UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
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þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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For the quarterly period ended September 30, 2007
or
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o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the transition period from
to
Commission File Number: 001-33297
VERICHIP CORPORATION
(Exact name of registrant as specified in its charter)
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DELAWARE
(State or other jurisdiction of
incorporation or organization)
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06-1637809
(I.R.S. Employer Identification No.)
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1690 South Congress Avenue, Suite 200
Delray Beach, Florida 33445
(Address of principal executive offices,
including zip code)
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(561) 805-8008
(Registrants telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 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 to such filing requirements for the past 90 days. Yes
þ
No
o
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated filer and
large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
o
Accelerated filer
o
Non-accelerated filer
þ
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes
o
No
þ
The number of shares outstanding of each of the issuers classes of common stock as of
the close of business on November 2, 2007 is as follows:
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Class
Common Stock: $0.01 Par Value
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Number of Shares
10,114,766
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VERICHIP CORPORATION
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
Item 1. Financial Statements.
VERICHIP CORPORATION
Condensed Consolidated Balance Sheets
(In thousands, except par value)
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September 30,
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December 31,
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2007
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2006
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(unaudited)
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Assets
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Current Assets:
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Cash
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$
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9,680
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$
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996
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Accounts receivable, net of allowance for doubtful accounts of
$144 (2006 - $146)
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4,888
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4,486
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Inventories, net of allowance
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2,871
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3,698
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Prepaid expenses and other current assets
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865
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567
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Deferred tax asset
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196
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520
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Total Current Assets
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18,500
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10,267
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Equipment, net of accumulated depreciation
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898
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950
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Intangible assets, net of accumulated amortization
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17,200
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18,567
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Goodwill
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16,025
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16,025
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Deferred offering costs
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5,079
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$
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52,623
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$
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50,888
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Liabilities and Stockholders Equity
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Current Liabilities:
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Bank indebtedness
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$
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1,465
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$
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853
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Accounts payable
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1,402
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3,671
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Accrued expenses and other current liabilities
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3,899
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4,968
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Note payable to Parent, current portion
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1,601
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Total Current Liabilities
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8,367
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9,492
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Deferred tax liability
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5,092
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5,415
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Note payable
to Parent, less current portion
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10,935
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13,635
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Total Liabilities
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24,394
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28,542
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Commitments and Contingencies
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Stockholders Equity:
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Capital stock:
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Preferred stock:
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Authorized 5,000 shares of $.001 par value; no shares
issued or outstanding
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Common stock:
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Authorized 40,000 shares, of $.01 par value; 10,296 and
6,056 shares issued and outstanding at September 30, 2007
and December 31, 2006, respectively
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103
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61
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Treasury stock, at cost; 18 shares
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(79
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)
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Additional paid-in capital
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54,406
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39,371
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Accumulated deficit
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(26,164
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)
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|
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(17,049
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)
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Accumulated other comprehensive loss foreign currency translation
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(37
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)
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(37
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)
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Total Stockholders Equity
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28,229
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22,346
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$
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52,623
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$
|
50,888
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|
|
|
|
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See
accompanying notes to condensed consolidated financial statements.
1
VERICHIP CORPORATION
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(unaudited)
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For the Three Months
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For the Nine Months
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Ended September 30,
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Ended September 30,
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2007
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2006
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2007
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2006
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Product revenue
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$
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7,414
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$
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6,354
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$
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21,909
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$
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19,074
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Service revenue
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502
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|
464
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1,570
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1,270
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|
|
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Total revenue
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7,916
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6,818
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23,479
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20,344
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Cost of products
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3,071
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|
|
|
2,831
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|
|
|
9,952
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|
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7,843
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|
Cost of services
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|
309
|
|
|
|
219
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|
|
|
898
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|
|
|
651
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|
|
|
|
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|
|
|
|
|
|
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|
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Total cost of products and services
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3,380
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|
|
|
3,050
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|
10,850
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8,494
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|
|
|
|
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Gross profit
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4,536
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3,768
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|
12,629
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11,850
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Operating expenses:
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|
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Selling, general and administrative
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6,092
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4,348
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16,833
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12,580
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Research and development
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1,140
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882
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3,503
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2,700
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|
|
|
|
|
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|
|
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|
|
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Total operating expenses
|
|
|
7,232
|
|
|
|
5,230
|
|
|
|
20,336
|
|
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|
15,280
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Operating loss
|
|
|
(2,696
|
)
|
|
|
(1,462
|
)
|
|
|
(7,707
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)
|
|
|
(3,430
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Interest income and other expense, net
|
|
|
37
|
|
|
|
18
|
|
|
|
120
|
|
|
|
61
|
|
Interest expense
|
|
|
389
|
|
|
|
219
|
|
|
|
1,142
|
|
|
|
501
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other expense
|
|
|
426
|
|
|
|
237
|
|
|
|
1,262
|
|
|
|
562
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Loss before
income tax provision (benefit)
|
|
|
(3,122
|
)
|
|
|
(1,699
|
)
|
|
|
(8,969
|
)
|
|
|
(3,992
|
)
|
Provision (Benefit) for income taxes
|
|
|
101
|
|
|
|
(438
|
)
|
|
|
146
|
|
|
|
(541
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Net loss
|
|
$
|
(3,223
|
)
|
|
$
|
(1,261
|
)
|
|
$
|
(9,115
|
)
|
|
$
|
(3,451
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Net loss per common share basic and diluted
|
|
$
|
(0.35
|
)
|
|
$
|
(0.23
|
)
|
|
$
|
(1.08
|
)
|
|
$
|
(0.62
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Weighted average number of shares
outstanding basic and diluted
|
|
|
9,323
|
|
|
|
5,556
|
|
|
|
8,479
|
|
|
|
5,556
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes to condensed consolidated financial statements.
2
VERICHIP CORPORATION
Condensed Consolidated Statement of Stockholders Equity
For the Nine Months Ended September 30, 2007
(In thousands)
(Unaudited)
|
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|
|
|
|
|
|
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
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|
Additional
|
|
|
|
|
|
|
|
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Other
|
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Total
|
|
|
|
Common Shares
|
|
|
Paid-in
|
|
|
Treasury
|
|
|
Accumulated
|
|
|
Comprehensive
|
|
|
Stockholders
|
|
|
|
Number
|
|
|
Amount
|
|
|
Capital
|
|
|
Stock
|
|
|
Deficit
|
|
|
Loss
|
|
|
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance December 31, 2006
|
|
|
6,056
|
|
|
$
|
61
|
|
|
$
|
39,371
|
|
|
$
|
|
|
|
$
|
(17,049
|
)
|
|
$
|
(37
|
)
|
|
$
|
22,346
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(9,115
|
)
|
|
|
|
|
|
|
(9,115
|
)
|
Stock issuance costs
|
|
|
|
|
|
|
|
|
|
|
(5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(5
|
)
|
Stock based
compensation
|
|
|
109
|
|
|
|
1
|
|
|
|
2,599
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,600
|
|
Issuance of shares
from option exercises
|
|
|
536
|
|
|
|
5
|
|
|
|
370
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
375
|
|
IBM Warrant exercise
|
|
|
395
|
|
|
|
4
|
|
|
|
(4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Share repurchase
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(79
|
)
|
|
|
|
|
|
|
|
|
|
|
(79
|
)
|
Issuance of shares in
public offering, net
of costs of $8,033
|
|
|
3,100
|
|
|
|
31
|
|
|
|
12,076
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12,107
|
|
Issuance of
restricted stock
|
|
|
100
|
|
|
|
1
|
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance September 30, 2007
|
|
|
10,296
|
|
|
$
|
103
|
|
|
$
|
54,406
|
|
|
$
|
(79
|
)
|
|
$
|
(26,164
|
)
|
|
$
|
(37
|
)
|
|
$
|
28,229
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes to condensed consolidated financial statements.
3
|
|
|
|
|
|
|
|
|
|
|
For the Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(9,115
|
)
|
|
$
|
(3,451
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
1,851
|
|
|
|
1,791
|
|
Stock-based compensation
|
|
|
2,600
|
|
|
|
154
|
|
Accrued interest
|
|
|
1,106
|
|
|
|
|
|
Deferred income tax
|
|
|
|
|
|
|
(702
|
)
|
(Recovery
of) Allowance for doubtful accounts
|
|
|
(2
|
)
|
|
|
82
|
|
Allowance for inventory excess
|
|
|
396
|
|
|
|
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Increase in accounts receivable
|
|
|
(400
|
)
|
|
|
(109
|
)
|
Decrease (increase) in inventories
|
|
|
430
|
|
|
|
(668
|
)
|
Increase in prepaid expenses and other current assets
|
|
|
(297
|
)
|
|
|
(200
|
)
|
(Decrease) increase in accounts payable and accrued expenses
|
|
|
(1,606
|
)
|
|
|
1,258
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in operating activities
|
|
|
(5,037
|
)
|
|
|
(1,845
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Payments for equipment
|
|
|
(432
|
)
|
|
|
(635
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(432
|
)
|
|
|
(635
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
Short term borrowings, net
|
|
|
612
|
|
|
|
986
|
|
Proceeds
from stock option exercises, net of share repurchase
|
|
|
291
|
|
|
|
|
|
Payments to Parent
|
|
|
(3,500
|
)
|
|
|
|
|
Borrowings from Parent
|
|
|
1,293
|
|
|
|
2,066
|
|
Initial public offering costs
|
|
|
(2,879
|
)
|
|
|
(1,133
|
)
|
Proceeds from initial public offering, net of underwriter fees
|
|
|
18,336
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities
|
|
|
14,153
|
|
|
|
1,919
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash
|
|
|
8,684
|
|
|
|
(561
|
)
|
Cash, beginning of period
|
|
|
996
|
|
|
|
1,440
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash, end of period
|
|
$
|
9,680
|
|
|
$
|
879
|
|
|
|
|
|
|
|
|
See
accompanying notes to condensed consolidated financial statements.
4
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Business and Basis of Presentation
VeriChip Corporation is a Delaware corporation formed in November 2001. The Company
commenced operations in January 2002. On February 14, 2007, the Company completed an initial
public offering of its common stock. As of September 30, 2007, Applied Digital Solutions,
Inc., Applied Digital, or parent, owned 52.1% of the Companys common stock.
The accompanying unaudited condensed consolidated financial statements of VeriChip
Corporation and its subsidiaries (the Company, Registrant, us, we, or our) as of
September 30, 2007 and December 31, 2006 (the December 31, 2006 financial information
included in this report has been extracted from our audited financial statements included in
our 2006 Annual Report on Form 10-K), and for the three and nine months ended September 30,
2007 and 2006 have been prepared in accordance with accounting principles generally accepted
in the United States of America (U.S.) for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X under the Securities Exchange Act
of 1934. Accordingly, they do not include all of the information and footnotes required by
accounting principles generally accepted in the U.S. for complete financial statements. In
the opinion of our management, all adjustments (including normal recurring adjustments)
considered necessary to present fairly the unaudited condensed consolidated financial
statements have been made.
The preparation of financial statements in conformity with accounting principles
generally accepted in the U.S. requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts of sales
and expenses during the reporting period. Actual results could differ from those estimates.
Included in these estimates are assumptions about allowances for excess inventory, warranty
reserves, bad debt reserves, lives of long lived assets, lives of intangible assets,
assumptions used in Black-Scholes valuation models, estimates of the fair value of acquired
assets and assumed liabilities, the determination of whether any impairment is to be
recognized on goodwill or intangibles, among others.
The unaudited condensed consolidated statements of operations for the three and nine
months ended September 30, 2007 and 2006 are not necessarily indicative of the results that
may be expected for the entire year. These statements should be read in conjunction with the
consolidated financial statements and related notes thereto included in our Annual Report on
Form 10-K for the year ended December 31, 2006.
The Company develops, markets and sells radio frequency identification, frequently
referred to as RFID, systems used for the identification, location and protection of people
and assets in the healthcare market. The Companys healthcare security systems utilize
external, active RFID tags to locate and protect people and assets. The Companys VeriMed
system uses the implantable microchip, a human-implantable passive RFID microchip that is
used in patient identification for access to personal health records. Each implantable
microchip contains a unique verification number that is read when it is scanned by the
Companys scanner. In October 2004, the U.S. Food and Drug Administration, or FDA, cleared
the Companys VeriMed system for use in medical applications in the United States.
The
Company purchases the implantable microchip from Digital Angel Corporation, or
Digital Angel, a majority-owned subsidiary of Applied Digital, under the terms of an amended
and restated supply agreement. The supply agreement is discussed in Note 11, Related Party
Transactions. Digital Angel, in turn, obtains the implantable microchip, a component of the
VeriChip, from a subsidiary of Raytheon Company, under a separate supply agreement. The
technology underlying these systems is covered, in part, by U.S. Patent No. 5,211,129
Syringe-Implantable Identification Transponders, which the Company refers to as the 129
patent. In 1994, Destron/IDI, Inc., a predecessor company to Digital Angel, granted a
co-exclusive license under this patent, other than for certain specified fields of use
retained by the predecessor company, to Hughes Aircraft Company, or Hughes, and its then
wholly-owned subsidiary, Hughes Identification Devices, Inc., or HID. The specified fields
of use retained by the predecessor company do not include human identification or security
applications. The rights licensed to Hughes and HID were freely assignable, and the Company
does not know which party or parties currently have these rights or whether these rights have been assigned, conveyed or transferred to any third
party. Digital Angel sources the implantable microchip indirectly from a subsidiary of
Raytheon Company, with which Hughes, then known as HE Holdings, Inc., was merged in 1997.
