work together with Internet Protocol to deliver services (voice, video, data and combinations thereof) uniformlyacross multiple access networks, including, among others, WiMAX, WiFi cellular and fixed. Worldwide revenue from IP mobility products like smartphonesand mobile data cards, femtocell equipment, rich communication devices and services is expected to grow from approximately $98 billion in 2010 toapproximately $166 billion by 2015, representing a CAGR of approximately 11%. We believe in order to realize the full functionality of IP mobility, severalchallenges including security must be overcome. When users are mobile, connections and data need to cross multiple network boundaries, each of whichposes a security threat. Wireless networks may be threatened or compromised by rogue users who enter through (insecure wireless access points. We believethat providing authenticated access to the wireless networks and enterprise applications through the wireless domain are important requirements and representa significant market opportunity for our patented technology and secure domain names to provide users fully authenticated secure access on a "zero-click" or"single-click" basis. 5Index Our Solutions Our software and technology solutions, including our secure domain name registry, our patents and our GABRIEL Connection Technology™ are designed tosecure all types of real-time communications over the Internet. Our technology uses industry standard encryption methods with our patented DNS lookupmechanisms to create a secure communication link between users intending to communicate in real time over the Internet. Our technology can be built intonetwork infrastructure, operating systems or silicon chips developed for a communication or computing device to secure real-time communications over theInternet between numerous devices. Our technology automatically encrypts data allowing organizations and individuals to establish communities of secure,registered users and transmit information between multiple devices, networks and operating systems. These secure network communities, which we callsecure private domains, or SPDs, are designed to be fully-customizable and support rich content applications such as IM, VoIP, mobile services, streamingvideo, file transfer and remote desktop in a completely secure environment. Our approach is a unique and patented solution that we believe provides the robustsecurity platform required by these rich content applications and real-time communications over the Internet. We believe the key benefits and features of ourtechnology include the following: ●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 sharing andremote 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 to makeconnections between secure domain names, thereby obviating the need to provide application specific security. Competitive Strengths We 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 solutions combineindustry standard encryption methods and communication protocols with our patented techniques for automated DNS lookup mechanisms. Ourtechnology and patented approach enables users to create a secure communication link by generating secure domain names. We have a portfoliocomprised of twenty (20) patents in the United States and thirty two (32) foreign patents, as well as several pending U.S. and foreign patentapplications. Our portfolio includes patents and pending patent applications in the United States and other key markets that support our securedomain name registry service for the Internet. ●Scalable licensing business model. We are actively engaged in pursuing additional 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 network securityand encryption technology scientists and experts that have worked together as a team for over ten years. During their careers, this team has developedseveral cutting-edge technologies for U.S. national defense, intelligence and civilian agencies, many of which remain critical to our national securitytoday. Prior to joining VirnetX, our team worked for SAIC during which time they invented the technology that is the foundation of our technology,and software. Based on the collective knowledge and experience of our development team, we believe that we have one of the most experienced andsophisticated groups of security experts researching vulnerability and threats to real-time communication over the Internet and developing solutions tomitigate these problems. Our Strategy Our 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: ●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. We have submitted a declaration with the 3rd Generation Partnership Project, or 3GPP, identifying a group of our patents and patent applications that webelieve are or may become essential to certain developing specifications in the 3GPP LTE, SAE project. We have agreed to make available a non-exclusivepatent license under fair, reasonable and non-discriminatory terms and conditions, with compensation, or FRAND, to 3GPP members desiring to implementthe technical specifications identified by us. We have also submitted a number of updates to our original declaration, identifying additional technicalspecifications that would also require a license to our US and International patents. 6Index License and Service Offerings We 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 secure domainnames, or who want to use their own techniques that are covered by our patent portfolio for establishing secure communication links, will purchase atechnology license. We anticipate that these licenses would typically include an initial license fee, as well as an ongoing royalty. We expect that theselicenses will include a one-time delivery of Gabriel software development kit including object libraries, sample code, testing and quality assurancetools and the supporting documentation necessary for a customer to implement of the techniques we have developed. ●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 name connectiontest server, a relay test server and a registration test server. We expect that customers would pay an up-front license fee to purchase an SDK licenseand 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 to enablesuch customers to provision devices with secure domain names and facilitate secure connections between registered devices. This suite includes thefollowing server software modules: ●Registrar server software: We anticipate that our registrar server software would enable customers to operate as a secure domain name registrar thatprovisions devices with secure domain names. The registrar server software is designed to provide an interface for our customers to register newvirtual private domains and sub-domain names. This server module must be enrolled with the VirnetX secure domain name master registry to obtainits credentials before functioning as an authorized registrar. ●Connection server software: We anticipate that our connection server software would allow customers to provide connection services to enrolleddevices. The connection services include registration of presence information for authenticated users and devices, presence information query requestservices, enforcement of policies and support for communication with peers behind firewalls. ●Relay server software: We anticipate that our relay server software would allow customers to dynamically maintain connections and relay data toprivate IP addresses for network devices that reside behind firewalls. Secure domain name registrar service customers will enter into a technologylicensing and revenue sharing agreement with VirnetX whereby we will typically receive an up-front licensing fee for the secure domain name registrartechnology, 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 that we willmaintain and manage the secure domain name master registry. This service is expected to enroll all secure domain name registrar customers andgenerate the credentials required to function as an authorized registrar. It also is expected to provide connection services and universal nameresolution, 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 customization anddeployment 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. Customers In connection with the settlement of our lawsuit against Microsoft Corporation in 2010, Microsoft became our first licensee. Pursuant to the Settlement andLicense Agreement between us and Microsoft, Microsoft paid us $200 million, which has been recognized as gain on settlement and Microsoft was granted aworldwide, irrevocable, nonexclusive, non-sub licensable fully paid up license for our patents for Microsoft products. We have also signed Patent LicenseAgreements with Aastra USA, Inc. Mitel Networks Corporation, NEC Corporation and NEC Corporation of America, Siemens Enterprise CommunicationsGmbH & Co. KG, and Siemens Enterprise Communications Inc. to license certain of our US patents, for a one-time payment and an ongoing royalty for allfuture sales through the expiration of the licensed patents with respect to certain current and future IP-encrypted products.We intend to seek further license of our technology, including our GABRIEL Connection Technology™ to developers and original equipment manufacturers,or OEMs, of chips, servers, smart phones, tablets, e-Readers, laptops, net books and other devices, within the IP-telephony, mobility, fixed-mobileconvergence and unified communications markets including 4G/LTE. We have published our royalty rates and guidelines on our website. All forward movinglicenses have adhered to these guidelines and have met or exceeded these rates and we will use these rates and guidelines in all future license negotiations. 7Index Marketing and Sales We plan to employ a leveraged, partner-oriented, marketing strategy for our technology licenses and software offerings. We expect the marketing strategy willprimarily 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 our relationshipwith SAIC to extend our offering to departments and agencies within the federal government. SAIC is a FORTUNE 500® scientific, engineering andtechnology applications company that uses its deep domain knowledge to solve problems of vital importance to the nation and the world, in national security,energy and the environment, critical infrastructure, and health. We intend to build a sales force that will be responsible for managing accounts and pursuingtechnology licensing and sales opportunities with new customers. Competition We believe our technology and solutions will compete primarily against various proprietary security solutions. We group these solutions into three maincategories: ●Proprietary or home-grown application specific security solutions have been developed by vendors and integrated directly into their products for ourtarget markets including IP-telephony, mobility, fixed-mobile convergence, and unified communications. These proprietary solutions have beendeveloped due to the lack of standardized approaches to securing real-time communications. This approach has led to corporate networks that areisolated and, as a result, restrict enterprises to using these next-generation networks within the boundaries of their private network. These solutionsgenerally do not provide security for communications over the Internet or require network administrators to manually exchange keys and othersecurity parameters with each destination network outside their corporate network boundary. The cost-savings and other benefits of IP-based real-time communications are significantly limited by this approach to securing real-time communications. ●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 created byfirewalls and other NAT devices and enable VoIP calls to be established successfully. However, SBCs must decrypt and analyze every single datapacket for the information to be transmitted successfully, thereby preventing end-to-end encryption. This network design results in SBCs becominga single point of congestion on the network, as well as a single point of failure. SBCs are also limited to the physical network they secure. ●SIP firewalls, or SIP-aware firewalls, and application layer gateways, manage and protect the traffic, flow and quality of VoIP and other SIP-relatedcommunications. They perform real-time network address translation, dynamic firewall functions; support multiple signaling protocols, and mediafunctionality, allowing secure interconnection and the flow of IP media streams across multiple networks. While SIP firewalls assist in analyzingSIP traffic transmitted over the corporate network to filter out various threats, they do not necessarily encrypt the traffic. As a result, this traffic isnot entirely secure from end-to-end nor is it protected against threats like man-in-middle and eavesdropping. Intellectual Property and Patent Rights Our intellectual property is primarily comprised of trade secrets, patented know-how, issued and pending patents, copyrights and technological innovation. We have a portfolio comprised of twenty (20) patents in the United States and thirty two (32) 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. 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 Trademark Office atwww.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 NumberLink to Patent 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) request7,921,211 Agile network protocol for secure communications using secure domain names7,933,990 Agile network protocol for secure communications with assured system availability7,945,654 Agile network protocol for secure communications using secure domain names7,944,915 Third party VPN certification7,897,274 Method for establishing secure communication link between computers of virtual private network7,986,688 Third party VPN certification7,996,539 Agile network protocol for secure communications with assured system availability8,051,181 Method for establishing secure communication link between computers of virtual private network Notwithstanding anything to the contrary set forth in any of our filings under the Securities Act of 1933 or the Securities Exchange Act of 1934 thatmight incorporate future filings, the information set forth on the United States Patent and Trademark Office, or the USPTO Website, shall not bedeemed to be a part of or incorporated by reference into any such filings. The Company does not warrant the accuracy, or completeness or adequacyof the USPTO Website, and expressly disclaims liability for errors or omissions on such website. 8Index Assignment of Patents Some of our issued patents and pending patent applications were acquired by our principal operating subsidiary, VirnetX, Inc., from Science ApplicationsInternational Corporation, or SAIC, pursuant to an Assignment Agreement dated December 21, 2006, and a Patent License and Assignment Agreement datedAugust 12, 2005, as amended on November 2, 2006, including documents prepared pursuant to the November amendment, and as further amended onMarch 12, 2008. We recorded the assignment from SAIC with the U.S. Patent Office on December 21, 2006. Key terms of these agreements are as follows: Patent Assignment. SAIC unconditionally and irrevocably conveyed, transferred, assigned and quitclaimed all its right, title and interest in and to thepatents and patent applications, as specifically set forth on Exhibit A to the assignment document recorded with the U.S. Patent Office, including, withoutlimitation, the right to sue for past infringement. License to SAIC Outside the Field of Use. On November 2, 2006, we granted to SAIC an exclusive, royalty free, fully paid, perpetual, worldwide,irrevocable, sub licensable and transferable right and license permitting SAIC and its assignees to make, have made, import, use, offer for sale, and sellproducts and services covered by, and to make improvements to, the patents and patent applications we acquired from SAIC, solely outside our field of use.We have, and retain, all right, title and interest to all our patents within our field of use. On March 12, 2008, SAIC relinquished the November 2, 2006,exclusive right and license outside our field of use referred to above, as well as any right to obtain such exclusive license in the future. Effective March 12,2008, we granted to SAIC a non-exclusive, royalty free, fully paid, perpetual, worldwide, irrevocable, sub licensable and transferable right and licensepermitting SAIC and its assignees to make, have made, import, use, offer for sale, and sell products and services covered by, and to make improvements to,the patents and patent applications we acquired from SAIC, solely outside our field of use. Compensation Obligations. As consideration for the assignment of the patents and for the rights we obtained from SAIC as amended, we are required tomake payments to SAIC based on cash or certain other values generated from those patents. The amount of such payments depends upon the type of valuegenerated, and certain categories are subject to maximums and other limitations. As of June 30, 2010, we met our maximum royalty payment requirement;however, SAIC is also entitled under certain circumstances to receive a portion of the proceeds paid to us for certain acquisitions of VirnetX, from thesettlement of certain patent infringement claims of ours. Government Regulation The 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 may cover,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. 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, thePresident of the United States directed the U.S. Secretary of Commerce to privatize the management of the domain name system in a manner that increasescompetition and facilitates international participation in its management. On September 29, 2006, the U.S. Department of Commerce extended its delegation of authority by entering into a new agreement with the Internet Corporationfor Assigned Names and Numbers, or ICANN, a California non-profit corporation headquartered in Marina Del Rey, California. ICANN is responsible formanaging the accreditation of registry providers and registrars that manage the assignment of top level domain names associated with the authoritative DNSroot directory. Although it is possible to create and manage other DNS root directories privately without accreditation from ICANN, the possibility ofconflicting name and number assignments makes it less likely that users would widely adopt a top level domain name associated with an alternative DNS rootdirectory 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 generic top-leveldomain (gTLD), or create our own alternative DNS root directory to manage the assignment of non-standard secure domain names. We have not yet begundiscussions with ICANN and we cannot assure you that we will be successful in obtaining ICANN accreditation for our registry service on terms acceptableto us or at all. Whether or not we obtain accreditation from ICANN, we will be subject to the ongoing risks arising out of the delegation of the U.S.government’s responsibilities for the domain name system to the U.S. Department of Commerce and ICANN and the evolving government regulatoryenvironment with respect to domain name registry services. Employees As of December 31, 2012, we had 14 full-time employees.Corporate Overview and History VirnetX, Inc., was incorporated in the State of Delaware in August 2005. In November 2006, VirnetX acquired certain patents from SAIC. In July 2007, weeffected a reverse merger between PASW, Inc. and VirnetX, which became our principal operating subsidiary. As a result of this merger, the former securityholders of VirnetX came to own a majority of our outstanding common stock. On October 29, 2007, we changed our name from PASW, Inc. to VirnetXHolding Corporation. 9Index Available Information We file or furnish various reports, such as registration statements, periodic and current reports, proxy statements and other materials with the SEC. OurInternet 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, quarterlyreports 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 the ExchangeAct, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information we post is intended forreference 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 Reference Room at100 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. 