virnetx holding corporationlte, sae series 33 specification. virnetx asserts that it is the only...

Wireless Equipment

VirnetX Holding Corporation

Initiating With Outperform (1)

May 27, 2011 Initiating with Outperform; VirnetX Moves to Secure its 4G LTE IPR Position

Analysts Matthew Hoffman (617) 946-3936 [email protected] Bryan Prohm (617) 946-3733 [email protected]

Conclusion: Real-time peer-to-peer communication, including video chat, should be among the compelling applications end-users adopt as all-IP 4G LTE wireless networks and two-camera smartphones proliferate. We believe VHC's intellectual property sits at the heart of that market opportunity, making connections between end-users on tomorrow's 4G networks as convenient and secure as those found on today's voice networks. Over the next 1-5 years, we expect most major device OEMs to license, or otherwise be made aware of, patents VirnetX has uniquely declared as essential to the 3GPP's LTE Series 33 specification. We expect VHC to appreciate >40% relative to the market over the next year as its model tracks toward our $185MM C14 revenue forecast.

■ VirnetX Declares Its IPR Essential to LTE Standard. VirnetX has declared its IP "essential" to the 3GPP standards body which governs the LTE technology specification. That declaration makes OEMs of LTE equipment aware VHC believes its technology must be licensed to avoid infringing its patents (IPR). VirnetX's key IPR automates the setup (lookup) of VPN connections between trusted peers, as called for in the Series 33 specification. We do not believe the 3GPP will (can) find a workaround for VirnetX's patents, especially now that VHC has agreed to FRAND licensing.

■ Royalty Revenue From Massive 4G Market Likely. We size the LTE market at $38B in 2014, growing at a ~34% 10-year CAGR through 2021. VHC should see >$175MM of licensing revenue from that C14 TAM; we expect its LTE equipment royalties will increase sharply beyond C14 as its licensee count grows. VHC's SDNI initiative, which automatically performs the look-up and key exchange (registry) services needed to connect trusted peers across networks, should see modest revenue near-term. SDNI has potential to become a highly valuable asset 4G operators utilize to deploy Skype-like (sold to MSFT for ~$8.5B) services, only using industry standard VPN.

VHC (05/26) $23.14 Revenue $MMMkt cap $1.3B FY 2010 2011E 2012E 2013E 2014EDil shares out 55.3MM Dec Actual Prior Current Prior Current Current CurrentAvg daily vol 1,246.2K Q1 0.0 � 0.0A � 2.2 9.7 36.152-wk range $5.1-28.9 Q2 0.0 � 0.0 � 2.8 12.4 43.3Dividend Nil Q3 0.0 � 0.0 � 4.2 21.1 49.4Dividend yield Nil Q4 0.0 � 0.9 � 5.5 26.2 56.0BV/sh $1.18 Year 0.1 � 1.0 � 14.6 69.4 184.8Net cash/sh $1.35 EV/S � � � � � � �Debt/cap NA ROIC (LTM) NA 5-yr fwd EPS NA EPS* $

FY 2010 2011E 2012E 2013E 2014Egrowth (Norm) Dec Actual Prior Current Prior Current Current Current

Q1 (0.22) � (0.14)A � (0.02) 0.05 0.24 Q2 1.66 � (0.08) � (0.02) 0.07 0.30 Q3 (0.49) � (0.06) � (0.01) 0.13 0.34S&P 500 1325.7 Q4 (0.06) � (0.04) � 0.00 0.16 0.37 Year 0.84 � (0.32) � (0.05) 0.40 1.25 P/E � � � � � 57.9x 18.5x *GAAP EPS, diluted

Please see addendum of this report for important disclosures. www.cowen.com


May 27, 2011 2

VHC: Initiating Coverage

VirnetX Inc. (VHC), based in Scotts Valley, California, is a leading provider of the technology that helps to secure real-time communications over the Internet. Originally developed at Science Applications International Corporation (SAIC), VirnetX�s intellectual property (IPR) can be used to create highly secure video, VoIP, and IM connections between trusted users on disparate networks. We believe the most compelling application of VirentX�s technology will be services that enable convenient video chat links between users on the 4G LTE networks, which are only now being deployed worldwide. VirnetX is basically pre-revenue today; its (almost) only source of income the last twelve months was a $200MM settlement from Microsoft in 2Q10 that allowed MSFT limited use of the company�s IPR. Looking forward, strong growth in VirnetX�s core market (and increased licensee count) should drive EPS from ($0.32) in C11 to $1.25/est. diluted share in C14.

Investment Thesis

We are initiating VirnetX stock with an Outperform rating and see shares appreciating 40% relative to the market over the next 12 months as VHC�s revenue increases from essentially zero today to ~$185MM by 2014. We believe most 4G LTE OEMs will need to license VirnetX�s patents as VHC has recently declared its 4G LTE patents are essential to the 3GPP�s emerging LTE Series 33 specification (standard). Our rating and estimates are predicated on the likelihood the company�s licensee count ramps sharply between 2H11 and 2014, with major smartphone, tablet and/or PC OEMs ultimately choosing to negotiate a royalty payment within the company�s published 1-2% rate (subject to possible early incentives and cross-licensing of IPR). With just 11 employees at YE10, VirnetX�s fixed costs are low, but we expect its litigation costs and headcount will both increase through C14. Our 3-year estimates for its two revenue streams, 1) Patent Licensing and 2) Secure Domain Name Initiative (SDNI), are below.

Estimated VHC Revenue Composition, 2011E-2014E

$5 $8

$65

$177

$1/ $0$13/ $1

$0

$100

$200

2011 2012 2013 2014

Re

ve

nu

e,

$U

SM

M

Patent Licensing Revenue

SDNI Revenue

Source: Cowen and Company


May 27, 2011 3

Investment Merits

1. Strategic LTE Position Makes VirnetX an Acquisition Target

A standard is formed when companies contribute their patents to a pool � declaring the patents essential to an emerging standard � and then make equipment that meets the standard. Owning patents that form the foundation of a mobile standard(s) has historically been highly correlated with high market share and revenue (e.g., Ericsson). That relationship likely holds forth because royalties paid by non-patent-holding OEMs boost the margins of the patent holders.

Patents among holding manufacturers are swapped in a cross-licensing mechanism where each company recognizes a contribution to the standard. The company with the superior portfolio (as measured in quality of contribution to the standard) typically receives more money from companies with weaker relative positions in a standard�s patent stack. VirnetX has no intellectual property in the 3G UMTS/HSPA standard; however, the company believes its patents are essential to the emerging all-IP 4G LTE standard. A company like VHC that does not manufacture equipment typically recognizes its share of the patent pool as revenue.

Cowen Sees Multiple 4G LTE IPR Holders � Some Notables Are Missing!