However, the Company has no documentation that establishes its right to use the patented
technology for human identification or security applications. Hughes, HID, any of their
respective successors in interest, or any party to whom any of the foregoing parties may
have assigned its rights under the 1994 license agreement may commence a claim against the
Company asserting that the Company is violating its rights.
5
In October 2007, Digital Angel and the successor to HID executed a cross-license which
includes Digital Angel obtaining a royalty free non-exclusive license to HIDs rights to the
implantable human applications of the 129 patent, for which it purports certain ownership
rights to. Digital Angel has, in turn, sublicensed those rights to VeriChip. (See Note 9
Unasserted Claim Potential Intellectual Property Conflict and Note 11 Related Party
Transactions).
Initial Public Offering and Underwriting Agreement
On February 14, 2007, the Company completed an initial public offering of its common
stock. In connection with the initial public offering, 3,100,000 shares of its common stock
were sold. The Company, Applied Digital and Merriman Curhan Ford & Co., as representative of
the several underwriters, entered into a underwriting agreement. The initial public offering
price was $6.50 per share and the underwriting discounts and commissions were $0.455 per
share.
The underwriting agreement required the Company to reimburse the underwriters for their
expenses on a non-accountable basis in the amount equal to 1.3% of the aggregate public
offering price. In addition, the Company reimbursed the underwriters $150,000 of their legal
fees incurred in connection with the offering.
A reconciliation of net proceeds from the initial public offering is provided as
follows:
|
|
|
|
|
|
|
Amount
|
|
|
|
|
|
|
Gross proceeds from public offering
|
|
$
|
20,150
|
|
|
|
|
|
|
Less fees and offering costs:
|
|
|
|
|
Underwriter discounts and fees
|
|
|
1,814
|
|
Offering costs paid prior to 2007
|
|
|
3,350
|
|
Offering costs paid in 2007
|
|
|
2,879
|
|
|
|
|
|
|
|
|
|
|
Net proceeds from public offering
|
|
$
|
12,107
|
|
|
|
|
|
In
the nine months ended September 30, 2006, the Company paid
$1.1 million in initial public offering costs.
Registration Rights Agreement
On August 31, 2007, the Company entered into a Registration Rights Agreement with
Kallina Corporation. The Agreement was entered into in connection with the execution of a
Securities Purchase Agreement between Applied Digital and Kallina Corporation under which
Applied Digital transferred to Kallina Corporation 200,000 shares of Company common stock
that Applied Digital owned. Under the agreement, the Company will register the 200,000
shares for resale by Kallina Corporation. Applied Digital has agreed to use its best efforts
to enter into a subordination agreement with a potential third party lender to the Company
and to reimburse the Company for all out of pocket expenses, including legal, accounting,
filing, and printing expenses, related to the agreement.
Stock Repurchase Program
On September 20, 2007, the Companys board of directors approved a stock repurchase
program, authorizing the purchase of $1.5 million of its common stock over four months. As
of September 30, 2007,
18,000 shares were repurchased at a cost of approximately $79,000.
From October 1 to November 7, 2007, the Company repurchased 0.2 million shares at a cost of $0.7 million. For
more information, see Note 5 and Item 2 Unregistered Sales of Equity Securities and Use of Proceeds.
6
Stock-Based Compensation
Effective January 1, 2006, the Company adopted Financial Accounting Standards Board
(FASB) SFAS No. 123 (revised 2004),
Share Based Payment
, or FAS 123R using the modified
prospective transition method. Under this method, stock-based compensation expense is
recognized using the fair-value based method for all awards granted on or after the date of
adoption. Compensation expense for new awards granted after January 1, 2006 is recognized
over the requisite service period based on the grant-date fair value of those options. Prior
to adoption, the Company used the intrinsic value method under Accounting Principles Board
(APB) 25, and related interpretations and provided the disclosure-only provisions of FAS
123. Under the intrinsic value method, no stock-based compensation had been recognized in
our consolidated statement of operations for options granted to the Companys employees and
directors because the exercise price of such stock options equaled or exceeded the fair
market value of the underlying stock on the dates of grant.
We recorded compensation expense, related to stock options, of approximately
$0.1 million and $0.3 million for the three and nine months ended September 30, 2007,
respectively, and nil and approximately $31,000 in the three and nine months ended September
30, 2006, respectively.
In December 2006, the Company issued 0.5 million shares of its restricted common stock
to Scott R. Silverman, its chairman and chief executive officer, which shares are subject to
forfeiture in the event that Mr. Silverman terminates his employment or the Company
terminates his employment for cause on or before December 31, 2008. The Company determined
the value of the stock to be $4.5 million based on the estimated value of its common stock
of $9.00 per share on the date of grant. The value of the restricted stock is being
amortized as compensation expense over the vesting period. The Company recorded compensation
expense of approximately $0.5 million and $1.6 million in the three and nine months ended
September 30, 2007 associated with the restricted stock.
In March 2007, the Company issued 0.1 million shares of its restricted common stock to
two officers, which shares will vest on March 2, 2009. The Company determined the value of
the stock to be $0.6 million based on the value of its common stock of $5.75 per share on
the date of grant. The value of the restricted stock is being amortized as compensation
expense over the vesting period. The Company recorded compensation expense of approximately
$0.1 million and $0.2 million in the three and nine months ended September 30, 2007
associated with this restricted stock.
In August 2007, the Company entered into a consulting agreement with an individual, who
was the former Chief Executive Officer of Digital Angel, with respect to identifying,
contacting and introducing strategic partners to the Company, identifying potential merger
and/or acquisition opportunities for the Company and participating with the Company inits
efforts to develop certain products related to an implantable glucose bio-sensor microchip.
Under the consulting agreement, the Company issued 107 thousand common shares, which
resulted in an equity based compensation charge of $0.6 million during the three months
ended September 30, 2007.
Stock-based compensation expense is reflected in the unaudited condensed consolidated
statement of operations in selling, general and administrative expense.
The Companys computation of expected life is determined based on the simplified
method. The interest rate is based on the U.S. Treasury Yield curve in effect at the time of
grant. Prior to its initial public offering, the Companys computation of expected
volatility was based on the historical volatility of Applied Digitals common stock.
Effective February 9, 2007, the Companys computation of expected volatility is based on the
historical volatility of the Companys comparable companies average historical volatility.
7
2. Principles of Consolidation
The financial statements include the accounts of the Company and its wholly-owned
Canadian subsidiaries, VeriChip Holdings Inc., or VHI, and Xmark Corporation, or Xmark. All
significant inter-company transactions and balances have been eliminated in consolidation.
3. Inventories
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
Raw materials
|
|
$
|
1,395
|
|
|
$
|
1,489
|
|
Work in process
|
|
|
590
|
|
|
|
1,255
|
|
Finished goods
|
|
|
1,448
|
|
|
|
1,119
|
|
|
|
|
|
|
|
|
|
|
|
3,433
|
|
|
|
3,863
|
|
Allowance for excess and obsolescence
|
|
|
(562
|
)
|
|
|
(165
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,871
|
|
|
$
|
3,698
|
|
|
|
|
|
|
|
|
4. Financing Agreements:
VHI is a party to a credit agreement with the Royal Bank of Canada. The credit facility
provides for borrowings up to CDN $1.5 million, or approximately U.S. $1.5 million at
September 30, 2007. Approximately USD $1.5 million was outstanding under the credit facility
as of September 30, 2007. The annual interest rate on the facility is the Royal Bank of
Canada prime rate of interest plus 1%. The borrowing limit is up to 85% of eligible accounts
receivable and up to 25% of eligible inventory. Under the terms of the agreement, the
Company must comply with certain reporting covenants and requirements. The loan is
collateralized by all of the assets of VHI. At September 30, 2007, VHI had aggregate net
assets of approximately USD $40.3 million.
The Company entered into a loan agreement with Applied Digital, which has resulted in
an amount due to Applied Digital totaling $12.5 million at September 30, 2007. The loan
agreement is more fully described in Note 11, Related Party Transactions.
5. Stockholders Equity
On February 14, 2007, the Company completed an initial public offering of its common
stock. In connection with its initial public offering, the Company sold 3,100,000 shares of
its common stock at a price of $6.50 per share. As a result, as of September 30, 2007,
Applied Digital owned 52.1% of the Companys common stock.
On September 20, 2007, the Companys board of directors approved a stock repurchase
program authorizing the purchase of $1.5 million of its common stock over four months. As of
September 30, 2007, 18,000 shares were repurchased at a cost of approximately $79,000.
Stock Option Plans
In April 2002, the Companys board of directors approved the VeriChip Corporation 2002
Flexible Stock Plan, or the VeriChip 2002 Plan. Under the VeriChip 2002 Plan, the number of
shares for which options, SARs or performance shares, may be granted is approximately
2.0 million. As of September 30, 2007 approximately 1.9 million options and restricted
shares, net of forfeitures, have been granted to directors, officers and employees under the
VeriChip 2002 Plan, and 1.6 million of the options or shares granted were outstanding as of
September 30, 2007. Approximately 1.4 million options are fully vested and expire up to nine
years from the vesting date and 0.2 million options vest ratably over three years. As of
September 30, 2007, no SARs have been granted and 22,000 shares may still be granted under
the VeriChip 2002 Plan.
8
On April 27, 2005, Applied Digitals board of directors approved the VeriChip
Corporation 2005 Flexible Stock Plan, or the VeriChip 2005 Plan. Under the VeriChip 2005
Plan, the number of shares for which options, SARs or performance shares may be granted is
approximately 0.3 million. As of September 30, 2007, approximately 0.3 million options have
been granted under the VeriChip 2005 Plan. None of the options are fully vested and expire
up to nine years from the vesting date and vest ratably over three years. As of September
30, 2007, no SARs have been granted and 832 shares may still be granted under the VeriChip
2005 Plan.
On June 17, 2007, the Company adopted the VeriChip 2007 Stock Incentive Plan, or the
VeriChip 2007 Plan. Under the VeriChip 2007 Plan, the number of shares for which options,
SARs or performance shares may be granted is 1.0 million. As of September 30, 2007,
approximately 0.1 million options and shares have been granted under the VeriChip 2007 Plan.
As of September 30, 2007, no SARs have been granted and 0.9 million shares may still be
granted under the VeriChip 2007 Plan.
In addition, as of September 30, 2007, options exercisable for approximately
0.4 million shares of the Companys common stock have been granted outside of the Companys
plans, and 0.3 million of the options or shares granted were outstanding as of September 30,
2007. These options were granted at exercise prices ranging from $0.23 to $8.55 per share,
are fully vested and are exercisable for a period of up to seven years.
In the nine months ended September 30, 2007, 0.1 million, 0.2 million, and 0.1 million
options and shares have been granted under the VeriChip 2002 Plan, the VeriChip 2005 Plan,
and the VeriChip 2007 Plan, respectively. In the nine months ended September 30, 2006,
50,000 and 2,012 options were granted under the 2002 Plan and outside of the Companys
plans, respectively.
A summary of option activity under our option plans as of September 30, 2007, and changes
during the nine months then ended is presented below (in thousands, except per share
amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
Exercise
|
|
|
|
Number of
|
|
|
Price Per
|
|
|
|
Options
|
|
|
Share
|
|
Outstanding on January 1, 2007
|
|
|
2,099
|
|
|
$
|
2.10
|
|
Granted
(1)
|
|
|
422
|
|
|
|
5.88
|
|
Exercised
(2)
|
|
|
(536
|
)
|
|
|
0.70
|
|
Forfeited
|
|
|
(22
|
)
|
|
|
5.75
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding on September 30, 2007
|
|
|
1,963
|
|
|
|
3.26
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable on September 30, 2007
(3)
|
|
|
1,530
|
|
|
|
2.42
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options available on September 30, 2007 for future grants
|
|
|
894
|
|
|
|
|
|
|
|
|
(1)
|
|
The total compensation expense associated with the options granted in the three and nine
months ended September 30, 2007 was approximately $0.1 million and $0.2 million,
respectively. The remaining amount of the compensation expense to be recorded over the
remaining vesting period of the options is approximately $1.0 million.
|
|
(2)
|
|
In the three and nine months ended September 30, 2007,
44 and 536 options were exercised under
the VeriChip 2002 Plan and outside the Companys plan, respectively. No options were
exercised in the three and nine months ended September 30, 2006. The intrinsic value of a stock option is the amount
by which the fair value of the underlying stock exceeds the exercise price of the option.
Total intrinsic values of options exercised for the VeriChip 2002 Plan and outside of the
Companys plan were $2.5 million and $0.2 million for the nine months ended September 30,
2007.
|
9
|
|
|
(3)
|
|
The intrinsic value of a stock option is the amount by which the fair value of the
underlying stock exceeds the exercise price of the option. Based upon the Companys closing
price on the NASDAQ, the fair value of the underlying stock was $4.02 at September 30, 2007.
