UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For the fiscal year ended December 31, 2007
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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
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Commission file number: 001-33297
VERICHIP CORPORATION
(Exact name of registrant as specified in its charter)
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DELAWARE
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06-1637809
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(State or other jurisdiction of incorporation or organization)
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(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) (Zip code)
(561) 805-8008
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
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Common Stock, par value $0.01 per share
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The NASDAQ Stock Market LLC
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(Title of each class)
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(Name of each exchange on which registered)
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Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act.
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No
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Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act.
Yes
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No
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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
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No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.
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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See definitions of large accelerated
filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
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Large accelerated filer
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Accelerated filer
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Non-accelerated filer
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Smaller reporting company
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(Do not check if smaller reporting company)
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes
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No
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The aggregate market value of the registrants common stock held by non-affiliates of the
registrant computed by reference to the price at which the common stock was last sold on the Nasdaq
Stock Market on June 30, 2007 was $30,042,082. For purposes of this calculation, the registrant has
assumed that its directors and executive officers are affiliates.
At March
24, 2008, 10,870,766 shares of our common stock were outstanding.
Documents Incorporated by Reference: Parts of the definitive Proxy Statement for the 2008 Annual
Meeting of Stockholders, which the Registrant will file with the Securities and Exchange Commission
within 120 days after the end of the Registrants fiscal year ended December 31, 2007, are
incorporated by reference in Part III of this Annual Report on Form 10-K to the extent described
herein.
Special Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K 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 Annual
Report on Form 10-K 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 Annual Report on Form 10-K 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 Annual Report on Form 10-K 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 Annual Report on Form 10-K are discussed under Item 1A.
Risk Factors and elsewhere in this 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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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/personnel 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/personnel 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 a new vibration monitoring
instrumentation platform;
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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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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 system will
develop and whether we will be able to generate more than a nominal level of revenue
from this business
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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 VeriTrace systems
from our largest stockholder, Applied Digital Solutions, Inc. d/b/a 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
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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 Annual Report on Form 10-K 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 Annual Report on Form 10-K.
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PART I
ITEM 1. BUSINESS
The Company
We were formed as a Delaware corporation by Applied Digital Solutions, Inc., d/b/a Digital
Angel, or Digital Angel, in November 2001. In January 2002, we began our efforts to create a market
for radio frequency identification, or RFID, systems that utilize our human implantable microchip.
Digital Angel owned over 90% of our stock as of December 31, 2006. On February 14, 2007, we
completed our initial public offering in which we sold 3,100,000 shares of our common stock at
$6.50 per share. As of December 31, 2007 and March 17, 2008, Digital Angel owned 50.8% and 49.3% of
our common stock, respectively.
In March 2005, we acquired EXI Wireless Inc., a Canadian corporation engaged through its
subsidiaries in the business of developing and marketing RFID systems for infant protection, wander
prevention and asset/personnel location and identification for use within the healthcare industry,
and asset management systems used by industrial companies to manage and track their mobile
equipment and tools. Subsequent to the acquisition, EXI Wireless was renamed VeriChip Holdings
Inc., or VHI.
In June 2005, we acquired Instantel Inc., a Canadian corporation engaged in the business of
developing and marketing RFID systems for infant protection, wander prevention, emergency response
and asset tracking within the healthcare industry, as well as vibration monitoring instruments for
the construction, mining and commercial blasting industries. In January 2006, we effected an
amalgamation of Instantel and the former EXI Wireless subsidiaries under Canadian law. The combined
entities operated as a wholly-owned subsidiary of VHI under the name VeriChip Corporation, which in
April 2007 was changed to Xmark Corporation, or Xmark. On January 1, 2008, VHI and Xmark were
amalgamated with Xmark surviving.
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 Annual Report on 10-K has been
reclassified to reflect the segment realignment.
Our principal executive offices are located at 1690 South Congress Avenue, Suite 200, Delray
Beach, Florida 33445. Our telephone number is (561) 805-8008. Unless the context provides
otherwise, when we refer to the Company, we, our, or us in this Annual Report on Form 10-K,
we are referring to VeriChip Corporation and its consolidated subsidiaries.
Hugs, Kisses, RoamAlert, Assetrac, Blastmate, Minimate, and BioBond are our registered
trademarks, and HALO, VeriMed, VeriChip, VeriTrace and ToolHound are our trademarks. This Annual
Report on
Form 10-K
contains trademarks and trade names of other organizations and corporations.
Available Information
We file or furnish with or to the Securities and Exchange Commission, or SEC, our quarterly
reports on Form 10-Q, annual reports on Form 10-K, current reports on Form 8-K, annual reports to
stockholders and annual proxy statements and amendments to such filings. Our SEC filings are
available to the public on the SECs website at http://www.sec.gov. These reports are also
available free of charge from our website at http://www.verichipcorp.com as soon as reasonably
practicable after we electronically file or furnish such material with or to the SEC. The
information on our website is not incorporated by reference into this Annual Report on Form 10-K or
any registration statement that incorporates this Annual Report on Form 10-K by reference.
Overview
We are primarily engaged in the development, marketing and sale of radio frequency
identification systems used to identify, locate and protect people and assets. The healthcare
industry represents the principal market for our RFID systems. Our goal is to become the leading
provider of RFID systems in the healthcare industry.
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Through our acquisitions in the first half of 2005 of two Canadian-based businesses, each of
which has been engaged in the design, marketing and sale of RFID systems for more than 10 years, we
have become one of the leading providers of:
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infant protection systems that help to prevent infant abduction and mother-baby
mismatching; and
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wander prevention systems that help to protect and locate residents in nursing homes
and assisted living facilities.
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As of December 31, 2007, our RFID systems for one or the other of these applications have been
installed in over 5,000 healthcare locations, primarily located in North America. Sales of these
systems currently represent a majority of our revenue.
We are in the early stages of marketing an asset/personnel location and identification system
to hospitals and other healthcare facilities. This system is designed to efficiently identify,
locate and protect medical staff, patients, visitors and medical equipment. We are seeking to
leverage our established brand reputation, reseller network and extensive end-use customer base for
our infant protection and wander prevention systems to gain inroads in the developing market for
RFID real-time location systems in hospitals and other healthcare facilities.
RFID technology involves the use of radio frequency, or RF, transmissions, typically achieved
through communication between a microchip-equipped transponder and a receiver, for identification,
location and other purposes. The basic components of an RFID system consist of:
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a tag, containing a microchip-equipped transponder, an antenna and a capacitor,
attached to the item to be identified, located or tracked, which wirelessly transmits
stored information to a receiver;
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one or more receivers, also referred to as readers, which are devices that read
the tag by sending out an RF signal to which a tag, in the range of the signal,
responds;
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the equipment, cabling, computer network and software applications to use the
processed data for one or more applications.
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Most RFID systems use either active or passive tags, with the choice reflecting the
different characteristics of the tags and the nature of the RFID system application. The key
difference in the technology is that active RFID systems deploy tags with battery-powered
microchips that emit a signal at regular intervals or continuously and do not rely on power from
the reader to operate, while passive RFID systems deploy tags with microchips that have no attached
power supply and receive an activating charge from the readers signal. Applications that require
receipt of signals between the tag and the reader beyond approximately ten meters in range usually
need a battery in the tags.
Our infant protection, wander prevention, emergency response, and asset/personnel location and
identification systems all make use of active RFID tags, which are worn by the people or attached
to the objects these systems are designed to identify, locate or protect, enabling the systems to
be used for perimeter control, tamper notification, and location and tracking purposes. Multiple
receivers with radio frequency antennas are placed in selected locations throughout a facility to
receive coded beacon messages from these active tags. All receivers in range of a particular tag
decode the message and send the received information to a central server. The received tag
information is used for multiple purposes across the range of system applications, including to
provide supervisory alerts when tag messages are absent and to provide tag positional location
through triangulation or other context-sensing algorithms. In addition, many of our active tags
include a tamper detection feature to prevent unauthorized removal, enhancing the security features
of our systems. This includes our proprietary skin-sensing and cut band technologies used with our
infant protection tags, as well as our proprietary tamper-proof asset tag used in our
asset/personnel location and identification system.
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We are also in the process of creating a market within the healthcare sector for the first,
and, to date, we believe the only, human-implantable radio frequency transponder system cleared for
use for patient identification
and health information purposes by the U.S. Food and Drug Administration, or FDA our VeriMed
Patient Identification System. As of December 31, 2007, we have generated nominal revenue from
sales of our VeriMed system. The key components of the VeriMed system are a passive microchip,
which is approximately the size of a grain of rice, a fixed location or a wireless handheld scanner
used to read the 16-digit identification number contained on the microchip, and a secure,
web-enabled database containing a patients personal health record. The implantable microchip is
not worn or attached as are the tags used in our infant protection and wander prevention systems
but rather is implanted under the skin of a persons upper right arm.
We are also engaged in the development, marketing and sale of products with applications
outside the healthcare sector that do not make use of RFID technology. Specifically, we offer a
wide range of vibration monitoring instruments used by engineering, construction and mining
professionals to monitor and document the effects of human-induced vibrations on neighboring
structures. We believe we are the leading provider of vibration monitoring instruments. Sales of
such instruments currently represent the second-largest source of our revenue.
Industry Overview
RFID and the Healthcare Industry
RFID technology has been widely adopted and used in a number of industries and for a number of
different applications. Today, RFID is being used to identify objects in retail, transportation and
logistics industries, as well as to identify and locate livestock and companion pets. RFID
technology offers a number of advantages over other systems used to identify and track objects,
such as barcode technology. RFID technology offers instantaneous location ability without the need
for ongoing human intervention, and provides greater range, accuracy, speed and lower line-of-sight
requirements than barcode technology.
According to a 2006 report prepared by IDTechEx, a United Kingdom-based consulting firm,
entitled RFID in Healthcare 2006-2016, the market for RFID tags and systems in the healthcare
industry in 2006 amounts to $90 million, representing approximately 3% of the total RFID market.
IDTechEx has forecast that by 2016 the market for RFID tags and systems in the healthcare industry
will grow to approximately $2.1 billion, estimated to then represent 8% of the total market for
RFID technology. The anticipated rapid growth in the healthcare industrys adoption of RFID
technology reflects the many healthcare-related applications envisioned and the benefits for
example, operational efficiencies, cost control and error prevention to be derived from such
applications.
Some of the major applications of RFID systems being deployed in the healthcare industry today
include:
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Infant Protection
At present, approximately 50% of maternity wards and other
birthing facilities in the United States, and 65-75% of maternity wards with greater
than 1,000 births per year, have some type of infant protection system though not
necessarily an RFID system. Based on our experience, we anticipate that hospital
maternity wards and birthing centers will continue to upgrade their security measures,
with RFID systems designed for these applications achieving greater market penetration.
The adoption of security measures, such as the implementation of an RFID infant
protection system, has been prompted by problems in dealing with mother-baby
mismatching and infant abduction. The Journal of Healthcare Protection Management has
reported that an estimated 20,000 mismatching incidents occur annually in the United
States. Between 1983 and 2004, 223 infants were recorded as being abducted in the
United States, with over 50% taken from healthcare facilities.
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Wander Prevention
At present, we estimate that roughly 30% of the long-term care
facilities in the United States have deployed an RFID-type wander prevention system.
The level of system deployment varies by type of facility. Nursing homes reflect the
highest level, followed by assisted living facilities. The implementation of RFID
wander prevention systems has been prompted by the significant number of individuals
residing in long-term care facilities, including nursing homes and assisted living
facilities, who are at risk of wandering away from their care facility. This can result
in danger to the individual and subsequent liability to the healthcare facility and its
insurer. According to the National Institute on Aging of the U.S. National Institutes
of Health, in 2005 there were approximately 37 million people over the age of 65 in the
United States alone, and that number is expected to grow to
approximately 58 million by 2025.
Furthermore, according to the
National Nursing Home
Survey,
published by the Centers for Disease Control in June 2002, as of 1999, there
were 18,000 nursing homes in the United States in which approximately 27% of the
residents suffered from Alzheimers disease, dementia or related disorders. We believe
that existing and future state regulations applicable to long-term facilities, which
include security and wander prevention requirements, will drive the growth in demand for
wander prevention systems.
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Real-time location systems are designed to locate persons or objects from a distance within a
defined physical space, such as an entire hospital, a care unit or a patients room. In this
context, real-time means that the RFID system checks and updates the location of the persons
and/or objects on a frequent basis, such as every few seconds. RFID real-time location systems can
enhance the operational flow and productivity of medical staff, enable appropriate personnel to
more quickly respond to incidents of patient violence against staff, locate patients and assets,
and respond to patients needs for assistance.
Notwithstanding the predictions of significant growth for RFID real-time location systems in
the healthcare sector, the pace at which healthcare facilities have implemented RFID systems has
been slower than many who follow the industry have anticipated. Market analysts have cited a number
of factors that may be constraining the rate and extent of the U.S. healthcare industrys adoption
of RFID asset/personnel location and identification systems, including:
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the cost of deployment, coupled with the limited budgets of many hospitals;
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the uncertainty or unquantifiable nature of the return on investment;
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system compatibility issues;
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the low level of awareness; and
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As of December 31, 2007, hospitals in the United States that have implemented real-time
location systems have done so primarily on a departmental basis. This reflects, in part, the
funding constraints of U.S. hospitals, as well as the difficulty of quantifying the return on
investment derived from deployment of an RFID system. Most of the existing system installations
represent early adopters of the technology, typically teaching hospitals. In general, a real-time
location system with a greater coverage area translates into greater potential for applications
that improve productivity, increase revenues and reduce costs.
We believe that RFID technology may also be used to address the need of emergency room
personnel and other first responder medical practitioners to identify uncommunicative patients and
rapidly access their personal health records, and we believe that use of such technology has the
potential to improve patient care, enhance productivity and lower costs. The IDTechEx report refers
to a study performed by the U.S. Institute of Medicine that estimated that preventable medical
errors in the United States cause between 44,000 and 98,000 deaths each year, due in part to
mistaken patient identification and lack of information on a patients medical history, and results
in losses, other than the loss of human life, of $17 billion to $29 billion annually. These losses
include the expense of additional care needed because of mistakes, disability, and lost
productivity and income. One factor that can contribute to the occurrence of preventable medical
errors is the inability to identify a patient and/or access his or her health records. Recognizing
the problem of patient identification and access to medical records, the United States government
is currently attempting to address certain inefficiencies in the healthcare system related to
information technology. In particular, the current administration has developed a National Health
Information Technology Plan that features as one of its main initiatives a plan to establish
electronic health records for a majority of Americans within the next ten years.
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Vibration Monitoring
Government regulations relating to the monitoring of vibrations resulting from activities,
such as mining, commercial blasting, pile driving and heavy construction, require compliance with
specified standards. These standards serve to limit the potential for damage to neighboring
structures and to minimize human annoyance. The demand for such monitoring, though affected by the
level of economic activity, has, in general, increased over the last five years, reflecting the
greater degree of blasting and vibration generating activities occurring closer to densely
populated areas.
Our Solutions
We are primarily engaged in the development, marketing and sale of RFID systems used to
identify, locate and protect people and assets. The healthcare industry represents the principal
market for our RFID systems. Also, we market and sell vibration monitoring instruments used to
monitor and document the effects of human-induced vibrations on neighboring structures in an area
where blasting occurs. All of our systems are designed to enable our end-use customers to enhance
operating efficiencies, reduce costs, and reduce the exposure to potential liability.
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 Annual Report on Form 10-K has
been reclassified to reflect the segment realignment.
Our Healthcare Security Systems
Infant Protection
We are a leading provider of RFID infant protection systems, which we market and sell under
the Hugs and HALO brand names, and unlabelled through original equipment manufacturer (OEM)
relationships. Our systems reduce the risk of infant abductions and enable healthcare professionals
to accurately identify infants. Our systems help protect infants from abductions by sounding
alarms, locking doors and disabling elevators. While infant abductions are rare, the impact of a
single case can create a severe negative impact on hospitals, birthing centers and families. With
an additional optional component worn by the mother, one of our systems can be used to help prevent
mother baby-mismatching through an audible signal to indicate a match or mismatch.
The benefits of our infant protection systems include:
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a reliable and accurate security system using RFID technology, requiring no manual
checking of infant tags or other devices to make sure they are working (as the system
software continually monitors the status of all key system components, and generates an
alarm if something goes wrong);
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automatic alerting of mother-baby mismatches (in the case of one of our systems);
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a proprietary skin-sensing or cut band technology that sounds an alarm if the tag is
removed or tampered with;
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a reduction of potential liability to hospitals and birthing centers; and
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an enhanced marketability of a hospital or birthing center.
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The Hugs System
The Hugs system uses a proprietary anklet band containing an active RFID tag. If the band is
cut or tampered with, a signal is emitted to a receiver. The Hugs system software continually
monitors the status of all infant tags, and will generate an alarm if a tag does not send a status
message every 10 seconds and more frequently when within the range of a mounted receiver at a
point of egress. The status message is received by
receivers positioned above the ceiling or by a door that monitor the tags location. Once a
signal is emitted to a receiver, the receiver then sends the signal to a server containing our
application software.
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The Hugs system will alert the staff of a maternity ward or birthing center if:
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someone tries to exit via a monitored door or elevator with a protected infant,
without authorization;
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The band is cut or tampered with;
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the tags signal is not detected by the system for a specified period of time;
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the tags battery power is low;
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an authorized exit occurs but someone tries to piggyback through the protected
exit with another infant; or
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an authorized exit occurs, but the infant is not returned to the designated safe
area in a specified time.
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In the event of an alarm, the server indicates the tag ID number and in some cases the
location on a floor plan map of the facility. The Hugs system can automatically activate magnetic
door locks or hold an elevator. It can also integrate with and activate other security and access
control systems, such as alpha-numeric pagers and cameras.
Through the use of simple password procedures, the Hugs system allows staff to sign tags out
of the system, so infants can be moved, for example, from the maternity ward for testing or other
medical procedures.
The optional Kisses component to the Hugs system is designed to ensure mother infant matching.
With the Kisses option, each mother wears a small Kisses tag. Every time a mother and infant are
brought together, an audible signal indicates a match or mismatch. In the event of a mismatch, the
infants tag immediately alerts the maternity ward or birthing center.
The Halo System
The HALO system uses a generic bracelet, which goes around an infants ankle, containing an
active RFID tag incorporating our proprietary skin-sensing technology. If the skin-sensing tag is
removed from the infants skin, a signal is emitted to a receiver. Any unauthorized attempt to
remove the HALO tag, or to take the infant through a monitored exit, immediately results in an
alarm at the HALO computer. The alarm identifies the infant and exact location.
The HALO system supports easy, secure bypass of exits via a keypad or card-access system,
recording the identity of the staff member and the baby being transported. With optional staff
tags, this process becomes completely automatic.
The HALO system is modular in design and can be easily expanded to new areas of the medical
facility with the addition of more receivers and tags.
Wander Prevention
We believe that we are one of the leading providers of active, wearable tag, RFID wander
prevention systems, which we market and sell under the RoamAlert brand name. Our systems allow
healthcare professionals to accurately identify and locate residents of long-term care facilities,
including nursing homes and assisted living facilities, as well as hospital psychiatric wards and
trauma units. Our systems help protect residents from wandering by sounding alarms, locking doors
and disabling elevators. Residents wearing our tags are typically individuals who suffer from a
dementia-related disorder, such as Alzheimers disease.
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The benefits of our wander prevention systems include:
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the protection of residents without physical restraint, providing them freedom to
move throughout their place of residence;
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the reduction of staffing requirements and the increased ability to focus on care
rather than protection; and
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the reduction of potential liability to long-term care and related facilities.
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With the RoamAlert wander prevention system, an at-risk resident of a long-term care facility
wears an active tag RFID bracelet, which we believe to be the smallest and lightest on the market.
Exits are protected by door receivers. When the resident approaches an exit, the door controller
locks the door to prevent the resident from leaving or, if the door is open, an alarm sounds. All
alarm information is presented in an intuitive visual format: the name of the resident, his/her
location and even a picture can be displayed on PCs installed at one or several nurse stations
around the long-term care facility. For bypassing doors, staff members wear staff pendant tags.
Doors will unlock automatically and the system will record the identity of the staff member, as
well as the resident(s) the staff member is escorting.
The RoamAlert system allows for customization of resident care so as to give each resident the
maximum possible freedom compatible with his/her safety. The system can be programmed to enable a
resident to pass through certain exits, for example to reach a common area, while all other exits
and residents remain protected.
The system provides not only wander prevention, but can also be expanded to include personal
emergency response and resident locating. Residents and staff can call for help from anywhere in
the facility at any time.
Our RoamAlert ECO product, which we sell at a lower price point, is targeted at facilities
with only a few exits to monitor and/or only a few residents in need of protection. The RoamAlert
ECO can cover elevators, and supports display of the resident tag ID number at the door with the
optional ID display unit. It is easily integrated with nurse call, access control and fire safety
systems. In addition, the RoamAlert ECO product can be upgraded to the fuller functionality of the
RoamAlert system.
Asset/Personnel Location and Identification
Our Assetrac asset/personnel location and identification system provides a reliable and
efficient method for hospitals and other healthcare facilities to locate high-value mobile medical
equipment, which we believe can be of help in providing ready access to such equipment when needed
and reducing losses due to misplacement or theft. The location information provided by the system
can also be used to establish whether that equipment has been sterilized since its last use. This
information helps to ensure that patients are treated with sterile and safe equipment.
Our location and identification system can be utilized for other applications, such as:
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tracking patients for identification purposes prior to the administration of
medications or surgery;
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tracking the location of caregivers in healthcare facilities to ensure timely
response to emergencies; and
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facilitating staff alarms in the event of patient violence.
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Hospitals have the ability to deploy asset/personnel location and identification systems of
varying scale, ranging from a system covering a single department, such as the emergency room or
the operating room, to one covering the entire facility. The system can provide a combination of
portal-based tracking and true real-time tracking. As of March 17, 2008, seven of our
asset/personnel location and identification systems have been sold. These systems were sold
through two dealers on a private label basis.
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Our VeriMed System
Our VeriMed system is designed to rapidly and accurately identify people who are unconscious,
confused or unable to communicate at the time of medical treatment, for example, upon arrival at a
hospital emergency room. Our VeriMed system provides emergency room physicians and staff who use
our scanner, linking a patient to the VeriMed Registry to have access to patient pre-approved
information, including the patients name, primary care physician, emergency contact information,
advance directives and, if the patient elects, other pertinent data, such as personal health
records. In addition, we believe that our recent introduction of our wireless handheld scanner will
make the VeriMed system an important identification tool for EMTs and other emergency personnel
outside the hospital emergency room setting. The components of our system include:
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a glass-encapsulated microchip-equipped transponder, antenna, and capacitor;
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a fixed location, or a wireless handheld, scanner; and
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a secure, web-enabled database containing patient-approved information.
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The microchip used in the VeriMed system is a passive RFID microchip, approximately the size
of a grain of rice, which is implanted under the skin in a patients upper right arm under the
supervision of a physician. The capsule is coated with a polymer, BioBond
TM
to form
adherence to human tissue, thereby preventing migration in the body. Each microchip contains a
unique 16-digit identification number. The identification number can be read by one of our handheld
scanners. When the scanner is placed within a few inches of the microchip, a small amount of radio
frequency energy passes from the scanner, energizing the dormant microchip, which then emits a
radio frequency signal transmitting the identification number. With that identification number,
emergency room personnel or EMTs can securely obtain from our or a third partys database the
patients pre-approved information, including the patients name, primary care physician, emergency
contact information, advance directives and, if the patient elects, other pertinent data, such as
personal health records.
Initially, we anticipate that a patient using the VeriMed system will take responsibility for
inputting all of his or her information into our database, including personal health records, as
physicians offices are not yet typically involved in this process primarily because of liability
concerns and because they are not generally paid for this service. However, in time we envision
that persons using the VeriMed system may prevail upon their physicians to assist them with
the inputting of information for which, by virtue of their medical training, physicians offices are
better equipped to provide. This, in turn, should provide emergency room personnel and EMTs with
greater confidence in the accuracy and completeness of patients personal health records in the
database.
An individual implanted with our microchip whose information is included in our database may
grant access to such information to any of the following categories of persons, at the sole
discretion of the patient:
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public safety personnel, including local police, fire and rescue workers;
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emergency medical personnel, including EMTs and paramedics;
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medical facilities, including hospitals, urgent care centers and physician offices;
and
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law enforcement personnel, including sheriffs departments, state police and the
FBI.
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Unless a patient decides otherwise, such persons will have read-only access to a patients
information.
There are a number of risks associated with our VeriMed business, including without
limitation:
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uncertainty as to whether a market for the VeriMed system will develop and whether
we will be able to generate more than a nominal level of revenue from the sale of such
systems;
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uncertainty as to the future availability of insurance reimbursement for the
microchip implant procedure from government and private insurers;
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a potential disruption in our operations, loss of sales and higher expense in the
event we are unable to obtain the implantable microchip from Digital Angel, our sole
supplier of the microchip, or have to make alternative arrangements for the manufacture
of the microchip;
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our obligation to meet annual minimum purchase requirements in 2008 under our supply
agreement with Digital Angel, as a condition to maintaining the exclusivity of our
supply arrangement, that may exceed our sales of the microchip; and
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possible third-party claims asserting that we hold no rights for the use of the
implantable microchip technology and are violating the third partys intellectual
property rights. If such a claim were successful, we could be enjoined from marketing
this technology and could be required to pay substantial damages.
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For additional information relating to the risks associated with our VeriMed business, see
Item 1A. Risk FactorsRisks Related to Our Businesses Which Utilize the Implantable Microchip.
Our Industrial Systems
Vibration Monitoring Instruments
Our Blastmate and Minimate vibration monitoring instruments provide engineering, construction
and mining professionals with an accurate and efficient means to monitor and document the effects
of human-induced vibrations on neighboring structures in an area where vibration occurs. Government
regulations relating to vibration monitoring require compliance with specified standards to limit
the potential for damage to neighboring structures and to minimize human annoyance that may result
from commercial blasting or heavy construction. Our instruments assist in evaluating the peak
vibration level, which is a key statistic in the prevention of structural damage.
We are in the process of developing and introducing a new instrumentation platform. The new
platform will replace our existing platforms for our vibration monitoring instruments, for which we
are facing certain manufacturing challenges due to the discontinuation and unavailability of key
components. We believe the new platform, when completed, will better integrate with contemporary
data communications protocols so as to improve our products remote monitoring capabilities. In
addition, we expect the new platform will entail the addition of several sensors and peripherals
that will enhance the ability to monitor additional environmental and structural parameters related
to vibration and overpressure monitoring.
We are currently in the process of selling our ToolHound business and expect to exit the
business by mid 2008. The sale of the ToolHound business is not expected to have a material impact
on our financial condition, results of operations or cash flows.
Our Strategy
For the foreseeable future, we expect that our revenue will continue to be derived primarily
from sales of our infant protection and wander prevention systems, which along with our
asset/personnel location and identification system, make up our healthcare security system
offerings, and sales of our vibration monitoring instruments.
Healthcare Security System Offerings
We believe that the global market for infant protection systems, including components of such
systems that are consumable items, is currently growing at a rate of approximately 10-15% per year,
although we consider the U.S. market relatively mature. There are approximately 3,800 birthing
hospitals in the United States. We estimate that infant security systems have been implemented in
approximately half of these facilities. Management estimates
that over 1,300 U.S. hospitals use our infant protection systems. In 2007, we achieved record
sales of our infant protection products. These sales were across all of our product platforms and
multiple geographies, focused in North America. We believe that growth opportunities exist among
the remaining facilities that do not yet have infant protection systems in place, as well as
through replacement of legacy systems. Presently, approximately half of our infant protection
system sales are replacement system sales.
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We estimate that within the United States RFID-type wander prevention systems are currently
installed in approximately 30% of the more than 52,000 nursing homes and assisted living
facilities. While the nursing home segment is considered fairly well penetrated, we believe that
existing and future state regulations, which include security and wander prevention requirements,
applicable to long-term facilities will continue to drive growth in demand for wander prevention
systems for the next several years. Over 200 and 240 of our wander prevention systems were
purchased by long-term care facilities in 2006 and 2007, respectively.
In view of the relative maturity of the markets for our infant protection and wander
prevention systems at least in the United States our growth strategy for these businesses
encompasses the following:
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Market and sell these systems internationally through distribution relationships. We
are only just beginning to penetrate geographic markets outside of North America for
our infant protection and wander prevention systems. In an effort to accelerate this
process, we have entered into distribution agreements with a combination of both local
distributors who have an in-depth knowledge of the relevant geographic region, as well
as larger distributors with a global or near-global reach.
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Leverage our established brand recognition, reseller network and extensive end-use
customer base for our infant protection and wander prevention systems to gain inroads
in the emerging market for asset/personnel location, identification and protection
systems. We intend to leverage our established brand reputation, reseller network and
extensive end-use customer base for our infant protection and wander prevention systems
to gain inroads in the emerging market for RFID location, identification and protection
systems for assets, patients and staff in the healthcare industry. We are in the
process of building out our distribution network for our asset/personnel location and
identification system and providing the requisite training to certain dealers in an
effort to be on the forefront of the emerging market for these systems in the
healthcare sector. We effected a limited commercial launch of our asset/personnel
location and identification system to our dealer channel for this system in the first
quarter of 2007. We believe that it is important for our asset/personnel location and
identification system to capture market share in this emerging market within the next
12-24 months, as we expect that a significant factor in hospitals choice of system
vendors will be referrals to other healthcare facilities that have deployed, and are
pleased with, such systems. To achieve this, we will need to be on the forefront of the
effort to educate the healthcare industry regarding the benefits, including the return
on investment, achievable through implementation of RFID location, identification and
protection systems.
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The VeriMed System and Other Applications for Our Implantable Microchip
We believe that our VeriMed system, which utilizes our implantable microchip, may make a
significant contribution to our revenue in the future. As part of our growth strategy, we are
dedicating the operating cash flows generated by our healthcare security systems and industrial products, as well as a significant portion of the proceeds of our initial public
offering, to our efforts to create markets for the VeriMed system, as well as our other systems
that utilize the implantable microchip.
Healthcare Application
We believe our VeriMed system will prove of use to emergency room personnel and other first
responder medical practitioners in identifying uncommunicative patients and rapidly accessing their
personal health records at the time of initial treatment. The primary target market for our VeriMed
system consists of people who are more likely to require emergency medical care, persons with
cognitive impairment, persons with chronic diseases and related conditions, and persons with
implanted medical devices. According to a study we commissioned by Fletcher
Spaght, Inc. in 2005, there were approximately 45 million patients in the United States alone
who fit this profile. Through use of our VeriMed system, currently a person can be scanned for the
unique, 16-digit identification number on the implanted microchip, enabling access to our VeriMed
Registry and that persons pre-approved information, including the persons name, primary care
physician, emergency contact information, advance directives, and if the person elects, other
pertinent data, such as personal health records. See Item 1A. Risk FactorsRisks Related to Our
Businesses Which Utilize the Implantable Microchip.
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Our sales and marketing strategy for our VeriMed system is to contemporaneously market our
system to hospitals, hospital networks, third-party emergency department management companies and
nursing homes, as well as to physicians who treat at-risk patients: persons with diabetes, cancer,
coronary heart disease, chronic obstructive pulmonary disease, cerebrovascular disease (stroke),
congestive heart failure, Alzheimers, epilepsy and other diseases or conditions, including persons
with implanted medical devices. This approach is intended to accelerate the adoption of the VeriMed
system by healthcare facilities, as well as by physicians and patients.
In the initial phase of our efforts to create a market for the VeriMed system, we have focused
on getting hospitals and third-party emergency room management companies to adopt the VeriMed
system protocol in their emergency rooms. This focus reflects our recognition that physicians who
treat patients within our target market may be disinclined to discuss with their patients, and
patients may not be persuaded by, the benefits of the VeriMed system in the absence of some or all
of the hospital emergency rooms in their immediate geographic area having become part of our
network. To build out our network, we have been providing our scanners, at no charge, to hospitals
and third-party emergency room companies. As of December 31, 2007, more than 200 hospitals and
other medical facilities have adopted our VeriMed system protocol in their emergency rooms. The
facilities that have adopted the VeriMed protocol have received training in the use of our system
and, as part of the standard protocol, are scanning patients who arrive in their emergency rooms
unconscious, confused or unable to communicate. We expect to continue this seeding process for
the foreseeable future, as we endeavor to build out the network across the United States and
overseas.
Physicians whose patients fit within our target market are the focus of the second phase of
our commercialization efforts. At present, our sales and marketing strategy for physicians who
treat patients who fit the profile for which our VeriMed system is intended to benefit includes
using our sales force to directly market to and educate such physicians in those geographic regions
surrounding hospitals that have adopted the VeriMed system as part of their standard protocol. We
are distributing marketing materials, such as brochures and posters, intended to be displayed in
physicians offices. Our focus on physicians reflects our belief that, as with all medical
treatments and procedures, it is the physician who is responsible for discussing and recommending a
particular course of action, knowing the particular circumstances of the individual patient.
As
of March 17, 2008, 616 people have received our VeriMed microchip and have enrolled in the
VeriMed patient registry, of which 108 have enrolled as paying subscribers. We attribute the modest
number of people who have undergone the microchip implant procedure to a number of factors:
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A lack of direct to consumer advertising to educate the patient population to the
benefits of the VeriMed system.
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Many people who fit the profile for which the VeriMed system was designed may not be
willing to have a microchip implanted in their upper right arms.
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Physicians may be reluctant to discuss the implant procedure with their patients
until a greater number of hospital emergency rooms have adopted the VeriMed system as
part of their standard protocol.
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The media has from time to time reported, and may continue to report, on the VeriMed
system in an unfavorable and, on occasion, an inaccurate manner. For example, there
have been articles published asserting, despite at least one study to the contrary,
that the implanted microchip is not MRI compatible. There have also been articles
published asserting, despite numerous studies to the contrary, that the implanted
microchip causes malignant tumor formation in animals.