Limited LTE IPR:

Apple

Microsoft

Google

Intel

Cisco

LTE Operators

PC OEMs

Japanese OEMs

Qualcomm

Nokia/NSN

ALUIDCC

DCM

Huawei

LG

ZTE

Others

VHC

Samsung

Ericsson Limited LTE IPR:

Apple

Microsoft

Google

Intel

Cisco

LTE Operators

PC OEMs

Japanese OEMs

Qualcomm

Nokia/NSN

ALUIDCC

DCM

Huawei

LG

ZTE

Others

VHC

Samsung

Ericsson


Our Take: We believe VirnetX�s core patents would be highly useful to a company with a weak relative position in the 4G LTE standard�s patent stack (or no position whatsoever). We believe companies in this group that want to manufacture 4G LTE devices and/or equipment - including Apple, Cisco, and others - will recognize their margins will be inferior to what could be achieved if they did not have to pay for the use of competitor IPR. Patent stacking means that an OEM who has no/limited patents could face as high as a 12-15% total payment to 4G LTE IPR holders without patents to cross-license. 3G patents are likely somewhat lower today (in the 12% range) because Qualcomm has struck deals to �pass through� others� patents for the 5%+ it charges (minus cross-licenses, its rate nets closer to 4%). To be competitive in the emerging tablet or converged 4G device market, many tech sector giants are likely to be looking for key 4G LTE IPR � and we believe VHC fits the bill.


May 27, 2011 4

2. Valuable 4G LTE Patents; Now FRAND Licensing At ETSI�s Request

On April 28, 2011, VirnetX announced that at the request of the European Telecommunications Standards Institute (ETSI), the company agreed to update its original December 2009 licensing declaration to ETSI. The April 2011 announcement states that VirnetX will now make available non-exclusive patent licenses to its IPR to interested companies under FRAND (fair, reasonable and non-discriminatory terms and conditions, with compensation) terms, not RAND (reasonable and non-discriminatory terms and conditions) terms, as had been previously declared. The move was made in response (we believe) to feedback the company received on its March 15, 2011, Statement of Patent Holder document.

In the March 2011 statement, VirnetX had apparently identified a group of its patents and patent applications the company believes are (or may become) essential to specifications the 3GPP LTE, SAE project Series 33 is developing. VirnetX has indicated the parties likely to need to license its patents will be 3GPP members seeking to implement the emerging specification. VirnetX has a lower patent count than several other companies with respect to the total LTE standard; however, the company believes the quality of its portfolio around automated VPN setup is unrivaled and virtually impossible to work around.

VHC�s Long-Term Licensing Stream Opportunity Could Be Significant

LTE Market Total Revenue

C14E: ~$38B

VHC C14 Royalty Revenue of ~$175MMLTE IPR

C14E: ~$5.5B

LTE Market Total Revenue

C14E: ~$38B

VHC C14 Royalty Revenue of ~$175MMLTE IPR

C14E: ~$5.5B


Our Take: The change leaves VirnetX sitting squarely within the ETSI tent and makes VirnetX exceptionally well-positioned to license its essential patents to 3GPP members making 4G LTE equipment. We estimate VirnetX could receive a >1.0% royalty from the overall LTE equipment market (we estimate a ~$38B C14 TAM) when/if the company finishes fully licensing OEMs. We note VirnetX�s effective royalty rate in C14 will be slightly lower in our model to account for the (likely) slow pace of licensee sign-up. Given we estimate the aggregate 2011-2021 LTE market at ~$625B (peaking outside of that window), and accounting for the early incentives discount, VHC�s patent licensing is worth $1.8B, midpoint, today in our DCF. (See page 18.)


May 27, 2011 5

Investment Risks

1. IPR Position Could Break Down

We believe VirnetX�s intellectual property will serve as a cornerstone of the 3GPP�s LTE, SAE Series 33 specification. VirnetX asserts that it is the only company to declare essential IPR in the Series 33 specification which establishes security standards for real-time communication between LTE clients. Because the Series 33 specification is highly likely to be a part of Release 10 of the 3GPP LTE standard, the technology will likely be touched by most � if not, ultimately, all � LTE handset OEMs who build products to the standard (that should be the vast majority). Thus, in our opinion, VirnetX is set to become a member of the IPR pool that 4G LTE handset OEMs must license to manufacture mobile phones utilizing the LTE, SAE Series 33 spec, with significant revenue likely.

There is a chance however, that the members of the 3GPP could 1) find a work-around for the VirnetX patents or 2) change the standard. The company believes that if the 3GPP could have developed a work-around for the patents � which VHC first declared in 2009 to the 3GPP � then the solution would have already been found by the members. We concur, but note the risk remains the company could be put in a position of fighting a much tougher battle to claim its licensing dollars � with revenue remaining elusive � than we now see. Any deterioration in its current position, which we now view as strong, would likely pressure the company�s stock valuation significantly.

2. Modest Means to Fight a Potentially Brutal Battle

If VirnetX has to fight legal battles around the world to defend its IPR, then the battle could get costly. Qualcomm spent hundreds of millions in outside legal fees to bring Nokia to the table; it recently concluded costly negotiations with Panasonic and others. We are building in a ~$50M increase in OPEX (legal, other) by 2014 to account for the likelihood there is some dispute that can not be negotiated away. However, if the VHC has no successes negotiating, and the company continues to believe its patents are being infringed, it will have no choice but to fight an expensive legal war; the company�s $67MM in cash and equivalents will help, but protracted legal battles would substantially delay the revenue recognition we have built into our model (as well as increasing OPEX). Post Microsoft�s recent Skype acquisition, we would not be surprised to see the two companies tangle again given the overlap in target markets and past licensing history.

3. Limited Business Operations

With only eleven employees, VirnetX is not now meeting its potential in terms of marketing its SDNI service provider model. VirnetX�s lookup technology sits at the heart of what end-users want to do with their mobile devices � talk, watch, listen, create and share. Without the ability to share video feeds across networks and operating systems � not just talk to other Facetime (iOS) users or Skype users � the utility of those services are limited. With more R&D headcount and marketing, the company could likely expand its business offerings significantly, diversifying outside of licensing. Instead, the company relies almost exclusively upon licensing and royalty dollars - today and in the near future.


May 27, 2011 6

VirnetX: Core Technology Overview

Intellectual property (IPR) is the heart of the VirnetX story. The company�s IPR largely relates to the technology needed to secure all types of real-time communications over the Internet, including applications like Instant Messaging, Video Streaming, VoIP, file transfer and remote desktop. Its technology creates safe neighborhoods it calls Secure Private Domains (SPD); these SPDs are private network enclaves that facilitate the secure movement of data and communication. The art in VirnetX�s technology is how it automatically creates secure VPN connections, not necessarily in the actual encryption and transport of data. According to VirnetX, its technology marries industry standard encryption methods with its patented DNS lookup mechanism to create a secure communications link between users seeking to communicate in real-time in a process called Secure DNS. Secure DNS is essentially a mechanism to automate VPN connections.

