VirnetX Holding Corp
Annual Report 2016

Plain-text annual report

TABLE OF CONTENTSUNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549FORM 10-K(Mark One)☒☒ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2016orooTRANSITION REPORT PURSUANT TO SECTION 13 Or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from to Commission File Number: 001-33852VirnetX Holding Corporation(Exact name of registrant as specified in its charter)Delaware77-0390628(State or other jurisdiction of incorporation or organization)(I.R.S. Employer Identification Number) 308 Dorla Court, Suite 206Zephyr Cove, Nevada89448(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 ClassName of Exchange on Which RegisteredCommon Stock, par value $0.0001 per shareNYSE MKT LLCSecurities registered pursuant to Section 12(g) of the Act:NoneIndicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No ☒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 ☒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 Actof 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes ☒ No oIndicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive DataFile required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or forsuch shorter period that the registrant was required to submit and post such files). Yes ☒ No oIndicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will notbe contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form10-K or any amendment to this Form 10-K. oIndicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.(Check one):Large accelerated filer oAccelerated filer ☒Non-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). Yeso No ☒The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant as of June 30, 2016, was$225,740,380 based upon the closing price of the common shares of the Registrant on June 30, 2016. This calculation does not reflect a determinationthat certain persons are affiliates of the Registrant for any other purpose.58,144,888 shares of Registrant’s Common Stock were outstanding as of March 10, 2017.DOCUMENTS INCORPORATED BY REFERENCECertain portions of this Annual Report on Form 10-K incorporate by reference information from the Registrant’s Proxy Statement to be filedwith the Securities and Exchange Commission not later than 120 days after December 31, 2016 in connection with the solicitation of proxies for theRegistrant’s 2017 Annual Meeting of Stockholders.TABLE OF CONTENTSINDEX Page PART I Item 1.Business 3 Item 1A.Risk Factors 13 Item 1B.Unresolved Staff Comments 23 Item 2.Properties 23 Item 3.Legal Proceedings 23 Item 4.Mine Safety Disclosure 26 PART II Item 5.Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of EquitySecurities 27 Item 6.Selected Financial Data 28 Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations 28 Item 7A.Quantitative and Qualitative Disclosures about Market Risk 41 Item 8.Financial Statements and Supplementary Data 42 Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 65 Item 9A.Controls and Procedures 65 Item 9B.Other Information 65 PART III Item 10.Directors, Executive Officers and Corporate Governance 66 Item 11.Executive Compensation 66 Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matter 66 Item 13.Certain Relationships and Related Transactions, and Director Independence 66 Item 14.Principal Accountant Fees and Services 67 PART IV Item 15.Exhibits and Financial Statement Schedules 67 TABLE OF CONTENTSSPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTSThe Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements made by us or on ourbehalf. We have included or incorporated by reference in this Annual Report on Form 10-K (including in the section entitledManagement’s Discussion and Analysis of Financial Condition and Results of Operations), and from time to time we may makestatements that may constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 andSection 21E of the Securities Exchange Act of 1934. These forward-looking statements are based upon our current expectations,estimates, assumptions and beliefs concerning future events and conditions and may discuss, among other things, anticipatedfuture performance (including sales and earnings), expected growth, future business plans and costs and potential liability forenvironmental-related matters. Any statement that is not historical in nature is a forward-looking statement and may be identifiedby the use of words and phrases such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “projects,”“will be,” “will continue,” “will likely result in,” and similar expressions. These statements include our belief and statementsregarding general industry and market conditions and growth rates, as well as general domestic and international economicconditions. Readers are cautioned not to place undue reliance on forward-looking statements. Forward-looking statements arenecessarily subject to risks, uncertainties and other factors, many of which are outside our control, which could cause actual resultsto differ materially from such statements and from our historical results and experience. These risks, uncertainties and other factorsinclude, but are not limited to those described in Item 1A - Risk Factors of this Annual Report on Form 10-K and elsewhere in theAnnual Report and those described from time to time in our future reports filed with the Securities and Exchange Commission.Readers are cautioned that it is not possible to predict or identify all of the risks, uncertainties and other factors that may affectfuture results and that the risks described herein should not be considered to be a complete list. Any forward-looking statementspeaks only as of the date on which such statement is made, and we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.EXCEPT AS REQUIRED BY LAW, WE UNDERTAKE NO OBLIGATION TO UPDATE OR REVISE ANY FORWARDLOOKING STATEMENT AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE.TABLE OF CONTENTSPART IItem1.Business.The CompanyWe are an Internet security software and technology Company with patented technology for secure communications including 4GLTE security. Our software and technology solutions, including our Secure Domain Name Registry and GABRIEL ConnectionTechnology™, are designed to facilitate secure communications and provide the security platform required by next-generationInternet-based applications such as instant messaging, or IM, voice over Internet protocol, or VoIP, mobile services, streamingvideo, file transfer, remote desktop and Machine-to-Machine, or M2M communications. Our technology generates secureconnections on a “zero-click” or “single-click” basis, significantly simplifying the deployment of secure real-time communicationsolutions by eliminating the need for end-users to enter any encryption information. Our portfolio of intellectual property is thefoundation of our business model. We currently own approximately 49 U.S. and 69 foreign patents with approximately 50 pendingpatent applications worldwide. Our patent portfolio is primarily focused on securing real-time 2017 communications over theInternet, as well as related services such as the establishment and maintenance of a secure domain name registry. Our patentedmethods also have additional applications in the key areas of device operating systems and network security for Cloud services,M2M communications in the new initiatives like “Smart City”, “Connected Car” and “Connected Home” that would connecteverything from social services and citizen engagement to public safety, transportation and economic development to the internetto enable more productivity, features and efficiency in our everyday lives. The subject matter of all our U.S. and foreign patentsand pending applications relates generally to securing communication over the internet, and as such covers all our technology andother products. Our issued U.S. and foreign patents expire at various times during the period from 2019 to 2024. Some of our issuedpatents and pending patent applications were acquired by our principal operating subsidiary; VirnetX, Inc., from Leidos, Inc., (f/k/aScience Applications International Corporation, or SAIC) in 2006 and we are required to make payments to Leidos, based on cashor certain other values generated from those patents. The amount of such payments depends upon the type of value generated, andcertain categories are subject to maximums and other limitations.Our product Gabriel Secure Communication Platform™, unlike other collaboration and communication products and services onthe market today, does not require access to user’s confidential data and reduces the threat of hacking and data mining. It enablesindividuals and organizations to maintain complete ownership and control over their personal and confidential data, securedwithin their own private network, while enabling authorized secure encrypted access from anywhere at any time. Our GabrielCollaboration Suite™ is a set of applications that run on top of our Gabriel Secure Communication Platform™. It enables seamlessand secure cross-platform communications between user’s devices that have our software installed. Our Gabriel CollaborationSuite™ is available for download and free trial, for Android, iOS, Windows, Linux and Mac OS X platforms, athttp://www.gabrielsecure.com/. We continue to enhance our products and add new functionality to our products. We will provideupdates to new and existing customers as they are released to the general public. Over 80 small and medium businesses haveinstalled our Gabriel Secure Communication Platform™ and Gabriel Collaboration Suite™ products in their corporate networks.We continue to rapidly expand our customer base with targeted promotions and direct sales initiatives.We have executed a number of patent and technology licenses and intend to seek further licensees for our technology, includingour GABRIEL Connection Technology™ to original equipment manufacturers, or OEMs, of chips, servers, smart phones, tablets, e-Readers, laptops, net books and other devices, within the IP-telephony, mobility, fixed-mobile convergence and unifiedcommunications markets including 4G/LTE Advanced.We have submitted a declaration with the 3rd Generation Partnership Project, or 3GPP, identifying a group of our patents andpatent applications that we believe are or may become essential to certain developing specifications in the 3GPP LTE, SAE project.We have agreed to make available a non-exclusive patent license under fair, reasonable and non-discriminatory terms andconditions, with compensation, or FRAND, to 3GPP members desiring to implement the technical specifications identified by us.We believe that we are positioned to license our essential security patents to 3GPP members as they move into deploying 4G/LTEAdvanced devices and solutions.We have an ongoing Gabriel Licensing Program under which we offer licenses to a portion of our patent portfolio, technology andsoftware, including our secure domain name registry service, to domain infrastructure providers, communication service providersas well as to system integrators. Our Gabriel Connection Technology™ License is offered to OEM customers who want to adopt theGABRIEL Connection Technology™ as their solution for establishing secure connections using secure domain names within theirproducts. We have developed GABRIEL3TABLE OF CONTENTSConnection Technology™ Software Development Kit (SDK) to assist with rapid integration of these techniques into existingsoftware implementations with minimal code changes and include object libraries, sample code, testing and quality assurance toolsand the supporting documentation necessary for a customer to implement our technology. Customers who want to develop theirown implementation of the VirnetX patented techniques for supporting secure domain names, or other techniques that are coveredby our patent portfolio for establishing secure communication links, can purchase a patent license. The number of patents licensed,and therefore the cost of the patent license to the customer, will depend upon which of the patents are used in a particular productor service. These licenses will typically include an initial license fee, as well as an ongoing royalty.We have signed Patent License Agreements with Avaya Inc., Aastra USA, Inc., Microsoft, Mitel Networks Corporation, NECCorporation and NEC Corporation of America, Siemens Enterprise Communications GmbH & Co. KG, and Siemens EnterpriseCommunications Inc. to license certain of our patents, for a one-time payment and/or an ongoing royalty for all future salesthrough the expiration of the licensed patents with respect to certain current and future IP-encrypted products. We have engagedIPVALUE Management Inc. to assist us in commercializing our portfolio of patents on securing real-time communications over theInternet. Under the multi-year agreement, IPVALUE is expected to originate and assist us with negotiating transactions related topatent licensing worldwide with respect to certain third parties.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 Advanced wireless networks and M2M communications in areasincluding Smart City, Connected Car and Connected Home. We also believe that all 4G/LTE Advanced mobile devices willrequire unique secure domain names and become part of a secure domain name registry.We intend to license our patent portfolio, technology and software, including our secure domain name registry service, to domaininfrastructure providers, communication service providers as well as to system integrators. We intend to seek further license of ourtechnology, 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.Our employees include the core development team behind our patent portfolio, technology and software. This team has workedtogether for over ten years and is the same team that invented and developed this technology while working at Leidos, Inc.(“Leidos”). Leidos is a FORTUNE 500® scientific, engineering and technology applications company that uses its deep domainknowledge to solve problems of vital importance to the nation and the world, in national security, energy and the environment,critical infrastructure and health. The team has continued its research and development work started at Leidos, and expanded theset of patents we acquired in 2006 from Leidos, into a larger portfolio of over 110 U.S. and international patents and with over 75pending 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 anddevelopment efforts to further strengthen 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 licensingbusiness by, for example, offering incentives to early licensing targets or asserting our rights for use of our patents. We also intendto expand our design pilot in participation with leading 4G/LTE companies (domain infrastructure providers, chipsetmanufacturers, service providers and others) and build our secure domain name registry.Industry OverviewWe believe that the rapid growth of mobile devices (smartphones/tablets/ultra-mobile PCs), with always-on network access, andneed to socially interact with friends and family while maintaining a constant online presence has transformed the “Internet of Web2.0” in to the “The Internet of the People”. It has become an evolving, rich and complex medium used by individuals andbusinesses to conduct commerce, share information and engage in real-time communications including email, text messaging, IM,and voice and video calls. We believe the user4TABLE OF CONTENTSdemand for high speed broadband access along with the quality of experience wherever they are and whatever BYOD (bring yourown device) they may be using; Mobility, IP video delivery, and the move to cloud have dramatically changed the way serviceproviders deliver services. While wireline networks remain the primary mechanism for delivering premium and high bandwidthservices, its growth has held steady compared to the growth of the mobile communications. The cost barrier to obtaining a mobiledevice with data access has disappeared allowing billions of people to have online access on fixed and mobile networks, and thoseusers accessing social networking websites, using peer-to-peer, or P2P applications, and uploading live content over the internet,which in turn is downloaded by millions, has led to significant growth in packet traffic. Not only is traffic growing and changing innature, its location of origin and timing has become completely unpredictable. There is a significant impact on the mobilesignaling network, brought on by smartphone penetration and consumer use of “chatty” applications that conduct frequentnetwork queries.We believe that as the users become more comfortable with using their smartphones/tablets and other connected devices, they willincreasingly treat their mobile and fixed/WiFi networks as a single network and demand seamless transition from one network typeto another without any disruption of service. The 4G/LTE standard was developed with the goal of creating a single IP network thatis efficient, flexible, open up new business models and services revenues and eventually lead to true “virtual networks” or software-defined networks (SDN). The service providers were forced to perform complete overhaul of their telecom network infrastructure inorder to move from TDM paradigm to next generation IP networks based on 4G/LTE for dealing with this rapidly growing demand.Before these network overhauls could be completed, some service providers decided to label their hybrid 3.5G/HSPA+/partial LTEimplementations as 4G networks in order to mitigate the risk of losing revenue. We believe this has led to significant confusionand misunderstanding among users.Adding to the demand for mobile and fixed broadband services is the fast adoption of connected machines or devices, or embeddedsystems capable of M2M communication. These M2M communications are made possible by a device (non-phone/tablet/pc suchas a sensor) that is attached to a machine to capture an event that is relayed over a network via 3G/4G routers or fixed broadbandlines, delivering data or events (such as temperature, location, consumption, heart rate, stress levels, light, movement, altitude andspeed) to applications creating an “Internet of Things” or IoT. As the service providers start deploying true 4G (Long TermEvolution-Advanced, or LTE-Advanced) and this pace picks up, we believe that almost every device will get its own uniqueidentity and a high-speed connection to the internet over a high speed IP (Internet Protocol) based telecommunication networkmaking it an “Internet of Everything”.We believe that growing security concerns and vulnerabilities in a large number of use-case scenarios due to the inherent “open”nature of this architecture can throttle the successful adoption of these technologies. Security can no longer exist as a pointsolution, and enterprises are currently upgrading core IT infrastructure (systems, networks, and management) to integrate securityinto everything. Because of the complexity of today’s networks and the requirement to connect users from any location at any timeon any device, enterprise buyers looking to improve security posture have to evaluate everything from software solutions forsmartphones to routers and switches with integrated security, massive security appliances for data centers, cloud-based securityservices, and security solutions for virtualized environments and public 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, as forecasted by Infonetics and by our internal estimates, are expected to grow fromapproximately $96 billion of worldwide revenues in 2012 to approximately $342 billion by 2017, representing a compoundannual growth rate, or CAGR, of approximately 29%. We believe that this growing trend represents a significant opportunity for usto license our technology and software, and establish our secure domain name registry.Enterprise Telephony – Unified Communications, VoIP, Telepresence and Video ConferencingEnterprise Telephony includes technologies that use Internet Protocol’s packet-switched connections to exchange voice, fax, andother forms of information traditionally carried over the dedicated circuit-switched connections of the public switched telephonenetwork, or PSTN. The adoption of Enterprise Telephony has helped businesses significantly lower network operating costs byusing a common network for voice and data. As the workforce becomes increasingly dispersed, mobile features enabled by Internetprotocol-based communications such as presence, unified messaging, peer-to-peer applications, find me/follow me, white-boardingand document sharing have become more commonplace. However, the development of the related security infrastructure haslagged behind,5TABLE OF CONTENTSleaving next-generation networks vulnerable to a multitude of threats including man-in-middle, eavesdropping, domain hijacking,distributed denial of service, or DDoS, spam over Internet telephony, or SPIT, and spam over instant messaging, or SPIM. Thesethreats continue to highlight the need for securing next-generation networks. As the use of Enterprise Telephony systems extendsbeyond the boundaries of an organization’s private network, security is likely to become an even bigger concern. Enterprises areincreasingly deploying an array of communication methodologies integrated into a single communications experience is oftenreferred to as unified communications. We believe that unified communications have higher utility and can increase productivityfor users. The basic components of unified communications include: a directory for storing addresses, various modes ofcommunication with each user/contact (desk phone, mobile phone, IM, etc.), message storage for all messages regardless ofcommunication method and secure presence of a user's status for each mode of communication (available, away, busy, etc.).Based on our estimates using Infonetics and other market data, we believe that worldwide revenue from IP telephony products likeIP-PBX including IP phones, service provider VoIP and IMS equipment, VoIP gateways, Enterprise Telepresence and VideoConferencing for businesses and Unified Communication clients, is expected to grow from approximately $38 billion in 2012 toapproximately $60 billion in 2017, representing a CAGR of approximately 9%. We believe our unique and patented solutionprovides a robust security platform for providing on-demand secure communication links between enterprises intending tocommunicate securely without manually configuring the connections. We believe a standard security solution such as ours willfurther accelerate the adoption of Enterprise telephony products in the market and allow enterprises to take full advantage of theserich content applications and real-time communications over the Internet, thereby significantly increasing their return oninvestment.IP Mobility- Smartphones, Embedded Devices, Machine-to-Machine (M2M) Devices (LTE)We believe that telecommunication markets are rapidly changing and presenting new challenges to the equipment and serviceproviders, including but not limited to increasing user demand for mobile, always-on connections with multiple devices. We alsobelieve that traffic growth, video acceleration, cloud services and a rapidly growing number of subscribers challenge currentlyavailable network architectures and that, because of this, service providers and carriers will eventually use a single network forfixed and mobile communications, private/premium communications and Internet access, in spite of the difficulties involvedchallenging their business models and forcing the consideration of new network architectures. We believe that LTE technologywill deliver users the benefits of faster data speeds and new services by creating a new radio access technology that's optimized forIP-based traffic and offers operators a simple upgrade path from 3G networks.Smartphones are multi-functional devices that handle a wide variety of business-critical applications and support increasinglycomplex functions including enhanced data processing, Internet access, e-mail access, calendars and scheduling, contactmanagement and the ability to view electronic documents. Users have continual access to these applications while on the movemaking them an increasingly essential business tool for the mobile worker. These devices enable mobile workers to have similarfunctionality inside or outside the office thereby increasing employee efficiency. However, it is critical that this mobileenvironment have the same level of security as an enterprise's internal network.Embedded mobile broadband computing devices include PCs, netbooks, tablets, and mobile Internet devices (MIDs) withembedded mobile broadband modems to enable Internet access via a mobile broadband network. A growing number of thesedevices are now shipping enabled with LTE/4G. Mobile Internet devices (MIDs) include handheld mobile Internet devices; e.g.eReader, gaming console, digital picture frame, digital camera, with embedded mobile broadband modems. Mobile broadbandrouters have mobile broadband modems or antenna as the broadband connection; have multiple Ethernet ports and integratedwireless access points for local area connectivity and bandwidth sharing; can have integrated hub or switch; may have anintegrated stateful firewall or IPSec VPN and are also known as mobile hotspot routers.Machine-to-Machine, or M2M, connected devices, or embedded systems; connected machines are fast becoming the eyes and earsof the enterprise. By adding sensors and networking technologies to the products they sell and the equipment they employ,companies are finding new ways to gather powerful insights and use new forms of data, thus creating a vast “internet of things”.This communication is made possible by a device (such as an intelligent sensor) that is attached to a machine to capture an event,such as such as temperature, location, consumption, heart rate, stress levels, light, movement, altitude and speed, that is relayedover a network delivering data to applications. The potential applications for this technology are numerous and as such includesmart meters in energy and utilities (the6TABLE OF CONTENTS“smart grid”), connected vehicles in automotive and logistics, heart monitors in healthcare, RFID tagged inventory in retail andmanufacturing, and digital signage in media and communications to name a few. Another fast growing application is in thewearable technology products namely, fitness and wellness, infotainment (information-based media content), healthcare andmedical, and industrial and military. The fitness and wellness segment comprises products like smart clothing and smart sensors,activity monitors, sleep sensors and others, whereas the Infotainment sector consists of products like smart watches, heads-updisplays, smart glasses and others. The products like continuous glucose monitor, drug delivery, monitors, wearable patches andothers have been covered under healthcare and medical segment and products like hand worn terminals, augmented realityheadsets and others have been mentioned under industrial and military segment. We believe that the large revenue potential forM2M services that has attracted the attention of carriers globally risks being thwarted by the growing security concerns in M2Mapplications. Porous security is exposing vulnerabilities in a large number of use-case scenarios, including cars, energymanagement systems, telemedicine, and telemetry. While built-in security is a high priority in all other information andcommunication technologies, it is yet to be considered, even at a basic level, in most M2M applications. The rapid and successfuladoption of M2M in automobiles, healthcare, industrial installations, and consumer homes may be jeopardized if communicationsecurity is not designed in to all M2M devices and applications. All these new devices will require a unique identity addressableby a secure domain name and all their communications, with application servers and other devices, completely securedautomatically and on-demand. IP mobility services require an environment where wired and wireless phones work together withInternet Protocol to deliver services (voice, video, data and combinations thereof) uniformly across multiple access networks,including, among others, LTE, WiMAX, WiFi cellular and fixed. Based on our estimates using Infonetics and other market data, webelieve that worldwide revenue from IP mobility products like smartphones, embedded devices, hotspots and mobile data cards,femtocell equipment, M2M communication devices and services is expected to grow from approximately $57 billion in 2012 toapproximately $282 billion by 2017, representing a CAGR of approximately 37%. We believe in order to realize the fullfunctionality of IP mobility, several challenges including security must be overcome. When users are mobile, connections and dataneed to cross multiple network boundaries, each of which poses a security threat. Wireless networks may be threatened orcompromised by rogue users who enter through (insecure wireless access points. We believe that providing authenticated access tothe M2M networks and enterprise applications are important requirements and represent a significant market opportunity for ourpatented technology and secure domain names to provide users or machines fully authenticated secure access on a “zero-click” or“single-click” basis.Our SolutionsOur software and technology solutions, including our secure domain name registry, our patents and our GABRIEL ConnectionTechnology™ are designed to secure real-time communications over the Internet. Our technology uses industry standardencryption methods with our patented DNS lookup mechanisms to create a secure communication link between users intending tocommunicate in real time over the Internet. Our technology can be built into network infrastructure, operating systems or siliconchips developed for a communication or computing device to secure real-time communications over the Internet betweennumerous devices. Our technology automatically encrypts data allowing organizations and individuals to establish communitiesof secure, registered users and transmit information between multiple devices, networks and operating systems. These securenetwork communities, which we call secure private domains, or SPDs, are designed to be fully-customizable and support richcontent applications such as IM, VoIP, mobile services, streaming video, file transfer and remote desktop in a completely secureenvironment. Our approach is a unique and patented solution that we believe provides the robust security platform required bythese 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 securechannel.•Control of data at all times. Users can secure and customize their unified communication and collaboration applicationssuch as file sharing and remote desktop with policy-based access and secure presence information.•Authenticated users. Users know they are communicating with authenticated users with secure domain names.7TABLE OF CONTENTS•Application-agnostic technology. Our solution provides security at the IP layer of the network by using patented DNSlookup mechanisms to make connections between secure domain names, thereby obviating the need to provideapplication specific security.Our ProductsOur Gabriel Secure Communication Platform™, unlike other collaboration and communication products and services on themarket today, does not require access to users’ confidential data and reduces the threat of hacking and data mining. It enablesindividuals and organizations to maintain complete ownership and control over their personal and confidential data, securedwithin their own private network, while enabling authorized secure encrypted access from anywhere at any time. Our GabrielCollaboration Suite™ is a set of applications that run on top of our Gabriel Secure Communication Platform™. It enables seamlessand secure cross-platform communications between users’ devices. The following applications are included in the current releaseand can be easily accessed through the Gabriel interface:•Secure chat - allows users to quickly send and receive text, files and screen shots•Secure share - allows users to grant coworkers read/write access to desired folders•Secure video/voice - provides users ability to conduct audio and/or video conferencing securely with any other Gabrieluser•Secure mail - allows users to send email and attachments directly from sender to recipient without requiring a centralizedmail server•Secure sync/backup - allows users to quickly push single files or automatically backup your files to one or multipleGabriel destinationsOur Gabriel Collaboration Suite™ is available for download and free trial, for Android, iOS, Windows, Linux and Mac OS Xplatforms, at http://www.gabrielsecure.com/. We continue to enhance our products and add new functionality to our products. Wewill provide updates to new and existing customers as they are released publically. Over 80 small and medium businesses haveinstalled our Gabriel Secure Communication Platform™ and Gabriel Collaboration Suite™ products in their corporate networks.We continue to rapidly expand our customer base with targeted promotions and direct sales initiatives.Competitive StrengthsWe believe the following competitive strengths will enable our success in the marketplace:•Unique patented technology. We are focused on developing innovative technology for securing real-timecommunications over the Internet, and establishing the exclusive secure domain name registry in the United States andother key markets around the world. Our unique solutions combine industry standard encryption methods andcommunication protocols with our patented techniques for automated DNS lookup mechanisms. Our technology andpatented approach enables users to create a secure communication link by generating secure domain names. We currentlyown approximately 49 U.S. and 69 foreign patents with approximately 50 pending patents applications worldwide. Ourportfolio includes patents and pending patent applications in the United States and other key markets that support oursecure domain name registry service for the Internet.