As of September 30, 2007, the aggregate intrinsic value of all options outstanding was
$1.5 million.
|
The following table summarizes information about stock options at September 30, 2007
(number amounts, except weighted-average amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable Stock
|
|
|
|
Outstanding Stock Options
|
|
|
Options
|
|
|
|
|
|
|
|
Weighted-
|
|
|
Weighted-
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
Remaining
|
|
|
Exercise
|
|
|
|
|
|
|
Exercise
|
|
Range of
|
|
|
|
|
|
Contractual
|
|
|
Price Per
|
|
|
|
|
|
|
Price Per
|
|
Exercise Prices
|
|
Number
|
|
|
Life (years)
|
|
|
Share
|
|
|
Number
|
|
|
Share
|
|
$0.0000 to $2.0250
|
|
|
1,087
|
|
|
|
2.7
|
|
|
$
|
0.47
|
|
|
|
1,087
|
|
|
$
|
0.47
|
|
$4.0501 to $6.0750
|
|
|
436
|
|
|
|
9.1
|
|
|
|
5.65
|
|
|
|
67
|
|
|
|
5.12
|
|
$6.0751 to $8.1000
|
|
|
328
|
|
|
|
6.2
|
|
|
|
7.09
|
|
|
|
298
|
|
|
|
7.04
|
|
$8.1001 to $10.1250
|
|
|
106
|
|
|
|
7.2
|
|
|
|
9.23
|
|
|
|
72
|
|
|
|
8.88
|
|
$18.2251 to $20.2500
|
|
|
6
|
|
|
|
5.3
|
|
|
|
20.25
|
|
|
|
6
|
|
|
|
20.25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,963
|
|
|
|
5.0
|
|
|
$
|
3.26
|
|
|
|
1,530
|
|
|
$
|
2.42
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The weighted average per share fair value of grants made in the nine months ended
September 30, 2007 and 2006 for the Companys incentive plans was $2.98 and $5.97,
respectively.
The Black-Scholes model, which the Company used to determine compensation expense,
required the Company to make several key judgments including:
|
|
the estimated value of the Companys common stock;
|
|
|
|
the expected life of issued stock options;
|
|
|
|
the expected volatility of the Companys stock price;
|
|
|
|
the expected dividend yield to be realized over the life of the stock options; and
|
|
|
|
the risk-free interest rate over the expected life of the stock options.
|
The Company prepared these estimates based upon its historical experience, the stock
price volatility of comparable publicly-traded companies, including Applied Digital, and its
best estimation of future conditions.
The fair values of the options granted were estimated on the grant date using the
Black-Scholes valuation model based on the following weighted-average assumptions:
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
Expected dividend yield
|
|
|
|
|
|
|
|
|
Expected stock price volatility
|
|
|
50
|
%
|
|
|
60
|
%
|
Risk-free interest rate
|
|
|
4.51
|
%
|
|
|
4.29
|
%
|
Expected term (in years)
|
|
|
6.0
|
|
|
|
5.0
|
|
10
6. Loss per Common Share
A reconciliation of the numerator and denominator of basic and diluted loss per common
share is provided as follows (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months
|
|
|
For the Nine Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator for basic and diluted loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(3,223
|
)
|
|
$
|
(1,261
|
)
|
|
$
|
(9,115
|
)
|
|
$
|
(3,451
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic and diluted loss per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding basic and
diluted
|
|
|
9,323
|
|
|
|
5,556
|
|
|
|
8,479
|
|
|
|
5,556
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted loss per share
|
|
$
|
(0.35
|
)
|
|
$
|
(0.23
|
)
|
|
$
|
(1.08
|
)
|
|
$
|
(0.62
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following stock options and warrants outstanding as of September 30, 2007 and 2006
were not included in the computation of dilutive loss per share because the net effect would
have been anti-dilutive:
|
|
|
|
|
|
|
|
|
|
|
For the Nine Months
|
|
|
|
Ended
|
|
|
|
September 30,
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
Stock options
|
|
|
1,963
|
|
|
|
2,099
|
|
Warrants
|
|
|
33
|
|
|
|
444
|
|
Restricted common stock
|
|
|
600
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,596
|
|
|
|
2,493
|
|
|
|
|
|
|
|
|
7. Segmented information:
In early 2007, the Company realigned its business into three business segments:
healthcare security, implantable, and industrial. This change was made to align the
Companys financial reporting with its new operational management structure. All segment
information in this Quarterly Report on Form 10-Q has been reclassified to reflect the
segment realignment.
Healthcare Security
Utilizing RFID technology, the Companys Healthcare Security segment currently engages
in marketing, selling and developing the following products:
|
|
infant protection systems used in hospital maternity wards and birthing centers to prevent infant
abduction and mother-baby mismatching;
|
|
|
|
wander prevention systems used by long-term care facilities to locate and protect their residents; and
|
|
|
|
asset/staff location and identification systems used by hospitals and other healthcare facilities to
identify, locate and protect medical staff, patients, visitors and medical equipment.
|
11
Implantable
The Companys Implantable segment includes its VeriMed system using the implantable
microchip, a human-implantable RFID microchip that is used in patient identification for
access to personal health records. Each implantable microchip contains a unique verification
number that is read when it is scanned by the Companys scanner. In October 2004, the FDA
cleared the Companys VeriMed system for use in medical applications in the United States.
Industrial
The Companys Industrial segment engages in marketing, selling and developing the
following products:
|
|
vibration monitoring instruments used by engineering, construction and
mining professionals to monitor the effects of human induced
vibrations, such as blasting activity; and
|
|
|
|
asset management systems that industrial companies use to manage and
track their mobile equipment and tools.
|
12
The following is the selected segment data as of and for the three months ended September 30:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Healthcare
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
Security
|
|
|
Implantable
|
|
|
Industrial
|
|
|
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue
|
|
$
|
5,715
|
|
|
$
|
53
|
|
|
$
|
1,646
|
|
|
$
|
|
|
|
$
|
7,414
|
|
Services revenue
|
|
|
158
|
|
|
|
|
|
|
|
344
|
|
|
|
|
|
|
|
502
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
5,873
|
|
|
$
|
53
|
|
|
$
|
1,990
|
|
|
$
|
|
|
|
$
|
7,916
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating (loss) income
|
|
|
750
|
|
|
|
(1,437
|
)
|
|
|
112
|
|
|
|
(2,121
|
)
|
|
|
(2,696
|
)
|
Depreciation and
amortization
|
|
|
526
|
|
|
|
8
|
|
|
|
63
|
|
|
|
8
|
|
|
|
605
|
|
Equity
based compensation
|
|
|
|
|
|
|
130
|
|
|
|
|
|
|
|
1,168
|
|
|
|
1,298
|
|
Interest income and
other expense, net
|
|
|
86
|
|
|
|
|
|
|
|
29
|
|
|
|
(78
|
)
|
|
|
37
|
|
Interest expense
|
|
|
20
|
|
|
|
|
|
|
|
|
|
|
|
369
|
|
|
|
389
|
|
Income (loss) before
provision (benefit) for income
taxes
|
|
$
|
644
|
|
|
$
|
(1,437
|
)
|
|
$
|
83
|
|
|
$
|
(2,412
|
)
|
|
$
|
(3,122
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segmented assets
|
|
$
|
35,674
|
|
|
$
|
1,015
|
|
|
$
|
8,958
|
|
|
$
|
6,976
|
|
|
$
|
52,623
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Healthcare
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
Security
|
|
|
Implantable
|
|
|
Industrial
|
|
|
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue
|
|
$
|
4,934
|
|
|
$
|
14
|
|
|
$
|
1,406
|
|
|
$
|
|
|
|
$
|
6,354
|
|
Services revenue
|
|
|
147
|
|
|
|
|
|
|
|
317
|
|
|
|
|
|
|
|
464
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
5,081
|
|
|
$
|
14
|
|
|
$
|
1,723
|
|
|
$
|
|
|
|
$
|
6,818
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
115
|
|
|
|
(1,038
|
)
|
|
|
46
|
|
|
|
(585
|
)
|
|
|
(1,462
|
)
|
Depreciation and
amortization
|
|
|
429
|
|
|
|
12
|
|
|
|
166
|
|
|
|
12
|
|
|
|
619
|
|
Equity
based compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
124
|
|
|
|
124
|
|
Interest income and
other expense, net
|
|
|
14
|
|
|
|
|
|
|
|
4
|
|
|
|
|
|
|
|
18
|
|
Interest expense
|
|
|
62
|
|
|
|
|
|
|
|
|
|
|
|
157
|
|
|
|
219
|
|
Loss (income) before
provision (benefit) for income
taxes
|
|
|
39
|
|
|
|
(1,038
|
)
|
|
|
42
|
|
|
|
(742
|
)
|
|
|
(1,699
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segmented assets
|
|
$
|
34,382
|
|
|
$
|
1,113
|
|
|
$
|
10,972
|
|
|
$
|
3,272
|
|
|
$
|
49,739
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13
The following is the selected segment data as of and for the nine months ended September 30:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Healthcare
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
Security
|
|
|
Implantable
|
|
|
Industrial
|
|
|
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue
|
|
$
|
16,622
|
|
|
$
|
54
|
|
|
$
|
5,233
|
|
|
$
|
|
|
|
$
|
21,909
|
|
Services revenue
|
|
|
424
|
|
|
|
|
|
|
|
1,146
|
|
|
|
|
|
|
|
1,570
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
17,046
|
|
|
$
|
54
|
|
|
$
|
6,379
|
|
|
$
|
|
|
|
$
|
23,479
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating (loss) income
|
|
|
987
|
|
|
|
(3,922
|
)
|
|
|
539
|
|
|
|
(5,311
|
)
|
|
|
(7,707
|
)
|
Depreciation and
amortization
|
|
|
1,400
|
|
|
|
28
|
|
|
|
396
|
|
|
|
28
|
|
|
|
1,852
|
|
Equity
based compensation
|
|
|
|
|
|
|
260
|
|
|
|
|
|
|
|
2,340
|
|
|
|
2,600
|
|
Interest income and
other expense, net
|
|
|
270
|
|
|
|
|
|
|
|
90
|
|
|
|
(240
|
)
|
|
|
120
|
|
Interest expense
|
|
|
38
|
|
|
|
|
|
|
|
|
|
|
|
1,104
|
|
|
|
1,142
|
|
(Loss) income before
provision (benefit) for income
taxes
|
|
$
|
679
|
|
|
$
|
(3,922
|
)
|
|
$
|
449
|
|
|
$
|
(6,175
|
)
|
|
$
|
(8,969
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segmented assets
|
|
$
|
35,674
|
|
|
$
|
1,015
|
|
|
$
|
8,958
|
|
|
$
|
6,976
|
|
|
$
|
52,623
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Healthcare
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
Security
|
|
|
Implantable
|
|
|
Industrial
|
|
|
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue
|
|
$
|
14,683
|
|
|
$
|
114
|
|
|
$
|
4,277
|
|
|
$
|
|
|
|
$
|
19,074
|
|
Services revenue
|
|
|
282
|
|
|
|
|
|
|
|
988
|
|
|
|
|
|
|
|
1,270
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
14,965
|
|
|
$
|
114
|
|
|
$
|
5,265
|
|
|
$
|
|
|
|
$
|
20,344
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
389
|
|
|
|
(2,657
|
)
|
|
|
708
|
|
|
|
(1,870
|
)
|
|
|
(3,430
|
)
|
Depreciation and
amortization
|
|
|
1,254
|
|
|
|
31
|
|
|
|
475
|
|
|
|
31
|
|
|
|
1,790
|
|
Equity
based compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
124
|
|
|
|
124
|
|
Interest income and
other expense, net
|
|
|
69
|
|
|
|
|
|
|
|
(8
|
)
|
|
|
|
|
|
|
61
|
|
Interest expense
|
|
|
66
|
|
|
|
|
|
|
|
|
|
|
|
435
|
|
|
|
501
|
|
Income (loss) before
provision (benefit) for income
taxes
|
|
$
|
254
|
|
|
$
|
(2,657
|
)
|
|
$
|
716
|
|
|
$
|
(2,305
|
)
|
|
$
|
(3,992
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segmented assets
|
|
$
|
34,382
|
|
|
$
|
1,113
|
|
|
$
|
10,972
|
|
|
$
|
3,272
|
|
|
$
|
49,739
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
14
8. Income Taxes
We had an effective tax rate of (1.6)% and (15.7)% for the nine months ended September
30, 2007 and 2006, respectively, related to our Canadian-based business. We incurred
consolidated losses before taxes for the nine months ended September 30, 2007 and 2006.
However, we have not recorded a tax benefit for the resulting U.S. net operating loss
carryforwards, as we have determined that a valuation allowance against our net U.S.
deferred tax assets was appropriate based primarily on our historical operating results.
FASB
Interpretation No. 48,
Accounting for Uncertainty in Income Taxes
(FIN 48), was
issued to clarify the requirements of Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes
, relating to the recognition of income tax benefits.