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Privacy concerns may influence individuals to refrain from undergoing the implant
procedure or dissuade physicians from recommending the VeriMed system to their
patients. Misperceptions that a microchip-implanted person can be tracked and that
the microchip itself contains a persons basic information and personal health records
may contribute to such concerns.
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Misperceptions and/or negative publicity may prompt legislative or administrative
efforts by politicians or groups opposed to the development and use of
human-implantable RFID microchips. In that regard, in 2006 and 2007, a number of states
have introduced, and at least three states have enacted, legislation that would
prohibit any requirement that an individual undergo a microchip-implant procedure.
While we support all pending and enacted legislation that would preclude anything other
than voluntary implantation, legislative bodies or government agencies may determine to
go further, and their actions may have the effect, directly or indirectly, of delaying,
limiting or preventing the use of human-implantable RFID microchips or the sale,
manufacture or use of RFID systems utilizing such microchips.
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At present, the cost of the microchip implant procedure is not covered by Medicare,
Medicaid or private health insurance.
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At present, no studies to assess the impact of the VeriMed system on the quality of
emergency department care have been completed and publicly released.
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With respect to the last two factors listed above, we are in the process of facilitating and,
in one case, funding clinical studies that we believe may demonstrate the efficacy of the VeriMed
system. We believe that once this is established, government and private insurers may be more
likely to cover the cost of the microchip implant process. In any event, these studies are likely
to be of considerable interest to physicians who treat at-risk patients.
In June 2006, we began a study with Horizon Blue Cross Blue Shield of New Jersey, the largest
health insurer in the State of New Jersey (Horizon BCBSNJ), the Hackensack University Medical
Center Independent Physicians Association (IPA) and the Hackensack University Medical Center, under
which Hackensack University Medical Center and its physicians have the right to test the VeriMed
system over a period of approximately two years. Together with BCBSNJ, we have enrolled in the
study 30 members of Horizon BCBSNJ who were treated for an episode of care by a Hackensack IPA
physician between January 1, 2004 and December 31, 2006. Each participant in the program is to be
tested for a period of two years after receiving the microchip implant. The objective of this
clinical study is to assess the impact of the VeriMed system on emergency department care provided
to patients with specified chronic medical conditions. This will include an assessment of: the
insertion technique; patient data selection and input; staff acceptance and use of the technology;
frequency of database access; the time involved for information gathering with current methods
compared to the VeriMed System; the impact of the VeriMed system on clinical presentation and
treatment; and the functionality of the VeriMed system in an application environment.
The Institutional Review Board approved a clinical study to be performed by the American
Medical Directors Association (AMDA) to assess the efficacy of the VeriMed system in improving
patient outcomes and improving access to patient medical information while patients are in route to
emergency rooms from long-term care facilities, both skilled nursing facilities and assisted living
facilities. The proposed study would involve 10 facilities, either skilled nursing facilities or
assisted living facilities, with an estimated study population of 100 people. The inclusion
criteria for the study participants would include being age 65 or above and having two or more of
the following conditions: dementia, stroke, diabetes, chronic obstructive pulmonary disease,
congestive heart failure, coronary heart disease and epilepsy. No patient or third party will be
billed for use of the VeriMed system during the study. This study is scheduled to begin in first
half of 2008.
14
In early 2007, we entered into a partnership with Alzheimers Community Care, or ACC, of West
Palm Beach, Florida, in which VeriChip and ACC will conduct a study of the effectiveness of the
VeriMed Patient Identification System in managing the records of Alzheimers patients and their
caregivers. In the two-year, 200 patient study, participating individuals suffering from
Alzheimers disease and other forms of dementia, as well as their caregivers, would receive the
VeriMed implantable microchip to provide emergency department staff easy
access to those patients identification and medical information. Alzheimers disease is one
of several medical conditions we identify as being ideally suited for the benefits of the VeriMed
system since individuals with the disease or other forms of dementia are often unable to give
necessary identifying information or critical medical history upon being admitted to a hospital.
ACC also believes it is important for caregivers to obtain the implantable VeriMed. If a caregiver
becomes ill, the VeriMed database will inform medical personnel that he or she is the caregiver for
someone unable to care for themselves. All participants in the study will be voluntary. The legally
designated responsible party of an Alzheimers patient unable to make medical decisions must give
permission for the patient to participate. As of December 31, 2007, more than 100 patients and
caregivers have received the VeriMed microchip as part of this study.
In July 2007, Christiana Care Health Services in Newark, Delaware, commenced a prospective
randomized, controlled study to analyze the effectiveness of the VeriMed system as a personal and
emergency medical heath record system in a disaster scenario. Christiana Hospital randomly
selected 100 patient charts based on the profile of the target population, removing all identifying
information of the patient, and divided such charts into two groups of fifty. Each chart in the
first group was assigned one of our active microchips. The patient data was entered into the
VeriMed database and associated with an active microchip. The second group consisted of fifty
placebo or inactivated microchips. Simulating a multi-casualty traumatic event, the activated
and inactivated microchips and related charts were distributed among teams of emergency physicians
and nurses. Using the VeriMed scanner, the teams scanned each chart as is protocol during
triage. If the team received a chart associated with a microchip that was activated, they accessed
the patients medical data through the VeriMed Registry. If the microchip was not activated, the
team only had access to the given synopsis, which may include the corresponding chart depending on
the synopsis (e.g., if the patient is conscious to give a history). Once the results are analyzed,
we believe that this study will support our position that the VeriMed system improves the quality
of care, decreases the cost of treatment and rapidly and accurately identifies people who are
unconscious, confused or unable to communicate at the time of medical treatment. The results of
this study are expected to be published by the summer of 2008.
We believe that if the results of these and other clinical studies that may be undertaken are
sufficiently compelling, the Center for Medicare and Medicaid Services may determine that the
VeriMed microchip implant procedure is reimbursable under Medicare and Medicaid. If this were to
occur, we believe many private insurers would follow suit. We can provide no assurance as to if and
when government or private insurers will decide to take such action. It may take a considerable
period of time for this to occur, if, in fact, it does occur. If government and private insurers do
not determine to reimburse the cost of the implant procedure, we would not expect to realize the
currently anticipated level of sales of our implantable microchip and the database subscription
fees.
We are also in the process of seeking endorsements of the VeriMed system from patient advocacy
groups, which we believe would greatly enhance our efforts to reach out directly to at-risk
patients. We are also seeking to develop physician champions to serve as spokespersons for the
VeriMed system.
Beginning in 2008 we plan to begin a direct to consumer advertising campaign, to educate
consumers as to the benefits of the VeriMed system and to direct them to our customer support
center and healthcare store fronts that we will co-locate with a healthcare provider partner. This
campaign will begin in South Florida where our infrastructure of VeriMed adopted hospitals is
strongest and upon success in South Florida will be replicated in additional geographies based on
the strength of our infrastructure in those geographies and consumer demographics.
Other Applications
We have also developed another system that utilizes the implantable microchip, our VeriTrace
system.
Our VeriTrace system was conceived of in the wake of Hurricane Katrina, when we donated
implantable microchips to FEMAs Department of Mortuary Services in Mississippi and Louisiana to
help with FEMAs efforts to identify corpses. Our implantable microchips were used to provide an
end-to-end tagging solution for the accurate tracking and identification of human remains and
associated evidentiary items. We began limited marketing of our VeriTrace system in 2006.
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Industrial System Offerings
We perceive the market for vibration monitoring instruments, like that for our healthcare
security system offerings, to be of limited size and growth potential. Our primary strategy to grow
this business is through the continued support of our large installed base of customers and the
introduction of a new instrumentation platform. We believe that the new platform, when completed,
will better integrate with contemporary data communications protocols so as to improve our
products remote monitoring capabilities and will make several sensors and peripherals that will
enhance the ability to monitor additional environmental and structural parameters related to
vibration and overpressure monitoring. We expect that the new platform will enable us to expand our
sales by selling products to new as well as existing customers at higher price points resulting in
greater revenues.
Technology
Active Tags and Readers
Our infant protection, wander prevention, emergency response and asset/personnel location and
identification systems all make use of active RFID tags, enabling the systems to be used for
perimeter control, tamper notification, location and tracking purposes. These active tags include
an internal lithium battery enabling them to transmit a coded radio frequency beacon on a continual
or intermittent basis. The beacon has a reliable range of approximately 30 to 50 feet indoors and
up to 100 feet outdoors. Multiple receivers with radio frequency antennas are placed in selected
locations throughout a facility to receive coded beacon messages from these active tags. All
receivers in range of a particular tag decode the message and send the received information to a
central server. The received tag information is used for multiple purposes across the range of
applications, including to provide supervisory alerts when tag messages are missing and to provide
tag positional location by triangulation and other context sensing algorithms.
In addition, many of our active tags include a tamper detection feature to prevent
unauthorized removal, enhancing the security features of our systems. This includes our proprietary
skin-sensing and cut band technologies used with our infant protection tags, as well as our
proprietary tamper-proof asset tag used in our asset/personnel location and identification system.
Technology Platform/Application Software
We are in the process of interfacing our technology platform with other location technologies.
The first interface we have completed is with WiFi. This has been done to illustrate the platforms
flexibility to interface to other wireless air interfaces and perform an even higher level of
system integration that collects location-based information. In addition, the platform can
interface with other vertically integrated systems for work flow management within the healthcare
industry. In such cases, the platform serves as the RFID engine, processing data from third-party
software applications. This capability makes the platform more flexible, scalable and expandable.
Research and Development
Our research and development group consists of 30 staff members, currently based in Ottawa,
Canada. These employees are responsible for the development of hardware, software and the
mechanical design of our systems. Further enhancements to our current systems and the development
of new systems are important components of our ability to remain competitive in our marketplace.
Intellectual Property
We rely on a combination of patents, copyrights, trade secrets (including know-how), employee
intellectual property agreements and third-party agreements to establish and protect proprietary
rights in our products.
16
Our patent portfolio consists of patents issued in the United States and patents issued in
Canada, including the following:
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U.S. Patent No. 6,144,303, Tag and System for Patient Safety Monitoring, applies
to infant protection tags that sense when they are in contact with the skin. The tag
can generate an alarm when it is removed. The U.S. patent expires in 2019. The
corresponding issued patent in Canada is Canadian Patent No. 2,260,577, which expires
in 2019.
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U.S. Patent No. 5,977,877, Multiple Conductor Security Tag, which is licensed from
BI Incorporated, applies to tags attached with bands that can detect unauthorized
cutting of a band attached to a person or object. This patent expires in 2018.
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U.S. Patent No. 5,374,921, Fiber Optic Security and Communications Link applies to
security tags with an optical fiber in the band to detect unauthorized removal. This
patent expires in 2011. The corresponding issued patent in Canada is Canadian Patent
No. 2,055,266, which expires in 2011.
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U.S. Patent No. 6,137,414, Asset Security Tag, applies to asset protection tags
that can generate an alarm if the asset to which it is attached (such as a piece of
hospital equipment) is moved to an unauthorized area or if the tag is removed without
authorization. This patent expires in 2019.
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U.S. Patent No. 6,456,191, Tag System with Anti-Collision Features, applies to
RFID tags with communication features that allow communications with multiple tags in
close proximity to one another. The U.S. patent expires in 2019. The corresponding
issued patent in Canada is Canadian Patent No. 2,266,337, which expires in 2019.
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U.S. Patent No. 7,116,230, Asset Location System, applies to an RFID tagging
system that utilizes a portable receiver, instead of a network of fixed receivers, to
track, analyze and prioritize information on the location of tagged assets within a
building or warehouse. This patent expires in 2025.
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The technology covered by the above-listed patents is widely used in our healthcare security
systems.
In addition to the patents described above, we have a license from Digital Angel under U.S.
Patent No. 5,952,935, Programmable Channel Search Reader, which applies to RFID tag readers that
are capable of reading different kinds of RFID tags with differing communications protocols. The
patent expires on May 3, 2016. We also have a license from BI Incorporated under U.S. Patent No.
4,952,913, Tag for Use with Personnel Monitoring System, which applies to tags, for individuals,
that sense and report tampering. The patent expires in December 2009. This patented technology is
used in our Hugs infant protection system.
We purchase the implantable microchip from Digital Angel under the terms of an amended and
restated supply agreement. The supply agreement is discussed in Item 1. Business Manufacturing;
Supply Arrangements. Digital Angel, in turn, obtains the implantable microchip, a component of the
VeriMed system, 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 we refer 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 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. 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. 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 us.
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 us asserting that we are violating its rights.
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Our employees, consultants and advisors are required to enter into confidentiality agreements
that prohibit the disclosure or use of our confidential and proprietary information. We also have
entered into confidentiality agreements to protect our confidential information delivered to third
parties. Our RFID tag designs benefit from confidential know-how we have developed through
experience. Our middleware product that is a component of our technology platform for our
healthcare security applications, as well as other software products, are protected by copyright
and trade secret rights.
We are seeking registration of our VeriChip and VeriMed trade names in various product markets
in the United States and elsewhere in the world. However, in June 2004, VeriSign, Inc. filed
oppositions with the U.S. Patent and Trademark Office, objecting to our registration of the
VeriChip trade name and our trademarks that begin with the Veri prefix. We and VeriSign are
seeking to amicably resolve the opposition proceeding. Settlement negotiations are ongoing;
however, the proceeding is currently active, and we served further discovery to VeriSign on January
3, 2008 to obtain information that will be relevant to any settlement. In the event an amicable
resolution is not reached and VeriSign is successful in the opposition proceedings, our
applications to register VeriChip and other Veri- marks will be refused. It is also possible that
VeriSign could bring a court action seeking to enjoin our use of VeriChip and the other Veri-
marks and/or seek monetary damages from our use of these marks. If VeriSign were to bring a court
action and prevail in that action, we may be required to re-name our Company and re-brand some of
our products, such as VeriChip, VeriMed and VeriTrace, as well as to possibly pay damages to
VeriSign for our use of any trademarks found to have been confusingly similar to those of VeriSign.
Despite our efforts to protect our intellectual property rights, it may be possible for
unauthorized third parties to copy portions of our products or to reverse engineer or otherwise
obtain and use some technology and information that we regard as proprietary. Our reliance on
intellectual property rights is subject to a number of risks. See Item 1A. Risk Factors.
Sales, Marketing and Distribution
Our end-use customers consist of healthcare facilities, such as hospitals and long-term care
facilities, healthcare professionals, such as physicians, individual patients, and other customers
that purchase our systems for non-healthcare applications, such as construction, oil and gas
companies.
Our sales and marketing strategy is to sell our systems through multiple channels. However, to
date we have sold essentially all of our active RFID systems through dealers. Most of our largest
dealers, by volume of systems sold, are focused exclusively or primarily on the healthcare
industry. As of December 31, 2007, our sales staff consists of a total of 19 people, based
primarily in Ottawa, Canada and at our corporate headquarters in Florida. We have a limited number
of medical device representatives strategically located in other places in North America, where we
have a number of hospitals that have adopted our VeriMed system.
In general, the terms of our dealer agreements for our healthcare security systems obligate
our dealers to provide us with reports, on a monthly basis, regarding information such as:
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sales and inventory levels for the preceding month;
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sales analyses within the dealers territories;
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forecasts for future sales on a rolling one month, three month and annual basis; and
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service and support activity.
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We use these reports, among other things, to effectively plan our inventory levels, manage
dealer performance against sales targets, identify and resolve channel conflicts, and manage our
customer support.
We market our systems primarily by attending trade shows and medical conferences and by
advertising in publications.
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Our Healthcare Security Systems
Infant Protection/Wander Prevention
We currently sell our infant protection and wander prevention systems through dealers. These
dealers are typically appointed, on a non-exclusive basis, to cover a specific geographic sales
territory. The term of such appointment is generally for one year, but subject to automatic renewal
from year-to-year in the absence of a termination by us or the dealer. In general, our agreements
with our dealers impose no minimum purchase requirements. Some of our dealer agreements include
price protection provisions, under which we undertake not to charge the dealer prices higher than
the best price we are offering our systems to any of our other dealers.
Our dealers of our infant protection and wander prevention systems have responsibility for the
installation and after-sale servicing and maintenance of such systems. System installation requires
relationships with cable companies, knowledge of the other products that need to be integrated with
our hardware and knowledge of local codes. To ensure that our systems are installed in accordance
with our standards, we have established a distribution technical training and certification
program. In addition to system installation, our dealers provide end-use customers with post-sale
customer service and system maintenance.
Asset/Personnel Location and Identification System
Through March 17, 2008, a limited number of our asset/personnel location and identification
systems have been sold and installed. Those systems were sold primarily through two dealers on a
private label basis. We are in the process of building out our distribution network for our
asset/personnel location and identification system and providing the requisite training to certain
dealers in an effort to be at the forefront of the emerging market for such systems in the
healthcare sector. We effected a limited commercial launch of our asset/personnel location and
identification system to our dealer channel for this system in 2007.
Our VeriMed System
As of December 31, 2007, our marketing efforts with respect to our VeriMed system have been to
provide our scanners to hospitals and third-party emergency room management companies at no charge
in order to build out the geographic footprint of the healthcare facilities that can and will use
our VeriMed system as part of their standard protocol. We expect to continue this seeding process
for the foreseeable future as we endeavor to build out our network across the United States and
overseas. In addition, we have been marketing our VeriMed system to physicians, who treat patients
who fit the profile for which our VeriMed system is intended to benefit, in those geographic areas
surrounding hospitals that have adopted the VeriMed system. In the future we expect to utilize
dealer arrangements to allow us to more widely distribute the VeriMed system and the microchip
insertion kits.
Beginning in 2008 we plan to begin a direct to consumer advertising campaign, to educate
consumers as to the benefits of the VeriMed system and to direct them to our customer support
center and healthcare store fronts that we will co-locate with a healthcare provider partner. This
campaign will begin in South Florida where our infrastructure of VeriMed adopted hospitals is
strongest and upon success in South Florida will be replicated in additional geographies based on
the strength of our infrastructure in those geographies and consumer demographics.
Our Industrial Systems
Vibration Monitoring Instruments
We distribute our Blastmate and Minimate systems to engineering, construction and mining
professionals through an independent network consisting of approximately 85 dealers, approximately
35 of which operate in North America.
Competition
Most of our systems utilize RFID technologies. While certain of our competitors in certain of
our system applications also sell products that use RFID technologies, some sell products that
incorporate other technologies, such as high frequency radio signals, or WiFi, barcode technology
and biometric technology. With respect to the healthcare industry in particular, we are unable to
predict which technology will be most widely adopted in the future. In addition, some of our
current competitors, as well as companies who utilize RFID technologies in applications outside of
our target markets, have significantly greater financial, marketing and product development
resources than we do. Low barriers to entry across most of our product lines may result in new
competitors entering
the markets we serve. Also, our competitors may be able to respond more quickly to new or
improved technologies by devoting greater resources to the development, promotion and sale of
products. We expect our competitors to continue to improve the performance of and support for their
current products. We also expect that, like us, they will introduce new products, technologies or
services. Our competitors new or upgraded products could adversely affect sales of our current and
future products.
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With respect to our infant protection and wander prevention systems, several other companies
offer solutions for these applications, including Visonic Technologies, RF Technologies, Innovative
Control Systems and Senior Technologies. We believe that competition in these markets is mainly
based on product features, reputation, including endorsements by other healthcare facilities, and
brand awareness.
With respect to our VeriMed system, we do not believe any other company currently offers a
human implantable microchip-based patient identification system. Various alternative patient
identification solutions are currently available, such as bracelets sold by MedicAlert, health
information wallet cards, biometric systems and key fobs that store personal health records. We are
currently in the process of seeking to create a market for our VeriMed system, and our competitive
position in this market will depend on whether hospitals and other healthcare providers accept this
new technology and incorporate it into their standard protocol. Our competitive position will also
depend on whether patients prefer our VeriMed system to existing or future identification systems,
as well as whether the implant process becomes subject to reimbursement by government and private
insurers.
With respect to the other systems we offer, we believe that competition is mainly based on
product performance and ease of use, purchase price and operating cost. We believe that our systems
are designed and manufactured to compete favorably based on these criteria with competitive systems
currently in the market.
Manufacturing; Supply Arrangements
We outsource the manufacturing of all the hardware components of our active RFID systems to
third-party contractors, but conduct final assembly, testing and quality control functions
internally. To date, we have not had material difficulties obtaining system components. Except as
discussed below, we believe that if any of our manufacturers or suppliers were to cease supplying
us with system components, we would be able to procure alternative sources without material
disruption to our business.
We source the custom straps used with our Hugs infant protection systems from a sole supplier,
Emerson & Cuming Microwave Products. Emerson & Cuming manufactures the straps at a single facility
located in New England, although it operates another facility in Belgium from which the straps
could be manufactured. While we and our dealers maintain excess inventory to ensure that we
maintain an adequate supply of the straps, we believe it would take several months to make
alternative arrangements should we be unable to source these custom straps from Emerson & Cuming.
Under the agreement with Emerson & Cuming, we are subject to minimum purchase requirements, with
the aggregate amount of our minimum purchase requirements being $4 million over the next five
years.
We and a wholly-owned subsidiary of Digital Angel are parties to an agreement dated December
27, 2005, as amended, pursuant to which Digital Angel supplies us with the implantable microchips,
readers, other products, and the underlying technology relating to the microchip, for use in secure
implantable human applications. The microchip and the related underlying technology are used in our
VeriMed and VeriTrace systems. Digital Angel is our sole supplier of the implantable microchips,
which it obtains from Raytheon Microelectronics España, a subsidiary of Raytheon Company, or RME,
under the terms of a separate supply agreement as discussed below. The following is a summary of
the principal terms of our amended and restated supply agreement with Digital Angel:
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Digital Angel has agreed to sell to us and our resellers, on an exclusive basis, the
transponders and reader equipment for our VeriMed system, as well any upgrades,
enhancements and improvements, which are to be used for the primary purpose of secure
human identification. Digital Angel has committed not to sell these products to any
other party if Digital Angel knows or should know that such products are to be used
principally for secure identification applications.
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Digital Angel has committed to use its best efforts to supply all of our
requirements for the transponders and reader equipment as and when required. However,
if Digital Angel is unable or unwilling to meet our requirements, we may obtain
additional suppliers and Digital Angel is obligated to permit the use of the underlying
intellectual property for that purpose. We also have the right to design and build, or
cause to be designed and built, and sell, our own readers, to be used for human
applications only, and Digital Angel has granted to us a fully-paid, royalty-free,
non-exclusive license to utilize one of its patents for that purpose.
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Digital Angel may not supply human implantable microchips to other parties if we
meet certain minimum purchase requirements, specifically: $0 in 2007; $0.9 million in
2008 less purchases made in 2006 and 2007; $1.8 million in 2009; $2.5 million in 2010;
and $3.8 million in each year thereafter, subject to the parties reaching agreement on
a different amount. If during any year we purchase in excess of the minimum purchase
requirement for that year, the excess will be credited against the minimum purchase
requirement for the following year or years. We purchased $0.4 million and nil of
implantable microchips from Digital Angel in 2006 and 2007, respectively.
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In the event a competitor makes, uses, sells or offers any similar product or
service, the price we are required to pay for products is subject to downward
adjustment to enable us to more effectively compete.
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The term of the agreement ends on March 4, 2014, subject to earlier termination in
the event of either partys default or bankruptcy. However, so long as we meet the
minimum purchase obligations under the agreement, the term is to be automatically
renewed on an annual basis until the expiration of the last of the patents covering any
of the supplied products.
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If we desire to have a third party manufacture any of the products, product
upgrades, enhancements or improvements, or any new products for reasons other than
Digital Angels inability or unwillingness to supply us we have the right to do so.
In such event, we are obligated to pay Digital Angel a royalty on each product
manufactured by third parties that would otherwise infringe Digital Angels underlying
intellectual property rights.
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Our implantable microchip is manufactured for Digital Angel by RME under the terms of a supply
agreement between Digital Angel and RME. The term of that agreement ends on June 30, 2010, subject
to earlier termination by either party if, among other things, the other party breaches the
agreement and does not remedy the breach within 30 days of receiving notice. Under the agreement,
RME is Digital Angels preferred supplier of the glass encapsulated, syringe-implantable
transponders, provided that RMEs pricing remains market competitive. Certain of the automated
equipment and tooling used in the production of the transponders is owned by Digital Angel; other
automated equipment and tooling is owned by RME. It would be difficult and time-consuming for
Digital Angel to arrange for production of the transponders by a third party. Accordingly, we
cannot assure you that we will be able to procure alternative manufacturing capability if we are
unable to obtain the implantable microchip from Digital Angel or if Digital Angel is unable to
obtain it from RME or another supplier.
Environmental Regulation
We must comply with local, state, federal, and international environmental laws and
regulations in the countries in which we do business, including laws and regulations governing the
management and disposal of hazardous substances and wastes. We expect our operations and products
will be affected by future environmental laws and regulations, but we cannot predict the effects of
any such future laws and regulations at this time. Our distributors who place our products on the
market in the European Union are required to comply with EU Directive 2002/96/EC on waste
electrical and electronic equipment, known as the WEEE Directive. Noncompliance by our distributors
with EU Directive 2002/96/EC may adversely affect the success of our business in that market.
Additionally, we are investigating the applicability of EU Directive 2002/95/EC on the restriction
of the use of certain hazardous substances in electrical and electronic equipment, known as the
RoHS Directive which took effect on July 1, 2006. We do not expect the RoHS Directive will have a
significant impact on our business.
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Government Regulation
Laws and Regulations Pertaining to RFID Technologies
Our active RFID systems, as well as our RFID systems that use our implantable microchip, rely
on low-power, localized use of radio frequency spectrum to operate. As a result, we must comply
with U.S. Federal Communications Commission, or FCC, and Industry Canada regulations, as well as
the laws and regulations of other jurisdictions where we sell our products, governing the design,
testing, marketing, operation and sale of RFID devices. Accordingly, all of our products and
systems have a paired FCC and Industry Canada equipment authorization.
U.S. Federal Communications Commission Regulations
Under FCC regulations and Section 302 of the Communications Act, RFID devices, including those
we market and sell, must be authorized and comply with all applicable technical standards and
labeling requirements prior to being marketed in the United States. The FCCs rules prescribe
technical, operational and design requirements for devices that operate on the electromagnetic
spectrum at very low powers. The rules ensure that such devices do not cause interference to
licensed spectrum services, mislead consumers regarding their operational capabilities or produce
emissions that are harmful to human health. Our RFID devices are intentional radiators, as defined
in the FCCs rules. As such, our devices may not cause harmful interference to licensed services
and must accept any interference received. We must construct all equipment in accordance with good
engineering design as well as manufacturers practices.
Manufacturers of RFID devices must submit testing results and/or other technical information
demonstrating compliance with the FCCs rules in the form of an application for equipment
authorization. The FCC processes each application when it is in a form acceptable for filing and,
upon grant, issues an equipment identification number. Each of our RFID devices must bear a label
which displays the equipment authorization number, as well as specific language set forth in the
FCCs rules. In addition, each device must include a user manual cautioning users that changes or
modifications not expressly approved by the manufacturer could void the equipment authorization. As
a condition of each FCC equipment authorization, we warrant that each of our devices marked under
the grant and bearing the grant identifier will conform to all the technical and operational
measurements submitted with the application. RFID devices used and/or sold in interstate commerce
must meet these requirements or the equipment authorization may be revoked, the devices may be
seized and a forfeiture may be assessed against the equipment authorization grantee. The FCC
requires all holders of equipment authorizations to maintain a copy of each authorization together
with all supporting documentation and make these records available for FCC inspection upon request.
The FCC may also conduct periodic sampling tests of equipment to ensure compliance. We believe we
are in substantial compliance with all FCC requirements applicable to our products and systems.
Industry Canada Regulations
Industry Canada regulates the design, sale and use of radio communications devices in
accordance with its Radio Standards Specifications, or RSS, and Radio Standards Procedures, or RSP.
As intentional emitters, our RFID devices are subject to Industry Canadas RSP-100, which
establishes the procedures by which RFID communications equipment receives certification by
Industry Canada. The RSP-100 certification procedure and RSS standards ensure that RFID radio
devices do not cause interference to licensed spectrum services and that the devices do not produce
emissions that are harmful to human health.
Manufacturers of RFID devices must demonstrate compliance with RSP-100 and RSS-210. Industry
Canada requires manufacturers of RFID devices to file an application and agreement for
certification of services. A manufacturer of active RFID equipment must submit testing results
and/or other technical information demonstrating compliance with RSS-210 along with the
manufacturers application. Industry Canadas Certification and Engineering Bureau processes the
application and, upon grant, issues a unique certification/registration number, which is required
to be displayed on each certified piece of equipment. In addition, in accordance with RSS-Gen, the
following information must appear on any radio frequency device: the certification/registration
number; the manufacturers name, trade name or brand name; and the model name or number.
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Each RFID device must include a user manual. The user manual must identify that the radio
frequency device operates on a no interference, no protection basis, meaning that the device may
not cause radio interference and cannot claim protection from interference. Radio frequency devices
that do not meet the certification, labeling and user manual provision requirements and are sold
within or between the Canadian territories/provinces are subject to penalty by Industry Canada,
which may include seizure of the devices and/or assessment of forfeitures. Industry Canada will
also conduct audit checks, from time to time, to ensure compliance. We believe we are in
substantial compliance with all Industry Canada requirements applicable to our products and
systems.
Regulation by the FDA
Our VeriMed microchip is a medical device subject to regulation by the FDA, as well as other
federal and state regulatory bodies in the United States and comparable authorities in other
countries. In October 2004, the VeriMed system received classification as a Class II medical device
by the FDA for patient identification and health information purposes. The FDA also permits us to
market and sell the VeriMed system in the United States.
FDA Premarket Clearance and Approval Requirements
. Generally speaking, unless an exemption
applies, each medical device we wish to distribute commercially in the United States will require
either prior clearance under Section 510(k) of the Federal Food, Drug, and Cosmetic Act, or FFDCA,
or a premarket approval application, or PMA, from the FDA. Medical devices are classified into one
of three classes Class I, Class II or Class III depending on the degree of risk to the patient
associated with the medical device and the extent of control needed to ensure safety and
effectiveness. Devices deemed to pose lower risks are placed in either Class I or II. The
manufacturer of a Class II device is typically required to submit to the FDA a premarket
notification requesting permission to commercially distribute the device and demonstrating that the
proposed device is substantially equivalent to a previously cleared and legally marketed 510(k)
device or a device that was in commercial distribution before May 28, 1976 for which the FDA has
not yet called for the submission of a PMA. This process is known as 510(k) clearance. Devices
deemed by the FDA to pose the greatest risk, such as life-sustaining, life-supporting implantable
devices, or devices deemed not substantially equivalent to a previously cleared 510(k) device, are
generally placed in Class III, requiring premarket approval.
In October 2004, we received classification of our VeriMed system as a Class II device. In
granting this classification, the FDA created a new device category for implantable radiofrequency
transponder systems for patient identification and health information. The FDA also determined
that devices that meet this description will be exempt from 510(k) premarket clearance so long as
they comply with the FFDCA, its implementing regulations and the provisions of an FDA guidance
document issued by the FDA in December 2004, entitled
Guidance for Industry and FDA Staff, Class
II Special Controls Guidance Document: Implantable Radiofrequency Transponder System for Patient
Identification and Health Information
, that establishes special controls for this type of device.
The special controls, which are intended to ensure that the device is safe and effective for its
intended use, include the following: biocompatibility testing, information security procedures,
performance standard verification, software validation, electro-magnetic compatibility and
sterility testing. We believe that we are in compliance with FFDCA, its implementing regulations
and the December 2004 guidance document. Similarly, a company that wishes to market products that
will compete with the VeriMed system will not be required to submit a 510(k) premarket clearance
application to the FDA if they comply with the requirements of the special controls guidance document
as well as a full spectrum of FDA regulations, described more fully below.
In January, 2007, the FDA published a Draft Guidance entitled
Radio-Frequency Wireless
Technology in Medical Devices.
This document includes the FDAs current recommendations regarding
specific risks and limitations to be considered when developing and implementing a Quality System
for medical devices using radio frequency wireless technology, as well as additional information to
be included in the labeling for such devices. We believe our Quality System and labeling for our
VeriMed System meet the recommendations outlined in the draft guidance.
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Pervasive and Continuing Regulation
. After a medical device is placed on the market, numerous
regulatory requirements continue to apply. These include:
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quality system regulations, or QSR, which require manufacturers, including
third-party manufacturers, to follow stringent design, testing, control, documentation
and other quality assurance procedures during all aspects of the manufacturing process;
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labeling regulations and FDA prohibitions against the promotion of regulated
products for uncleared, unapproved or off-label uses;
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clearance or approval of product modifications that could significantly affect
safety or effectiveness or that would constitute a major change in intended use;
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medical device reporting, or MDR, regulations, which require that a manufacturer
report to the FDA if the manufacturers device may have caused or contributed to a
death or serious injury or malfunctioned in a way that would likely cause or contribute
to a death or serious injury if the malfunction were to recur; and
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post-market surveillance regulations, which apply when necessary to protect the
public health or to provide additional safety and effectiveness data for the device.
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Our manufacturer, Digital Angel, has registered with the FDA as a medical device manufacturer.
The FDA has broad post-market and regulatory enforcement powers. We are subject to unannounced
inspections by the FDA to determine our compliance with the QSR and other regulations, and these
inspections may include the manufacturing facilities of our suppliers. The Digital Angel
manufacturing facility located in St. Paul, Minnesota, was inspected by the FDA in late May and
early June 2006, during which the FDA inspector conducted a routine Level II Quality System
Inspectional Technique inspection. During the inspection, the FDA inspector made three verbal
observations regarding deviations in Digital Angels quality system unrelated to our implantable
microchip. It is our understanding that Digital Angel has corrected the three deviations. To our
knowledge, the Raytheon Microelectronics España facility has not yet been inspected by the FDA.