•Scalable licensing business model. We are actively engaged in pursuing additional licensing agreements with OEMs,service providers and system integrators within the IP-telephony, mobility, mobile-to-mobile communications, fixed-mobile convergence and unified communications end-markets.•Highly experienced research and development team. Our research and development team is comprised of nationallyrecognized network security and encryption technology scientists and experts that have worked together as a team forover ten years. During their careers, this team has developed several cutting-edge technologies for U.S. national defense,intelligence and civilian agencies, many of which remain critical to our national security today. Prior to joining VirnetX,our team worked for Leidos, 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 oneof the most experienced and sophisticated groups of security experts researching vulnerability and threats to real-timecommunication over the Internet and developing solutions to mitigate these problems.8TABLE OF CONTENTSOur StrategyOur strategy is to become the market leader in securing real-time communications over the Internet and to establish our GABRIELCommunications Technology™ as the industry standard security platform. Key elements of our strategy are to:•Actively promote our Gabriel Secure Communication Platform™ and Gabriel Collaboration Suite™ products in thegeneral market for sale directly to end-user enterprises with targeted promotions and other marketing programs.•Continue to grow our technology licensing program to commercialize our intellectual property, including our GABRIELConnection Technology™ by adding more licensees in partnership with IPValue.•Establish VirnetX as the exclusive universal registry of secure domain names and to enable our customers to act asregistrars for their users and broker secure communication between users on different registries.We have submitted a declaration with the 3rd Generation Partnership Project, or 3GPP, identifying a group of our patents andpatent applications that we believe are or may become essential to certain developing specifications in the 3GPP LTE, SAE project.We have agreed to make available a non-exclusive patent license under fair, reasonable and non-discriminatory terms andconditions, with compensation, or FRAND, to 3GPP members desiring to implement the technical specifications identified by us.We have also submitted a number of updates to our original declaration, identifying additional technical specifications that wouldalso require a license to our US and International patents.License and Service OfferingsWe 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 modulefor supporting secure domain names, or who want to use their own techniques that are covered by our patent portfolio forestablishing secure communication links, could purchase a technology license. We anticipate that these licenses wouldtypically include an initial license fee, as well as an ongoing royalty. We expect that these licenses will include a one-time delivery of GABRIEL software development kit including object libraries, sample code, testing and qualityassurance tools and the supporting documentation necessary for a customer to implement of the techniques we havedeveloped.•GABRIEL Connection Technology™ Software Development Kit or SDK: OEM customers who want to adopt theGABRIEL Connection Technology™ as their solution for establishing secure connections using secure domain nameswithin their products could purchase an SDK license. The software development kit consists of object libraries, samplecode, testing and quality assurance tools and the supporting documentation necessary for a customer to implement ourtechnology. These tools are comprised of software for a secure domain name connection test server, a relay test server anda registration test server. We expect that customers would pay an up-front license fee to purchase an SDK license and aroyalty 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 and OEMs could purchase a license to our secure domain name registrar service. We would provide thesoftware suite and technology support to enable such customers to provision devices with secure domain names andfacilitate secure connections between registered devices. This suite includes the following server software modules:•Registrar server software: We anticipate that our registrar server software would enable customers to operate as a securedomain name registrar that provisions devices with secure domain names. The registrar server software is designed toprovide an interface for our customers to register new virtual private domains and sub-domain names. This server modulemust be enrolled with the VirnetX secure domain name master registry to obtain its credentials before functioning as anauthorized registrar.•Connection server software: We anticipate that our connection server software would allow customers to provideconnection services to enrolled devices. The connection services include registration of presence information forauthenticated users and devices, presence information query request services, enforcement of policies and support forcommunication with peers behind firewalls.9TABLE OF CONTENTS•Relay server software: We anticipate that our relay server software would allow customers to dynamically maintainconnections and relay data to private IP addresses for network devices that reside behind firewalls. Secure domain nameregistrar service customers will enter into a technology licensing and revenue sharing agreement with VirnetX wherebywe will typically receive an up-front licensing fee for the secure domain name registrar technology, as well as ongoingannual 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 registrarservice, we expect that we will maintain and manage the secure domain name master registry. This service is expected toenroll all secure domain name registrar customers and generate the credentials required to function as an authorizedregistrar. It also is expected to provide connection services and universal name resolution, presence information andsecure connections between authorized devices with secure domain names.•Technical support services: We intend to provide high-quality technical support services to licensees and customers forthe rapid customization and deployment of GABRIEL Connection Technology™ in an individual customer’s productsand services.Our research and development team was the team responsible for inventing the claimed subject matter of the patents that form thefoundation of our technology. This team has worked together for over ten years. We intend to leverage this experience andcontinue 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-time communications over the Internet and establishing the first andonly secure domain name registry, we believe our existing and future intellectual property portfolio will extend to additional areasincluding, among others, network security and operating systems for fixed and mobile devices.CustomersOur Gabriel Collaboration Suite™ is available for download and free trial, for Android, iOS, Windows, Linux and Mac OS Xplatforms, at http://www.gabrielsecure.com/. We continue to enhance our products and add new functionality to our products. Wewill provide updates to new and existing customers as they are released publically. Over 80 small and medium businesses haveinstalled our Gabriel Secure Communication Platform™ and Gabriel Collaboration Suite™ products in their corporate networks.We continue to rapidly expand our customer base with targeted promotions and direct sales initiatives.We have signed Patent License Agreements with Aastra USA, Inc. Avaya, Inc., Microsoft, Mitel Networks Corporation, NECCorporation and NEC Corporation of America, Siemens Enterprise Communications GmbH & Co. KG, and Siemens EnterpriseCommunications Inc. to license certain of our patents, for a one-time payment and an ongoing royalty for all future sales throughthe expiration of the licensed patents with respect to certain current and future IP-encrypted products.We are seeking further licensing of our technology, including our GABRIEL Connection Technology™ to developers and originalequipment manufacturers, or OEMs, of chips, servers, smart phones, tablets, e-Readers, laptops, net books and other devices, withinthe IP-telephony, mobility, fixed-mobile convergence and unified communications markets including 4G/LTE. We have publishedour royalty rates and guidelines on our website. All forward moving licenses have adhered to these guidelines and have met orexceeded these rates and we will use these rates and guidelines in all future license negotiations.Marketing and SalesWe plan to employ a leveraged, partner-oriented, marketing strategy for our technology licenses and software product offerings.We are actively working on a number of sales and marketing promotions that may involve online and direct sales programs as weseek to build out our customer base in 2017.We plan to directly market our Gabriel Secure Communication Platform™ and Gabriel Collaboration Suite™ products, domainname registry services to our service provider and system integrator customers. We market our Gabriel line of products directly tosmall and medium businesses using online marketing programs and tools. We hope to leverage our relationship with Leidos, toextend our offering to departments and agencies within the federal government. Leidos is a FORTUNE 500® scientific,engineering and technology applications company that uses its deep domain knowledge to solve problems of vital importance tothe nation and the world, in national security, energy10TABLE OF CONTENTSand the environment, critical infrastructure, and health. We intend to leverage our sales team for managing current accounts andpursuing sales opportunities with new customers.CompetitionWe believe our technology and solutions will compete primarily against various proprietary security solutions. We group thesesolutions into three main categories:•Proprietary or home-grown application specific security solutions have been developed by vendors and integrateddirectly into their products for our target markets including IP-telephony, mobility, fixed-mobile convergence, andunified communications. These proprietary solutions have been developed due to the lack of standardized approaches tosecuring real-time communications. This approach has led to corporate networks that are isolated and, as a result, restrictenterprises 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 manuallyexchange keys and other security parameters with each destination network outside their corporate network boundary.The cost-savings and other benefits of IP-based real-time communications are significantly limited by this approach tosecuring real-time communications.•A session border controller, or SBC, is a device used in networks to exert control over the signaling and media streamsinvolved in establishing, conducting and terminating VoIP calls. A traditional firewall or network address translation, orNAT, device typically block information like endpoint IP addresses and port numbers required by signaling protocols,such as SIP and XMPP, to reach and communicate with their intended destination. SBCs are used in physical networks toaddress these limitations and enable real-time session traffic to cross the boundaries created by firewalls and other NATdevices 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 designresults in SBCs becoming a single point of congestion on the network, as well as a single point of failure. SBCs are alsolimited to the physical network they secure.•SIP firewalls, or SIP-aware firewalls, and application layer gateways, manage and protect the traffic, flow and quality ofVoIP and other SIP-related communications. They perform real-time network address translation, dynamic firewallfunctions; support multiple signaling protocols, and media functionality, allowing secure interconnection and the flow ofIP media streams across multiple networks. While SIP firewalls assist in analyzing SIP traffic transmitted over thecorporate network to filter out various threats, they do not necessarily encrypt the traffic. As a result, this traffic is notentirely secure from end-to-end nor is it protected against threats like man-in-middle and eavesdropping.Intellectual Property and Patent RightsOur intellectual property is primarily comprised of trade secrets, patented know-how, issued and pending patents, copyrights andtechnological innovation.We currently own approximately 49 U.S. and 69 foreign patents with approximately 50 pending patent applications worldwide.Our portfolio includes a number of patents that describe unique systems and methods for securing real-time communications overthe Internet, as well as related services such as the establishment and maintenance of a secure domain name registry. Our softwareand technology solutions also may have additional applications relating to operating systems and network security. A completelist of our US patents is available on our website located at www.virnetx.com. Each patent is publicly accessible on the Internetwebsite of the U.S. Patent and Trademark Office at www.uspto.gov. The term of each of our issued U.S. and foreign patents willexpire during the period from 2019 to 2024.Notwithstanding anything to the contrary set forth in any of our filings under the Securities Act of 1933 or the SecuritiesExchange Act of 1934 that might incorporate future filings, the information set forth on the United States Patent and TrademarkOffice, or the USPTO Website, shall not be deemed to be a part of or incorporated by reference into any such filings. TheCompany does not warrant the accuracy, or completeness or adequacy of the USPTO Website, and expressly disclaims liability forerrors or omissions on such website.11TABLE OF CONTENTSAssignment of PatentsSome of our issued patents and pending patent applications were acquired by our principal operating subsidiary, VirnetX, Inc.,from Leidos, pursuant to an Assignment Agreement dated December 21, 2006, and a Patent License and Assignment Agreementdated August 12, 2005, as amended on November 2, 2006, including documents prepared pursuant to the November amendment,and as further amended on March 12, 2008. We recorded the assignment from Leidos, with the U.S. Patent Office on December 21,2006.Key terms of these agreements are as follows:Patent Assignment. Leidos, unconditionally and irrevocably conveyed, transferred, assigned and quitclaimed all its right, title andinterest in and to the patents and patent applications, as specifically set forth on Exhibit A to the assignment document recordedwith the U.S. Patent Office, including, without limitation, the right to sue for past infringement.License to Leidos, Outside the Field of Use. Effective March 12, 2008, we granted to Leidos, a non-exclusive, royalty free, fullypaid, perpetual, worldwide, irrevocable, sub licensable and transferable right and license permitting Leidos, and its assignees tomake, have made, import, use, offer for sale, and sell products and services covered by, and to make improvements to, the patentsand patent applications we acquired from Leidos, solely outside our field of use.Compensation Obligations. As consideration for the assignment of the patents and for the rights we obtained from Leidos, asamended, we are required to make payments to Leidos, based on cash or certain other values generated from those patents. Theamount of such payments depends upon the type of value generated, and certain categories are subject to maximums and otherlimitations. As of June 30, 2010, we met our maximum royalty payment requirement; however, Leidos, is also entitled undercertain circumstances to receive a portion of the proceeds paid to us for certain acquisitions of VirnetX and the settlement of certainpatent infringement claims of ours.Government RegulationThe laws governing online secure communications remain largely unsettled, even in areas where there has been legislative action.It may take years to determine whether and how existing laws governing intellectual property, privacy and libel apply to onlinecommunications and media. Such legislation may interfere with the growth in use of online secure communications and decreasethe acceptance of online secure communications as a viable solution, which could adversely affect our business.Due to the Internet’s popularity and increasing use, new laws regulating secure communications may be adopted. These laws andregulations may cover, among other things, issues relating to privacy, pricing, taxation, telecommunications over the Internet,content, copyrights, distribution and quality of products and services. We intend to comply with all new laws and regulations asthey 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, the President of the United States directed the U.S. Secretary of Commerce to privatize the management of thedomain name system in a manner that increases competition and facilitates international participation in its management.On September 29, 2006, the U.S. Department of Commerce extended its delegation of authority by entering into a new agreementwith the Internet Corporation for Assigned Names and Numbers, or ICANN, a California non-profit corporation headquartered inMarina Del Rey, California. ICANN is responsible for managing the accreditation of registry providers and registrars that managethe assignment of top level domain names associated with the authoritative DNS root directory. Although it is possible to createand manage other DNS root directories privately without accreditation from ICANN, the possibility of conflicting name andnumber assignments makes it less likely that users would widely adopt a top level domain name associated with an alternative DNSroot directory provided by a non-ICANN-accredited registry service.EmployeesAs of December 31, 2016 we had 20 full and part-time employees.Corporate Overview and HistoryVirnetX, Inc., was incorporated in the State of Delaware in August 2005. In November 2006, VirnetX acquired certain patents fromLeidos. In July 2007, we effected a reverse merger between PASW, Inc. and VirnetX, which became our12TABLE OF CONTENTSprincipal operating subsidiary. As a result of this merger, the former security holders of VirnetX came to own a majority of ouroutstanding common stock. On October 29, 2007 we changed our name from PASW, Inc. to VirnetX Holding Corporation.Available InformationWe file or furnish various reports, such as registration statements, periodic and current reports, proxy statements and other materialswith the SEC. Our Internet website address is www.virnetx.com. You may obtain, free of charge on our Internet website, copies ofour annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reportsfiled or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronicallyfile such material with, or furnish it to, the SEC. The information we post is intended for reference purposes only; none of theinformation 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’sPublic Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the PublicReference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy andother information statements, and other information regarding issuers, including us, that file electronically with the SEC. TheInternet address of the SEC’s Internet site is http://www.sec.gov.Item 1A.Risk FactorsOur operations and financial results are subject to various risks and uncertainties, including those described below, which couldadversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common andcapital stock. You should carefully consider the following information and the other information in this Form 10-K in evaluatingour business and prospects before making an investment decision with respect to our common stock. The risks and uncertaintieswe describe below are not the only ones facing us. Additional risks not presently known to us or that we currently deemimmaterial may also affect our business.Risks Related to Our Business and Our Financial ReportingWe are involved and will continue to be involved in litigation defending our patent portfolio, which can be time-consuming andcostly and we cannot anticipate the results.We spend a significant amount of our financial and management resources to pursue our current litigation. We believe that thislitigation and others that we may pursue in the future could continue for years and consume significant financial and managementresources. The counterpart to our litigation is a large, well-financed company with substantially greater resources than us. Wecannot assure you that any of our current or future litigation matters will result in a favorable outcome for us. In addition, even ifwe obtain favorable interim rulings or verdicts, they may be inconsistent with the ultimate resolution of the dispute. Also, wecannot assure you that we will not be exposed to claims or sanctions against us which may be costly or impossible for us to defend.Unfavorable or adverse outcomes may result in losses, exhaustion of financial resources or other adverse effects, which couldencumber our ability to develop and commercialize our products.We may seek additional capital to support our business growth, and this capital may be dilutive, cause our stock price to drop ormay not be available on acceptable terms, if at all.We may seek additional capital to support our business growth or to respond to business opportunities, challenges or unforeseencircumstances, including sales pursuant to our ATM Offering. Our ability to obtain additional capital, if and when required, willdepend on our business plans, investor demand, our operating performance, the condition of the capital markets, the terms of ourcurrent contractual obligations and other factors. If we raise additional funds through the issuance of equity, equity-linked or debtsecurities, including those pursuant to our ATM Offering, those securities may have rights, preferences, or privileges senior to therights of our common stock, and our existing stockholders may experience dilution. Additionally, we are unable to predict thesuccess of our current ATM offering. Sales of a substantial number of shares of our common stock in the public market, theperception that these sales or other financings might occur, could depress the market price of our common stock and could alsoimpair our ability to raise capital through the sale of additional equity securities. If we issue debt securities or incur indebtedness,the incurrence of indebtedness would result in increased fixed payment obligations and could also result in restrictive13TABLE OF CONTENTScovenants, such as limitations on our ability to incur additional debt, limitations on our ability to acquire, sell or licenseintellectual property rights and other operating restrictions that could adversely impact our ability to conduct our business. If weare unable to obtain additional capital, or are unable to obtain additional capital on satisfactory terms, our ability to continue tosupport our business growth or to respond to business opportunities, challenges, or other circumstances could be adverselyaffected, and our business may be harmed.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 basethan we could reach through direct sales and marketing efforts; as such, our business strategy and revenues will depend onintellectual property licensing fees and royalties for the majority of our revenues. We currently derive minimal revenue fromlicensing activities and we cannot assure you that we will successfully capitalize on our market opportunities or that our currentbusiness strategy will succeed. Factors that may affect our ability to execute our current business strategy include, but are notlimited to:•Although to date we have entered into a limited number of settlement and license agreements, we may not be successfulin entering into further licensing relationships, or if we are successful in entering into such relationships, the acquisitionof them may be expensive, and they, as well as our existing settlement and license agreements may not generate thefinancial 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 face, and we expect to continue to face, intense competition from new and established competitors who may havesuperior 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 ortechnologies similar to, competitive with 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 ofinfringement or invalidity claims with respect to our patents and such claims could give rise to material cost for defense orsettlement or both, jeopardize or substantially delay a successful outcome of litigation we are or may become involved in, divertresources away from our other activities, limit or cease our revenues related to such patents, or otherwise materially and adverselyaffect our business. Similar challenges could also prevent us from obtaining additional patents in the future. Additionally, severalof our patents are currently, and other patents may in the future be, subject to USPTO post-grant inter partes review proceedings(“IPR”) which may result in all or part of these patents being invalidated or the claims of our patents being limited. Unfavorable oradverse outcomes in our litigation or IPRs may result in losses, exhaustion of financial resources, reduction in our ability to enforceour intellectual property rights, or other adverse effects, which could encumber our ability to develop and commercialize ourproducts. Even if we are successful in enforcing our intellectual property rights, our patents may not ultimately provide us with anycompetitive advantages and may be less valuable than we currently expect. These risks may be heightened in countries other thanthe United States where laws regarding patent protection are less developed, and may be negatively affected by the fact that legalstandards in the United States and elsewhere for protection of intellectual property rights in Internet-related businesses areuncertain and still evolving. In addition, there are a significant number of United States and foreign patents and patent applicationsin our areas of interest, and we expect that significant litigation in these areas will continue, and will add uncertainty to the valueof certain patents and other intellectual property rights in our areas of interest. If we are unable to protect our intellectual propertyrights or otherwise realize value from them, our business would be negatively affected.We can provide no assurances that the licensing of our essential security patents under FRAND will be successful.At the request of the European Telecommunications Standards Institute or “ETSI”, and the Alliance for TelecommunicationsIndustry Solutions or “ATIS”, we agreed to update our licensing declaration to ETSI and ATIS under their respective IntellectualProperty Rights or “IPR” policies. This was in response to our Statement of Patent Holder identifying a group of our patents andpatent applications that we believe are or may become essential to certain developing specifications in the 3rd GenerationPartnership Project (3GPP) Long Term Evolution or “LTE”, Systems Architecture Evolution or “SAE” project. We will makeavailable a non-exclusive patent license under14TABLE OF CONTENTSFRAND (fair, reasonable and non-discriminatory terms and conditions, with compensation) for the patents identified by us that areor become essential, to applicants desiring to implement the Technical Specifications identified by us, as set forth in the updatedlicensing declaration under the ATIS and ETSI IPR policies. Our licensing declarations under the ATIS and ETSI IPR policies maylimit our flexibility in determining royalties and license terms for certain of our patents. Consequently, we cannot assure you thatthe licensing of the essential security patents will be successful or that third parties will be willing to enter into licenses with us onreasonable terms or at all, which could have an adverse effect on our business and harm our competitive position.Because our business is conducted or expected to be conducted in an environment that is subject to rapid change, we may besubject to various developments 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 plannedproduct offerings will be in compliance with laws and regulations of local, state, United States federal or foreign authorities.Further, we can give no assurance that we will not unintentionally violate such laws or regulations or that such laws or regulationswill not be modified, or that new laws or regulations will be enacted in the future which would cause us to be in violation of suchlaws or regulations. For example, Voice-over-Internet Protocol or “VoIP” services are not currently subject to all of the sameregulations that apply to traditional telephony, but it is possible that similar regulations may be applied to VoIP in the future andthat these could result in substantial costs to us which could adversely affect the marketability of our products and plannedproducts related to VoIP. For further example, the use of the Internet and private Internet Protocol or “IP” networks forcommunication is largely unregulated within the United States, but may become regulated in the future; also several foreigngovernments have enacted measures that could restrict or prohibit voice communications services over the Internet or private IPnetworks.Our business depends on the growth of instant messaging, VoIP, mobile services, streaming video, file transfer and remote desktopand other next-generation Internet-based applications. A decline in the use of these applications due to complexity or cost of theseapplications relative to alternate traditional or newly developed communications channels, or development of alternativetechnologies, could cause a material decline in the number of users in these areas.More aggressive domestic or international regulation of the Internet in general, and Internet telephony providers and servicesspecifically may materially and adversely affect our business, financial condition, operating results and future prospects.Our exposure to outside influences beyond our control, including new legislation, court rulings or actions by the United StatesPatent and Trademark Office, could adversely affect our licensing and enforcement activities and results of operations.Our licensing and enforcement activities are subject to numerous risks from outside influences, including the following:•New legislation, regulations or rules related to obtaining patents or enforcing patents could significantly increase ouroperating costs and decrease our revenue. For instance, the United States Supreme Court has recently modified some testsused by the United States Patent and Trademark Office or “USPTO” in granting patents during the past 20 years whichmay decrease the likelihood that we will be able to obtain patents and increase the likelihood of challenge of any patentswe obtain or license. In addition, the United States recently enacted sweeping changes to the United States patent systemunder the Leahy-Smith America Invents Act or “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.