FIN 48 provides a two-step approach to recognizing and measuring tax benefits when the
benefits realization is uncertain. The first step is to determine whether the benefit is to
be recognized, and the second step is to determine the amount to be recognized:
Income tax benefits should be recognized when, based on the technical merits of a tax
position, the entity believes that if a dispute arose with the taxing authority and were
taken to a court of last resort, it is more likely than not (i.e., a probability of greater
than 50 percent) that the tax position would be sustained as filed; and
If a position is determined to be more likely than not of being sustained, the
reporting enterprise should recognize the largest amount of tax benefit that is greater than
50 percent likely of being realized upon ultimate settlement with the taxing authority.
Effective January 1, 2007, the Company adopted FIN 48. The implementation of FIN 48 did
not result in any adjustment to the Companys beginning tax positions. The Company continues
to fully recognize its tax benefits which are offset by a valuation allowance to the extent
that it is more likely than not that the deferred tax assets will not be realized.
The Company files federal and provincial income tax returns in Canada and files federal
and state income tax returns in the U.S. The Company is generally no longer subject to
federal and provincial income tax examinations by Canadian tax authorities for years before
2001 and to federal and state income tax examinations by U.S. tax authorities for years
before 2003. Management does not anticipate that adjustments, if any, which may be proposed
by the Canadian Revenue Agency would result in a material change to its financial position.
The Company recognizes any interest accrued related to unrecognized tax benefits or
exposures in interest expense and penalties in operating expenses. During the nine months
ended September 30, 2007 and 2006, there was no such interest or penalty.
9. Unasserted ClaimPotential Intellectual Property Conflict
Hughes, HID, any of their respective successors in interest, or any party to whom any
of the foregoing parties may have assigned its rights under the 1994 license agreement (see
Note 1) may commence a claim against the Company asserting that the Company is violating its
rights. If such a claim is successful, sales of the Companys implantable microchip could be
enjoined and the Company could be required to cease its efforts to create a market for it
implantable microchip until the patent expires in April 2008. In addition, the Company could
be required to pay damages, which may be substantial. Management is not aware of any claims
asserting that the Company is violating the intellectual property rights owned by another
company or person.
15
If the Company or Digital Angel is denied use of the patented technology in
applications involving the identification of human beings, the Company will not be able to
purchase or sell any of its products that incorporate the implantable microchip before the
patent expires. The Company may be required to pay royalties and other damages to third
parties on products it has already purchased or will purchase from Digital Angel.
The Company has been publicly marketing and selling the implantable microchip for human
identification and security applications for approximately five years. The Companys supply
and development agreement with Digital Angel contains an indemnification provision. To the
extent that such an infringement claim is made, the Company believes it is entitled to
indemnification pursuant to the supply and development agreement with Digital Angel.
Under the circumstances, the accompanying financial statements make no provision with
respect to the unasserted claim described above.
10. Legal proceedings
The Company is engaged in certain legal actions and management believes that the
ultimate outcome of these actions will not have a material adverse effect on the Companys
operating results, liquidity or financial position.
Metro Risk
On January 10, 2005, the Company commenced an action in the Circuit Court for Palm
Beach County, Florida, against Metro Risk Management Group, LLC, or Metro Risk. In this
suit, the Company has claimed that Metro Risk breached the parties three international
distribution agreements by failing to meet required minimum purchase obligations. On July 1,
2005, Metro Risk asserted a counterclaim against the Company for breach of contract and
fraud in the inducement. Specifically, in its claim for breach of contract, Metro Risk
alleged that the Company breached the exclusivity provision of the parties distribution
agreements by later signing a different distribution agreement with a large distributor of
medical supplies. Metro Risk asserted that the distribution agreement with this other
distributor included areas in Europe. Moreover, regarding its claim for fraud in the
inducement, Metro Risk alleged that the Company fraudulently induced Metro Risk into signing
the distribution agreements by promising millions of dollars in profits and then later
signing a different distribution agreement with a large distributor of medical supplies. By
virtue of its counterclaim, Metro Risk seeks reliance damages in the amount of $155,000,
which represents the amount of money advanced by Metro Risk for the project, lost profits,
and attorneys fees. Given the early stage of the matter and because discovery has recently
begun, counsel is currently unable to assess the Companys risk.
Stock Option Plans
The Company has received demand letters from attorneys for several former employees
and/or consultants of the Company and Applied Digital, asserting claims related to stock
options to acquire approximately 540 thousand shares of the Companys common stock that
management believes that such employees and/or consultants had forfeited when they ceased
their employment or relationship with the Company and/or Applied Digital. The Company
believes that all of these potential claims are without merit and intends to vigorously
defend them in the event the claims are asserted or litigated.
The Company is a party to various legal actions, as either plaintiff or defendant,
including the matters identified above, arising in the ordinary course of business, none of
which management believes will have a material adverse effect on our business, financial condition or
results of operations.
16
11. Related Party Transactions
Transition Services Agreement with Applied Digital
During the nine months ended September 30, 2007, Applied Digital provided certain
general and administrative services to the Company including, accounting, finance, payroll
and legal services, telephone, rent and other miscellaneous items. The costs of these
services, which are included in the Companys statement of operations in selling, general
and administrative expense, were determined based on the Companys use of such services. In
determining the Companys estimated use, Applied Digital and the Company determined the
actual cost incurred for each of the services that Applied Digital provided to the Company
and determined the allocation of each cost that was attributable to the Companys
operations.
The services provided and the basis of allocation was as follows:
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Accounting, finance and payroll services
these costs were allocated
based upon a percentage of the total labor dollars incurred by Applied
Digitals accounting, finance and payroll staff in performing such
functions for the Company;
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Legal services
the costs were allocated based upon a percentage of
Applied Digitals general counsels salary and benefits based upon the
estimated time spent by its general counsel on the Companys legal
issues;
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Accounting fees
these costs were allocated based upon actual total
fees charged by third party accountants, considering the amount of
such accounting fees that the Company would have incurred if it was a
stand-alone entity;
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Rent
the cost was determined based upon the amount of office space
square footage that the Companys employees used; and
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Telephone, office supplies and other costs
these costs were
allocated based upon a percentage of the services or supplies that the
Company was deemed to incur.
|
On December 25, 2005, the Company entered into a transition services agreement with
Applied Digital under which Applied Digital agreed to provide the Company with certain
administrative transition services. On December 21, 2006, the Company and Applied Digital
entered into an amended and restated transition services agreement, which became effective
on February 14, 2007, the date of completion of the Companys initial public offering of the
Companys common stock. Prior to that time, the initial transition services agreement
remained in effect. The term of the amended and restated agreement will continue until such
time as the Company requests Applied Digital to cease performing transition services,
provided that Applied Digital is not obligated to continue to provide the transition
services for more than twenty-four months following the effective date. Except for any
request by the Company that Applied Digital cease to perform transition services, subject to
certain notice provisions, the agreement may not be terminated by either party except in the
event of a material default in Applied Digitals delivery of the transition services or in
the Companys payment for those services. The services to be provided by Applied Digital
under the amended and restated transition services agreement are the same as those provided
under the initial agreement. The estimated monthly charge for the fixed costs allocable to
these services was increased to approximately $72,000 per month, primarily as the result of
an increased allocation for office space. Effective April 1, 2007, the estimated monthly
charge for the fixed costs allocable to these services was reduced to $40,000 per month,
primarily as a result of a reduction in allocable accounting fees and accounting and legal
services.
The terms of the transition services agreement and the amendment and restatement of the
agreement were negotiated between certain of the Companys executive officers and certain
executive officers of Applied Digital. The Companys and Applied Digitals executive
officers were independent of one another and the terms of the agreement were based upon
historical amounts incurred by Applied Digital for payment of such services to third
parties. Accordingly, the Company believes that it negotiated the best terms and conditions under the circumstances, however, these costs are not necessarily
indicative of the costs which the Company would have incurred as an independent stand-alone
entity.
17
Management believes that the fees charged for these services are reasonable and
consistent with what the expenses would have been on a stand-alone basis. The costs of these
services to the Company were $0.1 million and $0.4 million for the three and nine months
ended September 30, 2007, respectively, and $0.2 million and $0.5 million for the three and
nine months ended September 30, 2006, respectively.
Loan Agreement with Applied Digital
Applied Digital funded and financed the Companys operations from its inception,
through its initial public offering which resulted in an amount due to Applied Digital
totaling $13.6 million at December 31, 2006. On December 27, 2005, the Company and Applied
Digital converted the amounts due to Applied Digital, including interest accrued, into a
revolving line of credit under the terms of a loan agreement, security agreement and a
revolving line of credit note.
On October 6, 2006, the Company entered into an amendment to the loan agreement, which
increased the principal amount available thereunder to $13.0 million, and the Company
borrowed an additional $2.0 million under the agreement to make the second purchase price
payment with respect to its acquisition of Instantel. In connection with that amendment, the
interest rate was also changed to a fixed rate of 12% per annum. Previously, the Companys
indebtedness to Applied Digital bore interest at the prevailing prime rate of interest as
published from time to time by
The Wall Street Journal
. That amendment further provided that
the loan matured in July 2008, but could be extended at the option of Applied Digital
through December 27, 2010.
On January 19, 2007, February 8, 2007 and February 13, 2007, the Company entered into
further amendments to the loan documents, which increased the maximum principal amount of
indebtedness that the Company may incur to $14.5 million. A portion of this increase was
used to cover approximately $0.7 million of intercompany advances made to the Company by
Applied Digital during the first week of January 2007. Upon the consummation of the
Companys initial public offering in February 2007, the loan ceased to be a revolving line
of credit, and the Company has no ability to incur additional indebtedness under the loan
documents. The interest continues to accrue on the outstanding indebtedness at a rate of 12%
per annum. On February 14, 2007, the closing date of the Companys initial public offering,
the Company was indebted to Applied Digital in the amount of $15.2 million, including
$1.0 million of accrued interest and, in accordance with the terms of the loan agreement as
most recently amended on February 13, 2007, the Company used $3.5 million of the net
proceeds of its initial public offering to repay a portion of its indebtedness to Applied
Digital upon consummation of its initial public offering. The Company is not obligated to
repay an additional amount of its indebtedness until January 1, 2008. Effective with the
payment of the $3.5 million, all interest which accrues on the loan as of the last day of
each month, commencing with February 2007, shall be added to the principal amount.
Commencing January 1, 2008 through January 1, 2010, the Company is obligated to repay
$300,000 on the first day of each month. A final balloon payment equal to the outstanding
principal amount then due under the loan plus all accrued and unpaid interest will be due
and payable on February 1, 2010.
The loan is collateralized by interests in all property and assets of the Company,
including the stock of the Companys subsidiaries, but is not secured by any of the property
or assets of the Companys subsidiaries. As of September 30, 2007, the amount due on the
loan was $12.5 million.
Interest expense incurred under the loan for the three and nine months ended September
30, 2007 was $0.4 million and $1.1 million, respectively, and $0.2 million and $0.4 million
for the three and nine months ended September 30, 2006, respectively. The previously
floating rate of interest negotiated between the parties was based upon the rate that
Applied Digital has historically charged to its wholly-owned subsidiaries. On October 6,
2006, the interest rate was modified as discussed above. The modified interest rate was
negotiated between the parties and represents the current rate that Applied Digital is
incurring on debt owed to its lender. Depending upon the Companys future operating
performance, this interest rate may not be comparable to the terms that the Company could
obtain from independent third parties.
18
Supply Agreement with Digital Angel
The Company and Digital Angel executed a supply and development agreement dated
March 4, 2002 as amended and restated on December 27, 2005 and as amended on May 9, 2007, or
the supply and development agreement. Under this agreement, Digital Angel is the Companys
sole supplier of human-implantable microchips and the Company has the exclusive license to
the technology related to human-implantable microchips.
The Companys purchases of product under the supply and development agreement were
approximately nil and $0.2 million in the nine months ended September 30, 2007 and 2006,
respectively. Under the terms of the May 9, 2007 amendment, the term of the agreement was
extended from March 2013 to March 2014. Also, under the May 9, 2007 amendment, the annual
minimum purchase requirements were each extended one year and, accordingly, there is no
minimum purchase requirement in 2007. The approximately $0.9 million originally required to
be purchased in 2007 is now required to be purchased in 2008, less purchases made in 2006
and 2007. As long as the Company continues to meet minimum purchase requirements, the supply
and development agreement will automatically renew annually under its terms until the
expiration of the last of the patents covering any of the supplied products. The supply and
development agreement may be terminated prior to its stated term under specified events,
including as a result of a bankruptcy event of either party or an uncured default. In
addition, Digital Angel may sell the microchips to third parties if the Company does not
take delivery and pay for a minimum number of microchips as specified in the supply and
development agreement. Further, the supply and development agreement provides that Digital
Angel must, at the Companys option, furnish and operate a computer database to provide data
collection, storage and related services for the Companys customers for a fee as provided.
The Company does not currently utilize this service.
The terms of the original supply and development agreement and each amendment were
negotiated by the executive officers of the respective companies and approved by the
independent members of each companys board of directors.