Automatically Securing DNS

For a Secure DNS connection to be created, two devices have to both register with a secure site; this registration process is similar to the creation of a buddy list � and adding buddies - in IM. The company�s technology kicks in when device A seeks device B, allowing each to recognize the other as a �friendly� device. Once that recognition takes place, a VPN connection is automatically established between the devices. Communication can then occur, end-to-end in a completely secure fashion. That allows the user to easily � and conveniently - share video, music and voice, etc.

VirnetX�s Secure DNS Architecture

Source: VirnetX

VirnetX�s technology eliminates the clicks (and password entry) it typically takes to create a one-off VPN connection; we believe that saving those extra steps is the key to convenience for end-users who want security for video communication and VoIP, on mobile (and fixed) networks but would be easily frustrated by typical VPN hoops. The company indicates its suite includes code that is not application specific and enables all TCP/IP protocols. Other solutions work application by application.


May 27, 2011 7

VirnetX�s solution installs security at the IP layer using industry standard VPN encryption and a proprietary technology called VirnetX instant secure connect (ISC). The advantage of the VirnetX solution is it allows for multiple applications � like IM, VoIP and video - to be integrated more easily across the entire platform.

VirnetX: Patent Overview

Several of VirnetX�s core patents that are being cited for alleged infringement in two currently-pending U.S. District Court lawsuits are briefly described below. More detailed overviews of the patents can be found on the United States Patent and Trademark Office website.

United States Patent #6,502,135: �Method for transparently creating a VPN in response to a domain name query�. This patent is referenced in the 8/11/10 complaint against Aastra USA, Inc., Aastra Technologies Ltd., Apple Inc., Cisco Systems Inc., NEC Corporation and NEC Corporation of America and in the 1/24/11 complaint against Avaya, Mitel Networks Corporation, Mitel Networks, Inc., Siemens Enterprise Communications GmbH & Co. KG, and Siemens Enterprise Communications.

United States Patent #6,839,759: �Method for automatically establishing secure communication link between computers of VPN without user entering any cryptographic information�. This patent is referenced in the 8/11/10 complaint against Aastra USA, Inc., Aastra Technologies Ltd., Apple Inc., Cisco Systems Inc., NEC Corporation and NEC Corporation of America and in the 1/24/11 complaint against Mitel Networks Corporation, Mitel Networks, Inc., Siemens Enterprise Communications GmbH & Co. KG, and Siemens Enterprise Communications.

United States Patent #7,188,180: �Method of establishing a secure communication link based on a domain name service (DNS) request�. This patent is referenced in the 8/11/10 complaint against Aastra USA, Inc., Aastra Technologies Ltd., Apple Inc., Cisco Systems Inc., NEC Corporation and NEC Corporation of America and in the 1/24/11 complaint against Mitel Networks Corporation, Mitel Networks, Inc., Siemens Enterprise Communications GmbH & Co. KG, and Siemens Enterprise Communications.

United States Patent #7,418,504: �Agile network protocol for secure communications using secure domain names�. This patent is referenced in the 8/11/10 complaint against Aastra USA, Inc., Aastra Technologies Ltd., Apple Inc., Cisco Systems Inc., NEC Corporation and NEC Corporation of America and in the 1/24/11 complaint against Avaya, Mitel Networks Corporation, Mitel Networks, Inc., Siemens Enterprise Communications GmbH & Co. KG, and Siemens Enterprise Communications.

United States Patent #7,490,151: �Establishment of a secure communication link based on a domain name service (DNS)�. This patent is referenced in the 8/11/10 complaint against Aastra USA, Inc., Aastra Technologies Ltd., Apple Inc., Cisco Systems Inc., NEC Corporation and NEC Corporation of America and in the 1/24/11 complaint against Mitel Networks Corporation, Mitel Networks, Inc., Siemens Enterprise Communications GmbH & Co. KG, and Siemens Enterprise Communications.


May 27, 2011 8

United States Patent #7,921,211: �A system for providing a domain name service for establishing a secure communication link, the system comprising: a domain name service system configured and arranged to be connected to a communication network, store a plurality of domain names and corresponding network addresses, receive a query for a network address, and indicate in response to the query whether the domain name service system supports establishing a secure communication link.� This patent was awarded on April 5th, 2011 and was added to the 8/11/10 complaint against Aastra USA, Inc., Aastra Technologies Ltd., Apple Inc., Cisco Systems Inc., NEC Corporation and NEC Corporation of America and the 1/24/11 complaint against Avaya, Mitel Networks Corporation, Mitel Networks, Inc., Siemens Enterprise Communications GmbH & Co. KG, and Siemens Enterprise Communications.

VirnetX: Products & Revenue

Patent Licensing

With VirnetX now engaged with the ETSI camp and prepared to license its �essential� IPR on FRAND terms to 3GPP members, we believe the company is exceptionally well-positioned to begin realizing ongoing royalty payments from 4G LTE OEMs. The company indicates it is seeking an incentivized royalty rate of 1-2% on the selling price of LTE devices, subject to discounts early licensees are likely to realize. We estimate VirnetX could receive aggregate annual royalty payments of 1.0% or more of total LTE equipment market revenue when/if the company finishes fully licensing OEMs, though in the initial phases of licensing the company�s effective royalty rate is likely to be much lower (as a % of the TAM).

Still, we believe the company�s position could lead to a patent licensing revenue stream which reaches $175MM in 2014. Given the evolution trajectory of 2G GSM and 3G W-CDMA standards, it is highly likely VirnetX�s revenue stream � assuming is IPR position holds where we believe it is � will grow at a >30% CAGR over the next 10 years. We note this is a similar position, albeit smaller in percentage terms, that Qualcomm occupied in W-CDMA standards bodies. It took time for Qualcomm to finally recognized the revenue stream it does today on W-CDMA/HSPA; although we believe the company could eventually see an effective royalty rate >1% of the annual dollar value of the LTE market, the path is likely to include constant negotiation and threat (at least) of litigation.

Secure DNS Makes IP-Based Communications Safe & Easy

Today voice services still generate the vast majority of global mobile operator revenue. However, as all-IP (IMS) 4G LTE networks roll-out worldwide, voice is likely to become just another series of 1�s and 0�s traveling the mobile Internet right beside lower-value bits (i.e. another form of mobile data traffic). That dynamic could significantly pressure voice (and overall) margins for operators. To cope, many operators are moving away from all-you-can-eat data plans (that allow VoIP services) and are moving users to tiered, per-GB plans. In a 4G LTE world, many believe operators will promote services that are bandwidth intensive, like video chat, over voice services.


May 27, 2011 9

How Secure Are Consumer VoIP and Video Chat Today?

There is one significant wrinkle with the view voice and video communications should be treated like all other traffic: security. Today, users take for granted a high degree of security when talking. Will users accept anything less in an all IP world? Based on our market research experience, our bet is no - users will not.