10Index Item 1A. Risk Factors. We face a variety of risks that may affect our business, financial condition, operating results, the trading price of our common stock, or anycombination thereof. You should carefully consider the following information and the other information in this Form 10-K in evaluating our businessand prospects and before making an investment decision with respect to our common stock. If any of these risks were to occur, our business, financialcondition, results of operations or prospects could be materially and adversely affected. In such an event, the market price of our common stock coulddecline, and you could lose all or part of your investment. The risks and uncertainties we describe below are not the only ones facing us. Additionalrisks not presently known to us or that we currently deem immaterial may also affect our business. We may not be able to capitalize on market opportunities related to our licensing strategy or our patent portfolio. Our business strategy includes licensing our patents and technology to other companies in order to reach a larger end-user base than we could reach throughdirect sales and marketing efforts; as such our business strategy and revenues will depend on intellectual property licensing fees and royalties for the majorityof our revenues. We currently derive nominal revenue from licensing activities and we cannot assure you that we will successfully capitalize on our marketopportunities or that our current business strategy will succeed. Factors that may affect our ability to execute our current business strategy including, but arenot limited to: ·Although we have to date entered into a limited number of settlement and license agreements, we may not be successful in entering into furtherlicensing relationships and existing settlement and license agreements may not generate the financial results we expect; ·Third parties may challenge the validity of our patents; ·The pendency of our various litigations may cause potential licensees not to do business with us; ·We expect that we will face intense competition new and established competitors who may have superior products and services or better marketing,financial or other capacities than we do; and ·It is possible that one or more of our potential customers or licensees develops or otherwise sources products or technologies similar to, competitivewith or superior to ours. If we are not able to adequately protect our patent rights, our business would be negatively impacted. We believe our patents are valid, enforceable and valuable. Notwithstanding this belief, third parties may make claims of infringement or invalidity claimswith respect to our patents and such claims could give rise to material cost for defense or settlement or both, jeopardize or substantially delay a successfuloutcome of litigation we are or may become involved in, divert resources away from our other activities, or otherwise materially and adversely affect ourbusiness. Similar challenges could also prevent us from obtaining additional patents in the future. Even if we are successful in enforcing our rights, ourpatents may not ultimately provide us with any competitive advantages and may be less valuable than we currently expect. These risks may be heightened incountries other than the United States, and may be negatively affected by the fact that legal standards in the United States and elsewhere for protection ofintellectual property rights in Internet-related businesses are uncertain and still evolving. In addition, there are a significant number of United States andforeign patents and patent applications in our areas of interest, and we expect that significant litigation in these areas will continue, and will add uncertainty tothe value of certain patents and other intellectual property rights in our areas of interest. If we are unable to protect our intellectual property rights or otherwiserealize value from them, our business would be negatively affected.Our litigation can be time-consuming, costly and we cannot anticipate the results. We spend a significant amount of our financial and management resources to pursue our current litigation matters. We believe that these litigation matters andothers that we may in the future determine to pursue could continue for years and continue to consume significant financial and management resources. Thecounterparties to our litigation are all large, well-financed companies with substantially greater resources than us. We cannot assure you that any of ourcurrent or future litigation matters will result in a favorable outcome for us. In addition, even if we obtain favorable interim rulings or verdicts in particularlitigation matters, they may not be predictive of the ultimate resolution of the dispute. Also, we cannot assure you that we will not be exposed to claims orsanctions against us which may be costly or impossible for us to defend. Unfavorable or adverse outcomes may result in losses, exhaustion of financialresources or other adverse effects which could encumber our ability to develop and commercialize products. We can provide no assurances that the licensing of our essential security patents under FRAND will be successful. At the request of the European Telecommunications Standards Institute (ETSI), and the Alliance for Telecommunications Industry Solutions (ATIS), weagreed to update our licensing declaration to ETSI and ATIS under their respective Intellectual Property Rights (IPR) policies. This was in response to ourStatement of Patent Holder identifying a group of our patents and patent applications that we believe are or may become essential to certain developingspecifications in the 3rd Generation Partnership Project (3GPP) Long Term Evolution (LTE), Systems Architecture Evolution (SAE) project. We will makeavailable a non-exclusive patent license under FRAND (fair, reasonable and non-discriminatory terms and conditions, with compensation) for the patentsidentified by VirnetX that are or become essential, to applicants desiring to implement the Technical Specifications identified by VirnetX, as set forth in theupdated licensing declaration under the ATIS and ETSI IPR policies. While we believe that our FRAND commitment positions us to license our essentialsecurity patents for the Technical Specifications identified by VirnetX, our licensing declarations under the ATIS and ETSI IPR policies may limit ourflexibility in determining royalties and license terms for certain of our patents. Consequently, we cannot assure you that the licensing of the essential securitypatents will be successful or that third parties will be willing to enter into licenses with VirnetX on reasonable terms or at all, which could have an adverseeffect on our business and harm our competitive position. Because our business is conducted or expected to be conducted in an environment that is subject to rapid change, we may be subjected to variousdevelopments in regulation, law and consumer preferences to which we may not be able to adapt successfully. The current regulatory environment for our products and services remains unclear. We can give no assurance that our planned product offerings will be incompliance with laws and regulations of local, state, United States federal or foreign authorities. Further, we can give no assurance that we will notunintentionally violate such laws or regulations or that such laws or regulations will not be modified, or that new laws or regulations will be enacted in thefuture which would cause us to be in violation of such laws or regulations. For example, Voice-over-Internet Protocol (or VoIP) services are not currently subjectto all of the same regulations that apply to traditional telephony, but it is possible that similar regulations may be applied to VoIP in the future and that thesecould result in substantial costs and adversely effect the marketability of our products and planned products related to VoIP. For further example, the use ofthe Internet and private Internet Protocol (IP) networks for communication is largely unregulated within the United States, but may become regulated in thefuture; also several foreign governments have enacted measures that could restrict or prohibit voice communications services over the Internet or private IPnetworks. 11Index Our business depends on the growth of instant messaging, VoIP, mobile services, streaming video, file transfer and remote desktop and other next-generationInternet-based applications which are relatively new. A decline in the use of these applications due to complexity or cost of these applications relative toalternate traditional or newly developed communications channels, or development of alternative technologies, could cause a material decline in the number ofusers in these areas. More aggressive domestic or international regulation of the Internet in general, and Internet telephony providers and services specifically, or a lack of growth inacceptance of the Internet as a long term viable marketplace for communications services, may materially and adversely affect our business, financialcondition, operating results and future prospects. Our exposure to outside influences beyond our control, including new legislation, court rulings or actions by the United States Patent andTrademark Office, could adversely affect our licensing and enforcement activities and results of operations. Our licensing and enforcement activities are subject to numerous risks from outside influences, including the following: •New legislation, regulations or rules related to obtaining patents or enforcing patents could significantly increase our operating costs and decrease ourrevenue. For instance, the U.S. Supreme Court has recently modified some tests used by the United States Patent and Trademark Office (USPTO)in granting patents during the past 20 years which may decrease the likelihood that we will be able to obtain patents and increase the likelihood ofchallenge of any patents we obtain or license. In addition, the U.S. recently enacted sweeping changes to the United States patent system under theLeahy-Smith America Invents Act (“AIA”), including changes that transition the United States from a “first-to-invent” system to a “first to file”system and alter the processes for challenging issued patents •More patent applications are filed each year resulting in longer delays in getting patents issued by the USPTO. •Federal courts are becoming more crowded, and as a result, patent enforcement litigation is taking longer. If we experience security breaches, we could be exposed to liability and our reputation and business could suffer. We expect to retain certain confidential customer information in our secure data centers and secure domain name registry. It will be critical to our 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 attacking security solutions could make some or all of our products obsolete or unmarketable. Likewise, if any of ourproducts are found to have significant security vulnerabilities, then we may need to dedicate engineering and other resources to eliminate the vulnerabilities andto repair or replace products already sold or licensed to our customers. Despite our security measures, our infrastructure may be vulnerable to physical break-ins, computer viruses, attacks by hackers or similar disruptive problems. It is possible that we may have to expend additional financial and other resourcesto address such problems. Any physical or electronic break-in or other security breach or compromise of the information stored at our secure data centers anddomain name registration systems may jeopardize the security of information stored on our premises or in the computer systems and networks of ourcustomers. In such an event, we could face significant liability and customers could be reluctant to use our services. Such an occurrence could also result inadverse publicity and therefore adversely affect the market’s perception of the security of electronic commerce and communications over IP networks as well asthe security or reliability of our services. A security breach could require a substantial amount of expense to rectify and could result in a product liability claim that causes us to incur substantialliability and related legal and other costs. A security breach may also harm our reputation and make it more difficult or impossible for us to successfullymarket to others. These matters could harm our operating results and financial condition. We expect that we will experience long and unpredictable sales cycles, which may impact our operating results. We expect that our sales cycles will be long and unpredictable due to a number of uncertainties such as: ·The need to educate potential customers about our patent rights and our product and service capabilities; ·Customers’ willingness to invest potentially substantial resources and modify their network infrastructures to take advantage of our products; ·Customers’ budgetary constraints; ·The timing of customers’ budget cycles; and ·Delays caused by customers’ internal review processes.Long sales cycles may increase the risk that our financial resources are exhausted before we are able to generate significant revenue. We expect that we will be substantially dependent on a concentrated number of customers. If we are unable to establish, maintain or replace ourrelationships with customers and develop a diversified customer base, our revenues may fluctuate and our growth may be limited. We expect that in the future, a significant portion of our revenues will be generated from a limited number of customers. Substantially all of our income during2010 was from the payments to us resulting from the Settlement and License Agreement we entered into with Microsoft. Nominal revenues from 2010 and 2011were derived from a single licensing agreement and 2012 revenues were derived from 3 settlement and license agreements entered into as we settled lawsuits weinitiated against customers for patent infringements. There can be no guarantee that we will be able to obtain additional customers, or if we do so, to sustainour revenue levels from these prospective customers. If we are not able to establish, maintain or replace the limited group of prospective customers that weanticipate may generate a substantial majority of our revenues in the future, or if they do not generate revenues at the levels or at the times that we anticipate,our ability to maintain or grow our revenues will be adversely affected. 12Index 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 may only bediscovered after a product has been installed and used by customers. Any errors or defects discovered in our products after commercial release could result infailure to achieve market acceptance, loss of revenue or delay in revenue recognition, loss of customers and increased service and warranty cost, any of whichcould adversely affect our business, operating results and financial condition. In addition, we could face claims for product liability, tort or breach ofwarranty, 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. Malfunctions of third-party communications infrastructure, hardware and software expose us to a variety of risks we cannot control. Our business will also depend upon the capacity, reliability and security of the infrastructure owned by third parties that we will use to deploy ourofferings. We have no control over the operation, quality or maintenance of a significant portion of that infrastructure or whether or not those third parties willupgrade or improve their equipment. We depend on these companies to maintain the operational integrity of our connections. If one or more of these companiesis unable or unwilling to supply or expand its levels of service to us in the future, our operations could be severely interrupted. Also, to the extent the numberof users of networks utilizing our future products suddenly increases, the technology platform and secure hosting services which will be required toaccommodate a higher volume of traffic may result in slower response times or service interruptions. System interruptions or increases in response time couldresult in a loss of potential or existing users and, if sustained or repeated, could reduce the appeal of the networks to users. In addition, users depend on real-time communications; outages caused by increased traffic could result in delays and system failures. These types of occurrences could cause users toperceive that our solution does not function properly and could therefore adversely affect our ability to attract and retain licensees, strategic partners andcustomers. System failure or interruption or our failure to meet increasing demands on our systems could harm our business. The success of our license and service offerings will depend on the uninterrupted operation of various systems, secure data centers and other computer andcommunication networks that we establish. To the extent the number of users of networks utilizing our future products suddenly increases, the technologyplatform and hosting services which will be required to accommodate a higher volume of traffic may result in slower response times, service interruptions ordelays or system failures. Our systems and operations will also be vulnerable to damage or interruption from: ·power loss, transmission cable cuts and other telecommunications failures; ·damage or interruption caused by fire, earthquake, and other natural disasters ·computer viruses or software defects; and ·physical or electronic break-ins, sabotage, intentional acts of vandalism, terrorist attacks and other events beyond our control. System interruptions or failures and increases or delays in response time could result in a loss of potential or existing users and, if sustained or repeated, couldreduce the appeal of the networks to users. These types of occurrences could cause users to perceive that our solution does not function properly and couldtherefore adversely affect our ability to attract and retain licensees, strategic partners and customers. Any significant problem with our systems or operations could result in lost revenue, customer dissatisfaction or lawsuits against us. A failure in the operationof our secure domain name registration system could result in the inability of one or more registrars to register and maintain secure domain names for a periodof time. A failure in the operation or update of the master directory that we plan to maintain could result in deletion or discontinuation of assigned securedomain names for a period of time. The inability of the registrar systems we establish, including our back office billing and collections infrastructure, andtelecommunications 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. Our ability to sell our solutions will be dependent on the quality of our technical support, and our failure to deliver high-quality technical supportservices could have a material adverse effect on our sales and results of operations. If we do not effectively assist our customers in deploying our products, succeed in helping our customers quickly resolve post-deployment issues and provideeffective ongoing support, or if potential customers perceive that we may not be able achieve to the foregoing, our ability to sell our products would beadversely 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. 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 interruptions inservice. As a result, certain local telephone carriers have petitioned governmental agencies to enforce regulatory tariffs on IP telephony traffic that crosses overtheir traditional telephone networks. If the relief sought in these petitions is granted, the costs of communicating via online could increase substantially,potentially adversely affecting the growth in the use of online secure communications. Any of these developments could have an adverse effect on ourbusiness. 