Digital Angel relies solely on a production agreement with RME, a subsidiary of
Raytheon Company for the manufacture of its human-implantable microchip products. RME
utilizes Digital Angels equipment in the production of the microchips. Digital Angel
entered into a new production agreement with RME related to the manufacture and distribution
of glass-encapsulated syringe-implantable transponders, including the human-implantable
microchip products sold by the Company expiring on June 30, 2010. The technology underlying
these systems is covered, in part, by U. S. Patent No. 5,211,129, Syringe-Implantable
Identification Transponders, which the Company refers to as the 129 patent. In 1994,
Destron/IDI, Inc., a predecessor company to Digital Angel, granted a co-exclusive license
under this patent, other than for certain specified fields of use related to Digital Angels
Animal Applications segment, which were retained by the predecessor company, to Hughes
Aircraft Company, or Hughes, and its then wholly owned subsidiary, Hughes Identification
Devices, Inc., or HID. The specified fields of use retained by the predecessor company do
not include human identification or security applications. The rights licensed to Hughes and
HID were freely assignable, and we do not know which party or parties currently have these
rights or whether these rights have been assigned, conveyed or transferred to any third
party.
The Company does not anticipate generating more than nominal revenue from the sale of
its human implantable microchips prior to the expiration of the patent in April 2008.
Hughes, HID, any of their respective successors in interest, or any party to whom one of the
foregoing parties may have assigned its rights under the 1994 license agreement may commence
a claim against the Company asserting that the Company is violating its rights. If such a
claim is successful, sales of the Companys human implantable systems could be enjoined, and
the Company could be required to cease its efforts to create a market for these systems,
until the patent expires in April 2008. In addition, the Company could be required to pay
damages, which may be substantial. Regardless of whether any claimant is successful, the
Company would face the prospect of the expenditure of funds in litigation, the diversion of
management time and resources, damage to its reputation and the potential impairment in the
marketability of its systems even after the expiration of the patent, which could harm the
Companys business and negatively affect its prospects. (See Note 9 Unasserted Claim
Potential Intellectual Property Conflict).
19
Digital Angel and the successor to HID have executed a cross-license which includes
Digital Angel obtaining a royalty free non-exclusive license to HIDs rights to the
implantable human applications of the 129 patent, for which it purports certain ownership
rights to. Digital Angel has, in turn, sublicensed those rights to VeriChip. (See Note 9
Unasserted Claim Potential Intellectual Property Conflict and Note 11 Related Party
Transactions).
Legal Services
During
2006, the Company incurred legal fees relating to its initial public
offering of $0.8 million to the
Companys legal counsel, Akin Gump Strauss Hauer & Feld LLP, or Akin Gump. Tommy G.
Thompson, a partner with Akin Gump, was a member of the Companys board of directors from
July 2005 to March 8, 2007, and, as a result of his directorship services, as of September
30, 2007, holds fully vested options to purchase 55,556 shares of the Companys common
stock.
Pledge Agreement of Applied Digital
On August 24, 2006, Applied Digital pledged 3,611,111 shares of Company common stock it
owns to its lender under the terms of a note and stock pledge agreement. In addition, on
August 31, 2007, Applied Digital pledged 4,284,445 shares of Company common stock it owns to
an affiliate of its lender, under the terms of a note and stock pledge agreement. Each of
the notes mature on February 1, 2010.
12. Supplementary Cash Flow Information
In the nine months ended September 30, 2007, the Company made the following payments
for income taxes and interest:
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Nine Months Ended
|
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|
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September 30,
|
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|
|
2007
|
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|
2006
|
|
Income taxes paid
|
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$
|
253
|
|
|
$
|
210
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|
Interest paid
|
|
|
72
|
|
|
|
24
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
325
|
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|
$
|
234
|
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|
|
|
|
|
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|
In the nine months ended September 30, 2007 and 2006, the Company had the following
non-cash investing and financing activities:
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|
|
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|
|
|
|
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Nine Months Ended
|
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|
|
September 30,
|
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|
|
2007
|
|
|
2006
|
|
|
Non-cash financing activities:
|
|
|
|
|
|
|
|
|
Offering costs
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$
|
|
|
|
$
|
1,278
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13. Exit and Disposal Activity
In November 2006, the Company made the decision to consolidate its healthcare security
operations into an existing facility located in Ottawa, Ontario, Canada to eliminate
duplicative functions and to improve operating efficiencies. The consolidation entailed the
closing of operations in Vancouver, British Columbia. The Company substantially completed
the consolidation by March 31, 2007. As a result of the consolidation, for the three and
nine months ended September 30, 2007, the Company has recorded charges of nil and
$0.3 million, resulting from payroll related charges. Such charges are reflected in the consolidated statement of operations in selling, general and administrative expense and
in research and development expenses.
20
Special Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements, within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, that reflect our current estimates,
expectations and projections about our future results, performance, prospects and
opportunities. Forward-looking statements include, without limitation, statements about our
market opportunities, our business and growth strategies, our projected revenue and expense
levels, possible future consolidated results of operations, the adequacy of our available
cash resources, our financing plans, our competitive position and the effects of competition
and the projected growth of the industries in which we operate. This Quarterly Report on
Form 10-Q also contains forward-looking statements attributed to third parties relating to
their estimates regarding the size of the future market for products and systems such as our
products and systems, and the assumptions underlying such estimates. Forward-looking
statements include all statements that are not historical facts and can be identified by
forward-looking statements such as may, might, should, could, will, intends,
estimates, predicts, projects, potential, continue, believes, anticipates,
plans, expects and similar expressions. Forward-looking statements are only predictions
based on our current expectations and projections, or those of third parties, about future
events and involve risks and uncertainties.
Although we believe that the expectations reflected in the forward-looking statements
contained in this Quarterly Report on Form 10-Q are based upon reasonable assumptions, no
assurance can be given that such expectations will be attained or that any deviations will
not be material. In light of these risks, uncertainties and assumptions, the forward-looking
statements, events and circumstances discussed in this Quarterly Report on Form 10-Q may not
occur and actual results could differ materially and adversely from those anticipated or
implied in the forward-looking statements. Important factors that could cause our actual
results, level of performance or achievements to differ materially from those expressed or
forecasted in, or implied by, the forward-looking statements we make in this Quarterly
Report on Form 10-Q are discussed under Item 1A. Risk Factors and elsewhere in our Annual
Report on Form 10-K and include:
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our ability to successfully implement our business strategy;
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our expectation that we will incur losses, on a consolidated basis, for the foreseeable future;
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our ability to fund our operations;
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borrowings under our existing bank facility are payable on demand and the facility could be
terminated at any time without notice;
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the impact on our success of the relative maturity in the United States, and limited size, of the
markets for our infant protection and wander prevention systems and vibration monitoring instruments;
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the degree of success we have in leveraging our brand reputation, reseller network and end-use
customer base for our infant protection and wander prevention systems to gain inroads in the emerging
market for asset/staff location and identification systems;
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the rate and extent of the U.S. healthcare industrys adoption of radio frequency identification, or
RFID, asset/staff location and identification systems;
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the relative degree of market acceptance of our zonal, or cell identification, active RFID systems
compared to competing technologies, such as lower power Ultra Wide Band-based location technologies,
802.11 and Zigbee-based location and wireless networking technologies;
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our ability to complete our efforts to introduce new vibration monitoring instrumentation products;
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uncertainty as to whether we will be able to increase our sales of infant protection and wander
prevention systems outside of North America;
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21
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our reliance on third-party dealers to successfully market and sell our products;
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we may become subject to costly product liability claims and claims that our products infringe the
intellectual property rights of others;
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our ability to comply with current and future regulations relating to our businesses;
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uncertainty as to whether a market for our VeriMed and Evitrace systems will develop and whether we
will be able to generate more than a nominal level of revenue from the sale of these systems;
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the potential for patent infringement claims to be brought against us asserting that we hold no
rights for the use of the implantable microchip technology and that we are violating another partys
intellectual property rights. If such a claim is successful, we could be enjoined from engaging in
activities to market the systems that utilize the implantable microchip and be required to pay
substantial damages;
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market acceptance of our VeriMed system, which will depend in large part on the future availability
of insurance reimbursement for the VeriMed system microchip implant procedure from government and
private insurers, and the timing of such reimbursement, if it, in fact, occurs;
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a potential disruption to our business, loss of sales and higher expense if we are unable to obtain
the implantable microchip used in our VeriMed and Evitrace systems from our sister company Digital
Angel and other risks related to our supply agreement with Digital Angel;
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our ability to provide uninterrupted, secure access to the VeriMed database;
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conflict of interest risks related to our continued affiliation with Digital Angel and our parent
company, Applied Digital; and
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our ability to establish and maintain proper and effective internal accounting and financial controls.
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You should not place undue reliance on any forward-looking statements. In addition,
past financial or operating performance is not necessarily a reliable indicator of future
performance, and you should not use our historical performance to anticipate future results
or future period trends. Except as otherwise required by federal securities laws, we
disclaim any obligation or undertaking to disseminate any updates or revisions to any
forward-looking statement contained in this Quarterly Report on Form 10-Q to reflect any
change in our expectations or any change in events, conditions or circumstances on which any
such statement is based. All forward-looking statements attributable to us, or persons
acting on our behalf, are expressly qualified in their entirety by the cautionary statements
included in this Quarterly Report on Form 10-Q.
22
Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations.
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the accompanying financial statements and
related notes included in Item 1 of this Quarterly Report on the Form 10-Q as well as our
2006 Annual Report on Form 10-K for the year ended December 31, 2006.
We develop, market, and sell radio frequency identification, frequently referred to as
RFID, systems used for the identification, location and protection of people and assets in
the healthcare market. In early 2007, we realigned our business into three business
segments: healthcare security, implantable, and industrial. This change was made to align
our financial reporting with our new operational management structure. All segment
information in this Quarterly Report on Form10-Q has been reclassified to reflect the
segment realignment.
Our healthcare security segment encompasses the development, marketing and sale of our
healthcare security and location systems, specifically:
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infant protection systems used in hospital maternity wards and birthing
centers to prevent infant abduction and mother-baby mismatching;
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wander prevention systems used by long-term care facilities to locate and
protect their residents; and
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asset/staff location and identification systems used by hospitals and other
healthcare facilities to identify, locate and protect medical staff, patients,
visitors and medical equipment.
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The principal offering of our implantable segment is our VeriMed system using the
implantable microchip, a FDA cleared human-implantable RFID microchip that is used in
patient identification for access to personal health records.
Our industrial segment encompasses the sale of vibration monitoring instruments used by
engineering, construction and mining professionals to monitor the effects of human induced
vibrations, such as blasting activity. Our industrial segment also encompasses the sale of
asset management systems used by industrial companies to manage and track their mobile
equipment and tools.
Highlights for our third quarter ended September 30, 2007, included:
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We generated $53,000 from our implantable segment, the first revenue from that
segment since our initial public offering, primarily from sales of the VeriTrace
System; we also launched the Patient First program, a program under which patients
receive the VeriMed implantable microchip with no up-front cost with a subscription to
the VeriMed Patient Registry at a fee of $9.95 per month.
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We partnered with Independent Dialysis Foundation (IDF) of Maryland to provide IDFs
500 patients access to the VeriMed implantable microchip over a one-year period.
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|
We officially launched our VeriMed Patient Identification System project with
Alzheimers Community Care and more than 100 patients and caregivers received the
VeriMed implantable microchip following the launch.
|
|
|
|
|
We entered into a memorandum of understanding with Digital Angel and RECEPTORS LLC,
an expert in the field of proteomics and the development of artificial receptors, to
develop a prototype renewable glucose sensor to use in conjunction with an implantable
bio-sensing RFID microchip to measure glucose levels in the human body.
|
23
|
|
|
The number of hospitals registered in the VeriMed Patient Identification System
network increased by 9.5% from 640 at the end of the second quarter of 2007 to 701 at
the end of the third quarter of 2007. The number of protocol-adopted hospitals
increased by 26.6% from 158 at the end of the second quarter of 2007 to 200 at the end
of the third quarter of 2007.
|
Results of Operations
The table below sets forth data from our consolidated statements of operations for the
three and nine months ended September 30, 2007 and 2006, expressed as a percentage of total
revenue. To date, substantially all of our revenue consists of revenue from our healthcare
security and industrial businesses, which were acquired in the first half of 2005.