Failure to comply with applicable regulatory requirements can result in enforcement action by
the FDA, which may include any of the following sanctions:
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FDA Form 483s, warning letters, fines, injunctions, consent decrees and civil
penalties;
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repair, replacement, refunds, recall or seizure of products;
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operating restrictions, partial suspension or total shutdown of production;
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refusing requests for 510(k) clearance or premarket approval of new products, new
intended uses or modifications to existing products;
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withdrawing 510(k) clearance or premarket approvals that have already been granted;
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Fraud and Abuse
We are subject to various federal and state laws pertaining to healthcare fraud and abuse,
including anti-kickback laws and false claims laws. Violations of these laws are punishable by
criminal and/or civil sanctions, including, in some instances, imprisonment and exclusion from
participation in federal and state healthcare programs, including Medicare, Medicaid and Veterans
Affairs health programs. We have never been challenged by a government authority under any of these
laws and believe that our operations are in material compliance with such laws. However, because of
the far-reaching nature of these laws, there can be no assurance that we would not be required to
alter one or more of our practices to be in compliance with these laws. In addition, there can be
no assurance that the occurrence of one or more violations of these laws would not result in a
material adverse effect on our financial condition and results of operations.
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Anti-Kickback Laws
We may directly or indirectly be subject to various federal and state laws pertaining to
healthcare fraud and abuse, including anti-kickback laws. In particular, the federal healthcare
program Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting, offering,
receiving or providing remuneration, directly or indirectly, in exchange for or to induce either
the referral of an individual, or the furnishing, arranging for or recommending a good or service,
for which payment may be made in whole or part under federal healthcare programs, such as the
Medicare and Medicaid programs. Penalties for violations include criminal penalties and civil
sanctions such as fines, imprisonment and possible exclusion from Medicare, Medicaid and other
federal healthcare programs.
Federal False Claims Act
We may become subject to the Federal False Claims Act, or FCA. The FCA imposes civil fines and
penalties against anyone who knowingly submits or causes to be submitted to a government agency a
false claim for payment. The FCA contains so-called whistle-blower provisions that permit a
private individual to bring a claim, called a qui tam action, on behalf of the government to
recover payments made as a result of a false claim. The statute provides that the whistle-blower
may be paid a portion of any funds recovered as a result of the lawsuit. Even though the VeriMed
system is not reimbursed by federal healthcare programs, it is still possible that we may be liable
for violations of the FCA, for instance, if a sales representative were to assist or instruct a
physician to bill a government program for microchip implantation by listing on the claim form some
other service that is reimbursable.
State Laws and Regulations
Many states have enacted laws similar to the federal Anti-Kickback Statute and FCA. The
Deficit Reduction Act of 2005 contains provisions that give monetary incentives to states to enact
new state false claims acts. The state Attorneys General are actively engaged in promoting the
passage and enforcement of these laws. While the Federal Anti-Kickback Statute and FCA apply only
to federal programs, many similar state laws apply both to state funded and to commercial health
care programs. In addition to these laws, all states have passed various consumer protection
statutes. These statutes generally prohibit deceptive and unfair marketing practices, including
making untrue or exaggerated claims regarding consumer products. There are potentially a wide
variety of other state laws, including state privacy laws, to which we might be subject. We have
not conducted an exhaustive examination of these state laws.
Privacy Laws and Regulations
Our VeriMed business is subject to various federal and state laws regulating the protection of
consumer privacy. We have never been challenged by a governmental authority under any of these laws
and believe that our operations are in material compliance with such laws. However, because of the
far-reaching nature of these laws, there can be no assurance that we would not be required to alter
one or more of our systems and data security procedures to be in compliance with these laws. Our
failure to protect health information received from customers could subject us to liability and
adverse publicity and could harm our business and impair our ability to attract new customers.
U.S. Federal Trade Commission Oversight
An increasing focus of the United States Federal Trade Commissions (FTCs) consumer
protection regulation is the impact of technological change on protection of consumer privacy.
Under the FTCs statutory authority to prosecute unfair or deceptive acts and practices, the FTC
vigorously enforces promises a business makes about how personal information is collected, used and
secured. Since 1999, the FTC has taken enforcement action against companies that do not abide by
their representations to consumers of electronic security and privacy. More recently, the FTC has
found that failure to take reasonable and appropriate security measures to protect sensitive
personal information is an unfair practice violating federal law. In the consent decree context,
offenders are routinely required to adopt very specific cybersecurity and internal compliance
mechanisms, as well as submit to
twenty years of independent compliance audits. Businesses that do not adopt reasonable and
appropriate data security controls have been found liable for as much as $10 million in civil
penalties and $5 million in consumer redress.
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The FTC continues to actively consider the potential impact of RFID on consumer protection
issues. In 2006, the FTC launched a new initiative, Protecting Consumers in the Next Tech-ade and
convened public hearings on November 6-8, 2006 that brought together experts from the business,
government and technology sectors as well as consumer advocates, academics and law enforcement
officials to explore ways in which convergence and the globalization of commerce impact consumer
protection. Panelists examined changes in marketing and technology over the past decade and
challenges facing consumers, business and government. One of the panels, entitled RFID Technology
in the Next Tech-ade, focused on the role of RFID in the healthcare and retail sectors.
State Legislation
During 2007, several state legislatures considered legislation addressing implantable chips
and consumer privacy concerns. Among the laws passed was a California bill prohibiting anyone from
requiring, coercing or compelling any other individual to undergo a subcutaneous chip implant. The
California law provides for a private cause of action for damages and injunctive relief. In
addition, North Dakota passed a law prohibiting any person from requiring another to undergo a
microchip implant. Violation of the North Dakota law is a misdemeanor. The Michigan legislature
also considered, but did not pass, a law similar to that of North Dakota that would have prohibited
chip implantation without the recipients prior consent. A number of states also have introduced
legislation focusing on the consumer privacy implications of RFID use in government identification
documents, prescription drug tracking and retail sales. As of December 31, 2007, none of this
legislative activity restricts our current or planned operations.
Many states have privacy laws relating specifically to the use and disclosure of healthcare
information. Federal healthcare privacy laws preempt state laws that are less restrictive than the
federal law, but more restrictive state laws still may apply to us. Therefore, we may be required
to comply with one or more of these multiple state privacy laws. Statutory penalties for violation
of these state privacy laws varies widely. Violations also may subject us to lawsuits for invasion
of privacy claims.
The European Union
In the European Union (EU), promotion of RFID technology is viewed as a critical economic
issue. It is established that insofar as RFID is a technology involving collection, sharing and
storage of personally identifiable information, the mandates of
Directive 95/46/EC of the European
Parliament and of the Council of 24 October 1995 on the Protection of Individuals With Regard to
the Processing of Personal Data and On the Free Movement of Such Data
(EU Data Directive)
applies. All 25 EU member countries have implemented the EU data directive. At issue today is
whether additional privacy protection laws beyond those prescribed by the EU data directive and its
country-specific laws are needed for privacy issues raised by RFID technology. On January 19, 2005,
the EUs Working Party 29, charged with interpretation and expansion of EU data protection law and
policy, adopted Working Document 105, addressing data protection issues related to RFID technology.
That document reinforced the need to comply with the basic principles of the EU data directive and
related documents whenever personal data is collected via RFID technology. Guidance to RFID
manufacturers was also provided regarding responsibilities to design privacy compliant technology.
The EU recently completed a six-month consultation with public and industry stakeholders on
the use of RFID tags. At a conference held on October 16, 2006, the Commissioner for Information
Society and Media, the top official leading the RFID consultation, announced that the EU must
consider adopting a specialized legal framework to ensure that RFID technology does not infringe on
privacy. The consultation results indicated that while the EU was prepared to be convinced of the
benefits of RFID, the public expressed great concerns about ensuring that privacy is not
compromised.
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Health Insurance Portability and Accountability Act of 1996
We are not a health care provider, health plan or health care clearinghouse. Therefore, we are
not subject to the Health Insurance Portability and Accountability Act of 1996, or HIPAA. To the
extent required by HIPAA, we have entered into business associate agreements with certain health
care providers and health plans relating to the privacy and security of protected health
information. We have implemented policies and procedures to enable us to comply with these HIPAA
business associate agreements.
Employees
As of March 17, 2008, we had 152 employees, of whom 46 were in our sales and marketing group,
27 were in project management/technical support, 30 were in research and development, 34 were in
operations and 15 were in finance and administration. We consider our relationship with our
employees to be satisfactory and have not experienced any interruptions of our operations as a
result of labor disagreements. None of our employees are represented by labor unions or covered by
collective bargaining agreements.
Financial Information About Segments and Geographic Areas
For a discussion of revenues attributed to our three business segments and to geographic areas
over the past three years, refer to Note 13 to our Consolidated Financial Statements.
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ITEM 1A. RISK FACTORS
The following risks and the risks described elsewhere in this Annual Report on
Form 10-K
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including the section entitled Managements Discussion and Analysis of Financial Condition and
Results of Operations, could materially affect our business, prospects, financial condition,
operating results and cash flows. If any these risks materialize, the trading price of our common
stock could decline, and you may lose all or part of your investment.
Risks Related to Our Business
If we cannot successfully implement our business strategy, we expect that our business, results of
operations and potential for growth will be adversely affected.
If our market assessments, or the assumptions, estimates and judgments underlying such
assessments, on which we have charted our course for our business, prove to be incorrect, we may
not be successful in implementing our strategy or achieving our objectives. In that case, we would
expect that our business, results of operations, financial condition and potential for growth will
be adversely affected.
Our business strategy for our Canadian-based business, from which we are currently generating
substantially all of our revenue, includes:
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endeavoring to market and sell, through international distributors, an increasing
number of our infant protection, wander prevention and asset/personnel location and
identification systems outside of North America, where the market for these products is
largely undeveloped;
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leveraging our established brand recognition, reseller network and extensive end-use
customer base for our infant protection and wander prevention systems to gain inroads
in the emerging market for asset/personnel location and identification systems; and
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introducing a new vibration monitoring instrumentation platform that better
integrates with contemporary data communications protocols so as to improve our
vibration monitoring instruments remote monitoring capabilities.
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Our business strategy also includes dedicating a portion of the operating cash flows derived
from our healthcare security, implantable and industrial, businesses, as well as a portion of the
net proceeds from our initial public offering, to funding our efforts to create markets for our
systems that utilize our implantable microchip, principally our VeriMed system, from which, to
date, we have generated only nominal revenue. We do not expect to generate more than nominal
revenue from these systems over the next 12 to 18 months and possibly for a longer period of time.
We may decide to alter or discontinue aspects of our business strategy and may adopt
alternative or additional strategies because of business or competitive factors or factors not
currently foreseen, such as the introduction of new products by our competitors or the emergence of
new technologies that would make our products and systems obsolete. If we are unable to
successfully implement our current or future business strategy, our business, results of
operations, financial condition and potential for growth may be adversely affected.
We have a history of losses, and expect to incur additional losses in the future. We are unable to
predict the extent of future losses or when we will become profitable.
We were formed by Digital Angel in November 2001 and have incurred operating losses since that
time. Our accumulated deficit was $29.0 million as of December 31, 2007. Our net losses for the
years ended December 31, 2007, 2006, 2005 and 2004 were $11.9 million, $6.7 million, $5.3 million
and $2.0 million, respectively. We expect to continue to incur operating losses for the foreseeable
future.
Our ability in the future to achieve or sustain profitability is based on a number of factors,
many of which are beyond our control, including the future demand for our active RFID systems
targeted at the healthcare sector
and the development of the market for our VeriMed system. If demand for our RFID systems
generally, and the VeriMed system in particular, does not reach anticipated levels, or if we fail
to manage our cost structure, we may not achieve or be able to sustain profitability.
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Our expense levels will increase over the next several years, contributing to our expectation that
we will incur losses for the foreseeable future.
We expect our operating expenses to increase over the next several years. For example, our
operating expenses for the year ended December 31, 2007 were 31.7% higher than our operating
expenses for the year ended December 31, 2006. The increase in 2007 was due, in part, to the
expansion of our sales and marketing efforts to create a market for our VeriMed system and our
having become an SEC-reporting and Nasdaq-listed company. The increase in future operating expenses
will result from, among other things:
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the expansion of our sales and marketing efforts to create a market for our VeriMed
system as we expect to continue the buildout of our VeriMed infrastructure in the
geographies in which we currently operate and to expand our geographical reach during
2008; and
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our having become an SEC-reporting and Nasdaq-listed company and, as such, being
subject to the requirements of the Sarbanes-Oxley Act of 2002, SEC rules and
regulations to implement certain of the Acts provisions, including the requirement to
have in place, and evaluate, internal control over financial reporting, and Nasdaq
listing standards. This Annual Report on Form 10-K does not include an attestation
report of our registered public accounting firm due to a transition period established
by rules of the SEC for newly public companies. Our independent registered public
accounting firm will not be engaged to attest to managements assessment of our
internal control over financial reporting until our annual report on Form 10-K for our
fiscal year ending December 31, 2008.
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In addition, we will incur significant amortization expense associated with intangible assets
that we acquired as a result of the acquisition of our Canadian-based businesses in the first half
of 2005. Specifically, we incurred approximately $1.8 million in amortization expense associated
with these intangible assets in the year ended December 31, 2007.
We may need additional funding and may be unable to raise capital when needed, which would force us
to delay, reduce or eliminate our product development programs or efforts to create a market for
our VeriMed system.
We expect to require funding in future years, in addition to the proceeds from our initial
public offering, to create a market for our VeriMed system and any additional technologies or
systems that we may license or develop. To the extent we raise additional capital by issuing equity
securities, our stockholders may experience substantial dilution. In addition, our business and
operations may change in a manner that would consume available resources at a greater rate than we
anticipated. In such event, we may need to raise substantial additional capital.
We may seek to raise necessary funds through public or private equity offerings, debt
financings or strategic alliance and licensing arrangements. If adequate funds are not available,
we may be required to delay, reduce the scope of or eliminate one or more of our development
programs, and our business, financial performance and stock price may be materially and adversely
affected. To raise additional funds through strategic alliance or licensing arrangements, we may be
required to relinquish rights to our technologies or systems, or grant licenses on terms that are
not favorable to us.
The markets for our infant protection and wander prevention systems in the United States and for
our vibration monitoring instruments internationally are relatively mature markets of limited size,
which may limit our ability to increase our sales of these systems.
In the near term, we expect that our revenue will continue to be derived primarily from sales
of our infant protection and wander prevention systems, and our vibration monitoring instruments.
The markets for our infant protection are wander prevention systemsin the United States, where
historically we have sold the substantial majority of our sales of these systemsand for our
vibration monitoring instruments internationally can all be
characterized as being of limited size and relatively mature. In the event we are not able to
develop new markets, our future growth prospects will be modest. We cannot assure you that our
historical revenue growth rates from these systems will continue.
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As of December 31, 2007, we have sold and had installed a limited number of our asset/personnel
location and identification systems. There are a number of factors beyond our control that may
limit future sales of these systems.
As of March 17, 2008, we have sold seven of our asset/personnel location and identification
systems. These systems were sold through two dealers on a private label basis. While we believe
that the potential for RFID real-time location systems, such as our asset/personnel location and
identification system, to improve the quality and decrease the cost of healthcare is significant,
the market for such systems in the healthcare sector is just emerging. The pace at which healthcare
facilities have implemented RFID systems has been slower than many who follow the industry have
anticipated. Market analysts have cited a number of factors that may be constraining the rate and
extent of the U.S. healthcare industrys adoption of RFID asset/personnel location and
identification systems, including:
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the cost of deployment, coupled with the limited budgets of many hospitals;
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the uncertainty or unquantifiable nature of the return on investment;
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system compatibility issues;
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the low level of awareness; and
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We believe that our asset/personnel location and identification system will need to capture
market share in this emerging market within the next 12-24 months, as we expect that a significant
factor in hospitals choice of system vendors will be referrals to other healthcare facilities that
have deployed, and are pleased with, such systems. To achieve this, we will need to be on the
forefront of the effort to educate healthcare industry personnel regarding the benefits, including
the return on investment, achievable through implementation of RFID location and identification
systems.
We may be unable to increase our sales of infant protection and wander prevention systems outside
of North America.
We currently sell substantially all of our infant protection and wander prevention systems in
North America. Part of our growth strategy is to increase our penetration of markets outside of
North America for these systems. Conducting business internationally entails numerous risks, which
could disrupt or otherwise adversely affect our business, including:
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unexpected changes in regulatory requirements, taxes, trade laws, tariffs, import
and export controls, customs duties and other trade restrictions or barriers;
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more stringent regulations relating to data privacy and the unauthorized use of, or
access to, commercial and personal information, particularly in Europe;
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regulations, such as with respect to radio frequency bands, that require us to
redesign our existing systems or develop new systems to comply;
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restrictions on the transfer of funds;
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changes in governmental policies and regulations;
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limitations on the level of intellectual property protections; and
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political unrest, terrorism and war.
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If we are unable to expand our international distribution network in a timely and
cost-effective manner, we could miss sales opportunities, which could constrain our growth.
Sales of our vibration monitoring instruments will be adversely affected if the introduction of our
new instrumentation platform for these instruments is delayed or if the new platform does not
achieve market acceptance.
If the introduction of our new vibration monitoring instrumentation platform is delayed or if
the new platform does do not achieve market acceptance, sales of our vibration monitoring
instruments, which currently represent the primary source of revenue in our industrial segment,
will be adversely affected. The introduction of the new platform represents our primary strategy to
grow our vibration monitoring business. If we fail to timely introduce the new platform or if the
new platform does not achieve market acceptance, our ability to grow this business will be
materially and adversely affected.
Our competitors, including those who have greater resources and experience than we do, may
commercialize technologies that make ours obsolete or noncompetitive.
There are many public and private companies, universities, governmental agencies and research
organizations actively engaged in research and development of RFID and other competing technologies
with the same or similar functionality as our systems and that target the same markets that we
target.
Our active RFID systems, such as our infant protection, wander prevention and asset/personnel
location and identification systems, utilize a zonal, also known as cell ID, system in which a
network of readers are positioned to cover a defined area, including points of ingress or egress,
to read tagged persons or objects within the defined area. There are a number of other
technologies, such as UHF-based active RFID technologies, lower power Ultra Wide Band-based
location technologies, 802.11 and Zigbee-based location and wireless networking technologies, and
advanced, long range, encrypted passive RFID technology, that are being developed and sold that can
be employed for our target applications. One or more of these technologies may prove to be a better
or more cost-effective solution than our RFID systems for customers in our target markets and thus
achieve greater market acceptance than the technologies used in our systems. If this were to occur,
our ability to sell our systems, as well as our results of operations, financial condition and
business prospects, would be adversely affected.
Some of our current competitors, as well as companies who utilize RFID technologies in
applications outside of our target markets, have significantly greater financial, marketing and
product development resources than we do. Low barriers to entry across most of our product lines
may result in new competitors entering the markets we serve. If a current or future competitor were
to successfully develop or acquire rights to more effective or lower cost systems for applications
targeted by our systems, then sales of our systems could suffer and our business, results of
operations and financial condition could be materially and adversely affected.
We rely upon third-party dealers to market and sell, as well as install, service and maintain, our
infant protection, wander prevention and asset/personnel location and identification systems, and
to market and sell our vibration monitoring instruments. As such, our revenue from sales of these
products significantly depends on their efforts, as does the level of end-use customer
satisfaction.
We currently have a limited sales, marketing and distribution infrastructure. We market and
sell our infant protection, wander prevention and asset/personnel location and identification
systems, as well as vibration monitoring instruments, through third-party dealers. We currently
derive substantially all of our revenue from these systems and instruments. In general, our dealer
agreements impose no minimum purchase requirements.
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By virtue of our reliance on dealers, our revenue significantly depends on the efforts of
others. In addition, we are at risk that an end-use customer may have an unfavorable view of one of
our systems based on a dealers improper installation, support or maintenance of that system.
Our dealers of our infant protection, wander prevention and asset/personnel location and
identification systems also have responsibility for the installation and after-sale servicing and
maintenance of such systems. System installation requires relationships with cable companies,
knowledge of the other products that need to be integrated with our hardware and knowledge of local
codes. After-market customer service and maintenance is an important aspect of overall end-use
customer satisfaction.
We may be subject to costly product liability claims from the use of our systems, which could
damage our reputation, impair the marketability of our systems and force us to pay costs and
damages that may not be covered by adequate insurance.
Manufacturing, marketing, selling, testing and operation of our systems entail a risk of
product liability. We could be subject to product liability claims in the event our systems fail to
perform as intended. Even unsuccessful claims against us could result in the expenditure of funds
in litigation, the diversion of management time and resources, damage to our reputation and
impairment in the marketability of our systems. While we maintain liability insurance, it is
possible that a successful claim could be made against us, that the amount of our insurance
coverage would not be adequate to cover the costs of defending against or paying such a claim, or
that damages payable by us would harm our business. In addition, the receipt of insurance proceeds
would not mitigate any damage to our reputation, which could harm future sales.
If others assert that our products infringe their intellectual property rights, including rights to
the patent covering our implantable microchip, we may be drawn into costly disputes and risk paying
substantial damages or losing the right to sell our products.
We face the risk of adverse claims and litigation alleging our infringement of the
intellectual property rights of others. If infringement claims are brought against us or our
suppliers, including, in the case of our implantable microchip, Digital Angel, these assertions
could distract management and necessitate our expending potentially significant funds and resources
to defend or settle such claims. We cannot be certain that we will have the financial resources to
defend ourselves against any patent or other intellectual property litigation.
If we or our suppliers are unsuccessful in any challenge to our rights to market and sell our
products, we may, among other things, be required to:
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pay actual damages, royalties, lost profits and/or increased damages and the third
partys attorneys fees, which may be substantial;
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cease the development, manufacture, use and/or sale of products that use the
intellectual property in question through a court-imposed sanction called an
injunction;
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expend significant resources to modify or redesign our products, manufacturing
processes or other technology so that it does not infringe others intellectual
property rights or to develop or acquire non-infringing technology, which may not be
possible; or
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obtain licenses to the disputed rights, which could require us to pay substantial
upfront fees and future royalty payments and may not be available to us on acceptable
terms, if at all, or to cease marketing the challenged products.
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Ultimately, we could be prevented from selling a product or otherwise forced to cease some
aspect of our business operations as a result of any intellectual property litigation. Even if we
or our suppliers are successful in defending an infringement claim, the expense, time delay, and
burden on management of litigation and negative publicity could have a material adverse effect on
our business.
See also Item 1A. Risks Related to Our Businesses Which Utilize the Implantable
MicrochipOur sales of systems that incorporate our implantable microchip may be
enjoined by third parties who have rights to the intellectual property used in these systems
and we may be required to pay damages which could have an adverse effect on our business.
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Our inability to safeguard our intellectual property may adversely affect our business by causing
us to lose a competitive advantage or by forcing us to engage in costly and time-consuming
litigation to defend or enforce our rights.
We rely on copyrights, trademarks, trade secret protections, know-how and contractual
safeguards to protect our non-patented intellectual property, including our software technologies.
Our employees, consultants and advisors are required to enter into confidentiality agreements that
prohibit the disclosure or use of our confidential information. We also have entered into
confidentiality agreements to protect our confidential information delivered to third parties for
research and other purposes. There can be no assurance that we will be able to effectively enforce
these agreements, the confidential information will not be disclosed, others will not independently
develop substantially equivalent confidential information and techniques or otherwise gain access
to our confidential information, or that we can meaningfully protect our confidential information.
Costly and time-consuming litigation could be necessary to enforce and determine the scope of our
confidential information, and failure to maintain the confidentiality of our confidential
information could adversely affect our business by causing us to lose a competitive advantage
maintained through such confidential information.
Disputes may arise in the future with respect to the ownership of rights to any technology
developed with third parties. These and other possible disagreements could lead to delays in the
collaborative research, development or commercialization of our systems, or could require or result
in costly and time-consuming litigation that may not be decided in our favor. Any such event could
have a material adverse effect on our business, financial condition and results of operations by
delaying our ability to commercialize innovations or by diverting our resources away from
revenue-generating projects.
Our efforts to protect our intellectual property may be less effective in some foreign countries
where intellectual property rights are not as well protected as in the United States.
The laws of some foreign countries do not protect intellectual property to as great an extent
as do the laws of the United States. Policing unauthorized use of the intellectual property
utilized in our systems and system components is difficult, and there is a risk that our means of
protecting our intellectual property may prove inadequate in these countries. Our competitors in
these countries may independently develop similar technology or duplicate our systems, which would
likely reduce our sales in these countries. Furthermore, some of our patent rights may be limited
in enforceability to the United States or certain other select countries, which may limit our
intellectual property rights abroad.
We may not be successful in our efforts to obtain federal registration of our trademarks containing
the Veri prefix with the U.S. Patent and Trademark Office.
In June 2004, VeriSign, Inc. filed oppositions with the U.S. Patent and Trademark Office,
objecting to our registration of the VeriChip trade name and our trademarks that begin with the
Veri prefix. We and VeriSign are seeking to amicably resolve the opposition proceeding.
Settlement negotiations are ongoing; however, the proceeding is currently active, and we served
further discovery to VeriSign on January 3, 2008 to obtain information that will be relevant to any
settlement. In the event an amicable resolution is not reached and VeriSign is successful in the
opposition proceedings, our applications to register VeriChip and our other Veri- marks will be
refused. It is also possible that VeriSign could bring a court action seeking to enjoin our use of
VeriChip and the other Veri- marks and/or seek monetary damages from our use of these marks. If
VeriSign were to bring a court action and prevail in that action, we may be required to re-name our
Company and re-brand some of our products, such as VeriChip, VeriMed and VeriTrace, as well as to
possibly pay damages to VeriSign for our use of any trademarks found to have been confusingly
similar to those of VeriSign.
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We depend on key personnel to manage our business effectively, and, if we are unable to hire,
retain or motivate qualified personnel, our ability to design, develop, market and sell our systems
could be harmed.
Our future success depends, in part, on certain key employees, including Scott R. Silverman,
our chief executive officer, and the chairman of our board of directors, and key technical and
operations personnel, and on our ability to attract and retain highly skilled personnel. The loss
of the services of any of our key personnel may seriously harm our business, financial condition
and results of operations. In addition, the inability to attract or retain qualified personnel, or
delays in hiring required personnel, particularly engineering, operations, finance, accounting,
sales and marketing personnel, may also seriously harm our business, financial condition and
results of operations. Our ability to attract and retain highly skilled personnel will be a
critical factor in determining whether we will be successful in the future.
We are subject to various environmental laws and regulations that could impose substantial costs
upon us.
We must comply with local, state, federal, and international environmental laws and
regulations in the countries in which we do business, including those governing the management and
disposal of hazardous substances and wastes. If we were to violate or become liable under
environmental laws, we could incur costs or fines, or be subject to third-party property damage or
personal injury claims, or be required to incur investigation or remediation costs. Our operations
and products will be affected by future environmental laws and regulations, but we cannot predict
the ultimate impact of any such future laws and regulations at this time. Our distributors who
place our products on the market in the European Union, or EU, are required to comply with EU
Directive 2002/96/EC on waste electrical and electronic equipment, known as the WEEE Directive.
Noncompliance by our distributors may adversely affect the success of our business in that market.
Additionally, we are investigating the applicability of EU Directive 2002/95/EC on the restriction
of the use of certain hazardous substances in electrical and electronic equipment, known as the
RoHS Directive. We do not expect the RoHS Directive will have a significant impact on our business.
Risks Related to Our VeriMed Business Which Utilizes the Implantable Microchip
We are endeavoring to create a market for our VeriMed system. We may never achieve market
acceptance or significant sales of this system.
We have been in the process of endeavoring to create a market for our VeriMed system since the
FDA cleared the VeriMed system for use for patient identification and health information purposes
in October 2004. Through December 31, 2007, we had generated nomial revenue from sales of the
microchip inserter kits. We may never achieve market acceptance or more than nominal or modest
sales of this system.
We attribute the modest number of people who, through March 17, 2008, have undergone the
microchip implant procedure to the following factors:
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Many people who fit the profile for which the VeriMed system was designed may not be
willing to have a microchip implanted in their upper right arm.
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Physicians may be reluctant to discuss the implant procedure with their patients
until a greater number of hospital emergency rooms have adopted the VeriMed system as
part of their standard protocol.
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Physicians may be reluctant to discuss the implant procedure with their patients
because of the cost to their patients.
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The media has from time to time reported, and may continue to report, on the VeriMed
system in an unfavorable and, on occasion, an inaccurate manner. For example, there
have been articles published asserting, despite at least one study to the contrary,
that the implanted microchip is not magnetic resonance imaging, or MRI, compatible.
There have also been articles published asserting, despite numerous studies to the
contrary, that the implanted microchip causes malignant tumor formation in laboratory
animals.
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Privacy concerns may influence individuals to refrain from undergoing the implant
procedure or dissuade physicians from recommending the VeriMed system to their
patients. Misperceptions that a microchip-implanted person can be tracked and that
the microchip itself contains a persons basic information, such as name, contact
information, and personal health records, may contribute to such concerns.
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Misperceptions and/or negative publicity may prompt legislative or administrative
efforts by politicians or groups opposed to the development and use of
human-implantable RFID microchips. In 2006 and 2007, a number of states introduced, and
at least three states (Wisconsin, California and North Dakota) have enacted,
legislation that would prohibit any requirement that an individual undergo a
microchip-implant procedure. While we support all pending and enacted legislation that
would preclude anything other than voluntary implantation, legislative bodies or
government agencies may determine to go further, and their actions may have the effect,
directly or indirectly, of delaying, limiting or preventing the use of
human-implantable RFID microchips or the sale, manufacture or use of RFID systems
utilizing such microchips.
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At present, the cost of the microchip implant procedure is not covered by Medicare,
Medicaid or private health insurance.
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At present, no studies to assess the impact of the VeriMed system on the quality of
emergency department care have been completed and publicly released.
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In light of these and perhaps other factors and if we are unable to successfully implement our
marketing strategy, it is difficult to predict whether our VeriMed system will achieve market
acceptance, how widespread that market acceptance will be, and the timing of such acceptance.
Accordingly, we are uncertain as to whether we will generate the level of future revenue and
revenue growth we have forecast from sales of the VeriMed system.
We believe that sales of our implantable microchip, and the extent to which our VeriMed system
achieves market acceptance, will depend, in part, on the availability of insurance reimbursement
from third-party payers, including federal and state governments under programs, such as Medicare
and Medicaid, and private insurance plans. Insurers may not determine to cover the cost of the
implant procedure, or it may take a considerable period of time for this to occur.
We believe that sales of our implantable microchip, and the extent to which our VeriMed system
achieves market acceptance, will depend, in part, on the availability of insurance reimbursement
from third-party payers, including federal and state government programs, such as Medicare and
Medicaid, private health insurers, managed care organizations and other healthcare providers. Both
governmental and private third-party payers are increasingly challenging the coverage and prices of
medical products and services, and require proven efficacy and cost effectiveness for
reimbursement. If patients undergoing the microchip implant procedure, or health institutions and
doctors using the VeriMed system, are not able to obtain adequate reimbursement for the cost of
using these products and services, they may forego or reduce their use. While we are in the process
of facilitating and, in one case, funding clinical studies that may demonstrate the efficacy of the
VeriMed system, which we believe will make it more likely that government and private insurers will
cover the cost of the microchip implant process, it may take a considerable period of time for this
to occur, if, in fact, it does occur. If government and private insurers do not determine to
reimburse the cost of the implant process, we would not expect to realize the anticipated level of
future sales of our implantable microchip and the database subscription fees.
Our sales of systems that incorporate our implantable microchip may be enjoined by third parties
who have rights to the intellectual property used in these systems and we may be required to pay
damages which would have an adverse effect on our business.
We may face a claim that we are violating the intellectual property rights of one or more
third parties with respect to U.S. Patent No. 5,211,129, Syringe-Implantable Identification
Transponders. If such a claim is successful, we could be required to cease engaging in activities
to market our systems that utilize the implantable microchip and to pay damages, which may be
substantial.
35
We obtain the implantable microchip used in our VeriMed and VeriTrace systems from a
wholly-owned subsidiary of Digital Angel, under the terms of a supply agreement. Digital Angel, in
turn, obtains the implantable microchip from a subsidiary of Raytheon Company under a separate
supply agreement. The technology underlying our VeriMed and VeriTrace systems is covered, in part,
by U.S. Patent No. 5,211,129. In 1994, Destron/IDI, Inc., a predecessor company to Digital Angel
Corporation, 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 and security
applications. The rights licensed in 1994 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,
transferred or conveyed to any third party. We source the implantable microchip indirectly from a
subsidiary of Raytheon Company, with which Hughes, then known as HE Holdings, Inc. was merged in
1997. However, we have no documentation that establishes our right to use the patented technology
for human identification and 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 us asserting that we are violating its
rights. 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 us. If such a claim is successful,
sales of our VeriMed and VeriTrace systems could be enjoined, and we could be required to cease our
efforts to create a market for these systems, until the patent expires in April 2008. In addition,
we could be required to pay damages, which may be substantial. Regardless of whether any claimant
is successful, we would face the prospect of the expenditure of funds in litigation, the diversion
of management time and resources, damage to our reputation and the potential impairment in the
marketability of our systems even after the expiration of the patent, which could harm our business
and negatively affect our prospects.
Even if our VeriMed system achieves some level of market acceptance, the anticipated significant
and growing recurrent revenue from microchip-implanted persons subscribing to our database may not
be realized.
Our business model envisages that our VeriMed system will achieve some level of penetration
within our target market for such system: the approximately 45 million at-risk people in the United
States with cognitive impairment, chronic diseases and related conditions, or implanted medical
devices. The model also anticipates our deriving significant and growing recurrent revenue from
subscriptions to our database by persons implanted with our microchip. However, a person implanted
with our microchip may decide not to subscribe to our database if, for example, the hospital
emergency room where he or she would most likely be taken in an emergency maintains its own
database. We do not currently anticipate that a significant percentage of VeriMed-adopting
hospitals and other healthcare facilities will choose to provide databases for this purpose.