13Index The departure of Kendall Larsen, our Chief Executive Officer and President, and/or other key personnel could compromise our ability to executeour 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 as engineers. Inability toattract and retain such personnel could adversely affect our business. Competition for engineering, sales, marketing and executive personnel is intense,particularly in the technology and Internet sectors and in the region in which our facility is located. We can provide no assurance that we will attract or retainsuch personnel. Our consolidated financial statements were restated in 2011 in connection with our identification of a material weakness in our internal controlover financial reporting; we may identify future material weakness which may result in late filings, increased costs or declines in our share price. In early 2011, we restated our previously filed financial statements for the fiscal quarter ended September 30, 2010, each of the then previous five fiscalquarters and the fiscal year ended December 31, 2009, to adjust our accounting for our Series I Warrants. In connection with these restatements, wedetermined that we had not maintained effective control over our accounting for these Series I Warrants and, as a result, that a material weakness existed withrespect to our reporting of complex, non-routine transactions as of the end of the periods covered by the Form 10-K and Form 10-Qs that included the financialstatements referenced above. Although we believe that we currently maintain effective control over our disclosure controls and procedures and internal controlover financial reporting as regards this issue, we may in the future identify deficiencies regarding the design and effectiveness of our system of internal controlover financial reporting. If we experience any material weaknesses in our internal control over financial reporting the future or are unable to provideunqualified management or attestation reports about our internal controls, we may be unable to meet financial and other reporting deadlines and may incurcosts associated with remediation, and any of which could cause our share price to decline.We do not currently pay dividends on our common stock and thus stockholders must look to appreciation of our common stock to realize a gainon 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 currently pay regular dividends onour common stock and instead retain future earnings to fund our business plan. Our future dividend policy is within the discretion of our Board of Directorsand will depend upon various factors, including our business, financial condition, results of operations, capital requirements, and investmentopportunities. We therefore can’t assure you that our Board of Directors will determine to pay regular or special dividends in the future. Accordingly, unlessour Board of Directors determines to pay dividends, stockholders will be required to look to appreciation of our common stock to realize a gain on theirinvestment. This appreciation may not occur. The exercise of our outstanding stock options would result in a dilution of our current stockholders' voting power and an increase in the numberof shares eligible for future resale in the public market which may negatively impact the market price of our stock. The exercise of our outstanding vested stock options would dilute the ownership interests of our existing stockholders. As of December 31, 2012, we hadoutstanding options and restricted stock units to purchase an aggregate of 4,927,889 shares of common stock (representing 9.57% of our total sharesoutstanding as of December 31, 2012) of which 4,033,124 are vested and therefore exercisable. To the extent outstanding stock options are exercised, additionalshares of common stock will be issued, and such issuance would dilute non-exercising stockholders' percentage voting interests and increase the number ofshares eligible for resale in the public market. The fair value of accounting for our Series I Warrants as derivative liabilities may materially impact our results of our operations in futureperiods. We record the Series I Warrants as a derivative liability in accordance with ASC 815-40, “Derivatives and Hedging – Contracts in Entity’s OwnEquity.” These derivative liabilities are reported at fair value each reporting period with changes in the fair value recognized as gain or loss during eachreporting period. An increase in our share price or measure of our share price volatility, for example, will generally result in an increase in the fair value of ourwarrant liability and a non-cash charge during the period of such increase, which could materially and negatively impact our results of operations in futureperiods. Trading in our common shares is limited and the price of our common shares 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 market price of ourcommon stock has experienced significant fluctuations. Between January 1, 2012, and December 31, 2012, the reported last sale price for our common stockranged between $20.27 and $40.47 per share. The price of our common stock may continue to be volatile as a result of a number of factors, some of whichare beyond our control. These factors include, but not limited to, the following: ●developments in any then-outstanding litigation; ●quarterly variations in our operating results; ●large purchases or sales of common stock or derivatives transactions related to our 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. 14Index The market price of our common stock may decline because our operating results may not be consistent and may be difficult to predict. Our reported net income has fluctuated in the past due to several factors. We expect that our future operating results may also fluctuate due to the same orsimilar factors. We had net income of $41.4 million for the year ended December 31, 2010, a net loss of $17.3 million for the year ended December 31, 2011,and a net loss $26.9 million for the year ended December 31, 2012 with an accumulated deficit of $62.9 million. The following include some of the factorsthat may cause our operating results to fluctuate: ·the outcome of actions to enforce our intellectual property rights currently in progress or that we may undertake in the future, and the timing thereof; ·the amount and timing of receipt of license fees from potential infringers, licensees or customers; ·the rate of adoption of our patented technologies; ·the number of new license arrangements we may execute, or that may expire, within a particular period and the scope of those licenses, including thenumber of our patents which are licensed, the extent of prior infringement of our patent rights, royalty rates, timing of payment obligations,expiration date etc; ·the success of a licensee in selling products that use our patented technologies; and ·the amount and timing of expenses related to our patent filings and enforcement proceedings, including litigation, related to our intellectual propertyrights. These fluctuations may make our business particularly difficult to manage, adversely affect our business and operating results, make our operating resultsdifficult for investors to predict and, further, cause our results to fall below investor’s expectations and adversely affect the market price of our commonstock. Because ownership of our common stock is concentrated, investors may have limited influence on stockholder decisions. As of December 31, 2012, our executive officers and directors beneficially owned approximately 20% of our then outstanding common stock. In addition, agroup of stockholders that, as of December 31, 2007, held 4,766,666 shares, or approximately 12%, of our then outstanding common stock, have enteredinto a voting agreement with us that requires them to vote all of their shares of our voting stock in favor of the director nominees approved by our Board ofDirectors at each director election going forward, and in a manner that is proportional to the votes cast by all other voting shares as to any other matterssubmitted 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. Our protective provisions could make it difficult for a third party to successfully acquire us even if you would like to sell your stock to them. We have a number of protective provisions that could delay, discourage or prevent a third party from acquiring control of us without the approval of ourBoard of Directors. Our protective provisions include: ●A staggered Board of Directors: This means that only one or two directors (since we have a five-person Board of Directors) will be up for electionat any given annual meeting. This has the effect of delaying the ability of stockholders to effect a change in control of us because it would take twoannual meetings to effectively replace a majority of the Board of Directors. ●Blank check preferred stock: Our Board of Directors has the authority to establish the rights, preferences and privileges of our 10,000,000authorized, but unissued, shares of preferred stock. Therefore, this stock may be issued at the discretion of our Board of Directors with preferencesover your shares of our common stock in a manner that is materially dilutive to you. In addition, blank check preferred stock can be used to create a“poison pill” which is designed to deter a hostile bidder from buying a controlling interest in our stock without the approval of our Board ofDirectors. We have not adopted such a “poison pill;” but our Board of Directors has the ability to do so in the future, very rapidly and withoutstockholder 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 date windows andin very specific form in order to have the matter voted on at a stockholder meeting. This has the effect of giving our Board of Directors andmanagement more time to react to stockholder proposals generally and could also have the effect of disregarding a stockholder proposal or deferring itto 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, this provision alsogives our Board of Directors and management more time to react to proposed stockholder actions. ●Super majority requirement for stockholder amendments to the By-laws: Stockholder proposals to alter or amend our By-laws or to adopt newBy-laws can only be approved by the affirmative vote of at least 66 2/3% of the outstanding shares of our common stock. ●No ability of stockholders to call a special meeting of the stockholders: Only the Board of Directors or management can call special meetings ofthe stockholders. This could mean that stockholders, even those who represent a significant percentage of our shares of common stock, may need towait for the annual meeting before nominating directors or raising other business proposals to be voted on by the stockholders. 15Index In addition, the provisions of Section 203 of the Delaware General Corporate Law govern us. These provisions may prohibit large stockholders, in particularthose owning 15% or more of our outstanding voting stock, from merging or combining with us for a certain period of time. These and other provisions in our amended and restated certificate of incorporation, our By-laws and under Delaware law could discourage potential takeoverattempts, reduce the price that investors might be willing to pay for shares of our common stock in the future and result in the market price being lower than itwould be without these provisions. Item 1B. Unresolved Staff Comments. None Item 2. Properties. Our principal executive offices are located at 308 Dorla Court, Suite 206, Zephyr Cove, Nevada 89448. We lease this property, which comprisesapproximately 2,090 square feet of office space, from a third party for a term that ends in 2013. We have no other properties and believe that our office facilityis suitable and appropriately supports our current business needs. Until October 2011, our principal executive offices were located at 5615 Scotts ValleyDrive, Suite 110, Scotts Valley, California 95066, which we leased for a term that was scheduled to end in 2012. In connection with the move of ourcorporate offices to Nevada, we terminated the Scotts Valley lease effective October 2011. Item 3. Legal Proceedings. We have four intellectual property infringement lawsuits pending against multiple parties in the United States District Court for the Eastern District of Texas,Tyler Division, pursuant to which we allege that these parties infringe on certain of our patents. We seek damages and injunctive relief in all the complaints.We have one complaint with the United States International Trade Commission (ITC) alleging that Apple, Inc. has engaged in unfair trade practices by theimportation, sale for importation, and sale after importation of certain devices with secure communication capabilities that infringe one or more claims of ourU.S. Patent No. 8,051,181. On February 27, 2013, we announced our intent to withdraw our complaint with the ITC and pursue comprehensive relief fromApple Inc.’s infringement through the district courts.VirnetX Inc. v. Cisco Systems, Inc. et alOn August 11, 2010, we initiated a lawsuit by filing a complaint against Aastra, Apple, Cisco, and NEC in the United States District Court for the EasternDistrict of Texas, Tyler Division, pursuant to which we allege that these parties infringe on certain of our patents. We seek damages and injunctive relief. OnFebruary 4, 2011, we amended our original complaint, filed on August 11, 2010, against Aastra, Apple, Cisco and NEC in the United States District Courtfor the Eastern District of Texas, Tyler Division, to assert U.S. Patent No. 7,418,504 against Apple and Aastra. On April 5, 2011, we again amended ourcomplaint against Aastra, Apple, Cisco and NEC in the United States District Court for the Eastern District of Texas, Tyler Division, to include Apple’s iPad2 in the list of Apple products that are accused of infringing our patents. We also asserted our newly-issued patent, U.S. Patent No. 7,921,211 against all ofthe defendants in that lawsuit. A claim construction hearing was held on January 5, 2012 and the court issued a Markman ruling on April 25, 2012. Aastraand NEC have signed license agreements with us and we have dismissed the patent infringement cases against them. At the pre-trial hearing, the judge decidedto postpone the trial against Cisco to March 4, 2013 and just try the case against Apple. On November 6, 2012, a Jury in the United States Court for theEastern District of Texas, Tyler Division, awarded us over $368,000,000 in a verdict against Apple Corporation for infringing four of our patents. A post-trialhearing in the case against Apple was held on December 20, 2012. On February 26, 2013, the United States District Court for the Eastern District of Texas,Tyler Division issued its Memorandum Opinion and Order regarding post-trial motions resulting from the prior jury verdict. The Court denied Apple’s motionto reduce the damages awarded by the jury for past infringement. The Court further denied Apple’s request for a new trial on the liability and damages portionsof the verdict. Additionally, the Court granted our motions for pre-judgment interest, post-judgment interest, and post-verdict damages to date. Specifically, theCourt ordered that Apple pay $33,561 in daily interest up to final judgment and $330,201 in daily damages for infringement up to final judgment for certainApple devices included in the verdict. The Court denied our request for a permanent injunction. In doing so, the Court ordered the parties to mediate over alicense in the following 45 days for Apple’s future infringing use not covered by the Court’s Order. If the parties fail to agree to a license, the Court requestedthat we file the appropriate motion with the Court. The preparations for the jury trial against Cisco on March 4, 2013 are underway.VirnetX Inc. v. Mitel Networks Corporation et alOn January 12, 2011, we initiated a lawsuit by filing a complaint against Siemens and Mitel in the United States District Court for the Eastern District ofTexas, Tyler Division, pursuant to which we allege that these companies infringe three of our patents. We seek damages and injunctive relief. On April 12,2011 we again amended our complaint against Siemens and Mitel in the United States District Court for the Eastern District of Texas, Tyler Division, to addAvaya Inc. as a defendant. On July 11, 2012, Mitel Network Corporation signed a license agreement with us and we dismissed the patent infringement caseagainst them. On July 12, 2012 we had a claims construction hearing in this case and a markman order was issued on August 1, 2012. On January 29, 2013Siemens signed a license agreement with us and we dismissed the patent infringement case against them. The preparations for the jury trial against Avaya onMarch 4, 2013 are underway. VirnetX Inc. v. Apple, IncOn November 1, 2011, we initiated a lawsuit against Apple in the United States District Court, Tyler Division, pursuant to which we allege that Appleinfringes one or more claims of our U.S. Patent No. 8,051,181. We seek damages and injunctive relief. No hearing or trial dates have been set. VirnetX Inc. v. Apple, Inc.On November 6, 2012, we filed a new complaint against Apple Inc., in the United States District Court for the Eastern District of Texas, Tyler Division forwillfully infringing four of our patents, U.S. Patent Nos. 6,502,135, 7,418,504, 7,921,211 and 7,490,151, and seeking both damages and injunctiverelief. The accused products include the iPhone 5, iPod Touch 5th Generation, iPad 4th Generation, iPad mini, and the latest Macintosh computers. Due totheir release dates, these products were not included in the previous lawsuit that concluded with a Jury verdict on November 6, 2012 that was subsequentlyupheld by the United States District Court for the Eastern District of Texas, Tyler Division, on February 26, 2013. ITC Investigation No. 337-TA-858On July 18, 2012, the Administrative Law Judge (ALJ) assigned to investigate our complaint against Apple Inc., identified a procedural discrepancy with ourcomplaint and dismissed it. On September 14, 2012, we re-filed our complaint with the ITC jointly with Science Applications International Corporation(SAIC) [NYSE: SAI] to remove a procedural standing issue that was identified as the reason for dismissal of our previous complaint. On October 16, 2012,the United States International Trade Commission (ITC) accepted our complaint and instituted an investigation against Apple and assigned ALJ E. JamesGildea to preside over this investigation. Subsequently on October 23, 2012, ALJ Gildea issued an order setting up February 21, 2014 as the target date forcompletion of this investigation. The hearing in-front of ALJ Gildea is scheduled for May 20, 2013. On February 27, 2013, we announced our intent towithdraw our complaint with the ITC and pursue comprehensive relief from Apple Inc.’s infringement through the district courts. One or more potential intellectual property infringement claims may also be available to us against certain other companies who have the resources to defendagainst any such claims. Although we believe these potential claims are worth pursuing, commencing a lawsuit can be expensive and time-consuming, andthere is no assurance that we will prevail on such potential claims. In addition, bringing a lawsuit may lead to potential counterclaims which may precludeour ability to commercialize our initial products, which are currently in development. Currently, we are not a party to any other pending legal proceedings, and are not aware of any proceeding threatened or contemplated against us by anygovernmental authority or other party. Item 4. Mine Safety Disclosure. Not applicable 16Index PART II Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Market Information Our common stock currently trades under the symbol “VHC” on the NYSE Amex Stock Exchange. The following table shows the price range of our common stock, as reported on the NYSE Amex Stock Exchange, for each quarter ended during the last twofiscal years. Quarter Ended High Low 3/31/11 $21.75 $11.43 6/30/11 $30.50 $19.66 9/30/11 $41.77 $14.81 12/31/11 $29.45 $11.02 3/31/12 $27.97 $19.13 6/30/12 $36.25 $21.71 9/30/12 $41.93 $21.25 12/31/12 $37.65 $23.41 The closing price of our common stock on the NYSE Amex Stock Exchange on February 22, 2013 was $35.42 per share. Holders As of February 22, 2013, we had 53 stockholders of record. Because many of our shares of common stock are held of record by brokers and otherinstitutions on behalf of stockholders, we are unable to estimate the total number of beneficial stockholders represented by such record holders. Dividends 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 to holders ofrecord on July 1, 2010. We currently intend to retain all available funds and any future earnings to support the operation of and to finance the growth anddevelopment of our business. We do not anticipate paying any cash dividends in the foreseeable future. Any future determination to declare cash dividendswill be made at the discretion of our board of directors and will depend on our financial condition, operating results, capital requirements, general businessconditions and other factors that our board of directors may deem relevant. Performance Graph This performance graph shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the ExchangeAct), or incorporated by reference into any filing of VirnetX under the Securities Act of 1933, as amended, or the Exchange Act, except as shall beexpressly set forth by specific reference in such filing. The stock price performance reflected on this graph is not necessarily indicative of future stock price performance. See the disclosure in partI, Item 1A. “Risk Factors” 12/07 12/08 12/09 12/10 12/11 12/12 VirnetX Holding Corp 100.00 25.17 50.00 273.77 460.35 539.80 S&P 500 100.00 63.00 79.67 91.67 93.61 108.59 RDG Technology Composite 100.00 56.89 91.53 103.10 103.14 117.75 17Index Recent Sales of Unregistered Securities During the year ended December 31, 2012, the Company had no sales of unregistered securities and no repurchases of stock. Item 6. Selected Financial Data. The consolidated statement of operations data for the three years ended December 31, 2012, 2011 and 2010 and the balance sheet data at December 31, 2012and 2011, respectively, are derived from, and qualified by reference to, our audited financial statements included elsewhere in this Annual Report on Form 10-K. The consolidated statements of operations data for the for the two years ended December 31, 2009 and 2008 and the balance sheet data at December 31,2010, 2009 and 2008, respectively, are derived from our audited financial statements not included in this Annual Report on Form 10-K. The selected consolidated financial data below are not necessarily indicative of future performance and should be read in conjunction with Item 7,“Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes theretoincluded in Item 8 of this Annual Report on Form 10-K. For the year ended December 31, 2012 2011 2010 2009 2008 Consolidated Statement of Operations Data: Revenue $412 $20 $68 $26 $134 Gain on settlement --- --- 200,000 — — Other operating expenses (39,273) (17,396) (95,383) (13,114) (12,355)Income tax benefit (expense ) 12,535 5,480 (34,062) — — Net (loss) income (26,924) (17,263) 41,417 (12,524) (12,072)Earnings (loss) per share $(0.53) $(0.35) $0.91 $(0.33) $(0.35)Dividends declared per common share $0.00 $0.00 $0.50 $0.00 $0.00 Consolidated Balance Sheet Data: Cash and cash equivalents $19,661 $49,482 $34,635 $2,011 457 Investments available for sale 26,493 14,438 43,457 — — Total assets $61,313 $74,633 $81,694 $2,242 979 Long-term obligation — — --- 120 160 Stockholders’ equity (deficit) $53,944 $68,277 $59,453 $(8,708) $(894) 18Index Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Company Overview We develop software and technology solutions for securing real-time communications over the Internet. Our patented GABRIEL Connection Technology™combines industry standard encryption protocols with our patented techniques for automated domain name system, or DNS, lookup mechanisms, andenables users to create a secure communication link using secure domain names over wired or wireless (4G/LTE) networks. We are currently beta testing ourGABRIEL Connection Technology™ as part of our Secure Domain Name Initiative, or (SDNI), on various platforms including PCs, smart phones andtablets. We also intend to establish the exclusive secure domain name registry in the United States and other key markets around the world. Our portfolio of intellectual property is the foundation of our business model. We currently own 20 patents in the United States and 32 foreign patents, as wellas several pending U.S. and foreign patent applications. Our patent portfolio is primarily focused on securing real-time communications over the Internet, aswell as related services such as the establishment and maintenance of a secure domain name registry. Our patented methods also have additional applicationsin operating systems and network security. We have submitted a declaration with the 3rd Generation Partnership Project, or 3GPP, identifying a group of ourpatents and patent applications that we believe are or may become essential to certain developing specifications in the 3GPP LTE, SAE project. We have agreedto make available a non-exclusive patent license under fair, reasonable and non-discriminatory terms and conditions, with compensation, or FRAND, to 3GPPmembers desiring to implement the technical specifications identified by us. We believe that we are positioned to license our essential security patents to 3GPPmembers as they move into 4G. We intend to seek further license of our technology, including our GABRIEL Connection Technology™ to enterprise customers, developers and originalequipment manufacturers, or OEMs, of chips, servers, smart phones, tablets, e-Readers, laptops, net books and other devices, within the IP-telephony,mobility, fixed-mobile convergence and unified communications markets including 4G/LTE. We have published our royalty rates and guidelines on ourwebsite. All forward moving licenses have adhered to these guidelines and have met or exceeded these rates and we will use these rates and guidelines in allfuture license negotiations. We believe that the market opportunity for our software and technology solutions is large and expanding as secure domain namesare now an integral part of securing the next generation 4G/LTE wireless networks. We also believe that all 4G mobile devices will require unique secure domainnames and become part of a secure domain name registry. Our software and technology solutions provide the security platform required by next-generation Internet-based applications such as instant messaging, or IM,voice over Internet protocol, or VoIP, mobile services, streaming video, file transfer and remote desktop. Our technology generates secure connections on a“zero-click” or “single-click” basis, significantly simplifying the deployment of secure real-time communication solutions by eliminating the need for end-users to enter any encryption information. In connection with the settlement of our lawsuit against Microsoft Corporation in 2010, Microsoft became our first licensee. Pursuant to the Settlement andLicense Agreement between us and Microsoft, Microsoft paid us $200 million, which has been recognized as gain on settlement and Microsoft was granted aworldwide, irrevocable, nonexclusive, non-sub licensable fully paid up license for our patents for Microsoft products. We have also signed Patent LicenseAgreements with Aastra USA, Inc. Mitel Networks Corporation, NEC Corporation and NEC Corporation of America, Siemens Enterprise CommunicationsGmbH & Co. KG, and Siemens Enterprise Communications Inc. to license certain of our US patents, for a one-time payment and an ongoing royalty for allfuture sales through the expiration of the licensed patents with respect to certain current and future IP-encrypted products. Our employees include the core development team behind our patent portfolio, technology and software. This team has worked together for over ten years andis the same team that invented and developed this technology while working at Science Application International Corporation, or SAIC. SAIC is a FORTUNE500® scientific, engineering and technology applications company that uses its deep domain knowledge to solve problems of vital importance to the nation andthe world, in national security, energy and the environment, critical infrastructure and health. The team has continued its research and development workstarted at SAIC and expanded the set of patents we acquired in 2006 from SAIC into a larger portfolio with 52 issued U.S. and foreign patents and numerouspending U.S. and foreign patent applications. This portfolio now serves as the foundation of our licensing business and planned service offerings and isexpected to generate the majority of our future revenue in license fees and royalties. We intend to continue our research and development efforts to furtherstrengthen and expand our patent portfolio. Please see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations –Operations – Research and Development Expenses for a description of our research and development expenses for the past three fiscal years. We intend to continue using an outsourced and leveraged model to maintain efficiency and manage costs as we grow our licensing business by offeringincentives to early licensing targets or asserting our rights for use of our patents. We also intend to expand our design pilot in participation with leading4G/LTE companies (domain infrastructure providers, chipset manufacturers, service providers, and others) and build our secure domain name registry. 19Index Developments in the Year Ended December 31, 2012 Litigation We have four intellectual property infringement lawsuits pending against multiple parties in the United States District Court for the Eastern District of Texas,Tyler Division, pursuant to which we allege that these parties infringe on certain of our patents. We seek damages and injunctive relief in all the complaints.We have one complaint with the United States International Trade Commission (ITC) alleging that Apple, Inc. has engaged in unfair trade practices by theimportation, sale for importation, and sale after importation of certain devices with secure communication capabilities that infringe one or more claims of ourU.S. Patent No. 8,051,181. On January 5, 2012, a claim construction hearing was held in our case against Aastra, Apple, Cisco and NEC in the United States District Court for theEastern District of Texas, Tyler Division. On April 25, 2012 the United States District Court for the Eastern District of Texas, Tyler Division, issued itsMarkman Order on the claim terms that were in dispute in the Aastra, Apple, Cisco and NEC litigation and adopted certain interpretations that we believe arefavorable to us. On May 3, 2012, we entered into a License Agreement with Aastra USA, Inc. Under the terms of the Agreement, the parties agreed to dismiss the patentinfringement case between the parties and their affiliates before the U.S. District Court for the Eastern District of Texas. On July 11, 2012, we entered into a License Agreement with Mitel Network Corporation. Under the terms of the Agreement, the parties agreed to dismiss thepatent infringement case between the parties and their affiliates before the U.S. District Court for the Eastern District of Texas. On July 12, 2012, a claims construction hearing was held in our complaint against Siemens Enterprise Communications and Avaya Inc. in the United StatesDistrict Court for the Eastern District of Texas, Tyler Division. On August 1, 2012 the United States District Court for the Eastern District of Texas, TylerDivision, issued its Markman Order denying the request by the defendants to change the interpretation of some of the claim terms that were in dispute in thelitigation, leaving them unchanged from what was previously adopted by the court in the Markman ruling in its other ongoing infringement action againstCisco, Apple and NEC. At that time jury selection for the trial in connection with the Siemens and Avaya litigation was scheduled to start on November 5,2012. On July 18, 2012, the Administrative Law Judge assigned to investigate our complaint with the United States International Trade Commission (ITC) againstApple Inc., identified a procedural discrepancy with the complaint that would impact the scheduling of the investigation. We disagreed with this finding andon July 26, 2012 filed an appeal with the ITC in this regard. This appeal was denied on August 20, 2012. On August 2, 2012, we entered into a License Agreement with NEC Corporation and NEC Corporation of America. Under the terms of the Agreement, theparties agreed to dismiss the patent infringement case between the Parties and their affiliates before the U.S. District Court for the Eastern District of Texas. On September 14, 2012, we re-filed our complaint with the United States International Trade Commission (ITC) alleging that Apple Inc. has engaged in unfairtrade practices by the importation, sale for importation, and sale after importation of certain devices with secure communication capabilities that infringe oneor more claims of VirnetX’s U.S. Patent No. 8,051,181 (“the ‘181 patent”). The accused products include the latest iPhones, iPads, iPods, and Macintoshcomputers. The complaint was filed jointly with Science Applications International Corporation (SAIC) [NYSE: SAI] to remove a procedural standing issuethat was identified as the reason for dismissal of our previous complaint. On September 18, 2012, we announced that after a hearing at the United States District Court for the Eastern District of Texas, Tyler Division, requested byall the parties, the judge agreed to modify the trial schedule in our patent infringement suits against Apple, Cisco, Avaya and Siemens to allow for optimumuse of resources for trial preparation while giving parties additional time to try to reach an agreement. Per the updated schedule, jury selection in our complaintagainst Apple was to begin on October 29, 2012 followed by a jury trial on October 31, 2012. Remaining defendants including Cisco, Avaya and Siemens arenow scheduled for a jury selection on March 4, 2013. On October 16, 2012, the United States International Trade Commission (ITC) accepted our complaint and instituted an investigation against Apple andassigned Administrative Law Judge (ALJ) E. James Gildea to preside over this investigation. Subsequently on October 23, 2012, the ALJ issued an ordersetting February 21, 2014 as the Target date for completion of this investigation. The hearing in-front of the ALJ is scheduled for May 20, 2013.On November 6, 2012, a jury in the United States Court for the Eastern District of Texas, Tyler Division, awarded us over $368,000,000 in a verdict againstApple Corporation for infringing four of our patents. On November 6, 2012, we filed a new complaint against Apple Inc., in the United States District Court for the Eastern District of Texas, Tyler Division forwillfully infringing four of our patents, U.S. Patent Nos. 6,502,135, 7,418,504, 7,921,211 and 7,490,151, and seeking both damages and injunctiverelief. The accused products include the iPhone 5, iPod Touch 5th Generation, iPad 4th Generation, iPad mini, and the latest Macintosh computers. Due totheir release dates, these products were not included in the previous lawsuit that resulted in a jury verdict on November 6, 2012. On December 20, 2012, a post-trial motion hearing was held in the United States District Court for the Eastern District of Texas, Tyler Division with respectto the jury verdict against Apple Inc. During the hearing, a number of motions from both sides were heard by the judge. At the hearing the judge ordered AppleInc., to provide updated sales data for certain accused and non-accused products, including the iPhone 5 by January 15, 2013. This data was submitted onJanuary 15, 2013. On February 26, 2013, the United States District Court for the Eastern District of Texas, Tyler Division issued its Memorandum Opinionand Order regarding post-trial motions resulting from the prior jury verdict. The Court denied Apple’s motion to reduce the damages awarded by the jury forpast infringement. The Court further denied Apple’s request for a new trial on the liability and damages portions of the verdict. Additionally, the Court grantedour motions for pre-judgment interest, post-judgment interest, and post-verdict damages to date. Specifically, the Court ordered that Apple pay $33,561 indaily interest up to final judgment and $330,201 in daily damages for infringement up to final judgment for certain Apple devices included in the verdict. TheCourt denied our request for a permanent injunction. In doing so, the Court ordered the parties to mediate over a license in the following 45 days for Apple’sfuture infringing use not covered by the Court’s Order. If the parties fail to agree to a license, the Court requested that we file the appropriate motion with theCourt. 20Index Patents On August 10, 2012, we submitted updates to our licensing declaration to European Telecommunications Standards Institute (ETSI) and the Alliance forTelecommunications Industry Solutions (ATIS) where we identified three (3) additional developing specifications in the 3GPP LTE, SAE project to which ourpatents and patent applications are or may become essential. On September 18, 2012, we submitted additional updates to our licensing declaration to European Telecommunications Standards Institute (ETSI) and theAlliance for Telecommunications Industry Solutions (ATIS) where we identified seven (7) additional developing specifications in the 3GPP LTE, SAE projectto which our patents and patent applications are or may become essential.On February 28, 2012, we announced that the United States Patent and Trademark Office (“USPTO”) issued an Action Closing Prosecution for our U.S.Patent No. 7,188,180 in the inter-partes reexamination filed by Cisco Systems, Inc. on October 25, 2011, confirming all of our claims as valid andpatentable. The USPTO rejected all of Cisco’s proposed validity challenges to U.S. Patent No. 7,188,180, and withdrew all of its grounds for rejection. Commitments On October 30, 2011, we entered into a new lease agreement with Sierra Tahoe Professional Center, LLC., for our corporate headquarters located at 308 DorlaCourt, Suite 206, Zephyr Cove, Nevada 89448. The lease commencement date was October 30, 2011 and includes montly payments of $5 until the leaseterm expires in October 2013. Recent Developments On January 29, 2013, we entered into a License Agreement with Siemens Enterprise Communications GmbH & Co. KG, and Siemens EnterpriseCommunications Inc.. Under the terms of the Agreement, the Parties have agreed to dismiss the patent infringement case between the Parties and their affiliatesbefore the U.S. District Court for the Eastern District of Texas.Critical Accounting Policies The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates andassumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statementsand 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. We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the U.S. ("U.S. GAAP"). In doing so, wehave to make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues, and expenses, as well as related disclosure ofcontingent assets and liabilities. In some cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in theaccounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extentthat there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We base ourestimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoingbasis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss further below. We have reviewed our criticalaccounting policies and estimates with the audit committee of our board of directors. Revenue Recognition We derive our revenue from patent licensing. The timing and amount of revenue recognized from each licensee depends upon a variety of factors, including thespecific terms of each agreement and the nature of the deliverables and obligations. Such agreements can be complex and may or may not include multipleelements. These agreements may include, without limitation, elements related to the settlement of past patent infringement liabilities, up-front and non-refundable license fees for the use of patents, patent licensing royalties on covered products sold by licensees, and the compensation structure and ownershipof intellectual property rights associated with contractual technology development arrangements. Beginning January 1, 2011, licensing agreements areaccounted for under the Financial Accounting Standards Board ("FASB") revenue recognition guidance, "Revenue Arrangements with Multiple Deliverables."This guidance requires consideration to be allocated to each element of an agreement that has stand-alone value using the relative fair value method. In othercircumstances, such as those agreements involving consideration for past and expected future patent royalty obligations, after consideration of the particularfacts and circumstances, the appropriate recording of revenue between periods may require the use of judgment. In all cases, revenue is only recognized afterall of the following criteria are met: (1) written agreements have been executed; (2) delivery of technology or intellectual property rights has occurred or serviceshave been rendered; (3) fees are fixed or determinable; and (4) collectability of fees is reasonably assured. Patent License Agreements: Upon signing a patent license agreement, we provide the licensee permission to use our patented technology in specificapplications. We account for patent license agreements in accordance with the guidance for revenue arrangements with multiple deliverables and the guidancefor revenue recognition. We have elected to utilize the leased-based model for revenue recognition, with revenue being recognized over the expected period ofbenefit to the licensee. Under our patent license agreements, we typically receive one or a combination of the following forms of payment as consideration forpermitting our licensees to use our patented inventions in specific applications and products: Consideration for Past Sales: Consideration related to a licensee’s product sales from prior periods may result from a negotiated agreement with a licenseethat utilized our patented technology prior to signing a patent license agreement with us or from the resolution of a disagreement or arbitration with a licenseeover the specific terms of an existing license agreement. We may also receive royalty for past sales in connection with the settlement of patent litigation wherethere was no prior patent license agreement. These amounts are negotiated based upon application of a royalty rate to historical sales prior to the execution of thelicense agreement. In each of these cases, since delivery has occurred, we record the consideration as revenue when we have obtained a signed agreement,identified a fixed or determinable price, and determined that collectability is reasonably assured. Current Royalty Payments: These are ongoing royalty payments covering a licensee’s obligations to us related to its sales of covered products in the currentcontractual reporting period. Licensees that owe Current Royalty Payments are obligated to provide us with quarterly or semi-annual royalty reports thatsummarize their sales of covered products and their related royalty obligations to us. We expect to receive these royalty reports subsequent to the period inwhich our licensees’ underlying sales occurred. As a result, it is impractical for us to recognize revenue in the period in which the underlying sales occur, and,in most cases, we will recognize revenue in the period in which the royalty report is received and other revenue recognition criteria are met due to the fact thatwithout royalty reports from our licensees, our visibility into our licensees’ sales is limited. Current Royalty Payments will be calculated based on related per-unit sales of covered products. 21Index Earnings Per Share Basic earnings per share are computed by dividing earnings available to common stockholders by the weighted average number of outstanding common sharesduring the period. Diluted earnings per share is computed by dividing net income by the weighted average number of shares outstanding during the periodincreased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued.During 2012 and 2011 we incurred losses; therefore, the effect of any Common Stock equivalent is anti-dilutive during those periods. 