•As patent enforcement becomes more prevalent, it may become more difficult for us to voluntarily license our patents.15TABLE OF CONTENTSIf 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 becritical to our business strategy that our facilities and infrastructure remain secure and are perceived by the marketplace to besecure. Our secure domain name registry operations will also depend on our ability to maintain our computer andtelecommunications equipment in effective working order and to reasonably protect our systems against interruption, andpotentially 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 andmoney to maintain or increase the security of our facilities and infrastructure. Security technologies are constantly being tested bycomputer professionals, academics and “hackers.” Advances in the techniques for attacking security solutions could make some orall of our products obsolete or unmarketable. Likewise, if any of our products are found to have significant security vulnerabilities,then we may need to dedicate engineering and other resources to eliminate the vulnerabilities and to repair or replace productsalready 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 financialand other resources to address such problems. Any physical or electronic break-in or other security breach or compromise of theinformation stored at our secure data centers and domain name registration systems may jeopardize the security of informationstored on our premises or in the computer systems and networks of our customers. In such an event, we could face significantliability and customers could be reluctant to use our services. Such an occurrence could also result in adverse publicity andtherefore adversely affect the market’s perception of the security of electronic commerce and communications over IP networks aswell as the security or reliability of our services.A security breach could require a substantial level of financial resources to rectify and could result in a product liability claim thatcauses us to incur substantial liability and related legal and other costs. A security breach may also harm our reputation and make itmore difficult or impossible for us to successfully market to others. These matters could harm our operating results and financialcondition.Privacy and data security concerns, and data collection and transfer restrictions and related domestic or foreign regulations maylimit the use and adoption of our solutions and adversely affect our business.Personal privacy, information security, and data protection are significant issues in the United States, Europe and many otherjurisdictions where we have operations or offer our products. The regulatory framework governing the collection, processing,storage and use of confidential and proprietary business information and personal data is rapidly evolving. The U.S. federal andvarious state and foreign governments have adopted or proposed requirements regarding the collection, distribution, use, securityand storage of personally identifiable information and other data relating to individuals, and federal and state consumer protectionlaws are being applied to enforce regulations related to the online collection, use and dissemination of data.Further, many foreign countries and governmental bodies, including the European Union, or EU, where we conduct business, havelaws and regulations concerning the collection and use of personal data obtained from their residents or by businesses operatingwithin their jurisdiction. These laws and regulations often are more restrictive than those in the United States. Laws and regulationsin these jurisdictions apply broadly to the collection, use, storage, disclosure and security of data that identifies or may be used toidentify or locate an individual, such as names, email addresses and, in some jurisdictions, Internet Protocol, or IP, addresses.We also expect that there will continue to be new proposed laws, regulations and industry standards concerning privacy, dataprotection and information security in the United States, the EU, and other jurisdictions. For example, the European Commissionrecently adopted a General Data Protection Regulation, effective in May 2018, that will supersede current EU data protectionlegislation, impose more stringent EU data protection requirements, and provide for greater penalties for noncompliance. Wecannot yet determine the impact such future laws, regulations and standards may have on our business. Such laws and regulationsare often subject to differing interpretations, may be inconsistent among jurisdictions, and may be alleged to be inconsistent withour current or future practices. Additionally, we may be bound by contractual requirements applicable to our collection, use,processing, and disclosure of various types of data, including personal data, and may be bound by, or voluntarily comply with,self-regulatory or other industry standards relating to these matters. These and other requirements could reduce demand for ourproducts, increase our costs, impair our ability to grow our business, or restrict our ability to store and process data or, in somecases, impact our ability to offer our service in some locations and may subject us to liability. Any failure or perceived failure tocomply with applicable laws, regulations, industry standards, and16TABLE OF CONTENTScontractual obligations may adversely affect our business. Further, in view of new or modified federal, state or foreign laws andregulations, industry standards, contractual obligations and other legal obligations, or any changes in their interpretation, we mayfind it necessary or desirable to fundamentally change our business activities and practices or to expend significant resources tomodify our product and otherwise adapt to these changes. We may be unable to make such changes and modifications in acommercially reasonable manner or at all, and our ability to develop new products and features could be limited.The costs of compliance with and other burdens imposed by laws, regulations and standards may limit the use and adoption of ourservice and reduce overall demand for it, or lead to significant fines, penalties or liabilities for any noncompliance. Privacy,information security, and data protection concerns, whether valid or not valid, may inhibit market adoption of our platform,particularly in certain industries and foreign countries.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 factors, including but not limited to:•The need to educate potential customers about our patent rights and our product and service capabilities;•Our customers’ willingness to invest potentially substantial resources and modify their network infrastructures to takeadvantage of our products;•Our customers’ budgetary constraints;•The timing of our customers’ budget cycles;•Delays caused by customers’ internal review processes; and•Long sales cycles that may increase the risk that our financial resources are exhausted before we are able to generatesignificant revenue.If we are unable to expand our revenue sources or establish, sustain, grow or replace relationships with a diversified customerbase, our revenues may be limited.We currently generate revenue from a limited number of customers that have entered into Settlement and License Agreements.Although our GABRIEL Collaboration Suite is not currently generating revenue, it will take time for us to grow our installed userbase and generate new customers. Additionally, there is no guarantee that we will be able to derive revenue from new customers,sustain or increase revenue from existing customers or replace customers from whom we currently generate revenue. As a result, ourrevenue may be limited or static.We have limited technical resources and are at an early stage in the development and commercialization of our GABRIELCollaboration Suite.We recently launched our first commercial product, the GABRIEL Collaboration Suite. As such, we have a small technical team,which limits our ability to rapidly adapt our product to customer requirements or add new product features to maintain ourcompetitive edge and drive adoption. Based on the scale of our technical resources, our limited historical financial data uponwhich to base our projected revenue or planned operating expenses related to our GABRIEL Collaboration Suite, we may not beable to effectively:•generate revenues or profit from product sales;•drive adoption of our products;•attract and retain customers for our products;•provide appropriate levels of customer training and support for our products;•implement an effective marketing strategy to promote awareness of our products;•focus our research and development efforts in areas that generate returns on our efforts;•anticipate and adapt to changes in our market; or•protect our products from any system failures or other breaches.17TABLE OF CONTENTSIn addition, a high percentage of our expenses are and will continue to be fixed. Accordingly, if we do not generate revenue as andwhen anticipated, our losses may be greater than expected and our operating results will suffer.Our products are highly technical and may contain undetected errors, which could cause harm to our reputation and adverselyaffect our business.Our products are highly technical and complex and, when deployed, may contain errors or defects. Despite testing, some errors inour products may only be discovered after a product has been installed and used by customers. Any errors or defects discovered inour products after commercial release could result in failure to achieve market acceptance, loss of revenue or delay in revenuerecognition, loss of customers and increased service and warranty cost, any of which could adversely affect our business, operatingresults and financial condition. In addition, we could face claims for product liability, tort or breach of warranty, including claimsrelating 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 thatutilize our services, which could result in legal claims against us, harming our business. Furthermore, we expect to provideimplementation, consulting and other technical services in connection with the implementation and ongoing maintenance of ourproducts, which typically involves working with sophisticated software, computing and communications systems. We expect thatour contracts with customers will contain provisions relating to warranty disclaimers and liability limitations, which may not beupheld. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and adversely affect themarket’s perception of us and our products. In addition, if our business liability insurance coverage proves inadequate or futurecoverage is unavailable on acceptable terms or at all, our business, operating results and financial condition could be adverselyimpacted.Malfunctions of third-party communications infrastructure, hardware and software expose us to a variety of risks that we cannotcontrol.Our business will depend upon, among other things, the capacity, reliability and security of the infrastructure owned by thirdparties that we will use to deploy our offerings. We have no control over the operation, quality or maintenance of a significantportion of that infrastructure or whether or not those third parties will upgrade or improve their equipment. We depend on thesecompanies to maintain the operational integrity of our connections. If one or more of these companies is unable or unwilling tosupply or expand its levels of service to us in the future, our operations could be severely interrupted. Also, to the extent that thenumber of users of networks utilizing our current or future products suddenly increases, the technology platform and secure hostingservices which will be required to accommodate a higher volume of traffic may result in slower response times or serviceinterruptions. System interruptions or increases in response time could result in a loss of potential or existing users and, if sustainedor repeated, could reduce the appeal of the networks to users. In addition, users depend on real-time communications; outagescaused by increased traffic could result in delays and system failures. These types of occurrences could cause users to perceive thatour solution does not function properly and could therefore adversely affect our ability to attract and retain licensees, strategicpartners and customers.System failure or interruption or our failure to meet increasing demands on our systems could harm our business.The success of our license and service offerings will depend on the uninterrupted operation of various systems, secure data centersand other computer and communication networks that we establish. To the extent the number of users of networks utilizing ourfuture products suddenly increases, the technology platform and hosting services which will be required to accommodate a highervolume of traffic may result in slower response times, service interruptions or delays or system failures. Our systems and operationswill also be vulnerable to damage or interruption from, among other things:•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 ourcontrol.System interruptions or failures and increases or delays in response time could result in a loss of potential or existing users and, ifsustained or repeated, could reduce the appeal of the networks to users. These types of occurrences could18TABLE OF CONTENTScause users to perceive that our solution does not function properly and could therefore adversely affect our ability to attract andretain licensees, strategic partners and customers.Any significant problem with our systems or operations could result in lost revenue, customer dissatisfaction or lawsuits against us.A failure in the operation of our secure domain name registration system could result in the inability of one or more registrars toregister and maintain secure domain names for a period of time. A failure in the operation or update of the master directory that weplan to maintain could result in deletion or discontinuation of assigned secure domain names for a period of time. The inability ofthe registrar systems we establish, including our back office billing and collections infrastructure, and telecommunications systemsto 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-qualitytechnical support services could have a material adverse effect on our sales and results of operations.If we do not effectively assist our customers in deploying our products, succeed in helping our customers quickly resolve post-deployment issues and provide effective ongoing support, or if potential customers perceive that we may not be able achieve to theforegoing, our ability to sell our products would be adversely affected, and our reputation with current and potential customerscould be harmed. In addition, as we expand our operations internationally, our technical support team will face additionalchallenges, including those associated with delivering support, training and documentation in languages other than English. Ourfailure to deliver and maintain high-quality technical support services to our customers could result in customers choosing to useour competitors’ products and support services instead of ours in the future.Telephone carriers have petitioned governmental agencies to enforce regulatory tariffs, which, if granted, would increase thecost of online communication, and such increase in cost may impede the growth of online communication and adversely affectour business.Use of the Internet has over-burdened existing telecommunications infrastructures, and many high traffic areas have begun toexperience interruptions in service. As a result, certain local telephone carriers have petitioned governmental agencies to enforceregulatory tariffs on IP telephony traffic that crosses over their traditional telephone networks. If the relief sought in these petitionsis granted, the costs of communicating via online could increase substantially, potentially adversely affecting the growth in the useof online secure communications. Any of these developments could have an adverse effect on our business.The departure of Kendall Larsen, our Chief Executive Officer and President, and/or other key personnel could compromise ourability to execute our strategic plan and may result in additional severance costs to us.Our success largely depends on the skills, experience and efforts of our key personnel, including Kendall Larsen, our ChiefExecutive Officer and President. We have no employment agreements with any of our key executives that prevent them fromleaving us at any time. In addition, we do not maintain key person life insurance for any of our officers or key employees. The lossof Mr. Larsen, or our failure to retain other key personnel, would jeopardize our ability to execute our strategic plan and materiallyharm 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 engineering, operations, marketing, sales andexecutive personnel. Inability to attract and retain such personnel could adversely affect our business. Competition forengineering, operations, marketing, sales and executive personnel is intense, particularly in the technology and Internet sectorsand in the regions where we conduct our business. We can provide no assurance that we will attract or retain such personnel.We may identify future material weakness which may result in late filings, increased costs or declines in our share price.Although we believe that we currently maintain effective control over our disclosures and procedures and internal control overfinancial reporting, we may in the future identify deficiencies regarding the design and effectiveness of our system of internalcontrol over financial reporting. If we experience any material weaknesses in our internal19TABLE OF CONTENTScontrol over financial reporting the future or are unable to provide unqualified management or attestation reports about ourinternal controls, we may be unable to meet financial and other reporting deadlines and may incur costs associated withremediation, and any of which could cause our share price to decline.Risks Related to Our StockWe do not currently pay dividends on our common stock and thus stockholders must look to appreciation of our common stockto realize a gain on their investments.Our dividend policy is within the discretion of our Board of Directors and will depend upon various factors, including ourbusiness, financial condition, results of operations, capital requirements, and investment opportunities. We therefore cannot makeassurances that our Board of Directors will determine to pay regular or special dividends in the future. Accordingly, unless ourBoard of Directors determines to pay dividends, stockholders will be required to look to appreciation of our common stock torealize a gain on their investment. This appreciation may not occur.The exercise of our outstanding stock options and issuance of new shares would result in a dilution of our current stockholders’voting power and an increase in the number of shares eligible for future resale in the public market which may negatively impactthe market price of our stock.The exercise of our outstanding vested stock options would dilute the ownership interests of our existing stockholders. As ofDecember 31, 2016, we had outstanding options to purchase an aggregate of 5,378,571 shares of common stock representing9.25% of our total shares outstanding of which 4,472,193 were vested and therefore exercisable. To the extent outstanding stockoptions are exercised, additional shares of common stock will be issued, existing stockholders’ percentage voting interests willdecline and the number of shares eligible for resale in the public market will increase. Such increase may have a negative effect onthe value or market trading price of our common stock.Trading in our common shares is limited and the price of our common shares may be subject to substantial volatility.Our common stock is listed on NYSE MKT. Over the past years the market price of our common stock has experienced significantfluctuations. Between January 1, 2016, and December 31, 2016, the reported last adjusted closing price on NYSE MKT for ourcommon stock ranged between $2.00 and $7.31 per share. The price of our common stock may continue to be volatile as a result ofa number of factors, some of which are beyond our control. These factors include, but not limited to, the following:•developments or lack thereof in any then-outstanding litigation;•quarterly variations in our operating results;•large purchases or sales of common stock or derivative 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•general social, political, economic and financial conditions, including the significant volatility in the global financialmarkets as a result of the announcement of the Referendum of the United Kingdom’s membership of the European Union,referred to as Brexit.In addition, we believe there has been and may continue to be substantial trading in derivatives of our stock, including shortselling activity or related similar activities, which are beyond our control and which may be beyond the full control of the SEC andFinancial Institutions Regulatory Authority or “FINRA”. While the SEC and FINRA rules prohibit some forms of short selling andother activities that may result in stock price manipulation, such activity may nonetheless occur without detection or enforcement.We have held conversations with regulators concerning trading activity in our stock; however, there can be no assurance thatshould there be any illegal manipulation in the trading of our stock, it will be detected, prosecuted or successfully eradicated.Significant short selling or other types of market manipulation could cause our stock trading price to decline, to become morevolatile, or both.The market price of our common stock may decline because our operating results may not be consistent and may be difficult topredict.Our reported net income has fluctuated in the past due to several factors. We expect that our future operating results may alsofluctuate due to the same or similar factors. We had a net loss of $9.9 million for the year ended20TABLE OF CONTENTSDecember 31, 2014, and a net loss of $29.2 million for the year ended December 31, 2015 and a net loss $28.6 million for theperiod ended December 31, 2016, with an accumulated deficit of $158.2 million. The following include some of the factors thatmay 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 thefuture, 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 ofthose licenses, including the number of our patents which are licensed, the extent of prior infringement of our patentrights, royalty rates, timing of payment obligations, expiration date etc.;•the success of a licensee in selling products that use our patented technologies; and•the amount and timing of expenses related to our patent filings and enforcement proceedings, including litigation,related to our intellectual property rights.These fluctuations may make our business particularly difficult to manage, adversely affect our business and operating results,make our operating results difficult for investors to predict and, further, cause our results to fall below investor’s expectations andadversely affect the market price of our common stock.The market price of our common stock has been and may continue to be volatile, and you could lose all or part of yourinvestment.The trading price of our common stock has been volatile since our initial public offering, and is likely to continue to be volatile.Factors that could cause fluctuations in the market price of our common stock include the following:•price and volume fluctuations in the overall stock market from time to time;•volatility in the market prices and trading volumes of companies in our industry or companies that investors considercomparable;•changes in operating performance and stock market valuations of other companies generally, or those in our industry inparticular;•sales of shares of our common stock by us or our stockholders;•failure of securities analysts to maintain coverage of us, changes in financial estimates by securities analysts who followus, or our failure to meet these estimates or the expectations of investors;•the financial projections we may provide to the public, any changes in those projections or our failure to meet thoseprojections;•announcements by us or our competitors of new products or services;•the public’s reaction to our press releases, other public announcements and filings with the SEC;•rumors and market speculation involving us or other companies in our industry;•actual or anticipated changes in our results of operations;•changes in tax and other incentives that we rely upon in order to raise tax equity investment funds;•changes in the regulatory environment and utility policies and pricing, including those that could reduce the savings weare able to offer to customers;•actual or anticipated developments in our business, our competitors’ businesses or the competitive landscape generally;•litigation involving us, our industry or both, or investigations by regulators into our operations or those of ourcompetitors;•announced or completed acquisitions of businesses or technologies by us or our competitors;•new laws or regulations or new interpretations of existing laws or regulations applicable to our business;21TABLE OF CONTENTS•changes in accounting standards, policies, guidelines, interpretations or principles;•any significant change in our management; and•general economic conditions and slow or negative growth of our markets.Further, in recent years the stock markets have experienced extreme price and volume fluctuations that have affected and continueto affect the market prices of equity securities of many companies. These fluctuations often have been unrelated ordisproportionate to the operating performance of those companies. In addition, the stock prices of many renewable energycompanies have experienced wide fluctuations that have often been unrelated to the operating performance of those companies.These broad market and industry fluctuations, as well as general economic, political and market conditions such as recessions,government shutdowns, interest rate changes the stability of the EU and the exit of the United Kingdom or international currencyfluctuations, may cause the market price of our common stock to decline. In the past, following periods of volatility in the overallmarket and the market price of a particular company’s securities, securities class action litigation has often been instituted againstthese companies.Because ownership of our common stock is concentrated, investors may have limited influence on stockholder decisions.As of December 31, 2016, our executive officers and directors beneficially owned approximately 19% of our outstanding commonstock. In addition, a group of stockholders that, as of December 31, 2007, held 4,766,666 shares, or approximately 8.4% of our thenoutstanding common stock, have entered into a voting agreement with us that requires them to vote all of their shares of our votingstock in favor of the director nominees approved by our Board of Directors at each director election going forward, and in a mannerthat is proportional to the votes cast by all other voting shares as to any other matters submitted to the stockholders for a vote.However, we cannot be certain how many shares of our common stock this group of stockholders currently owns. Because of theirbeneficial ownership interest, our officers and directors could significantly influence stockholder actions of which you disapproveor that are contrary to your interests. This ability to exercise significant influence could prevent or significantly delay anothercompany from acquiring or merging with us.Our protective provisions could make it difficult for a third party to successfully acquire us even if you would like to sell yourstock to them.We have a number of protective provisions that could delay, discourage or prevent a third party from acquiring control of uswithout the approval of our Board of Directors. Our protective provisions include:•A staggered Board of Directors: This means that only one or two directors (since we have a five-person Board ofDirectors) will be up for election at any given annual meeting. This has the effect of delaying the ability of stockholdersto effect a change in control of us because it would take two annual meetings to effectively replace a majority of theBoard of Directors.•Blank check preferred stock: Our Board of Directors has the authority to establish the rights, preferences and privilegesof our 10,000,000 authorized, but unissued, shares of preferred stock. Therefore, this stock may be issued at the discretionof our Board of Directors with preferences over your shares of our common stock in a manner that is materially dilutive toyou. In addition, blank check preferred stock can be used to create a “poison pill” which is designed to deter a hostilebidder from buying a controlling interest in our stock without the approval of our Board of Directors. We have notadopted 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 stockholdermeetings: Stockholders wishing to submit director nominations or raise matters to a vote of the stockholders mustprovide notice to us within very specific date windows and in very specific form in order to have the matter voted on at astockholder meeting. This has the effect of giving our Board of Directors and management more time to react tostockholder proposals generally and could also have the effect of disregarding a stockholder proposal or deferring it to asubsequent 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 andwithout prior notice to our Board of Directors and management or to the minority stockholders. Along with the advancenotice requirements described above, this provision also gives our Board of Directors and management more time to reactto proposed stockholder actions.22TABLE OF CONTENTS•Super majority requirement for stockholder amendments to the By-laws: Stockholder proposals to alter or amend ourBy-laws or to adopt new By-laws can only be approved by the affirmative vote of at least 66 2/3% of the outstandingshares of our common stock.•No ability of stockholders to call a special meeting of the stockholders: Only the Board of Directors or management cancall special meetings of the stockholders. This could mean that stockholders, even those who represent a significantpercentage of our shares of common stock, may need to wait for the annual meeting before nominating directors or raisingother business proposals to be voted on by the stockholders.In addition, the provisions of Section 203 of the Delaware General Corporate Law govern us. These provisions may prohibit largestockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us for acertain period of time.These and other provisions in our amended and restated certificate of incorporation, our By-laws and under Delaware law coulddiscourage potential takeover attempts, reduce the price that investors might be willing to pay for shares of our common stock inthe future and result in the market price being lower than it would be without these provisions.Item 1B.Unresolved Staff Comments.NoneItem 2.PropertiesOur principal executive offices are located at 308 Dorla Court, Suite 206, Zephyr Cove, Nevada, 89448. We lease this property,which comprises approximately 2,090 square feet of office space, from a third party for a term that ends in October 2017. We haveno other properties and believe that our office facility is suitable and appropriately supports our current business needs.Item 3.Legal ProceedingsWe have nine intellectual property infringement lawsuits pending in the United States District Court for the Eastern District ofTexas, Tyler Division, and United States Court of Appeals for the Federal Circuit (“USCAFC”).VirnetX Inc. v. Apple, Inc. (Case 6:12-CV-00855-LED)On March 30, 2015, the United States Court for the Eastern District of Texas, Tyler Division, issued an order finding substantialoverlap between the remanded portions of the Civil Action Case 6:10-CV-00417-LED (VirnetX vs. Cisco et. al.), and the ongoingCivil Action Case 6:12-CV-00855-LED (VirnetX Inc. v. Apple, Inc.). The court consolidated the two civil actions under CivilAction Case 6:12-CV-00855-LED (VirnetX Inc. v. Apple, Inc.) and designated it as the lead case. The jury trial in this case was heldon January 25, 2016. On February 4, 2016, a jury in the United States Court for the Eastern District of Texas, Tyler Division,awarded us $625.6 million in a verdict against Apple Inc. for infringing four of our US patents, marking it the second time a federaljury has found Apple liable for infringing VirnetX’s patented technology. The verdict includes royalties awarded to us based on anearlier patent infringement finding (Case 6:10-CV-00417-LED) against Apple. The jury found that Apple’s modified VPN On-Demand, iMessage and FaceTime services infringed VirnetX’s patents and that Apple’s infringement was willful. In addition todetermining the royalty owed by Apple for its prior infringement, this verdict also includes an award based on the jury’s findingthat Apple’s modified VPN On Demand, iMessage and FaceTime services have continued to infringe VirnetX’s patents. The post-trial hearing was held on May 25, 2016 in the United States Court for the Eastern District of Texas, Texarkana Division. On July29, 2016, the court issued a new order, vacating its previous orders consolidating the cases (Case No. 6:10-cv-417, Docket No. 878(“Apple I case”); Case No. 6:12-cv-855, Docket No. 220 (“Apple II case”)), ordering that the two cases be retried separately, andsetting the retrial date for Apple I case with jury selection to begin on September 26, 2016. The court also ordered that the issue ofwillfulness in both cases is bifurcated and that the Apple II case will be retried after Apple I case. Events and developmentssubsequent to the order from the court are described to support Apple I and Apple II matters.VirnetX Inc. v. Cisco Systems, Inc. et al. (Case 6:10-CV-00417-LED) (“Apple I”)On August 11, 2010, we initiated a lawsuit by filing a complaint against Aastra USA. Inc. (“Aastra”), Apple, Cisco Systems, Inc.