Today, users of the most popular real-time VoIP and video communication applications - Apple�s Facetime, Microsoft�s Skype and Cisco�s Webex � establish connections only with end-users using the same service (software/service combo). Many of the current offerings that connect users across networks use a registry like VHC�s solutions. Those solutions do not, however, appear to use VPN and instead use other, less secure, proprietary technology to connect users, potentially opening up security holes in the connection.

Enter VirnetX�s Secure Domain Name Initiative (SDNI)

VirnetX�s Secure Domain Name Initiative (SDNI) service has the potential to unlock connections among multiple users on different networks, using different operating systems and applications, all encrypted with industry standard VPN. SDNI combines VPN and IP-based communications, creating a registry of trusted users that automatically � or via a single click � establish a VPN with another user, with no physical passwords entered.

VirnetX�s Secure Domain Name Initiative is only likely to see modest revenue near-term, but longer-term SDNI could become the backbone technology operators deploy to maintain a central role in securely connecting people and/or devices - just as they are today. We believe it is clear the current generation of peer-to-peer video solutions will not meet the security needs of enterprises and consumers as/when threats emerge. When security risks do demand a VPN oriented solution, VirnetX�s technology will be well-positioned to make those connections easy and safe. It is unlikely the business is worth a Skype-like $8.5B today � given it has no brand nor customers � but the potential is there for this to become a business that charges operators a per-user, per-month, or per-connection fee (or licenses the technology) to create a revenue stream beyond its emerging standards-based licensing business.

How Will SDNI Work?

VirnetX�s Secure Domain Name Initiative (SDNI) service promises to provide VPN-based peer-to-peer connections among users who reside on different networks (whether mobile or fixed) and use devices with disparate operating systems (e.g. iOS, Andriod, Windows, etc). VirnetX�s Secure Domain Name Initiative combines VPN and IP-based real-time communications by creating a registry of trusted users that are automatically � or with one click � connected via VPN with no passwords entered or credentials exchanged.

We believe VirnetX�s SDNI would work similarly to the way Microsoft�s Exchange Active Sync securely sends and receives corporate email on an iPhone. Our take is that the primary difference is that the registry that establishes �trust� would be on the Internet, not a corporate network, and that the traffic would include speech and video, not email only. It seems clear the patents that Microsoft was forced to license from VHC in 2010 are at the heart of the Exchange Active Sync solution (yes, the same Exchange Active Sync that we believe broke RIMM�s hold on wireless email).


May 27, 2011 10

SDNI Takes Shape

To implement the SNDI strategy VirnetX indicates the company has been in (active) discussion with the 4G LTE companies including: 1) service providers 2) domain infrastructure providers, 3) chipsets suppliers and others. The company is attempting to design a pilot service that would show how the company�s technology would work in practice, including how trusted lists would be generated and maintained. The pilot will apparently implement both VirnetX�s patented Secure Domain Name and GABRIEL Connection Technologies. The technology automatically performs the look-up and key exchange (registry) services needed to connect trusted peers across networks.

One caveat, as straightforward as the IP licensing story is for VirnetX, the shape of the SDNI opportunity is somewhat murkier - it is unclear exactly how the company will monetize the service. Will it partner with operators to offer a service which re-centralized the operators� role in the communications world? Or will the company sell the technology to equipment OEMs who then brand a service? The current generation of peer-to-peer solutions does not appear to be well suited to meet the security needs of enterprises and most consumers if/when threats emerge. Eventually we believe security risks will demand a VPN oriented solution, and VirnetX�s technology is what makes those connections easy and safe.

Our Take: SDNI is a way VHC can demonstrate services it believes end-users are going to demand � both enterprise and consumer � before the need is necessarily apparent. Over time, we believe the need will become obvious as security threats to proprietary, non-standard, non-VPN real-time IP-based communications emerge. SDNI can become a highly valuable asset that 4G LTE operators utilize to deploy Skype-like services, only using industry standard VPN.

VirnetX: Management & Key Personnel

Kendall Larsen, CEO, President and Chairman of the Board: Mr. Larsen is VirnetX�s Chief Executive Officer (CEO), President and Chairman of the company�s board of directors. Mr. Larsen has served as CEO and Chairman of the Board since June 2007 and as President of the company since July 2007.

William E. Sliney, CFO: Mr. Sliney has served as VirnetX�s Chief Financial Officer (CFO) on an interim and part-time basis since July 2007. Mr. Sliney previously served as president, CFO and as a member the board of directors of PASW, Inc., (which merged with VirnetX in July 2007).

Dr. Robert Dunham Short III, CTO and Chief Scientist: Dr. Short has served as VirnetX�s Chief Technical Officer since June 2010 and as VirnetX�s Chief Scientist since May 2006. Dr. Short previously served as Assistant Vice President and Division Manager at Science Applications International Corporation (SAIC). Dr. Short also serves as a member of VirnetX�s board of directors.


May 27, 2011 11

LTE Market Analysis

Long Term Evolution (LTE) Standards: An Overview

The 3GPP (3rd Generation Partnership Project) is comprised of a body of members that include: 1) organizational partners, 2) mobile network operators, 3) original equipment manufacturers (OEMs) and 4) intellectual property contributors (e.g. VirnetX). The 3GPP�s organizational partners include leading telecoms associations (e.g. the European Telecommunications Standards Institute/ETSI) and collaborate to determine 3GPP policy, standards and strategy.

In 2004 the 3GPP began its initial work on Long Term Evolution (LTE) project with the objectives of: 1) establishing standards for enhanced radio access architectures for existing 2G GSM and 3G UMTS/HSPA networks and 2) establishing a core network evolution path for all mobile access technologies to a fully packet (i.e. all-IP) mode. As a result of the 3GPP�s work, LTE is now accepted as the next generation (�4G�) standard for the vast majority of the world�s 2G GSM and 3G mobile operators (both UMTS/HSPA and CDMA), though there are some alternative access technologies that fall under the �4G� umbrella (e.g. WiMAX).

The 3GPP�s LTE standard encompasses both the technology rules and performance targets that dictate how LTE networks must operate (i.e. increased uplink/downlink data throughput speeds, scalable channel bandwidth to fit different spectrum, spectral efficiency improvement, secure all-IP architecture, etc.) as well as the technology and performance specifications that equipment running on/over the network must meet. The 3GPP�s LTE standards concerning secure all-IP architecture represent the principal market opportunity for VirnetX�s technology.

CDMA Operators Lead the LTE Migration Near-Term

Cowen maintains a real-time, comprehensive database of mobile connection data at the country, operator and technology level across more than 180 countries. As of 1Q11, we estimate there were >100 CDMA mobile networks worldwide that collectively had ~500MM connections. We expect a majority of that ~500MM CDMA connection base will migrate to 4G LTE networks over the next ten years (2012-2021), driven largely by operators in North America (e.g. Verizon Wireless, Metro PCS, U.S. Cellular and possibly others) and in Asia-Pacific (e.g. China Telecom, KDDI and others).