However, future regulatory changes, such as in connection with the U.S. governments efforts to
address inefficiencies in the U.S. healthcare system related to information technology, could spur
hospitals and other healthcare facilities to establish systems to maintain electronic health
records. This might have the effect of reducing the number of people implanted with our microchip
who might otherwise subscribe to our database which could, in turn, negatively affect the future
revenue that we anticipate we will derive from the VeriMed system.
Currently, individuals implanted with our microchip take responsibility for inputting all of
their information into our database, including personal health records, as physicians currently
have little interest in being involved in this process primarily because of liability concerns
and because they are generally not paid for this service. Over time, we envision that persons
implanted with our microchip may prevail upon their physicians to assist them with the inputting of
information for which, by virtue of their medical training, physicians are better equipped to
handle. If this does not occur, emergency room personnel and emergency medical technicians may lack
confidence in the accuracy and completeness of implanted persons personal health records in the
database. This could negatively affect the revenue we anticipate we will derive in the future from
the VeriMed system. We obtain the implantable microchip used in our VeriMed and VeriTrace systems
from a single supplier, making us vulnerable to supply disruptions that could constrain our sales
of such systems and/or increase our per-unit cost of production of the microchip.
36
At present, Digital Angel is our sole supplier of our implantable microchip under the terms of
an agreement we entered into with Digital Angel in December 2005. Digital Angel, in turn, sources
the microchip from Raytheon
Microelectronics España, or RME, the actual manufacturer, under a supply agreement between
Digital Angel and RME. The term of that agreement expires on June 30, 2010, subject to earlier
termination by either party if, among other things, the other party breaches the agreement and does
not remedy the breach within 30 days of receiving notice. Digital Angel and RME each own certain of
the automated equipment and tooling used in the manufacture of the microchip. Accordingly, it would
be difficult for Digital Angel to arrange for a third party other than RME to manufacture the
implantable microchip if for any reason RME was unable to manufacture the implantable microchip or
RME did not manufacture sufficient implantable microchips for Digital Angel to satisfy our
requirements. Even if Digital Angel were able to arrange to have the implantable microchip
manufactured in another facility, we currently believe making such arrangements and commencement of
production could take at least three to six months. A supply disruption of this length could cause
customers to cancel orders, negatively affect future sales and damage our business reputation. In
addition, the per-unit cost of production at another facility could be more than the price per unit
we pay to Digital Angel.
If we do not meet the minimum purchase requirements under our agreement with Digital Angel, Digital
Angel may sell implantable microchips for secure human identification applications to third
parties. Our loss of this exclusive supply arrangement may result in our facing competition with
respect to our implantable microchip-based systems, which could have a material adverse effect on
the expected growth of our business.
Our agreement with Digital Angel, under which we source our implantable microchip, includes a
provision that Digital Angel may not sell to parties other than us and our resellers the
implantable microchips, as well as the reader equipment, for secure human identification
applications, provided we meet specified minimum purchase requirements. If we do not meet the
minimum purchase requirements, Digital Angel is free to sell to other parties implantable
microchips for secure human identification applications.
The minimum purchase requirements for implantable microchips under the agreement are as
follows:
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Minimum
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Purchase
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Year
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Requirement
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2007
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$
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0
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2008
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$
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875,000
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2009
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$
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1,750,000
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2010
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$
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2,500,000
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2011 and thereafter
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$
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3,750,000
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For the years ended December 31, 2007, 2006 and 2005, the aggregate amount of our purchases
under our agreement with Digital Angel were nil, $0.4 million and $0.7 million, respectively.
If we lose the benefit of the exclusivity provision under our agreement with Digital Angel, we
may face competition in the various target markets for our systems that use our implantable
microchip, such as VeriMed and VeriTrace, or face such competition at an earlier point in time than
might otherwise have been the case, which could negatively affect our revenue, cash flows from
operations, operating margins and profitability, as well as our growth prospects.
If Digital Angel were to terminate its agreement with us, we would not be able to obtain our
implantable microchip. This would make it difficult to fulfill our expectations for future revenue
and revenue growth from the sale of systems that use the implantable microchip.
Provided we meet our minimum purchase requirements, our agreement with Digital Angel is
scheduled to remain in force until the last of the patents covering the supplied products expire.
However, Digital Angel can terminate the agreement upon the occurrence of any of the following
events:
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our default in the performance of any of our obligations under the agreement (e.g.,
our failure to take delivery and pay for products) that is not cured within 90 days of
receiving written notice of the default;
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37
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either party to the agreement filing a petition in bankruptcy; or
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a petition in bankruptcy is filed against us and is not discharged within 30 days.
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If the agreement were to be terminated, we would not be able to purchase our implantable
microchip from Digital Angel. Further, if the termination occurred while the patents covering our
implantable microchip remain in force, we could not obtain implantable microchips for secure human
identification applications from any other source. As a result, we would not be able to sell our
VeriMed system or any other products that incorporate our implantable microchip, such as our
VeriTrace system. This would make it difficult for us to fulfill our expectations of future revenue
and revenue growth from sales of such systems.
Implantation of our implantable microchip may be found to cause risks to a persons health, which
could adversely affect sales of our systems which incorporate the implantable microchip.
The implantation of our implantable microchip may be found, or be perceived, to cause risks to
a persons health. Potential or perceived risks include adverse tissue reactions, migration of the
microchip and infection from implantation. There have been articles published asserting, despite
numerous studies to the contrary, that the implanted microchip causes malignant tumor formation in
laboratory animals. As more people are implanted with our implantable microchip, it is possible
that these and other risks to health will manifest themselves. Actual or perceived risks to a
persons health associated with the microchip implantation process could constrain our sales of the
VeriMed system or result in costly and expensive litigation. Further, the potential resultant
negative publicity could damage our business reputation, leading to loss in sales of our other
systems targeted at the healthcare market which would harm our business and negatively affect our
prospects.
If we are required to effect a recall of our implantable microchip, our reputation could be
materially and adversely affected and the cost of any such recall could be substantial, which could
adversely affect our results of operations and financial condition.
From time to time, implanted devices have become subject to recall due to safety, efficacy,
product failures or other concerns. To date, we have not had to recall any of our implantable
microchips. However, if, in the future, we are required to effect such a recall, the cost of the
recall, and the likely related loss of system sales, could be substantial and could materially and
adversely affect our results of operations and financial condition. In addition, any such recall
could materially adversely affect our reputation and our ability to sell our systems that make use
of the implantable microchip which would harm our business and negatively affect our prospects.
Interruptions in access to, or the hacking into, our VeriMed patient information database may have
a negative impact on our revenue, damage our reputation and expose us to litigation.
Reliable access to the VeriMed patient information database is a key component of the
functionality of our VeriMed system. Our ability to provide uninterrupted access to the database,
whether operated by us or one or more third parties with whom we contract, will depend on the
efficient and uninterrupted operation of the computer and communications systems involved. Although
certain elements of technological, power, communications, personnel and site redundancy are
maintained, the database may not be fully redundant. Further, the database may not function
properly if certain necessary third-party systems fail, or if some other unforeseen act or natural
disaster should occur. In the past, we have experienced short periods during which the database was
inaccessible as a result of development work, system maintenance and power outages. Any disruption
of the database services, computer systems or communications networks, or those of third parties
that we rely on, could result in the inability of users to access the database for an indeterminate
period of time. This, in turn, could cause us to lose the confidence of the healthcare community
and persons who have undergone the microchip implant procedure, resulting in a loss of revenue and
possible litigation.
In addition, if the firewall software protecting the information contained in our database
fails or someone is successful in hacking into the database, we could face damage to our business
reputation and litigation.
38
Regulation of products and services that collect personally-identifiable information or otherwise
monitor an individuals activities may make the provision of our services more difficult or
expensive and could jeopardize our growth prospects.
Certain technologies that we currently, or may in the future, support are capable of
collecting personally-identifiable information. A growing body of laws designed to protect the
privacy of personally- identifiable information, as well as to protect against its misuse, and the
judicial interpretations of such laws, may adversely affect the growth of our business. In the
United States, these laws include the Health Insurance Portability and Accountability Act, or
HIPAA, the Federal Trade Commission Act, the Electronic Communications Privacy Act, the Fair Credit
Reporting Act, and the Gramm-Leach-Bliley Act, as well as various state laws and related
regulations. Although we are not a covered entity under HIPAA, we have entered into agreements with
certain covered entities in which we are considered to be a business associate under HIPAA. As a
business associate, we are required to implement policies, procedures and reasonable and
appropriate security measures to protect individually identifiable health information we receive
from covered entities. Our failure to protect health information received from customers could
subject us to liability and adverse publicity, and could harm our business and impair our ability
to attract new customers.
In addition, certain governmental agencies, like the U.S. Department of Health and Human
Services and the Federal Trade Commission, have the authority to protect against the misuse of
consumer information by targeting companies that collect, disseminate or maintain personal
information in an unfair or deceptive manner. We are also subject to the laws of those foreign
jurisdictions in which we operate, some of which currently have more protective privacy laws. If we
fail to comply with applicable regulations in this area, our business and prospects could be
harmed.
Certain regulatory approvals generally must be obtained from the governments of the countries
in which our foreign distributors sell our systems. However, any such approval may be subject to
significant delays or may not be obtained. Any actions by regulatory agencies could materially and
adversely affect our growth plans and the success of our business.
If we fail to comply with anti-kickback and false claims laws, we could be subject to costly and
time-consuming litigation and possible fines or other penalties.
We are, or may become subject to, various federal and state laws designed to address
healthcare fraud and abuse, including anti-kickback laws and false claims laws. The federal
anti-kickback statute prohibits the offer, payment, solicitation or receipt of any form of
remuneration in return for referring items or services payable by Medicare, Medicaid or any other
federally-funded healthcare program. This statute also prohibits remuneration in return for
purchasing, leasing or ordering or arranging, or recommending the purchasing, leasing or ordering,
of items or services payable by Medicare, Medicaid or any other federally-funded healthcare
program. The anti-kickback laws of various states apply more broadly to prohibit remuneration in
return for referrals of business payable by payers other than federal healthcare programs.
False claims laws prohibit anyone from knowingly presenting, or causing to be presented, for
payment to third-party payers, including Medicare and Medicaid, which currently do not provide
reimbursement for our microchip implant procedure, claims for reimbursed drugs or services that are
false or fraudulent, claims for items or services not provided as claimed, or claims for medically
unnecessary items or services. Our activities relating to the reporting of wholesale or estimated
retail prices of our VeriMed system, the reporting of Medicaid rebate information, and other
information affecting federal, state and third-party payment for the VeriMed system, will be
subject to scrutiny under these laws.
The anti-kickback statute and other fraud and abuse laws are very broad in scope, and many of
their provisions have not been uniformly or definitively interpreted by existing case law or
regulations. Violations of the anti-kickback statute and other fraud and abuse laws may be
punishable by criminal and/or civil sanctions, including fines and civil monetary penalties, as
well as the possibility of exclusion from federal healthcare programs, including Medicare and
Medicaid, which currently do not provide reimbursement for our microchip implant procedure. We have
not been challenged by a governmental authority under any of these laws and believe that our
operations are in compliance with such laws. However, because of the far-reaching nature of these
laws, we may be
required to alter one or more of our practices to be in compliance with these laws. Healthcare
fraud and abuse regulations are complex and even minor, inadvertent irregularities in submissions
can potentially give rise to claims that the statute has been violated. If we are found to have
violated these laws, or are charged with violating them, our business, financial condition and
results of operations could suffer, and our management team could be required to dedicate
significant time addressing the actual or alleged violations.
39
Risks Related to Our Continued Affiliation with Digital Angel
Digital Angel maintains significant voting control over us. This may delay, prevent or deter
corporate actions that may be in the best interest of our stockholders.
As of December 31, 2007, Digital Angel owned 50.8% of our outstanding common stock and 44.1%
of our common stock on a fully-diluted basis. As of March 17, 2008, Digital Angel owned 49.3% of
our common stock. As a result, Digital Angel may exercise significant influence over all matters
requiring approval of our stockholders, including the election of directors and approval of
significant corporate transactions. This concentration of ownership may have the effect of
delaying, preventing or deterring a change in control of our Company even when such a change may be
in the best interests of all our stockholders. It could also have the effect of depriving
stockholders of an opportunity to receive a premium for their common stock as part of a sale of our
Company or assets and might affect the prevailing market price of our common stock.
Conflicts of interest may arise among Digital Angel and us that could be resolved in a manner
unfavorable to us.
Questions relating to conflicts of interest may arise between Digital Angel and us, in a
number of areas relating to our past and ongoing relationships. During 2007, three of our five
directors served as directors of Digital Angel. This included Scott R. Silverman, our chief
executive officer and the chairman of our board of directors, who served as the chairman of the
board of a subsidiary of Digital Angel until December 2007.
Areas in which conflicts of interest between or among Digital Angel and us could arise
include, but are not limited to, the following:
Cross directorships and stock ownership.
The equity interests of our directors in Digital
Angel or service as a director of both Digital Angel and us in the past could create, or appear to
create, conflicts of interest when directors are faced with decisions that could have different
implications for the two companies. For example, these decisions could relate to, among other
matters:
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the nature, quality and cost of services rendered to us by Digital Angel;
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the desirability of a potential acquisition or joint venture opportunity;
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employee retention or recruiting; or
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our dividend policy.
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Intercompany transactions
. From time to time, Digital Angel or its affiliates, may enter into
transactions with us or our subsidiary or other affiliates. Although the terms of any such
transactions will be established based upon negotiations between employees of Digital Angel and/or
the applicable affiliate and us and, when appropriate, subject to the approval of the independent
directors on our board or a committee of disinterested directors, there can be no assurance that
the terms of any such transactions will be as favorable to us or our subsidiary or affiliates as
may otherwise be obtained in arms-length negotiations with an unaffiliated third party.
Intercompany agreements
. We have entered several agreements with Digital Angel, including:
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a transition services agreement under which Digital Angel provides us certain
management, administrative, accounting, tax, legal and other services;
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40
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a tax allocation agreement setting forth Digital Angels and our rights and
obligations with respect to the handling and allocation of taxes and related matters
for all periods prior to the consummation of our initial public offering, which
occurred on February 14, 2007;
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a loan agreement; and
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letter agreements amending financing terms entered into with Digital Angel.
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The terms of these agreements were established while we have been controlled by Digital Angel
and were not the result of arms-length negotiations. In addition, conflicts could arise in the
interpretation, or in connection with any extension or renegotiation, of these existing agreements.
Risks Related to Our Common Stock
We expect that our stock price will fluctuate significantly due to events and developments unique
to our business or the healthcare industry generally.
The stock market has from time to time experienced significant volatility. Factors that could
cause volatility in the market price of our common stock include:
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false and/or defamatory comments made about our product made in the press;
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failure of any of our products, particularly our asset/personnel location and
identification system and our VeriMed system, to achieve commercial success;
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FDA or international regulatory actions;
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announcements of new products by our competitors;
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market conditions in the healthcare sector;
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litigation or public concern about the efficacy or safety of existing, new or
potential products or technologies;
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comments by securities analysts; and
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rumors relating to us or our competitors.
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These and other factors may cause the market price and demand for our common stock to
fluctuate substantially, which may limit or prevent investors from readily selling their shares of
our common stock and may otherwise negatively affect the liquidity of our common stock. In
addition, in the past, when the market price of a companys common stock has been volatile, holders
of that stock have instituted securities class action litigation against the company that issued
the stock. If any of our stockholders brought a lawsuit against us, we could incur substantial
costs defending the lawsuit and the time and attention of our management may be diverted. Since our
common stock began trading on the Nasdaq Global Market on February 9, 2007 through March 17, 2008,
the price has ranged between $1.76 and $10.62.
Provisions of our second amended and restated certificate of incorporation or our amended and
restated bylaws could delay or prevent an acquisition of our company, even if the acquisition would
be beneficial to our stockholders, and could make it more difficult for you to change management.
Provisions of our second amended and restated certificate of incorporation and our amended and
restated bylaws may discourage, delay or prevent a merger, acquisition or other change in control
that stockholders may consider favorable, including transactions in which stockholders might
otherwise receive a premium for their shares.
41
This is because these provisions may prevent or frustrate attempts by stockholders to replace
or remove our current management or members of our board of directors. These provisions, among
other things:
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prohibit cumulative voting in the election of directors, which might otherwise allow
holders of less than a majority of our outstanding shares of voting stock to elect one
or more director candidates;
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permit our board of directors to issue, without further action by our stockholders,
up to 5,000,000 shares of blank check preferred stock, with any rights, preferences
and privileges as they may designate (including the right to approve an acquisition or
other change in control);
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establish advance notice procedures with respect to stockholder proposals and the
nomination of candidates for election as directors, other than nominations made by or
at the direction of our board of directors;
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prohibit stockholders from calling special meetings of stockholders;
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prohibit stockholder action by written consent, thereby requiring all actions to be
taken at a meeting of the stockholders; and
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provide that members of our board of directors may only be removed for cause by the
affirmative vote of holders of at least a majority of the voting power of all then
outstanding shares of capital stock entitled to vote generally in the election of
directors, voting together as a single class.
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As a result, these provisions and others available under Delawares General Corporation Law
could limit the price that investors are willing to pay in the future for shares of our common
stock.
We will need to dedicate significant time and expense to enhancing, documenting, testing and
certifying our internal control over financial reporting.
As a publicly-traded company, we are required to file annual and quarterly reports containing
our financial statements within specified time periods. SEC rules will require that our chief
executive officer and chief financial officer periodically provide certifications as to, among
other things, the existence and effectiveness of our internal control over financial reporting and
disclosure controls and procedures. In general, this process requires significant documentation of
policies, procedures and controls, review of that documentation by our internal accounting staff,
and testing of our internal controls by our internal accounting staff and our outside independent
registered public accounting firm. Documentation and testing of our internal controls will involve
considerable time and expense and may strain our internal resources. Ensuring that we have adequate
internal financial and accounting controls and procedures in place to help ensure that we can
produce accurate financial statements on a timely basis is a costly and time-consuming effort that
needs to be re-evaluated on a periodic basis.
This Annual Report on Form 10-K does not include an attestation report of our registered
public accounting firm due to a transition period established by rules of the SEC for newly public
companies. Our independent registered public accounting firm will not be engaged to attest to
managements assessment of our internal control over financial reporting until our annual report on
Form 10-K for our fiscal year ending December 31, 2008.
If we fail to maintain proper and effective internal controls, our ability to produce accurate
financial statements could be impaired, which could adversely affect our operating results, our
ability to operate our business and our stock price.
During the course of our testing of our internal controls, we may identify, and have to
disclose, material weaknesses or significant deficiencies in our internal controls that will have
to be remediated. Implementing any appropriate changes to our internal controls may require
specific compliance training of our directors, officers and employees, entail substantial costs in
order to modify our existing accounting systems, and take a significant period of time to complete.
Such changes may not, however, be effective in maintaining the adequacy of our internal controls,
and any failure to maintain that adequacy, or consequent inability to produce accurate financial
statements
on a timely basis, could increase our operating costs and could materially impair our ability
to operate our business. In addition, investors perceptions that our internal controls are
inadequate or that we are unable to produce accurate financial statements may negatively affect our
stock price.
42
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our corporate headquarters is located in Delray Beach, Florida, where we occupy approximately
2,200 square feet of office space pursuant to a transition services agreement with Digital Angel.
We occupy approximately 21,000 square feet of office space in Ottawa, Canada, at an annual
rental rate of Canadian $11.00 per square foot, under the terms of a lease that expires May 31,
2009. We have an option to renew the lease for a further five-year term. At the Ottawa facility,
13,000 square feet is utilized for the final assembly of certain of our active RFID systems and our
vibration monitoring equipment. In addition, 8,000 square feet is utilized to provide customer
service, product support and engineering functions from this facility. The operations conducted at
our Ottawa facility are certified to the ISO 9001 international quality standard.
We leased approximately 11,500 square feet of office space in Vancouver, Canada. By March 31,
2007, we had substantially shifted our operations in Vancouver to our Ottawa facility, which have
included research and development, business development and a portion of our sales and
administration functions. We terminated the Vancouver lease in July 2007.
Each of our business segments, healthcare security, implantable and industrial, utilizes the
properties identified above.
ITEM 3. LEGAL PROCEEDINGS
On January 10, 2005, we commenced an action in the Circuit Court for Palm Beach County,
Florida, against Metro Risk Management Group, LLC, or Metro Risk. In this suit, we have 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 us for breach of contract and fraud in the inducement. Specifically, in its claim for
breach of contract, Metro Risk alleged that we 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 we fraudulently induced Metro Risk into signing the
distribution agreements by promising millions of dollars in profits. 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. The parties have taken
very little discovery at the present time. Metro Risk has propounded no discovery on us, and we
have propounded a request for production and a request for admissions on Metro Risk. The parties
have not taken any depositions yet. Given the early stage of the matter and because discovery has
recently begun, counsel is currently unable to assess the ultimate outcome.
We have received demand letters from attorneys for several former employees and/or consultants
of ours and of Digital Angel, asserting claims related to stock options to acquire approximately
540 thousand shares of our common stock that management believes that such employees and/or
consultants had forfeited when they ceased their employment or relationship with us and/or Digital
Angel. We believe that all of these potential claims are without merit and intends to vigorously
defend them in the event the claims are asserted or litigated.
We are 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 is expected to
have a material adverse effect on our business, financial condition or results of operations.
However, litigation is inherently unpredictable, and the costs
and other effects of pending or future litigation, governmental investigations, legal and
administrative cases and proceedings, whether civil or criminal, settlements, judgments and
investigations, claims or charges in any such matters, and developments or assertions by or against
us relating to us or to our intellectual property rights and intellectual property licenses could
have a material adverse effect on our business, financial condition and operating results.
43
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
|
|
ITEM 5.
|
MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER
PURCHASES OF EQUITY SECURITIES
|
Our common stock is traded on the Nasdaq Stock Market under the symbol CHIP. Trading of our
common stock commenced on February 9, 2007. Prior to that date, there was no public market for our
common stock. The following table presents the high and low sales price for our common stock for
the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
High
|
|
|
Low
|
|
Quarter ended December 31, 2007
|
|
$
|
4.40
|
|
|
$
|
2.14
|
|
Quarter ended September 30, 2007
|
|
$
|
10.62
|
|
|
$
|
3.25
|
|
Quarter ended June 30, 2007
|
|
$
|
9.75
|
|
|
$
|
4.27
|
|
Quarter ended March 31, 2007
|
|
$
|
6.99
|
|
|
$
|
4.80
|
|
Holders
According to the records of our transfer agent, as of March 10, 2008, there were approximately
12 holders of record of our common stock, which number does not reflect beneficial stockholders who
hold their stock in nominee or street name through various brokerage firms.
Dividend Policy
We have never declared or paid any cash dividends on our capital stock. We presently intend to
retain future earnings, if any, to finance the development and growth of our business, and we do
not expect to pay any cash dividends in the foreseeable future. Any future determination with
respect to the payment of dividends will be at the discretion of our board of directors and will be
dependent upon our financial condition, results of operations, capital requirements, general
business conditions, terms of financing arrangements and other factors that our board of directors
may deem relevant.
44
Equity Compensation Plan Information
The following table presents information regarding options and rights outstanding under our
compensation plans as of December 31, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(c)
|
|
|
|
|
|
|
|
|
|
|
|
Number of
|
|
|
|
|
|
|
|
|
|
|
|
securities
|
|
|
|
|
|
|
|
|
|
|
|
remaining
|
|
|
|
(a)
|
|
|
(b)
|
|
|
available for
|
|
|
|
Number of
|
|
|
Weighted-
|
|
|
future issuance
|
|
|
|
securities to be
|
|
|
average
|
|
|
under equity
|
|
|
|
issued upon
|
|
|
exercise price
|
|
|
compensation
|
|
|
|
exercise of
|
|
|
per share of
|
|
|
plans
|
|
|
|
outstanding
|
|
|
outstanding
|
|
|
(excluding
|
|
|
|
options,
|
|
|
options,
|
|
|
securities
|
|
|
|
warrants and
|
|
|
warrants and
|
|
|
reflected in
|
|
Plan Category
(1)
|
|
rights
|
|
|
rights
|
|
|
column (a))
|
|
Equity compensation plans approved by security holders
|
|
|
1,649,728
|
|
|
$
|
2.28
|
|
|
|
864,940
|
|
Equity compensation plans not approved by security holders
(2)
|
|
|
313,122
|
|
|
$
|
6.83
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
1,962,850
|
|
|
$
|
3.00
|
|
|
|
864,940
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
A narrative description of the material terms of our equity compensation plans is
set forth in Note 9 to our consolidated financial statements for the year ended December
31, 2007.
|
|
(2)
|
|
In addition, we have made grants outside of our equity plans and have outstanding
options exercisable for 313,122 shares of our common stock. These options were granted as
an inducement for employment or for the rendering of consulting services.
|
Recent Sales of Unregistered Securities
None.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ISSUER PURCHASES OF EQUITY SECURITIES DURING THE FOURTH QUARTER OF 2007
(1)
|
|
|
|
|
|
|
|
|
|
|
|
(c)
|
|
|
(d)
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
Approximate
|
|
|
|
|
|
|
|
|
|
|
|
Number of
|
|
|
Dollar
|
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Value of
|
|
|
|
|
|
|
|
|
|
|
(or Units)
|
|
|
Shares
|
|
|
|
(a)
|
|
|
(b)
|
|
|
Purchased
|
|
|
(or Units) that
|
|
|
|
Total
|
|
|
Average
|
|
|
as Part of
|
|
|
May Yet Be
|
|
|
|
Number
|
|
|
Price Paid
|
|
|
Publicly
|
|
|
Purchased
|
|
|
|
of Shares
|
|
|
per
|
|
|
Announced
|
|
|
Under the
|
|
|
|
(or
Units)
|
|
|
Share
|
|
|
Plans or
|
|
|
Plans or
|
|
Period
|
|
Purchased
(2)
|
|
|
(or Unit) (3)
|
|
|
Programs
|
|
|
Programs
|
|
10/1/2007 - 10/31/2007
|
|
|
163,199
|
|
|
$
|
4.18
|
|
|
|
163,199
|
|
|
$
|
0
|
|
Total
|
|
|
163,199
|
|
|
$
|
4.18
|
|
|
|
163,199
|
|
|
$
|
0
|
|
|
|
|
(1)
|
|
Our stock repurchase program was announced on September 20, 2007. Our board of
directors unanimously authorized the repurchase of up to $1.5 million of our common
stock over a four month period.
|
|
(2)
|
|
All shares were purchased through our 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.
|
45
Performance Graph
The following graph compares our cumulative total stockholder return since the date our common stock began trading
on the Nasdaq Stock Market on February 9, 2007 with the the Russell 2000 Stock Index, Nasdaq Stock Market
®
-
U.S., and the AMEX U.S. The graph assumes that the value of the investment in our common stock and each index was
$100 on February 9, 2007. We caution that the stock performance shown in the graph below is not indicative of or
intended to forecast our potential future performance.
Comparison of Cumulative Total Return
Based on Investment of $100
February 9, 2007 December 31, 2007
Notwithstanding anything to the contrary set forth in any of our previous or future filings under the Securities
Act of 1933, as amended, or Securities Exchange Act of 1934, as amended, that might incorporate this Annual Report on
Form 10-K or future filings made by us under those statutes, the Stock Performance Graph shall not be deemed filed with
the Securities and Exchange Commission and shall not be deemed incorporated by reference into any of those prior
filings or into any future filings made by us under those statutes.
46
ITEM 6. SELECTED FINANCIAL DATA
VeriChip Corporation
The following table sets forth our consolidated financial data with respect to each of the
five years in the period ended December 31, 2007. The selected financial data at December 31, 2007
and 2006, and for the three years ended December 31, 2007, have been derived from, and should be
read in conjunction with, our audited consolidated financial statements and related notes appearing
elsewhere in this Annual Report on Form 10-K. The selected financial data at December 31, 2004 and
2003, and for the fiscal year ended December 31, 2003, have been derived from our audited financial
statements which are not included in this Annual Report on Form 10-K. The information below should
be read in conjunction with Managements Discussion and Analysis of Financial Condition and
Results of Operations, included in Item 7 of the Annual Report on Form 10-K.
We acquired two businesses during the first half of 2005 and, accordingly, our historical
results only include their results of operations since their respective dates of acquisition. The
pro forma results reflected below give effect to the acquisitions of these two businesses as if
they had occurred on January 1, 2005.
Consolidated Statements of Operations Data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
|
|
|
|
|
|
|
|
2005 Pro
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
forma
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
|
Historical
|
|
|
Historical
|
|
|
(unaudited)
|
|
|
Historical
|
|
|
Historical
|
|
|
Historical
|
|
|
|
(in thousands, except per share data)
|
|
Consolidated Statements of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
32,106
|
|
|
$
|
27,304
|
|
|
$
|
24,554
|
|
|
$
|
15,869
|
|
|
$
|
247
|
|
|
$
|
545
|
|
Total cost of products and services
|
|
|
14,960
|
|
|
|
11,779
|
|
|
|
10,332
|
|
|
|
6,395
|
|
|
|
199
|
|
|
|
200
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
17,146
|
|
|
|
15,525
|
|
|
|
14,222
|
|
|
|
9,474
|
|
|
|
48
|
|
|
|
345
|
|
Selling, general and administrative
|
|
|
23,514
|
|
|
|
17,620
|
|
|
|
16,990
|
|
|
|
12,442
|
|
|
|
1,930
|
|
|
|
1,977
|
|
Research and development
|
|
|
4,678
|
|
|
|
3,786
|
|
|
|
3,260
|
|
|
|
1,958
|
|
|
|
|
|
|
|
|
|
Other income
|
|
|
(222
|
)
|
|
|
(57
|
)
|
|
|
(83
|
)
|
|
|
(63
|
)
|
|
|
(15
|
)
|
|
|
|
|
Interest expense
|
|
|
1,698
|
|
|
|
868
|
|
|
|
343
|
|
|
|
343
|
|
|
|
144
|
|
|
|
78
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before benefit for income taxes
|
|
|
(12,966
|
)
|
|
|
(6,692
|
)
|
|
|
(6,288
|
)
|
|
|
(5,206
|
)
|
|
|
(2,011
|
)
|
|
|
(1,710
|
)
|
(Benefit from) provision for income taxes
|
|
|
(1,056
|
)
|
|
|
33
|
|
|
|
(761
|
)
|
|
|
56
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(11,910
|
)
|
|
|
(6,725
|
)
|
|
|
(5,527
|
)
|
|
|
(5,262
|
)
|
|
|
(2,011
|
)
|
|
|
(1,710
|
)
|
Deemed dividends
|
|
|
|
|
|
|
|
|
|
|
(1
|
)
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common stockholder
|
|
$
|
(11,910
|
)
|
|
$
|
(6,725
|
)
|
|
$
|
(5,528
|
)
|
|
$
|
(5,263
|
)
|
|
$
|
(2,011
|
)
|
|
$
|
(1,710
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common stockholder per
common share- basic and diluted
|
|
$
|
(1.36
|
)
|
|
$
|
(1.21
|
)
|
|
$
|
(0.99
|
)
|
|
$
|
(1.00
|
)
|
|
$
|
(0.45
|
)
|
|
$
|
(0.38
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares
outstanding: Basic and diluted
|
|
|
8,756
|
|
|
|
5,556
|
|
|
|
5,556
|
|
|
|
5,279
|
|
|
|
4,444
|
|
|
|
4,444
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
|
Historical (in thousands)
|
|
Consolidated Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
7,250
|
|
|
$
|
996
|
|
|
$
|
1,440
|
|
|
$
|
23
|
|
|
$
|
269
|
|
Equipment, net of accumulated depreciation and amortization
|
|
|
952
|
|
|
|
950
|
|
|
|
890
|
|
|
|
131
|
|
|
|
147
|
|
Goodwill
|
|
|
15,776
|
|
|
|
16,025
|
|
|
|
16,982
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
|
49,998
|
|
|
|
50,888
|
|
|
|
48,438
|
|
|
|
283
|
|
|
|
782
|
|
Long-term debt
|
|
|
10,753
|
|
|
|
13,635
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total debt
|
|
|
14,435
|
|
|
|
14,488
|
|
|
|
6,975
|
|
|
|
4,221
|
|
|
|
2,864
|
|
Stockholders equity (deficit)
|
|
|
25,591
|
|
|
|
22,345
|
|
|
|
28,527
|
|
|
|
(4,012
|
)
|
|
|
(2,258
|
)
|
47
EXI Wireless Inc.
We have presented the following selected consolidated financial data for EXI Wireless Inc.
because EXI Wireless is considered to be a predecessor of ours. The information presented is for
periods prior to our acquisition of EXI Wireless. We acquired EXI Wireless effective March 31,
2005.