(“Cisco”), and NEC Corporation (“NEC”) in the United States District Court for the Eastern District of Texas, Tyler Division,pursuant to which we alleged that these parties infringe on certain of our patents. We sought23TABLE OF CONTENTSdamages and injunctive relief. Aastra and NEC agreed to sign license agreements with us and we agreed to drop all the accusationsof infringement against them. At the pre-trial hearing, the judge decided to conduct separate jury trial for each defendant, and tryonly the case against Apple on the scheduled trial date. The jury trial of our case against Cisco was held on March 4, 2013. Thejury in our case against Cisco came back with a verdict of non-infringement also determined that all our patents-in-suit patents arenot invalid. Our motions for a new trial and Cisco’s infringement of certain VirnetX patents were denied and the case against Ciscowas closed.The jury trial of our case against Apple was held on October 31, 2012. On November 6, 2012, a jury in the United States Court forthe Eastern District of Texas, Tyler Division, awarded us over $368 million in a verdict against Apple for infringing four of ourpatents. On February 26, 2013, the court issued its Memorandum Opinion and Order regarding post-trial motions resulting from theprior jury verdict denying Apple’s motion to reduce the damages awarded by the jury for past infringement. The Court furtherdenied Apple’s request for a new trial on the liability and damages portions of the verdict and granted our motions for pre-judgment interest, post-judgment interest, and post-verdict damages to date. The Court ordered that Apple pay $34 in daily interestup to final judgment and $330 in daily damages for infringement up to final judgment for certain Apple devices included in theverdict. The Court denied our request for a permanent injunction and severed the future infringement portion into its own separateproceedings under Case 6:13-CV-00211-LED.On July 3, 2013, Apple filed an appeal of the judgment dated February 27, 2013 and order dated June 4, 2013 denying Apple’smotion to alter or amend the judgment to the USCAFC. On September 16, 2014, USCAFC issued their opinion, affirming the jury’sfinding that all 4 of our patents are valid, confirming the jury’s finding of infringement of VPN on Demand under many of theasserted claims of our ‘135 and ‘151 patents, and confirming the district’s court’s decision to allow evidence concerning ourlicenses and royalty rates in connection with the determination of damages. In its opinion, the USCAFC also vacated the jury’sdamages award and the district court’s claim construction with respect to parts of our ‘504 and ‘211 patents and remanded thedamages award and determination of infringement with respect to FaceTime –for further proceedings consistent with its opinion.On October 16, 2014, we filed a petition with the USCAFC, requesting a rehearing and rehearing en banc of the Federal Circuit’sSeptember 14, 2014, decision concerning VirnetX’s litigation against Apple Inc. On December 16, 2014, USCAFC denied ourpetition requesting a rehearing and rehearing en banc of the Federal Circuit’s September 14, 2014, decision and remanded the caseback to the Eastern District of Texas, Tyler Division, for further proceedings consistent with its opinion. On February 25, 2015,USCAFC granted Apple’s motions to lift stay of proceedings and vacate Case 6:13-CV-00211-LED. On March 30, 2015, the courtissued an order finding substantial overlap between the remanded portions of this case and the ongoing Civil Action Case 6:12-CV-00855-LED (VirnetX Inc. v. Apple, Inc.). The court consolidated the two civil actions under Civil Action Case 6:12-CV-00855-LED (VirnetX Inc. v. Apple, Inc.) and designated it as the lead case.On July 29, 2016, the court issued a new order, vacating its previous orders consolidating the cases Apple I case and Apple II case,ordering that the two cases be retried separately, and setting the retrial date for Apple I case with jury selection to begin onSeptember 26, 2016. The court also ordered that the issue of willfulness in both cases is bifurcated and that the Apple II will beretried after Apple I case.The jury trial in this case was held on September 26, 2016. On September 30, 2016, a Jury in the United States Court for the EasternDistrict of Texas, Tyler Division, in the case VirnetX Inc., et al. v. Apple Inc., No. Apple I, has awarded VirnetX $302.4 million in averdict against Apple Corporation for infringing four VirnetX patents, marking the third time a federal jury has found Apple liablefor infringing VirnetX’s patented technology.The verdict includes royalties awarded to VirnetX, for unresolved issues in the Apple I case, remanded back from the USCAFC,related to (1) damages owed to VirnetX for infringement by Apple’s original VPN-on-Demand (VOD) and (2) the allegedinfringement by Apple’s original FaceTime product, under the new claim construction of “secure communication link” pertainingto the ’504 and ’211 patents by the USCAFC, and the damages associated with that infringement. The hearing on all the post-trialmotions was held on November 22, 2016. We are currently awaiting the court ruling and final judgement in this case.VirnetX Inc. v. Apple, Inc. (Case 6:12-CV-00855-LED) (“Apple II”)On November 6, 2012, we filed a new complaint against Apple in the United States District Court for the Eastern District of Texas,Tyler Division for willfully infringing four of our patents, U.S. Patent Nos. 6,502,135, 7,418,504, 7,921,211 and 7,490,151, andseeking both an unspecified amount of damages and injunctive relief. The accused products include the iPhone 5, iPod Touch 5thGeneration, iPad 4th Generation, iPad mini, and the latest Macintosh24TABLE OF CONTENTScomputers. Due to their release dates, these products were not included in the previous lawsuit that concluded with a Jury verdicton November 6, 2012 that was subsequently upheld by the United States District Court for the Eastern District of Texas, TylerDivision, on February 26, 2013. On July 1, 2013, we filed a consolidated and amended complaint to include U.S. Patent No.8,051,181 and consolidate Civil Action No. 6:11-cv-00563-LED. On August 27, 2013, we filed an amended complaint includingallegations of willful infringement related to U.S. Patent No. 8,504,697 seeking both damages and injunctive relief. The Markmanhearing in this case was held on May 20, 2014 and on August 8, 2014, issued its Markman Order, denying Apple’s motion forsummary judgment of indefiniteness, in which Apple alleged that some of the disputed claims terms in the patents asserted by uswere invalid for indefiniteness. In a separate order, the court granted in part and denied in part our motion for partial summaryjudgment on Apple’s invalidity counterclaims, precluding Apple from asserting invalidity as a defense against infringement of theclaims that were tried before a jury in our prior litigation against Apple (VirnetX vs. Cisco et. al., Case 6:10-CV-00417-LED). Thejury trial in this case was scheduled for October 13, 2015. On March 30, 2015, the court issued an order finding substantial overlapbetween this case and the remanded portions of Case 6:10-CV-00417-LED (VirnetX vs. Cisco et. al.). The court consolidated thetwo civil actions under Civil Action Case 6:12-CV-00855-LED (VirnetX Inc. v. Apple, Inc.) and designated it as the lead case. OnJuly 29, 2016, the court issued a new order, vacating its previous orders consolidating the cases Apple I case and Apple II case,ordering that the two cases be retried separately, and setting the retrial date for Apple I case with jury selection to begin onSeptember 26, 2016. The court also ordered that the issue of willfulness in both cases is bifurcated and that the Apple II will beretried after Apple I case. We are awaiting court order setting the date for a new jury trial in Apple II case.VirnetX Inc. v. Apple, Inc. (Case 15-1934)On July 10, 2015, we filed appeals with the USCAFC, appealing the invalidity findings by the United States Patent and TrademarkOffice, Patent Trial and Appeal Board (“PTAB”) in IPR2014-00237 and IPR2014-00238, related to U.S. Patent No. 8,504,697. Theoral arguments in this case were heard on November 7, 2016. On December 9, 2016, the USCAFC affirmed the PTAB based on thegrounds discussed in IPR2014-00238. We are currently evaluating our options in this case.VirnetX Inc. v. Apple, Inc. (Case 16-1211)On September 28, 2015, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in IPR2014-00403 andIPR2014-00404 and on October 22, 2015 for IPR2014-00481 and IPR2014-00482 involving our U.S. Patent Nos. 7,188,180, and7,987,274. The oral arguments in this case were heard on November 7, 2016. On December 9, 2016, the USCAFC affirmed thePTAB based on the grounds discussed in IPR2014-00403 and IPR2014-00481. We are currently evaluating our options in thiscase.VirnetX Inc. v. Apple, Inc. (Case 16-1480)On November 30, 2015, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in inter-partesreexamination no. 95/001,949 related to U.S. Patent No. 8,051,181. The oral arguments in this case were heard on November 7,2016. On December 9, 2016, the USCAFC affirmed the PTAB based on certain grounds. We are currently evaluating our options inthis case.VirnetX Inc. v. Apple, Inc. (case 16-119)On March 4, 2016, we filed a petition for writ of mandamus with the USCAFC, requesting the USCAFC’s intervention to revoke thePTAB’s decision joining Apple to IPR2015-01046 and IPR2015-01047, related to U.S. Patent Nos. 6,502,135 and 7,490,151. OnMarch 18, 2016, the USCAFC denied the petition without prejudice to us raising the arguments on appeal after the PTAB’s finaldecisions. We are currently evaluating our options in this case.VirnetX Inc. v. Apple, Inc. (Case 17-1131)On October 31, 2016, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in IPR2015-00810,IPR2015-00812, on November 9, 2016 for IPR2015-00811, and on November 28, 2016 for IPR2015-00866, IPR2015-00868,IPR2015-00870, IPR2015-00871 involving our U.S. Patent Nos.8,868,705, 8,850,009, 8,458,341, 8,516,131, and 8,560,705. Theseappeals have been consolidated.VirnetX Inc. v. The Mangrove Partners (Case 17-1368)On December 16, 2016, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in IPR2015-01046, andon December 20, 2016 for IPR2015-1047, involving our U.S. Patent Nos. 6,502,135, and 7,490,151. These appeals also involveApple, Inc. and one of them involves Black Swamp IP, LLC.25TABLE OF CONTENTSOne or more potential intellectual property infringement claims may also be available to us against certain other companies whohave the resources to defend against any such claims. Although we believe these potential claims are worth pursuing, commencinga lawsuit can be expensive and time-consuming, and there is no assurance that we will prevail on such potential claims. Inaddition, bringing a lawsuit may lead to potential counterclaims which may preclude our ability to commercialize our initialproducts, which are currently in development. Currently, we are not a party to any other pending legal proceedings, and are notaware of any proceeding threatened or contemplated against us by any governmental authority or other party.Item 4.Mine Safety Disclosure.Not applicable26TABLE OF CONTENTSPART IIItem 5.Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.Market InformationOur common stock currently trades under the symbol “VHC” on the NYSE MKT LLC.The following table shows the price range of our common stock, as reported on the NYSE MKT LLC, for each quarter ended duringthe last two fiscal years.Quarter EndedHighLow3/31/15$8.09 $4.66 6/30/15$7.48 $4.02 9/30/15$4.76 $2.71 12/31/15$4.29 $2.12 3/31/16$9.64 $1.95 6/30/16$6.50 $3.99 9/30/16$4.64 $2.29 12/31/16$5.13 $2.10 The closing price of our common stock on the NYSE MKT LLC on March 10, 2017 was $2.20 per share.HoldersAs of March 10, 2017, we had 45 stockholders of record. Because many of our shares of common stock are held of record bybrokers and other institutions on behalf of stockholders, we are unable to estimate the total number of beneficial stockholdersrepresented by such record holders.DividendsWe do not currently intend to begin paying a regular dividend in the foreseeable future. Any future determination to declare cashdividends will be made at the discretion of our board of directors and will depend on our financial condition, operating results,capital requirements, general business conditions and other factors that our board of directors may deem relevant.Performance GraphThis performance graph shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, asamended (the Exchange Act), or incorporated by reference into any filing of VirnetX under the Securities Act of 1933, asamended, or the Exchange Act, except as shall be expressly set forth by specific reference in such filing. 27TABLE OF CONTENTSThe stock price performance reflected on this graph is not necessarily indicative of future stock price performance. See thedisclosure in part I, Item 1A. “Risk Factors” 12/1112/1212/1312/1412/1512/16VirnetX Holding Corp 100.00 117.26 77.73 21.99 10.29 8.81 S&P 500 100.00 116.00 153.58 174.60 177.01 198.18 RDG Technology Composite 100.00 114.61 152.95 178.50 183.08 206.81 Recent Sales of Unregistered SecuritiesDuring the year ended December 31, 2016, we had no sales of unregistered securities and no repurchases of stock.Item 6.Selected Financial Data. (in thousands except per share data)The consolidated statement of operations data for the three years ended December 31, 2016, 2015 and 2014 and the balance sheetdata at December 31, 2016 and 2015, are derived from our audited financial statements included elsewhere in this Annual Reporton Form 10-K. The consolidated statement of operations data for the two years ended December 31, 2013 and 2012 and the balancesheet data at December 31, 2014, 2013 and 2012 are derived from our audited financial statements not included in this annualreport on Form 10-K.The selected consolidated financial data below are not necessarily indicative of future performance and should be read inconjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and theconsolidated financial statements and related notes thereto included in Item 8 of this Annual Report on Form 10-K. For the year ended December 31, 20162015201420132012Consolidated Statement of Operations Data: Revenue$1,550 $1,555 $1,249 $2,197 $412 Gain on settlement$— $— $23,000 $— — Other operating expenses$(30,055)$(30,732)$(36,414)$(30,784)$(39,273)Income tax (expense) benefit$(133)$(8)$(15)$(751)$12,535 Net loss$(28,569)$(29,234)$(9,902)$(27,608)$(26,924)Loss per share$(0.51)$(0.56)$(0.19)$(0.54)$(0.53)Consolidated Balance Sheet Data: Cash and cash equivalents$6,627 $8,726 $18,658 $19,173 $19,661 Investments available for sale$9.249 $9,954 $22,571 $19,815 $26,493 Total assets$18,871 $22,172 $45,090 $39,398 $61,313 Stockholders’ equity$11,147 $15,095 $32,627 $34,024 $53,944 (a)The gain on settlement in 2014 relates to a cash settlement of litigation with Microsoft.(b)In 2010, we had a taxable income of $75 million, which allowed us to carry back 2012 NOLs for tax refunds. Due to the tax refunds derived fromcarrying back the 2012 NOLs, we recognized the tax benefit of $12.5 million in 2012. In addition, we made a determination to provide a fullvaluation allowance for our net deferred tax assets at the end of 2012, based on our evaluation of positive and negative evidence, including ourhistory of operating losses and the uncertainty of generating future taxable income that would enable it to realize its deferred tax assets.Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations.Company OverviewWe develop software and technology solutions for securing real-time communications over the Internet. Our patented GABRIELConnection Technology™ combines industry standard encryption protocols with our patented techniques for automated domainname system, or DNS, lookup mechanisms, and enables users to create a secure communication link using secure domain namesover wired or wireless (4G/LTE) networks. Our Gabriel Collaboration Suite™ is available for download and free trial, for Android,iOS, Windows, Linux and Mac OS X platforms, at http://www.gabrielsecure.com/. We continue to enhance our products and addnew functionality to our products. We will provide updates to new and existing customers as they are released to the generalpublic. Over 8028TABLE OF CONTENTSsmall and medium businesses have installed our Gabriel Secure Communication Platform™ and Gabriel Collaboration Suite™products in their corporate networks. We continue to rapidly expand our customer base with targeted promotions and direct salesinitiatives. We also intend to establish the exclusive secure domain name registry in the United States and other key marketsaround the world.Our portfolio of intellectual property is the foundation of our business model. We currently own over 100 U.S. and internationalpatents with over 50 pending applications. Our patent portfolio is primarily focused on securing real-time communications overthe Internet, as well as related services such as the establishment and maintenance of a secure domain name registry. Our patentedmethods also have additional applications in the key areas of device operating systems and network security for Cloud services,M2M communications in areas of Smart City, Connected Car and Connected Home.We have submitted a declaration with the 3rd Generation Partnership Project, or 3GPP, identifying a group of our patents andpatent applications that we believe are or may become essential to certain developing specifications in the 3GPP LTE, SAE project.We have agreed to make available a non-exclusive patent license under fair, reasonable and non-discriminatory terms andconditions, with compensation, or FRAND, to 3GPP members desiring to implement the technical specifications identified by us.We believe that we are positioned to license our essential security patents to 3GPP members as they move into 4G.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 Advanced wireless networks and M2M communications in areasincluding Smart City, Connected Car and Connected Home. We also believe that all 4G/LTE Advanced mobile devices willrequire unique secure domain names and become part of a secure domain name registry.We intend to license our patent portfolio, technology and software, including our secure domain name registry service, to domaininfrastructure providers, communication service providers as well as to system integrators. We intend to seek further license of ourtechnology, 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 ourroyalty rates and guidelines on our website. All forward moving licenses have adhered to these guidelines and have met orexceeded these rates and we will use these rates and guidelines in all future license negotiations.Our software and technology solutions, including our Secure Domain Name Registry and GABRIEL Connection Technology™,are designed to facilitate secure communications and provide the security platform required by next-generation Internet-basedapplications such as instant messaging, or IM, voice over Internet protocol, or VoIP, mobile services, streaming video, file transfer,remote desktop and, or M2M communications. 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-usersto enter any encryption information.Our product Gabriel Secure Communication Platform™, unlike other collaboration and communication products and services onthe market today, does not require access to user’s confidential data and minimizes the threat of hacking and data mining. Itenables individuals and organizations to maintain complete ownership and control over their personal and confidential data,secured within their own private network, while enabling authorized secure encrypted access from anywhere at any time. OurGabriel Collaboration Suite™ is a set of applications that run on top of our Gabriel Secure Communication Platform™. It enablesseamless and secure cross-platform communications between user’s devices that have our software installed. Our GabrielCollaboration Suite™ is available for download and free trial, for Android, iOS, Windows, Linux and Mac OS X platforms, athttp://www.gabrielsecure.com/. We continue to enhance our products and add new functionality to our products. We will provideupdates to new and existing customers as they are released to the general public.We have signed Patent License Agreements with Avaya Inc., Aastra USA, Inc., Microsoft, Mitel Networks Corporation, NECCorporation and NEC Corporation of America, Siemens Enterprise Communications GmbH & Co. KG, and Siemens EnterpriseCommunications Inc. to license certain of our patents, for a one-time payment and/or an ongoing royalty for all future salesthrough the expiration of the licensed patents with respect to certain current29TABLE OF CONTENTSand future IP-encrypted products. We have engaged IPVALUE Management Inc. to assist us in commercializing our portfolio ofpatents on securing real-time communications over the Internet. Under the multi-year agreement, IPVALUE will originate andassist us with negotiating transactions related to patent licensing worldwide with respect to certain third parties.Our employees include the core development team behind our patent portfolio, technology and software. This team has workedtogether for over ten years and is the same team that invented and developed this technology while working at Leidos, is aFORTUNE 500® scientific, engineering and technology applications company that uses its deep domain knowledge to solveproblems of vital importance to the nation and the world, in national security, energy and the environment, critical infrastructureand health. The team has continued its research and development work started at Leidos, and expanded the set of patents weacquired in 2006 from Leidos, into a larger portfolio with over 100 U.S. and international patents with over 50 pendingapplications. This portfolio now serves as the foundation of our licensing business and planned service offerings and is expected togenerate the majority of our future revenue in license fees and royalties. We intend to continue our research and developmentefforts to further strengthen and expand our patent portfolio. See – Operations – Research and Development Expenses for adescription of our research and development expenses for the past three fiscal years discussed below.We continue using an outsourced and leveraged model to maintain efficiency and manage costs as we grow our licensing businessby, for example, offering incentives to early licensing targets or asserting our rights for use of our patents. We also intend to expandour design pilot in participation with leading 4G/LTE companies (domain infrastructure providers, chipset manufacturers, serviceproviders, and others) and build our secure domain name registry.Developments in the Year Ended December 31, 2016LitigationWe have nine intellectual property infringement lawsuits pending in the United States District Court for the Eastern District ofTexas, Tyler Division, and United States Court of Appeals for the Federal Circuit (“USCAFC”).VirnetX Inc. v. Apple, Inc. (Case 6:12-CV-00855-LED)On March 30, 2015, the United States Court for the Eastern District of Texas, Tyler Division, issued an order finding substantialoverlap between the remanded portions of the Civil Action Case 6:10-CV-00417-LED (VirnetX vs. Cisco et. al.), and the ongoingCivil Action Case 6:12-CV-00855-LED (VirnetX Inc. v. Apple, Inc.). The court consolidated the two civil actions under CivilAction Case 6:12-CV-00855-LED (VirnetX Inc. v. Apple, Inc.) and designated it as the lead case. The jury trial in this case was heldon January 25, 2016. On February 4, 2016, a jury in the United States Court for the Eastern District of Texas, Tyler Division,awarded us $625.6 million in a verdict against Apple Inc. for infringing four of our US patents, marking it the second time a federaljury has found Apple liable for infringing VirnetX’s patented technology. The verdict includes royalties awarded to us based on anearlier patent infringement finding (Case 6:10-CV-00417-LED) against Apple. The jury found that Apple’s modified VPN On-Demand, iMessage and FaceTime services infringed VirnetX’s patents and that Apple’s infringement was willful. In addition todetermining the royalty owed by Apple for its prior infringement, this verdict also includes an award based on the jury’s findingthat Apple’s modified VPN On Demand, iMessage and FaceTime services have continued to infringe VirnetX’s patents. The post-trial hearing was held on May 25, 2016 in the United States Court for the Eastern District of Texas, Texarkana Division. On July29, 2016, the court issued a new order, vacating its previous orders consolidating the cases (Case No. 6:10-cv-417, Docket No. 878(“Apple I case”); Case No. 6:12-cv-855, Docket No. 220 (“Apple II case”)), ordering that the two cases be retried separately, andsetting the retrial date for Apple I case with jury selection to begin on September 26, 2016. The court also ordered that the issue ofwillfulness in both cases is bifurcated and that the Apple II case will be retried after Apple I case. Events and developmentssubsequent to the order from the court are described to support Apple I and Apple II matters.VirnetX Inc. v. Cisco Systems, Inc. et al. (Case 6:10-CV-00417-LED) (“Apple I”)On August 11, 2010, we initiated a lawsuit by filing a complaint against Aastra USA. Inc. (“Aastra”), Apple, Cisco Systems, Inc.(“Cisco”), and NEC Corporation (“NEC”) in the United States District Court for the Eastern District of Texas, Tyler Division,pursuant to which we alleged that these parties infringe on certain of our patents. We sought damages and injunctive relief. Aastraand NEC agreed to sign license agreements with us and we agreed to drop all the accusations of infringement against them. At thepre-trial hearing, the judge decided to conduct separate jury trial30TABLE OF CONTENTSfor each defendant, and try only the case against Apple on the scheduled trial date. The jury trial of our case against Cisco was heldon March 4, 2013. The jury in our case against Cisco came back with a verdict of non-infringement also determined that all ourpatents-in-suit patents are not invalid. Our motions for a new trial and Cisco’s infringement of certain VirnetX patents were deniedand the case against Cisco was closed.The jury trial of our case against Apple was held on October 31, 2012. On November 6, 2012, a jury in the United States Court forthe Eastern District of Texas, Tyler Division, awarded us over $368 million in a verdict against Apple for infringing four of ourpatents. On February 26, 2013, the court issued its Memorandum Opinion and Order regarding post-trial motions resulting from theprior jury verdict denying Apple’s motion to reduce the damages awarded by the jury for past infringement. The Court furtherdenied Apple’s request for a new trial on the liability and damages portions of the verdict and granted our motions for pre-judgment interest, post-judgment interest, and post-verdict damages to date. The Court ordered that Apple pay $34 in daily interestup to final judgment and $330 in daily damages for infringement up to final judgment for certain Apple devices included in theverdict. The Court denied our request for a permanent injunction and severed the future infringement portion into its own separateproceedings under Case 6:13-CV-00211-LED.On July 3, 2013, Apple filed an appeal of the judgment dated February 27, 2013 and order dated June 4, 2013 denying Apple’smotion to alter or amend the judgment to the USCAFC. On September 16, 2014, USCAFC issued their opinion, affirming the jury’sfinding that all 4 of our patents are valid, confirming the jury’s finding of infringement of VPN on Demand under many of theasserted claims of our ‘135 and ‘151 patents, and confirming the district’s court’s decision to allow evidence concerning ourlicenses and royalty rates in connection with the determination of damages. In its opinion, the USCAFC also vacated the jury’sdamages award and the district court’s claim construction with respect to parts of our ‘504 and ‘211 patents and remanded thedamages award and determination of infringement with respect to FaceTime –for further proceedings consistent with its opinion.On October 16, 2014, we filed a petition with the USCAFC, requesting a rehearing and rehearing en banc of the Federal Circuit’sSeptember 14, 2014, decision concerning VirnetX’s litigation against Apple Inc. On December 16, 2014, USCAFC denied ourpetition requesting a rehearing and rehearing en banc of the Federal Circuit’s September 14, 2014, decision and remanded the caseback to the Eastern District of Texas, Tyler Division, for further proceedings consistent with its opinion. On February 25, 2015,USCAFC granted Apple’s motions to lift stay of proceedings and vacate Case 6:13-CV-00211-LED. On March 30, 2015, the courtissued an order finding substantial overlap between the remanded portions of this case and the ongoing Civil Action Case 6:12-CV-00855-LED (VirnetX Inc. v. Apple, Inc.). The court consolidated the two civil actions under Civil Action Case 6:12-CV-00855-LED (VirnetX Inc. v. Apple, Inc.) and designated it as the lead case.On July 29, 2016, the court issued a new order, vacating its previous orders consolidating the cases Apple I case and Apple II case,ordering that the two cases be retried separately, and setting the retrial date for Apple I case with jury selection to begin onSeptember 26, 2016. The court also ordered that the issue of willfulness in both cases is bifurcated and that the Apple II will beretried after Apple I case.The jury trial in this case was held on September 26, 2016. On September 30, 2016, a Jury in the United States Court for the EasternDistrict of Texas, Tyler Division, in the case VirnetX Inc., et al. v. Apple Inc., No. Apple I, has awarded VirnetX $302.4 million in averdict against Apple Corporation for infringing four VirnetX patents, marking the third time a federal jury has found Apple liablefor infringing VirnetX’s patented technology.The verdict includes royalties awarded to VirnetX, for unresolved issues in the Apple I case, remanded back from the USCAFC,related to (1) damages owed to VirnetX for infringement by Apple’s original VPN-on-Demand (VOD) and (2) the allegedinfringement by Apple’s original FaceTime product, under the new claim construction of “secure communication link” pertainingto the ’504 and ’211 patents by the USCAFC, and the damages associated with that infringement. The hearing on all the post-trialmotions was held on November 22, 2016. We are currently awaiting the court ruling and final judgement in this case.VirnetX Inc. v. Apple, Inc. (Case 6:12-CV-00855-LED) (“Apple II”)On November 6, 2012, we filed a new complaint against Apple in the United States District Court for the Eastern District of Texas,Tyler Division for willfully infringing four of our patents, U.S. Patent Nos. 6,502,135, 7,418,504, 7,921,211 and 7,490,151, andseeking both an unspecified amount of damages and injunctive relief. The accused products include the iPhone 5, iPod Touch 5thGeneration, iPad 4th Generation, iPad mini, and the latest Macintosh computers. Due to their release dates, these products were notincluded in the previous lawsuit that concluded with a Jury verdict on November 6, 2012 that was subsequently upheld by theUnited States District Court for the Eastern31TABLE OF CONTENTSDistrict of Texas, Tyler Division, on February 26, 2013. On July 1, 2013, we filed a consolidated and amended complaint toinclude U.S. Patent No. 8,051,181 and consolidate Civil Action No. 6:11-cv-00563-LED. On August 27, 2013, we filed anamended complaint including allegations of willful infringement related to U.S. Patent No. 8,504,697 seeking both damages andinjunctive relief. The Markman hearing in this case was held on May 20, 2014 and on August 8, 2014, issued its Markman Order,denying Apple’s motion for summary judgment of indefiniteness, in which Apple alleged that some of the disputed claims terms inthe patents asserted by us were invalid for indefiniteness. In a separate order, the court granted in part and denied