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. Deposits held with these financial institutions mayexceed the amount of insurance provided on such deposits. The balances are insured by the Federal Deposit Insurance Corporation, or FDIC. During the yearended December 31, 2012, 2011 and 2010, we had, at times, funds that were uninsured. We do not believe that we are subject to any unusual financial riskbeyond the normal risk associated with commercial banking relationships. We have not experienced any losses on our deposits of cash and cash equivalents. Derivative Instruments Our Series I Warrants contain an anti-dilution provision which prevents them from being considered indexed to our stock. As a result, the warrants arerequired to be accounted for as derivative instruments. We recognize derivative instruments as either assets or liabilities on the accompanying Consolidated Balance Sheets at fair value. We record changes in the fairvalue (i.e., gains or losses) of the derivatives in the accompanying Consolidated Statements of Operations. Impairment of Long-Lived Assets We identify and record impairment losses on long-lived assets used in operations when events and changes in circumstances indicate that the carrying amountof an asset might not be recoverable, but not less than annually. Recoverability is measured by comparison of the anticipated future net undiscounted cashflows to the related assets’ carrying value. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by whichthe carrying amount of the assets exceeds the projected discounted future net cash flows arising from the asset. Income TaxesThe provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expectedfuture tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating loss and tax creditcarry forwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years inwhich those tax assets are expected to be realized or settled. The Company records a valuation allowance to reduce deferred tax assets to the amount that isbelieved more likely than not to be realized. Because of our history of operating losses, we do not currently recognize the benefit of all of our deferred tax assets, including tax loss carry forwards, thatmay be used to offset future taxable income. We continually assess our ability to generate sufficient taxable income during future periods in which our deferredtax assets may be realized. If and when we believe it is more likely than not that we will recover our deferred tax assets, we will reverse the valuation allowanceas an income tax benefit in our statements of operations. Stock-based Compensation We account for stock-based compensation using the fair value recognition method. We recognize these compensation costs net of the applicable forfeiture rateand recognize the compensation costs for only those shares expected to vest on a straight-line basis over the requisite service period of the award, which isgenerally the option vesting term of 4 years. We estimate the forfeiture rate based on our historical experience. In addition, we record stock and options granted to non-employees at fair value of the consideration received or the fair value of the equity investments issuedas they vest over the performance period. Fair ValueWe apply fair value accounting to all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in thefinancial statements on a recurring basis. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair valueinto three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:Level 1 – Quoted prices in active markets for identical assets or liabilities.Level 2 – Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets orliabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assetsor liabilities.Level 3 – Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing theasset or liability. Our financial instruments are stated at amounts that equal, or are intended to approximate, fair value. When we approximate fair value, we utilize market dataor assumptions that we believe market participants would use in pricing the financial instrument, including assumptions about risk and inputs to thevaluation technique. We use quoted valuation techniques, primarily the income and market approach that maximize the use of observable inputs andminimize the use of unobservable inputs for recurring fair value measurements. 22IndexNew Accounting Pronouncements In May 2011, the FASB issued a new accounting standard update, which amends the fair value measurement guidance and includes some enhanceddisclosure requirements. The most significant change in disclosures is an expansion of the information required for Level 3 measurements based onunobservable inputs. The standard is effective for fiscal years beginning after December 15, 2011. This standard did not have an impact on our consolidatedresults of operations and financial position, when adopted on January 1, 2012. On January 31, 2013 the FASB issued an update to an existing accounting standard the objective of which is to clarify the scope of Accounting StandardsUpdate No. 2011-11, Disclosures about Offsetting Assets and Liabilities, would apply to derivatives including bifurcated embedded derivatives,repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance withSection 210-20-45 or Section 815-10-45 or are subject to a master netting arrangement or similar agreement. Management does not expect adoption to have aneffect on our consolidated results of operations and financial position. On February 5, 2013 the FASB issued an amendment to a prior update of existing standards. The amendments in this update supersede and replace thepresentation requirements for reclassifications out of accumulated other comprehensive income in ASUs 2011-05 (issued in June 2011) and 2011-12 (issuedin December 2011) for all public and private organizations. The amendments would require an entity to provide additional information about reclassificationsout of accumulated other comprehensive income. Management does not expect adoption to have an effect on our consolidated results of operations andfinancial position. Impact of Recently Issued Accounting Pronouncements New accounting guidance was issued in 2011 to require more prominent disclosure of comprehensive income. This guidance was effective for us beginning inthe first quarter of 2012, and requires the presentation of net income, items of other comprehensive income and total comprehensive income in one continuousstatement or two separate but consecutive statements. We elected to present two separate but consecutive statements. New accounting guidance was issued inFebruary 2013 that requires the presentation of information about the amounts reclassified out of accumulated other comprehensive income by component foreach reporting period. This guidance is effective for us in the first quarter of 2013 and is not expected to have an effect on our financial condition or results ofoperations. In addition, new accounting guidance was issued in 2011 and 2012 which was intended to reduce the complexity and costs of performing annual goodwill andindefinite-lived intangible asset testing by allowing companies the option to make a qualitative evaluation about the likelihood of impairment to determinewhether it should calculate the fair value of a reporting unit or the indefinite-lived intangible asset. The adoption of this guidance did not have an effect on theCompany’s financial condition or results of operations. Operations (all amounts in this section are expressed in thousands) Revenue 2012 2011 2010 Revenue 412 20 68 Revenue generated for the year ended December 31, 2012 was approximately $412 compared to $20 for the year ended December 31, 2011 and $68 for thetwelve months ended December 31, 2010. Our revenue in 2012, was as a result of entering into license agreements with our customers. In 2011 and2010, revenue was solely limited to the royalties earned under our single license agreement through our Japanese subsidiary. We expect the revenue from thislicense will continue to be insignificant in the future. We do not intend to seek additional licenses or other revenue through our Japanese subsidiary. Gain on Settlement In June 2010, we received $200,000 from Microsoft Corporation related to a licensing agreement. We determined that we could not practically and objectivelyseparate any settlement portion from the revenue element as discussed under the guidance of U.S. GAAP Accounting Standards Codification Topic 605:Revenue Recognition, or ASC Topic 605. As a result, this amount was classified as a gain on settlement. This reclassification had no impact on our netincome, financial position or cash flows for any period. We did not receive a gain on settlement for the twelve months ended December 31, 2012 or 2011,respectively. Royalty Expense There was no royalty expense for the years ended December 31, 2012 and 2011 compared to $59,207 for the year ended December 31, 2010. Under ouragreements with SAIC, we were obligated to pay SAIC 35% of the proceeds from the settlement of litigation with Microsoft after reduction for costs, includinglegal fees and expenses, incurred by us and SAIC in connection with the Microsoft litigation. Research and Development Expenses 2012 2011 2010 Research and Development 1,555 1,464 2,412 Research and development costs include expenses paid to outside development consultants and compensation-related expenses for our engineering staff.Research and development costs are expensed as incurred. Our research and development expenses for the year ended December 31, 2012 was $1,555 compared to $1,464 for the year ended December 31, 2011 and$2,412 for the year ended December 31, 2010. The increase in 2012 was primarily due to the increase in bonuses paid in 2012 compared to 2011. Theincrease in 2010 as compared to 2012 and 2011, was primarily due to the increase in wages due to the dividend payment paid to our research and developmentstaff. Selling, General and Administrative Expenses 2012 2011 2010 Selling, General and Administration 37,718 15,932 33,764 Selling, general and administrative expenses include compensation expense for management and administrative personnel, as well as expenses for outside legal,accounting, and consulting services. Our selling, general and administrative expenses for the year ended December 31, 2012 was $37,718 compared to $15,932 for the year ended December 31,2011 and $33,764 for the year ended December 31, 2010. The increase in 2012 and in 2010 was primarily due to the increase in legal fees associated with thesettlement of the Aastra, Mitel and NEC cases as well as the ongoing Apples, Cisco and Avaya cases in 2012 and the Microsoft litigation in 2010. Legal feesrepresent approximately 71% of general and administrative expenses for 2012 as compared to 40% for 2011 and 75% for 2010. Within selling, general and administrative expenses, legal fees for the year ended December 31, 2012 was $26,537 compared to $6,342 for the year endedDecember 31, 2011 and $25,353 for the year ended December 31, 2010. The increase in 2010 was primarily due to the increase in legal fees associated withthe settlement of the Microsoft litigation. Other Income and Expenses 2012 2011 2010 Other Income and Expense 927 5,595 30,516 Our non-cash loss related to the periodic revaluation of our Series I Warrants liability for the year ended December 31, 2012 was $927 compared to $5,595for the year ended December 31, 2011 and $30,516 for the year ended December 31, 2010. Our non-cash loss related to the periodic revaluation of our Series IWarrants liability decreased by $4,668 in the year ended December 31, 2012, as compared to the comparable period in 2011 as a result of a higher commonshare price and warrant exercises during the year ended 2012. Interest income for the year ended December 31, 2012 was $329 compared to $228 for the year ended December 31, 2011, and $1,310 for the year endedDecember 31, 2010. These changes are due to timing on the maturity of the investments as well as the amount of cash available for investments. 23Index Liquidity and Capital Resources For the year ended December 31, 2012, our cash and cash equivalents totaled $19,661 and our short-term investments totaled $26,493 compared to $49,482and $14,438, respectively, for the year ended December 31, 2011 and $34,635 and $43,457, respectively, as of December 31, 2010. Before entering into the Microsoft Settlement, we allocated a large amount of cash to legal fees and other expenses associated with the Microsoft litigation. Weexpect that our cash and cash equivalents as of December 31, 2012, will be sufficient to fund our operations and provide working capital for general corporatepurposes and legal expenses including the expenses for our ongoing complaints against Apple, Cisco, Siemens and Avaya in the United States District Courtof the Eastern District of Texas, Tyler Division, as well as the complaint with the U.S. International Trade Commission, for at least the next 36months. While we do not expect to generate net income in the near term similar to in the net income generated during the year ended December 31, 2010,generally attributable to the Microsoft Settlement, we do expect to derive the majority of our future revenue from license fees and royalties associated with ourpatent portfolio, technology, software and secure domain name registry in the United States and other markets around the world over the long term. However,we will not receive any proceeds from these claims unless and until they may be resolved in our favor, and we expect to continue to incur substantial legal andother costs associated with pursuit of our claims.Contractual Commitments The following table summarizes our contractual obligations, including interest expense, and commitments as of December 31, 2012: Operating Obligations Total Less than 1year 1 - 3 Years 3 - 5 Years More than 5Years Operating Lease Obligations 46 46 --- --- --- Total 46 46 --- --- --- Off-Balance Sheet Arrangements As of December 31, 2012, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K. Item 7A. Quantitative and Qualitative Disclosures about Market Risk We invest our excess cash primarily in highly liquid debt instruments of the time deposits, money market, and corporate debt securities. By policy, we limitthe amount of credit exposure to any one issuer. Investments in fixed rate earning securities carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to arise in interest rates. Due in part to these factors, our income from investments may decrease in the future. We considered the historical volatility of short-term interest rates and determined that it was reasonably possible that an adverse change of 100 basis pointscould be experienced in the near term but would have an immaterial impact in the fair value of our marketable securities as they will be maturing in six monthsor less. Although we have no obligation to settle our Series I Warrant obligations in cash or an unknown number of shares, the embedded liability in the Series IWarrant obligations is recorded at estimated fair value. That estimated fair value is determined in large part by reference to our assumptions and estimates ofvarious factors. Notably, our liability will increase and we may incur significant non-cash expenses, all other factors being constant, if the market price ofour common shares increases. Conversely, our liability will decrease and we may recognize significant non-cash gains, all other factors being constant, if themarket price of our common shares decreases. We considered the historical volatility of our stock prices and determined that it was reasonably possible that the fair market value of our stock price coulddrastically increase in the near term but would have an immaterial impact to our consolidated balance sheets and statement of operations as there are onlyapproximately 160,000 warrants outstanding. 24Index Item 8. Financial Statements and Supplementary Data.FINANCIAL STATEMENTS Financial Statements Index PageReport of Farber Hass Hurley LLP, Independent Registered Public Accounting Firm26Consolidated Balance Sheets of VirnetX Holding Corporation as of December 31, 2012 and December 31, 201127Consolidated Statements of Operations of VirnetX Holding Corporation for the years ended December 31, 2012, December 31, 2011 andDecember 31, 201028Consolidated Statements of Comprehensive Income (Loss) of VirnetX Holding Corporation for the years ended December 31, 2012, December 31,2011 and December 31, 201028Consolidated Statements of Stockholders’ Equity of VirnetX Holding Corporation for the years ended December 31, 2012, December 31, 2011and December 31, 201029Consolidated Statements of Cash Flows of VirnetX Holding Corporation for the years ended December 31, 2012, December 31, 2011 andDecember 31, 201030Notes to Financial Statements of VirnetX Holding Corporation31 25Index REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and ShareholdersVirnetX Holding Corporation We have audited the accompanying consolidated balance sheets of VirnetX Holding Corporation (the “Company”) as of December 31, 2012 and 2011, and therelated consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period endedDecember 31, 2012. VirnetX Holding Corporation’s management is responsible for these consolidated financial statements. Our responsibility is to express anopinion 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 standards require thatwe plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our auditsprovide 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, 2012and 2011, and the consolidated results of their operations, and cash flows for each of the three years in the periodended December 31, 2012, 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 Holding Corporation’sinternal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 1, 2013 expressed an unqualified opinion as tothe effectiveness of the Company’s control over financial reporting. /s/ Farber Hass Hurley LLP Granada Hills, California March 1, 2013 26Index VirnetX Holding Corporation CONSOLIDATED BALANCE SHEETS(in thousands, except share amounts) As of December 31,2012 As of December 31,2011 ASSETS Current assets: Cash and cash equivalents $19,661 $49,482 Investments available for sale 26,493 14,438 Prepaid taxes 14,963 10,459 Prepaid expenses and other current assets 114 91 Total current assets 61,231 74,470 Property and equipment, net 70 56 Intangible and other assets 12 60 Deferred tax benefit — 47 Total assets $61,313 $74,633 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities $3,197 $1,227 Income tax liability — 430 Derivative liability 4,172 4,699 Total current liabilities 7,369 6,356 Stockholders' equity: Preferred stock, par value $0.0001 per share Authorized: 10,000,000 shares at December 31, 2012 and 2011, Issued and outstanding: 0 shares at December 31, 2012 and 2011 — — Common stock, par value $0.0001 per share Authorized: 100,000,000 shares at December 31, 2012 and 2011, Issued and outstanding: 51,150,242 shares and 50,619,136 shares, at December 31, 2012 and 2011, respectively 5 5 Additional paid-in capital 116,856 104,277 Accumulated deficit (62,925) (36,001)Accumulated other comprehensive income/(loss) 8 (4)Total stockholders' equity 53,944 68,277 Total liabilities and stockholders' equity $61,313 $74,633 The accompanying notes are an integral part of these consolidated financial statements 27Index VirnetX Holding Corporation CONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except share and per share amounts) Year EndedDecember 31,2012 Year EndedDecember 31,2011 Year EndedDecember 31,2010 Revenue $412 $20 $68 Operating expenses: Royalty expense — — 59,207 Research and development 1,555 1,464 2,412 General, selling and administrative 37,718 15,932 33,764 Gain on settlement — — (200,000)Total operating expenses 39,273 17,396 (104,617)Income (loss) from operations (38,861) (17,376) 104,685 Loss on change in value of embedded derivative and warrants (927) (5,595) (30,516)Interest income, net 329 228 1,310 Income (loss) before taxes (39,459) (22,743) 75,479 Income tax expense (benefit) (12,535) (5,480) 34,062 Net Income (loss) $(26,924) $(17,263) $41,417 Basic earnings (loss) per share: $(0.53) $(0.35) $0.91 Diluted earnings (loss) per share: $(0.53) $(0.35) $0.84 Weighted average shares outstanding basic 50,934,266 50,028,413 45,452,550 Weighted average shares outstanding dilutive 50,934,266 50,028,413 49,066,704 Dividends declared per common share $— $— $0.50 VirnetX Holding Corporation CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)(in thousands) Year EndedDecember 31,2012 Year EndedDecember 31,2011 Year EndedDecember 31,2010 Net income (loss) $(26,924) $(17,263) $41,417 Other comprehensive income (loss), net of tax: Change in unrealized gain (loss) on investments, net of tax 12 (3) (984) Other comprehensive income (loss), net of tax 12 (3) (984)Comprehensive income (loss) $(26,912) $(17,266) $40,433 The accompanying notes are an integral part of these consolidated financial statements 28Index