You should read the following selected consolidated financial data in conjunction with the EXI
Wireless consolidated financial statements and related notes and Item 7. Managements Discussion
and Analysis of Financial Condition and Results of Operations appearing elsewhere in this Annual
Report on Form 10-K. The consolidated statements of operations and balance sheet data at and for
the years ended December 31, 2004, 2003, and 2002, and at and for the three months ended March 31,
2005, are derived from the EXI Wireless audited consolidated financial statements.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months
|
|
|
|
|
|
|
ended
|
|
|
|
|
|
|
March 31,
|
|
|
Year Ended December 31,
|
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
|
(in thousands)
|
|
Consolidated Statements of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
1,986
|
|
|
$
|
6,004
|
|
|
$
|
6,118
|
|
|
$
|
6,383
|
|
Cost of sales
|
|
|
575
|
|
|
|
1,763
|
|
|
|
1,735
|
|
|
|
1,754
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
1,411
|
|
|
|
4,241
|
|
|
|
4,383
|
|
|
|
4,629
|
|
Selling, general and administrative expense and depreciation and amortization
|
|
|
1,355
|
|
|
|
3,524
|
|
|
|
3,222
|
|
|
|
3,276
|
|
Research and development
|
|
|
262
|
|
|
|
918
|
|
|
|
741
|
|
|
|
728
|
|
Interest and other income
|
|
|
(2
|
)
|
|
|
(17
|
)
|
|
|
(4
|
)
|
|
|
(7
|
)
|
Foreign exchange loss (gain)
|
|
|
(18
|
)
|
|
|
169
|
|
|
|
334
|
|
|
|
36
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss) before income taxes
|
|
|
(186
|
)
|
|
|
(353
|
)
|
|
|
90
|
|
|
|
596
|
|
Benefit from income taxes
|
|
|
|
|
|
|
(24
|
)
|
|
|
(55
|
)
|
|
|
(75
|
)
|
Loss from discontinued operations net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(512
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
(186
|
)
|
|
|
(329
|
)
|
|
|
145
|
|
|
|
159
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
Consolidated Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
|
554
|
|
|
|
1,127
|
|
|
|
1,025
|
|
|
|
1,296
|
|
Property, plant and equipment
|
|
|
191
|
|
|
|
189
|
|
|
|
294
|
|
|
|
318
|
|
Goodwill
|
|
|
1,441
|
|
|
|
1,450
|
|
|
|
1,348
|
|
|
|
1,103
|
|
Total assets
|
|
|
4,975
|
|
|
|
5,338
|
|
|
|
5,203
|
|
|
|
4,847
|
|
Long-term debt
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months
|
|
|
|
|
|
|
ended
|
|
|
|
|
|
|
March 31,
|
|
|
Year Ended December 31,
|
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
Total debt
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders equity
|
|
|
3,971
|
|
|
|
4,025
|
|
|
|
4,070
|
|
|
|
3,184
|
|
48
Instantel Inc.
We have presented the following selected consolidated financial data for Instantel Inc.
because Instantel is considered to be a predecessor of ours. The information presented is for
periods prior to our acquisition of Instantel. We acquired Instantel effective June 10, 2005.
You should read the following selected consolidated financial data in conjunction with
Instantels consolidated financial statements and related notes and Item 7. Managements
Discussion and Analysis of Financial Condition and Results of Operations appearing elsewhere in
this Annual Report on Form 10-K. The consolidated statements of operations and balance sheet data
at and for the years ended December 31, 2004, 2003, and 2002, and at and for the period ended June
9, 2005, are derived from Instantels audited financial statements.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Period Ended
|
|
|
|
|
|
|
June 9,
|
|
|
Year Ended December 31,
|
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
|
(in thousands)
|
|
Consolidated Statements of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
6,759
|
|
|
$
|
13,595
|
|
|
$
|
11,382
|
|
|
$
|
11,344
|
|
Cost of goods sold
|
|
|
3,226
|
|
|
|
5,450
|
|
|
|
4,645
|
|
|
|
4,430
|
|
Gross profit
|
|
|
3,533
|
|
|
|
8,145
|
|
|
|
6,737
|
|
|
|
6,914
|
|
Selling, general and administrative expense
|
|
|
4,205
|
|
|
|
6,928
|
|
|
|
6,281
|
|
|
|
6,447
|
|
Research and development
|
|
|
1,040
|
|
|
|
1,688
|
|
|
|
1,397
|
|
|
|
1,138
|
|
Interest and other income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
367
|
|
|
|
943
|
|
|
|
1,055
|
|
|
|
1,265
|
|
Loss before income taxes
|
|
|
(2,079
|
)
|
|
|
(1,414
|
)
|
|
|
(1,996
|
)
|
|
|
(1,935
|
)
|
Benefit from income taxes
|
|
|
(1,221
|
)
|
|
|
(660
|
)
|
|
|
(795
|
)
|
|
|
(697
|
)
|
Net loss
|
|
|
(858
|
)
|
|
|
(754
|
)
|
|
|
(1,201
|
)
|
|
|
(1,238
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At June 9,
|
|
|
At December 31,
|
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
2002
|
|
|
|
(in thousands)
|
|
Consolidated Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
4
|
|
|
$
|
46
|
|
|
$
|
167
|
|
|
$
|
659
|
|
Property and Equipment
|
|
|
493
|
|
|
|
474
|
|
|
|
278
|
|
|
|
273
|
|
Goodwill
|
|
|
593
|
|
|
|
593
|
|
|
|
593
|
|
|
|
593
|
|
Total Assets
|
|
|
10,280
|
|
|
|
11,593
|
|
|
|
14,418
|
|
|
|
17,925
|
|
Long-term debt
|
|
|
|
|
|
|
5,500
|
|
|
|
5,500
|
|
|
|
8,633
|
|
Total debt
|
|
|
6,214
|
|
|
|
6,087
|
|
|
|
8,133
|
|
|
|
9,892
|
|
Stockholders (deficit) equity
|
|
|
(222
|
)
|
|
|
634
|
|
|
|
1,382
|
|
|
|
2,463
|
|
49
ITEM 7. 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 Selected Financial Data and our audited annual financial
statements and the notes to those financial statements included elsewhere in this Annual Report on
Form 10-K. Our discussion contains forward-looking statements based upon current expectations that
involve risks and uncertainties. Our actual results and the timing of events could differ
materially from those anticipated in, or implied by, these forward-looking statements as a result
of various factors, including those set forth under Item 1A. Risk Factors, Item 1. Business,
and elsewhere in this Annual Report on
Form 10-K
. Due to our limited operating history and our
acquisition of two Canadian-based businesses in the first half of 2005 which significantly expanded
our operations and product offerings, period to period comparisons of or changes in financial data
are not necessarily indicative of, and you should not rely upon them as an indicator of, our future
financial performance.
Overview
Our History
We were formed as a Delaware corporation by Digital Angel in November 2001. In January 2002,
we began our efforts to create a market for our RFID systems that utilize our human-implantable
microchip. These efforts included obtaining FDA clearance, which occurred in October 2004, of our
VeriMed system for use for patient identification and health information purposes. Digital Angel
owned over 90% of our stock as of December 31, 2006. On February 14, 2007, we completed our
initial public offering in which we sold 3,100,000 shares of our common stock. As a result, Digital
Angel owned approximately 50.8% of our common stock on December 31, 2007.
On March 31, 2005, Digital Angel acquired EXI Wireless through a plan of arrangement under
which Digital Angel issued 3,388,407 shares of its common stock valued at approximately $11.7
million to EXI Wireless shareholders. In addition, all outstanding EXI Wireless options and
warrants were converted into options or warrants exercisable for shares of Digital Angels common
stock. The value of the options and warrants exchanged was approximately $0.7 million. Included in
the aggregate $13.3 million purchase price was approximately $0.9 million of acquisition costs
consisting primarily of a finders fee and legal and accounting related services that were direct
costs of the acquisition. Digital Angel contributed EXI Wireless to us effective March 31, 2005
under the terms of an exchange agreement dated June 9, 2005, in consideration for approximately 1.1
million shares of our common stock.
On June 10, 2005, we acquired Instantel under the terms of a share purchase agreement. The
purchase price for Instantel was $24.5 million payable in two installments. Digital Angel funded
the initial purchase price payment of $22.0 million with such funding being recorded as a capital
contribution to us. In September 2006, the sellers of Instantel exercised their election to receive
the second purchase price payment in cash. Accordingly, in 2006 we paid the sellers $2.1 million,
which amount reflected a holdback of $0.4 million for an indemnification claim we have asserted
against the sellers of Instantel. We funded this payment through borrowings under our loan
agreement with Digital Angel. A final payment of approximately $0.2 million was made upon
resolution of the indemnification claim. In addition, we incurred approximately $0.3 million in
acquisition costs. Under the terms of the share purchase agreement, Instantel became a wholly-owned
subsidiary of VeriChip Holdings, Inc., or VHI.
In January 2006, we effected an amalgamation of Instantel and the former EXI Wireless
subsidiaries under Canadian law. The combined entities operated as a wholly-owned subsidiary of VHI
under the name VeriChip Corporation, which in April 2007 was changed to Xmark Corporation, or
Xmark. On January 1, 2008, VHI and Xmark were amalgamated with Xmark surviving.
50
Recent Events
During the fourth quarter ended December 31, 2007 and through the date of this Annual Report
on Form 10-K, we have had the following recent and other events that have had or could have a
significant affect on our results of operations and cash flows:
On December 20, 2007, we entered into a letter agreement with Digital Angel (the December
2007 Letter Agreement) under which we may pay all principal amounts outstanding, at a discount,
under the Third Amended and Restated Revolving Line of Credit Note, dated February 8, 2007,
executed by us in favor of Digital Angel. See, Liquidity and Capital Resources Credit
Facilities, below for more information.
On February 29, 2008, we entered into a $8.0 million debt financing with Valens Offshore SPV
II, Corp. and entered into a letter agreement with Digital Angel, which amends certain financing
terms under the Third Amended and Restated Revolving Line of Credit Note and the December 2007
Letter Agreement. See, Liquidity and Capital Resources Credit Facilities, below for more
information.
On August 31, 2007 we entered into a Registration Rights Agreement with Kallina Corporation,
or Kallina, in connection with the execution of a Securities Purchase Agreement between Digital
Angel and Kallina under which Digital Angel transferred to Kallina 200,000 shares of our common
stock that Digital Angel owned (the Grant Shares). The Registration Rights Agreement required
that we register the Grant Shares for resale by Kallina. On February 29, 2008, we, Kallina and two
entities to which Kallina assigned a portion of its interest in the Registration Rights Agreement,
entered into a Letter Agreement. The Letter Agreement terminates the Registration Rights Agreement
and provides that we will file a registration statement for the Grant Shares after April 30, 2008
only if Kallina or its assigns are unable to sell the Grant Shares pursuant to an exemption to
registration under Rule 144 of the Securities Act of 1933.
On January 11, 2008, Daniel E. Penni and Constance K. Weaver resigned as members of our Board
of Directors. Barry M. Edelstein and Steven R. Foland were appointed on February 11, 2008 and
February 21, 2008, respectively, to serve on our Board of Directors.
Our Business
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 Annual Report on 10-K has been
reclassified to reflect the segment realignment.
Healthcare Security Segment
Our healthcare security segment encompasses the development, marketing and sale of our
healthcare and patient identification systems, specifically:
|
|
|
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
|
|
|
|
|
an asset/personnel location and identification system used by hospitals
and other healthcare facilities to identify, locate and protect medical staff,
patients, visitors and medical equipment.
|
Infant Protection Systems
Our infant protection systems are sold through dealers. Under the terms of our dealer
agreements, our dealers are responsible for system installation and post-sale customer service and
system maintenance. We derive revenue from the sale of the systems, specifically the tags,
bracelets, anklets and wristbands, receivers, the computer hardware and application software. The
average sales price of our infant protection systems generally ranges from $30,000 to $40,000.
However, system prices can vary widely depending on the hardware and software requirements of the
particular system installation, the number of RFID transponders or tags needed in a particular
installation, the desired level of integration with a facilitys existing communication and
security systems, the size and general layout or floor plan of the facility and the number of
egress points in the facility that need to be covered by the
system. The RFID tags, bracelets, anklets, wristbands and receivers that are component parts
of our infant protection systems are consumable items. During the year ended December 31, 2007,
revenue from consumables represented approximately 36% of our aggregate infant protection revenue.
51
We believe that the global market for infant protection products, including consumables, is
currently growing at approximately 10-15% per year. The United States currently accounts for more
than 95% of the global market for infant protection systems. There are approximately 3,800 birthing
hospitals in the United States. We estimate that infant security systems have been implemented in
approximately half of these facilities. Approximately 1,300 U.S. hospitals and birthing centers use
our infant protection systems. We believe that growth opportunities exist among the remaining
facilities that do not yet have infant protection systems in place, as well as through replacement
of legacy systems. Presently, approximately half of our infant protection system sales are
replacement system sales.
The Joint Commission on Accreditation of Healthcare Organizations, or JCAHO, has begun to
recommend the installation of electronic security systems in hospitals pediatric departments.
Although this is a largely untapped market, we believe that we can leverage our existing end-use
customer base and expand such customers infant protection systems into pediatrics.
Wander Prevention Systems
We sell our wander prevention systems through dealers. As with our dealer agreements for our
infant protection systems, our dealer agreements for our wander prevention systems provide that our
dealers are responsible for system installation and post-sale customer service and system
maintenance. We derive revenues from the sale of the systems, specifically the tags, bracelets,
anklets and wristbands, receivers, the computer hardware and application software. The average
sales price of our wander prevention systems generally ranges from $8,000 to $10,000. However, as
with our infant protection systems, system prices can vary. The RFID tags and wristbands that are
component parts of our wander prevention systems are consumable items. During the year ended
December 31, 2007, revenue from consumables represented approximately 39% of our aggregate wander
prevention revenue.
We estimate that within the United States RFID-type wander prevention systems are currently
installed in approximately 30% of the more than 52,000 nursing homes and assisted living
facilities. While the nursing home segment is fairly well penetrated, we believe that existing and
future state regulations applicable to long-term facilities, which include security and wander
prevention requirements, will continue to drive growth in demand for wander prevention systems for
the next several years. We also believe that our wander prevention business will benefit from key
demographic trends. In that regard, the U.S. Census Bureau has estimated that the 65 and older
population in the United States will reach 70 million people by the year 2030. An estimated half of
all elderly people now require nursing home care in their lifetime, with the highest use occurring
after age 85. We believe the aging of the U.S. population, combined with the increased prevalence
of Alzheimers (nearly half of all nursing home residents have Alzheimers or a related disorder),
we believe has caused nursing homes and assisted living facilities to place increased emphasis on
wander prevention systems. In light of the problems that exist in controlling residents suffering
from dementia or Alzheimers, a number of assisted living facilities are building special wings to
accommodate such residents special needs.
Asset/Personnel Location and Identification Systems
Through March 17, 2008, a limited number of our asset/personnel location and identification
systems have been sold and installed. Those systems were sold through two dealers on a private
label basis. We are in the process of building out our distribution network for our asset/personnel
location and identification system and providing the requisite training to certain dealers in an
effort to be at the forefront of the emerging market for such systems in the healthcare sector.
We expect the sales price for our asset/personnel location and identification system will vary
widely based on the level of system implementation and specific application of each system. For
instance, the number of departments within a healthcare facility, the desired resolution, such as
the degree of precision in location, and the
number of asset/personnel tags required will have a significant impact on the price of a
system. Based on our system sales to date, we expect the average system sales price will be between
$175,000 to $225,000.
52
According to a report prepared by IDTechEx, a United Kingdom-based consulting firm, over the
next ten years the second-largest RFID application, by value, within the healthcare industry will
be real-time location systems for staff, patients, visitors and assets. The largest RFID
application is anticipated to be item-level tagging of pharmaceuticals. IDTechEx predicts that
these two applications, on a combined basis, will represent an $800 million market by 2016. We
believe that it is important for our asset/personnel location and identification system to capture
market share in the emerging market for real-time location and identification systems in the
healthcare industry within the next 12-24 months, as we expect that a significant factor in
hospitals choice of system vendors will be referrals to other healthcare facilities that have
deployed, and are pleased with, such systems. To achieve this, we will need to be on the forefront
of the effort to educate healthcare industry professionals regarding the benefits, including the
return on investment, we believe can be achieved through implementation of RFID location and
identification systems.
Implantable Segment
The principal offering of our implantable segment is our VeriMed patient identification system
using the implantable microchip, a human-implantable RFID microchip that can be used in a variety
of patient identification applications. Each implantable microchip contains a unique verification
number that is read when it is scanned by our scanner. In October 2004, the FDA cleared our VeriMed
system for use in medical applications in the United States.
For information relating to the risks associated with our implantable segment, see Item 1A.
Risk FactorsRisks Related to Our Businesses Which Utilize the Implantable Microchip.
VeriMed Patient Identification System
Through December 31, 2007, we have generated less than $0.1 million in revenue from our
VeriMed system, primarily from the sale of the implantable microchip inserter kits.
Currently, we are providing scanners to hospitals and third party emergency room management
companies at no charge in order to build out the geographic footprint of the healthcare facilities
that can and will use our VeriMed system as part of their standard protocol. The cost of the
scanners, which was approximately $46,000 in 2007 and approximately $57,000 in 2006, is included as
selling, general and administrative expense in our consolidated statements of operations included
elsewhere in this Annual Report on Form 10-K. We expect to continue this seeding process for the
foreseeable future as we endeavor to build out our network across the United States and overseas.
Ultimately, we intend to sell our scanners directly to hospitals, third-party emergency room
management companies and other potential users of our VeriMed system, such as emergency medical
technicians and other emergency personnel outside the hospital emergency room setting, and to sell
our implantable microchips and scanners to doctors, primarily through distributors. At the time
that we begin selling scanners, the cost of the scanners will be reflected in cost of products sold
in our consolidated statements of operations.
Systems Incorporating the Implantable Microchip for Other Applications
We have recently begun to market our VeriTrace system which uses our implantable microchip and
wirelessly integrates with a Ricoh
®
digital camera for accurate tagging and
identification of human remains and associated evidentiary items.
Since our VeriTrace system, like our VeriMed system, incorporates our implantable microchip,
many of the risks associated with the VeriMed system apply to VeriTrace system, including the risk
of possible third-party claims asserting we are violating rights with respect to certain patented
intellectual property underlying each of these systems. We do not anticipate generating more than
nominal revenues from the sale of the VeriTrace system prior to the expiration of the patent in
April 2008.
53
Industrial Segment
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; and
|
|
|
|
|
asset management systems used by industrial companies to manage and track
their mobile equipment and tools.
|
Vibration Monitoring Instruments
Sales of vibration monitoring instruments currently represent the primary source of revenue in
our industrial segment. We sell our vibration monitoring instruments through an independent network
of approximately 75 dealers, approximately half of which operate in North America. The average
sales price of our vibration monitoring instruments ranges from $4,500 to $5,000. We also generate
revenues from rendering post-sale calibration services, typically performed annually. On a
historical basis, revenues from these services have represented approximately 20% of our instrument
sales.
Our vibration monitoring business is currently the most international of our business
activities. We have a strong market presence in North America, Southeast Asia, India and
Scandinavia, and a growing market presence in South Africa, Europe and Australia. We believe the
greater geographical diversity of this business serves as a buffer against declines in construction
and mining activity in any one geographic area or region, though this business continues to be
influenced by changes in global economic activity.
We are in the process of developing and introducing a new instrumentation platform. The new
platform will replace our existing platforms for our vibration monitoring instruments, for which we
are facing certain manufacturing challenges due to the discontinuation and unavailability of key
components. We believe the new platform, when completed, will better integrate with contemporary
data communications protocols so as to improve our products remote monitoring capabilities. In
addition, we expect the new platform will entail the addition of several sensors and peripherals
that will enhance the ability to monitor additional environmental and structural parameters related
to vibration and overpressure monitoring.
Asset Management Systems
We sell our entry-level asset management systems through our direct sales force at price
points that vary widely based on the size and scope of the system. We are currently in the process
of selling our ToolHound business and expect to exit the business by mid 2008. The sale of the
ToolHound business is not expected to have a material impact on our financial condition, results of
operations or cash flows.
Basis of Presentation
For the reasons discussed below, our historical consolidated financial statements included
elsewhere in this Annual Report on Form 10-K, and those of the businesses acquired in the first
half of 2005, are not necessarily indicative of our future operating results or financial
condition. You should not rely upon such financial statements as an indicator of our future
financial performance.
Our Acquisitions of the Businesses Located in Canada
On March 31, 2005 and June 10, 2005, we acquired two businesses located in Canada that were
primarily engaged in the development, marketing and sale of healthcare security systems utilizing
RFID technology. Prior to that time, our operations were comprised of efforts to create markets for
our human-implantable microchip. As a result of these acquisitions, we acquired approximately $21.5
million of intangible assets and recorded approximately $16.0 million of goodwill. Of the
intangible assets acquired, approximately $5.4 million represents patented and non-patented
proprietary technology that is being amortized in cost of products sold on a straight line
basis over finite lives ranging from 11.8 to 12.3 years. Approximately $11.1 million
represents customer relationships and distribution networks with finite lives ranging from 4-10
years. These intangible assets are being amortized on a straight line basis as selling, general and
administrative expense. The remaining $4.9 million of intangible assets acquired represents
trademarks with indefinite lives.
54
Efforts to Create Markets for Our Systems that Utilize the Implantable Microchip
For the next several years, we expect that we will generate significant operating losses in
connection with our efforts to create markets for our systems that utilize the implantable
microchip. Our expectations in this regard reflect our belief that revenue derived from sales of
our VeriMed system will remain at a nominal level or show only modest growth in revenue from the
sale of the system prior to government and private insurers determinations to reimburse the cost
of the microchip implant procedure. However, we can provide no assurance as to when or if
government or private insurers will decide to take such action. The expected significant operating
losses from our systems which utilize the implantable microchip, and in particular, the VeriMed
system, also reflect an anticipated increase in our selling, general and administrative expenses as
we augment our direct sales force, seek to develop a distribution network for the VeriMed system,
enhance our marketing efforts directed toward physicians and patients, and fund or otherwise
facilitate clinical studies of the VeriMed system that we hope prove successful in demonstrating
the efficacy of the system to fulfill its intended functions. While we anticipate that we will
continue to generate operating profits from our Xmark business, on a consolidated basis we expect
to incur operating losses for at least the next 12-24 months.
Transition Services Agreement with Digital Angel
Digital Angel currently provides certain general and administrative support to us. We and
Digital Angel entered into an amended and restated transition services agreement, which became
effective upon the consummation of our initial public offering in February 2007, under which
Digital Angel has agreed to provide this support through February 14, 2009, subject to earlier
termination of the agreement. Under the agreement, we are obligated to reimburse Digital Angel for
providing us with certain administrative transition services and related expenses, including
payroll, legal, finance, accounting, information technology, and tax services, and services related
to our initial public offering. We anticipate that the aggregate cost of such services in 2008 and
subsequent years during the term of the agreement will be approximately $0.1 million per year for
fixed costs, such as insurance, rent, payroll services, legal and accounting services, or, if we
elect, prior to the end of the term of the agreement, we will be responsible for providing these
services internally or engaging third parties, which may result in an increase in selling, general
and administrative expense. We believe that the cost of these services reflects an amount
consistent with what we would have to pay to independent parties.
Critical Accounting Policies and Estimates
The following is a description of the accounting policies that our management believes involve
a high degree of judgment and complexity, and that, in turn, could materially affect our
consolidated financial statements if various estimates and assumptions made in connection with the
application of such policies were changed significantly. The preparation of our consolidated
financial statements requires that we make certain estimates and judgments that affect the amounts
reported and disclosed in our consolidated financial statements and related notes. We base our
estimates on historical experience and on other assumptions that we believe to be reasonable under
the circumstances. Actual results may differ from these estimates. For more detailed information on
our significant accounting policies, see Note 1 to our audited consolidated financial statements as
of and for the year ended December 31, 2007, included elsewhere in this Annual Report on Form 10-K.
Revenue Recognition
Our revenue recognition policies provide very specific and detailed guidelines in measuring
revenue; however, certain estimates and judgments affect the application of our revenue recognition
policies. The complexity of the estimation process and all issues related to the assumptions, risks
and uncertainties inherent in our revenue recognition policies affect the amounts reported in our
financial statements. A number of internal and external factors affect the timing of our revenue
recognition, including estimates of customer returns and the timing of customer acceptance.
55
Revenue Recognition Policy for Our Healthcare Security Systems and Industrial Systems
We recognize revenue from the sale of the hardware and software components of our healthcare
security and asset management systems, as well as our vibration monitoring instruments, when the
following criteria are met:
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persuasive evidence of an arrangement exists (e.g., a purchase order has
been received or a contract has been executed);
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the system components are shipped;
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title has transferred;
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the price is fixed or determinable; and
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collection of the sales proceeds is reasonably assured.
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Revenue from software implementation and consulting services is recognized as the services are
performed. Revenue from post-contract support services is recognized over the term of the service
agreement.
When software arrangements include multiple elements to which contract accounting does not
apply, the individual elements are accounted for separately if vendor specific objective evidence,
or VSOE, of fair value exists for the undelivered elements. Generally, the residual method is
applied in allocating revenue between delivered and undelivered elements. If VSOE does not exist,
the revenue associated with the entire agreement is deferred until the earlier of VSOE being
established or all of the undelivered elements are delivered or performed with the following
exceptions:
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If the only undelivered element is post-contract support, the deferred
amount is recognized ratably over the post-contract support period.
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If the only undelivered element is services that do not require
significant production, modification or customization of the software, the deferred
amount is recognized as the services are performed.
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Maintenance revenue is deferred and recognized ratably over the terms of the maintenance
agreements.
Revenue Recognition Policy for Systems Using Our Implantable Microchip
Revenue from the sale of systems using our implantable microchip are recorded at gross
amounts. As we are in the initial process of commercializing these systems, the level of
distributor or physician returns cannot yet be reasonably estimated. Accordingly, we do not
recognize revenues until the following criteria are met:
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a purchase order has been received or a contract has been executed;
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the product is shipped;
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title has transferred;
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the price is fixed or determinable;
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there are no uncertainties regarding customer acceptance;
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collection of the sales proceeds is reasonably assured; and
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the period during which the distributor or physician has a right to
return the product has elapsed.
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56
We intend to recognize revenue from consignment sales, if any, when all of the criteria listed
above have been met and after the receipt of notification of such product sales from the
distributors customers (e.g., physicians). Once the level of returns can be reasonably estimated,
revenues (net of expected returns) will be recognized when all of the criteria above are met for
either direct or consignment sales.
Revenue Recognition Policy for VeriMed Services
The services for maintaining subscriber information on our VeriMed database will be sold on a
stand-alone contract basis, separate and apart from the implant procedure itself, and treated
according to the terms of the contractual arrangements then in effect. Revenue from the database
service will be recognized over the term of the subscription period or the terms of the contractual
arrangements then in effect.
With respect to the sales of products whose functionality is dependent on services (e.g.,
database records maintenance), the revenue recognition policy will follow the ultimate
arrangements, subject to the aforementioned revenue recognition criteria and determining whether
there is VSOE.
Inventory
Estimates are used in determining the likelihood that inventory on hand can be sold.
Historical inventory usage and current revenue trends are considered in estimating both
obsolescence and slow-moving inventory. Inventory is stated at the lower of cost or market,
determined by the first-in, first-out method, net of any reserves for obsolete or slow-moving
inventory. As of December 31, 2007, 2006 and 2005, inventory reserves were $0.6 million, $0.2
million and $0.1 million, respectively. The estimated market value of our inventory is based upon
assumptions about future demand and market conditions. If actual market conditions are less
favorable than those projected by management, additional inventory write-downs may be required,
which could have a material effect on our financial condition and results of operations.
Goodwill and Other Intangible Assets
We account for goodwill and other intangible assets in accordance with Statement of Financial
Accounting Standard (FAS) No. 142,
Goodwill and Other Intangible Assets
, or FAS 142. FAS 142
eliminated the amortization of goodwill and other intangible assets with indefinite lives and
instead requires that goodwill and other intangible assets with indefinite lives be tested for
impairment at least annually. Intangible assets with finite lives are amortized over their useful
lives.
In accordance with FAS 142, we are required to test our goodwill and intangible assets with
indefinite lives for impairment annually. We test our goodwill and intangible assists with
indefinite lives annually as part of our business planning cycle during the fourth quarter of each
fiscal year. The determination of the value of our intangible assets requires management to make
estimates and assumptions about the future operating results of our reporting units, as that term
is defined in FAS 142. Our reporting units are those businesses for which discrete financial
information is available and upon which segment management makes operating decisions. As of
December 31, 2007, we operated in three reporting segments: healthcare security, implantable and
industrial. As of December 31, 2004, we did not have goodwill or other intangible assets. However,
as a result of the acquisitions of the two Canadian-based businesses during the first half of 2005,
as of December 31, 2007, our consolidated goodwill was $15.8 million and the value of our
intangible assets with indefinite lives totaled $4.9 million.
In the fourth quarter of 2007, we tested our goodwill and other intangible assets at each
reporting unit level in accordance with FAS 142. The fair value of our reporting units,
substantially all of the operations of which were acquired during 2005, was based on valuations
prepared by management. Based on these assessments, there was no impairment of goodwill and other
intangible assets at December 31, 2007.
Our intangible assets with indefinite lives consist of trademarks, acquired in connection with
the acquisition of our Xmark business. In determining the value of these trademarks, we employed
the income approach. We used the discounted cash flow method to calculate the present value of the
projected income from the product lines to which the EXI Wireless and Instantel trademarks relate.
In our valuation model, we considered the relief
from royalty concept, which assumes that if a company owns a trademark it does not have to
rent one and therefore is relieved from paying a royalty. The amount of the phantom payment
(after-tax) is used as a surrogate for income attributable to the trademark.
57
In valuing these trademarks, we applied a market-based royalty rate to projections of revenue
for the various product lines to which the trademarks relate. The projected royalty cash flows, on
an after-tax basis, were discounted to present value using a discount rate that adequately
reflected the inherent risks of such cash flows. We applied what we believe to be appropriate
discount rates, ranging from 17.0% to 23.7%, and used a terminal revenue growth rate of 5%.
Future events, such as market conditions or operational performance of our acquired
businesses, could cause us to conclude that impairment exists relating to our goodwill and
trademarks. In such event, we would record impairment charges, which could have a material impact
on our financial condition and results of operations. Specifically, our annual test of the
estimated fair value of our trademarks is subject to assumptions regarding:
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the future level of royalty cash flows related to the trademarks;
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the relief from royalty rate applied to the future revenue;
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the discount rate used to bring the future cash flows to present value;
and
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any changes in our determination regarding the estimated useful life of
the trademarks.
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The acquisition date valuations for the EXI Wireless and Instantel trademarks were $1,131,000
and $3,790,000, respectively. We have evaluated the sensitivity of our trademark valuations to
variations in our estimated useful life assumptions for these trademarks. We concluded that our
valuations would not change significantly due to variations in the estimated useful life
assumptions. Approximately 86.0% of the present value of the trademark cash flows is contributed by
the cash flows generated between year 1 (2005) and year 20 (2025). Therefore, a sensitivity
analysis based on variations of the estimated useful lives of the trademarks would not
significantly change our valuations.
We evaluated the sensitivity of the trademark valuations to variations in the projected
revenue estimates for fiscal years 2005 through 2009 and variations in the 5.0% terminal revenue
growth rate for fiscal years 2010 and beyond. A summary of the valuation scenarios is as follows:
Scenario 1:
A 10.0% increase in the projected annual revenue for 2005 through 2009 and a 10.0%
increase in the terminal revenue growth rate from 5.0% to 5.5%. The Scenario 1 assumptions result
in the following valuations:
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EXI Wireless Trademarks:
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$1,266,000 (11.9% greater than acquisition date valuation)
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Instantel Trademarks:
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$4,290,000 (13.2% greater than acquisition date valuation)
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Scenario 2:
A 10.0% decrease in the projected annual revenue for 2005 through 2009 and a 10.0%
decrease in the terminal revenue growth rate from 5.0% to 4.5%. The Scenario 2 assumptions result
in the following valuations:
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EXI Wireless Trademarks:
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$1,001,000 (11.5% less than acquisition date valuation)
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Instantel Trademarks:
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$3,310,000 (12.7% less than acquisition date valuation)
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Based on our analysis of the uncertainties associated with the assumptions used in our
trademark valuations, we concluded that, when performing our annual tests for impairment,
variations in the level of projected revenue represent the most significant variable affecting the
future estimated fair value of our trademarks.
58
Stock-Based Compensation
Effective January 1, 2006, we adopted 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 the adoption of FAS 123R, we used the intrinsic value method under APB 25 and
Financial Accounting Standards Board Interpretation No. 44, Accounting for Certain Transactions
Involving Stock Compensationan Interpretation of APB Opinion No. 25, and provided the pro forma
and disclosure information required by FAS 123. Under the intrinsic value method, no stock-based
compensation was recognized in our consolidated statements of operations for options granted to our
employees and directors because the exercise price of such stock options granted to employees and
directors equaled or exceeded the fair value of the underlying stock on the dates of grant.
FAS 123R requires forfeitures of stock-based grants to be estimated at the time of grant and
revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In
our pro forma information required under FAS 123 for the periods prior to January 1, 2006, we
accounted for forfeitures as they occurred.
In the year ended December 31, 2006, we incurred stock-based compensation expense of
approximately $0.1 million as a result of our adoption of FAS 123R on January 1, 2006. This expense
resulted from the issuance of 52,012 stock options during the year ended December 31, 2006, which
were granted with a weighted average exercise price of $9.88 per share. The weighted-average fair
market value of the options was determined to be $5.96 per share.
In 2006, as a result of the termination of certain employees whose options were in-the-money
at the time their options were accelerated, we incurred additional equity based compensation of
approximately $0.4 million.
In December 2006, we issued 0.5 million shares of our restricted common stock to our chairman
and chief executive officer, which shares will vest on December 31, 2008. We determined the value
of the stock to be $4.5 million based on the estimated value of our common stock of $9.00 per share
on the date of the grant. The value of the restricted stock is being amortized as compensation
expense over the vesting period. We recorded compensation expense of approximately $2.1 million
and $0.2 million in 2007 and 2006, respectively, related to this restricted stock.
Stock-based compensation expense is reflected in the condensed consolidated statement of
operations in selling, general and administrative expense.
During the period January 1, 2005 to August 11, 2005, we granted to certain of our employees
and directors options exercisable for approximately 0.3 million shares of our common stock. These
options have exercise prices ranging from $6.93 to $8.55 per share. These exercise prices were
equal to or greater than the estimated fair value, as determined by our management, of the
underlying common stock on the date of each grant. We did not grant any options to employees from
August 12, 2005 through December 31, 2005.