in part our motionfor partial summary judgment on Apple’s invalidity counterclaims, precluding Apple from asserting invalidity as a defense againstinfringement of the claims that were tried before a jury in our prior litigation against Apple (VirnetX vs. Cisco et. al., Case 6:10-CV-00417-LED). The jury trial in this case was scheduled for October 13, 2015. On March 30, 2015, the court issued an orderfinding substantial overlap between this case and the remanded portions of Case 6:10-CV-00417-LED (VirnetX vs. Cisco et. al.).The court consolidated the two civil actions under Civil Action Case 6:12-CV-00855-LED (VirnetX Inc. v. Apple, Inc.) anddesignated it as the lead case. On July 29, 2016, the court issued a new order, vacating its previous orders consolidating the casesApple I case and Apple II case, ordering that the two cases be retried separately, and setting the retrial date for Apple I case withjury selection to begin on September 26, 2016. The court also ordered that the issue of willfulness in both cases is bifurcated andthat the Apple II will be retried after Apple I case. We are awaiting court order setting the date for a new jury trial in Apple II case.VirnetX Inc. v. Apple, Inc. (Case 15-1934)On July 10, 2015, we filed appeals with the USCAFC, appealing the invalidity findings by the United States Patent and TrademarkOffice, Patent Trial and Appeal Board (“PTAB”) in IPR2014-00237 and IPR2014-00238, related to U.S. Patent No. 8,504,697. Theoral arguments in this case were heard on November 7, 2016. On December 9, 2016, the USCAFC affirmed the PTAB based on thegrounds discussed in IPR2014-00238. We are currently evaluating our options in this case.VirnetX Inc. v. Apple, Inc. (Case 16-1211)On September 28, 2015, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in IPR2014-00403 andIPR2014-00404 and on October 22, 2015 for IPR2014-00481 and IPR2014-00482 involving our U.S. Patent Nos. 7,188,180, and7,987,274. The oral arguments in this case were heard on November 7, 2016. On December 9, 2016, the USCAFC affirmed thePTAB based on the grounds discussed in IPR2014-00403 and IPR2014-00481. We are currently evaluating our options in thiscase.VirnetX Inc. v. Apple, Inc. (Case 16-1480)On November 30, 2015, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in inter-partesreexamination no. 95/001,949 related to U.S. Patent No. 8,051,181. The oral arguments in this case were heard on November 7,2016. On December 9, 2016, the USCAFC affirmed the PTAB based on certain grounds. We are currently evaluating our options inthis case.VirnetX, Inc. v. Apple, Inc. (case 16-119)On March 4, 2016, we filed a petition for writ of mandamus with the USCAFC, requesting the USCAFC’s intervention to revoke thePTAB’s decision joining Apple to IPR2015-01046 and IPR2015-01047, related to U.S. Patent Nos. 6,502,135 and 7,490,151. OnMarch 18, 2016, the USCAFC denied the petition without prejudice to us raising the arguments on appeal after the PTAB’s finaldecisions. We are currently evaluating our options in this case.VirnetX Inc. v. Apple, Inc. (Case 17-1131)On October 31, 2016, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in IPR2015-00810,IPR2015-00812, on November 9, 2016 for IPR2015-00811, and on November 28, 2016 for IPR2015-00866, IPR2015-00868,IPR2015-00870, IPR2015-00871 involving our U.S. Patent Nos.8,868,705, 8,850,009, 8,458,341, 8,516,131, and 8,560,705. Theseappeals have been consolidated.VirnetX Inc. v. The Mangrove Partners (Case 17-1368)On December 16, 2016, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in IPR2015-01046, andon December 20, 2016 for IPR2015-1047, involving our U.S. Patent Nos. 6,502,135, and 7,490,151. These appeals also involveApple, Inc. and one of them involves Black Swamp IP, LLC.32TABLE OF CONTENTSOne or more potential intellectual property infringement claims may also be available to us against certain other companies whohave the resources to defend against any such claims. Although we believe these potential claims are worth pursuing, commencinga lawsuit can be expensive and time-consuming, and there is no assurance that we will prevail on such potential claims. Inaddition, bringing a lawsuit may lead to potential counterclaims which may preclude our ability to commercialize our initialproducts, which are currently in development. Currently, we are not a party to any other pending legal proceedings, and are notaware of any proceeding threatened or contemplated against us by any governmental authority or other party.PatentsOn June 30, 2016, the USPTO granted a petition for IPR filed by Apple Inc., seeking review of certain claims of our U.S. Patent No.8,504,696.On July 1, 2016, the USPTO granted a petition for IPR filed by Apple Inc., seeking review of certain claims of our U.S. Patent No.8,504,696.On August 30, 2016, the USPTO entered two final decisions in IPR proceedings filed by Apple Inc., finding certain claims of ourU.S. Patent Nos. 8,868,705 and 8,850,009 to be unpatentable. We have filed appeals in the U.S. Court of Appeals for the FederalCircuit with respect to these decisions.On September 8, 2016, the USPTO entered a final decision in an IPR proceeding filed by Apple Inc., finding certain claims of ourU.S. Patent Nos. 8,868,705 to be unpatentable. We have filed an appeal in the U.S. Court of Appeals for the Federal Circuit withrespect to this decision.On September 9, 2016, the USPTO granted a petition for IPR filed by Black Swamp IP, LLC seeking review of certain claims of ourU.S. Patent No. 7,921,211. On the same day, the USPTO granted a petition for IPR filed by Black Swamp IP, LLC seeking review ofcertain claims of our U.S. Patent No. 7,418,504. On the same day, the USPTO entered a final decision in an IPR proceeding filed byThe Mangrove Partners Master Fund, Ltd., finding certain claims of our U.S. Patent No. 6,502,135 to be unpatentable. We havefiled an appeal in the U.S. Court of Appeals for the Federal Circuit with respect to this decision. Apple Inc. is also a party to thisappeal. On the same day, the USPTO entered final decisions in an IPR proceeding filed by The Mangrove Partners Master Fund,Ltd., finding certain claims of our U.S. Patent No. 7,490,151 to be unpatentable. We have filed an appeal in the U.S. Court ofAppeals for the Federal Circuit with respect to this decision. Apple Inc. and Black Swamp IP, LLC are also parties to this appeal.One September 12, 2016, the USPTO entered decisions in inter-partes reexamination nos. 95/001,788 and 95/001,851 related toU.S. Patent No. 7,418,504 and inter-partes reexamination nos. 95/001,789 and 95/001,856 related to U.S. Patent No. 7,921,211,finding certain claims of these patents to be invalid. We have appealed in the U.S. Court of Appeals for the Federal Circuit withrespect to three of the decisions and have filed a request to reopen prosecution in one of the proceedings.On September 28, 2016, the USPTO entered a final decision in IPR proceedings filed by Apple Inc., finding certain claims of ourU.S. Patent Nos. 8,458,341, 8,516,131, and 8,560,705 to be unpatentable. We have filed appeals in the U.S. Court of Appeals forthe Federal Circuit with respect to these decisions.On October 18, 2016, the USPTO entered final decisions in two IPR proceeding filed by Apple Inc., finding certain claims of ourU.S. Patent No. 8,843,643 to be patentable and certain claims to be invalid.Commitments and Related Party TransactionsWe lease our offices under an operating lease with a third party expiring in October 2017. We recognize rent expense on a straight-line basis over the term of the lease.We lease the use of an aircraft from K2 Investment Fund LLC (“LLC”) for business travel for employees of the Company. Weincurred approximately $772 and $593 in rental fees and reimbursements to the LLC during the years ended December 31, 2016and 2015, respectively. Our Chief Executive Officer and Chief Administrative Officer are the managing partners of the LLC andcontrol the equity interests of the LLC. On January 31, 2015 we entered into a 12-month non-exclusive lease with the LLC for useof the plane at a rate of $8 per flight hour, with no minimum usage requirement. The agreement contains other terms and conditionsnormal in such transactions and can be cancelled by either us or the LLC with 30 days’ notice. The lease renews on an annual basisunless terminated by the lessor or lessee. Neither party has exercised their termination rights.33TABLE OF CONTENTSCritical Accounting PoliciesThe preparation of financial statements in conformity with accounting principles generally accepted in the United States requiresus to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period.The critical accounting policies we employ in the preparation of our consolidated financial statements are those which involveimpairment of long-lived assets, income taxes, fair value of financial instruments and stock-based compensation.Basis of ConsolidationThe consolidated financial statements include the accounts of VirnetX Holding Corporation and our wholly-owned subsidiaries.All intercompany balances and transactions have been eliminated.Use of EstimatesThe preparation of consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptionsthat affect the amounts reported and disclosed in the financial statements and the accompanying notes. Actual results could differmaterially from these estimates. On an ongoing basis, we evaluate our estimates, including those related to the fair values offinancial instruments, fair values of stock-based awards, income taxes, and derivative liabilities, among others. We base ourestimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which formthe basis for making judgments about the carrying values of assets and liabilities.Revenue RecognitionWe derive our revenue from patent licensing. The timing and amount of revenue recognized from each licensee depends upon avariety of factors, including the specific terms of each agreement and the nature of the deliverables and obligations. Suchagreements may be complex and include multiple elements. These agreements may include, without limitation, elements related tothe settlement of past patent infringement liabilities, up-front and non-refundable license fees for the use of patents, patentlicensing royalties on covered products sold by licensees, and the compensation structure and ownership of intellectual propertyrights associated with contractual technology development arrangements. Licensing agreements are accounted for under theFinancial Accounting Standards Board (“FASB”) revenue recognition guidance, “Revenue Arrangements with MultipleDeliverables.” This guidance requires consideration to be allocated to each element of an agreement that has stand-alone valueusing the relative fair value method. In other circumstances, such as those agreements involving consideration for past andexpected future patent royalty obligations, after consideration of the particular facts and circumstances, the appropriate recordingof revenue between periods may require the use of judgment. In all cases, revenue is only recognized after all the following criteriaare met: (1) written agreements have been executed; (2) delivery of technology or intellectual property rights has occurred orservices have 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, including licenses entered upon settlement of litigation, weprovide the licensee permission to use our patented technology in specific applications. We account for patent license agreementsin accordance with the guidance for revenue recognition for arrangements with multiple deliverables, with amounts allocated toeach element based on their fair values. We have elected to utilize the leased-based model for revenue recognition with revenuebeing recognized over the expected period of benefit to the licensee. Under our patent license agreements, we do or expect totypically receive one or a combination of the following forms of payment as consideration for permitting our licensees to use ourpatented inventions in specific applications and products:•Consideration for Past Sales: Consideration related to a licensee’s product sales from prior periods may result from anegotiated agreement with a licensee that utilized our patented technology prior to signing a patent license agreementwith us or from the resolution of a litigation, disagreement or arbitration with a licensee over the specific terms of anexisting license agreement. We may also receive royalty for past sales in connection with the settlement of patentlitigation where there was no prior patent license agreement. These amounts are negotiated, typically based uponapplication of a royalty rate to historical sales prior to the execution of the license agreement. In each of these cases,because 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.34TABLE OF CONTENTS•Current Royalty Payments: Ongoing royalty payments cover a licensee’s obligations to us related to its sales of coveredproducts in the current contractual reporting period. Licensees that owe these current royalty payments are obligated toprovide us with quarterly or semi-annual royalty reports that summarize their sales of covered products and their relatedroyalty obligations to us. We expect to receive these royalty reports subsequent to the period in which our licensees’underlying sales occurred. As a result, it is impractical for us to recognize revenue in the period in which the underlyingsales occur, and, in most cases, we will recognize revenue in the period in which the royalty report is received and otherrevenue recognition criteria are met due to the fact that without royalty reports from our licensees, our visibility into ourlicensees’ sales is limited.•Non-Refundable Up-Front Fees and Minimum Fee Contracts: For licenses that provide for non-refundable up-front orfixed minimum fees over their term, for which we have no future obligations or performance requirements, revenue isgenerally recognized over the license term. For licenses that provide for fees that are not fixed or determinable, includinglicenses that provide for extended payment terms and/or payment of a significant portion of the fee after expiration of thelicense or more than 12 months after delivery, the fees are generally presumed not to be fixed or determinable, andrevenue is deferred and recognized as earned, but generally not in advance of collection.•Non-Royalty Elements: Elements that are not related to royalty revenue in nature, such as settlement fees, expensereimbursement, and damages, if any, are recorded as gain from settlement which is reflected as a separate line item withinthe operating expenses section in the consolidated statements of operations.Deferred revenueIn August 2013 we began receiving annual payments on a contract that requires payment to us over 4 years of $10,000 (“August2013 Contract Settlement”). From the inception of that license to December 31, 2016, we received cash totaling $10,000, all ofwhich is non-refundable. We recognized $1,500, $1,500 and $1,167 of revenue related to the August 2013 Contract Settlementduring the years ended December 31, 2016, 2015 and 2014 respectively.Activity under the August 2013 Contract Settlement was as follows (in thousands): 201620152014Deferred Revenue, beginning of year$3,000 $2,000 $667 Payment received 2,500 2,500 2,500 Less: Amount amortized as revenue 1,500 1,500 1,167 Deferred Revenue, end of year$4,000 $3,000 $2,000 Royalty ExpenseRoyalty expense for the years ended December 31, 2016, 2015 and 2014 was $884, $5,265 and $6,100, respectively, and was aresult of our royalty agreement with Leidos. The agreement provides for revenue sharing and legal reimbursements related toattorney time and expenses incurred by Leidos during discovery and other aspects of litigation involving the defense of ourpatents which have been resolved.Earnings Per ShareBasic earnings per share are computed by dividing earnings available to common stockholders by the weighted average number ofoutstanding common shares during the period. Diluted earnings per share is computed by dividing net income by the weightedaverage number of shares outstanding during the period increased to include the number of additional shares of common stock thatwould have been outstanding if the potentially dilutive securities had been issued. During the years ended 2016, 2015 and 2014we incurred losses. Therefore, the effect of any Common Stock equivalent is anti-dilutive during those periods.Concentration of Credit Risk and Other Risks and UncertaintiesOur cash and cash equivalents are primarily maintained at two major financial institutions in the United States. A portion of thosebalances are insured by the Federal Deposit Insurance Corporation. During the year ended December 31, 2016, and 2015 we had, attimes, funds which were uninsured. We do not believe that we are subject to any unusual financial risk beyond the normal riskassociated with commercial banking relationships with major financial institutions. We have not experienced any losses on ourdeposits of cash and cash equivalents.35TABLE OF CONTENTSDerivative InstrumentsOur Series I Warrants contained an anti-dilution provision which prevented them from being considered indexed to our stock. As aresult, the warrants were required to be accounted for as derivative instruments during 2015. The remaining balance of Series 1Warrants expired during the year ended December 31, 2015.We recognize derivative instruments as either assets or liabilities on the accompanying Consolidated Balance Sheets at fair value.We record changes in the fair value (i.e., gains or losses) of the derivatives in the accompanying Consolidated Statements ofOperations.Impairment of Long-Lived AssetsWe identify and record impairment losses on long-lived assets used in operations when events and changes in circumstancesindicate that the carrying amount of an asset might not be recoverable, but not less than annually. Recoverability is measured bycomparison of the anticipated future net undiscounted cash flows to the related assets’ carrying value. If such assets are consideredto be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds theprojected discounted future net cash flows arising from the asset.Income TaxesWe account for income taxes using the asset and liability method. The asset and liability method requires the recognition ofdeferred tax assets and liabilities for expected future tax consequences of temporary differences that currently exist between the taxbasis and financial reporting basis of our assets and liabilities. We calculate current and deferred tax provisions based on estimatesand assumptions that could differ from actual results reflected on the income tax returns filed during the following years.Adjustments based on filed returns are recorded when identified in the subsequent years. The effect on deferred taxes for a changein tax rates is recognized in income in the period that the tax rate change is enacted. In assessing if we will realize our deferred taxassets, we consider whether it is more likely than not that some portion of the deferred tax assets will not be realized.A valuation allowance is provided for deferred income tax assets when, in our judgment, based upon currently availableinformation and other factors, it is more likely than not that all or a portion of such deferred income tax assets will not be realized.The determination of the need for a valuation allowance is based on an on-going evaluation of current information including,among other things, historical operating results, estimates of future earnings in different taxing jurisdictions and the expectedtiming of the reversals of temporary differences. We believe the determination to record a valuation allowance to reduce a deferredincome tax asset is a significant accounting estimate because it is based, among other things, on an estimate of future taxableincome in the United States and certain other jurisdictions, which is susceptible to change and may or may not occur, and becausethe impact of adjusting a valuation allowance may be material. In determining when to release the valuation allowance establishedagainst our net deferred income tax assets, we consider all available evidence, both positive and negative. Consistent with ourpolicy, and 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, that may be used to offset future taxable income. We continually assess our ability to generatesufficient taxable income during future periods in which our deferred tax assets may be realized. If and when we believe it is morelikely than not that we will recover our deferred tax assets, we will reverse the valuation allowance as an income tax benefit in ourstatements of operations.We account for our uncertain tax positions in accordance with U.S. GAAP. The U.S. GAAP method of accounting for uncertain taxpositions utilizes a two-step approach to evaluate tax positions. Step one, recognition, requires evaluation of the tax position todetermine if based solely on technical merits it is more likely than not to be sustained upon examination. Step two, measurement, isaddressed only if a position is more likely than not to be sustained. In step two, the tax benefit is measured as the largest amount ofbenefit, determined on a cumulative probability basis, which is more likely than not to be realized upon ultimate settlement withtax authorities. If a position does not meet the more likely than not threshold for recognition in step one, no benefit is recordeduntil the first subsequent period in which the more likely than not standard is met, the issue is resolved with the taxing authority, orthe statute of limitations expires. Positions previously recognized are derecognized when we subsequently determine the positionno longer is more likely than not to be sustained. Evaluation of tax positions, their technical merits, and measurements usingcumulative probability are highly subjective management estimates. Actual results could differ materially from these estimates.36TABLE OF CONTENTSStock-based CompensationWe account for stock-based compensation using the fair value recognition method. We recognize these compensation costs net ofthe applicable forfeiture rate and recognize the compensation costs for only those shares expected to vest on a straight-line basisover the requisite service period of the award, which is generally the option vesting term of 4 years. We estimate the forfeiture ratebased on our historical experience, if any.In addition, we record stock and options granted to non-employees at fair value of the consideration received or the fair value ofthe equity investments issued as 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 ordisclosed at fair value in the financial statements on a recurring basis. Fair value is estimated by applying the following hierarchy,which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon thelowest 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 foridentical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated byobservable market data for substantially the full term of the assets or liabilities.Level 3 – Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that marketparticipants would use in pricing the asset or liability.Our financial instruments are stated at amounts that equal, or are intended to approximate, fair value. When we approximate fairvalue, we utilize market data or assumptions that we believe market participants would use in pricing the financial instrument,including assumptions about risk and inputs to the valuation technique. We use quoted valuation techniques, primarily the incomeand market approach that maximize the use of observable inputs and minimize the use of unobservable inputs for recurring fairvalue measurements.New Accounting PronouncementsIn August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-15,Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This update addresses adiversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flowsunder Topic 230, Statement of Cash Flows, and other Topics. The amendments in this Update are effective for public businessentities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption ispermitted, including adoption in an interim period. We adopted this ASU in 2016 and the implementation did not have a materialimpact on our financial position or statement of operations.In June 2016, the FASB issued ASU No. 2016-13. The purpose of this ASU is to require a financial asset measured at amortized costbasis to be presented at the net amount expected to be collected. Credit losses relating to available-for-sale debt securities shouldbe recorded through an allowance for credit losses. This ASU is effective for interim and annual reporting periods beginning afterDecember 15, 2019. We are currently evaluating the impact this guidance will have on our financial position and statement ofoperations.In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718) (“ASU 2016-09”), whichsimplified certain aspects of the accounting for share-based payment transactions, including income taxes, classification of awardsand classification in the statement of cash flows. ASU 2016-09 will be effective for the Company beginning in its first quarter of2018. We are currently evaluating the impact of adopting the new stock compensation standard on our consolidated financialstatements.In February 2016, FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 requires an entity to recognizeright-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. For publiccompanies, ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018, including interim periodswithin that reporting period, and requires a modified retrospective adoption, with early adoption permitted. We are evaluating theimpact this guidance will have on our financial position and statement of operations.37TABLE OF CONTENTSIn November 2015, the FASB issued “Accounting Standards Update No. 2015-17—Income Taxes (Topic 740)”. Current GAAPrequires an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classifiedstatement of financial position. To simplify the presentation of deferred income taxes, this Update requires that deferred taxliabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments in this Updateapply to all entities that present a classified statement of financial position. The current requirement that deferred tax liabilities andassets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments in thisUpdate. For public business entities, the amendments in this Update are effective for financial statements issued for annual periodsbeginning after December 15, 2016, and interim periods within those annual periods. Earlier application is permitted for all entitiesas of the beginning of an interim or annual reporting period. We do not expect the implementation of this ASU to have a materialimpact on our financial position or statement of operations.In August 2014, the FASB issued Accounting Standards Update No. 2014-15, “Presentation of Financial Statements – GoingConcern”, Subtopic 205-40, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.” Theamendments in this ASU apply to all entities and require management to assess an entity’s ability to continue as a going concernby incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Specifically, the amendments(1) provide a definition of the term substantial doubt, (2) require an evaluation every reporting period including interim periods,(3) provide principles for considering the mitigating effect of management’s plans, (4) require certain disclosures when substantialdoubt is alleviated as a result of consideration of management’s plans, (5) require an express statement and other disclosures whensubstantial doubt is not alleviated, and (6) require an assessment for a period of one year after the date that the financial statementsare issued (or available to be issued). The amendments in this update are effective for the annual period ending after December 15,2016, and for annual periods and interim periods thereafter. Early application is permitted. We adopted this ASU in 2016 and theimplementation did not have a material impact on our financial position or results of operations.In May 2014, the FASB issued ASU No. 2014-09 “Revenue from Contracts with Customers” (Topic 606). This ASU wassubsequently amended by ASU No. 2016-10 and 2016-12. As amended, Topic 606 supersedes the revenue recognitionrequirements in Topic 605, “Revenue Recognition” including most industry-specific revenue recognition guidance throughout theIndustry Topics of the Codification. In addition, the amendments create a new Subtopic 340-40, “Other Assets and Deferred Costs—Contracts with Customers”. In summary, the core principle of Topic 606 is that an entity recognizes revenue to depict thetransfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to beentitled in exchange for those goods or services. For a public entity, the amendments in this update are effective for annualreporting periods beginning after December 15, 2017, including interim periods within that reporting period. Earlier application ispermitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within thatreporting period. We are currently evaluating the impact this guidance will have on our financial position and statement ofoperations.Results of Operations (all amounts in this section are expressed in thousands)Revenue 201620152014Revenue$1,550 $1,555 $1,249 Revenue generated for the year ended December 31, 2016 was $1,550 compared to December 31, 2015 of $1,555, and December31, 2014 revenue of approximately $1,249. Revenue for the year ended December 31, 2016 of $1,550, was largely attributable tothe 2013 Contract Settlement described under the heading “Deferred Revenue” above. Under the terms of the 2013 ContractSettlement we were paid annual payments of $2,500 over the contract period for a total of $10,000. During the year endedDecember 31, 2016 we recognized $1,500 of revenue for royalties from the 2013 Contract Settlement and $50 of revenue forroyalties from other licensees.In addition to the settlement discussed above, during 2016, 2015 and 2014 we recognized royalty revenue as part of licenseagreements entered into with customers during the patent infringement actions (see Note 14 “Litigation”). These revenues relate topayment for use of our patented technology prior to the signing of a license agreement, and royalty payments after the execution ofthe license agreements. No amounts were allocable to settlement fees, expense reimbursement, damages or any other amounts otherthan historical and future sales as no such amounts were requested or received.38TABLE OF CONTENTSResearch and Development Expenses 201620152014Research and Development$2,499 $2,277 $2,004 Research and development costs include expenses paid to outside development consultants and compensation-related expenses forour engineering staff. Research and development costs are expensed as incurred.Our research and development expenses for the year ended December 31, 2016 was $2,499 compared to December 31, 2015 of$2,227 and $2,004 for the year ended December 31, 2014. The increase in 2016 compared to 2015 was primarily due to theincrease in staff, wages and bonuses. The increase in 2015 compared to 2014 was primarily due to increase in wages and bonusespaid in 2015 compared to 2014.Selling, General and Administrative Expenses 201620152014Selling, General and Administrative$26,672 $23,190 $28,310 Selling, general and administrative expenses include compensation expense for management and administrative personnel, as wellas expenses for outside legal, accounting, and consulting services.Our selling, general and administrative expenses for the year ended December 31, 2016 was $26,672 compared to December 31,2015 of $23,190 and $28,310 for the year ended December 31, 2014. The increase in 2016 was primarily due to an increase in legalfees, mostly related to cases involving the defense of our patents. The decreases in 2015 were primarily due to the decrease in legalfees. Legal fees represent approximately 49% of general and administrative expenses for 2016 as compared to 42% for 2015 and49% for 2014.Within selling, general and administrative expenses, legal fees for the year ended December 31, 2016 were $13,002 compared tothe year ended December 31, 2015 of $9,638 and $14,020 for the year ended December 31, 2014.Also included in selling, general and administrative expense in 2016, 2015 and 2014 is royalty expense of $884 for the year endedDecember 31, 2016, $5,265 for the year ended December 31, 2015 and $6,100 for the year ended December 31, 2014, paid toLeidos, in connection with the settlement with Microsoft, Avaya and Mitel et al.Gain on Settlement 201620152014Gain on Settlement$— $— $(23,000)In December 2014, we received a $23,000 cash settlement resulting from litigation with Microsoft. In June 2010, we received a$200,000 cash settlement from litigation with Microsoft, in which