VirnetX Holding CorporationCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY(in thousands, except share and per share amounts) Other Total Additional Comprehensive Stockholders' Common Stock Paid-in Accumulated Income Equity Shares Amount Capital Deficit (Expense) (Deficit) Balance at December 31, 2009 39,750,927 $4.00 $26,861 $(35,572) $- $(8,707) Stock issued for cash exercise of warrantsat $2.52 per share, net 2,380,943 .24 5,395 5,395 Stock issued for cash exercise of warrantsat $2.00 per share, net 1,233,741 .12 2,354 2,354 Stock issued for cash exercise of warrantsat $3.00 per share, net 1,235,000 .12 3,750 3,750 Stock issued for cash exercise of warrantsat $4.00 per share, net 1,235,000 .12 4,945 4,945 Stock issued for cash exercise of warrantsat $1.80 per share, net 220,000 .02 396 396 Stock issued for cash exercise of warrantsat $4.80 per share, net 228,648 .02 1,098 1,098 Stock issued for cash exercise of warrantsat $3.93-3.59 per share, net 1,787,620 .17 6,593 6,593 Stock issued for cash exercise of options,net 1,269,149 .12 1,404 1,404 Stock-based compensation 3,381 3,381 Deferred tax benefit related to stock basedcompensation 528 528 Fees and commissions (980) (980)Derivative liability 22,462 22,462 Dividend (23,600) (23,600)Net Income 41,417 41,417 Other comprehensive income net of tax (984) (984)Comprehensive income 40,433 Balance at December 31, 2010 49,341,028 4.93 78,187 (17,755) (984) 59,453 Stock issued for cash exercise of warrantsat $3.93-3.59 per share, net 855,536 .09 3,063 3,063 Stock-based compensation 4,368 4,368 Deferred tax benefit related to stock basedcompensation 2,331 2,331 Derivative liability 15,260 15,260 Cashless exercise of $4.80 underwriterwarrants 24,178 -- Exercise of options 398,394 .04 1,068 1,068 Comprehensive income: Reclassification adjustment for net lossincluded in net income (983) 983 -- Net loss (17,263) (17,263)Other comprehensive income net of tax (3) (3)Comprehensive loss (17,266)Balance at December 31, 2011 50,619,136 5.06 104,277 (36,001) (4) 68,277 Stock issued for cash exercise of warrantsat $3.93-3.59 per share, net 44,941 .01 161 161 Stock-based compensation 6,162 6,162 Deferred tax benefit related to stock basedcompensation 3,111 3,111 Derivative liability 1,454 1,454 Exercise of options 486,165 .04 1,691 1,691 Comprehensive income: Net loss (26,924) (26,924)Other comprehensive income net of tax 12 12 Comprehensive loss (26,912)Balance at December 31, 2012 51,150,242 $5.11 $116,856 $(62,925) $8 $53,944 The accompanying notes are an integral part of these consolidated financial statements 29Index VirnetX Holding Corporation CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands) Year EndedDecember 31,2012 Year EndedDecember 31,2011 Year EndedDecember 31,2010 Cash flows from operating activities: Net income (loss) $(26,924) $(17,263) $41,417 Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation and amortization 71 68 59 Stock-based compensation 6,162 4,367 3,381 Net change in deferred taxes 3,158 5,663 (2.851)Change in value of derivative liability 927 5,595 30,516 Changes in assets and liabilities: Receivables and other current assets (23) (3) (39)Prepaid taxes (4,934) (10,459) — Accounts payable and accrued liabilities 1,970 708 (3,960)Income tax liability — (6,928) 7,358 Net cash provided by (used in) operating activities (19,593) (18,252) 75,881 Cash flows from investing activities: Purchase of property and equipment (37) (51) (13)Purchase of investments (59,342) (34,082) (44,441)Proceeds from sale, maturity of investments 47,299 63,101 — Net cash provided by (used in) investing activities (12,080) 28,968 (44,454)Cash flows from financing activities: Payment of royalty obligation less imputed interest — — (160)Payment of dividend — — (23,599)Proceeds from exercise of options 1,691 1,068 1,341 Proceeds from exercise of warrants 161 3,063 23,615 Net cash provided by financing activities 1,852 4,131 1,197 Net increase (decrease) in cash and cash equivalents (29,821) 14,847 32,623 Cash and cash equivalents, beginning of year 49,482 34,635 2,011 Cash and cash equivalents, end of year $19,661 $49,482 $34,635 Supplemental disclosure of cash flow information: Cash paid during the year for taxes $— $9,600 $29,556 Cash paid during the year for interest $— $— $10 The accompanying notes are an integral part of these consolidated financial statements 30Index VirnetX Holding CorporationNOTES TO FINANCIAL STATEMENTS(in thousands except share and per share amounts) Note 1 - Formation and Business of the Company VirnetX Holding Corporation, which we refer to as” we”, “us”, “our”, “the Company” or “VirnetX”, is engaged in the business of commercializing a portfolioof patents. We seek to license our technology, including GABRIEL Connection Technology™, to various original equipment manufacturers, or OEMs, thatuse our technologies in the development and manufacturing of their own products within the IP-telephony, mobility, fixed-mobile convergence and unifiedcommunications markets. Prior to 2012 our revenue was limited to an insignificant amount of software royalties pursuant to the terms of a single licenseagreement. During 2012 we had revenues from settlements of patent infringement disputes whereby we received consideration for past sales of licensees thatutilized our technology, where there was no prior patent license agreement (see “Revenue Recognition). 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 material intercompanyaccounts and transactions have been eliminated. Certain prior year amounts have been reclassified to conform to current year presentations. Use of Estimates We have made a number of estimates and assumptions related to the reporting of assets, liabilities, revenues and expenses to prepare these financial statementsin conformity with accounting principles generally accepted in the United States of America (U.S. GAAP) as delineated by the Financial AccountingStandards Board (FASB) in its Accounting Standards Codification (ASC). Generally, assets and liabilities that are subject to estimation and judgment includethe fair value of stock-based compensation, the fair value of our warrant liability and deferred income taxes. While actual results could differ, we believe suchestimates to be reasonable..Revenue Recognition We derive our revenue from patent licensing. The timing and amount of revenue recognized from each licensee depends upon a variety of factors, including thespecific terms of each agreement and the nature of the deliverables and obligations. Such agreements can be complex and may or may not include multipleelements. These agreements may include, without limitation, elements related to the settlement of past patent infringement liabilities, up-front and non-refundable license fees for the use of patents, patent licensing royalties on covered products sold by licensees, and the compensation structure and ownershipof intellectual property rights associated with contractual technology development arrangements. Beginning January 1, 2011, licensing agreements areaccounted for under the FASB revenue recognition guidance, "Revenue Arrangements with Multiple Deliverables." This guidance requires consideration to beallocated to each element of an agreement that has stand-alone value using the relative fair value method. In other circumstances, such as those agreementsinvolving consideration for past and expected future patent royalty obligations, after consideration of the particular facts and circumstances, the appropriaterecording of revenue between periods may require the use of judgment. In all cases, revenue is only recognized after all of the following criteria are met: (1)written agreements have been executed; (2) delivery of technology or intellectual property rights has occurred or services have been rendered; (3) fees are fixed ordeterminable; and (4) collectability of fees is reasonably assured. Patent License Agreements: Upon signing a patent license agreement, we provide the licensee permission to use our patented technology in specificapplications. We account for patent license agreements in accordance with the guidance for revenue arrangements with multiple deliverables and the guidancefor revenue recognition. We have elected to utilize the leased-based model for revenue recognition, with revenue being recognized over the expected period ofbenefit to the licensee. Under our patent license agreements, we typically receive one or a combination of the following forms of payment as consideration forpermitting our licensees to use our patented inventions in specific applications and products:Consideration for Past Sales: Consideration related to a licensee’s product sales from prior periods may result from a negotiated agreement with a licenseethat utilized our patented technology prior to signing a patent license agreement with us or from the resolution of a disagreement or arbitration with a licenseeover the specific terms of an existing license agreement. We may also receive royalty for past sales in connection with the settlement of patent litigation wherethere was no prior patent license agreement. These amounts are negotiated based upon application of a royalty rate to historical sales prior to the execution of thelicense agreement. In each of these cases, since delivery has occurred, we record the consideration as revenue when we have obtained a signed agreement,identified a fixed or determinable price, and determined that collectability is reasonably assured. Current Royalty Payments: These are ongoing royalty payments covering a licensee’s obligations to us related to its sales of covered products in the currentcontractual reporting period. Licensees that owe Current Royalty Payments are obligated to provide us with quarterly or semi-annual royalty reports thatsummarize their sales of covered products and their related royalty obligations to us. We expect to receive these royalty reports subsequent to the period inwhich our licensees’ underlying sales occurred. As a result, it is impractical for us to recognize revenue in the period in which the underlying sales occur, and,in most cases, we will recognize revenue in the period in which the royalty report is received and other revenue recognition criteria are met due to the fact thatwithout royalty reports from our licensees, our visibility into our licensees’ sales is limited. Current Royalty Payments will be calculated based on related per-unit sales of covered products.Revenues recognized during 2012 resulted from settlements of patent infringement disputes (see Note 15 “Litigation”) whereby we received consideration forpast sales of licensees that utilized our technology, where there was no prior patent license agreement. 31Index 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. Our cashand cash equivalents are not subject to significant interest rate risk due to the short maturities of these investments. Investments Investments are classified as available-for-sale and are recorded at fair market value. Unrealized gain and losses are reported as other comprehensive income.Realized gains and losses are recorded in income in the period they are realized. The Company's investments consist of debt securities and certificates ofdeposit with maturity dates 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 computed using theaccelerated and straight line methods over the estimated useful lives of the assets, which range from five to seven years. Repair and maintenance costs arecharged to expense as incurred. Concentration of Credit Risk and Other Risks and Uncertainties Our cash and cash equivalents are primarily maintained at two major financial institutions in the United States. Deposits held with these financialinstitutions may exceed the amount of insurance provided on such deposits. A portion of those balances are insured by the Federal Deposit InsuranceCorporation, or FDIC. During the year ended December 31, 2012, we had, at times, funds that were uninsured. We do not believe that we are subject to anyunusual financial risk beyond the normal risk associated with commercial banking relationships. We have not experienced any losses on our deposits of cashand cash equivalents. Fair Value The carrying amounts of our financial instruments, including cash equivalents, accounts payable, and accrued liabilities, approximate fair value because oftheir generally short maturities. Intangible Assets We record intangible assets at cost, less accumulated amortization. Amortization of intangible assets is provided over their estimated useful lives, which canrange 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 long-lived assets used in operations when events and changes in circumstances indicate that the carrying amountof an asset might not be recoverable, but not less than annually. Recoverability is measured by comparison of the anticipated future net undiscounted cashflows to the related assets’ carrying value. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by whichthe 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 The provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expectedfuture tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax creditcarry forwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years inwhich those tax assets are expected to be realized or settled. The Company records a valuation allowance to reduce deferred tax assets to the amount that isbelieved more likely than not to be realized. In addition, the calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Weare subject to examinations by the Internal Revenue Service (“IRS”) and other taxing jurisdictions on various tax matters, including challenges to variouspositions we assert in our filings. In the event that the IRS or another taxing jurisdiction levies an assessment in the future, it is possible the assessment couldhave a material adverse effect on our consolidated financial condition or results of operations. The financial statement recognition of the benefit for a tax position is dependent upon the benefit being more likely than not to be sustainable upon audit by theapplicable tax authority. If this threshold is met, the tax benefit is then measured and recognized at the largest amount that is greater than 50 percent likely ofbeing realized upon ultimate settlement. In the event that the IRS or another taxing jurisdiction levies an assessment in the future, it is possible the assessmentcould have a material adverse effect on our consolidated financial condition or results of operations. See Note 11, “Income Taxes” for additional information. Derivative Instruments Our Series I Warrants are accounted for as derivative instruments as a result of an anti-dilution provision which, in accordance with U.S. GAAP, preventsthem from being considered indexed to our stock and qualified for an exception to derivative accounting. We recognize derivative instruments as either assets or liabilities on the accompanying Consolidated Balance Sheets at fair value. We record changes in the fairvalue (i.e., gains or losses) of the derivatives in the accompanying Consolidated Statements of Operations. 32Index Stock-Based Compensation We account for stock-based compensation using the fair value recognition method in accordance with U.S. GAAP. We recognize these compensation costs netof the applicable forfeiture rate and recognize the compensation costs for only those shares expected to vest on a straight-line basis over the requisite serviceperiod of the award, which is generally the option vesting term of 4 years. We estimate the forfeiture rate based on our historical experience if any. See Note 6 -Stock-Based Compensation for additional information concerning our share-based compensation awards. 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 are computed by dividing earnings available to common stockholders by the weighted average number of outstanding common sharesduring the period. Diluted earnings per share is computed by dividing net income by the weighted average number of shares outstanding during the periodincreased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued.During 2012 and 2011 we had incurred losses; therefore the effect of any common stock equivalent would be anti-dilutive during these periods. New Accounting Pronouncements In May 2011, the FASB issued a new accounting standard update, which amends the fair value measurement guidance and includes some enhanceddisclosure requirements. The most significant change in disclosures is an expansion of the information required for Level 3 measurements based onunobservable inputs. The standard is effective for fiscal years beginning after December 15, 2011. This standard did not have an impact on our consolidatedresults of operations and financial position, when adopted on January 1, 2012. On January 31, 2013 the FASB issued an update to an existing accounting standard the objective of which is to clarify the scope of Accounting StandardsUpdate No. 2011-11, Disclosures about Offsetting Assets and Liabilities, would apply to derivatives including bifurcated embedded derivatives, repurchaseagreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with Section210-20-45 or Section 815-10-45 or are subject to a master netting arrangement or similar agreement. Management does not expect adoption to have an effect onour consolidated results of operations and financial position. On February 5, 2013 the FASB issued an amendment to a prior update of existing standards. The amendments in this update supersede and replace thepresentation requirements for reclassifications out of accumulated other comprehensive income in ASUs 2011-05 (issued in June 2011) and 2011-12 (issuedin December 2011) for all public and private organizations. The amendments would require an entity to provide additional information about reclassificationsout of accumulated other comprehensive income. Management does not expect adoption to have an effect on our consolidated results of operations andfinancial position. Impact of Recently Issued Accounting Pronouncements New accounting guidance was issued in 2011 to require more prominent disclosure of comprehensive income. This guidance was effective for us beginning inthe first quarter of 2012, and requires the presentation of net income, items of other comprehensive income and total comprehensive income in one continuousstatement or two separate but consecutive statements. We elected to present two separate but consecutive statements. New accounting guidance was issued inFebruary 2013 that requires the presentation of information about the amounts reclassified out of accumulated other comprehensive income by component foreach reporting period. This guidance is effective for us in the first quarter of 2013 and is not expected to have an effect on our financial condition or results ofoperations. In addition, new accounting guidance was issued in 2011 and 2012 which was intended to reduce the complexity and costs of performing annual goodwill andindefinite-lived intangible asset testing by allowing companies the option to make a qualitative evaluation about the likelihood of impairment to determinewhether it should calculate the fair value of a reporting unit or the indefinite-lived intangible asset. The adoption of this guidance did not have an effect on theCompany’s financial condition or results of operations. Note 3 - Property and Equipment Our major classes of property and equipment were as follows: December 31 2012 2011 2010 Office furniture $70 $57 $22 Computer equipment 115 91 75 Total 185 148 97 Less accumulated depreciation (115) (92) (72) $70 $56 $25 Depreciation expense for the years ended December 31, 2012, 2011, 2010 was $23, $20 and $11 respectively. Note 4 - Commitments We lease our offices under an operating lease with a third party expiring in October 2013. We recognize rent expense on a straight-line basis over the term of thelease. Rent expense was $56, $59 and $52 for the years ended December 31, 2012, 2011 and 2010 respectively. For the Year MinimumRequired LeasePayments inPeriod 2013 $46 Total $46 33Index Note 5 - 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 VirnetX HoldingCorporation 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 un-exercisable or is otherwise forfeited, the shares subject to such award will again becomeavailable for issuance under the Plan. The Plan provides for the granting of stock options and restricted stock purchase rights (RSU) to our employees andconsultants. Stock options granted under the Plan may be incentive stock options or nonqualified stock options. Incentive stock options ("ISO") may only begranted to our employees (including officers and directors). Nonqualified stock options ("NSO") and stock purchase rights may be granted to our employeesand 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 price determined byour Board of Directors, or a duly appointed committee thereof, provided, however, that the exercise price of an option granted to any employee shall be not lessthan 100% of the fair market value at the date of grant in the case of ISO or 85% of the case of an NSO, the exercise price of an ISO or NSO granted to one ofour Named Executive