We believe LTE is likely to be largely confined to countries with legacy CDMA operators in the near-term because CDMA�s technology roadmap (to Rev B) has not been widely embraced by its current adherents. The upgrade path to higher data speeds on HSPA+ is a high return/limited investment equation for most operators when compared to a move to 4G LTE. However, the aggressive deployment timetables of leading U.S. CDMA operators (e.g. Verizon is now planning to have a 4G LTE footprint at YE13 that matches its current 3G footprint) is forcing accelerated 4G LTE deployment timetables from 1) smaller U.S. CDMA operators (e.g. U.S. Cellular) and 2) leading U.S. 3G UMTS/HSPA competitors (e.g. AT&T now plans a 15-market 4G LTE roll-out by YE11).


May 27, 2011 12

Commercial 4G LTE Networks Should Exceed 30 in 2H11

USA Verizon, Metro PCS launched in 2H10; AT&T, US Cellular launching in 2H11.

Canada Rogers plans 4-market roll-out by YE11.

Japan DoCoMo launched in December 2010; 2011 Softbank launch pending.

Korea SK Telecom plans Seoul launch in July 2011.

Hong Kong CSL New World launched in November 2010.

Philippines Smart launched in April 2011.

Australia Telstra plans 2H11 launch.

Nigeria Globacom (Glo Mobile) launched in January 2011.

Armenia Viva-Cell (MTS) 2011 launch pending.

Estonia EMT (Telia) launched in December 2010.

Lithuania Omnitel (Telia) launched in April 2011.

Poland CenterNet/Mobyland launched in September 2010.

Uzbekistan MTS launched in 2H10; Ucell (TeliaSonera) launched in 2H10.

Austria T-Mobile launched in 4Q10; Mobikom launched in 4Q10.

Denmark Telia Denmark (TeliaSonera) launched in December 2010.

Finland Elisa launched in 4Q10; Telia launched in 4Q10.

Germany Vodafone launched in November 2010; T-Mobile launched in April 2011.

Norway Netcom (TeliaSonera) launched in December 2009.

Sweden TeliaSonera launched in December 2009; Tele2 launched in November 2010.

Israel Partner (Orange) plans 2H11 launch.

UAE Etisalat plans 2011 launch; du plans 2H11 launch.

Market Key 4G LTE Launch Developments

Source: Company reports, Cowen and Company estimates

Sizing the Long-Term LTE Market

With mobile voice traffic set to move to IP � and the �dialing� method most subscribers use to �call� another party today likely to evolve beyond entering a ten-digit phone number on a keypad � we believe a majority of the world�s ~500+ 3G UMTS/HSPA operators will deploy 4G LTE networks at some time during the next ten years (2012-2021). Based upon a count of commercial LTE launches to date as well as launches pending in 2H11 we forecast global LTE connections to exceed 7MM at YE11 (+>4000% y/y) and top 188MM by YE14 (a five-year CAGR of >300%).

Cowen 4G LTE Connection, Device and Revenue Forecast, 2010-2014

2010 2011E 2012E 2013E 2014E

LTE Connections (MM) 0.2 7.1 27.6 84.2 188.4

LTE Device Shipments (MM) 0.2 8.2 24.2 66.9 125.3

LTE Revenue ($USB) $0.1 $2.4 $6.7 $17.8 $32.1



May 27, 2011 13

VirnetX: Financial Analysis

Revenue Today is Minimal; Long-Term Growth Potential is Great

We believe VHC�s core technology/IPR position could help to produce a revenue stream that exceeds $175MM by 2014, with significant annual growth well beyond that time frame as 4G LTE continues to ramp worldwide. We note this is a very similar position, albeit at a smaller-scale, that Qualcomm occupies within the 3GPP�s established 3G UMTS/HSPA (W-CDMA) standards. It took many years for Qualcomm to recognize the full licensing revenue stream that the company does today for 3G UMTS/HSPA (W-CDMA) standards via its QTL business. Although we believe VirnetX could eventually achieve an effective royalty rate that exceeds 1% of the annual value of the 4G LTE market, we expect that the company�s path to that result will likely include constant negotiation/renegotiation and the threat (at least) of litigation (based upon Qualcomm�s recent history). We are being conservative with our rate assumptions until licensees begin to sign - but the rate could well move up.

VHC�s prospective LTE licensing stream is by far the most valuable component of the model; licensing generates almost all of the company�s revenue in our model today, and still generates in excess of 95% of revenue in F14. VirnetX�s current market capitalization of ~$1.28B would be hard to justify based on current financials, much less appreciate from current levels if the company�s 5+ year opportunity were not so great. VHC shares currently trade at ~18-19X our $1.25 F14 EPS (fully diluted).

Cowen versus Consensus

Sell-side coverage of VHC is currently very limited. Thomson First Call shows the last set of estimates for VHC were provided in early April (i.e., before the company�s 4/27/11 1Q11 March quarterly results report and conference call), and consisted of only a FY11 top and bottom line estimate. Therefore, we assume there is no standing consensus for VHC. We note the company does not provide full financial guidance.

Cowen VHC Estimates versus Consensus

In USD

Revenue ($MM) $1.0 $25.0 $14.6 n/a $69.4 n/a

Patent & Licensing ($MM) $1.0 n/a $13.4 n/a $64.6 n/a

EPS -$0.32 -$0.21 -$0.05 n/a $0.40 n/a

FY13

Cons.CowenCons.

FY12FY11

Cowen CowenCons.

Source: Thomson, Cowen and Company estimates

Stock Valuation

VHC�s current valuation is based upon its strategic potential, not its financial performance. We further believe an investment in VHC is highly speculative as the value of the stock could drop very significantly if its IPR position weakens. Conditions which could weaken its IPR include, but are not limited to: 1) shifts in technology which obviate the need for VHC patents, 2) changes to emerging 3GPP standards 3) challenges and / or reviews of its patents. We currently do not expect


May 27, 2011 14

any of those risks/outcomes to materialize, but we do anticipate (and believe our estimates account for) the challenges the company will have signing new licensees.

While we believe the stock should outperform just on the basis the value of its share of the LTE licensing pool, the prospect that weak-IP companies with 4G aspirations might view VHC as an acquisition target could unlock more even more value. We could make the case that VHC, knowing its strategic position in LTE � and the possibility it could get the SDNI initiative to generate revenue � a case could be made VHC could value the company even higher.

We believe VHC is tracking along similar lines to those Qualcomm took in its early days. Today, Qualcomm�s QTL licensing business generates more than $4.0B/year from device OEMs around the world that make products (e.g., mobile phones, smartphones, tablets, etc.) using technology within the 3G UMTS/HSPA standard (to which Qualcomm contributed key IPR). While we do not believe VirnetX�s patents are as critical to 4G LTE as Qualcomm�s were in 3G CDMA (or in 4G LTE, for that matter), we note that the VHC patents do appear to sit right in the middle of what we believe is the key use case for 4G LTE, namely real-time video communications.