we agreed to dismiss the pending lawsuits and any damages. The2010 settlement agreement was amended in December 2014 to settle a subsequent lawsuit with Microsoft, raising the total cashsettlement with Microsoft, as amended, to $223,000. In both the original settlement and the December 2014 amendment, we couldnot practically and objectively separate any settlement portion from the revenue element as discussed under the guidance ofAccounting Standards Codification, or ASC, 605 and as a result, the settlement proceeds are classified as a gain on settlement inour statement of operations.Other Income and Expenses 201620152014Other Income and Expense$69 $(49)$2,278 Our non-cash gain (loss) related to the periodic revaluation of our Series I Warrants liability for the year ended December 31, 2015was ($117) compared to $2,238 for the year ended December 31, 2014. During the year ended December 31, 2015 our Series IWarrants liability increased by $117 compared to a decrease in the value of our Series I Warrants liability for the year endedDecember 31, 2014. The increase in 2015 was due to the exercise of Series I Warrants and termination of Warrants. All outstandingSeries 1 Warrants expired in March 2015.Interest income for the year ended December 31, 2016 was $69, compared to December 31, 2015 of $68 and $40 for the year endedDecember 31, 2014. These changes are due to timing on the maturity of the investments as well as the amount of cash available forinvestments.39TABLE OF CONTENTSEffective Income Tax RateA reconciliation of the United States federal statutory income tax rate to our effective income tax rate is as follows: Year EndedDecember 31,2016Year EndedDecember 31,2015Year EndedDecember 31,2014United States federal statutory rate 35.00% 35.00% 35.00%State taxes, net of federal benefit (0.31)% (0.04)% (0.02)%Valuation allowance (35.43)% (33.36)% (41.67)%Stock options — (1.62)% 0.39%Prior year adjustment (0.06)% 0.03% (0.13)%R&D Credit 0.66% 0.38% — Warrants — (0.14)% 7.92%Other (0.33)% (0.29)% (1.64)%Effective income tax rate (0.47)% (0.04)% (0.15)%In 2016, 2015 and 2014, we had pre-tax losses of $28, $29 and $10 million, respectively, which are available for carry forward tooffset future taxable income. We made determinations to provide full valuation allowances for our net deferred tax assets at the endof 2016, 2015 and 2014, including NOL carryforwards generated during the years, based on our evaluation of positive andnegative evidence, including our history of operating losses and the uncertainty of generating future taxable income that wouldenable us to realize our deferred tax.Liquidity and Capital ResourcesFor the year ended December 31, 2016, our cash and cash equivalents totaled $6,627 and our short-term investments totaled$9,249 compared to $8,726 and $9,954, respectively, for the year ended December 31, 2015.We expect that our cash and cash equivalents and short-term investments as of December 31, 2016 will be sufficient to fund ourcurrent operations and provide working capital for general corporate purposes and legal expenses for the foreseeable future. Wemay undertake additional opportunities to seek to grow our business and as a result, we may seek to raise capital in some formwithin the next twelve months including the actions described below under “Universal Shelf Registration and ATM Offering”.Over the long term, we expect to derive the majority of our revenue from license fees and royalties associated with our patentportfolio, technology, software and secure domain name registry in the United States and other markets around the world.Universal Shelf Registration and ATM OfferingIn August 2015, we filed a universal shelf registration statement with the SEC enabling us to offer and sell from time to time up to$100 million of equity, debt or other types of securities. We also entered into an at-the-market (“ATM”) equity offering salesagreement with Cowen & Company, LLC in August 2015, under which we may offer and sell shares of our common stock havingan aggregate value of up to $35 million. We have and expect to use proceeds from this offering for GABRIEL product developmentand marketing, and general corporate purposes, which may include working capital, capital expenditures, other corporate expensesand acquisitions of complementary products, technologies or businesses. As of December 31, 2016, common stock with anaggregate value of up to $11,831 remains available for offer and sale under the ATM agreement.We sold 4,760,594 and 835,056 shares of common stock under the ATM program during the years ended December 31, 2016 and2015, respectively. The average sales price per common share sold during the year ended December 31, 2016 was $4.16 and theaggregate proceeds from the sales totaled $19,791 during the period. Sales commissions, fees and other costs associated with theATM transactions totaled $594 for 2016. The average sales price per common share sold during the year ended December 31, 2015was $4.04 and the aggregate proceeds from the sales totaled $3,378 during the period. Sales commissions, fees and other costsassociated with the ATM totaled $101 for 2015.40TABLE OF CONTENTSContractual Commitments Total2017ThereafterLeases$46 $46 $— Total$46 $46 $— Off-Balance Sheet ArrangementsAs of December 31, 2016, we had no off-balance sheet arrangements.Item 7A.Quantitative and Qualitative Disclosures about Market RiskWe invest our excess cash primarily in highly liquid debt instruments including corporate, government and federal agencysecurities. By policy, we limit the 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 valueadversely impacted due to a rise in interest rates. Due in part to these factors, our income from investments may decrease in thefuture.We considered the historical volatility of short-term interest rates and determined that it was reasonably possible that an adversechange of 100 basis points could be experienced in the near term but would have an immaterial impact in the fair value of ourmarketable securities as they will be maturing in six months or less.The embedded liability in the Series I Warrant obligations was recorded at estimated fair value. That estimated fair value wasdetermined in large part by reference to our assumptions and estimates of various factors. Notably, our liability increased andincurred significant non-cash expenses, all other factors being constant, when the market price of our common shares increased.Conversely, our liability decreased and we recognized significant non-cash gains, all other factors being constant, when the marketprice of our common shares decreased. All remaining outstanding Series I Warrants expired in March 2015.41TABLE OF CONTENTSItem 8.Financial Statements and Supplementary Data.FINANCIAL STATEMENTS Financial Statements Index PageReport of Farber Hass Hurley LLP, Independent Registered Public Accounting Firm 43 Consolidated Balance Sheets of VirnetX Holding Corporation as of December 31, 2016 and December 31, 2015 44 Consolidated Statements of Operations of VirnetX Holding Corporation for the years ended December 31, 2016,December 31, 2015 and December 31, 2014 45 Consolidated Statements of Comprehensive Loss of VirnetX Holding Corporation for the years ended December 31,2016, December 31, 2015 and December 31, 2014 45 Consolidated Statements of Stockholders’ Equity of VirnetX Holding Corporation for the years ended December 31,2016, December 31, 2015 and December 31, 2014 46 Consolidated Statements of Cash Flows of VirnetX Holding Corporation for the years ended December 31, 2016,December 31, 2015 and December 31, 2014 47 Notes to Financial Statements of VirnetX Holding Corporation 48 42TABLE OF CONTENTSREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMBoard of Directors and ShareholdersVirnetX Holding CorporationWe have audited the accompanying consolidated balance sheets of VirnetX Holding Corporation (the “Company”) as of December31, 2016 and 2015, and the related consolidated statements of operations, comprehensive loss, stockholders’ equity, and cashflows for each of the three years in the period ended December 31, 2016. VirnetX Holding Corporation’s management isresponsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financialstatements 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 that we plan and perform the audit to obtain reasonable assurance about whether the financial statementsare free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonablebasis for our opinion.In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial positionof VirnetX Holding Corporation, Inc. as of December 31, 2016 and 2015, and the consolidated results of their operations, and cashflows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generallyaccepted 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’s internal control over financial reporting as of December 31, 2016, based on criteria established inInternal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO), and our report dated March 16, 2017 expressed an unqualified opinion as to the effectiveness of the Company’s controlover financial reporting. /s/ Farber Hass Hurley LLP Chatsworth, CaliforniaMarch 16, 2017 43TABLE OF CONTENTSVIRNETX HOLDING CORPORATIONCONSOLIDATED BALANCE SHEETS(in thousands, except share amounts) As ofDecember 31, 2016As ofDecember 31, 2015ASSETS Current assets: Cash and cash equivalents$6,627 $8,726 Investments available for sale 9,249 9,954 Prepaid expenses and other current assets 588 685 Total current assets 16,464 19,365 Prepaid expenses, non-current 2,374 2,759 Property and equipment, net 33 48 Total assets$18,871 $22,172 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable and accrued liabilities$1,806 $2,283 Accrued payroll and related expenses 1,522 1,383 Related-party payable — 11 Income tax liability 396 400 Deferred revenue, current portion 1,500 1,500 Total current liabilities 5,224 5,577 Deferred revenue, non-current portion 2,500 1,500 Commitments and contingencies (Note 5) — — Total liabilities 7,724 7,077 Stockholders’ equity: Preferred stock, par value $0.0001 per share Authorized: 10,000,000 shares atDecember 31, 2016 and December 31, 2015, Issued and outstanding: 0 shares atDecember 31, 2016 and December 31, 2015 — — Common stock, par value $0.0001 per share Authorized: 100,000,000 shares at December 31, 2016 and December 31, 2015,Issued and outstanding: 58,144,888 shares and 53,198,835 shares, at December31, 2016 and December 31, 2015, respectively 6 5 Additional paid-in capital 169,391 144,778 Accumulated deficit (158,238) (129,669)Accumulated other comprehensive loss (12) (19)Total stockholders’ equity 11,147 15,095 Total liabilities and stockholders’ equity$18,871 $22,172 See accompanying notes to consolidated financial statements.44TABLE OF CONTENTSVIRNETX HOLDING CORPORATIONCONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except share and per share amounts) Year EndedDecember 31, 2016Year EndedDecember 31, 2015Year EndedDecember 31, 2014Revenue$1,550 $1,555 $1,249 Operating expense: Royalty expense 884 5,265 6,100 Research and development 2,499 2,277 2,004 Selling, general and administrative expenses 26,672 23,190 28,310 Gain of settlement (Note 3) — — (23,000)Total operating expense 30,055 30,732 13,414 Loss from operations (28,505) (29,177) (12,165)Gain (loss) on change in value of derivative liability — (117) 2,238 Interest and other income, net 69 68 40 Loss before taxes (28,436) (29,226) (9,887)Income tax expense (133) (8) (15)Net loss$(28,569)$(29,234)$(9,902)Basic and diluted loss per share$(0.51)$(0.56)$(0.19)Weighted average shares outstanding basic and diluted 55,984,825 52,384,494 51,570,472 VIRNETX HOLDING CORPORATIONCONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS(in thousands) Year EndedDecember 31, 2016Year EndedDecember 31, 2015Year EndedDecember 31, 2014Net loss$(28,569)$(29,234)$(9,902)Other comprehensive gain (loss), net of tax: Change in equity adjustment from foreign currencytranslation, net of tax 3 (1) — Change in unrealized gain (loss) on investments, net of tax 4 (3) 22 Total other comprehensive income (loss), net of tax 7 (4) 22 Comprehensive loss$(28,562)$(29,238)$(9,880)See accompanying notes to consolidated financial statements.45TABLE OF CONTENTSVirnetX Holding CorporationCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(in thousands, except share amounts) Common StockAdditionalPaid-inCapitalAccumulatedDeficitAccumulatedOtherComprehensiveLossTotalStockholders'Equity(Deficit) SharesAmountBalance at December 31, 2013 51,236,141 $5 $124,589 $(90,533)$(37)$34,024 Stock issued for cash exercise of warrantsat $3.59 per share, net 2,500 9 9 Stock-based compensation 8,189 8,189 Exercise of options 679,321 278 278 Vested RSUs 78,739 Derivative liability 7 7 Comprehensive income: Net loss (9,902) (9,902)Other comprehensive income, net of tax 22 22 Comprehensive loss (9,880)Balance at December 31, 2014 51,996,701 $5 $133,072 $(100,435)$(15)$32,627 Stock issued for cash exercise of warrantsat $3.59 per share, net 120,161 431 431 Stock issued for cash at $4.04 per share,net 835,056 3,276 3,276 Advisor warrant issuance 121 121 Stock-based compensation 7,275 7,275 Exercise of options 143,100 165 165 Vested RSUs 103,817 Derivative liability 438 438 Comprehensive income: Net loss (29,234) (29,234)Other comprehensive loss, net of tax (4) (4)Comprehensive loss (29,238)Balance at December 31, 2015 53,198,835 $5 $144,778 $(129,669)$(19)$15,095 Stock issued for cash at $3.00 -$5.05 pershare, net 4,760,594 1 19,195 19,196 Stock-based compensation 5,398 5,398 Exercise of options 50,357 20 20 Vested RSUs 135,102 Comprehensive income: Net loss (28,569) (28,569)Other comprehensive income, net of tax 7 7 Comprehensive loss (28,562)Balance at December 31, 2016 58,144,888 $6 $169,391 $(158,238)$(12)$11,147 See accompanying notes to consolidated financial statements.46TABLE OF CONTENTSVIRNETX HOLDING CORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands) Twelve MonthsEndedDecember 31, 2016Twelve MonthsEndedDecember 31, 2015Twelve MonthsEndedDecember 31, 2014Cash flows from operating activities: Net loss$(28,569)$(29,234)$(9,902)Adjustments to reconcile net loss to net cash provided by(used in) operating activities: Depreciation 28 26 25 Amortization of warrant issuance costs 30 91 — Stock-based compensation 5,398 7,275 8,189 Change in value of derivative liability — 117 (2,238)Changes in assets and liabilities: Prepaid expenses and other current assets 66 (2) (296)Prepaid expense – Non-current 385 385 (3,144)Accounts payable and accrued liabilities (477) (1,044) 1,806 Accrued payroll and related expenses 139 1,156 — Royalty payable — (6,100) 6,100 Related-party payable (11) (70) 81 Income tax liability (4) (8) 13 Deferred revenue 1,000 1,000 1,333 Net cash (used in) provided by operating activities (22,015) (26,408) 1,967 Cash flows from investing activities: Purchase of property and equipment (13) (10) (35)Purchase of investments (10,527) (10,673) (45,500)Proceeds from sale or maturity of investments 11,240 23,287 42,766 Net cash (used in) provided by investing activities 700 12,604 (2,769)Cash flows from financing activities: Proceeds from exercise of options 20 165 278 Proceeds from exercise of warrants — 431 9 Proceeds from sale of common stock 19,196 3,276 — Net cash provided by financing activities 19,216 3,872 287 Net decrease in cash and cash equivalents (2,099) (9,932) (515)Cash and cash equivalents, beginning of period 8,726 18,658 19,173 Cash and cash equivalents, end of period$6,627 $8,726 $18,658 Cash paid for income taxes$126 $6 $2 Cash paid for interest$— $— $— Non-cash transactions Fair value of warrants issued for services$— $121 $— See accompanying notes to consolidated financial statements.47TABLE OF CONTENTSVirnetX Holding CorporationNOTES TO FINANCIAL STATEMENTS(in thousands except share and per share amounts)Note 1 − Formation and Business of the CompanyVirnetX Holding Corporation, which we refer to as” we”, “us”, “our”, “the Company” or “VirnetX”, is engaged in the business ofcommercializing a portfolio of patents. We seek to license our technology, including GABRIEL Connection Technology™, tovarious original equipment manufacturers, or OEMs, that use our technologies in the development and manufacturing of their ownproducts within the IP-telephony, mobility, fixed-mobile convergence and unified communications markets. Prior to 2012 ourrevenue was limited to an insignificant amount of software royalties pursuant to the terms of a single license agreement. During2013 and 2012 we had revenues from settlements of patent infringement disputes whereby we received consideration for past salesof licensees that utilized our technology, where there was no prior patent license agreement (see “Revenue Recognition”).Our portfolio of intellectual property is the foundation of our business model. We currently own approximately 49 U.S. and 69foreign patents with approximately 50 pending patent applications worldwide. Our patent portfolio is primarily focused onsecuring real-time communications over the Internet, as well as related services such as the establishment and maintenance of asecure domain name registry. Our patented methods also have additional applications in the key areas of device operating systemsand network security for Cloud services, M2M communications in areas of Smart City, Connected Car and Connected Home. Thesubject matter of all our U.S and foreign patents and pending applications relates generally to securing communications over theinternet and such covers all our technology and other products. Our issued U.S. and foreign patents expire at various times duringthe period from 2019 to 2024. Some of our issued patents and pending patent applications were acquired by our principaloperating subsidiary; VirnetX, Inc., from Leidos, (f/k/a Science Applications International Corporation or SAIC) in 2006 and we arerequired to make payments to Leidos, based on cash or certain other values generated from those patents. The amount of suchpayments depends upon the type of value generated, and certain categories are subject to maximums and other limitations.Note 2 − Summary of Significant Accounting PoliciesThe preparation of financial statements in conformity with accounting principles generally accepted in the United States requiresus to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period.The critical accounting policies we employ in the preparation of our consolidated financial statements are those which involveimpairment of long-lived assets, income taxes, fair value of financial instruments and stock-based compensation.Use of EstimatesWe prepare our consolidated financial statements in accordance with accounting principles generally accepted in the U.S. (“U.S.GAAP”). In doing so, we have to make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues,and expenses, as well as related disclosure of contingent assets and liabilities. In some cases, we could reasonably have useddifferent accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur fromperiod to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are materialdifferences 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 theseestimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which wediscuss further below. We have reviewed our critical accounting policies and estimates with the audit committee of our board ofdirectors.Basis of ConsolidationThe consolidated financial statements include the accounts of VirnetX Holding Corporation and our wholly-owned subsidiaries.All intercompany balances and transactions have been eliminated.Revenue RecognitionWe derive our revenue from patent licensing. The timing and amount of revenue recognized from each licensee depends upon avariety of factors, including the specific terms of each agreement and the nature of the deliverables and obligations. Suchagreements may be complex and include multiple elements. These agreements may include,48TABLE OF CONTENTSwithout limitation, elements related to the settlement of past patent infringement liabilities, up-front and non-refundable licensefees for the use of patents, patent licensing royalties on covered products sold by licensees, and the compensation structure andownership of intellectual property rights associated with contractual technology development arrangements. Licensing agreementsare accounted for under the Financial Accounting Standards Board (“FASB”) revenue recognition guidance, “RevenueArrangements with Multiple Deliverables.” This guidance requires consideration to be allocated to each element of an agreementthat has stand-alone value using the relative fair value method. In other circumstances, such as those agreements involvingconsideration for past and expected future patent royalty obligations, after consideration of the particular facts and circumstances,the appropriate recording of revenue between periods may require the use of judgment. In all cases, revenue is only recognizedafter all the following criteria are met: (1) written agreements have been executed; (2) delivery of technology or intellectualproperty rights has occurred or services have been rendered; (3) fees are fixed or determinable; and (4) collectability of fees isreasonably assured.Patent License Agreements: Upon signing a patent license agreement, including licenses entered upon settlement of litigation, weprovide the licensee permission to use our patented technology in specific applications. We account for patent license agreementsin accordance with the guidance for revenue recognition for arrangements with multiple deliverables, with amounts allocated toeach element based on their fair values. We have elected to utilize the leased-based model for revenue recognition with revenuebeing recognized over the expected period of benefit to the licensee. Under our patent license agreements, we do or expect totypically receive one or a combination of the following forms of payment as consideration for permitting our licensees to use ourpatented inventions in specific applications and products:•Consideration for Past Sales: Consideration related to a licensee’s product sales from prior periods may result from anegotiated agreement with a licensee that utilized our patented technology prior to signing a patent license agreementwith us or from the resolution of a litigation, disagreement or arbitration with a licensee over the specific terms of anexisting license agreement. We may also receive royalty for past sales in connection with the settlement of patentlitigation where there was no prior patent license agreement. These amounts are negotiated, typically based uponapplication of a royalty rate to historical sales prior to the execution of the license agreement. In each of these cases,because 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: Ongoing royalty payments cover a licensee’s obligations to us related to its sales of coveredproducts in the current contractual reporting period. Licensees that owe these current royalty payments are obligated toprovide us with quarterly or semi-annual royalty reports that summarize their sales of covered products and their relatedroyalty obligations to us. We expect to receive these royalty reports subsequent to the period in which our licensees’underlying sales occurred. As a result, it is impractical for us to recognize revenue in the period in which the underlyingsales occur, and, in most cases, we will recognize revenue in the period in which the royalty report is received and otherrevenue recognition criteria are met due to the fact that without royalty reports from our licensees, our visibility into ourlicensees’ sales is limited.•Non-Refundable Up-Front Fees and Minimum Fee Contracts: For licenses that provide for non-refundable up-front orfixed minimum fees over their term, for which we have no future obligations or performance requirements, revenue isgenerally recognized over the license term. For licenses that provide for fees that are not fixed or determinable, includinglicenses that provide for extended payment terms and/or payment of a significant portion of the fee after expiration of thelicense or more than 12 months after delivery, the fees are generally presumed not to be fixed or determinable, andrevenue is deferred and recognized as earned, but generally not in advance of collection.•Non-Royalty Elements: Elements that are not related to royalty revenue in nature, such as settlement fees, expensereimbursement, and damages, if any, are recorded as gain from settlement which is reflected as a separate line item withinthe operating expenses section in the consolidated statements of operations.49TABLE OF CONTENTSDeferred RevenueIn August 2013 we began receiving annual payments on a contract that requires payment to us over 4 years totaling $10,000(“August 2013 Contract Settlement”). As of December 31, 2016, we received cash totaling $10,000, all of which is non-refundable.We recognized $1,500, $1,500 and $1,167 of revenue related to the August 2013 Contract Settlement during the years endedDecember 31, 2016, 2015 and 2014 respectively.Activity under the August 2013 Contract Settlement was as follows: 201620152014Deferred Revenue, beginning of year$3,000 $2,000 $667 Payment received 2,500 2,500 2,500 Less: Amount amortized as revenue 1,500 1,500 1,167 Deferred Revenue, end of year$4,000 $3,000 $2,000 Royalty ExpenseRoyalty expense for the years ended December 31, 2016, 2015 and 2014 was $884, $5,265 and $6,100, respectively and was aresult of our royalty agreement with Leidos. The agreement provides for revenue sharing and legal reimbursements related toattorney time and expenses incurred by Leidos during discovery and other aspects of litigation matters that have been resolved.Cash and Cash EquivalentsWe consider all highly liquid investments purchased with original maturities of three months or less at the date of purchase to becash equivalents. Our cash and cash equivalents are not subject to significant interest rate risk due to the short maturities of theseinvestments.Prepaid Expenses and Other Current AssetsPrepaid Expense and Other Current Assets at December 31, 2016 includes the current portion of prepaid rent for a facility lease forcorporate promotional and marketing purposes. Beginning March 2014, the prepayment totaling $4,000 is being amortized overthe 10-year term of the lease. The unamortized non-current portion of the prepayment is included in Prepaid Expenses-Non-currenton the consolidated balance sheet.InvestmentsInvestments are classified as available-for-sale and are recorded at fair market value. Unrealized gains and losses are reported asother comprehensive income. Realized gains and losses are recorded in income in the period they are realized. Unrealized gainsand losses on our investments are included in other comprehensive income. We invest our excess cash primarily in highly liquiddebt instruments including corporate, government and federal agency securities, with contractual maturities less than two years. Bypolicy, we limit the amount of credit exposure to any one issuer.Property and EquipmentProperty and equipment are stated at historical cost, less accumulated depreciation and amortization. Depreciation andamortization are computed using the accelerated and straight line methods over the estimated useful lives of the assets, whichrange from five to seven years. Repair and maintenance costs are charged to expense as incurred.Concentration of Credit Risk and Other Risks and UncertaintiesOur cash and cash equivalents are primarily maintained at two major financial institutions in the United States. Deposits held withthese financial institutions may exceed the amount of insurance provided on such deposits. A portion of those balances are insuredby the Federal Deposit Insurance Corporation, or FDIC. During the year ended December 31, 2016 and 2015, we had, at times,funds that were uninsured. We do not believe that we are subject to any unusual financial risk beyond the normal risk associatedwith commercial banking relationships. We have not experienced any losses on our deposits of cash and cash equivalents.50TABLE OF CONTENTSFair ValueThe carrying amounts of our financial instruments, including cash equivalents, accounts payable, and accrued liabilities,approximate fair value because of their generally short maturities.Intangible AssetsWe record intangible assets at cost, less accumulated amortization. Amortization of intangible assets is provided over theirestimated useful lives, which can range from 3 to 15 years, on either a straight-line basis or as revenue is generated by the assets.Impairment of Long-Lived AssetsWe identify and record impairment losses on long-lived assets used in operations when events and changes in circumstancesindicate that the carrying amount of an asset might not be recoverable, but not less than annually. Recoverability is measured bycomparison of the anticipated future net undiscounted cash flows to the related assets’ carrying value. If such assets are consideredto be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds theprojected discounted future net cash flows arising from the asset.Research and DevelopmentResearch and development costs include expenses paid to outside development consultants and compensation related expenses forour engineering staff. Research and development costs are expensed as incurred.Income TaxesWe account for income taxes using the asset and liability method. The asset and liability method requires the recognition ofdeferred tax assets and liabilities for expected future tax consequences of temporary differences that currently exist between the taxbasis and financial reporting basis of our assets and liabilities. We calculate current and deferred tax provisions based on estimatesand assumptions that could differ from actual results reflected on the income tax returns filed during the following years.Adjustments based on filed returns are recorded when identified in the subsequent years. The effect on deferred taxes for a changein tax rates is recognized in income in the period that the tax rate change is enacted. In assessing if we will realize our deferred taxassets, we consider whether it is more likely than not that some portion of the deferred tax assets will not be realized.A valuation allowance is provided for deferred income tax assets when, in our judgment, based upon currently availableinformation and other factors, it is more likely than not that all or a portion of such deferred income tax assets will not be realized.The determination of the need for a valuation allowance is based on an on-going evaluation of current information including,among other things, historical operating results, estimates of future earnings in different taxing jurisdictions and the expectedtiming of the reversals of temporary differences. We believe the determination to record a valuation allowance to reduce a deferredincome tax asset is a significant accounting estimate because it is based, among other things, on an estimate of future taxableincome in the United States and certain other jurisdictions, which is susceptible to change and may or may not occur, and becausethe impact of adjusting a valuation allowance may be material. In determining when to release the valuation allowance establishedagainst our net deferred income tax assets, we consider all available evidence, both positive and negative. Consistent with ourpolicy, and 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, that may be used to offset future taxable income. We continually assess our ability to generatesufficient taxable income during future periods in which our deferred tax assets may be realized. If and when we believe it is morelikely than not that we will recover our deferred tax assets, we will reverse the valuation allowance as an income tax benefit in ourstatements of operations.We account for our uncertain tax positions in accordance with U.S. GAAP. The purpose of this method is to clarify accounting foruncertain tax positions recognized. The U.S. GAAP method of accounting for uncertain tax positions utilizes a two-step approachto evaluate tax positions. Step one, recognition, requires evaluation of the tax position to determine if based solely on technicalmerits it is more likely than not to be sustained upon examination. Step two, measurement, is addressed only if a position is morelikely than not to be sustained. In step two, the tax benefit is measured as the largest amount of benefit, determined on a cumulativeprobability basis, which is more likely than not to be realized upon ultimate settlement with tax authorities. If a position does notmeet the more likely than not51TABLE OF CONTENTSthreshold for recognition in step one, no benefit is recorded until the first subsequent period in which the more likely than notstandard is met, the issue is resolved with the taxing authority, or the statute of limitations expires. Positions previously recognizedare