Officers shall not be less than 100% fair market value of the shares at the date of grant and the exercise price of an ISO granted to a 10%shareholder shall not be less than 110% of the fair market value of the shares on the date of grant. Stock options granted under the Plan typically vest overfour years and have a 10 year term. All RSUs are considered to be granted at the fair value of our stock on the date of grant because they have no exerciseprice. RSUs typically vest over four years.Activity under the Plan is as follows: Options Outstanding SharesAvailable forGrant Number ofShares WeightedAverageExercise Price Balance at December 31, 2009 1,417,228 5,785,790 $2.57 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 Options granted (475,000) 475,000 23.80 Options exercised — (398,393) 2.68 Balance at December 31, 2011 628,478 4,906,998 $5.12 Options granted (367,500) 367,500 26.97 RSU’s granted (151,665) 151,665 25.60 Options exercised — (486,165) 3.48 Options cancelled 12,109 (12,109) 17.34 Balance at December 31, 2012 121,422 4,927,889 $7.52 Note 6 - Stock-Based Compensation The following table summarizes information about stock options outstanding at December 31, 2012: Options Outstanding Options Vested and Exercisable Date of Option Issue Range ofExercise Prices NumberOutstanding WeightedAverageRemainingContractualLife (Years) WeightedAverageExercise Price NumberExercisable WeightedAverageRemainingContractualLife (Years) WeightedAverageExercise Price 2006 $0.24 690,612 3.22 $0.24 690,612 3.22 $0.24 2007 4.20 1,277,574 4.56 4.20 1,277,574 4.56 4.20 2007 5.88-6.47 563,931 4.99 6.10 563,931 4.99 6.10 2008 1.74-6.20 207,000 5.39 4.93 207,000 5.39 4.93 2009 1.15- 1.58 934,711 6.26 1.16 830,777 6.26 1.16 2010 5.48-6.03 279,896 7.17 5.49 199,687 7.18 5.47 2011 19.85-23.62 455,000 8.40 23.37 195,416 8.37 23.62 2012 23.84 – 35.25 367,500 9.39 26.97 68,125 9.35 27.09 4,776,224 5.68 $6.94 4,033,122 5.18 $4.59 34Index RSU Outstanding RSU Vested and Exercisable Date of RSU Issue Range ofExercise Prices NumberOutstanding Weighted AverageExercise Price NumberExercisable Weighted AverageExercise Price 2012 24.75 – 29.90 151,665 25.60 — — 151,665 $25.60 — $— The following table summarizes activity under the Plan for the indicated periods: Number ofShares Weighted Average ExercisePrice Weighted AverageRemaining ContractualLife (Years) Aggregate IntrinsicValue 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 — — Options granted 475,000 23.80 — — Options exercised (398,393) 2.68 — — Options cancelled — — — — Outstanding at December 31, 2011 4,906,998 5.12 Options granted 367,500 26.97 — — Options exercised (486,165) 3.48 — — Options cancelled (12,109) 17.34 — — Outstanding at December 31, 2012 4,776,224 $6.94 5.68 $106,971 Number ofRSU's Weighted Average Grant Date Fair Value Aggregate IntrinsicValue Outstanding at December 31, 2011 — — RSU's granted 151,665 25.60 — RSU's exercised — — — RSU's cancelled — — — Outstanding at December 31, 2012 151,665 $25.60 $574 Intrinsic value is calculated as the difference between the per share market price of our common stock on the last trading day of 2012, which was $29.28,and the exercise price of the options. For options exercised, the intrinsic value is the difference between market price and the exercise price on the date ofexercise. We received cash proceeds of $1,691and $1,068 from stock options exercised in 2012 and 2011, respectively. The total intrinsic value of optionsexercised was $11,509, $8,050 and $7,350 during the years ended December 31, 2012, 2011 and 2010, respectively. The aggregate intrinsic value ofoptions exercisable at December 31, 2012 was $99,723. 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, 2012 Year EndedDecember 31, 2011 Year EndedDecember 31, 2010 Employee stock options $ 5,171 $ 4,367 $ 3,381 RSU’s 991 — — Total stock-based compensation expense $6,162 $4,367 $3,381 As of December 31, 2012, there was $12,883 of unrecognized stock-based compensation expense expected to be recognized related to unvested employee stockoptions and $2,891 of unrecognized stock-based compensation expense to be recognized related to unvested RSU’s. These costs are expected to be recognizedover a weighted-average period of 1.36 and 2.81 years, respectively. 35Index The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model using the following weighted averageassumptions: Year EndedDecember 31,2012 Year EndedDecember 31,2011 Year EndedDecember 31,2010Expected stock price volatility 111% 123% 110%Risk-free interest rate 1.90% 3.05% 3.66%Expected life term (in years) 6.8 years 6.6 years 7.0 yearsExpected dividends 0% 0% 0% Based on the Black-Scholes option pricing model, the weighted average estimated fair value of employee stock options granted was $23.15, $21.13 and $4.83during the years ended December 31, 2012, 2011 and 2010 respectively. The expected life was determined using the simplified method outlined in ASC 718, taking the average of the vesting term and the contractual term of theoption. Expected volatility of the stock options was based upon historical data and other relevant factors, such as the volatility of comparable publicly-tradedcompanies at a similar stage of life cycle. We have not provided an estimate for forfeitures because we have no history of forfeited options and believe that alloutstanding options at December 31, 2012, will vest. In the future, the Company may change this estimate based on actual and expected future forfeiturerates.Note 7 - 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 the weightedaverage number of shares and potentially dilutive common shares outstanding. Potential common shares outstanding principally include stock options, underour stock plan and warrants. During 2012 and 2011, we incurred losses; therefore the effect of any common stock equivalent would be anti-dilutive duringthose periods. The table below sets forth the basic loss per share calculations: Period Ended December 31, 2012 2011 2010 Net income (loss) $(26,924) $(17,263) $41,417 Basic weighted average number of shares outstanding 50,934 50,028 45,453 Diluted weighted average number of shares outstanding 50,934 50,028 49,067 Basic earnings (loss) per share $(0.53) $(0.35) $0.91 Diluted earnings (loss) per share $(0.53) $(0.35) $0.84 Options to purchase 2.3 million shares at prices ranging from $0.24 to $6.47 were excluded from the diluted earnings per share calculation for the year endingDecember 31, 2010 because they would have been anti-dilutive due to their exercise prices exceeding the average market prices for the period. Note 8 - 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 legally available andwhen declared by our Board of Directors, subject to the prior rights of holders of all classes of stock outstanding having priority rights as to dividends. OnJune 15, 2010, the Company's Board of Directors declared a special cash dividend of $0.50 per share of the Company's common stock to holders of recordon 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 9 - Warrants Information about warrants outstanding during the twelve months ended December 31, 2012 follows: OriginalNumber ofWarrantsIssued Exercise Price perCommon Share Exercisable atDecember 31,2011 BecameExercisable Exercised Terminated /Cancelled /Expired Exercisable atDecember 31,2012 ExpirationDate 2,619,036(1) $3.59 204,908 — (44,941) — 159,967 March 2015Total 204,908 (44,941) — 159,967 (1)Referred to as our Series I Warrants. 36Index Note 10 - Employee Benefit Plan We sponsor a defined contribution, 401k plan, covering substantially all our employees. The Company's matching contribution to the plan wasapproximately, $41 in 2012, $36 in 2011 and $36 in 2010. Note 11 - Income Taxes The (benefit) provision for income taxes is comprised of the following: Year EndedDecember 31,2012 Year EndedDecember 31,2011 Year Ended December 31,2010 Current: Federal $(12,154) $(8,036) 27,822 State (428) (767) 9,609 Foreign - (9) 11 (12,582) (8,812) 37,442 Deferred: Federal 40 3,331 (3,380)State 7 1 - Foreign - - - 47 3,332 (3,380)Total (benefit) provision for income taxes $(12,535) $(5,480) 34,062 A reconciliation of the United States federal statutory income tax rate to our effective income tax rate is as follows: Year EndedDecember 31,2012 Year EndedDecember 31,2011 Year EndedDecember 31,2010 United States federal statutory rate (35.00%) (35.00%) 35.00%State taxes, net of federal benefit (1.07%) (2.19%) 8.28%Valuation allowance 4.41% 4.39% (9.69%)Stock options (0.14%) 1.92% 0.00%Prior year true-up (1.03%) - - Warrants 0.82% 8.60% 14.15%Other 0.32% (1.79%) (3.64%)Balance at the end of the year (31.69%) (24.07%) 44.10%Deferred tax assets (liabilities) consist of the following: Year Ended December 31,2012 Year Ended December 31,2011 Year EndedDecember 31,2010 Deferred tax assets: Reserves and accruals $50 $46 $53 State tax 1 1 3,326 Research and development credits and other credits - - 225 Net operating loss carry forward 2,254 2,822 372 Stock based compensation 4,506 3,155 3,109 Other 177 211 - Total deferred tax assets 6,989 6,235 7,085 Valuation allowance (6,970) (6,168) (3,687)Deferred tax assets after valuation allowance 19 67 3,398 Deferred tax liability Depreciation and amortization (19) (20) (18) - - Total deferred tax liability (19) (20) (18) Net deferred tax assets $0 $47 $3,380 37Index In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of deferred assets will not berealized. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income during the periods in which thosetemporary differences become deductible. Based on the available objective evidence, we believe it is more likely than not that the net deferred tax assets as of December 31, 2012 will not be fullyrealizable. Accordingly, management has established a full valuation allowance against its net deferred tax assets at December 31, 2012. The net change in thetotal valuation allowance for the year ended December 31, 2012 was an increase of $802. At December 31, 2012, the Company has federal and state netoperating loss carry forwards of approximately $912 and $39,432, respectively expiring in 2027 and 2012, respectively. At December 31, 2012, theCompany has federal research and development credits carry forwards of approximately zero expiring beginning in 2031. Internal Revenue Code Section 382 places a limitation (the "Section 382 Limitation") on the amount of taxable income can be offset by net operating loss carryforwards after a change in control (generally greater than 50% change in ownership) of a loss corporation. California has similar rules. Our capitalizationdescribed herein may have resulted in such a change. Generally, after a control change, a loss corporation cannot deduct net operating loss carry forward inexcess of the Section 382 Limitation. Management has analyzed the utilization of its net operating loss carry forward against taxable income in future periodsand determined on a more likely than not basis it will be able to use all its recognized net operating losses before they expire.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 the position willbe sustained upon examination. As a result, we have provided contingent reserve under ASC 740-10 of $128 and $128 at December 31, 2012 and December31, 2011, respectively. Our tax returns are subject to review by various tax authorities. The returns are subject to review those from 2005 forward. Our policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. We did not have associatedaccrued interest or penalties nor was any interest expense or penalties recognized during the year ended December 31, 2012. A reconciliation of beginning and ending amounts of unrecognized tax benefits follows: Year EndedDecember 31,2012 Year EndedDecember 31,2011 Year EndedDecember 31,2010 Balance at the beginning of the year $128 $128 $- Additions based on tax positions related to the current year - - - Additions for tax positions of prior years - - 128 Settlements - - - Lapse of applicable statute of limitations - - - Balance at the end of the year $128 $128 $128 38Index Note 12 - Fair Value Measurement We apply fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in thefinancial statements on a recurring basis. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair valueinto three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:Level 1 – Quoted prices in active markets for identical assets or liabilities.Level 2 – Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets orliabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assetsor liabilities.Level 3 – Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing theasset or liability.The carrying amounts for cash and cash equivalents, investments in certificates of deposit, accounts payable and accrued expenses approximate their fairvalues due to the short period of time until maturity. Certificate of deposits: Fair value measured at face value plus accrued interest. Corporate bonds: Fair value measured at the closing price reported on the active market on which the individual securities are traded. Series I Warrants: Fair value measured by using a Binomial valuation model. As of December 31, 2012, the assumptions used to measure fairvalue of the liability embedded in our outstanding Series I Warrants included a warrant exercise price of $3.59 per share, a common share price of $29.28, adiscount rate of 0.72%, and a volatility of 94.15%. As of December 31, 2011, the assumptions used to measure fair value of the liability embedded in ouroutstanding Series I Warrants included a warrant exercise price of $3.59 per share, a common share price of $24.97, a discount rate of 0.83%, and avolatility of 123%.The following table sets forth by level, within the fair value hierarchy, our financial instrument assets as of December 31, 2012 (in thousands): Level 1 Level 2 Level 3 Total Certificates of deposit $17,836 — — $17,836 Corporate Bonds: AA 4,099 — — 4,099 A 4,047 4,047 BAA 511 511 Total Corporate Bonds 8,657 — — 8,657 Total Investments at Fair Value $26,493 — — $26,493 The following table sets forth by level, within the fair value hierarchy, our financial instrument assets as of December 31, 2011 (in thousands): Level 1 Level 2 Level 3 Total Certificates of deposit $2,584 — — $2,584 Corporate Bonds: AA 2,011 — — 2,011 A 9,843 — — 9,843 Total Corporate Bonds 11,854 — — 11,854 Total Investments at Fair Value $14,438 — — $14,438 The following table sets forth, by level within the fair value hierarchy, our financial instrument liabilities as of December 31, 2012 (in thousands): QuotedPrices inActiveMarkets forIdenticalAssets SignificantOtherObservableInputs SignificantUnobservableInputs (Level 1) (Level 2) (Level 3) Total Series l Warrants $— $— $4,172 $4,172 Total $— $— $4,172 $4,172 39IndexThe following table sets forth, by level within the fair value hierarchy, our financial instrument liabilities as of December 31, 2011 (in thousands): QuotedPrices inActiveMarkets forIdenticalAssets SignificantOtherObservableInputs SignificantUnobservableInputs (Level 1) (Level 2) (Level 3) Total Series l Warrants $— $— $4,699 $4,699 Total $— $— $4,699 $4,699 The following table sets forth a summary of changes in the fair value of our Level 3 financial instrument liability for the year ended December 31, 2012, 2011and 2010 (in thousands): Fair Value Measurements Using Significant UnobservableInputs (Level 3) Year endedDecember 31,2012 Year endedDecember 31,2011 Year endedDecember 31,2010 Beginning Balance $4,699 $14,364 $6,311 Net loss included in earnings 927 5,595 30,516 Settlements (1,454) (15,260) (22,463)Ending Balance $4,172 $4,699 $14,364 Note 13 - Patent Portfolio As of December 31, 2012, we own 20 issued U.S. and 32 issued foreign patents, in addition to several pending U.S. and foreign patent applications. Ourissued U.S. and foreign patents expire at various times during the period from 2019 to 2024. Some of our issued patents and pending patent applications wereacquired by our principal operating subsidiary, VirnetX, Inc., from Science Applications International Corporation, or SAIC, in 2006 and we are required tomake payments to SAIC based on cash or certain other values generated from those patents. The amount of such payments depends upon the type of valuegenerated, and certain categories are subject to maximums and other limitations. As of June 30, 2010, we met our maximum royalty payment requirement;however, SAIC is also entitled under certain circumstances to receive a portion of the proceeds paid to us for certain acquisitions of VirnetX or from thesettlement of certain patent infringement claims of ours. As of December 31, 2012, the expected future amortization of the intangible assets is as follows: 2013 $12 Total $12 40Index Note 14 - Litigation We have four intellectual property infringement lawsuits pending against multiple parties in the United States District Court for the Eastern District of Texas,Tyler Division, pursuant to which we allege that these parties infringe on certain of our patents. We seek damages and injunctive relief in all the complaints.We have one complaint with the United States International Trade Commission (ITC) alleging that Apple, Inc. has engaged in unfair trade practices by theimportation, sale for importation, and sale after importation of certain devices with secure communication capabilities that infringe one or more claims of ourU.S. Patent No. 8,051,181. On February 27, 2013, we announced our intent to withdraw our complaint with the ITC and pursue comprehensive relief fromApple Inc.’s infringement through the district courts.VirnetX Inc. v. Cisco Systems, Inc. et alOn August 11, 2010, we initiated a lawsuit by filing a complaint against Aastra, Apple, Cisco, and NEC in the United States District Court for the EasternDistrict of Texas, Tyler Division, pursuant to which we allege that these parties infringe on certain of our patents. We seek damages and injunctive relief. OnFebruary 4, 2011, we amended our original complaint, filed on August 11, 2010, against Aastra, Apple, Cisco and NEC in the United States District Courtfor the Eastern District of Texas, Tyler Division, to assert U.S. Patent No. 7,418,504 against Apple and Aastra. On April 5, 2011, we again amended ourcomplaint against Aastra, Apple, Cisco and NEC in the United States District Court for the Eastern District of Texas, Tyler Division, to include Apple’s iPad2 in the list of Apple products that are accused of infringing our patents. We also asserted our newly-issued patent, U.S. Patent No. 7,921,211 against all ofthe defendants in that lawsuit. A claim construction hearing was held on January 5, 2012 and the court issued a Markman ruling on April 25, 2012. Aastraand NEC have signed license agreements with us and we have dismissed the patent infringement cases against them. At the pre-trial hearing, the judge decidedto postpone the trial against Cisco to March 4, 2013 and just try the case against Apple. On November 6, 2012, a Jury in the United States Court for theEastern District of Texas, Tyler Division, awarded us over $368,000,000 in a verdict against Apple Corporation for infringing four of our patents. A post-trialhearing in the case against Apple was held on December 20, 2012. On February 26, 2013, the United States District Court for the Eastern District of Texas,Tyler Division issued its Memorandum Opinion and Order regarding post-trial motions resulting from the prior jury verdict. The Court denied Apple’s motionto reduce the damages awarded by the jury for past infringement. The Court further denied Apple’s request for a new trial on the liability and damages portionsof the verdict. Additionally, the Court granted our motions for pre-judgment interest, post-judgment interest, and post-verdict damages to date. Specifically, theCourt ordered that Apple pay $33,561 in daily interest up to final judgment and $330,201 in daily damages for infringement up to final judgment for certainApple devices included in the verdict. The Court denied our request for a permanent injunction. In doing so, the Court ordered the parties to mediate over alicense in the following 45 days for Apple’s future infringing use not covered by the Court’s Order. If the parties fail to agree to a license, the Court requestedthat we file the appropriate motion with the Court. The preparations for the jury trial against Cisco on March 4, 2013 are underway.VirnetX Inc. v. Mitel Networks Corporation et alOn January 12, 2011, we initiated a lawsuit by filing a complaint against Siemens and Mitel in the United States District Court for the Eastern District ofTexas, Tyler Division, pursuant to which we allege that these companies infringe three of our patents. We seek damages and injunctive relief. On April 12,2011 we again amended our complaint against Siemens and Mitel in the United States District Court for the Eastern District of Texas, Tyler Division, to addAvaya Inc. as a defendant. On July 11, 2012, Mitel Network Corporation signed a license agreement with us and we dismissed the patent infringement caseagainst them. On July 12, 2012 we had a claims construction hearing in this case and a markman order was issued on August 1, 2012. On January 29, 2013Siemens signed a license