Through September 30, 2007, we have recorded nominal revenue from sales of our VeriMed
system. Over time, we expect that sales of our VeriMed system will become a significant part
of our revenue, although there can be no assurance that they will.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
Product revenue
|
|
|
93.7
|
%
|
|
|
93.2
|
%
|
|
|
93.3
|
%
|
|
|
93.8
|
%
|
Service revenue
|
|
|
6.3
|
|
|
|
6.8
|
|
|
|
6.7
|
|
|
|
6.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of products sold
|
|
|
38.8
|
|
|
|
41.5
|
|
|
|
42.4
|
|
|
|
38.6
|
|
Cost of services sold
|
|
|
3.9
|
|
|
|
3.2
|
|
|
|
3.8
|
|
|
|
3.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
57.3
|
|
|
|
55.3
|
|
|
|
53.8
|
|
|
|
58.2
|
|
|
Selling, general and
administrative expense
|
|
|
77.0
|
|
|
|
63.8
|
|
|
|
71.7
|
|
|
|
61.8
|
|
Research and development
|
|
|
14.4
|
|
|
|
12.9
|
|
|
|
14.9
|
|
|
|
13.3
|
|
Other income
|
|
|
0.5
|
|
|
|
0.3
|
|
|
|
0.5
|
|
|
|
0.3
|
|
Interest expense
|
|
|
4.9
|
|
|
|
3.2
|
|
|
|
4.9
|
|
|
|
2.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before provision for
income taxes
|
|
|
(39.4
|
)
|
|
|
(24.9
|
)
|
|
|
(38.2
|
)
|
|
|
(19.6
|
)
|
Provision for income taxes
|
|
|
1.3
|
|
|
|
(6.4
|
)
|
|
|
0.6
|
|
|
|
(2.7
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to
common stockholder
|
|
|
(40.7
|
)%
|
|
|
(18.5
|
)
|
|
|
(38.8
|
)%
|
|
|
(17.0
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
24
Three Months Ended September 30, 2007 Compared to Three Months Ended September 30, 2006
The table below presents unaudited condensed statement of operations data by segment
and in total for the three months ended September 30, 2007 and 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
|
Healthcare
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Security
|
|
|
Implantable
|
|
|
Industrial
|
|
|
Corporate
|
|
|
Total
|
|
|
|
(in thousands)
|
|
Product revenue
|
|
$
|
5,715
|
|
|
$
|
53
|
|
|
$
|
1,646
|
|
|
$
|
|
|
|
$
|
7,414
|
|
Service revenue
|
|
|
158
|
|
|
|
|
|
|
|
344
|
|
|
|
|
|
|
|
502
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
5,873
|
|
|
|
53
|
|
|
|
1,990
|
|
|
|
|
|
|
|
7,916
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
3,360
|
|
|
|
37
|
|
|
|
1,139
|
|
|
|
|
|
|
|
4,536
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and
administrative
|
|
|
1,945
|
|
|
|
1,467
|
|
|
|
559
|
|
|
|
2,121
|
|
|
|
6,092
|
|
Research and development
|
|
|
665
|
|
|
|
7
|
|
|
|
468
|
|
|
|
|
|
|
|
1,140
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
2,610
|
|
|
|
1,474
|
|
|
|
1,027
|
|
|
|
2,121
|
|
|
|
7,232
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating (loss) income
|
|
$
|
750
|
|
|
$
|
(1,437
|
)
|
|
$
|
112
|
|
|
$
|
(2,121
|
)
|
|
$
|
(2,696
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
|
Healthcare
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Security
|
|
|
Implantable
|
|
|
Industrial
|
|
|
Corporate
|
|
|
Total
|
|
|
|
(in thousands)
|
|
Product revenue
|
|
$
|
4,934
|
|
|
$
|
14
|
|
|
$
|
1,406
|
|
|
$
|
|
|
|
$
|
6,354
|
|
Service revenue
|
|
|
147
|
|
|
|
|
|
|
|
317
|
|
|
|
|
|
|
|
464
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
5,081
|
|
|
|
14
|
|
|
|
1,723
|
|
|
|
|
|
|
|
6,818
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
2,750
|
|
|
|
3
|
|
|
|
1,015
|
|
|
|
|
|
|
|
3,768
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and
administrative
|
|
|
2,133
|
|
|
|
1,041
|
|
|
|
589
|
|
|
|
585
|
|
|
|
4,348
|
|
Research and development
|
|
|
502
|
|
|
|
|
|
|
|
380
|
|
|
|
|
|
|
|
882
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
2,632
|
|
|
|
1,041
|
|
|
|
969
|
|
|
|
585
|
|
|
|
5,230
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
$
|
115
|
|
|
$
|
(1,038
|
)
|
|
$
|
46
|
|
|
$
|
(585
|
)
|
|
$
|
(1,462
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
Revenue for the three months ended September 30, 2007 was $7.9 million, an increase of
$1.1 million, or 16.2%, compared to the comparable period of the prior year.
Our healthcare security segments revenue was $5.9 million for the three months ended
September 30, 2007 compared to $5.1 million for the three months ended September 30, 2006.
The $0.8 million increase in revenue in our healthcare security segment is primarily
attributable to increased sales of infant protection systems reflecting increased sales
volumes generated by our key dealers for both new systems and the sale of RFID tags and
other consumables to our installed base. Revenue from the sale of our wander prevention products also increased for the three months ended September 30, 2007 compared to the
three months ended September 30, 2006.
25
Our industrial segments revenue was $2.0 million for the three months ended September
30, 2007 compared to $1.7 million for the three months ended September 30, 2006. The
$0.3 million increase in revenue in our industrial segment reflects continued strong demand
in the worldwide construction market for our vibration monitoring systems. The strength or
weakness of the worldwide construction market has historically had a significant influence
on the sales volumes of our vibration monitoring instruments.
Our implantable segment revenue was $53,000 for the three months ended September 30,
2007 compared to $14,000 for the three months ended September 30, 2006. This increase is
attributable to sales of VeriTrace systems to state and local government agencies.
Gross Profit and Gross Profit Margin
Our cost of products consists of component parts, direct labor and finished goods.
Component parts and finished goods are purchased from contract manufacturers, including our
implantable microchip and scanners used in our VeriMed system, which are purchased as
finished goods under the terms of our agreement with Digital Angel Corporation, or Digital
Angel. Moreover, included in our cost of products is amortization of intangible assets
acquired in the acquisitions of Instantel Corporation and EXI Wireless Inc., during the
first half of 2005. Such amortization amounted to $0.5 million and $0.4 million for the
three months ended September 30, 2007 and 2006, respectively.
Cost of services consists primarily of third-party installation services in connection
with direct sales to healthcare customers. In addition, cost of services sold in our
industrial segment consists of servicing our existing systems, principally the calibration
services we provide for our vibration monitoring instruments.
Gross profit for the three months ended September 30, 2007 was $4.5 million compared to
$3.8 million for the three months ended September 30, 2006. As a percentage of revenue, our
gross profit margin was 57.3% and 55.3% for the three months ended September 30, 2007 and
2006, respectively.
Our healthcare security segments gross profit was $3.4 million and $2.8 million for
the three months ended September 30, 2007 and 2006, respectively. Our healthcare security
segments gross profit margin increased to 57.2% in the three months ended September 30,
2007 compared to 54.1% in the three months ended September 30, 2006. The increase in gross
profit margin is due to improved inventory management as a result of the consolidation of
operations from Vancouver to Ottawa.
Our industrial segments gross profit for the three months ended September 30, 2007 was
$1.1 million compared to $1.0 million for the three months ended September 30, 2006. Our
industrial segments gross profit margin decreased to 57.2% in the three months ended
September 30, 2007 compared to 58.9% in the three months ended September 30, 2006. The
decrease in gross profit margin resulted from increased revenues from the sale of tool
management products compared to the three months ended September 30, 2006, which have a
lower gross margin than our vibration monitoring products.
Selling, General and Administrative Expense
Selling, general and administrative expense consists primarily of compensation for
employees in executive, sales, marketing and operational functions, including finance and
accounting, and corporate development. Other significant costs include depreciation and
amortization, professional fees for accounting and legal services, consulting fees and
facilities costs.
Selling, general and administrative expense increased $1.8 million to $6.1 million for
the three months ended September 30, 2007 as compared to $4.3 million for the three months
ended September 30, 2006. As a percentage of revenue, selling, general and administrative
expense was 77.0% and 63.8% for the three months ended September 30, 2007 and 2006,
respectively.
26
During the three months ended September 30, 2007 and 2006, we incurred stock-based
compensation expense of $1.3 million and $0.1 million, respectively.
Included in selling, general and administrative expense was $0.1 and $0.2 million of
certain general and administrative services provided to us by Applied Digital, including
accounting, finance and legal services, insurance, telephone, rent and other miscellaneous
items in both the three months ended September 30, 2007 and 2006.
Selling, general and administrative expense included depreciation and amortization
expense of approximately $0.5 million for the three months ended September 30, 2007 and
2006.
Our healthcare security segments selling, general and administrative expense was $1.9
million in the three months ended September 30, 2007 as compared to $2.1 million in the
three months ended September 30, 2006. The decrease of $0.2 million is a result of cost
savings from the close of our Vancouver operations, which was completed in the first quarter
of 2007. As a percentage of our healthcare security segments revenue, selling, general and
administrative expense was 33.1% and 42.0% for the three months ended September 30, 2007 and
2006, respectively.
Our industrial segments selling, general and administrative expense remained constant
at approximately $0.6 million for the three months ended September 30, 2007 and 2006. As a
percentage of our industrial segments revenue, selling, general and administrative expense
was 28.1% and 34.2% for the three months ended September 30, 2007 compared to the three
months ended September 30, 2006, respectively. We attribute the decrease in selling,
general, and administrative expense as a percentage of our industrial segments revenue
primarily to revenue growth in our vibration monitoring business and the fixed nature of our
general and administrative expenses.
Our implantable segments selling, general and administrative expense increased to $1.5
million from $1.0 million for the three months ended September 30, 2007 compared to the
three months ended September 30, 2006. The increase was due to our increased sales and
marketing expenses associated with the build out of our VeriMed business, primarily through
increased sales staff and costs related to our market development efforts.
Our corporate segments selling, general and administrative expense increased from $0.6
million to $2.1 million in three months ended September 30, 2007 compared to the three
months ended September 30, 2006. This increase in selling, general and administrative
expense during the three months ended September 30, 2007 compared to the three months ended
September 30, 2006 was due primarily to non-cash equity based compensation of $1.3 million
and the costs of being a public entity.
Research and Development
Our research and development expense consists primarily of payroll costs for
engineering personnel and costs associated with various projects, including testing,
developing prototypes and related expenses.
Research and development expense was $1.1 million for the three months ended September
30, 2007 compared to $0.9 million for the three months ended September 30, 2006. As a
percentage of revenue, research and development expense was 14.4% and 12.9% for the three
months ended September 30, 2007 and 2006, respectively.
Our healthcare security segments research and development expense increased to $0.7
million for the three months ended September 30, 2007 from approximately $0.5 million for
the three months ended September 30, 2006. This increase is attributable to higher Canadian
dollar denominated compensation costs related to changes in the foreign exchange rate.
Our industrial segments research and development expense was approximately
$0.5 million for the three months ended September 30, 2007 as compared to $0.4 in the three
months ended September 30, 2006.
27
Interest Expense
Interest expense was $0.4 million and $0.2 million for the three months ended September
30, 2007 and 2006, respectively. The increase in interest expense was due to the increased
amount owed and increased interest rate under our loan agreement with Applied Digital, and
our increased borrowings under our revolving credit facility with the Royal Bank of Canada.
We used a portion of the proceeds from our initial public offering to repay $3.5 million of
outstanding indebtedness owed to Applied Digital at the closing of our initial public
offering. During the three months ended September 30, 2007 and 2006, the interest rate under
our loan agreement with Applied Digital was 12% and 7% per annum, respectively.
Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006
The table below presents statement of operations data by segment and in total for the
nine months ended September 30, 2007 and 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
|
Healthcare
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Security
|
|
|
Implantable
|
|
|
Industrial
|
|
|
Corporate
|
|
|
Total
|
|
|
|
(in thousands)
|
|
Product revenue
|
|
$
|
16,622
|
|
|
$
|
54
|
|
|
$
|
5,233
|
|
|
$
|
|
|
|
$
|
21,909
|
|
Service revenue
|
|
|
424
|
|
|
|
|
|
|
|
1,146
|
|
|
|
|
|
|
|
1,570
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
17,046
|
|
|
|
54
|
|
|
|
6,379
|
|
|
|
|
|
|
|
23,479
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
9,126
|
|
|
|
38
|
|
|
|
3,465
|
|
|
|
|
|
|
|
12,629
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and
administrative
|
|
|
5,850
|
|
|
|
3,855
|
|
|
|
1,817
|
|
|
|
5,311
|
|
|
|
16,833
|
|
Research and development
|
|
|
2,289
|
|
|
|
105
|
|
|
|
1,109
|
|
|
|
|
|
|
|
3,503
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
8,139
|
|
|
|
3,960
|
|
|
|
2,926
|
|
|
|
5,311
|
|
|
|
20,336
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating (loss) income
|
|
$
|
987
|
|
|
$
|
(3,922
|
)
|
|
$
|
539
|
|
|
$
|
(5,311
|
)
|
|
$
|
(7,707
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
|
Healthcare
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Security
|
|
|
Implantable
|
|
|
Industrial
|
|
|
Corporate
|
|
|
Total
|
|
|
|
(in thousands)
|
|
Product revenue
|
|
$
|
14,683
|
|
|
$
|
114
|
|
|
$
|
4,277
|
|
|
$
|
|
|
|
$
|
19,074
|
|
Service revenue
|
|
|
282
|
|
|
|
|
|
|
|
988
|
|
|
|
|
|
|
|
1,270
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
14,965
|
|
|
|
114
|
|
|
|
5,265
|
|
|
|
|
|
|
|
20,344
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
8,618
|
|
|
|
49
|
|
|
|
3,183
|
|
|
|
|
|
|
|
11,850
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and
administrative
|
|
|
6,422
|
|
|
|
2,706
|
|
|
|
1,582
|
|
|
|
1,870
|
|
|
|
12,580
|
|
Research and development
|
|
|
1,807
|
|
|
|
|
|
|
|
893
|
|
|
|
|
|
|
|
2,700
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
8,229
|
|
|
|
2,706
|
|
|
|
2,475
|
|
|
|
1,870
|
|
|
|
15,280
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
$
|
389
|
|
|
$
|
(2,657
|
)
|
|
$
|
708
|
|
|
$
|
(1,870
|
)
|
|
$
|
(3,430
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
28
Revenue
Revenue for the nine months ended September 30, 2007 was $23.5 million, an increase of
$3.1 million, or 15.4%, compared to the comparable period of the prior year.