Valuing VirnetX Licensing Potential

Our ten-year DCF returns a value of $1.8B (midpoint) for VHC�s patent licensing stream, forming the foundation of the ~40% appreciation potential we see for the company versus the market. We use a WACC of 13% to adjust for a higher than normal risk to the estimates. We assume the cumulative global market for 4G LTE products is ~$625B though YE21. We assume the company�s royalty rate gradually increases to 1.0% by the very end of the period, yielding a taxed revenue range of $3.0-4.0B for VHC over the 10-year period. The company�s free cash flow (we assume very high licensing margins) discounted back to today, returns a value of $1.6-2.0B.

Cowen�s VHC WACC Worksheet

WACC CALCULATIONRisk-free rate (10-Year T-Bond), Rf 5.0%Required Equity Mkt. Return, Rm 13.0%Equity Risk Premium, (Rm-Rf) 8.0%

Beta, B 1.00Cost of Equity, Ke = Rf + B x (Rm-Rf) 13.0%Avg. Cost of Debt Capital, Pre-tax, D 6.5%Tax Rate, t 30.0%Cost of Debt, After Tax, Kd = D x (1-t) 4.6%Debt/Total Capital 0.0%

Share Price (5/26/11) $23.14Shares Outstanding (Basic, MM) 49.5 MV of Equity 1,145 Long Term Debt - Enterprise Value 1,145 Debt/Enterprise Value 0.0%

Equity/Total Capital 100.0%

WACC 13.0%



May 27, 2011 15

Estimated Comps

We used three publicly traded mobile and wireless licensing companies, Qualcomm (QCOM), ARM Holdings (ARM) and InterDigital (IDCC) as comps for VHC. Although VHC does not currently have meaningful revenue, we believe that as the company signs up 4G LTE licensees, the company�s market cap will move to close the market cap gap versus IDCC (though we recognize IDCC does have a significant number of 4G LTE patents).

Selected List of VHC Comps

Qualcomm QCOM $14,885 $3.13 $75,554 5.1x $96,560

ARM Holdings ARMH $757.9 $0.54 $37,399 49.3x $37,688

InterDigital IDCC $349 $2.47 $1,424 4.1x $1,951

AVERAGE n/a $5,331 $2.05 $38,126 19.5x $45,400

VirnetX VHC $1.0 (0.32) $1,212 N/M $1,279

EV ($MM) EV/SMarket Cap

($MM)Company Ticker

C11E Sales ($MM)

C11E EPS

Source: Thomson, Company reports, Cowen and Company estimates

Conclusion

Real-time peer-to-peer communication, including video chat, should be among the compelling applications end-users adopt as all-IP 4G LTE wireless networks and two-camera smartphones proliferate. We believe VHC's intellectual property sits at the heart of that market opportunity, making connections between end-users on tomorrows 4G networks as convenient and secure as those found on today's voice networks. Over the next 1-5 years, we expect most major device OEMs will license, or otherwise be made aware of, patents VirnetX has uniquely declared as essential to the 3GPP's LTE Series 33 specification. We expect VHC to appreciate >40% relative to the market over the next year as its model tracks toward our $185MM C14 revenue forecast.


May 27, 2011 16

VirnetX Income Statement

FY09A FY10A 1Q11A 2Q11E 3Q11E 4Q11E FY11E 1Q12E 2Q12E 3Q12E 4Q12E FY12E FY13E FY14EC09 C10 MAR JUN SEPT DEC C11 MAR JUN SEPT DEC C12 C13 C14

Total Revenue $0.03 $0.1 $0.0 $0.0 $0.0 $0.9 $1.0 $2.2 $2.8 $4.2 $5.5 $14.6 $69.4 $184.8 % Change Q/Q 100.3% 15.9% 36.1% 3369.2% 132.5% 29.3% 48.9% 31.6% % Change Y/Y 159.2% -18.1% -15.8% 72.6% 10862.7% 1357.5% 12624.7% 14097.3% 15431.1% 489.3% 1369.9% 374.8% 166.5%

Revenue - Patent Licensing $0.0 $0.1 $0.0 $0.0 $0.0 $0.9 $0.99 $2.2 $2.8 $3.7 $4.8 $13.4 $64.6 $176.6 % Change Q/Q 100.3% 15.9% 36.1% 3369.2% 132.5% 29.3% 31.0% 30.7% % Change Y/Y 159.2% -18.1% -15.8% 72.6% 10862.7% 1357.5% 12624.7% 14097.3% 13566.5% 415.1% 1250.0% 381.4% 173.4%

Revenue - SDNI & Registry $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.00 $0.0 $0.0 $0.5 $0.7 $1.2 $4.8 $8.2 % Change Q/Q 38.2% % Change Y/Y 300.2% 72.5%

Cost of revenue $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.1 $0.1 $0.2 $0.2 $0.6 $2.6 $6.8

Operating margin $0.0 $0.1 $0.0 $0.0 $0.0 $0.9 $1.0 $2.1 $2.7 $4.0 $5.2 $14.0 $66.7 $178.0 Operating margin (%) 100.0% 100.0% 100.0% 100.0% 100.0% 97.0% 97.2% 97.0% 96.9% 95.7% 95.5% 96.1% 96.2% 96.3%

Operating expenses Royalty expense $0.0 -$59.2 $0.0 $0.0 $0.0 -$0.3 -$0.3 -$0.6 -$0.8 -$1.1 -$1.4 -$4.0 -$14.5 -$39.7

Research and development -$0.9 -$2.4 -$0.2 -$0.2 -$0.2 -$0.3 -$0.9 -$0.3 -$0.3 -$0.3 -$0.3 -$1.1 -$1.4 -$2.4

General, selling and administrative -$12.3 -$33.8 -$2.6 -$2.9 -$3.2 -$3.1 -$11.8 -$3.3 -$3.3 -$3.4 -$3.6 -$13.6 -$15.8 -$23.4

Gain on settlement $0.0 $200.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0

Total operating expenses -$13.1 $104.6 -$2.8 -$3.1 -$3.5 -$3.7 -$13.0 -$4.2 -$4.5 -$4.8 -$5.3 -$18.8 -$31.7 -$65.5

% of revenue NM NM NM NM NM NM NM NM NM NM 96.9% NM 45.7% 35.5%

Income (loss) from operations -$13.1 $104.7 -$2.8 -$3.1 -$3.4 -$2.7 -$12.0 -$2.1 -$1.7 -$0.8 -$0.1 -$4.7 $35.0 $112.5 % of revenue NM NM NM NM NM NM NM -96.2% -62.3% -20.2% -1.3% -32.4% 50.5% 60.9%

Interest and other income, net $0.6 -$29.2 -$5.1 -$2.7 -$0.5 $0.0 -$8.3 $0.3 $0.3 $0.3 $0.3 $1.1 $1.2 $1.5

Income (loss) before taxes -$12.5 $75.5 -$7.8 -$5.8 -$3.9 -$2.7 -$20.3 -$1.8 -$1.5 -$0.6 $0.3 -$3.6 $36.2 $114.0

