Summary of VIRNETX HOLDING CORP

ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
This Quarterly Report on Form 10-Q, including this Management's Discussion and Analysis of Financial Condition and Results of Operations contains "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995, which provides a "safe harbor" for statements about future events, products and future financial performance that are based on the beliefs of, estimates made by and information currently available to our management. Except for the historical information contained herein, the outcome of the events described in these forward-looking statements is subject to risks and uncertainties. See "Risk Factors" for a discussion of these risks and uncertainties. The following discussion should be read in conjunction with and is qualified in its entirety by reference to our consolidated financial statements included elsewhere in this report. Actual results and the outcome or timing of certain events may differ significantly from those stated or implied by these forward-looking statements due to the factors listed under "Risk Factors," and from time to time in our other filings with the Securities and Exchange Commission, or SEC. For this purpose, using the terms "believe," "expect," "expectation," "anticipate," "can," "should," "would," "could," "estimate," "appear," "based on," "may," "intended," "potential," "indicate," "are emerging" and "possible" or similar statements are forward-looking statements that involve risks and uncertainties that could cause our actual results and the outcome and timing of certain events to differ materially from those stated or implied by these forward-looking statements. By making forward-looking statements, we have not assumed any obligation to, and you should not expect us to, update or revise those statements because of new information, future events or otherwise.
As used herein, "we," "us," "our," or the "Company" means VirnetX Holding Corporation, together with its consolidated subsidiaries where applicable. Company Overview
We are a development stage company focused on commercializing a patent portfolio for securing real-time communications over the Internet. These patents were acquired by our principal operating subsidiary, VirnetX, from Science Applications International Corporation, or SAIC. SAIC is a FORTUNE 500Ž scientific, engineering, and technology applications company that uses its deep domain knowledge to solve problems of vital importance to the nation and the world, in national security, energy and the environment, critical infrastructure, and health.
In December 2007, we closed an underwritten public offering of 3.45 million shares of our common stock, raising gross proceeds of $13.8 million before underwriting discounts and commissions and offering expenses. In connection with the 2007 offering, our common shares began trading on the American Stock Exchange under the ticker symbol "VHC." Our principal business activities to date are our efforts to commercialize our patent portfolio. We also conduct the remaining activities of PASW, Inc., which are generally limited to the collection of royalties on certain Internet-based communications by our wholly-owned Japanese subsidiary pursuant to the terms of a single license agreement. The revenue generated by this agreement is not significant.
Although we believe we may derive revenues in the future from our principal patent portfolio and are currently endeavoring to develop certain of those patents into marketable products, we have not done so to date. Because we have limited capital resources, our revenues are insignificant and our expenses, including but not limited to those we expect to incur in our patent infringement case against Microsoft, are substantial, we may be unable to successfully complete our business plans, our business may fail and your investment in our securities may become worthless. See "Risk Factors" for additional information.
We are in the development stage and consequently we are subject to the risks associated with development stage companies including: the need for additional financings; the uncertainty that our patent and technology licensing program development efforts will produce revenue bearing licenses for us; the uncertainty that our development initiatives will produce successful commercial products as well as the marketing and customer acceptance of such products; competition from larger organizations; dependence on key personnel; uncertain patent protection; and dependence on corporate partners and collaborators. To achieve successful operations, we will require additional capital to continue research and development and marketing efforts. No assurance can be given as to the timing or ultimate success of obtaining future funding.

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Recent Developments in the Quarter Ended September 30, 2008 On August 6, 2008 we entered into an engagement letter with Cowen and Company LLC a New York based investment banking group to act as lead placement agent in connection with a proposed public offering of up to $30,000,000 in common stock and warrants to purchase shares of our common stock. On August 25, 2008 we entered into an engagement letter with Craig-Hallum Capital Group LLC, a Minneapolis, MN based research, institutional sales and trading, and investment banking group, to act as co-placement agent in connection with this proposed offering.
On August 26, 2008, we were awarded another U.S. patent, number 7,418,504, by the U.S. Patent and Trademark Office. The new patent, titled "Agile network protocol for secure communications using secure domain names" describes a system for establishing a secure communication link using secure domain names. In conjunction with the issuance of this patent, we will seek to commercialize these exclusive rights in the United States by establishing the secure domain name registry service for the Internet. Additional information about the patent can be found on www.uspto.gov.
On September 24, 2008 we announced that we have filed a registration statement with the U.S. Securities and Exchange Commission, or SEC, for a proposed public offering of up to $30,000,000 in common stock and warrants to purchase shares of our common stock and that Cowen and Company, LLC and Craig-Hallum Capital Group LLC have agreed to act as lead placement agent and co-placement agent, respectively, in connection with this proposed offering.
On October 23, 2008, our Board of Directors authorized the establishment of an advisory board and we concurrently entered into advisory board agreements with John Cronin, Paul Henderson, and John F. Slitz. The members of our advisory board will collaborate with and provide advice and assistance to us, with a focus on facilitating the development and commercialization of our licensing program. We will strategically select members of our advisory board, including those appointed on October 23, 2008, who are well-informed and well-connected in fields relevant to our software and technology solutions, market direction, and future plans. Biographical information regarding the Company's three advisory members is available on Form 8-K filed with the SEC on October 27, 2008. Application of Critical Accounting Policies There were no material changes in the application of the Company's critical accounting policies since the end of the most recent fiscal year. For further information, see the "Critical Accounting Policies" section of Item 7 in the Company's Annual Report on Form 10-K for the year ended December 31, 2007, filed with the SEC on March 31, 2008.
Recent Accounting Pronouncements
There were no material updates to recent accounting pronouncements since the end of the most recent fiscal year. For further information, see the "Recent Accounting Pronouncements" section of Item 7 in the Company's Annual Report on Form 10-K for the year ended December 31, 2007, filed with the SEC on March 31, 2008.
Results of Operations
Nine Months Ended September 30, 2008 Compared with Nine Months Ended September 30, 2007 Revenue - Royalties
Revenue generated decreased to $23,905 for the three months ended September 30, 2008 from $46,664 for the three months ended September 30, 2007. Revenue generated increased to $107,955 for the nine months ended September 30, 2008 from $46,664 for the nine months ended September 30, 2007. Our revenue in 2008 was solely limited to the royalties earned under our single license agreement through our Japan subsidiary. We expect the revenue from this license to decrease substantially in the future. We do not intend to seek additional licenses or other revenue through our Japan subsidiary.