agreement with us and we dismissed the patent infringement case against them. The preparations for the jury trial against Avaya onMarch 4, 2013 are underway. VirnetX Inc. v. Apple, IncOn November 1, 2011, we initiated a lawsuit against Apple in the United States District Court, Tyler Division, pursuant to which we allege that Appleinfringes one or more claims of our U.S. Patent No. 8,051,181. We seek damages and injunctive relief. No hearing or trial dates have been set.VirnetX Inc. v. Apple, Inc.On November 6, 2012, we filed a new complaint against Apple Inc., in the United States District Court for the Eastern District of Texas, Tyler Division forwillfully infringing four of our patents, U.S. Patent Nos. 6,502,135, 7,418,504, 7,921,211 and 7,490,151, and seeking both damages and injunctiverelief. The accused products include the iPhone 5, iPod Touch 5th Generation, iPad 4th Generation, iPad mini, and the latest Macintosh computers. Due totheir release dates, these products were not included in the previous lawsuit that concluded with a Jury verdict on November 6, 2012 that was subsequentlyupheld by the United States District Court for the Eastern District of Texas, Tyler Division, on February 26, 2013. ITC Investigation No. 337-TA-858On July 18, 2012, the Administrative Law Judge (ALJ) assigned to investigate our complaint, against Apple Inc., identified a procedural discrepancy with ourcomplaint and dismissed it. On September 14, 2012, we re-filed our complaint with the ITC jointly with Science Applications International Corporation(SAIC) [NYSE: SAI] to remove a procedural standing issue that was identified as the reason for dismissal of our previous complaint. On October 16, 2012,the United States International Trade Commission (ITC) accepted our complaint and instituted an investigation against Apple and assigned ALJ E. JamesGildea to preside over this investigation. Subsequently on October 23, 2012, the ALJ issued an order setting February 21, 2014 as the target date forcompletion of this investigation. The hearing in-front of ALJ is scheduled for May 20, 2013. On February 27, 2013, we announced our intent to withdraw ourcomplaint with the ITC and pursue comprehensive relief from Apple Inc.’s infringement through the district courts. One or more potential intellectual property infringement claims may also be available to us against certain other companies who have the resources to defendagainst any such claims. Although we believe these potential claims are worth pursuing, commencing a lawsuit can be expensive and time-consuming, andthere is no assurance that we will prevail on such potential claims. In addition, bringing a lawsuit may lead to potential counterclaims which may precludeour ability to commercialize our initial products, which are currently in development.Note 15 - Quarterly Financial Information (unaudited) First Second Third Fourth (in thousands except per share) 2012 Revenue $- $36 $368 $8 Loss from operations (7,223) (11,734) (9,371) (10,533)Net loss (4,707) (10,264) (4,719) (7,234)Basic loss per common share $(0.09) $(0.20) $(0.09) $(0.14)Diluted loss per common share $(0.09) $(0.20) $(0.09) $(0.14) First Second Third Fourth (in thousands except per share)2011 Revenue $16 $1 $3 $- Loss from operations (2,752) (3,754) (4,180) (6,690)Net (loss) income (7,122) (9,805) 5,879 (6,215)Basic earnings (loss) per common share $(0.14) $(0.20) $0.12 $(0.12)Diluted earnings (loss) per common share $(0.14) $(0.20) $0.11 $(0.12) Note 16. Subsequest Event On January 29, 2013, we entered into a License Agreement with Siemens Enterprise Communications GmbH & Co. KG, and Siemens EnterpriseCommunications Inc.. Under the terms of the Agreement, the Parties have agreed to dismiss the patent infringement case between the Parties and their affiliatesbefore the U.S. District Court for the Eastern District of Texas. On February 26, 2013, the United States District Court for the Eastern District of Texas, Tyler Division issued its Memorandum Opinion and Orderregarding post-trial motions resulting from the November 6, 2012 jury verdict against Apple, Inc. The Court denied Apple’s motion to reduce the damagesawarded by the jury for past infringement. The Court further denied Apple’s request for a new trial on the liability and damages portions of the verdict.Additionally, the Court granted our motions for pre-judgment interest, post-judgment interest, and post-verdict damages to date. The Court ordered that Applepay daily interest up to final judgment and daily damages for infringement up to final judgment for certain Apple devices included in the verdict. The Courtdenied our request for a permanent injunction. The Court has ordered the parties to mediate over a license in the following 45 days for Apple’s future infringinguse not covered by the Court’s Order. If the parties fail to agree to a license, the Court requested that we file the appropriate motion with the Court for itsassistance. There can be no assurance a license agreement can be reached. Due to the remaining uncertainty regarding the conclusion of this litigation, thefinancial statements do not include any provision for gains or losses regarding this matter. 41Index Report of Independent Registered Public Accounting Firm To the Board of Directors andStockholders of VirnetX Holding Corporation We have audited the internal control over financial reporting of VirnetX Holding Corporation (the “Company”) as of December 31, 2012, based on criteriaestablished in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). TheCompany's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is toexpress 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 standards require thatwe plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all materialrespects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing therisk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our auditalso included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis forour opinion. A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principalfinancial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to providereasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’sassets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override ofcontrols, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of theeffectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changesin conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on thecriteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financialstatements as of and for the year ended December 31, 2012, of the Company and our report dated March 1, 2013, expressed an unqualified opinion on thosefinancial statements. /s/ Farber Hass Hurley LLP Granada Hills, CaliforniaMarch 1, 2013 42Index 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 Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted anevaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended, December 31, 2012. The purpose of this evaluation was to determine whether as of December 31, 2012 our disclosure controls and procedures were effective to provide reasonableassurance that the information we are required to disclose in our filings with the SEC, (i) is recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate to allow timely decisions regarding required disclosure. Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of December 31, 2012, our disclosure controls andprocedures were effective. Management's Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the company. Internal control overfinancial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting for external purposes in accordance withaccounting principles generally accepted in the United States of America. Internal control over financial reporting includes maintaining records that inreasonable detail accurately and fairly reflect our transactions; providing reasonable assurance that transactions are recorded as necessary for preparation ofour financial statements; providing reasonable assurance that receipts and expenditures of company assets are made in accordance with managementauthorization; and providing reasonable assurance that unauthorized acquisition, use or disposition of company assets that could have a material effect on ourfinancial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is notintended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected. Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control –Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, managementconcluded that the Company’s internal control over financial reporting was effective as of December 31, 2012. There were no changes in our internal controlover financial reporting during the quarter ended December 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internalcontrol over financial reporting. Farber Hass Hurley LLP has audited our internal control over financial reporting as of December 31, 2012; their report isincluded elsewhere herein. Item 9B. Other Information. None. 43Index PART III Certain information required by Part III is omitted from this report and is incorporated by reference to our definitive proxy statement pursuant to Regulation14A for our 2013 annual meeting of stockholders (the “Definitive Proxy Statement”) which will be filed within 120 days of our fiscal year end. Item 10. Directors, Executive Officers and Corporate Governance. The information required by this item is incorporated by reference to the information set forth in the Definitive Proxy Statement under the sections “Board ofDirectors,” “Nominee and Continuing Directors,” “Executive Officers,” “Composition of the Board of Directors,” “Board Meetings and Committees andAnnual Meeting Attendance,” “Audit Committee Matters” and “Section 16(a) Beneficial Ownership Reporting Compliance.” Information regarding delinquentfilers pursuant to Item 405 of Regulation S-K will be included under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in our ProxyStatement for the 2013 Annual Meeting of Stockholders and is incorporated herein by reference. Item 11. Executive Compensation. The information required by this item is incorporated by reference to the information set forth in the Definitive Proxy Statement under the sections“Compensation Committee Matters,” “Director Compensation,” “Executive Compensation,” “Compensation Committee Report,” “Summary CompensationTable,” “Outstanding Equity Awards at 2012 Fiscal Year-End,” and “Option Exercises in Fiscal Year 2012.” Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. The information required by this item is incorporated by reference to the information set forth in the Definitive Proxy Statement under the section “VotingSecurities and Principal Holders.” Securities Authorized for Issuance Under Equity Compensation Plans We have a stock incentive plan for employees and others called the “VirnetX Holding Corporation 2007 Stock Plan”, or the Plan, which has been approved byour stockholders. The Plan provides for the granting of up to 11,624,469 shares of our common stock, including stock options and stock purchase rights,and will expire in 2018. As of December 31, 2012, there were 121,422 shares available to be granted under the Plan. We had 4,776,224 and 4,906,998options outstanding at December 31, 2012, and December 31, 2011, respectively, with an average exercise price of $6.94 and $5.12, respectively and151,665 and zero restricted stock units outstanding at December 31, 2012 and December 31, 2011 respectively with an average exercise price of $25.60 andzero respectively. Plan Category Number ofSecurities tobe IssuedUpon ExerciseofOutstandingOptions,Warrantsand Rights (a) Weighted-AverageExercise PriceofOutstandingOptions,Warrants andRights (b) Number ofSecuritiesRemainingAvailable forFutureIssuanceUnder EquityCompensationPlansExcludingSecuritiesReflected inColumn (a) (c) Equity compensation plans approved by security holders 5,087,856 7.40 121,422 Equity compensation plans not approved by security holders — — Total 5,087,856 7.40 121,422 On April 5, 2012 the Compensation Committee granted 50,000 options to the employees of VirnetX Inc. On April 13, 2012 the CompensationCommittee granted an additional 190,000 options and 126,666 RSU’s to the employees of VirnetX, Inc. On May 24, 2012 the Compensation Committeegranted an additional 37,500 options and 24,999 RSU’s to the Board of Directors of VirnetX, Inc. On July 23, 2012 the Compensation Committee granted anadditional 40,000 options to the employees of VirnetX, Inc. On October 23, 2012 the Compensation Committee granted an additional 50,000 options to theemployees of VirnetX, Inc. 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 the Definitive Proxy Statement under the sections“Transactions with Related Persons” and “Composition of Board of Directors.” Item 14. Principal Accountant Fees and Services. The information required by this item is incorporated by reference to the information set forth in the Definitive Proxy Statement for the 2012 Annual Meeting ofStockholders under “Principal Accountant Fees & Services.” 44Index PART IV Item 15. Exhibits and Financial Statement Schedules. (a)The following documents are filed as part of this Annual Report on Form (1)Financial Statements: See the Index to Consolidated Financial Statements under Item 8 of this Annual Report on Form 10-K. (2)Financial Statement Schedule: Financial statement schedules are omitted because they are not applicable or the required information is shown in thefinancial statements or notes thereto. All other schedules are omitted because of the absence of conditions under which they are required or because therequired information is given in the financial statements or the notes thereto. (3)Exhibits: See Exhibit Index immediately following the signature page of this Form 10-K. 45Index 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 on Form 10-K tobe 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 1, 2013 46Index POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Kendall Larsen his or herattorney-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 file thesame, with exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, hereby ratifying and confirming allthat 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 following persons onbehalf of the registrant and in the capacities indicated. Name Capacity Date /s/ Kendall Larsen Director, Chief Executive Officer and President March 1, 2013Kendall Larsen (Principal Executive Officer) /s/ Richard Nance Chief Financial Officer March 1, 2013Richard Nance (Principal Financial Officer and PrincipalAccounting Officer) /s/ Robert D. Short III Director March 1, 2013Robert D. Short III /s/ Scott C. Taylor Director March 1, 2013Scott C. Taylor /s/ Michael F. Angelo Director March 1, 2013Michael F. Angelo /s/ Thomas M. O'Brien Director March 1, 2013Thomas M. O'Brien 47Index EXHIBIT INDEX ExhibitNumber Description3.1 Certificate of Incorporation of the Company. (1)3.2 By-Laws of the Company. (1)4.1 Form of Warrant Agency Agreement by and between the Company and Corporate Stock Transfer, Inc. as Warrant Agent. (2)4.2 Form of Series I Warrant. (3)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 Richard Nance. (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. (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 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)10.13 IP Brokerage Agreement by and between ipCapital Group, Inc. and VirnetX, Inc., effective as of March 13, 2008. (7)10.14 Engagement Letter by and between VirnetX Holding Corporation and ipCapital Group, Inc. dated March 12, 2008. (7)10.15* Engagement Letter dated June 9, 2009, by and between McKool Smith, a professional corporation, and the Company. (9)10.16 Engagement Letter dated April 15, 2010, by and between McKool Smith, a professional corporation, and the Company. (10)10.17* Settlement and License Agreement, by and between Microsoft Corporation, a Washington corporation, and VirnetX, Inc., a Delawarecorporation. (11)10.18 Amended Form of Stock Option Agreement - 2007 Stock Plan. (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 of2002.101.INS†† XBRL Instance Document101.SCH†† XBRL Taxonomy Extension Schema Document101.CAL†† XBRL Taxonomy Extension Calculation Linkbase Document101.DEF†† XBRL Taxonomy Extension Definition Linkbase Document101.LAB†† XBRL Taxonomy Extension Label Linkbase Document101.PRE†† XBRL Taxonomy Extension Presentation Linkbase Document (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 onMarch 18, 2008.(8)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.(9)Incorporated by reference to the Company's Form 10-Q (Commission File No. 001-33852) filed with the Securities and Exchange Commission onMay 7, 2010.(10)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.(11)Incorporated by reference to the Company's Form 10-Q (Commission File No. 001-33852) filed with the Securities and Exchange Commission onMay 10, 2011. *Confidential treatment has been granted by the U.S. Securities and Exchange Commission as to certain portions of this Exhibit. † The certifications attached as Exhibit 32.1 and 32.2 that accompany this Annual Report on Form 10-K are not deemed filed with the Securities andExchange Commission and are not to be incorporated by reference into any filing of VirnetX Holding Corporation under the Securities Act of 1933, asamended, or the Securities Act of 1934, as amended, whether before or after the date of this Form 10-K, irrespective of any general incorporation languagecontained in such filing. †† XBRL (eXtensible Business Reporting Language) information is furnished and not filed herewith, is not a part of a registration statement orprospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of1934, and otherwise is not subject to liability under these sections. 48EXHIBIT 21.1 Subsidiaries of Registrant Name of EntityJurisdiction ofIncorporation orOrganization Network Research Corporation Japan Ltd. (known as Network Research Corporation Japan Kabushiki Kaisha in Japan)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) and Form S-8 (No. 333-149883) of our reports dated March 1, 2013, relating to the consolidated financial statements of VirnetX Holding Corporation (the “Company”),and the effectiveness of the Company’s internal control over financial reporting, appearing in this Annual Report on Form 10-K of the Company for the yearended December 31, 2012. /s/ Farber Hass Hurley LLP Granada Hills, CA March 1, 2013 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, 2012;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 to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial 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 defined in ExchangeAct 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)) for theregistrant and have: (a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure 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 our supervision,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 the effectivenessof 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 most recent fiscalquarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and5.The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant'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 are reasonably likelyto 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 internal control overfinancial reporting. /s/ Kendall Larsen Kendall Larsen President and Chief Executive Officer (Principal Executive Officer) Date: March 1, 2013 EXHIBIT 31.2 CERTIFICATIONS I, Richard Nance, certify that: 1.I have reviewed this Annual Report on Form 10-K of VirnetX Holding Corporation for the fiscal year ended December 31, 2012;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 to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial 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 defined in ExchangeAct 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)) for theregistrant and have: (a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure 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 our supervision,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 the effectivenessof 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 most recent fiscalquarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and5.The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant'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 are reasonably likelyto 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 internal control overfinancial reporting. /s/ Richard Nance Richard Nance Chief Financial Officer (Principal Accounting and Financial Officer) Date: March 1, 2013 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, 2012as filed with the Securities and Exchange Commission on March 1, 2013 (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 1, 2013 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, 2012as filed with the Securities and Exchange Commission on March 1, 2013 (the "Report"), I, Richard Nance, 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/ Richard Nance Richard Nance Chief Financial Officer (Principal Accounting and Financial Officer) Date: March 1, 2013

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