derecognized when we subsequently determine the position no longer is more likely than not to be sustained. Evaluation of taxpositions, their technical merits, and measurements using cumulative probability are highly subjective management estimates.Actual results could differ materially from these estimates. We include interest and penalties, if any, in income tax expense. Duringthe years ended December 31, 2016, 2015 and 2014, income tax expense included interest and penalties totaling $48, $0 and $11,respectively.Derivative InstrumentsOur Series I Warrants were accounted for as derivative instruments as a result of an anti-dilution provision which, in accordancewith U.S. GAAP, prevented them from being considered indexed to our stock and qualified for an exception to derivativeaccounting. The balance of our Series I Warrants expired during the year ended December 31, 2015.We recognize derivative instruments as either assets or liabilities on the accompanying Consolidated Balance Sheets at fair value.We record changes in the fair value (i.e., gains or losses) of the derivatives in the accompanying Consolidated Statements ofOperations.Stock-Based CompensationWe account for stock-based compensation using the fair value recognition method in accordance with U.S. GAAP. We recognizethese compensation costs net of the applicable forfeiture rate and recognize the compensation costs for only those shares expectedto vest on a straight-line basis over the requisite service period of the award, which is generally the vesting term of 4 years. Weestimate the forfeiture rate based on our historical experience if any. See Note 7 - Stock-Based Compensation for additionalinformation 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 fairvalue of the equity instruments issued as they vest over the performance period.Earnings per ShareBasic earnings per share are computed by dividing earnings available to common stockholders by the weighted average number ofoutstanding common shares during the period. Diluted earnings per share is computed by dividing net income by the weightedaverage number of shares outstanding during the period increased to include the number of additional shares of common stock thatwould have been outstanding if the potentially dilutive securities had been issued. During 2016, 2015 and 2014 we incurredlosses; therefore, the effect of any common stock equivalent would be anti-dilutive during these periods.ReclassificationsCertain prior year amounts in the accompanying consolidated financial statements have been reclassified to conform to the currentyear’s presentation.New Accounting PronouncementsIn August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-15,Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This update addresses adiversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flowsunder Topic 230, Statement of Cash Flows, and other Topics. The amendments in this Update are effective for public businessentities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption ispermitted, including adoption in an interim period. We adopted this ASU in 2016 and the implementation did not have a materialimpact on our financial position or statement of operations.In June 2016, the FASB issued ASU No. 2016-13. The purpose of this ASU is to require a financial asset measured at amortized costbasis to be presented at the net amount expected to be collected. Credit losses relating to available-for-sale debt securities shouldbe recorded through an allowance for credit losses. This ASU is effective for interim and annual reporting periods beginning afterDecember 15, 2019. We are currently evaluating the impact this guidance will have on our financial position and statement ofoperations.52TABLE OF CONTENTSIn March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718) (“ASU 2016-09”), whichsimplified certain aspects of the accounting for share-based payment transactions, including income taxes, classification of awardsand classification in the statement of cash flows. ASU 2016-09 will be effective for the Company beginning in its first quarter of2018. We are currently evaluating the impact of adopting the new stock compensation standard on our consolidated financialstatements.In February 2016, FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 requires an entity to recognizeright-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. For publiccompanies, ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018, including interim periodswithin that reporting period, and requires a modified retrospective adoption, with early adoption permitted. We are evaluating theimpact this guidance will have on our financial position and statement of operations.In November 2015, the FASB issued “Accounting Standards Update No. 2015-17—Income Taxes (Topic 740)”. Current GAAPrequires an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classifiedstatement of financial position. To simplify the presentation of deferred income taxes, this Update requires that deferred taxliabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments in this Updateapply to all entities that present a classified statement of financial position. The current requirement that deferred tax liabilities andassets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments in thisUpdate. For public business entities, the amendments in this Update are effective for financial statements issued for annual periodsbeginning after December 15, 2016, and interim periods within those annual periods. Earlier application is permitted for all entitiesas of the beginning of an interim or annual reporting period. We do not expect the implementation of this ASU to have a materialimpact on our financial position or statement of operations.In August 2014, the FASB issued Accounting Standards Update No. 2014-15, “Presentation of Financial Statements – GoingConcern”, Subtopic 205-40, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.” Theamendments in this ASU apply to all entities and require management to assess an entity’s ability to continue as a going concernby incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Specifically, the amendments(1) provide a definition of the term substantial doubt, (2) require an evaluation every reporting period including interim periods,(3) provide principles for considering the mitigating effect of management’s plans, (4) require certain disclosures when substantialdoubt is alleviated as a result of consideration of management’s plans, (5) require an express statement and other disclosures whensubstantial doubt is not alleviated, and (6) require an assessment for a period of one year after the date that the financial statementsare issued (or available to be issued). The amendments in this update are effective for the annual period ending after December 15,2016, and for annual periods and interim periods thereafter. Early application is permitted. We adopted this ASU in 2016 and theimplementation did not have a material impact on our financial position or results of operations.In May 2014, the FASB issued ASU No. 2014-09 “Revenue from Contracts with Customers” (Topic 606). This ASU wassubsequently amended by ASU No. 2016-10 and 2016-12. As amended, Topic 606 supersedes the revenue recognitionrequirements in Topic 605, “Revenue Recognition” including most industry-specific revenue recognition guidance throughout theIndustry Topics of the Codification. In addition, the amendments create a new Subtopic 340-40, “Other Assets and Deferred Costs—Contracts with Customers”. In summary, the core principle of Topic 606 is that an entity recognizes revenue to depict thetransfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to beentitled in exchange for those goods or services. For a public entity, the amendments in this Update are effective for annualreporting periods beginning after December 15, 2017, including interim periods within that reporting period. Earlier application ispermitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within thatreporting period. We are currently evaluating the impact this guidance will have on our financial position and statement ofoperations.Note 3 − Gain on SettlementIn June 2010, we received a $200,000 cash settlement from litigation with Microsoft, in which we agreed to dismiss the pendinglawsuits and any damages. In December 2014, we received a $23,000 cash settlement resulting from litigation with Microsoft. The2010 settlement agreement was amended in December 2014 to settle a subsequent lawsuit with Microsoft, raising the total cashsettlement with Microsoft, as amended, to $223,000. In both the original53TABLE OF CONTENTSsettlement and the December 2014 amendment, we could not practically and objectively separate any settlement portion from therevenue element as discussed under the guidance of Accounting Standards Codification, or ASC, 605, “Revenue Recognition”, andas a result, the settlement proceeds are classified as a gain on settlement in our consolidated statement of operations.Note 4 − Property and EquipmentOur major classes of property and equipment were as follows: December 31 201620152014Office furniture$79 $70 $70 Computer equipment 172 168 157 Total 251 238 227 Less accumulated depreciation (218) (190) (163) $33 $48 $64 Depreciation expense for the years ended December 31, 2016, 2015 and 2014 was $28, $26 and $25, respectively.Note 5 − Commitments and Related Party TransactionsWe lease our offices under an operating lease with a third party expiring in October 2017. We recognize rent expense on a straight-line basis over the term of the lease. Rent expense was $56, for each of the years ended December 31, 2016, 2015 and 2014. Futureminimum rents due under the lease total $46 in 2017, when the lease expires.During 2016, 2015 and 2014 we leased the use of an aircraft from K2 Investment Fund LLC (“LLC”) for business travel foremployees of the Company. We incurred approximately $772, $593 and $296 in rental fees (including fees and otherreimbursements) to the LLC during the year ended December 31, 2016, 2015 and 2014, respectively. Our Chief Executive Officerand Chief Administrative Officer are the managing partners of the LLC and control the equity interests of the LLC. On January 31,2015 we entered into a 12-month non-exclusive lease with the LLC for use of the plane at a rate of $8 per flight hour, with nominimum usage requirement. The agreement contains other terms and conditions normal in such transactions and can be cancelledby either us or the LLC with 30 days’ notice. The lease renews on an annual basis unless terminated by the Lessor or Lessee.Neither party has yet exercised their termination rights.Note 6 − Stock PlanWe have a stock incentive plan for employees and others called the VirnetX Holding Corporation 2013 Equity Incentive Plan (the“Plan”), which has been approved by our stockholders. The 2013 Plan provides for the issuance of up to 2,500,000 shares of ourcommon stock. To the extent that any award should expire, become un-exercisable or is otherwise forfeited, the shares subject tosuch award will again become available for issuance under the 2013 Plan. The 2013 Plan provides for the granting of stock optionsand restricted stock purchase rights (“RSU”) to our employees and consultants. Stock options granted under the 2013 Plan may beincentive stock options or nonqualified stock options. Incentive stock options (“ISO”) may only be granted to our employees(including officers and directors). Nonqualified stock options (“NSO”) and stock purchase rights may be granted to our employeesand consultants.The 2013 Plan will expire in 2023. Options may be granted under the 2013 Plan with an exercise price determined by our Board ofDirectors, or a duly appointed committee thereof, provided, however, that the exercise price of an option granted to any employeeshall be not less than 100% of the fair market value at the date of grant in the case of ISO or 85% of the fair market value at the dateof grant in the case of an NSO. The exercise price of an ISO or NSO granted to one of our Named Executive Officers shall not be lessthan 100% fair market value of the shares at the date of grant and the exercise price of an ISO granted to a 10% shareholder shallnot be less than 110% of the fair market value of the shares on the date of grant. Stock options granted under the 2013 Plantypically vest over four years and have a 10-year term. All RSUs are considered to be granted at the fair value of our stock on thedate of grant because they have no exercise price. RSUs typically vest over four years. At December 31, 2016 there were 421,221shares available for grant under the 2013 Plan.54TABLE OF CONTENTSNote 7 − Stock-Based CompensationThe following tables summarize information about stock-options and RSUs outstanding at December 31, 2016:Options OutstandingOptions Vested and ExercisableRange ofExercise PricesNumberOutstandingWeightedAverageRemainingContractualLife (Years)WeightedAverageExercisePriceNumberExercisableWeightedAverageRemainingContractualLife (Years)WeightedAverageExercisePrice$   0.24-   1.58  771,045 2.26 $1.16 771,045 2.26 $1.16 $   1.74-   6.95  3,353,901 3.66 4.74 2,558,275 2.00 4.82 $ 14.52- 35.25  1,253,625 5.71 23.16 1,142,873 5.56 23.73 5,378,571 3.94 $8.52 4,472,193 2.96 $9.02 The following tables summarize activity under the Plan for the indicated periods: Options Number ofSharesWeightedAverageExercisePriceWeightedAverageRemainingContractualLife (Years)AggregateIntrinsicValueOutstanding at December 31, 2013 4,976,849 $7.86 — — Options granted 261,500 15.21 — — Options exercised (679,321) 0.41 — — Options cancelled (70,000) 13.38 — — Outstanding at December 31, 2014 4,489,028 $9.33 — — Options granted 694,000 4.47 — — Options exercised (143,100) 1.15 — — Options cancelled (40,000) 25.61 — — Outstanding at December 31, 2015 4,999,928 $8.76 — — Options granted 429,000 4.77 — — Options exercised (50,357) 0.40 — — Options cancelled — — — — Outstanding at December 31, 2016 5,378,571 $8.52 3.94 $810 Options exercisable at December 31, 2016 4,472,193 $9.02 2.96 $810 RSUs Number ofRSUsWeightedAverageGrant DateFair ValueAggregateIntrinsicValueOutstanding at December 31, 2013 248,915 $24.10 $— RSUs granted 154,332 15.30 — RSUs vested (88,686) 24.08 — RSUs cancelled (4,167) 24.13 — Outstanding at December 31, 2014 310,394 $19.74 $— RSUs granted 162,665 5.57 — RSUs vested (113,103) 20.11 — RSUs cancelled — — — Outstanding at December 31, 2015 359,956 $13.22 $— RSUs granted 219,331 4.75 — RSUs vested (155,852) 15.27 — RSUs cancelled — — — Outstanding at December 31, 2016 423,435 $8.08 $— 55TABLE OF CONTENTSIntrinsic value is calculated as the difference between the per-share market price of our common stock on the last trading day of2016, which was $2.20, and the exercise price of the options. For options exercised, the intrinsic value is the difference betweenmarket price and the exercise price on the date of exercise. We received cash proceeds of $20, $165 and $278 from stock optionsexercised in 2016, 2015 and 2014, respectively. The total intrinsic value of options exercised was $91, $203 and $3,575 during theyears ended December 31, 2016, 2015 and 2014, respectively. For RSUs vested, the intrinsic value is the difference between marketprice and the vested price on the date of vest. The total intrinsic value of the RSUs vested was zero during the year ended December31, 2016.Stock-based compensation expense is included in general and administrative expense for each period as follows:Stock-Based Compensation by Type of AwardYear EndedDecember 31, 2016Year EndedDecember 31, 2015Year EndedDecember 31, 2014Employee stock options$3,436 $4,939 $5,951 RSUs 1,962 2,336 2,238 Total stock-based compensation expense$5,398 $7,275 $8,189 As of December 31, 2016, there was $3,805 of unrecognized stock-based compensation expense expected to be recognized relatedto unvested employee stock options and $2,462 of unrecognized stock-based compensation expense to be recognized related tounvested RSUs. These costs are expected to be recognized over a weighted-average period of 2.69 and 2.44 years, respectively.The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model using thefollowing weighted average assumptions: Year EndedDecember 31, 2016Year EndedDecember 31, 2015Year EndedDecember 31, 2014Expected stock price volatility79.6%82%88%Risk-free interest rate1.85%2.12%2.56%Expected life term (in years)6.03 years6.07 years6.0 yearsExpected dividends0%0%0%Based on the Black-Scholes option pricing model, the weighted average estimated fair value of employee stock options grantedwas $3.25, $3.17 and $11.26 per share during the years ended December 31, 2016, 2015 and 2014, respectively.The expected life was determined using the simplified method outlined in ASC 718, “Compensation - Stock Compensation”,taking the average of the vesting term and the contractual term of the option. Expected volatility of the stock options was basedupon historical data and other relevant factors, such as the volatility of comparable publicly-traded companies at a similar stage oflife cycle. We have not provided an estimate for forfeitures because we have had nominal forfeited options and RSUs and believethat all outstanding options and RSUs at December 31, 2016, will vest. In the future, we may change this estimate based on actualand expected future forfeiture rates.Note 8 − Earnings Per ShareBasic earnings per share are based on the weighted average number of shares outstanding for a period. Diluted earnings per shareare based upon the weighted average number of shares and potentially dilutive common shares outstanding. Potential commonshares outstanding principally include stock options, under our stock plan and warrants. During 2016, 2015 and 2014 we incurredlosses; therefore, the effect of any common stock equivalent would be anti-dilutive during those periods.56TABLE OF CONTENTSThe table below sets forth the basic and diluted loss per share calculations: Year Ended December 31, 201620152014Net loss$(28,569)$(29,234)$(9,902)Basic and diluted weighted average number of sharesoutstanding 55,985 52,384 51,570 Basic and diluted loss per share$(0.51)$(0.56)$(0.19)Note 9 − Common StockEach share of common stock has the right to one vote. The holders of common stock are entitled to receive dividends wheneverfunds are legally available and when declared by our Board of Directors, subject to the prior rights of holders of all classes of stockoutstanding having priority rights as to dividends. Our restated articles of incorporation authorize us to issue up to 100,000,000shares of $.0001 par value common stock.On August 21, 2015 we filed a universal shelf registration statement with the SEC enabling us to offer and sell from time to time upto $100 million of equity, debt or other types of securities. We also entered into an at-the-market (“ATM”) equity offering salesagreement with Cowen & Company, LLC on August 20, 2015, under which we may offer and sell shares of our common stockhaving an aggregate value of up to $35 million. As of December 31, 2016, common stock with an aggregate value of up to $11,831remains available for offer and sale under the ATM agreement.We sold 4,760,594 and 835,056 shares of common stock under the ATM program during the year ended December 31, 2016 and2015, respectively. The average sales price per common share sold during the year ended December 31, 2016 was $4.16 and theaggregate proceeds from the sales totaled $19,791 during the period. Sales commissions, fees and other costs associated with theATM transactions totaled $594 for 2016. The average sales price per common share sold during the year ended December 31, 2015was $4.04 and the aggregate proceeds from the sales totaled $3,378 during the period. Sales commissions, fees and other costsassociated with the ATM totaled $101 for 2015.Note 10 − EquityWarrantsDuring the year ended December 31, 2015 we issued warrants (“Advisor Warrants”) for the purchase of 25,000 shares of commonstock for $7 per share, which expire in April 2020. The Advisor Warrants were issued for advisory services provided by a thirdparty. Our Advisor Warrants were recorded at fair value on the issuance date and included in Additional Paid in Capital on ourConsolidated Balance Sheet. The Advisor Warrants are exercisable by the holder, in whole or in part, until expiration, and may alsobe net-share-settled. Terms of the warrant agreement include no registration requirements for the underlying common stock andthere are no anti-dilution provisions. The fair value at issuance of the warrants was recorded in Prepaid Expenses and Other CurrentAssets, and is being amortized over the twelve-month life of the service contract, with the expense included in Selling, General andAdministrative Expense in our Consolidated Statements of Operations.Information about the Advisor Warrants outstanding during the twelve months ended December 31, 2016 follows:OriginalNumber ofWarrantsIssuedExercisePrice perCommonShareExercisable atDecember 31,2015BecameExercisableExercisedTerminated /Cancelled /ExpiredExercisable atDecember 31,2016ExpirationDate25,000$7.0025,000———25,000April 2020Note 11 − Employee Benefit PlanWe sponsor a defined contribution, 401k plan, covering substantially all our employees. Our matching contribution to the planwas approximately $90, $59 and $45 in 2016, 2015 and 2014, respectively.57TABLE OF CONTENTSNote 12 − Income TaxesThe income tax provision is comprised of the following: Year EndedDecember 31, 2016Year EndedDecember 31, 2015Year EndedDecember 31, 2014Current: Federal$— $10 $(13)State (133) (18) (2)Foreign — — — (133) (8) (15)Deferred: Federal — — — State — — — Total income tax provision$(133)$(8)$(15)A reconciliation of the United States federal statutory income tax rate to our effective income tax rate is as follows: Year EndedDecember 31, 2016Year EndedDecember 31, 2015Year EndedDecember 31, 2014United States federal statutory rate 35.00% 35.00% 35.00%State taxes, net of federal benefit (0.31)% (0.04)% (0.02)%Valuation allowance (35.43)% (33.36)% (41.67)%Stock options — (1.62)% 0.39%Prior year true-up (0.06)% 0.03% (0.13)%R&D Credit 0.66% 0.38% — Warrants — (0.14)% 7.92%Other (0.33)% (0.29)% (1.64)%Effective income tax rate (0.47)% (0.04)% (0.15)%In 2016, 2015 and 2014, we had pre-tax losses of $28, $29 and $10 million, respectively, which are available for carry forward tooffset future taxable income. We made determinations to provide full valuation allowances for our net deferred tax assets at the endof 2016, 2015 and 2014, including NOL carryforwards generated during the years, based on our evaluation of positive andnegative evidence, including our history of operating losses and the uncertainty of generating future taxable income that wouldenable us to realize our deferred tax assets.Deferred tax assets (liabilities) consist of the following: Year EndedDecember 31, 2016Year EndedDecember 31, 2015Deferred tax assets: Reserves and accruals$1,063 $462 State tax 1 1 Research and development credits and other credits 1,092 908 Net operating loss carry forward 29,186 18,496 Stock based compensation 13,031 9,855 Other 88 102 Total deferred tax assets 44,461 29,824 Valuation allowance (44,455) (29,814)Deferred tax assets after valuation allowance 6 10 Deferred tax liability: Depreciation and amortization (6) (10) Total deferred tax liability (6) (10) Net deferred tax assets$— $— 58TABLE OF CONTENTSIn assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or allof deferred assets will not be realized. The ultimate realization of the deferred tax assets is dependent upon the generation of futuretaxable income during the periods in which those temporary differences become deductible.Based on the available objective evidence, management believes it is more likely than not that the net deferred tax assets atDecember 31, 2016 will not be fully realizable. Accordingly, management has maintained a full valuation allowance against its netdeferred tax assets at December 31, 2016. The net change in the total valuation allowance for the 12 months ended December 31,2016 was an increase of $14,641. At December 31, 2016, we had federal and state net operating loss carry-forwards ofapproximately $74,728 and $58,079, respectively, expiring beginning in 2028 and 2017, respectively. At December 31, 2016, wehad federal research and development credit carry-forwards of approximately $1,092 expiring beginning in 2031.Internal Revenue Code Section 382 places a limitation (the “Section 382 Limitation”) on the amount of taxable income that can beoffset by net operating loss carry forwards after a change in control (generally greater than 50% change in ownership) of a losscorporation. California the state in which our headquarters was once located has similar rules. Our capitalization described hereinmay have resulted in such a change. Generally, after a control change, a loss corporation cannot deduct net operating loss carryforwards generated in years prior to the deemed change of control under IRC Section 382 in excess of the Section 382 Limitation.We are required to recognize the financial statement effects of a tax position when it is more likely than not, based on the technicalmerits, that the position will be sustained upon examination. As a result, we have provided contingent reserve under ASC 740-10of $316 and $316 at December 31, 2016, and December 31, 2015, respectively. Our tax returns are subject to review by various taxauthorities. The returns subject to review are 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 have accrued interest or penalties during the 12-month period ended December 31, 2016 in the amount of $5.A reconciliation of beginning and ending amounts of unrecognized tax benefits follows: Year EndedDecember 31, 2016Year EndedDecember 31, 2015Year EndedDecember 31, 2014Balance at the beginning of the year$316 $316 $316 Additions based on tax positions related to the current year — — — Additions for tax positions of prior years — — — Settlements — — — Lapse of applicable statute of limitations — — — Balance at the end of the year$316 $316 $316 Note 13 − Fair Value MeasurementWe apply fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized ordisclosed at fair value in the financial statements on a recurring basis. Fair value is estimated by applying the following hierarchy,which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon thelowest 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 foridentical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated byobservable market data for substantially the full term of the assets or liabilities.Level 3 – Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that marketparticipants would use in pricing the asset or liability.The carrying amounts for cash and cash equivalents, investments in certificates of deposit, accounts payable and accrued expensesapproximate their fair values due to the short period of time until maturity.Mutual Funds: Valued at the quoted net asset value (NAV) of shares held.59TABLE OF CONTENTSU.S. Government and U.S. Agency securities: Fair value measured at the closing price reported on the active market on whichthe individual securities are traded.Series I Warrants: Fair value measured by using a Binomial valuation model. The assumptions used to measure fair value ofour outstanding Series I Warrants carried as derivative liabilities on our Consolidated Balance Sheet for December 31, 2014 were awarrant exercise price of $3.59 per share, a common share price of $5.49, a discount rate of 1.65%, and a volatility of 89.6%. Thebalance of the Series 1 Warrants expired in March 2015.The following table shows our cash and available-for-sale securities adjusted cost, gross unrealized gains, gross unrealized lossesand fair value by significant investment category recorded as cash and cash equivalents of investments available for sale as ofDecember 31, 2016 and 2015 (in thousands): December 31, 2016 AdjustedCostUnrealizedGainsUnrealizedLossesFairValueCashand CashEquivalentsInvestmentsAvailablefor SaleCash$3,432 $— $— $3,432 $3,432 $— Level 1: Mutual funds 3,195 — — 3,195 3,195 — U.S. government securities 1,254 — — 1,254 — 1,254 U.S. agency securities 7,996 2 (3) 7,995 — 7,995 12,445 2 (3) 12,444 3,195 9,249 Total$15,877 $2 $(3)$15,876 $6,627 $9,249 December 31, 2015 AdjustedCostUnrealizedGainsUnrealizedLossesFairValueCashand CashEquivalentsInvestmentsAvailablefor SaleCash$3,296 $— $— $3,296 $3,296 $— Level 1: Mutual funds 5,005 — — 5,005 5,005 — U.S. government securities 1,806 — (3) 1,803 — 1,803 U.S. agency securities 8,579 1 (4) 8,576 425 8,151 15,390 1 (7) 15,384 5,430 9,954 Total$18,686 $1 $(7)$18,680 $8,726 $9,954 The maturities of our marketable securities generally range from within one to two years. Actual maturities could differ fromcontractual maturities due to call or prepayment provisions.The following table sets forth a summary of changes in the fair value of our Level 3 financial instrument liability for the year endedDecember 31, 2016, 2015 and 2014 (in thousands): Fair Value Measurements Using SignificantUnobservable Inputs (Level 3) Year endedDecember 31, 2016Year endedDecember 31, 2015Year endedDecember 31, 2014Beginning Balance$— $320 $2,564 (Gain) losses included in net losses — 117 (2,237)Settlements — (333) (7)Expiration of warrants — (104) — Ending Balance$— $— $320 60TABLE OF CONTENTSNote 14 − LitigationWe have nine intellectual property infringement lawsuits pending in the United States District Court for the Eastern District ofTexas, Tyler Division, and United States Court of Appeals for the Federal Circuit (“USCAFC”).VirnetX Inc. v. Apple, Inc. (Case 6:12-CV-00855-LED)On March 30, 2015, the United States Court for the Eastern District of Texas, Tyler Division, issued an order finding substantialoverlap between the remanded portions of the Civil Action Case 6:10-CV-00417-LED (VirnetX vs. Cisco et. al.), and the ongoingCivil Action Case 6:12-CV-00855-LED (VirnetX Inc. v. Apple, Inc.). The court consolidated the two civil actions under CivilAction Case 6:12-CV-00855-LED (VirnetX Inc. v. Apple, Inc.) and designated it as the lead case. The jury trial in this case was heldon January 25, 2016. On February 4, 2016, a jury in the United States Court for the Eastern District of Texas, Tyler Division,awarded us $625.6 million in a verdict against Apple Inc. for infringing four of our US patents, marking it the second time a federaljury has found Apple liable for infringing VirnetX’s patented technology. The verdict includes royalties awarded to us based on anearlier patent infringement finding (Case 6:10-CV-00417-LED) against Apple. The jury found that Apple’s modified VPN On-Demand, iMessage and FaceTime services infringed VirnetX’s patents and that Apple’s infringement was willful. In addition todetermining the royalty owed by Apple for its prior infringement, this verdict also includes an award based on the jury’s findingthat Apple’s modified VPN On Demand, iMessage and FaceTime services have continued to infringe VirnetX’s patents. The post-trial hearing was held on May 25, 2016 in the United States Court for the Eastern District of Texas, Texarkana Division. On July29, 2016, the court issued a new order, vacating its previous orders consolidating the cases (Case No. 6:10-cv-417, Docket No. 878(“Apple I case”); Case No. 6:12-cv-855, Docket No. 220 (“Apple II case”)), ordering that the two cases be retried separately, andsetting the retrial date for Apple I case with jury selection to begin on September 26, 2016. The court also ordered that the issue ofwillfulness in both cases is bifurcated and that the Apple II case will be retried after Apple I case. Events and developmentssubsequent to the order from the court are described to support Apple I and Apple II matters.VirnetX Inc. v. Cisco Systems, Inc. et al. (Case 6:10-CV-00417-LED) (“Apple I”)On August 11, 2010, we initiated a lawsuit by filing a complaint against Aastra USA. Inc. (“Aastra”), Apple, Cisco Systems, Inc.