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Research and Development Expenses
Research and development costs include expenses paid to outside development consultants and compensation related expenses for our engineering staff. Research and development costs are expensed as incurred.
Our research and development expenses increased by $165,095 to $633,335 for the nine months ended September 30, 2008, from $468,240 for the nine months ended September 30, 2007. This increase is primarily due to increased engineering activities for product development and the addition of one engineer. We expect research and development expenses to increase as employees are hired to provide in-house research and development. While we expect to use outside contractors for additional product development on a limited basis, we expect those costs to remain level or decline.
Selling, General and Administrative Expenses Selling, general and administrative expenses include management and administrative personnel, as well as outside legal, accounting, and consulting services.
Our selling, general and administrative expenses increased by $4,516,767 to $8,620,276 for the nine months ended September 30, 2008 from $4,103,509 for the nine month period ended September 30, 2007.
Within selling, general and administrative expenses, legal fees increased by $2,166,735 to $4,618,256 for the nine months ended September 30, 2008 from $2,451,521 for the nine months ended September 30, 2007. The increase in fees incurred was due primarily to our patent infringement litigation against Microsoft and filing of Form S-1 dated September 24, 2008.
In addition, during the nine months ended September 30, 2008, we made our first minimum annual royalty payment of $50,000 to SAIC pursuant to the patent license and assignment agreement, as amended, by and between VirnetX and SAIC. As of September 30, 2008, we had not received any royalty revenue on the patents nor begun to amortize the related intangible asset.
Also within selling, general and administrative expenses, expenses increased by $2,350,032 to $4,002,020 for the nine months ended September 30, 2008, from $1,651,988 for the nine month period ended September 30, 2007. The increase was due principally to stock options granted to our employees and directors. In addition, we increased the number of employees and resources in order to comply with the requirements associated with being an SEC reporting company.
Once we begin to generate royalty revenues, we expect that our selling expenses will increase significantly as we must make payments to ipCapital Group and SAIC with respect to such revenues and as we begin to expand our sales force.
Liquidity and Capital Resources
We are in the development stage and have raised capital since our inception through the issuance of our equity securities. We have used the net proceeds from the sale of common and preferred stock for general corporate purposes, which have included funding research and development, litigation efforts and working capital needs. As of September 30, 2008, we had approximately $2,260,170 in cash. We believe that our cash and cash equivalents will be sufficient to fund operations for at least the next 12 months. We will need to generate additional revenue or raise additional funding in the near future to continue our operations thereafter.
We expect to finance future cash needs primarily through proceeds from equity or debt financings, loans, and/or collaborative agreements with corporate partners. On September 24, 2008, we filed a Registration Statement on Form S-1 (File No. 333-153645) with the SEC. This registration statement contemplates a public offering of shares of our common stock and warrants to purchase shares of our common stock. This registration statement has not yet been declared effective by the SEC, but we anticipate that our existing cash and cash equivalents, together with the net proceeds from this offering if this registration statement is declared effective and assuming that the offering is fully subscribed and is completed, will be sufficient to fund operations for at least the next 12 months. There can be no assurance that this offering will be fully subscribed on acceptable terms or at all, particularly in the current capital markets environment.
We believe that our 2008 cash requirement to fund our operations will average approximately $660,000 per month and that our 2009 average cash requirement to fund operations will increase to approximately $950,000 per month. We anticipate our monthly cash requirements will increase significantly as we increase our expenditures for:

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our lawsuit against Microsoft;

infrastructure;

sales and marketing;

research and development;

personnel; and

general business enhancements.

We may exceed those projected amounts if we increase these expenditures in response to business conditions we do not currently anticipate or for other reasons.
The process of developing new security solutions is inherently complex, time-consuming, expensive and uncertain. We must make long-term investments and commit significant resources before knowing whether our patented technology offerings will achieve market acceptance. We are unable to predict when we will begin to generate material net cash inflows from our patent and technology licensing program and our secure domain name registry service.
To obtain additional capital when needed, we expect to evaluate alternative financing sources, including, but not limited to, the issuance of equity or debt securities, corporate alliances, joint ventures and licensing agreements; however, there can be no assurance that funding will be available on favorable terms, if at all. We cannot assure you that we will successfully commercialize our products and services or that our products and services will gain sufficient market acceptance to enable us to earn a profit. If we are unable to obtain additional capital, we may be required to cease operations or to reduce cash used in our business, including the termination of commercialization efforts that may appear to be promising, the sale of our patent portfolio or other assets, the abandonment of our litigation with Microsoft or others and the reduction in overall operating activities. Off-Balance Sheet Arrangements
As of September 30, 2008, we did not have any off balance sheet arrangements except for operating lease commitments and the contingent portion of our royalty obligation under our royalty agreement with SAIC. We have discussed these arrangements in more detail in Note 4 and Note 5 to the financial statements included in this Quarterly Report on Form 10-Q.