Prior to the initial public offering, our management determined the value of our common stock
principally based upon internal valuation estimates, as well as arms-length transactions involving
the fair value of the businesses we acquired. Due to managements familiarity with discounted cash
flow analyses and the readily available values of the businesses we acquired during the first half
of 2005, management chose not to obtain contemporaneous valuations by an unrelated valuation
specialist. The assumptions used by management during this period related to:
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our projected operating performance;
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risk of non-achievement of projected operating performance;
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59
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the purchase prices of the two businesses acquired during the first half
of 2005, including the risk that the acquisitions might not have been completed at
certain interim valuation dates; and
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trends and comparable valuations in the broad market for privately-held
and publicly-traded technology and medical device companies.
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Managements valuation methodology, including terminal and enterprise values, was based on the
following factors:
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Unlevered free cash flows for our implantable microchip business were
projected for five years, which was deemed to be the appropriate valuation period.
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Earnings before interest, taxes, depreciation and amortization, or
EBITDA, was used to estimate terminal value.
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Management considered the relevant multiples for RFID and medical device
companies to determine the appropriate terminal value multiple.
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A discount rate was applied to the net free cash flows and terminal
value. The rate was determined based on the risk-free rate of the 10-year U.S.
Treasury Bond plus an applicable market risk premium and the specific risk premium
associated with our facts and circumstances. The discount rate utilized by us was
the rate of return expected from the market or the rate of return for a similar
investment with similar risks.
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The purchase prices of the acquired businesses, adjusted for the risk
that the acquisitions might not have been completed at certain interim valuation
dates, were added to the value of the implantable microchip business to determine
enterprise value.
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Management computed the fully diluted value of each share of our common
stock in order to factor in the dilutive effect of reflecting in-the-money stock
options and warrants at each valuation date.
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There are inherent uncertainties in forecasting future operating results and identifying
comparable companies and transactions that may be indicative of the fair value of our common stock.
We believe that the estimates of the fair value of our common stock at each option grant date
occurring prior to our initial public offering were reasonable under the circumstances.
During 2005, we granted to consultants and employees of Digital Angel options exercisable for
approximately 0.1 million shares of our common stock. In accordance with FAS 123, we recorded
compensation expense associated with these options based on an estimate of the fair value, as
determined by our management (using the methodology discussed above), of our common stock on each
date of grant and using the Black-Scholes valuation model. We were required to re-measure the
stock-based compensation expense associated with these options on December 30, 2005, the date of
acceleration of the vesting of all of these options, as more fully discussed below. This
re-measurement was based on the estimated fair value of our common stock on December 30, 2005,
which was assumed to be the then estimated initial public offering price, and using the
Black-Scholes valuation model. This re-measurement resulted in stock-based compensation expense
being recorded in 2005 based upon the fair value of these stock options on the accelerated vesting
date.
During 2005 and 2004, we granted to employees of Digital Angel, and other non-employees who
had provided services to us, options exercisable for approximately 1.1 million shares of our common
stock. We recognized compensation expense related to these option grants using the same methodology
as was used for the 2005 option grants, as discussed above. We recorded aggregate compensation
expense of approximately $2.3 million during the year ended December 31, 2005, in connection with
these stock options.
60
The Black-Scholes option pricing model, which we use to value our stock options, requires us
to make several key judgments including:
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the estimated value of our common stock;
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the expected life of issued stock options;
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the expected volatility of our stock price;
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the expected dividend yield to be realized over the life of the stock
options; and
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the risk-free interest rate over the expected life of the stock options.
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Our computation of the expected life of issued stock options was determined based on
historical experience of similar awards giving consideration to the contractual terms of the
stock-based awards, vesting schedules and expectations about employees future length of service.
The interest rate was based on the U.S. Treasury yield curve in effect at the time of grant.
Historically, our computation of expected volatility was based on the historical volatility of
Digital Angels common stock. Now that we are a public company, our computation of volatility will
be based on the historical volatility of our common stock, or comparable public companies in our
industry.
The significant factors contributing to the difference between the fair value of the stock
options granted during the period January 1, 2005 to August 11, 2005 and the estimated initial
public offering price of shares of our common stock as of December 30, 2005 included, among others:
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Certain hospital emergency rooms adopted our VeriMed system beginning in
the latter part of the third quarter of 2005. Specifically, as of August 1, 2005,
five hospitals had agreed to adopt our VeriMed system in their emergency departments
and we had a goal of having 20 to 25 hospitals agree to adopt our VeriMed system by
December 31, 2005. Having an infrastructure of hospitals that have adopted the
VeriMed system as part of their standard protocol is considered a necessary step in
the commercialization of the VeriMed system, because, without that infrastructure,
those persons who fit the profile for which the VeriMed system was designed have
little or no reason to undergo the microchip implant procedure. After our attendance
at the American College of Emergency Physicians Scientific Assembly, which took
place in Washington D.C. from September 26 to 29, 2005, 49 hospitals had agreed to
adopt our VeriMed system in their emergency rooms. As of December 15, 2005, 66
hospitals had agreed to do so.
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We came to the view that there is a significant market opportunity for
our asset/personnel location and identification system. Today, our asset/personnel
location and identification system is essentially a new product. It was the first
healthcare security application adapted to our technology platform. The new platform
has expanded the deployment options for our asset/personnel location and
identification system, which can range from a portal-based system to a full,
real-time location system.
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We identified additional strategic markets for the implantable microchip.
For example, during the second half of 2005 and specifically in the wake of
Hurricane Katrina, we donated implantable microchips to FEMAs Department of
Mortuary Services in Mississippi and Louisiana to help with FEMAs efforts to
identify corpses. The acceptance of this new use for the implantable microchip has
led to the development of VeriTrace, the only end-to-end implantable tagging
solution for the accurate tracking and identification of human remains and
associated evidentiary items.
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We used the enterprise value to forward-looking revenue valuation
approach to determine the estimated IPO value on December 30, 2005. Under this
approach, fair value was determined based upon a range of multiples of projected
future revenue. The multiples used represented those multiples of revenue that our
peers common stock were trading for in the public markets. This
approach was deemed appropriate because revenue multiples for publicly traded
companies provide the highest correlation of public company trading values.
Specifically, publicly-traded companies in comparable industries tend to have similar
revenue multiples, whereas their EBITDA and net income multiples are not deemed to be
as consistent in part because certain companies in comparable industries are not
EBITDA positive or do not earn net income.
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61
On December 12, 2005, our board of directors approved a proposal which provided for vesting on
December 30, 2005 of all of our then outstanding and unvested stock options previously awarded to
employees, directors, one employee of Digital Angel, one employee of Digital Angel and consultants.
In connection with the acceleration of these options, we stipulated that a grantee that acquires
any shares through exercise of any of such options shall not be permitted to sell such shares until
the earlier of (i) the original vesting date applicable to such option or (ii) the date on which
such grantees employment terminates for any reason.
The purpose of accelerating the vesting of the options granted to our directors and employees
was to enable us to avoid recognizing in future periods non-cash compensation expense associated
with such options in our consolidated statements of operations, which would have otherwise been
required upon our adoption of FAS 123R on January 1, 2006. As a result of the acceleration, we
avoided recognition of up to approximately $0.6 million of compensation expense in our consolidated
statements of operations over the course of the original vesting period, substantially all of which
was avoided in 2006. Such expense is included in our pro forma stock-based compensation footnote
disclosure for the year ended December 31, 2005. FASB Financial Interpretation No. 44 requires us
to recognize compensation expense under certain circumstances, such as a change in the vesting
schedule when the options whose vesting schedule was changed are in-the-money on the date of
change, which would allow an employee to vest in an option that would have otherwise been forfeited
based on the awards original terms. We would be required to begin to recognize compensation
expense over the new expected vesting period based on estimates of the number of options that
employees ultimately will retain that otherwise would have been forfeited, absent the
modifications. The majority of the accelerated options, absent the acceleration, would have vested
during the first half of 2006, with a smaller percentage vesting over 30 months. Such estimates of
compensation expense would be based on such factors as historical and expected employee turnover
rates and similar statistics. Of options exercisable for approximately 0.3 million shares of our
common stock that were affected by the acceleration of vesting, substantially all of the $4.4
million of intrinsic value of these options is attributable to our executive officers and directors
at that time. We are unable to estimate the number of options that our employees and directors will
ultimately retain that otherwise would have been forfeited, absent our acceleration of the vesting
of these options. Based on the then current circumstances, the high concentration of such options
awarded to officers and directors and our historical turnover rates, no compensation expense
resulting from the new measurement date was recognized by us upon acceleration of vesting on
December 30, 2005. We will recognize compensation expense in future periods, should a benefit be
realized by the holders of the aforementioned options, which they would not otherwise have been
entitled to receive. During the year ended December 31, 2006, we recognized approximately $0.4
million of compensation expense as a result of three terminated employees receiving a benefit
related to the accelerated vesting of their options that they would not otherwise have received. If
we are required to recognize additional compensation expense in connection with the accelerated
vesting of in-the-money stock options, it could have a material impact on our future results of
operations.
Accounting for Income Taxes
As part of the process of preparing our consolidated financial statements, we are required to
estimate our income tax liability in each of the jurisdictions in which we do business. This
process involves estimating our actual current tax expense together with assessing temporary
differences resulting from differing treatment of items, such as deferred revenues, for tax and
accounting purposes. These differences result in deferred tax assets and liabilities, which are
included in our consolidated balance sheet. We must then assess the likelihood that our net
deferred tax assets in each tax jurisdiction will be recovered from future taxable income in the
applicable jurisdiction and, to the extent we believe that recovery is not more likely than not or
is unknown, we must establish a valuation allowance.
Significant management judgment is required in determining the provision for income taxes,
deferred tax assets and liabilities and any valuation allowance recorded against the deferred tax
assets. As of December 31, 2007, we had $3.6 million in net deferred tax liabilities, associated
with our Xmark business, located in Canada. As of December 31, 2007, 2006 and 2005, we had recorded
a full valuation allowance against our U.S. net deferred tax
assets due to uncertainties related to our ability to utilize these deferred tax assets,
primarily consisting of net operating loss carryforwards. The valuation allowance was based on our
historical operating performance and estimates of taxable income in the United States and the
period over which our deferred tax assets will be recoverable. As of December 31, 2007, we have
provided a valuation allowance of $0.6 million against our Canadian deferred tax assets, based on
managements analysis of the amount of deferred tax assets that are not expected to be realized
over their respective lives.
62
If we continue to incur U.S. operating losses we will continue to provide a full valuation
allowance against our U.S. net deferred tax assets. Conversely, if our U.S. operations become
profitable in the future, we may reduce some or all of our valuation allowance, which could result
in a significant tax benefit and a favorable impact on our financial condition and operating
results.
If for Canadian tax purposes we incur operating losses in the future or if we are unable to
generate sufficient future Canadian taxable income, or if there is a material change in the actual
effective tax rates or time period within which the underlying temporary differences become taxable
or deductible, and we were to establish a valuation allowance against all or a significant portion
of our Canadian deferred tax assets, it could result in a material adverse impact on our operating
results.
Effective January 1, 2007, we adopted the provisions of the Financial Accounting Standards
Board (FASB) Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes an
interpretation of FASB Statement No. 109. FIN 48 contains a two-step approach to recognizing and
measuring uncertain tax positions accounted for in accordance with SFAS No. 109, Accounting for
Income Taxes. The first step is to evaluate the tax position for recognition by determining if the
weight of available evidence indicates it is more likely than not that the position will be
sustained on audit, including resolution of related appeals or litigation processes, if any. The
second step is to measure the tax benefit as the largest amount which is more than 50% likely of
being realized upon ultimate settlement. We consider many factors when evaluating and estimating
our tax positions and tax benefits, which may require periodic adjustments and which may not
accurately anticipate actual outcomes. Accordingly, we report a liability for unrecognized tax
benefits resulting from the uncertain tax positions taken or expected to be taken in a tax return
and recognizes interest and penalties, if any, related to uncertain tax positions in income tax
expense. There was no impact relating to the adoption of FIN 48 on our financial position. In
connection with the adoption of FIN 48, we have elected an accounting policy to classify interest
and penalties related to unrecognized tax benefits as interest expense.
Results of Operations
The table below sets forth data from our consolidated statements of operations for the years
ended December 31, 2007, 2006 and 2005, 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. Prior to the acquisitions of these
businesses, we had minimal revenue and, therefore, period-to-period results are not comparable.
Accordingly, our historical results are not necessarily indicative of our future results.
Through December 31, 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.
All pro forma revenue information discussed in this Managements Discussion and Analysis of
Financial Condition and Results of Operations concerning our 2005 fiscal year assumes that the
acquisitions of EXI Wireless and Instantel occurred on January 1, 2005. The discussion also assumes
that these companies segment reporting was consistent with our current segment reporting. Such pro
forma information is not necessarily indicative of what our results of operations would have been
had EXI Wireless and Instantel been owned and operated by us as of January 1, 2005, nor does it
purport to represent our results of operations for future periods.
63
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Year Ended December 31,
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2007
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2006
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2005
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Product revenue
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93.6
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%
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93.9
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%
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91.5
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%
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Service revenue
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6.4
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%
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6.1
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%
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8.5
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%
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Total revenue
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100.0
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%
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100.0
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%
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100.0
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%
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Cost of products sold
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42.6
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%
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40.0
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%
|
|
|
34.4
|
%
|
Cost of services sold
|
|
|
4.0
|
%
|
|
|
3.1
|
%
|
|
|
5.9
|
%
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
46.6
|
%
|
|
|
56.9
|
%
|
|
|
59.7
|
%
|
Selling, general and administrative expense
|
|
|
73.2
|
%
|
|
|
64.5
|
%
|
|
|
78.4
|
%
|
Research and development
|
|
|
14.6
|
%
|
|
|
13.9
|
%
|
|
|
12.3
|
%
|
Gain/ loss on exchange
|
|
|
1.6
|
%
|
|
|
|
|
|
|
|
|
Other income
|
|
|
(0.9
|
)%
|
|
|
(0.2
|
)%
|
|
|
(0.4
|
)%
|
Interest expense
|
|
|
5.3
|
%
|
|
|
3.1
|
%
|
|
|
2.2
|
%
|
|
|
|
|
|
|
|
|
|
|
Loss before provision for income taxes
|
|
|
(40.4
|
)%
|
|
|
(24.5
|
)%
|
|
|
(32.8
|
)%
|
Benefit (provision) for income taxes
|
|
|
3.3
|
%
|
|
|
(0.1
|
)%
|
|
|
(0.4
|
)%
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(43.7
|
)%
|
|
|
(24.6
|
)%
|
|
|
(33.2
|
)%
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
The table below presents statement of operations data by segment and in total for the years
ended December 31, 2007 and 2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
|
Healthcare
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Security
|
|
|
Implantable
|
|
|
Industrial
|
|
|
Corporate
|
|
|
Total
|
|
|
|
(in thousands)
|
|
Product revenue
|
|
$
|
22,644
|
|
|
$
|
76
|
|
|
$
|
7,321
|
|
|
$
|
|
|
|
$
|
30,041
|
|
Service revenue
|
|
|
549
|
|
|
|
|
|
|
|
1,516
|
|
|
|
|
|
|
|
2,065
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
23,193
|
|
|
|
76
|
|
|
|
8,837
|
|
|
|
|
|
|
|
32,106
|
|
Gross profit (loss)
|
|
|
12,489
|
|
|
|
(285
|
)
|
|
|
4,942
|
|
|
|
|
|
|
|
17,146
|
|
Selling, general and
administrative
|
|
|
7,858
|
|
|
|
5,229
|
|
|
|
2,471
|
|
|
|
7,956
|
|
|
|
23,514
|
|
Research and development
|
|
|
2,979
|
|
|
|
105
|
|
|
|
1,594
|
|
|
|
|
|
|
|
4,678
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
10,837
|
|
|
|
5,334
|
|
|
|
4,065
|
|
|
|
7,956
|
|
|
|
28,192
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
$
|
1,652
|
|
|
$
|
(5,619
|
)
|
|
$
|
877
|
|
|
$
|
(7,956
|
)
|
|
$
|
(11,046
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
|
Healthcare
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Security
|
|
|
Implantable
|
|
|
Industrial
|
|
|
Corporate
|
|
|
Total
|
|
|
|
(in thousands)
|
|
Product revenue
|
|
$
|
20,035
|
|
|
$
|
116
|
|
|
$
|
5,480
|
|
|
$
|
|
|
|
$
|
25,631
|
|
Service revenue
|
|
|
380
|
|
|
|
|
|
|
|
1,293
|
|
|
|
|
|
|
|
1,673
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
20,415
|
|
|
|
116
|
|
|
|
6,773
|
|
|
|
|
|
|
|
27,304
|
|
Gross profit (loss)
|
|
|
11,717
|
|
|
|
(340
|
)
|
|
|
4,148
|
|
|
|
|
|
|
|
15,525
|
|
Selling, general and
administrative
|
|
|
8,328
|
|
|
|
3,933
|
|
|
|
2,312
|
|
|
|
3,047
|
|
|
|
17,620
|
|
Research and development
|
|
|
2,609
|
|
|
|
|
|
|
|
1,177
|
|
|
|
|
|
|
|
3,786
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
10,937
|
|
|
|
3,933
|
|
|
|
3,489
|
|
|
|
3,047
|
|
|
|
21,406
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
$
|
780
|
|
|
$
|
(4,273
|
)
|
|
$
|
659
|
|
|
$
|
(3,047
|
)
|
|
$
|
(5,881
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
64
Revenue
Revenue for the year ended December 31, 2007 was $32.1 million, an increase of $4.8 million
compared to the prior year.
Our healthcare security segments revenue was $23.2 million for the year ended December 31,
2007 compared to $20.4 million for the year ended December 31, 2006. The $2.8 million increase in
revenue in our healthcare security segment is primarily attributable to increased sales of infant
protection and wander prevention 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.
Our industrial segments revenue was $8.8 million for the year ended December 31, 2007
compared to $6.8 million for the year ended December 31, 2006. The $2.0 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 $76,000 for the year ended December 31, 2007 compared to
$116,000 for the year ended December 31, 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 Patient Identification
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 $0.4 million and $0.4
million for the years ended December 31, 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 was $17.1 million and $15.5 million for the years ended December 31, 2007 and
2006, respectively. As a percentage of revenue, our gross profit margin was 53.4% and 56.9% for the
years ended December 31, 2007 and 2006, respectively.
Our healthcare security segments gross profit for the year ended December 31, 2007 was $12.5
million compared to $11.7 million for the year ended December 31, 2006. Gross profit margin
decreased to 53.8% in the year ended December 31, 2007 from 57.4% in the year ended December 31,
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. The inventory management processes in our
Ottawa facility, including improved quality management, reducing the number of tag defects, have
resulted in a reduction of warranty costs.
Our industrial segments gross profit for the year ended December 31, 2007 was $4.9 million
compared to $4.1 million for the year ended December 31, 2006. Our industrial segments gross
profit margin decreased to 55.9% in the year ended December 31, 2007 compared to 61.2% in the year
ended December 31, 2006. The decline
in gross profit margin resulted from increased inventory reserves for slower moving inventory
and to increased revenues from tool management products compared to the year ended December 31,
2006, which have a lower gross margin than our vibration monitoring products.
65
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 $5.9 million to $23.5 million for the
year ended December 31, 2007 as compared to $17.6 million for the year ended December 31, 2006. As
a percentage of revenue, selling, general and administrative expense was 73.2% and 64.5% for the
years ended December 31, 2007 and 2006, respectively. For 2008, 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 and the cost resulting from the issuance of equity based compensation. During the
years ended December 31, 2007 and 2006, we incurred stock-based compensation expense of $3.4
million and $0.6 million, respectively.
Included in selling, general and administrative expense was $0.5 million and $0.8 million of
certain general and administrative services provided to us by Digital Angel, including accounting,
finance and legal services, insurance, telephone, rent and other miscellaneous items in the years
ended December 31, 2007 and 2006, respectively. We expect these costs to continue in 2008, at a
lesser rate as we continue to separate our general and administrative processes from those of
Digital Angel.
Selling, general and administrative expense included depreciation and amortization expense of
approximately $2.0 million for each of the years ended December 31, 2007 and 2006.
Our healthcare security segments selling, general and administrative expense was $7.9 million
and $8.3 million in the years ended December 31, 2007 and 2006, respectively. As a percentage of
our healthcare security segments revenue, selling, general and administrative expense was 33.9%
and 40.8% for the years ended December 31, 2007 and 2006, respectively. The decrease of $0.4
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 from the closing of our Vancouver
operations due to operating and administrative efficiencies.
Our industrial segments selling, general and administrative expense increased approximately
$0.2 million to $2.5 million for the years ended December 31, 2007 compared to the year ended
December 31, 2006. As a percentage of our industrial segments revenue, selling, general and
administrative expense was 28.0% and 34.1% for the years ended December 31, 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 $1.3 million
to $5.2 million for the year ended December 31, 2007 compared to the year ended December 31, 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 $5.0 million to
$8.0 million in year ended December 31, 2007 compared to the year ended December 31, 2006. This
increase was due primarily to the additional costs resulting from non-cash equity based
compensation of $3.4 million and increased costs related to being a public entity during the year
ended December 31, 2007. We expect corporate selling, general and administrative expense to
continue at 2007 levels as a result of the costs of equity based compensation and costs related to
being a public entity.
66
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 $4.7 million for the year ended December 31,
2007 compared to $3.8 million for the year ended December 31, 2006. As a percentage of revenue,
research and development expense was 14.6% and 13.9% for the years ended December 31, 2007 and
2006, respectively.
Our healthcare security segments research and development expense increased $0.4 million to
approximately $3.0 million for the year ended December 31, 2007 compared to the year ended December
31, 2006. The increase in our healthcare security segments research and development expense was
due to the costs of additional staffing during the period prior to closing our Vancouver facility
in early 2007.
Our industrial segments research and development expense was approximately $1.6 million and
$1.2 million for the years ended December 31, 2007 and 2006, respectively. Our industrial segments
research and development expense increased $0.4 million due to
development of our next generation technology platform.
Interest Expense
Interest expense was $1.7 million and $0.9 million for the years ended December 31, 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 Digital Angel, 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
Digital Angel at the closing of our initial public offering. During the years ended December 31,
2007 and 2006, the interest rate under our loan agreement with Digital Angel was 12% and 7% per
annum, respectively.
Income Taxes
We had an effective tax rate of (8.1)% and 0.5% for the years ended December 31, 2007 and
2006, respectively, related to our Xmark business. We incurred consolidated losses before taxes for
the years ended December 31, 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.
Year Ended December 31, 2006 Compared to Year Ended December 31, 2005
The table below presents statement of operations data by segment and in total for the years
ended December 31, 2006 and 2005.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
|
Healthcare
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Security
|
|
|
Implantable
|
|
|
Industrial
|
|
|
Corporate
|
|
|
Total
|
|
|
|
(in thousands)
|
|
Product revenue
|
|
$
|
20,035
|
|
|
$
|
116
|
|
|
$
|
5,480
|
|
|
$
|
|
|
|
$
|
25,631
|
|
Service revenue
|
|
|
380
|
|
|
|
|
|
|
|
1,293
|
|
|
|
|
|
|
|
1,673
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
20,415
|
|
|
|
116
|
|
|
|
6,773
|
|
|
|
|
|
|
|
27,304
|
|
Gross profit (loss)
|
|
|
11,717
|
|
|
|
(340
|
)
|
|
|
4,148
|
|
|
|
|
|
|
|
15,525
|
|
Selling, general and
administrative
|
|
|
8,328
|
|
|
|
3,933
|
|
|
|
2,312
|
|
|
|
3,047
|
|
|
|
17,620
|
|
Research and development
|
|
|
2,609
|
|
|
|
|
|
|
|
1,177
|
|
|
|
|
|
|
|
3,786
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
10,937
|
|
|
|
3,933
|
|
|
|
3,489
|
|
|
|
3,047
|
|
|
|
21,406
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
$
|
780
|
|
|
$
|
(4,273
|
)
|
|
$
|
659
|
|
|
$
|
(3,047
|
)
|
|
$
|
(5,881
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
67
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005
|
|
|
|
Healthcare
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Security
|
|
|
Implantable
|
|
|
Industrial
|
|
|
Corporate
|
|
|
Total
|
|
|
|
(in thousands)
|
|
Product revenue
|
|
$
|
11,200
|
|
|
$
|
68
|
|
|
$
|
3,252
|
|
|
$
|
|
|
|
$
|
14,520
|
|
Service revenue
|
|
|
849
|
|
|
|
|
|
|
|
500
|
|
|
|
|
|
|
|
1,349
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
12,049
|
|
|
|
68
|
|
|
|
3,752
|
|
|
|
|
|
|
|
15,869
|
|
Gross profit
|
|
|
7,115
|
|
|
|
33
|
|
|
|
2,326
|
|
|
|
|
|
|
|
9,474
|
|
Selling, general and
administrative
|
|
|
4,855
|
|
|
|
3,637
|
|
|
|
1,195
|
|
|
|
2,757
|
|
|
|
12,444
|
|
Research and development
|
|
|
1,313
|
|
|
|
|
|
|
|
643
|
|
|
|
|
|
|
|
1,956
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
6,168
|
|
|
|
3,637
|
|
|
|
1,838
|
|
|
|
2,757
|
|
|
|
14,400
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
$
|
947
|
|
|
$
|
(3,604
|
)
|
|
$
|
488
|
|
|
$
|
(2,757
|
)
|
|
$
|
(4,926
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
Revenue for the year ended December 31, 2006 was $27.3 million, an increase of $11.4 million
compared to the comparable period of the prior year. Revenue for the year ended December 31, 2005
includes only nine months of revenue from EXI Wireless, which we acquired on March 31, 2005, and
revenue from Instantel for the period from June 10, 2005 (the date of acquisition) to December 31,
2005.
On a pro forma basis, revenue for the year ended December 31, 2006 increased $2.8 million, or
11.2%, to $27.3 million compared to pro forma revenue of $24.6 million for the year ended December
31, 2005.
Our healthcare security segments revenue was $20.4 million for the year ended December 31,
2006 compared to $12.0 million for the year ended December 31, 2005. The $8.4 million increase in
revenue in our healthcare security segment reflects a full year of revenue from our acquisitions of
Instantel and EXI Wireless in 2006 compared to only a portion of the 2005 period.
On a pro forma basis, our healthcare security segments revenue increased $2.1 million, or
11.6%, to $20.4 million for the year ended December 31, 2006 compared to $18.3 million for the year
ended December 31, 2005. This increase is the result of a $2.2 million increase in sales to the
hospital market, which includes sales of infant protection and asset/personnel location and
identification systems. The year over year increase is attributable to increased sales of infant
protection systems primarily related to our efforts in 2006 to consolidate and rationalize our
dealer network so as to increase our sales volumes generated by our key dealers. Additionally, we
experienced revenue growth associated with our sale of RFID tags and other consumables relating to
our infant protection system. This increase in consumable sales was driven by our installed base of
healthcare facilities. In 2005 and 2006, we continued the development of our new asset/personnel
location and identification RFID system, and sold three of these systems in 2005. Revenue from
asset/personnel location and identification systems in decreased in 2006 as compared to 2005 as the
initial systems sold in 2005 were installed in 2006. We launched our asset/personnel location
and identification system through the dealer channel for this system on a limited basis in the
fourth quarter of 2006. On a pro forma basis, revenue from the sale of our wander protection
systems was consistent from 2005 to 2006. The lack of year over year growth was the result of our
efforts in 2006 to consolidate the product lines from EXi and Instantel as well as the two separate
distribution channels, all of which were accomplished by the end of 2006.
Our industrial segments revenue was $6.8 million for the year ended December 31, 2006
compared to $3.8 million for the year ended December 31, 2005. The $3.0 million increase in revenue
in our industrial segment reflects a full year of revenue from our Canadian-based businesses in
2006 compared to only a portion of the 2005 period. Segment sales consist principally of sales of
our vibration monitoring instruments.
On a pro forma basis, our industrial segments revenue increased $0.6 million, or 9.4%, to
$6.8 million for the year ended December 31, 2006 compared to $6.2 million for the year ended
December 31, 2005. The increase was primarily the result of a $0.7 million increase in revenue from
our vibration monitoring instruments
due to continued strong demand in the worldwide construction market. The strength or weakness
of the worldwide construction market has historically had a significant influence on the sales
volumes of our vibration monitoring instruments.
68
Our implantable segments revenue was $116,000 for the year ended December 31, 2006 compared
to $68,000 for the year ended December 31, 2005. This increase is attributable to increased sales
of VeriMed and VeriTrace systems.
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 our Canadian-based businesses
during the first half of 2005. Such amortization amounted to $0.4 million and $0.2 million in the
years ended December 31, 2006 and 2005, 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 with
respect to our vibration monitoring instruments.
Gross profit for the year ended December 31, 2006 was $15.5 million compared to $9.5 million
for the year ended December 31, 2005. As a percentage of revenue, our gross profit margin was 56.9%
and 59.7% for the years ended December 31, 2006 and 2005, respectively.
Our healthcare security segments gross profit for the year ended December 31, 2006 was $11.7
million compared to $7.1 million for the year ended December 31, 2005. The increase in gross profit
of $4.6 million was primarily the result of the 2006 period including a full year of operations
from our Canadian-based businesses as compared to only a portion of the 2005 period. Our healthcare
security segments gross profit margin decreased to 57.4% in the year ended December 31, 2006
compared to 59.1% in the year ended December 31, 2005. The decline in gross profit margin reflected
an increase in warranty reserves of $0.6 million resulting from the consolidation of the operations
of our Canadian-based businesses and changes in product mix.
Our industrial segments gross profit for the year ended December 31, 2006 was $4.1 million
compared to $2.3 million for the year ended December 31, 2005. The increase in gross profit of $1.8
million was attributable to sales of our vibration monitoring instruments as a result of our
acquisition of Instantel on June 10, 2005. Our industrial segments gross profit margin was 61.2%
and 62.0% for the years ended December 31, 2006 and 2005, respectively.
Our implantable segments gross profit decreased from $33,000 to a loss of $(340,000) . The
$373,000 decrease was almost entirely the result of a charge recorded to reduce the carrying amount
of our VeriMed inventory to the lower of cost or market.
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 $5.2 million to $17.6 million for the
year ended December 31, 2006 as compared to $12.4 million for the years ended December 31, 2005. As
a percentage of revenue, selling, general and administrative expense was 64.5% and 78.4% for the
years ended December 31, 2006 and 2005, respectively. Included in selling, general and
administrative expense for the year ended December 31, 2006 was $0.9 million for exit costs in
Vancouver, British Columbia related to the consolidation of the operations of our Canadian-based
businesses in Ottawa, Ontario.
69
Included in selling, general and administrative expense for the years ended December 31, 2006
and 2005 was $0.8 million and $0.5 million, respectively, of certain general and administrative
services provided to us by Digital Angel, including accounting, finance and legal services,
insurance, telephone, rent and other miscellaneous items. We expect the annual cost of the services
being provided by Digital Angel under the terms of the amended and restated transition services
agreement will be approximately $0.9 million in 2007 and thereafter, reflecting that the scope of
the services provided by Digital Angel under the agreement was expanded at the end of 2005.
Selling, general and administrative expense for the years ended December 31, 2006 and 2005
included approximately $2.0 million and $1.1 million, respectively, of depreciation and
amortization expense. The increase was due to increased amortization of intangible assets as a
result of the acquisition of the Canadian-based businesses in the first half of 2005.
Included in selling, general and administrative expense for the years ended December 31, 2005
was $2.3 million of compensation expense associated with stock options granted to employees of
Digital Angel and consultants. Our board of directors accelerated the vesting of all of our then
unvested employee and director stock options on December 30, 2005. During the year ended December
31, 2006, we incurred compensation expense associated with granting 52,012 stock options to
employees of $0.1 million. Moreover, as a result of the termination of certain employees whose
options were in-the-money at the time their options were accelerated, we incurred equity based
compensation of approximately $0.4 million during the year ended December 31, 2006. Also,
effective December 6, 2006, we granted our chief executive officer 500,000 restricted shares and
incurred equity based compensation of $0.2 million relating to this grant, which is also included
in selling, general and administrative expense for 2006.
Our healthcare security segments selling, general and administrative expense was $8.3 million
in the year ended December 31, 2006, an increase of $3.5 million compared to the prior year. The
increase was primarily a result of a full year of operations from our Canadian-based businesses as
compared to the 2005 period. As a percentage of our healthcare security segments revenue,
selling, general and administrative expense was 40.8% and 40.3% for the years ended December 31,
2006 and 2005, respectively. We attribute the increase in selling, general, and administrative
expense as a percentage of revenue primarily to the charges related to the exit of our facility in
Vancouver, British Colombia.
Our industrial segments selling, general and administrative expense increased $1.1 million to
$2.3 million for the years ended December 31, 2006 compared to the prior year. The increase was
primarily the result of our acquisition of Instantel in June 2005. As a percentage of our
industrial segments revenue, selling, general and administrative expense was 34.1% and 31.8% for
the years ended December 31, 2006 and 2005, respectively. We attribute the increase in selling,
general, and administrative expense as a percentage of segment revenue primarily to the inclusion
of the results of Instantel for the full year in 2006.
Our implantable segments selling, general and administrative expense increased $0.3 million
to $3.9 million for the year ended December 31, 2006 compared to the prior year. The increase was
due to our increased staffing and associated costs related to the build out of our VeriMed
infrastructure.
Our corporate segments selling, general and administrative expense increased $0.2 million to
$3.0 million in 2006 compared to the corresponding period in the prior year. This 10.5% increase
was due to increased legal and accounting fees related to our preparation for becoming a public
company.
We expect selling, general and administrative expense to increase in the future due to
contemplated additions of sales and marketing staff related to our marketing and sale of our
VeriMed system and database services, as well as the additional costs resulting from equity based
compensation and from our being a publicly held company effective February 9, 2007.
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.