Our healthcare security segments revenue was $17.0 million for the nine months ended
September 30, 2007 compared to $15.0 million for the nine months ended September 30, 2006.
The $2.0 million increase in revenue in our healthcare security segment is primarily
attributable to increased sales of infant protection systems reflecting increased sales
volumes generated by our key dealers for both new systems and the sale of RFID tags and
other consumables to our installed base. Revenue from the sale of our wander prevention
products also increased for the nine months ended September 30, 2007 compared to the nine
months ended September 30, 2006.
Our industrial segments revenue was $6.4 million for the nine months ended September
30, 2007 compared to $5.3 million for the nine months ended September 30, 2006. The
$1.1 million increase in revenue in our industrial segment reflects continued strong demand
in the worldwide construction market for our vibration monitoring systems. The strength or
weakness of the worldwide construction market has historically had a significant influence
on the sales volumes of our vibration monitoring instruments.
Our implantable segments revenue was $54,000 for the nine months ended September 30,
2007 compared to $0.1 million for the nine months ended September 30, 2006. This decrease is
attributable to the sale of access security systems to several international distributors in
the first three months of 2006 prior to the shift in our sales and marketing efforts to the
build out of our VeriMed business.
Gross Profit and Gross Profit Margin
Our cost of products consists of component parts, direct labor and finished goods.
Component parts and finished goods are purchased from contract manufacturers, including our
implantable microchip and scanners used in our VeriMed system, which are purchased as
finished goods under the terms of our agreement with Digital Angel. Moreover, included in
our cost of products is amortization of intangible assets acquired in the acquisitions of
Instantel Corporation and EXI Wireless Inc., during the first half of 2005. Such
amortization amounted to $1.4 million for the nine months ended September 30, 2007 and 2006.
Cost of services consists primarily of third-party installation services in connection
with direct sales to healthcare customers. In addition, cost of services sold in our
industrial segment consists of servicing our existing systems, principally the calibration
services we provide for our vibration monitoring instruments.
Gross profit was $12.6 million and $11.9 million for the nine months ended September
30, 2007 and 2006, respectively. As a percentage of revenue, our gross profit margin was
53.8% and 58.2% for the nine months ended September 30, 2007 and 2006, respectively.
Our healthcare security segments gross profit for the nine months ended September 30,
2007 was $9.1 million compared to $8.6 million for the nine months ended September 30, 2006.
Comparing the same nine month periods, gross profit margin decreased to 53.5% in the nine
months ended September 30, 2007 from 57.6% in the nine months ended September 30, 2006. The
decline in gross profit margin is the result of increased warranty costs related to our
former Vancouver operations in the first half of 2007. Our improved inventory management
processes in our Ottawa facility have resulted in a reduction of these costs and as a result
in the three months ended September 30, 2007 gross profit margin increased to 57.2% compared
to 54.1% in the three months ended September 30, 2006.
Our industrial segments gross profit for the nine months ended September 30, 2007 was
$3.5 million compared to $3.2 million for the nine months ended September 30, 2006. Our
industrial segments gross profit margin decreased to 54.3% in the nine months ended
September 30, 2007 compared to 60.5% in the nine months ended September 30, 2006. The
decline in gross profit margin resulted from increased inventory reserves for slower moving
inventory and due to increased revenues from tool management products compared to the nine months ended September 30, 2006, which have a lower gross
margin that our vibration monitoring products.
29
Our implantable segments gross profit decreased from $49,000 for the nine months ended
September 30, 2006 to $38,000 for the nine months ended September 30, 2007. The $11,000
decrease resulted from the decrease in revenue from access security systems sold in early
2006.
Selling, General and Administrative Expense
Selling, general and administrative expense consists primarily of compensation for
employees in executive, sales, marketing and operational functions, including finance and
accounting, and corporate development. Other significant costs include depreciation and
amortization, professional fees for accounting and legal services, consulting fees and
facilities costs.
Selling, general and administrative expense increased $4.2 million to $16.8 million for
the nine months ended September 30, 2007 as compared to $12.6 million for the nine months
ended September 30, 2006. As a percentage of revenue, selling, general and administrative
expense was 71.7% and 61.8% for the nine months ended September 30, 2007 and 2006,
respectively. For the remainder of 2007, we expect the increased year over year selling,
general and administrative expense to continue as a result of the build out of our VeriMed
business, the cost resulting from the issuance of equity based compensation, and the cost
related to becoming a public entity.
During the nine months ended September 30, 2007 and 2006, we incurred stock-based
compensation expense of $2.6 million and $0.1 million, respectively.
Included in selling, general and administrative expense was $0.4 million of certain
general and administrative services provided to us by Applied Digital, including accounting,
finance and legal services, insurance, telephone, rent and other miscellaneous items in both
the nine months ended September 30, 2007 and 2006.
Selling, general and administrative expense included depreciation and amortization
expense of approximately $1.5 million and $0.5 million for the nine months ended September
30, 2007 and 2006, respectively.
Our healthcare security segments selling, general and administrative expense was $5.9
million and $6.4 million in the nine months ended September 30, 2007 and 2006, respectively.
As a percentage of our healthcare security segments revenue, selling, general and
administrative expense was 34.3% and 42.9% for the nine months ended September 30, 2007 and
2006, respectively. The decrease of $0.5 million is a result of cost savings from the
closing of our Vancouver operations in the first quarter of 2007. We expect to continue to
realize cost savings year over year from the closing of our Vancouver operations.
Our industrial segments selling, general and administrative expense increased
approximately $0.2 million to $1.8 million for the nine months ended September 30, 2007
compared to the nine months ended September 30, 2006. As a percentage of our industrial
segments revenue, selling, general and administrative expense was 28.5% and 30.0% for the
nine months ended September 30, 2007 and 2006, respectively. We attribute the decrease in
selling, general, and administrative expense as a percentage of segment revenue primarily to
revenue growth in our vibration monitoring business and the fixed nature of our general and
administrative expenses.
Our implantable segments selling, general and administrative expense increased $1.2
million to $3.9 million for the nine months ended September 30, 2007 compared to the nine
months ended September 30, 2006. The increase was due to our increased sales and marketing
expenses associated with the build out of our VeriMed business, primarily through increased
sales staff and costs related to our market development efforts.
30
Our corporate segments selling, general and administrative expense increased $3.4
million to $5.3 million in nine months ended September 30, 2007 compared to the nine months
ended September 30, 2006. This increase was due primarily to the additional costs resulting from non-cash
equity based compensation of $2.6 million and increased costs related to being a public
entity during the nine months ended September 30, 2007. We expect the increased year over
year selling, general and administrative expense to continue as a result of the costs of
equity based compensation and costs related to being a public entity.
Research and Development
Our research and development expense consists primarily of payroll costs for
engineering personnel and costs associated with various projects, including testing,
developing prototypes and related expenses. Research and development expense was
$3.5 million for the nine months ended September 30, 2007 compared to $2.7 million for the
nine months ended September 30, 2006. As a percentage of revenue, research and development
expense was 14.9% and 13.3% for the nine months ended September 30, 2007 and 2006,
respectively.
Our healthcare security segments research and development expense increased
$0.5 million to approximately $2.3 million for the nine months ended September 30, 2007
compared to the nine months ended September 30, 2006. The increase in our healthcare
security segments research and development expense was due to the costs of duplicative
staffing during the period of closing our Vancouver facility in early 2007.
Our industrial segments research and development expense was approximately
$1.1 million and $0.9 million for the nine months ended September 30, 2007 and 2006,
respectively.
Our implantable segments research and development expense was approximately $0.1
million and nil for the nine months ended September 30, 2007 and 2006, respectively.
Interest Expense
Interest expense was $1.1 million and $0.5 million for the nine months ended September
30, 2007 and 2006, respectively. The increase in interest expense was due to the increased
amount owed and increased interest rate under our loan agreement with Applied Digital, and
our increased borrowings under our revolving credit facility with the Royal Bank of Canada.
We used a portion of the proceeds from our initial public offering to repay $3.5 million of
outstanding indebtedness owed to Applied Digital at the closing of our initial public
offering. During the nine months ended September 30, 2007 and 2006, the interest rate under
our loan agreement with Applied Digital was 12% and 7% per annum, respectively.
Liquidity and Capital Resources
As of September 30, 2007, cash totaled $9.7 million compared to cash of approximately
$1.0 million at December 31, 2006.
Cash Flows Used in Operating Activities
Net cash used in operating activities totaled $5.0 million and $1.8 million during the
nine months ended September 30, 2007 and 2006, respectively. For each of the periods
presented, cash was used primarily to fund operating losses, accounts receivable, and
payments of accounts payable and accrued expenses.
Since our acquisitions of our healthcare security and industrial businesses in the
first half of 2005, we have generated operating cash flows from such operations that have
partially funded our efforts to create a market for our VeriMed system. We expect to
continue to generate significant net cash operating outflows for the foreseeable future in
our VeriMed business as a result of our continuing investment in marketing and sales efforts
related to our VeriMed business. We expect that these net cash operating outflows will
continue to be funded through cash flows generated by our Healthcare Security and Industrial
operations, as well as from the net proceeds of our initial public offering. As a result, we
expect that our consolidated statements of cash flows will reflect significant cash flows used in operating
activities for at least the next 12-24 months.
31
The components of our VeriMed system (i.e., scanners, insertion kits and the
implantable microchips) are purchased as finished goods under the terms of our agreement
with Digital Angel. The agreement imposes minimum purchase requirements as follows:
$0 million in 2007; $0.9 million in 2008, net of $0.4 million of purchases in 2006 and less
purchases made in 2007; $1.8 million in 2009; $2.5 million in 2010; $3.8 million in 2011;
and $3.8 million in each year thereafter, subject to the parties reaching agreement on a
different amount. Under the terms of the agreement, Digital Angel may not supply human
implantable microchips to other parties if we meet the minimum purchase requirements. If
sales of the implantable microchip do not materialize or do not reach the level of the
applicable minimum purchase requirement in any year, we intend to satisfy the minimum
purchase requirements nonetheless. In such event, our inventory of implantable microchips
will increase. We believe that we will have sufficient liquidity to meet the minimum
purchase requirements under the agreement for the next few years.
Cash Flows from Investing Activities
Investing activities used cash of $0.4 million and $0.6 million during the nine months
ended September 30, 2007 and 2006, respectively, which was used to purchase equipment.
Cash Flows from Financing Activities
Financing activities provided cash of $14.2 million and $1.9 million during the nine
months ended September 30, 2007 and 2006, respectively. In the nine months ended September
30, 2007 and 2006, cash of $0.6 million and $1.0 million was provided from net borrowings
under our credit agreement with the Royal Bank of Canada and cash of $3.5 million was paid
to Applied Digital as principle payment on our Note Payable in the nine months ended
September 30, 2007. During the nine months ended September 30, 2007 and 2006, borrowing of
$1.3 million and $2.1 million were made from Applied Digital. During the nine months ended
September 30, 2007, cash of $15.5 million was provided from our initial public offering, net
of underwriting fees and offering costs.
Credit Facilities
Prior to the date of our initial public offering, which was consummated on February 14,
2007, we financed a significant portion of our operations and investing activities primarily
through funds that Applied Digital provided. As of September 30, 2007, we were indebted to
Applied Digital in the amount of $12.5 million.
Through October 5, 2006, our loan with Applied Digital bore interest at the prevailing
prime rate of interest as published by
The Wall Street Journal
, which as of September 30,
2006 was 8.25% per annum. On October 6, 2006, we entered into an amendment to the loan
agreement which increased the principal amount available thereunder to $13.0 million and we
borrowed an additional $2.0 million under the agreement to make the second purchase price
payment with respect to our acquisition of Instantel Inc. In connection with that amendment,
the interest rate was also changed to a fixed rate of 12% per annum. That amendment further
provided that the loan matured on July 1, 2008, but could be extended at the option of
Applied Digital through December 27, 2010.
On January 19, 2007, February 8, 2007 and February 13, 2007, we entered into further
amendments to the loan documents which increased the maximum principal amount of
indebtedness that we may incur to $14.5 million. A portion of this increase was used to
cover approximately $0.7 million of intercompany advances made to us by Applied Digital
during the first week of January 2007. Upon the consummation of our initial public offering
in February 2007, the loan ceased to be a revolving line of credit, and we have no ability
to incur additional indebtedness under the loan documents. The interest continues to accrue
on the outstanding indebtedness at a rate of 12% per annum. On February 14, 2007, the
closing date of our initial public offering, we were indebted to Applied Digital in the
amount of $15.1 million, including $1.0 million of accrued interest and, in accordance with
the terms of the loan agreement as most recently amended on February 13, 2007, we used
$3.5 million of the net proceeds of our initial public offering to repay a portion
32
of our indebtedness to Applied Digital upon consummation of our initial public
offering. We are not obligated to repay an additional amount of our indebtedness until
January 1, 2008. Effective with the payment of the $3.5 million, all interest which accrues
on the loan as of the last day of each month, commencing with February 2007, is added to the
principal amount. Commencing January 1, 2008 through January 1, 2010, we are obligated to
repay $300,000 on the first day of each month. A final balloon payment equal to the
outstanding principal amount then due under the loan plus all accrued and unpaid interest
will be due and payable on February 1, 2010. We amended the repayment terms of the loan to
allow us to retain a greater portion of the net proceeds of our initial public offering for
use in our business, thereby improving our liquidity for at least the next 12 to 18 months.