Income tax benefit (provision) $0.0 -$34.1 $0.7 -$1.7 -$1.2 -$0.8 -$3.0 -$0.5 -$0.4 -$0.2 $0.1 -$1.1 $13.0 $41.0 tax rate N/M -45.1% N/M 30.0% 30.0% 30.0% 15.0% 30.0% 30.0% 30.0% 30.0% 30.0% 36.0% 36.0%

Net income (loss) -$12.5 $41.4 -$7.1 -$4.0 -$2.8 -$1.9 -$15.8 -$1.3 -$1.0 -$0.4 $0.2 -$2.5 $23.2 $72.9

Shares outstanding

Basic 37.9 45.5 49.5 49.7 49.9 50.1 49.8 56.2 56.4 56.6 56.8 56.5 57.0 57.3 Diluted 37.9 49.1 55.3 55.5 55.7 55.9 55.6 56.2 56.4 56.6 56.8 56.5 57.4 58.3

GAAP EPS, Basic -0.33 0.91 -0.14 -0.08 -0.06 -0.04 -0.32 -0.02 -0.02 -0.01 0.00 -0.05 0.41 1.27

GAAP EPS, Diluted -0.33 0.84 -0.14 -0.08 -0.06 -0.04 -0.32 -0.02 -0.02 -0.01 0.00 -0.05 0.40 1.25

US $MM, except per share data

Source: Company reports and Cowen and Company estimates


May 27, 2011 17

VirnetX Balance Sheet

VirnetX Holding Corp (VHC) FY09 FY10 1Q11A 2Q11E 3Q11E 4Q11E FY11E 1Q12E 2Q12E 3Q12E 4Q12E FY12E FY13E FY14EFY End December ($MM) C09 C10 MAR JUN SEPT DEC C11 MAR JUN SEPT DEC C12 C13 C14

Assets: Current assets: Cash and cash equivalents 2.0 34.6 43.6 43.6 39.7 37.0 37.0 35.1 32.8 30.8 29.4 29.4 41.7 98.3 Investments available for sale 0.0 43.5 23.3 23.5 23.8 24.0 24.0 24.2 24.5 24.7 25.0 25.0 26.0 27.0 Accounts receivable, net 0.0 0.0 0.0 0.0 0.0 0.2 0.2 0.4 0.5 0.7 0.9 0.9 4.4 9.3 Inventories 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Prepaid taxes 0.0 0.0 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 Current deferred tax benefit 0.0 1.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Prepaid expense and other current assets 0.0 0.1 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 Total current assets 2.1 79.9 73.5 73.7 70.1 67.9 67.9 66.4 64.4 62.9 61.9 61.9 78.7 141.3

Property and equipment, net 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.1 0.2 0.2 1.5 5.2 Intangible and other assets 0.2 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Long term deferred tax benefit 0.0 1.6 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Total assets 2.2 81.7 73.7 73.9 70.2 68.0 68.0 66.6 64.6 63.2 62.3 62.3 80.4 146.7

Liabilities: Current liabilities: Accounts payable and accrued liabilities 4.5 0.5 0.5 0.0 0.0 0.0 0.0 0.1 0.1 0.2 0.2 0.2 1.0 2.1 Income tax liability 0.0 7.4 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Current portion of long-term obligation 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Derivative liability 6.3 14.4 14.9 15.2 15.5 15.8 15.8 16.1 16.4 16.8 17.1 17.1 18.5 20.0 Total current liabilities 10.8 22.2 15.4 15.2 15.5 15.8 15.8 16.2 16.5 16.9 17.4 17.4 19.5 22.1

Long-term obligation, net of current portion 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Total liabilities 10.9 22.2 15.4 15.2 15.5 15.8 15.8 16.2 16.5 16.9 17.4 17.4 19.5 22.1

Stockholders' equity Preferred stock 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 par value $0.0001 per share Common stock 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 par value $0.0001 per share Additional paid-in capital 26.9 78.2 84.2 84.2 84.2 84.2 84.2 84.2 84.2 84.2 84.2 84.2 84.2 84.2 Accumulated deficit -35.6 -17.8 -25.9 -25.9 -25.9 -25.9 -25.9 -25.9 -25.9 -25.9 -25.9 -25.9 -25.9 -25.9 Accumulated other comprehensive loss 0.0 -1.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Stockholders' equity -8.7 59.5 58.3 58.7 54.7 52.2 52.2 50.4 48.1 46.2 44.9 44.9 60.9 124.6

Total liabilities and equity 2.2 81.7 73.7 73.9 70.2 68.0 68.0 66.6 64.6 63.2 62.3 62.3 80.4 146.7 Source: Company reports and Cowen and Company estimates


May 27, 2011 18

VirnetX Cash Flow Statement

VirnetX Holding Corp (VHC) FY09 FY10 1Q11A 2Q11E 3Q11E 4Q11E FY11E 1Q12E 2Q12E 3Q12E 4Q12E FY12E FY13E FY14EFY End December ($MM) C09 C10 MAR JUN SEPT DEC C11 MAR JUN SEPT DEC C12 C13 C14

Cash flows from operating activities:Net income (loss) (12.5) 41.4 (7.1) (4.0) (2.8) (1.9) (15.8) (1.3) (1.0) (0.4) 0.2 (2.5) 23.2 72.9 Adjustments to reconcile net income (loss) to cash used in operating activities: Stock-based compensation 3.0 3.4 0.6 0.6 0.7 0.7 2.6 0.7 0.7 0.7 0.7 2.7 2.8 2.9 Depreciation and amortization 0.1 0.1 0.0 0.0 0.0 0.0 0.1 0.0 0.0 0.0 0.0 0.1 0.1 0.1 Unrealized gain (loss) - (1.0) (0.1) - - - (0.1) - - - - - - - Net change in deferred taxes - (2.9) 3.3 - - - 3.3 - - - - - - - Change in value of derivative liability (0.6) 30.5 5.1 - - - 5.1 - - - - - - - Other - - - - - - - - - - - - - -

Changes in assets and liabilities Receivables and other current assets 0.1 (0.0) (0.0) 0.0 (0.0) (0.2) (0.2) (0.2) (0.1) (0.2) (0.2) (0.8) (3.5) (5.0) Prepaid expenses and other current assets 0.1 - (0.2) - - - (0) - - - - - - - Accounts payable and accrued liabilities 2.8 3.4 (0.0) (0.5) (0.5) (0.5) (1.5) (1.5) (1.5) (1.4) (1.3) (5.7) 0.7 1.1 Income tax liability - - (13.7) - - - (13.7) - - - - - - - Net cash provided by (used in) operating activities (6.9) 74.9 (12.0) (3.9) (2.6) (1.9) (20.4) (2.3) (1.9) (1.3) (0.7) (6.2) 23.4 72.1