70
Research and development expense was $3.8 million for the year ended December 31, 2006
compared to $2.0 million for the year ended December 31, 2005. As a percentage of revenue, research
and development expense was 13.9% and 12.3% for the years ended December 31, 2006 and 2005,
respectively.
Our healthcare security segments research and development expense increased $1.3 million to
approximately $2.6 million for the year ended December 31, 2006 compared to the prior year. The
increase in our healthcare security segments research and development expense was primarily due to
the acquisitions of our Canadian-based businesses during the first half of 2005, the continued
development of our asset/personnel location and identification system, and our initiative to
integrate virtually all of our healthcare security systems on to a common technology platform.
Our industrial segments research and development expense increased $0.6 million to
approximately $1.2 million for the year ended December 31, 2006 compared to the prior year. The
increase in our industrial segments research and development expense was primarily due to the
acquisition of Instantel on June 10, 2005. The period-over-period increase also reflected costs
associated with the development efforts for our next generation vibration monitoring instruments.
Interest Expense
Interest expense was $0.9 million and $0.3 million for the years ended December 31, 2006 and
2005, respectively. The increase in interest expense was primarily due to our increased level of
outstanding borrowings owed to Digital Angel 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 Digital Angel at the
closing of our initial public offering. Through October 5, 2006, the interest rate under our loan
agreement with Digital Angel was based upon the prevailing prime rate as published by
The Wall
Street Journal
in effect during the applicable periods. Since that date, the interest rate on our
loan was fixed at 12% per annum.
Income Taxes
We had an effective tax rate of 0.1% and 0.4% for the years ended December 31, 2006 and 2005,
respectively, related to our Canadian-based businesses. We incurred consolidated losses before
taxes for the years ended December 31, 2006 and 2005. 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.
Liquidity and Capital Resources
As of December 31, 2007, cash totaled $7.2 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 $6.5 million, $1.5 million and $1.9 million
during the years ended December 31, 2007, 2006 and 2005, respectively. For each of the periods
presented, cash was used primarily to fund operating losses, accounts receivable and for purchases
of inventory.
Since our acquisitions of our Xmark business 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 Xmark 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 at least through the end of 2009.
71
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 in 2007; $875,000 in 2008;
$1,750,000 in 2009; $2,500,000 in 20010; $3,750,000 in 2011; and $3,750,000 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 through 2008.
Cash Flows from Investing Activities
Investing activities (used) provided cash of $(0.8) million, $(2.9) million and $1.4 million
during the years ended December 31, 2007, 2006 and 2005, respectively. In the years ended December
31, 2007 and 2006, respectively, $0.6 million and $0.8 million were used to purchase equipment. In
the year ended December 31, 2005, $0.4 million was used to purchase equipment. In the year ended
December 31, 2005, net cash acquired in business acquisitions contributed by Digital Angel was $1.8
million. In 2007 and 2006, we paid the remaining installments of the purchase price for the
acquisition of Instantel of $0.2 million and $2.1 million, respectively.
Cash Flows from Financing Activities
Financing activities provided cash of $13.5 million, $3.9 million and $2.0 million during the
years ended December 31, 2007, 2006 and 2005, respectively. In the year ended December 31, 2007,
cash of $0.7 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 Digital Angel as principal payment on the Third
Amended and Restated Revolving Line of Credit Note in favor of Digital Angel. During the years
ended December 31, 2007 and 2006, borrowing of $1.3 million and $6.1 million, respectively, were
made from Digital Angel. During the year ended December 31, 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 Digital Angel provided. As of December 31, 2007, we were indebted to Digital Angel in
the amount of $12.9 million.
Through October 5, 2006, our loan with Digital Angel 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 Digital Angel 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 Digital Angel 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
Digital Angel 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 of our
indebtedness to Digital Angel upon consummation of our initial public offering. 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. 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.
72
The loan with Digital Angel is subordinated to our obligations under our credit agreement with
Valens Offshore SPV II, Corp., which is discussed below, and is collateralized by security
interests in all of our property and assets, except as otherwise encumbered by the rights of Valens
Offshore SPV II, Corp.
We entered into the December 2007 Letter Agreement, which was subsequently amended February
29, 2008, as is discussed below, with Digital Angel pursuant to which we prepaid $0.5 million of
principal and in exchange received an option, through October 2008, to prepay the Digital Angel
indebtedness for $10.0 million, less the $0.5 million paid and less any additional principal
payments made subsequent to October 1, 2007, plus any accrued and unpaid interest.
On February 29, 2008, we closed an $8.0 million debt financing (the Agreement) with Valens
Offshore SPV II, Corp. (the Lender). Under the terms of the Agreement, the Lender extended
financing to us in the form of an $8.0 million secured term note (the Note). The Note accrues
interest at a rate of 12% per annum, and has a maturity date of March 31, 2009. The terms of the
Note allow for optional redemption by paying 100% of the principal amount plus $120,000, if such
amounts are paid prior to the six month anniversary of February 29, 2008, or $240,000, if such
amounts are paid on or after the six month anniversary of February 29, 2008. Pursuant to the
Agreement, we issued to the Lender 120,000 shares of our common stock.
We used part of the proceeds of the financing with the Lender to prepay $5.3 million of debt
owed to Digital Angel. In connection with the financing, we entered into a letter agreement with
Digital Angel, dated February 29, 2008, under which we agreed, among other things, to prepay the
$5.3 million to Digital Angel, and to amend the December 2007 Letter Agreement, to provide that we
will have until October 30, 2008 to prepay in full the entire outstanding principal amount to
Digital Angel by paying to Digital Angel $10 million, less the $500,000 paid pursuant to the
December 2007 Letter Agreement, less the $5.3 million paid in connection with this financing, less
other principal payments made to reduce the outstanding principal amount between the date of the
December 2007 Letter Agreement and the date of such prepayment, plus any accrued and unpaid
interest between October 1, 2007 and the date of such prepayment. As a result of the $5.3 million
payment, we will not be required to make any further debt service payments to Digital Angel until
September 1, 2009. If we pay Digital Angel and additional
$4.2 million, plus accrued interest, prior to October 30, 2008,
we will be discharged from our remaining obligation to Digital Angel.
Our subsidiaries, VHI and Xmark, 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 December 31, 2007, of revolving credit loans, provided that
outstanding borrowings under the facility could 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 December 31, 2007. At December 31, 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 could
be made in either Canadian or U.S. dollars, were 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 provided for letters of credit and letters of guarantee denominated in Canadian
dollars. Borrowings, letters of credit and letters of guarantee under the facility were secured by
all of the assets of VHI and Xmark, and was guaranteed by Xmark in the amount of CDN$2.0 million.
The loan agreements contained customary representations and warranties and events of default for
loan arrangements of this type. In addition, the loan agreements contained customary covenants
restricting VHIs ability to, among other things, merge or enter into business combinations, create
liens, or sell or otherwise transfer assets. The credit agreement was terminated on February 28,
2008. 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.
73
Financial Condition
As of December 31, 2007, we had working capital of approximately $6.7 million and an
accumulated deficit of $29.0 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.
We believe that with the remaining net proceeds of our initial public offering, together with
the cash we have on hand, our February 2008 debt financing 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 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.
Contractual Obligations
The following table summarizes our significant contractual obligations as of December 31, 2007
and the effect such obligations are expected to have on our liquidity and cash flows in future
periods:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than
|
|
|
|
|
|
|
|
|
|
|
More than
|
|
|
|
Total
|
|
|
1 Year
|
|
|
1-3 Years
|
|
|
3-5 Years
|
|
|
5 Years
|
|
Contractual Obligations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount due Digital Angel
(1)
|
|
$
|
12,920
|
|
|
$
|
2,167
|
|
|
$
|
6,800
|
|
|
$
|
3,953
|
|
|
$
|
|
|
Other debt
(2)
|
|
|
1,515
|
|
|
|
1,515
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employment related contract
|
|
|
1,986
|
|
|
|
462
|
|
|
|
1,016
|
|
|
|
508
|
|
|
|
|
|
Operating lease obligations
(3)
|
|
|
726
|
|
|
|
514
|
|
|
|
212
|
|
|
|
|
|
|
|
|
|
Purchase commitments
(4)
|
|
|
53,031
|
|
|
|
2,542
|
|
|
|
7,956
|
|
|
|
8,414
|
|
|
|
34,119
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
70,178
|
|
|
$
|
7,200
|
|
|
$
|
15,984
|
|
|
$
|
12,875
|
|
|
$
|
34,119
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
The approximately $12.9 million reflected in the table represents the amount owed to Digital
Angel as of December 31, 2007, including accrued interest. Per the terms of a letter agreement dated February 29, 2008,
we agreed to prepay $5.3 million of the debt owed to Digital Angel. As a result of the $5.3
million payment, we will not be required to make any further debt service payments to Digital
Angel until September 1, 2009. Interest on the outstanding principal amount of the loan will
continue to accrue at the rate of 12% per annum. Commencing on September 1, 2009 through
January 1, 2010, we must repay $300,000 on the first day of each month. On February 1, 2010,
a balloon payment equal to the outstanding principal amount then due under the loan plus all
accrued and unpaid interest is due. Accordingly, the amount to be due during the 2008-2009
period, will be approximately $6.8 million and the amount to be due during the 2010-2011
period, including the balloon payment, will be approximately $4.0 million. For a description
of the material terms of the loan agreement with Digital Angel, see Credit Facilities above.
|
|
(2)
|
|
Represents borrowings under our revolving credit facility with Royal Bank of Canada, which
was terminated on February 28, 2008. The table assumes the accrual of interest through
December 31, 2007. For a description of the terms of the loan agreement with Royal Bank of
Canada, see Credit Facilities above.
|
74
|
|
|
(3)
|
|
For further discussion on operating leases, see Item 2 Properties.
|
|
(4)
|
|
Includes the minimum purchase requirements for our implantable microchips under our supply
agreement with Digital Angel and for our custom straps under our supply agreement with Emerson
& Cuming Microwave Products. Our exclusivity rights under the supply agreement with Digital
Angel can be terminated if we do not purchase the prescribed minimum quantities. Under the
agreement with Digital Angel, if during any year we purchase in excess of the minimum purchase
requirement for that year, the excess will be credited against the minimum purchase
requirement for the following year or years. The agreement with Digital Angel ends in 2014,
subject to earlier termination in the event of either partys default or bankruptcy, except
that, so long as we meet the minimum purchase obligations under the agreement, the term is
automatically renewed on an annual basis until the expiration of the last patents covering any
of the supplied products (currently in 2021). Accordingly, the amount shown in the After 2012
column includes the annual purchase commitment of $3,750,000 through 2021. See Item 1.
Business Manufacturing; Supply Arrangements.
|
Impact of Recently Issued Accounting Standards
In September 2006, the FASB issued Statement of Financial Accounting Standard 157 Fair
Value Measurements, or FAS 157. FAS 157 defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles, and expands disclosures about fair value
measurements. FAS 157 applies under other accounting pronouncements that require or permit fair
value measurements. Accordingly, FAS 157 does not require any new fair value measurements. However,
for some entities, the application of FAS 157 will change current practice. FAS 157 is effective
for financial statements issued for fiscal years beginning after November 15, 2007, and interim
periods within those fiscal years. We will adopt SFAS 157 beginning in the first quarter of fiscal
year 2008 and do not expect the adoption of SFAS 157 to have a material impact to our consolidated
results of operations and financial position.
In February 2008, the FASB issued Staff Position No. FAS 157-1 (FSP FAS 157-1),
Application
of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address
Fair Value Measurements for Purposes of Lease Classification or Measurement Under Statement 13
and
Staff Position No. FAS 157-2 (FSP FAS 157-2),
Effective Date of FASB Statement No. 157
. FSP FAS
157-1 excludes Statement of Financial Accounting Standards No. 13 (SFAS 13),
Accounting for
Leases
, as well as other accounting pronouncements that address fair value measurements on lease
classification or measurement under SFAS 13 from the scope of SFAS 157. FSP FAS 157-2 delays the
effective date of SFAS 157 for all nonrecurring fair value measurements of nonfinancial assets and
nonfinancial liabilities until fiscal years beginning after November 15, 2008. Both FSP FAS 157-1
and FSP FAS 157-2 are effective upon an entitys initial adoption of SFAS 157, which is our first
quarter of fiscal year 2008.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No.
108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current
Year Financial Statements, or SAB 108, that requires public companies to utilize a dual approach
to assessing the quantitative effects of financial misstatements. This dual approach includes both
an income statement focused assessment and a balance sheet focused assessment. SAB 108 is effective
for annual financial statements covering the first fiscal year ending after November 15, 2006. The
adoption of SAB 108 did not have a material effect on our consolidated financial position, results
of operations or cash flows.
In February 2007, FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets and
Financial Liabilities
including an amendment of FAS 115, or FAS 159. 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 will adopt SFAS 159 beginning in the first quarter of fiscal year 2008 and do not
expect SFAS 159 to have a material impact to our consolidated results of operations and financial
condition.
75
In December 2007, FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial
Statements an amendment of ARB No. 51 (FASB 160). This statement amends ARB 51 to establish
accounting and reporting standards for the noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an
ownership interest in the consolidated entity that should
be reported as equity in the consolidated financial statements. In addition, FASB 160 changes
the way the consolidated income statement is presented by requiring consolidated net income to be
reported at amounts that include the amounts attributable to both the parent and the noncontrolling
interest. This statement also establishes a single method of accounting for changes in a parents
ownership interest in a subsidiary that do not result in deconsolidation and requires that a parent
recognize a gain or loss in net income when a subsidiary is deconsolidated. This statement is
effective for fiscal years, and interim periods within those fiscal years, beginning on or after
December 15, 2008 and earlier adoption is prohibited. FASB 160 shall be applied prospectively as of
the beginning of the fiscal year in which this statement is initially applied, except for the
presentation and disclosure requirement which shall be applied retrospectively for all periods
presented. We have not yet determined the impact that this requirement may have on our condensed
consolidated financial position, results of operations, cash flows or financial statement
disclosures.
In December 2007, FASB issued SFAS No. 141R, Business Combinations (FASB 141R). FASB 141R
replaces FASB Statement No. 141 Business Combinations but retains the fundamental requirements in
FASB 141. This statement defines the acquirer as the entity that obtains control of one or more
businesses in the business combination and establishes the acquisition date as the date that the
acquirer achieves control. FASB 141R also requires that an acquirer recognized the assets acquired,
the liabilities assumed and any noncontrolling interest in the acquiree at the acquisition date,
measured at their fair values as of that date. In addition, this statement requires that the
acquirer in a business combination achieved in stages to recognize the identifiable assets and
liabilities, as well as the noncontrolling interest in the acquiree, at the full amounts of their
fair values. FASB 141R is applied prospectively to business combinations for which the acquisition
date is on or after the beginning of the first annual reporting period beginning on or after
December 15, 2008. An entity may not apply the standard before that date. We have not yet
determined the impact that this requirement may have on our condensed consolidated financial
position, results of operations, cash flows or financial statement disclosures.
In December 2007, the FASB ratified EITF Issue No. 07-1,
Accounting for Collaborative
Arrangements Related to the Development and Commercialization of Intellectual Property
(EITF
07-1). The EITF concluded that a collaborative arrangement is one in which the participants are
actively involved and are exposed to significant risks and rewards that depend on the ultimate
commercial success of the endeavor. Revenues and costs incurred with third parties in connection
with collaborative arrangements would be presented gross or net based on the criteria in EITF Issue
No. 99-19,
Reporting Revenue Gross as a Principal versus Net as an Agent
, and other accounting
literature. Payments to or from collaborators would be evaluated and presented based on the nature
of the arrangement and its terms, the nature of the entitys business, and whether those payments
are within the scope of other accounting literature. The nature and purpose of collaborative
arrangements are to be disclosed along with the accounting policies and the classification and
amounts of significant financial statement amounts related to the arrangements. Activities in the
arrangement conducted in a separate legal entity should be accounted for under other accounting
literature; however required disclosure under EITF 07-1 applies to the entire collaborative
agreement. This Issue is effective for fiscal years beginning after December 15, 2008, and is to be
applied retrospectively to all periods presented for all collaborative arrangements existing as of
the effective date. We are currently evaluating the impact that this pronouncement may have on our
consolidated financial position and results of operations.
ITEM 7A. 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 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.
76
The table below presents the principal amount, including accrued interest, and
weighted-average interest rate for our debt portfolio:
|
|
|
|
|
|
|
December 31, 2007
|
|
|
|
(dollars in thousands)
|
|
Loan due Digital Angel
|
|
$
|
12,477
|
|
Credit agreement with Royal Bank of Canada
|
|
$
|
1,019
|
|
Weighted-average interest rate for the year ended December 31, 2007
|
|
|
11.5
|
%
|
Based upon the average variable rate debt outstanding during 2007, 2006 and 2005, a 1% change
in our variable interest rates would have affected our loss before income taxes by approximately
$0.1 million in each of those three years.
Our Canadian subsidiaries operational accounts are denominated in local currency and are
translated into U.S. dollars at the average exchange rate for each reporting period. In 2007, we
recorded $0.5 million of net foreign currency losses in our consolidated statements of operations
related to debt borrowings and payments.
A 10% change in the applicable foreign exchange rates would result in an increase or decrease in
our foreign currency gains and losses and translation adjustments of approximately $0.2 million.
The estimated fair value of our indebtedness to Digital Angel is not reasonably determinable
due to the related party nature of the instrument.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements, including supplementary data and the accompanying
report of independent registered public accounting firm filed as part of this Annual Report on Form
10-K, are listed in the Index to Consolidated Financial Statements and Financial Statement
Schedules on page F-1.
ITEM 9. CHANGES IN
AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A(T). 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 December 31, 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 Annual Report on Form 10-K we present
the conclusions of the CEO and CFO about the effectiveness of our disclosure controls and
procedures as of December 31, 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 Annual Report on
Form 10-K, 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.
Conclusion
. Based upon the disclosure controls evaluation, our CEO and CFO have concluded
that, as of December 31, 2007, our disclosure controls and procedures were effective to provide
reasonable assurance that the foregoing objectives are achieved.
77
Changes in Internal Control Over Financial Reporting
As described above, we reviewed our internal controls over financial reporting and 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
fourth quarter of our last fiscal year and have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
Managements Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Our internal control
system is designed to provide reasonable assurance to our management and Board of Directors
regarding the preparation and fair presentation of published financial statements. All internal
control systems, no matter how well designed, have inherent limitations. Therefore, even those
systems determined to be effective can provide only reasonable assurance with respect to financial
statement preparation and presentation.
Under the supervision and with the participation of management, including the CEO and CFO, we
conducted an evaluation of the effectiveness of our internal control over financial reporting, as
of December 31, 2007, based upon the framework in Internal Control Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission. Based on such evaluation
under the framework in Internal Control Integrated Framework, management concluded that our
internal control over financial reporting was effective as of December 31, 2007.
This Annual Report does not include an attestation report of the our registered public
accounting firm regarding internal control over financial reporting. Managements report was not
subject to attestation by our registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit us to provide only managements report in this
Annual Report.
ITEM 9B. OTHER INFORMATION
None.
PART III
The information required in Item 10 (Directors, Executive Officers and Corporate Governance),
Item 11 (Executive Compensation), Item 12 (Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters), Item 13 (Certain Relationships and Related
Transactions, and Director Independence), and Item 14 (Principal Accounting Fees and Services) is
incorporated by reference to our definitive proxy statement for the 2008 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following documents are filed as a part of this Annual Report on Form 10-K:
|
(a)(1)
|
|
List of Financial Statements Filed as Part of this Annual Report on Form 10-K:
|
|
|
|
|
A list of the consolidated financial statements, notes to consolidated financial
statements, and accompanying report of independent registered public accounting firm
appears on page F-1 of the Index to Consolidated Financial Statements and Financial
Statement Schedules, which is filed as part of this Annual Report on Form 10-K.
|
78
|
(a)(2)
|
|
Financial Statement Schedules:
|
|
|
|
|
Schedule II Valuation and Qualifying Accounts, for each of the fiscal years ended
December 31, 2007, 2006 and 2005, which appears on page F-34, is filed as part
of this Annual Report on Form 10-K.
|
|
|
|
|
All other schedules are omitted because they are not applicable, the amounts are not
significant, or the required information is shown in our consolidated financial
statements or the notes thereto.
|
|
|
(a)(3)
|
|
Exhibits:
|
|
|
|
|
See the Exhibit Index filed as part of this Annual Report on Form 10-K.
|
79
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
|
|
|
|
|
|
VERICHIP CORPORATION
|
|
Date: March 28, 2008
|
By:
|
/s/ Scott R. Silverman
|
|
|
|
Scott R. Silverman*
|
|
|
|
Chairman of the Board and Chief Executive Officer
|
|
|
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the capacities and on the
dates indicated.
|
|
|
|
|
Signature
|
|
Title
|
|
Date
|
|
|
|
|
|
/s/ SCOTT R. SILVERMAN
Scott R. Silverman*
|
|
Chairman of the Board and Chief
Executive Officer (Principal
Executive Officer)
|
|
March 28, 2008
|
|
|
|
|
|
/s/ WILLIAM J. CARAGOL
William J. Caragol
|
|
President and Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
|
|
March 28, 2008
|
|
|
|
|
|
/s/ JEFFREY S. COBB
Jeffrey Cobb*
|
|
Director
|
|
March 28, 2008
|
|
|
|
|
|
/s/ BARRY M. EDELSTEIN
Barry Edelstein*
|
|
Director
|
|
March 28, 2008
|
|
|
|
|
|
/s/ PAUL C. GREEN
Paul C. Green*
|
|
Director
|
|
March 28, 2008
|
|
|
|
|
|
/s/ STEVEN R. FOLAND
Steven R. Foland*
|
|
Director
|
|
March 28, 2008
|
|
|
|
|
|
*By:
|
William J. Caragol
|
|
|
|
William J. Caragol
|
|
|
|
Attorney-in-Fact
|
|
80
INDEX TO FINANCIAL STATEMENTS
CONTENTS
|
|
|
|
|
|
|
Page
|
|
VERICHIP CORPORATION
|
|
|
|
|
|
|
|
|
|
|
|
|
F-2
|
|
|
|
|
|
|
|
|
|
F-3
|
|
|
|
|
|
|
|
|
|
F-4
|
|
|
|
|
|
|
|
|
|
F-5
|
|
|
|
|
|
|
|
|
|
F-6
|
|
|
|
|
|
|
|
|
|
F-7
|
|
|
|
|
|
|
EXI WIRELESS INC.
|
|
|
|
|
|
|
|
|
|
|
|
|
F-35
|
|
|
|
|
|
|
|
|
|
F-36
|
|
|
|
|
|
|
|
|
|
F-37
|
|
|
|
|
|
|
|
|
|
F-38
|
|
|
|
|
|
|
|
|
|
F-39
|
|
|
|
|
|
|
|
|
|
F-40
|
|
|
|
|
|
|
INSTANTEL INC.
|
|
|
|
|
|
|
|
|
|
|
|
|
F-49
|
|
|
|
|
|
|
|
|
|
F-50
|
|
|
|
|
|
|
|
|
|
F-51
|
|
|
|
|
|
|
|
|
|
F-52
|
|
|
|
|
|
|
|
|
|
F-53
|
|
|
|
|
|
|
|
|
|
F-54
|
|
|
|
|
|
|
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
VeriChip Corporation
We have audited the accompanying consolidated balance sheets of VeriChip Corporation and
subsidiaries (the Company) as of December 31, 2007 and 2006, and the related consolidated
statements of operations, stockholders equity and cash flows for each of the years in the
three-year period ended December 31, 2007. Our audits also included the financial statement
schedule Valuation and Qualifying Accounts. These consolidated financial statements and schedule
are the responsibility of the Companys management. Our responsibility is to express an opinion on
these consolidated financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and schedule are free of
material misstatement. We were not engaged to perform an audit of the Companys internal control
over financial reporting. Our audits include consideration of internal control over financial
reporting as a basis for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the Companys internal control
over financial reporting. Accordingly, we express no such opinion
.
An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements enumerated above present fairly, in all material
respects, the consolidated financial position of VeriChip Corporation and subsidiaries as of
December 31, 2007 and 2006, and the consolidated results of their operations and their consolidated
cash flows for each of the years in the three-year period ended December 31, 2007, in conformity
with accounting principles generally accepted in the United States. Also, in our opinion, the
financial statement schedule referred to above, when considered in relation to the financial
statements taken as a whole, presents fairly, in all material respects, the information stated
therein.
As discussed in Note 1 to the consolidated financial statements, the Company adopted Financial
Accounting Standards Board (FASB) Interpretation No. 48,
Accounting for Uncertainty in Income
Taxes- an interpretation of FASB No. 109
, effective January 1, 2007, and Statement of Financial
Accounting Standards No. 123(R),
Share-Based Payment
, applying the modified prospective method,
effective January 1, 2006.
As more fully described in Note 14, the Company sells, markets and distributes
human-implantable passive radio frequency identification microchips which it obtains from an
affiliate. These microchips depend on a key technology for which the Company may have insufficient
rights to support its use of or to protect such intellectual property.
/s/ Eisner LLP
New York, New York
March 28, 2008
F-2
VERICHIP CORPORATION
Consolidated Balance Sheets
(In thousands, except par value)
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
Assets
|
|
|
|
|
|
|
|
|
Current Assets:
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
7,221
|
|
|
$
|
996
|
|
Accounts receivable, net of allowance for
doubtful accounts of $144 (2006 - $146)
|
|
|
5,438
|
|
|
|
4,486
|
|
Inventories, net of allowance
|
|
|
2,343
|
|
|
|
3,698
|
|
Prepaid expenses and other current assets
|
|
|
1,300
|
|
|
|
567
|
|
Deferred tax asset
|
|
|
216
|
|
|
|
520
|
|
|
|
|
|
|
|
|
Total Current Assets
|
|
|
16,518
|
|
|
|
10,267
|
|
Equipment, net of accumulated depreciation and amortization
|
|
|
952
|
|
|
|
950
|
|
Intangible assets, net of accumulated amortization
|
|
|
16,752
|
|
|
|
18,567
|
|
Goodwill
|
|
|
15,776
|
|
|
|
16,025
|
|
Deferred offering costs
|
|
|
|
|
|
|
5,079
|
|
|
|
|
|
|
|
|
|
|
$
|
49,998
|
|
|
$
|
50,888
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Stockholders Equity
|
|
|
|
|
|
|
|
|
Current Liabilities:
|
|
|
|
|
|
|
|
|
Bank indebtedness
|
|
$
|
1,515
|
|
|
$
|
853
|
|
Accounts payable
|
|
|
1,855
|
|
|
|
3,671
|
|
Accrued expenses and other current liabilities
|
|
|
4,308
|
|
|
|
4,968
|
|
Note payable to stockholder, current portion
|
|
|
2,167
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Current Liabilities
|
|
|
9,845
|
|
|
|
9,492
|
|
Deferred tax liability
|
|
|
3,809
|
|
|
|
5,415
|
|
Note payable to stockholder, less current portion
|
|
|
10,753
|
|
|
|
13,635
|
|
|
|
|
|
|
|
|
Total Liabilities
|
|
|
24,407
|
|
|
|
28,542
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders Equity:
|
|
|
|
|
|
|
|
|
Capital stock:
|
|
|
|
|
|
|
|
|
Preferred stock:
|
|
|
|
|
|
|
|
|
Authorized 5,000 shares of $.001 par value; no shares issued
or outstanding
|
|
|
|
|
|
|
|
|
Common stock:
|
|
|
|
|
|
|
|
|
Authorized 40,000 shares, of $.01 par value; 10,144 and 6,056 shares
issued and outstanding at December 31, 2007 and 2006, respectively
|
|
|
101
|
|
|
|
61
|
|
Additional paid-in capital
|
|
|
54,486
|
|
|
|
39,371
|
|
Accumulated deficit
|
|
|
(28,959
|
)
|
|
|
(17,049
|
)
|
Other comprehensive loss foreign currency translation
|
|
|
(37
|
)
|
|
|
(37
|
)
|
|
|
|
|
|
|
|
Total Stockholders Equity
|
|
|
25,591
|
|
|
|
22,346
|
|
|
|
|
|
|
|
|
|
|
$
|
49,998
|
|
|
$
|
50,888
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
F-3
VERICHIP CORPORATION
Consolidated Statements of Operations
(In thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue
|
|
$
|
30,041
|
|
|
$
|
25,631
|
|
|
$
|
14,520
|
|
Service revenue
|
|
|
2,065
|
|
|
|
1,673
|
|
|
|
1,349
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
32,106
|
|
|
|
27,304
|
|
|
|
15,869
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of product
|
|
|
13,678
|
|
|
|
10,918
|
|
|
|
5,455
|
|
Cost of services
|
|
|
1,282
|
|
|
|
861
|
|
|
|
940
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of products and services
|
|
|
14,960
|
|
|
|
11,779
|
|
|
|
6,395
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
17,146
|
|
|
|
15,525
|
|
|
|
9,474
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative
|
|
|
23,514
|
|
|
|
17,620
|
|
|
|
12,442
|
|
Research and development
|
|
|
4,678
|
|
|
|
3,786
|
|
|
|
1,958
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
28,192
|
|
|
|
21,406
|
|
|
|
14,400
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
|
(11,046
|
)
|
|
|
(5,881
|
)
|
|
|
(4,926
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Interest income and other expense, net
|
|
|
222
|
|
|
|
(57
|
)
|
|
|
(63
|
)
|
Interest expense
|
|
|
1,698
|
|
|
|
868
|
|
|
|
343
|
|
|
|
|
|
|
|
|
|
|
|
Total other expense
|
|
|
1,920
|
|
|
|
811
|
|
|
|
280
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before income tax provision
|
|
|
(12,966
|
)
|
|
|
(6,692
|
)
|
|
|
(5,206
|
)
|
(Benefit) provision for income taxes
|
|
|
(1,056
|
)
|
|
|
33
|
|
|
|
56
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(11,910
|
)
|
|
$
|
(6,725
|
)
|
|
$
|
(5,262
|
)
|
Deemed dividend
|
|
|
|
|
|
|
|
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common stockholders
|
|
$
|
(11,910
|
)
|
|
$
|
(6,725
|
)
|
|
$
|
(5,263
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss basic and diluted
|
|
$
|
(1.36
|
)
|
|
$
|
(1.21
|
)
|
|
$
|
(1.00
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of shares outstanding basic and diluted
|
|
|
8,756
|
|
|
|
5,556
|
|
|
|
5,279
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
F-4
VERICHIP CORPORATION
Consolidated Statement of Stockholders Equit
y
(In thousands)
For the Years Ended December 31, 2007, 2006 and 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional
|
|
|
|
|
|
|
Other
|
|
|
Total
|
|
|
|
Common Shares
|
|
|
Paid-in
|
|
|
Accumulated
|
|
|
Comprehensive
|
|
|
Stockholders
|
|
|
|
Number
|
|
|
Amount
|
|
|
Capital
|
|
|
Deficit
|
|
|
Loss
|
|
|
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance December 31, 2004
|
|
|
4,444
|
|
|
$
|
44
|
|
|
$
|
1,006
|
|
|
$
|
(5,062
|
)
|
|
$
|
|
|
|
$
|
(4,012
|
)
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(5,262
|
)
|
|
|
|
|
|
|
(5,262
|
)
|
Comprehensive loss -
Foreign currency
translation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(37
|
)
|
|
|
(37
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(5,262
|
)
|
|
|
(37
|
)
|
|
|
(5,299
|
)
|
Issuance of common shares
to Digital Angel
for the contribution of
VeriChip Holdings Inc.
to the Company
|
|
|
1,111
|
|
|
|
11
|
|
|
|
13,272
|
|
|
|
|
|
|
|
|
|
|
|
13,283
|
|
Contribution of Instantel
Inc. by Digital Angel
|
|
|
|
|
|
|
|
|
|
|
22,272
|
|
|
|
|
|
|
|
|
|
|
|
22,272
|
|
Issuance of warrants to
investors
|
|
|
|
|
|
|
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
1
|
|
Deemed dividend (value of
warrants issued to
investors)
|
|
|
|
|
|
|
|
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
(1
|
)
|
Issuance of options at fair
value for services
|
|
|
|
|
|
|
|
|
|
|
2,283
|
|
|
|
|
|
|
|
|
|
|
|
2,283
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance December 31, 2005
|
|
|
5,556
|
|
|
$
|
55
|
|
|
$
|
38,833
|
|
|
$
|
(10,324
|
)
|
|
$
|
(37
|
)
|
|
$
|
28,527
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6,725
|
)
|
|
|
|
|
|
|
(6,725
|
)
|
Stock based compensation
|
|
|
|
|
|
|
|
|
|
|
579
|
|
|
|
|
|
|
|
|
|
|
|
579
|
|
Adjustment to Instantel
purchase price
|
|
|
|
|
|
|
|
|
|
|
(35
|
)
|
|
|
|
|
|
|
|
|
|
|
(35
|
)
|
Issuance of restricted
stock
|
|
|
500
|
|
|
|
6
|
|
|
|
(6
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance December 31, 2006
|
|
|
6,056
|
|
|
$
|
61
|
|
|
$
|
39,371
|
|
|
$
|
(17,049
|
)
|
|
$
|
(37
|
)
|
|
$
|
22,346
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(11,910
|
)
|
|
|
|
|
|
|
(11,910
|
)
|
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
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant exercise
|
|
|
395
|
|
|
|
4
|
|
|
|
(4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of shares from
option exercises
|
|
|
536
|
|
|
|
5
|
|
|
|
486
|
|
|
|
|
|
|
|
|
|
|
|
375
|
|
Stock issuance costs
|
|
|
|
|
|
|
|
|
|
|
(11
|
)
|
|
|
|
|
|
|
|
|
|
|
(11
|
)
|
Stock based compensation
|
|
|
109
|
|
|
|
1
|
|
|
|
3,445
|
|
|
|
|
|
|
|
|
|
|
|
3,446
|
|
Repurchase of shares
|
|
|
(181
|
)
|
|
|
(2
|
)
|
|
|
(760
|
)
|
|
|
|
|
|
|
|
|
|
|
(762
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance December 31, 2007
|
|
|
10,144
|
|
|
$
|
101
|
|
|
$
|
54,486
|
|
|
$
|
(28,959
|
)
|
|
$
|
(37
|
)
|
|
$
|
25,591
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
F-5
VERICHIP CORPORATION
Consolidated Statements of Cash Flows
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(11,910
|
)
|
|
$
|
(6,725
|
)
|
|
$
|
(5,262
|
)
|
Adjustments to reconcile net loss to
net cash used in operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
2,456
|
|
|
|
2,428
|
|
|
|
1,383
|
|
Stock based compensation
|
|
|
3,446
|
|
|
|
579
|
|
|
|
2,283
|
|
Accrued interest
|
|
|
1,491
|
|
|
|
687
|
|
|
|
343
|
|
Deferred income taxes
|
|
|
(1,304
|
)
|
|
|
(160
|
)
|
|
|
(71
|
)
|
Allowance for doubtful accounts
|
|
|
(2
|
)
|
|
|
134
|
|
|
|
12
|
|
Allowance for inventory excess and obsolescence
|
|
|
427
|
|
|
|
69
|
|
|
|
17
|
|
Disposal of equipment
|
|
|
|
|
|
|
150
|
|
|
|
22
|
|
Changes in operating assets and liabilities, net of effects of
acquired businesses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(950
|
)
|
|
|
644
|
|
|
|
(877
|
)
|
Inventories
|
|
|
864
|
|
|
|
(1,290
|
)
|
|
|
(137
|
)
|
Prepaid expenses and other current assets
|
|
|
(665
|
)
|
|
|
(304
|
)
|
|
|
119
|
|
Accounts payable and accrued expenses
|
|
|
(305
|
)
|
|
|
2,310
|
|
|
|
242
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in operating activities
|
|
|
(6,452
|
)
|
|
|
(1,478
|
)
|
|
|
(1,926
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments for equipment
|
|
|
(643
|
)
|
|
|
(810
|
)
|
|
|
(424
|
)
|
Cash acquired in businesses contributed by the Stockholder
|
|
|
|
|
|
|
|
|
|
|
1,783
|
|
Payment of purchase price installment
|
|
|
(193
|
)
|
|
|
(2,058
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash (used in) provided by investing activities
|
|
|
(836
|
)
|
|
|
(2,868
|
)
|
|
|
1,359
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Short term borrowings, net
|
|
|
662
|
|
|
|
759
|
|
|
|
94
|
|
Note payment to stockholder
|
|
|
(3,500
|
)
|
|
|
|
|
|
|
|
|
Borrowings from stockholder
|
|
|
1,293
|
|
|
|
6,067
|
|
|
|
2,316
|
|
Proceeds from stock option exercises
|
|
|
363
|
|
|
|
|
|
|
|
|
|
Proceeds from initial public offering, net of underwriter fees
|
|
|
18,336
|
|
|
|
|
|
|
|
|
|
Offering costs, exclusive of underwriter fees
|
|
|
(2,879
|
)
|
|
|
(2,924
|
)
|
|
|
(426
|
)
|
Share repurchase
|
|
|
(762
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities
|
|
|
13,513
|
|
|
|
3,902
|
|
|
|
1,984
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase(decrease) in cash
|
|
|
6,225
|
|
|
|
(444
|
)
|
|
|
1,417
|
|
Cash, beginning of year
|
|
|
996
|
|
|
|
1,440
|
|
|
|
23
|
|
|
|
|
|
|
|
|
|
|
|
Cash, end of year
|
|
$
|
7,221
|
|
|
$
|
996
|
|
|
$
|
1,440
|
|
|
|
|
|
|
|
|
|
|
|
Supplementary cash flow information is presented in Note 17.