Our subsidiary, VeriChip Holdings Inc., or VHI, has entered into a credit facility
dated March 15, 2006 with the Royal Bank of Canada, or RBC, providing for up to
CDN$1.5 million, or approximately $1.5 million based on the exchange rate as of September
30, 2007, of revolving credit loans, provided that outstanding borrowings under the facility
may not exceed at any time an amount determined by reference to eligible accounts receivable
plus eligible inventory, in each case as defined in the agreement, of VHI, or
CDN$3.8 million at September 30, 2007. At September 30, 2007, $1.5 million was outstanding
under the facility. The facility is not a committed facility as it provides that loans are
made available to VHI at the sole discretion of RBC and that RBC may cancel or restrict the
availability or any unutilized portion thereof at any time or from time to time. Borrowings
may be made in either Canadian or U.S. dollars, are repayable on demand, as a result of
which outstanding borrowings under the facility are reflected as current liabilities in our
consolidated financial statements, and bear interest at a floating rate per annum equal to
the Canadian or U.S. dollar prime rate, as applicable, announced by RBC from time to time,
plus in each case 1%. The facility also provides for letters of credit and letters of
guarantee denominated in Canadian dollars. Borrowings, letters of credit and letters of
guarantee under the facility are secured by all of the assets of VHI and its subsidiary, and
is guaranteed by VHIs subsidiary in the amount of CDN$2.0 million. The loan agreements
contain customary representations and warranties and events of default for loan arrangements
of this type. In addition, the loan agreements contain customary covenants restricting VHIs
ability to, among other things, merge or enter into business combinations, create liens, or
sell or otherwise transfer assets. The foregoing is a summary of the material terms of the
credit facility and related agreements, and is qualified in its entirety by reference to the
terms and provisions of those agreements.
Financial Condition
As of September 30, 2007, we had working capital of approximately $10.1 million and an
accumulated deficit of $26.2 million compared to a working capital of approximately
$0.8 million and an accumulated deficit of approximately $17.0 million as of December 31,
2006. The increase in working capital was primarily due to proceeds from our initial public
offering completed on February 14, 2007, net of offering costs and underwriter fees, on
February 14, 2007.
We believe that with the remaining net proceeds of our initial public offering,
together with the cash we have on hand, our expected borrowing capacity under current or new
bank facilities and operating cash flows we expect to generate from our Healthcare Security
and Industrial segments, we will have sufficient funds available to cover our cash
requirements, including capital expenditures, debt service requirements and the minimum
purchase obligations under our supply agreement with Digital Angel, through 2008. However, a
decrease in operating cash flows from our healthcare security and industrial businesses, or
our inability to enter into a larger, committed bank credit facility, or failure to control
or, as necessary, reduce costs related to our continuing investment in our VeriMed business,
would have a material adverse effect on our planned business operations, financial
condition, results of operations and liquidity.
Impact of Recently Issued Accounting Standards
In February 2007, FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets
and Financial Liabilities
(FAS 159), including an amendment of FAS 115. This statement
provides companies with an option to report selected financial assets and liabilities at
fair value. This statement is effective for fiscal years beginning after November 15, 2007
with early adoption permitted. We are currently assessing the impact that the adoption of
FAS 159 could have on results of operations or financial position, if any.
33
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We presently do not use any derivative financial instruments to hedge our exposure to
adverse fluctuations in interest rates, foreign exchange rates, fluctuations in commodity
prices or other market risks, nor do we invest in speculative financial instruments. Our
line of credit with the Royal Bank of Canada bears interest at the Bank of Canada prime rate
plus 1%. Our interest income is sensitive to changes in the general level of U.S. interest
rates, particularly since our investments are short-term.
Due to the nature of our short-term investments, we have concluded that there is no
material market risk exposure and, therefore, no quantitative tabular disclosures are
required. Due to the minimal amounts of foreign currency exchange gains and losses and
translation adjustments during the nine months ended September 30, 2007, a sensitivity
analysis of fluctuations in foreign currency exchange rates is not required. During the nine
months ended September 30, 2007, we incurred $0.4 million in foreign exchange loss primarily
from the fluctuation of Canadian dollar exchange related RBC credit facility and other
Canadian denominated liabilities.
The table below presents the principal amount, including accrued interest, and
weighted-average interest rate for our debt portfolio:
|
|
|
|
|
|
|
September
|
|
|
|
30, 2007
|
|
|
|
(dollars in
thousands)
|
|
Loan due Applied Digital
|
|
$
|
12,535
|
|
Credit agreement with Royal Bank of Canada
|
|
$
|
1,465
|
|
Weighted-average interest rate for the nine months ended September 30, 2007
|
|
|
11.6
|
%
|
Based upon the average variable rate debt outstanding during the nine months ended
September 30, 2007, a 1% change in our variable interest rates would have a de minimis
affect on our loss before income taxes.
The estimated fair value of our indebtedness to Applied Digital is not reasonably
determinable due to the related party nature of the instrument.
Item 4. Controls and Procedures.
Disclosure Controls and Procedures
Evaluation of Disclosure Controls
. We evaluated the effectiveness of the design and
operation of our disclosure controls and procedures as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934, as amended (the Exchange Act) as of September 30, 2007.
This evaluation (the disclosure controls evaluation) was done under the supervision and
with the participation of management, including our chief executive officer (CEO) and
chief financial officer (CFO). Rules adopted by the SEC require that in this section of
our Quarterly Report on Form 10-Q we present the conclusions of the CEO and CFO about the
effectiveness of our disclosure controls and procedures as of September 30, 2007 based on
the disclosure controls evaluation.
Objective of Controls.
Our disclosure controls and procedures are designed so that
information required to be disclosed in our reports filed under the Exchange Act, such as
this Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within
the time periods specified in the SECs rules and forms. Our disclosure controls and
procedures are also intended to ensure that such information is accumulated and communicated
to our management, including the CEO and CFO, as appropriate to allow timely decisions
regarding required disclosure. There are inherent limitations to the effectiveness of any
system of disclosure controls and procedures, including the possibility of human error and
the circumvention or overriding of the controls and procedures. Accordingly, even effective
disclosure controls and procedures can only provide reasonable assurance of achieving their
control objectives, and management necessarily is required to use its judgment in evaluating the cost-benefit
relationship of possible disclosure controls and procedures.
34
Conclusion
. Based upon the disclosure controls evaluation, our CEO and CFO have
concluded that, as of September 30, 2007, our disclosure controls and procedures were
effective to provide reasonable assurance that the foregoing objectives are achieved.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting identified in
connection with the evaluation required by paragraph (d) of Rule 13a-15 under the Exchange
Act that occurred during the quarter ended September 30, 2007 that have materially affected,
or are reasonably likely to materially affect, our internal control over financial
reporting.
35
PART II OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is a party to various legal actions, as either plaintiff or defendant,
arising in the ordinary course of business, none of which is expected to have a material
adverse effect on our business, financial condition or results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ISSUER PURCHASES OF EQUITY SECURITIES
(1)
|
|
|
|
|
|
|
|
|
|
|
|
(c) Total Number of
|
|
|
(d) Approximate Dollar
|
|
|
|
|
|
|
|
(b) Average
|
|
|
Shares (or Units)
|
|
|
Value of Shares (or
|
|
|
|
(a) Total Number
|
|
|
Price Paid per
|
|
|
Purchased as Part of
|
|
|
Units) that May Yet Be
|
|
|
|
of Shares (or
|
|
|
Share (or
|
|
|
Publicly Announced
|
|
|
Purchased Under the
|
|
Period
|
|
Units) Purchased
(2)
|
|
|
Unit)
(3)
|
|
|
Plans or Programs
|
|
|
Plans or Programs
|
|
9/20/2007 -
9/30/2007
|
|
|
18,000
|
|
|
$
|
4.38
|
|
|
|
18,000
|
|
|
$
|
1,420,000
|
|
10/1/2007 -
10/31/2007
|
|
|
163,199
|
|
|
$
|
4.18
|
|
|
|
163,199
|
|
|
$
|
740,000
|
|
Total
|
|
|
181,199
|
|
|
$
|
4.20
|
|
|
|
181,199
|
|
|
$
|
740,000
|
|
|
|
|
(1)
|
|
The Companys stock repurchase program was announced on September 20, 2007. The Companys
board of directors unanimously authorized the repurchase of up to $1.5 million of Company
common stock over a four month period.
|
|
(2)
|
|
All shares were purchased through the Companys publicly announced stock repurchase plan.
The purchases were made in open market transactions.
|
|
(3)
|
|
The average price paid per share includes commissions paid to effect the transactions.
|
36
Item 6. Exhibits.
|
|
|
Exhibit
|
|
|
Number
|
|
Description
|
2.1
|
|
Acquisition Agreement dated as of January 25, 2005 between Applied Digital Solutions,
Inc. and EXI Wireless Inc. (1)
|
2.2
|
|
Amendment to Acquisition Agreement dated as of March 11, 2005 between Applied Digital
Solutions, Inc. and EXI Wireless Systems Inc. (1)
|
2.3
|
|
Exchange Agreement dated as of June 9, 2005 between Applied Digital Solutions, Inc. and
VeriChip Corporation (1)
|
2.4
|
|
Waiver and Release between Applied Digital Solutions, Inc. and VeriChip Corporation (1)
|
2.5
|
|
Share Purchase Agreement dated as of June 10, 2005 by and among Instantel Inc.,
Instantel Holding Company s.ár.l., Perceptis, L.P., VeriChip Inc., Applied Digital
Solutions, Inc. and VeriChip Corporation (1)
|
2.6
|
|
Letter Agreement dated as of December 21, 2005, by and among VeriChip Corporation,
VeriChip Inc., and Applied Digital Solutions, Inc. (1)
|
2.7
|
|
Registration Rights Agreement dated as of June 10, 2005 between VeriChip Corporation
and Perceptis, L.P. (1)
|
3.1
|
|
Second Amended and Restated Certificate of Incorporation of VeriChip Corporation filed
with the Secretary of State of Delaware on December 18, 2006 (1)
|
3.2
|
|
Amended and Restated By-laws of VeriChip Corporation adopted as of December 12, 2005 (1)
|
4.1
|
|
Warrant Agreement dated as of August 21, 2002 between VeriChip Corporation and IBM
Credit Corporation (1)
|
4.2
|
|
Form of Specimen Common Stock Certificate (1)
|
4.3
|
|
Form of Warrant to Purchase Common Stock of VeriChip Corporation (1)
|
10.1*
|
|
Form of Stock Award Agreement
|
10.2
|
|
Consulting Agreement dated as of August 8, 2007, between VeriChip Corporation and
Randolph K. Geissler(2)
|
10.3
|
|
Registration Rights Agreement dated as of August 31, 2007, between VeriChip Corporation
and Kallina Corporation(3)
|
31.1*
|
|
Certification by Scott R. Silverman, Chief Executive Officer, pursuant to Exchange Act
Rules 13A-14(a) and 15d-14(a)
|
31.2*
|
|
Certification by William J. Caragol, Chief Financial Officer, pursuant to Exchange Act
Rules 13A-14(a) and 15d-14(a)
|
32.1*
|
|
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
|
|
|
|
*
|
|
Filed herewith.
|
|
(1)
|
|
Incorporated by reference to the Registration Statement on Form S-1
previously filed by VeriChip Corporation (Registration No. 333-130754).
|
|
(2)
|
|
Incorporated by reference to the Quarterly Report on Form 10-Q previously
filed by VeriChip Corporation on August 8, 2007.
|
|
(3)
|
|
Incorporated by reference to the Current Report on Form 8-K previously filed
by VeriChip Corporation on September 7, 2007.
|
37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
|
|
|
|
|
|
VERICHIP CORPORATION
(Registrant)
|
|
Date: November 8, 2007
|
By:
|
/s/ William J. Caragol
|
|
|
|
William J. Caragol
|
|
|
|
President, Chief Financial
Officer,
Treasurer and Secretary
|
|
38
Exhibit Index
|
|
|
Exhibit
|
|
|
Number
|
|
Description
|
10.1
|
|
Form of Stock Award Agreement
|
31.1
|
|
Certification by Scott R. Silverman, Chief Executive Officer,
pursuant to Exchange Act Rules 13A-14(a) and 15d-14(a)
|
31.2
|
|
Certification by William J. Caragol, Chief Financial Officer,
pursuant to Exchange Act Rules 13A-14(a) and 15d-14(a)
|
32.1
|
|
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|
39
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