Cash flows from investing activities: Purchases of property and equipment (0.0) (0.0) - (0.0) (0.0) (0.0) (0.0) (0.0) (0.1) (0.1) (0.1) (0.3) (1.4) (3.7) Purchases of investments - (43.5) (10.2) - - - (10.2) - - - - - - - Proceeds from sale of investments - - 30.4 - - - 30.4 - - - - - - - Net cash provided by (used in) investing activities (0.0) (43.5) 20.2 (0.0) (0.0) (0.0) 20.2 (0) (0) (0) (0) (0) (1) (4)

Cash flows from financing activities: Payment of dividend - (23.6) - - - - - - - - - - - - Payment of royalty obligation less imputed interest (0.0) (0.2) - - - - - - - - - - - - Proceeds from exercise of options - 1.3 - - - - - - - - - - - - Proceeds from exercise of warrants - 23.6 0.7 - - - 0.7 - - - - - - - Proceeds from sale of common stock 8.5 - - - - - - - - - - - - - Other - - - - - - - - - - - - - - Net cash provided by (used in) financing activities 8.5 1.2 0.7 - - - 0.7 - - - - - - -

Net increase (decrease) in cash and cash equivalents 1.6 32.6 8.9 (3.9) (2.6) (1.9) 0.5 (2.4) (2.0) (1.4) (0.8) (6.5) 22.0 68.4 Cash and cash equivalents at beginning end of period 0.5 2.0 34.6 43.6 39.7 37.0 34.6 35.1 32.8 30.8 29.4 35.1 28.6 50.6 Cash and cash equivalents at end end of period 2.0 34.6 43.6 39.7 37.0 35.1 35.1 32.8 30.8 29.4 28.6 28.6 50.6 118.9

Source: Company reports and Cowen and Company estimates

VirnetX DCF (Condensed) $MM 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Market revenue 6,708 17,829 32,108 38,058 49,476 64,319 83,614 96,157 110,580 127,167

Effective Royalty Rate 0.2% 0.4% 0.6% 0.6% 0.7% 0.8% 0.9% 1.0% 1.1% 1.1%Royalty Revenue 13 65 177 228 346 515 753 962 1,216 1,399 FCF margin 90% 90% 90% 90% 90% 90% 90% 90% 90% 90%FCF on royalty revenue 12 58 159 206 312 463 677 865 1,095 1,259 Taxed @ 30% 8 41 111 144 218 324 474 606 766 881

Discount rate - Today $7 $32 $77 $88 $118 $156 $202 $228 $255 $649 Source: Cowen and Company


May 27, 2011 19

Addendum

STOCKS MENTIONED IN IMPORTANT DISCLOSURES Ticker Company Name VHC VirnetX Holding Corporation

ANALYST CERTIFICATION Each author of this research report hereby certifies that (i) the views expressed in the research report accurately reflecthis or her personal views about any and all of the subject securities or issuers, and (ii) no part of his or her compensation was, is, or will be related, directly or indirectly, to the specific recommendations or views expressed in this report.

IMPORTANT DISCLOSURES Cowen and Company, LLC and or its affiliates make a market in the stock of VHC securities. Cowen and Company, LLC compensates research analysts for activities and services intended to benefit the firm's investor clients. Individual compensation determinations for research analysts, including the author(s) of this report, are based on a variety of factors, including the overall profitability of the firm and the total revenue derived from all sources, including revenues from investment banking. Cowen and Company, LLC does not compensate research analysts based on specific investment banking transactions.

DISCLAIMER This research is for our clients only. Our research is disseminated primarily electronically and, in some cases, in printed form. Research distributed electronically is available simultaneously to all Cowen and Company, LLC clients. All published research, including required disclosures, can be obtained on the Firm�s client website, www.cowenresearch.com. Further information on any of the above securities may be obtained from our offices. This report is published solely for information purposes, and is not to be construed as an offer to sell or the solicitation of an offer to buy any security in any state where such an offer or solicitation would be illegal. Other than disclosures relating to Cowen and Company, LLC, the information herein is based on sources we believe to be reliable but is not guaranteed by us and does not purport to be a complete statement or summary of the available data. Any opinions expressed herein are statements of our judgment on this date and are subject to change without notice. Notice to UK Investors: This publication is produced by Cowen and Company, LLC, which is regulated in the United States by FINRA and is disseminated in the United Kingdom by Cowen International Limited ("CIL"). In the United Kingdom, �Cowen and Company� is a Trading Name of CIL. It is communicated only to persons of a kind described in Articles 19 and 49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005. It must not be further transmitted to any other person without the consent of CIL. Copyright, User Agreement and other general information related to this report © 2011 Cowen and Company, LLC. Member NYSE, FINRA and SIPC. All rights reserved. This research report is prepared for the exclusive use of Cowen clients and may not be reproduced, displayed, modified, distributed, transmitted or disclosed, in whole or in part, or in any form or manner, to others outside your organization without the express prior written consent of Cowen. Cowen research reports are distributed simultaneously to all clients eligible to receive such research prior to any public dissemination by Cowen of the research report or information or opinion contained therein. Any unauthorized use or disclosure is prohibited. Receipt and/or review of this research constitutes your agreement not to reproduce, display, modify, distribute, transmit, or disclose to others outside your organization the contents, opinions, conclusion, or information contained in this report (including any investment recommendations, estimates or price targets). All Cowen trademarks displayed in this report are owned by Cowen and may not be used without its prior written consent. Cowen and Company, LLC. New York (646) 562-1000 Boston (617) 946-3700 San Francisco (415) 646-7200 Chicago (312) 577-2240 Cleveland (440) 331-3531 Atlanta (866) 544-7009 Dallas (214) 978-0107 London (affiliate) 44-207-071-7500 Geneva (affiliate) 41-22-707-6900


May 27, 2011 20

COWEN AND COMPANY RATING DEFINITIONS (a) Rating DefinitionOutperform (1) Stock expected to outperform the S&P 500Neutral (2) Stock expected to perform in line with the S&P 500Underperform (3) Stock expected to underperform the S&P 500(a) Assumptions: Time horizon is 12 months; S&P 500 is flat over forecast period.

COWEN AND COMPANY RATING ALLOCATION (a)

Rating Pct of companies under

coverage with this ratingPct for which Investment Banking services

have been provided within the past 12 monthsBuy (b) 48.9% 6.7%Hold (c) 47.7% 1.4%Sell (d) 3.4% 0.0%(a) As of 03/31/2011. (b) Corresponds to "Outperform" rated stocks as defined in Cowen and Company, LLC's rating definitions (see above). (c)Corresponds to "Neutral" as defined in Cowen and Company, LLC's ratings definitions (see above). (d) Corresponds to "Underperform" as defined inCowen and Company, LLC's ratings definitions (see above). Note: "Buy," "Hold" and "Sell" are not terms that Cowen and Company, LLC uses in itsratings system and should not be construed as investment options. Rather, these ratings terms are used illustratively to comply with NASD and NYSEregulations.

virnetx holding corporationlte, sae series 33 specification. virnetx asserts that it is the only...

Documents