(“Cisco”), and NEC Corporation (“NEC”) in the United States District Court for the Eastern District of Texas, Tyler Division,pursuant to which we alleged that these parties infringe on certain of our patents. We sought damages and injunctive relief. Aastraand NEC agreed to sign license agreements with us and we agreed to drop all the accusations of infringement against them. At thepre-trial hearing, the judge decided to conduct separate jury trial for each defendant, and try only the case against Apple on thescheduled trial date. The jury trial of our case against Cisco was held on March 4, 2013. The jury in our case against Cisco cameback with a verdict of non-infringement also determined that all our patents-in-suit patents are not invalid. Our motions for a newtrial and Cisco’s infringement of certain VirnetX patents were denied and the case against Cisco was closed.The jury trial of our case against Apple was held on October 31, 2012. On November 6, 2012, a jury in the United States Court forthe Eastern District of Texas, Tyler Division, awarded us over $368 million in a verdict against Apple for infringing four of ourpatents. On February 26, 2013, the court issued its Memorandum Opinion and Order regarding post-trial motions resulting from theprior jury verdict denying Apple’s motion to reduce the damages awarded by the jury for past infringement. The Court furtherdenied Apple’s request for a new trial on the liability and damages portions of the verdict and granted our motions for pre-judgment interest, post-judgment interest, and post-verdict damages to date. The Court ordered that Apple pay $34 in daily interestup to final judgment and $330 in daily damages for infringement up to final judgment for certain Apple devices included in theverdict. The Court denied our request for a permanent injunction and severed the future infringement portion into its own separateproceedings under Case 6:13-CV-00211-LED.On July 3, 2013, Apple filed an appeal of the judgment dated February 27, 2013 and order dated June 4, 2013 denying Apple’smotion to alter or amend the judgment to the USCAFC. On September 16, 2014, USCAFC issued their opinion, affirming the jury’sfinding that all 4 of our patents are valid, confirming the jury’s finding of infringement of VPN on Demand under many of theasserted claims of our ‘135 and ‘151 patents, and confirming the district’s court’s decision to allow evidence concerning ourlicenses and royalty rates in connection with the determination of damages. In its opinion, the USCAFC also vacated the jury’sdamages award and the district court’s claim construction with respect to parts of our ‘504 and ‘211 patents and remanded thedamages award and determination of infringement with respect to FaceTime –for further proceedings consistent with its opinion.On October 16, 2014, we filed a petition with the USCAFC, requesting a rehearing and rehearing en banc of the Federal Circuit’s61TABLE OF CONTENTSSeptember 14, 2014, decision concerning VirnetX’s litigation against Apple Inc. On December 16, 2014, USCAFC denied ourpetition requesting a rehearing and rehearing en banc of the Federal Circuit’s September 14, 2014, decision and remanded the caseback to the Eastern District of Texas, Tyler Division, for further proceedings consistent with its opinion. On February 25, 2015,USCAFC granted Apple’s motions to lift stay of proceedings and vacate Case 6:13-CV-00211-LED. On March 30, 2015, the courtissued an order finding substantial overlap between the remanded portions of this case and the ongoing Civil Action Case 6:12-CV-00855-LED (VirnetX Inc. v. Apple, Inc.). The court consolidated the two civil actions under Civil Action Case 6:12-CV-00855-LED (VirnetX Inc. v. Apple, Inc.) and designated it as the lead case.On July 29, 2016, the court issued a new order, vacating its previous orders consolidating the cases Apple I case and Apple II case,ordering that the two cases be retried separately, and setting the retrial date for Apple I case with jury selection to begin onSeptember 26, 2016. The court also ordered that the issue of willfulness in both cases is bifurcated and that the Apple II will beretried after Apple I case.The jury trial in this case was held on September 26, 2016. On September 30, 2016, a Jury in the United States Court for the EasternDistrict of Texas, Tyler Division, in the case VirnetX Inc., et al. v. Apple Inc., No. Apple I, has awarded VirnetX $302.4 million in averdict against Apple Corporation for infringing four VirnetX patents, marking the third time a federal jury has found Apple liablefor infringing VirnetX’s patented technology.The verdict includes royalties awarded to VirnetX, for unresolved issues in the Apple I case, remanded back from the USCAFC,related to (1) damages owed to VirnetX for infringement by Apple’s original VPN-on-Demand (VOD) and (2) the allegedinfringement by Apple’s original FaceTime product, under the new claim construction of “secure communication link” pertainingto the ’504 and ’211 patents by the USCAFC, and the damages associated with that infringement. The hearing on all the post-trialmotions was held on November 22, 2016. We are currently awaiting the court ruling and final judgement in this case.VirnetX Inc. v. Apple, Inc. (Case 6:12-CV-00855-LED) (“Apple II”)On November 6, 2012, we filed a new complaint against Apple in the United States District Court for the Eastern District of Texas,Tyler Division for willfully infringing four of our patents, U.S. Patent Nos. 6,502,135, 7,418,504, 7,921,211 and 7,490,151, andseeking both an unspecified amount of damages and injunctive relief. The accused products include the iPhone 5, iPod Touch 5thGeneration, iPad 4th Generation, iPad mini, and the latest Macintosh computers. Due to their release dates, these products were notincluded in the previous lawsuit that concluded with a Jury verdict on November 6, 2012 that was subsequently upheld by theUnited States District Court for the Eastern District of Texas, Tyler Division, on February 26, 2013. On July 1, 2013, we filed aconsolidated and amended complaint to include U.S. Patent No. 8,051,181 and consolidate Civil Action No. 6:11-cv-00563-LED.On August 27, 2013, we filed an amended complaint including allegations of willful infringement related to U.S. Patent No.8,504,697 seeking both damages and injunctive relief. The Markman hearing in this case was held on May 20, 2014 and on August8, 2014, issued its Markman Order, denying Apple’s motion for summary judgment of indefiniteness, in which Apple alleged thatsome of the disputed claims terms in the patents asserted by us were invalid for indefiniteness. In a separate order, the court grantedin part and denied in part our motion for partial summary judgment on Apple’s invalidity counterclaims, precluding Apple fromasserting invalidity as a defense against infringement of the claims that were tried before a jury in our prior litigation against Apple(VirnetX vs. Cisco et. al., Case 6:10-CV-00417-LED). The jury trial in this case was scheduled for October 13, 2015. On March 30,2015, the court issued an order finding substantial overlap between this case and the remanded portions of Case 6:10-CV-00417-LED (VirnetX vs. Cisco et. al.). The court consolidated the two civil actions under Civil Action Case 6:12-CV-00855-LED(VirnetX Inc. v. Apple, Inc.) and designated it as the lead case. On July 29, 2016, the court issued a new order, vacating its previousorders consolidating the cases Apple I case and Apple II case, ordering that the two cases be retried separately, and setting theretrial date for Apple I case with jury selection to begin on September 26, 2016. The court also ordered that the issue of willfulnessin both cases is bifurcated and that the Apple II will be retried after Apple I case. We are awaiting court order setting the date for anew jury trial in Apple II case.VirnetX Inc. v. Apple, Inc. (Case 15-1934)On July 10, 2015, we filed appeals with the USCAFC, appealing the invalidity findings by the United States Patent and TrademarkOffice, Patent Trial and Appeal Board (“PTAB”) in IPR2014-00237 and IPR2014-00238, related to U.S. Patent No. 8,504,697. Theoral arguments in this case were heard on November 7, 2016. On December 9, 2016, the USCAFC affirmed the PTAB based on thegrounds discussed in IPR2014-00238. We are currently evaluating our options in this case.62TABLE OF CONTENTSVirnetX Inc. v. Apple, Inc. (Case 16-1211)On September 28, 2015, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in IPR2014-00403 andIPR2014-00404 and on October 22, 2015 for IPR2014-00481 and IPR2014-00482 involving our U.S. Patent Nos. 7,188,180, and7,987,274. The oral arguments in this case were heard on November 7, 2016. On December 9, 2016, the USCAFC affirmed thePTAB based on the grounds discussed in IPR2014-00403 and IPR2014-00481. We are currently evaluating our options in thiscase.VirnetX Inc. v. Apple, Inc. (Case 16-1480)On November 30, 2015, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in inter-partesreexamination no. 95/001,949 related to U.S. Patent No. 8,051,181. The oral arguments in this case were heard on November 7,2016. On December 9, 2016, the USCAFC affirmed the PTAB based on certain grounds. We are currently evaluating our options inthis case.VirnetX, Inc. v. Apple, Inc. (case 16-119)On March 4, 2016, we filed a petition for writ of mandamus with the USCAFC, requesting the USCAFC’s intervention to revoke thePTAB’s decision joining Apple to IPR2015-01046 and IPR2015-01047, related to U.S. Patent Nos. 6,502,135 and 7,490,151. OnMarch 18, 2016, the USCAFC denied the petition without prejudice to us raising the arguments on appeal after the PTAB’s finaldecisions. We are currently evaluating our options in this case.VirnetX Inc. v. Apple, Inc. (Case 17-1131)On October 31, 2016, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in IPR2015-00810,IPR2015-00812, on November 9, 2016 for IPR2015-00811, and on November 28, 2016 for IPR2015-00866, IPR2015-00868,IPR2015-00870, IPR2015-00871 involving our U.S. Patent Nos.8,868,705, 8,850,009, 8,458,341, 8,516,131, and 8,560,705. Theseappeals have been consolidated.VirnetX Inc. v. The Mangrove Partners (Case 17-1368)On December 16, 2016, we filed appeals with the USCAFC, appealing the invalidity findings by the PTAB in IPR2015-01046, andon December 20, 2016 for IPR2015-1047, involving our U.S. Patent Nos. 6,502,135, and 7,490,151. These appeals also involveApple, Inc. and one of them involves Black Swamp IP, LLC.One or more potential intellectual property infringement claims may also be available to us against certain other companies whohave the resources to defend against any such claims. Although we believe these potential claims are worth pursuing, commencinga lawsuit can be expensive and time-consuming, and there is no assurance that we will prevail on such potential claims. Inaddition, bringing a lawsuit may lead to potential counterclaims which may preclude our ability to commercialize our initialproducts, which are currently in development. Currently, we are not a party to any other pending legal proceedings, and are notaware of any proceeding threatened or contemplated against us by any governmental authority or other party.Note 15 − Quarterly Financial Information (unaudited) FirstSecondThirdFourth (in thousands except per share)2016 Revenue$375 $398 $375 $402 Loss from operations (8,618) (5,353) (7,287) (7,247)Net loss (8,610) (5,337) (7,387) (7,235)Basic earnings (loss) per common share$(0.16)$(0.10)$(0.13)$(0.12)Diluted earnings (loss) per common share$(0.16)$(0.10)$(0.13)$(0.12) FirstSecondThirdFourth (in thousands except per share)2015 Revenue$375 $400 $375 $405 Loss from operations (5,759) (9,567) (6,102) (7,749)Net loss (5,855) (9,546) (6,097) (7,736)Basic earnings (loss) per common share$(0.11)$(0.18)$(0.12)$(0.15)Diluted earnings (loss) per common share$(0.11)$(0.18)$(0.12)$(0.15)63TABLE OF CONTENTSReport of Independent Registered Public Accounting FirmTo the Board of Directors andStockholders of VirnetX Holding CorporationWe have audited the internal control over financial reporting of VirnetX Holding Corporation (the “Company”) as of December 31,2016, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internalcontrol over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included inthe accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinionon 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 that we plan and perform the audit to obtain reasonable assurance about whether effective internal controlover financial reporting was maintained in all material respects. Our audit of internal control over financial reporting includedobtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, andtesting and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also includedperforming such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonablebasis for our opinion.A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’sprincipal executive and principal financial officers, or persons performing similar functions, and effected by the company’s boardof directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting andthe preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Acompany’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance ofrecords that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2)provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordancewith generally accepted accounting principles, and that receipts and expenditures of the company are being made only inaccordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a materialeffect on the financial statements.Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or impropermanagement override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis.Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subjectto the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December31, 2016, based on the criteria established in Internal Control – Integrated Framework (2013) issued by the Committee ofSponsoring Organizations of the Treadway Commission.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), theconsolidated financial statements as of and for the year ended December 31, 2016, of the Company and our report dated March 16,2017, expressed an unqualified opinion on those financial statements./s/ Farber Hass Hurley LLPChatsworth, CaliforniaMarch 16, 201764TABLE OF CONTENTSItem 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.None.Item 9A.Controls and Procedures.Evaluation of Disclosure Controls and ProceduresUnder the supervision and with the participation of our management, including our Chief Executive Officer and Chief FinancialOfficer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, asdefined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, December 31, 2016.The purpose of this evaluation was to determine whether as of December 31, 2016 our disclosure controls and procedures wereeffective to provide reasonable assurance that the information we are required to disclose in our filings with the SEC, (i) isrecorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulatedand communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allowtimely decisions regarding required disclosure.Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of December 31, 2016,our disclosure controls and procedures were effective.Changes in Internal Control Over Financial ReportingThere were no changes in our internal controls over financial reporting (as such term is defined in rules 13a-15 (f) under theSecurities Exchange Act of 1934, as amended) during the fiscal year ended December 31, 2016 that have materially affected, or arereasonably likely to materially affect, our internal controls over financial reporting.Management’s Report on Internal Control Over Financial ReportingOur management is responsible for establishing and maintaining adequate internal control over financial reporting for theCompany. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of ourfinancial reporting for external purposes in accordance with accounting principles generally accepted in the United States ofAmerica. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairlyreflect our transactions; providing reasonable assurance that transactions are recorded as necessary for preparation of our financialstatements; providing reasonable assurance that receipts and expenditures of Company assets are made in accordance withmanagement authorization; and providing reasonable assurance that unauthorized acquisition, use or disposition of Companyassets that could have a material effect on our financial statements would be prevented or detected on a timely basis. Because of itsinherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement ofour financial statements would be prevented or detected.Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the frameworkin Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the TreadwayCommission. Based on this evaluation, management concluded that the Company’s internal control over financial reporting waseffective as of December 31, 2016. There were no changes in our internal control over financial reporting during the period endedDecember 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financialreporting. Farber Hass Hurley LLP has audited our internal control over financial reporting as of December 31, 2016; their report isincluded elsewhere herein.Item 9B.Other Information.None.65TABLE OF CONTENTSPART IIICertain information required by Part III is omitted from this report and is incorporated by reference to our definitive proxystatement pursuant to Regulation 14A for our 2017 Annual Meeting of Stockholders (the “Definitive Proxy Statement”) which willbe 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 Statementunder the sections “Board of Directors,” “Nominee and Continuing Directors,” “Executive Officers,” “Composition of the Board ofDirectors,” “Board Meetings and Committees and Annual Meeting Attendance,” “Audit Committee Matters” and “Section 16(a)Beneficial Ownership Reporting Compliance.” Information regarding delinquent filers pursuant to Item 405 of Regulation S-K willbe included under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in our Proxy Statement for the 2017Annual 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 Statementunder the sections “Compensation Committee Matters,” “Director Compensation,” “Executive Compensation,” “CompensationCommittee Report,” “Summary Compensation Table,” “Outstanding Equity Awards at 2016 Fiscal Year-End,” and “OptionExercises in Fiscal Year 2016.”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 Statementunder the section “Voting Securities and Principal Holders.”Securities Authorized for Issuance Under the Equity Compensation PlansWe have a stock incentive plan for employees and others called the “VirnetX Holding Corporation 2013 Stock Plan”, or the Plan,which has been approved by our stockholders. The Plan provides for the granting of up to 14,124,469 shares of our common stock,including stock options and stock purchase rights, and will expire in 2023. As of December 31, 2016, there were 421,221 sharesavailable to be granted under the Plan. We had 5,378,571 and 4,999,928 options outstanding at December 31, 2016, and December31, 2015, respectively, with an average exercise price of $8.52 and $8.76, respectively. We had 423,435 and 359,956 restrictedstock units outstanding at December 31, 2016 and December 31, 2015, respectively, with a weighted average grant price of $8.08and $13.22 respectively.Plan CategoryNumber ofSecurities to beIssued UponExercise ofOutstandingOptions,Warrants andRightsWeighted-AverageExercise Price ofOutstandingOptions, Warrantsand RightsNumber ofSecuritiesRemainingAvailable forFuture IssuanceUnder EquityCompensationPlansEquity compensation plans approved by security holders 5,827,006 $8.48 421,221 Equity compensation plans not approved by security holders — — Total 5,827,006 $8.48 421,221 On April 25, and May 23, 2016 the Compensation Committee granted 100,000 options to Advisory members. On May 23, 2016,the Compensation Committee granted 291,500 options and 194,332 RSUs to the employees of VirnetX Inc. On June 2, 2016, theCompensation Committee granted 37,500 options and 24,999 RSUs to members of the Board of Directors 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 Statementunder the sections “Transactions with Related Persons” and “Composition of Board of Directors.”66TABLE OF CONTENTSItem 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 forthe 2016 Annual Meeting of Stockholders under “Principal Accountant Fees & Services.”PART IVItem 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 onForm 10-K.(2)Financial Statement Schedule: Financial statement schedules are omitted because they are not applicable or therequired information is shown in the financial statements or notes thereto. All other schedules are omitted because ofthe absence of conditions under which they are required or because the required information is given in the financialstatements or the notes thereto.(3)Exhibits: See Exhibit Index immediately following the signature page of this Form 10-K.67TABLE OF CONTENTSSIGNATURESPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused thisAnnual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. VirnetX Holding Corporation By:/s/ Kendall Larsen Name: Kendall Larsen Title: Chief Executive Officer and PresidentDated: March 16, 201768TABLE OF CONTENTSPOWER OF ATTORNEYKNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints KendallLarsen his or her attorney-in-fact, with full power of substitution, for him or her in any and all capacities, to sign any amendmentsto this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith with theSecurities and Exchange Commission, hereby ratifying and confirming all that said attorney-in-fact, or his or her substitute orsubstitutes 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 bythe following persons on behalf of the registrant and in the capacities indicated.NameCapacityDate /s/ Kendall LarsenDirector, Chief Executive Officer and PresidentMarch 16, 2017Kendall Larsen(Principal Executive Officer) /s/ Richard H. NanceChief Financial OfficerMarch 16, 2017Richard H. Nance(Principal Financial Officer andPrincipal Accounting Officer) /s/ Robert D. Short IIIDirectorMarch 16, 2017Robert D. Short III /s/ Gary FeinerDirectorMarch 16, 2017Gary Feiner /s/ Michael F. AngeloDirectorMarch 16, 2017Michael F. Angelo /s/ Thomas M. O'BrienDirectorMarch 16, 2017Thomas M. O’Brien 69TABLE OF CONTENTSEXHIBIT INDEXExhibitNumber Incorporated by reference hereinDescriptionFormExhibit No.Filing DateFile No.3.1Certificate of Incorporation of theCompany.8-K3.111/01/2007000-268953.2By-Laws of the Company.8-K3.211/01/2007000-268954.1Form of Warrant Agency Agreement by andbetween the Company and Corporate StockTransfer, Inc. as Warrant Agent.S-1/A4.101/16/2009333-1536454.2Form of Series I Warrant.8-K4.109/03/2009001-338524.3Specimen Common Stock Certificate.S-34.108/20/2015333-2064974.4Form of Senior IndentureS-34.208/20/2015333-2064974.5Form of Subordinated IndentureS-34.408/20/2015333-20649710.1Form of Indemnification Agreement by andbetween the Company and each of KendallLarsen, Robert D. Short III, Gary Feiner,Michael F. Angelo, Thomas M. O’Brien andRichard Nance.8-K10.307/12/2007000-2689510.2*2007 Stock Plan, as amended on April 13,2012.10-Q10.205/10/2012001-3385210.3*Amended Form of Stock Option Agreement– 2007 Stock Plan.10-Q4.505/10/2011001-3385210.4*Form of Restricted Stock Unit AwardAgreement – 2007 Stock Plan.10-Q10.305/10/2012001-3385210.5*2013 Equity Incentive Plan.DEF 14AAppendix A04/12/2013001-3385210.6*Form of Stock Option Agreement – 2013Equity Incentive Plan.10-K10.603/02/2015001-3385210.7*Form of Restricted Stock Unit Agreement –2013 Equity Incentive Plan.10-K10.703/02/2015001-3385210.8Voting Agreement among the Company andcertain of its stockholders, dated as ofDecember 12, 2007.10-K10.1103/31/2008001-3385210.9Securities Purchase Agreement, dated as ofSeptember 2, 2009, by and between theCompany and the Purchasers (as definedtherein).8-K10.109/03/2009001-3385210.10Form of Registration Rights Agreement byand between the Company and thePurchasers (as defined therein).8-K10.209/03/2009001-3385210.11Form of Underwriting Agreement betweenVirnetX Holding Corporation and GilfordSecurities Incorporated.S-1/A1.101/16/2009333-15364510.12Patent License and Assignment Agreementby and between the Company and Leidos,Inc. (formerly Science ApplicationsInternational Corporation) dated as ofAugust 12, 2005.8-K10.407/12/2007000-2689570TABLE OF CONTENTSExhibitNumber Incorporated by reference hereinDescriptionFormExhibit No.Filing DateFile No.10.13Amendment No. 1 to Patent License andAssignment Agreement by and between theCompany and Leidos, Inc. dated as ofNovember 2, 2006.8-K10.607/12/2007000-2689510.14Amendment No. 2 to Patent License andAssignment Agreement by and betweenVirnetX, Inc. and Leidos, Inc. dated as ofMarch 12, 2008.8-K10.103/18/2008001-3385210.15Security Agreement by and between theCompany and Leidos, Inc. dated as ofAugust 12, 2005.8-K10.507/12/2007000-2689510.16Assignment Agreement between theCompany and Leidos, Inc. dated as ofDecember 21, 2006.8-K10.707/12/2007000-2689510.17Professional Services Agreement by andbetween the Company and Leidos, Inc.dated as of August 12, 2005.8-K10.807/12/2007000-2689510.18IP Brokerage Agreement by and betweenipCapital Group, Inc. and VirnetX, Inc.,effective as of March 13, 2008.8-K10.203/18/2008001-3385210.19Engagement Letter by and between VirnetXHolding Corporation and ipCapital Group,Inc. dated March 12, 2008.8-K10.303/18/2008001-3385210.20**Engagement Letter dated June 8, 2009, byand between McKool Smith, a professionalcorporation, and VirnetX, Inc.10-Q10.108/10/2009001-3385210.21**Engagement Letter dated April 15, 2010, byand between McKool Smith, a professionalcorporation, and VirnetX, Inc.10-Q10.105/07/2010001-3385210.22**Settlement and License Agreement, by andbetween Microsoft Corporation andVirnetX, Inc., dated May 14, 2010.10-Q/A10.101/31/2011000-3385210.23***Amended Settlement and LicenseAgreement, by and between MicrosoftCorporation and VirnetX, Inc., datedDecember 17, 2014.10-K10.2303/02/2015001-3385210.24*Employment Offer Letter from VirnetX, Inc.to Richard H. Nance.10-Q10.405/10/2012001-3385210.25Patent Licensing RepresentativeAgreement, by and between IPValueManagement, Inc. and VirnetX, Inc., datedMay 8, 2015.10-Q10.105/11/2015001-3385271TABLE OF CONTENTSExhibitNumber Incorporated by reference hereinDescriptionFormExhibit No.Filing DateFile No.21.1Subsidiaries of VirnetX HoldingCorporation. 23.1Consent of Farber Hass Hurley LLP,Independent Registered Public AccountingFirm. 31.1Chief Executive Officer Certificationpursuant to Rule 13a-14(a) of the SecuritiesExchange Act. 31.2Chief Financial Officer Certificationpursuant to Rule 13a-14(a) of the SecuritiesExchange Act. 32.1†Chief Executive Officer Certificationpursuant to 18 U.S.C. Section 1350 asadopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002 32.2†Chief Financial Officer Certificationpursuant to 18 U.S.C. Section 1350 asadopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002. 101.INSXBRL Instance Document 101.SCHXBRL Taxonomy Extension SchemaDocument 101.CALXBRL Taxonomy Extension CalculationLinkbase Document 101.DEFXBRL Taxonomy Extension DefinitionLinkbase Document 101.LABXBRL Taxonomy Extension LabelLinkbase Document 101.PREXBRL Taxonomy Extension PresentationLinkbase Document *Indicates management contract or compensatory plan.**Confidential treatment has been granted by the U.S. Securities and Exchange Commission as to certain portions of this Exhibit.***Portions of this Exhibit have been omitted pending a determination by the Securities and Exchange Commission as to whether these portionsshould be granted confidential treatment.†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 of1933, as amended, or the Securities Act of 1934, as amended, whether before or after the date of this Form 10-K, irrespective of any generalincorporation language contained in such filing.72EXHIBIT 21.1Subsidiaries of RegistrantName of EntityJurisdiction ofIncorporation orOrganizationNetwork Research Corporation Japan Ltd. (known as Network Research Corporation Japan KabushikiKaisha in Japan)JapanVirnetX Inc.DelawareEXHIBIT 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (Nos. 333-149884, 333-153645and 333-162145) and Form S-8 (No. 333-149883) of our reports dated March 16, 2017, relating to the consolidated financialstatements of VirnetX Holding Corporation (the “Company”), and the effectiveness of the Company’s internal control overfinancial reporting, appearing in this Annual Report on Form 10-K of the Company for the year ended December 31, 2016./s/ Farber Hass Hurley LLPChatsworth, CAMarch 16, 2017EXHIBIT 31.1CERTIFICATIONSI, 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 31,2016;2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material factnecessary to make the statements made, in light of the circumstances under which such statements were made, not misleadingwith 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 allmaterial respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periodspresented in this report;4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (asdefined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:(a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designedunder our supervision, to ensure that material information relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularly during the period in which this report isbeing prepared;(b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to bedesigned under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance with generally accepted accounting principles;(c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report ourconclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by thisreport based on such evaluation; and(d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during theregistrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, theregistrant’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 overfinancial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or personsperforming the equivalent functions):(a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reportingwhich are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financialinformation; and(b)Any fraud, whether or not material, that involves management or other employees who have a significant role in theregistrant’s internal control over financial reporting. /s/ Kendall Larsen Kendall Larsen President and Chief Executive Officer(Principal Executive Officer)Date: March 16, 2017EXHIBIT 31.2CERTIFICATIONSI, Richard H. Nance, certify that:1.I have reviewed this Annual Report on Form 10-K of VirnetX Holding Corporation for the fiscal year ended December 31,2016;2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material factnecessary to make the statements made, in light of the circumstances under which such statements were made, not misleadingwith 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 allmaterial respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periodspresented in this report;4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (asdefined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:(a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designedunder our supervision, to ensure that material information relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularly during the period in which this report isbeing prepared;(b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to bedesigned under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance with generally accepted accounting principles;(c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report ourconclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by thisreport based on such evaluation; and(d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during theregistrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, theregistrant’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 overfinancial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or personsperforming the equivalent functions):(a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reportingwhich are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financialinformation; and(b)Any fraud, whether or not material, that involves management or other employees who have a significant role in theregistrant’s internal control over financial reporting. /s/ Richard H. Nance Richard H. Nance Chief Financial Officer(Principal Accounting and Financial Officer)Date: March 16, 2017EXHIBIT 32.1CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002In connection with the Annual Report of VirnetX Holding Corporation (the “Company”) on Form 10-K for the fiscal year endedDecember 31, 2016 as filed with the Securities and Exchange Commission on March 16, 2017 (the “Report”), I, Kendall Larsen,President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section906 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 ofoperations of the Company. /s/ Kendall Larsen Kendall Larsen President and Chief Executive Officer(Principal Executive Officer)Date: March 16, 2017EXHIBIT 32.2CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002In connection with the Annual Report of VirnetX Holding Corporation (the “Company”) on Form 10-K for the fiscal year endedDecember 31, 2016 as filed with the Securities and Exchange Commission on March 16, 2017 (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 theSarbanes-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 ofoperations of the Company. /s/ Richard H. Nance Richard H. Nance Chief Financial Officer(Principal Accounting and Financial Officer)Date: March 16, 2017

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