See accompanying notes to consolidated financial statements.
F-6
VERICHIP CORPORATION
Notes to Consolidated Financial Statements
(tabulated amounts in thousands of dollars, except per share amounts)
1 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, selling 3,100,000 shares of its common stock at a price of $6.50 per share. As
of December 31, 2007, Applied Digital Solutions, Inc., doing business as Digital Angel (Digital
Angel or Stockholder), owned 50.8% of the Companys common stock. As of March 17, 2008 Digital
Angel owned 49.3% of the Companys common stock.
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 applications,
securely linking a patient to their personal health record as maintained in the Companys
proprietary database. 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 obtains the implantable microchip from a wholly-owned subsidiary of Digital
Angel, under the terms of an amended and restated supply agreement. The supply agreement is
discussed in Note 16. Digital Angel obtains the implantable microchip, a component of the VeriMed
microchip, 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. 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. Through
December 31, 2007, no intellectual property claims against the Company have been asserted. (See
Note 14 Unasserted Claim Potential Intellectual Property Conflict and Note 16 Related Party
Transactions).
Through December 31, 2005, all research and development efforts related to the implantable
microchip were performed by Digital Angel and its predecessors. Subsequent to that time, research
and development efforts related to the implantable microchip were performed by both the Company and
Digital Angel.
Effective March 31, 2005, Digital Angel acquired VeriChip Holdings Inc., formerly eXI
Wireless, Inc., (EXI) and contributed EXI to the Company under the terms of an exchange agreement
as more fully discussed in Note 4. In addition, on June 10, 2005, Instantel Inc., or Instantel,
became a wholly-owned subsidiary of the Company under the terms of a share purchase agreement as
more fully discussed in Note 4. EXI and Instantel offered infant protection, wander prevention,
asset/staff location and identification systems and vibration monitoring systems.
In December 2005, a 2-for-3 reverse stock split was approved. In addition, in December 2005,
the Companys board of directors proposed and the Companys stockholder approved the authorization
of 5 million shares of blank check preferred stock and an increase in the authorized shares of the
Companys common stock from 50 million to 70 million. In December 2006, the Company effectuated a
1-for-3 reverse stock split. All share amounts reflected in these statements have been
retroactively adjusted for the reverse stock split for all periods presented. In addition, the
Company amended and restated it certificate of incorporation to decrease the authorized number of
shares of its common stock from 70 million to 40 million shares and to change the par value of its
common stock to $0.01 per share.
Certain items in the consolidated financial statements for the prior periods have been
reclassified to conform to the current period presentation.
F-7
Significant Accounting Policies
Principles of Consolidation
The financial statements include the accounts of the Company and its wholly-owned
subsidiaries, VeriChip Holdings Inc. (VHI) and Xmark Corporation (Xmark) (formerly EXI Wireless
and Instantel respectively) from their respective date of acquisition. Effective January 1, 2008,
VHI and Xmark were amalgamated, with Xmark being the surviving entity. All significant
inter-company transactions and balances have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America, requires management to make certain estimates and
assumptions that affect the amounts reported in the financial statements and accompanying notes.
Although these estimates are based on the knowledge of current events and actions the Company may
undertake in the future, they may ultimately differ from actual results. Included in these
estimates are assumptions about allowances for inventory obsolescence, 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.
Foreign Currency
Effective March 31, 2005, Digital Angel contributed EXI to the Company. From April 1, 2005
until June 30, 2005, the subsidiary used its local currency, the Canadian dollar, as is functional
currency. Results of operations and cash flow were translated to U.S. dollars at average exchange
rates during the period, and assets and liabilities were translated at end of period exchange
rates. Translation adjustments resulting from this process are included in accumulated other
comprehensive loss in the statement of stockholders equity.
On July 1, 2005, the functional currency changed from the local currency to the reporting
currency. This was done as a result of a functional currency determination test that showed that
the majority of EXIs business operations were transacted in the reporting currency. Translation
adjustments for the period April 1 to June 30, 2005 were not removed from equity, and will remain
in equity until a sale or substantially complete liquidation of the investment in EXI. The
translated amounts for non-monetary assets at the end of the period became the accounting basis for
those assets in the period of the change and subsequent periods.
Transaction gains and losses that arise from exchange rate fluctuations on transactions
denominated in a currency other than the functional currency are included in the results of
operations as incurred. Foreign currency gains and losses on debt borrowings and repayments are
included as a component of interest income and other expenses. We recorded a (loss)/gain of
$(0.5) million, $39,800 and $59,930 for the years ended December 31, 2007, 2006, and 2005,
respectively.
Inventories
Inventories consist of raw materials, work in process, and finished goods. Inventory is valued
at the lower of cost, determined by the first-in, first-out method, or market. The Company monitors
and analyzes inventory for potential obsolescence and slow-moving items based upon the aging of the
inventory and the inventory turns by product. Inventory items designated as slow moving are reduced
to net realizable value. Inventory items designated as obsolete are written off. The allowance for
inventory excess and obsolescence was approximately $0.6 million and $0.2 million as of
December 31, 2007 and 2006, respectively.
Equipment
Equipment is carried at cost less accumulated depreciation computed using the straight-line
method over the estimated useful lives. Leasehold improvements are depreciated over the life of the
lease, software is depreciated over 2 years, and equipment is depreciated over periods ranging from
3 to 5 years. Repairs and maintenance, which do not extend the useful life of the asset, are
charged to expense as incurred. Gains and losses on sales and retirements are reflected in the
consolidated statements of operations.
F-8
Advertising Costs
The Company expenses production costs of print advertisements on the first date the
advertisements take place. Advertising expense included in selling, general and administrative
expense was approximately $0.7 million, $0.6 million and $0.2 million in 2007, 2006 and 2005,
respectively.
Goodwill and Other Intangible Assets
The Company follows Statement of Financial Accounting Standards, or SFAS, No. 142,
Goodwill
and Intangible Assets
, or FAS 142. Goodwill represents the excess of purchase price over the fair
values assigned to the net assets acquired in business combinations. Goodwill is allocated to
reporting units as of the acquisition date for the purpose of goodwill impairment testing. The
Companys reporting units are those businesses for which discrete financial information is
available and upon which segment management makes operating decisions. Goodwill of a reporting unit
is tested for impairment at least once a year, or between testing dates if an impairment condition
or event is determined to have occurred.
The Companys trademarks are indefinite lived-assets, and accordingly are not amortized. The
Company tests its trademarks for impairment at least once a year, or between testing dates if an
impairment condition or event is determined to have occurred.
Future events, such as market conditions or operational performance of our acquired
businesses, could cause us to conclude that additional impairment conditions exist. Any resulting
impairment loss could also have a material adverse impact on our financial condition and results of
operations. See Notes 4, 5 and 6 for more information.
The Company has other intangible assets consisting of patented and non-patented technologies,
customer relationships and distribution networks. These intangible assets are amortized over their
expected economic lives ranging from 4 to 12.3 years. The lives were determined based upon the
expected use of the asset, the estimated average life of the replacement parts of the reporting
units products, the stability of the industry, expected changes in and replacement value of
distribution networks and other factors deemed appropriate.
In accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived
Assets,
the Company continually evaluates whether events or circumstances have occurred that
indicate the remaining estimated useful lives of its definite-lives intangible assets may warrant
revision or that the remaining balance of such assets may not be recoverable. The Company uses an
estimate of the related undiscounted cash flows over the remaining life of the asset in measuring
whether the asset is recoverable. There was no impairment of definite-lived intangible or other
long-lived assets during 2007, 2006 and 2005.
Revenue Recognition
The Company follows the revenue recognition guidance in Staff Accounting Bulletin, or SAB,
101, and SAB 104. The Companys revenue recognition policies by product type are as follows:
Revenue Recognition Policy for Healthcare Security and Industrial Systems
Hardware and software revenue is recognized when persuasive evidence of an arrangement exists,
the goods are shipped and title has transferred, the price is fixed or determinable and collection
of the sales proceeds is reasonably assured. Revenue from the sale of software implementation
services and consulting services is recognized as the services are performed. Revenue from
post-contract support services is recognized over the term of the agreement. When software
arrangements include multiple elements to which contract accounting does not apply, the individual
elements are accounted for separately if vendor specific objective evidence, or VSOE, of fair value
exists for the undelivered elements. Generally, the residual method is applied in allocating
revenue between delivered and undelivered elements. If VSOE does not exist, the revenue on the
completed arrangement is deferred until the earlier of VSOE being established or all of the
undelivered elements are delivered or performed with the following exceptions: if the only
undelivered element is post contract support, the deferred amount is recognized ratably over the
post contract support period, and if the only undelivered element is services that do not require
significant production, modification or customization of the software, the deferred amount is
recognized as the services are performed. Maintenance revenue is deferred and recognized ratably
over the terms of the maintenance agreements.
F-9
Revenue Recognition Policy for VeriMed and Other Implantable Systems and Services
The Company markets the implantable microchip, insertion kits and scanners under the name
VeriMed. The Companys distributors are separate legal and economic entities, and the Company does
not have any ownership interest in any of these entities. Additionally, the Company has hired sales
staff to market VeriMed directly to hospitals, and physicians.
The sale of the VeriMed patient identification system will include the implantable microchip,
scanners, insertion kits and patient registration forms. These items will be sold directly and
through distributors with a limited warranty period. The Company also generally indemnifies its
distributors against third party claims of intellectual property infringement. In conjunction with
the implantation of a microchip, the patient completes a registration form enrolling the patient in
the VeriMed Patient Registry.
Product Revenue
Revenues from the sale of the implantable microchip kits and scanners are recorded at gross
amounts. Until the amount of returns can be reasonably estimated, the Company does not recognize
revenue until after the products are shipped to customers and title has transferred, provided that
a purchase order has been received or a contract has been executed, the price is fixed or
determinable, there are no uncertainties regarding customer acceptance, the period of time in which
the distributor or physician has to return the product has elapsed and collection of the sales
proceeds is reasonably assured. Once the level of returns can be reasonably estimated, revenue (net
of expected returns) will be recognized at the time of shipment and the passage of title, assuming
there are no uncertainties regarding customer acceptance. If uncertainties regarding customer
acceptance exist, revenue will not be recognized until such uncertainties are resolved. The Company
has one distribution arrangement that provides for sales on a consignment basis. The Company
intends to recognize revenue from consignment sales to this distributor after receipt of
notification from the distributor of product sales to the distributors customers provided that a
purchase order has been received or a contract has been executed with the distributor, the sales
price is fixed or determinable, the period of time the distributor has to return the product as
provided in its distributor agreement has elapsed and collectability is reasonably assured.
Management believes the product sales are multiple deliverables that can be divided into
separate units of accounting under the guidance provided in EITF 00-21 and SOP 97-2. The sale of
the scanners, one of the deliverables, is considered a separate product sale (separate unit of
accounting). Software is included in this product. The software is bundled with the scanner which
allows the number on the implantable microchip to be read. This software is not sold separately,
the scanner has no value without it, there are no post contract support agreements or after sale
services, upgrades, customization or training services. Management believes that within this
product the scanner and software are not separate deliverables as defined in EITF 00-21 because as
separate units they have no value to the customer on a stand-alone basis, there is no objective and
reliable evidence of fair value of undelivered elements since they are never delivered
independently and the arrangement does not include a general right of return.
Management also believes that SOP 97-2 is not relevant for these same reasons. The implantable
microchip and insertion kits are another deliverable and are accounted for as a separate unit of
accounting because they also have value to customers on a stand-alone basis. The microchips, which
are a component of the insertion kits, are sold separately from the scanners and have independent
usefulness.
Services Revenue
The services for maintaining subscriber information on a database maintained by the Company
are sold as a stand-alone contract and treated according to the terms of the contractual
arrangements then in effect. Revenue from this service will generally be recognized over the term
of the subscription period or the terms of the contractual arrangements then in effect.
With respect to the sales of products whose functionality is dependent on services (e.g.,
database records maintenance), the revenue recognition policy will follow the ultimate
arrangements, subject to the aforementioned revenue recognition criteria and determining whether
there is VSOE.
Warranties
The Company provides certain warranties on all of its products. Provisions for future warranty
costs are based on managements best estimates and are recorded when revenue on product sales is
recognized. The warranty periods for the Companys implantable microchip products range from 15 to
60 days. The warranty periods for the Companys other
products range from one to three years. Management determines the warranty provision based on
known product failures, historical experience, and other currently available evidence.
Warranty expense was approximately $0.6 million, $0.6 million and $0.2 million during 2007,
2006 and 2005.
F-10
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 the Companys 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.
FAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary,
in subsequent periods if actual forfeitures differ from those estimates. In the Companys pro forma
information required under FAS 123 for the periods prior to January 1, 2006, the Company accounted
for forfeitures as they occurred.
During 2007, compensation expense of approximately $0.4 million was recorded as 0.4 million
options were granted with a weighted-average fair market value of $3.13 during 2007.
In 2006, as a result of the termination of certain employees whose options were in-the-money
at the time their options were accelerated, the Company incurred additional equity based
compensation of approximately $0.4 million.
In December 2006, the Company issued 0.5 million shares of its restricted common stock to its
chairman and chief executive officer, which will vest on 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 $2.1 million and $0.2 million in 2007 and 2006, respectively, 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 $0.2 million in 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 in its 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 in 2007.
In October 2007, the Company issued 29 thousand shares of its common stock to various parties
for services performed, which resulted in an equity based compensation charge of $0.1 million in
2007.
Stock-based compensation expense is reflected in the consolidated statement of operations in
selling, general and administrative expense.
The Companys computation of expected life is determined based on the simplified method as the
Company does not have sufficient historical exercise data to provide a reasonable basis upon which
the estimate the expected term due to the limited period of time its equity shares have been
publicly traded. 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 Digital Angels 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.
F-11
Income Taxes
The Company accounts for income taxes under the asset and liability approach for the financial
accounting and reporting for income taxes. Deferred taxes are recorded based upon the tax impact of
items affecting financial reporting and tax filings in different periods. A valuation allowance is
provided against net deferred tax assets when the Company determines realization is not currently
judged to be more likely than not. Through 2006, the Company was part of the consolidated U.S.
federal income tax group with Digital Angel. Effective February 14, 2007, upon completion of the
Companys initial public offering, Digital Angels ownership was reduced to 60.7% and the Company
is required to file a separate federal income tax return in 2007. Income taxes are more fully
discussed in Note 11.
Effective January 1, 2007, the Company adopted the provisions of the Financial Accounting
Standards Board (FASB) Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes
an interpretation of FASB Statement No. 109. FIN 48 contains a two-step approach to recognizing and
measuring uncertain tax positions accounted for in accordance with SFAS No. 109, Accounting for
Income Taxes. The first step is to evaluate the tax position for recognition by determining if the
weight of available evidence indicates it is more likely than not that the position will be
sustained on audit, including resolution of related appeals or litigation processes, if any. The
second step is to measure the tax benefit as the largest amount which is more than 50% likely of
being realized upon ultimate settlement. The Company considers many factors when evaluating and
estimating its tax positions and tax benefits, which may require periodic adjustments and which may
not accurately anticipate actual outcomes. The impact of FIN 48 on the Companys financial position
is discussed in Note 11 Income Taxes. Accordingly, the Company reports a liability for
unrecognized tax benefits resulting from the uncertain tax positions taken or expected to be taken
in a tax return and recognizes interest and penalties, if any, related to uncertain tax positions
in income tax expense. In connection with the adoption of FIN 48, the Company has elected an
accounting policy to classify interest and penalties related to unrecognized tax benefits as
interest expense.
Loss Per Common Share and Common Share Equivalent
Basic and diluted loss per common share is computed by dividing the loss by the weighted
average number of common shares outstanding for the period. Diluted earnings per common share is
computed giving effect to all potentially dilutive common shares that were outstanding during the
period. Dilutive common shares consist of incremental shares issuable upon exercise of stock
options and warrants to the extent that the average fair value of the Companys common stock for
each period is greater than the exercise price of the potential common shares, options and
warrants, except where there is a loss attributable to the common stockholder. As of December 31,
2007 and 2006, stock options and warrants exercisable for approximately 2.0 million and 2.5 million
common shares, respectively, were outstanding. In addition, 0.6 million and 0.5 million shares of
restricted stock were outstanding at December 31, 2007 and 2006, respectively.
Impact of Recently Issued Accounting Standards
In September 2006, the FASB issued Statement of Financial Accounting Standard 157 Fair Value
Measurements, or FAS 157. FAS 157 defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles, and expands disclosures about fair value
measurements. FAS 157 applies under other accounting pronouncements that require or permit fair
value measurements. Accordingly, FAS 157 does not require any new fair value measurements. However,
for some entities, the application of FAS 157 will change current practice. FAS 157 is effective
for financial statements issued for fiscal years beginning after November 15, 2007, and interim
periods within those fiscal years. The Company will adopt SFAS 157 beginning in the first quarter
of fiscal year 2008 and does not expect the adoption of SFAS 157 to have a material impact to its
consolidated results of operations and financial position.
In February 2008, the FASB issued Staff Position No. FAS 157-1 (FSP FAS 157-1),
Application
of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address
Fair Value Measurements for Purposes of Lease Classification or Measurement Under Statement 13
and
Staff Position No. FAS 157-2 (FSP FAS 157-2),
Effective Date of FASB Statement No. 157
. FSP
FAS 157-1 excludes Statement of Financial Accounting Standards No. 13 (SFAS 13),
Accounting for
Leases
, as well as other accounting pronouncements that address fair value measurements on lease
classification or measurement under SFAS 13 from the scope of SFAS 157. FSP FAS 157-2 delays the
effective date of SFAS 157 for all nonrecurring fair value measurements of nonfinancial assets and
nonfinancial liabilities until fiscal years beginning after November 15, 2008. Both FSP FAS 157-1
and FSP FAS 157-2 are effective upon an entitys initial adoption of SFAS 157, which is the
Companys first quarter of fiscal year 2008. The Company does not expect the adoption of FSP
SFAS 157-1 to have a material impact to its consolidated results of operations and financial
position.
F-12
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No.
108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current
Year Financial Statements, or SAB 108, that requires public companies to utilize a dual approach
to assessing the quantitative effects of financial misstatements. This dual approach includes both
an income statement focused assessment and a balance sheet focused assessment. SAB 108 is effective
for annual financial statements covering the first fiscal year ending after November 15, 2006. The
adoption of SAB 108 did not have a material effect on the Companys consolidated financial
position, results of operations or cash flows.
In February 2007, FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets and
Financial Liabilities
including an amendment of FAS 115, or FAS 159. 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. The Company will adopt SFAS 159 beginning in the first quarter of fiscal year 2008 and
does not expect SFAS 159 to have a material impact to its consolidated results of operations and
financial condition.
In December 2007, FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial
Statements an amendment of ARB No. 51 (FASB 160). This statement amends ARB 51 to establish
accounting and reporting standards for the noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an
ownership interest in the consolidated entity that should be reported as equity in the consolidated
financial statements. In addition, FASB 160 changes the way the consolidated income statement is
presented by requiring consolidated net income to be reported at amounts that include the amounts
attributable to both the parent and the noncontrolling interest. This statement also establishes a
single method of accounting for changes in a parents ownership interest in a subsidiary that do
not result in deconsolidation and requires that a parent recognize a gain or loss in net income
when a subsidiary is deconsolidated. This statement is effective for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008 and earlier adoption is
prohibited. FASB 160 shall be applied prospectively as of the beginning of the fiscal year in which
this statement is initially applied, except for the presentation and disclosure requirement which
shall be applied retrospectively for all periods presented. We have not yet determined the impact
that this requirement may have on our condensed consolidated financial position, results of
operations, cash flows or financial statement disclosures.
In December 2007, FASB issued SFAS No. 141R, Business Combinations (FASB 141R). FASB 141R
replaces FASB Statement No. 141 Business Combinations but retains the fundamental requirements in
FASB 141. This statement defines the acquirer as the entity that obtains control of one or more
businesses in the business combination and establishes the acquisition date as the date that the
acquirer achieves control. FASB 141R also requires that an acquirer recognized the assets acquired,
the liabilities assumed and any noncontrolling interest in the acquiree at the acquisition date,
measured at their fair values as of that date. In addition, this statement requires that the
acquirer in a business combination achieved in stages to recognize the identifiable assets and
liabilities, as well as the noncontrolling interest in the acquiree, at the full amounts of their
fair values. FASB 141R is applied prospectively to business combinations for which the acquisition
date is on or after the beginning of the first annual reporting period beginning on or after
December 15, 2008. An entity may not apply the standard before that date. We have not yet
determined the impact that this requirement may have on our condensed consolidated financial
position, results of operations, cash flows or financial statement disclosures.
In December 2007, the FASB ratified EITF Issue No. 07-1,
Accounting for Collaborative
Arrangements Related to the Development and Commercialization of Intellectual Property
(EITF
07-1). The EITF concluded that a collaborative arrangement is one in which the participants are
actively involved and are exposed to significant risks and rewards that depend on the ultimate
commercial success of the endeavor. Revenues and costs incurred with third parties in connection
with collaborative arrangements would be presented gross or net based on the criteria in EITF Issue
No. 99-19,
Reporting Revenue Gross as a Principal versus Net as an Agent
, and other accounting
literature. Payments to or from collaborators would be evaluated and presented based on the nature
of the arrangement and its terms, the nature of the entitys business, and whether those payments
are within the scope of other accounting literature. The nature and purpose of collaborative
arrangements are to be disclosed along with the accounting policies and the classification and
amounts of significant financial statement amounts related to the arrangements. Activities in the
arrangement conducted in a separate legal entity should be accounted for under other accounting
literature; however required disclosure under EITF 07-1 applies to the entire collaborative
agreement. This Issue is effective for fiscal years beginning after December 15, 2008, and is to be
applied retrospectively to all periods presented for all collaborative arrangements existing as of
the effective date. The Company is currently evaluating the impact that this pronouncement may have
on its consolidated financial position and results of operations.
F-13
Research and Development
Research and development costs are expensed as incurred and consist of development work
associated with the Companys existing and potential products. The Companys research and
development expenses relate primarily to payroll costs for engineering personnel, costs associated
with various projects, including testing, developing prototypes and related expenses.
2 Inventories
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
Raw materials
|
|
$
|
1,412
|
|
|
$
|
1,489
|
|
Work in process
|
|
|
512
|
|
|
|
1,255
|
|
Finished goods
|
|
|
1,011
|
|
|
|
1,119
|
|
|
|
|
|
|
|
|
|
|
|
2,935
|
|
|
|
3,863
|
|
Allowance for excess and obsolescence
|
|
|
(592
|
)
|
|
|
(165
|
)
|
|
|
|
|
|
|
|
|
|
$
|
2,343
|
|
|
$
|
3,698
|
|
|
|
|
|
|
|
|
3 Equipment
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
Leasehold improvements
|
|
$
|
130
|
|
|
$
|
128
|
|
Equipment
|
|
|
2,251
|
|
|
|
1,639
|
|
Software
|
|
|
220
|
|
|
|
227
|
|
|
|
|
|
|
|
|
|
|
|
2,601
|
|
|
|
1,994
|
|
Less accumulated depreciation
|
|
|
(1,649
|
)
|
|
|
(1,044
|
)
|
|
|
|
|
|
|
|
|
|
$
|
952
|
|
|
$
|
950
|
|
|
|
|
|
|
|
|
Depreciation and amortization expense charged against income amounted to approximately $0.6
million, $0.6 million and $0.3 million for the years ended December 31, 2007, 2006 and 2005,
respectively.
4 Acquisitions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
other
|
|
|
Other net
|
|
|
|
|
|
|
|
Acquisition
|
|
|
intangible
|
|
|
assets and
|
|
Company acquired
|
|
Date Acquired
|
|
|
Price
|
|
|
assets
|
|
|
liabilities
|
|
VHI, formerly EXI Wireless Inc.
|
|
|
3/31/05
|
|
|
$
|
13,283
|
|
|
$
|
11,541
|
|
|
$
|
1,742
|
|
Instantel Inc.
|
|
|
6/10/05
|
|
|
$
|
24,488
|
|
|
$
|
25,687
|
|
|
$
|
(1,199
|
)
|
VeriChip Holdings Inc.
On March 31, 2005, Applied Digital acquired EXI paying CDN$1.60 for each outstanding share of
EXI (a total of 10,265,178 EXI common shares were outstanding on March 31, 2005) payable in shares
of Applied Digitals common stock based on the daily weighted-average closing price of its common
stock quoted for the ten consecutive trading days that ended three trading days before the closing.
The resulting exchange ratio was 3.0295 shares of EXIs common stock for each share of Applied
Digitals common stock. Accordingly, Applied Digital issued 3,388,407 shares of its common stock
valued at approximately $11.7 million to EXIs shareholders. In addition, all existing EXI options
and warrants outstanding were converted pro rata, based upon the exchange ratio, into options or
warrants exercisable into shares of Applied Digital common stock. The value of the options and
warrants exchanged was approximately $0.7 million. Included in the purchase price was approximately
$0.9 million in acquisition costs consisting primarily of a finders fee and legal and accounting
related services that were direct costs of the acquisition. The total cost of the acquisition was
approximately $13.3 million.
Effective March 31, 2005, Applied Digital contributed EXI to the Company, under the terms of
an exchange agreement between Applied Digital and the Company dated June 9, 2005, in consideration
for approximately 1.1 million shares of the Companys common stock.
F-14
EXI, has developed patient wandering, maternity ward infant protection and asset location and
identification systems combining automated identification and real-time location technologies.
The acquisition of EXI was accounted for under the purchase method of accounting. The excess
of purchase price over the fair value of the assets and liabilities of EXI was recorded as goodwill
of approximately $5.0 million. The intangible assets with a value of approximately $6.5 million are
comprised of patents, trademarks, customer relationships and distribution networks. These
intangibles assets are being amortized over periods ranging from 4 to 12.3 years. The trademarks
have indefinite lives. The Company recorded amortization expense of approximately $0.6 million,
$0.6 million and $0.5 million in 2007, 2006 and 2005, respectively, associated with these
intangible assets.
Instantel Inc.
On June 10, 2005, the Companys subsidiary, VHI, entered into a share purchase agreement by
and among Instantel, Instantel Holding Company s.ar.l., Perceptis, L.P., VHI, the Company and
Applied Digital to acquire 100% of the common stock of Instantel. Applied Digital funded the
acquisition, with such funding being recorded as a capital contribution to the Company. Under the
terms of the agreement, Instantel became a wholly-owned subsidiary of the VHI.
The purchase price for Instantel was $24.5 million. The first payment of $22.0 million was
paid in cash at the closing of the transaction. The second payment was required to be made on the
earlier of (i) the closing of the Companys initial public offering or (ii) September 30, 2006.
Prior to September 30, 2006, in accordance with the share purchase agreement, the Company was
notified by Perceptis that it would exercise its right to receive the second payment of the
purchase price in the form of a cash payment of $2.5 million. In 2006, the Company paid Perceptis
$2.1 million, which amount reflected a holdback of the amount due to Perceptis resulting from a
pending $0.4 million indemnification claim resulting from certain tax obligations. The final
payment of $0.2 was made in 2007, $0.2 million was waived as settlement of the indemnification
claim. In addition, the Company incurred approximately $0.3 million in acquisition costs consisting
primarily of legal and accounting related services that are direct costs of the acquisition.
Instantel, based in Ottawa, Canada, manufactures and sells healthcare security systems for the
hospital and long term care markets and vibration monitoring for the commercial construction
market.
The Instantel acquisition was accounted for under the purchase method of accounting. The
excess of purchase price over the estimated fair value of the assets acquired and liabilities
assumed of Instantel was recorded as goodwill of $11.0 million. In addition, the Company has
recorded intangible assets of $14.9 million comprised of patents, trademarks, customer
relationships and distribution networks. These intangibles assets are being amortized over periods
ranging from 8.4 to 11.8 years. The trademarks have indefinite lives. The Company recorded
amortization expense of approximately $1.2 million, $1.2 million and $0.6 million in 2007, 2006 and
2005, respectively, associated with these intangibles.
During the year ended December 31, 2006, the Company completed its purchase price allocations
related to both the EXI and Instantel acquisitions. The finalization of the purchase price
allocation resulted in a decrease in stockholders equity of $35,000 from the finalization of
certain transaction related costs, resulting in an adjustment to Applied Digitals contributions.
In considering the benefits of the EXI and Instantel acquisitions, management recognized the
strategic complement of these businesses technologies and customer bases with the Companys
existing RFID implantable microchip business. The estimated fair value of the acquired intangible
assets of EXI and Instantel were determined on the basis of customer relationships, patents and
other proprietary rights for technologies, contract lives and revenue, distributor relationships
and other factors related to distribution networks, and using discounted cash flow methodology.
Under this method, the Company estimated the cash flows that each of these intangible assets are
expected to generate over the course of their expected economic lives. Actual cash flows may differ
significantly from these estimates. The expected economic lives of these intangible assets were
determined based upon the expected use of the asset, the ability to extend or renew patents and
other contractual provisions associated with the asset, the estimated average life of the
associated products, the stability of the industry, expected changes in and replacement value of
distribution networks, and other factors deemed appropriate.
In performing the expected life analysis, the Company determined that the acquired trademarks
had indefinite lives. In making this assessment, the Company evaluated whether there were any
legal, regulatory, or contractual factors limiting the useful lives of the acquired trademarks and
the Company concluded that these factors did not limit the useful lives of the acquired trademarks
as of the dates of their acquisition. In addition, the Company evaluated and determined that there
were no competitive or economic factors, including technological advances or obsolescence of the
related products, that limited the useful lives of the acquired trademarks. Given the Companys
market share, the proprietary nature of the Companys RFID products, and the current competitive
environment, the Company is not aware of any significant risk that the Companys technology will be
rendered obsolete in the foreseeable future. Therefore, the Company concluded that based on (i) the
current market positions for the acquired products; (ii) the overall expected growth of the RFID
technology in the Companys market; (iii) the market presence provided by the established
distribution networks of EXI and Instantel; (iv) the lack of legal, contractual or competitive
factors limiting the useful lives of the acquired trademarks; and (v) the conclusion that the
trademarks will have value for the foreseeable future, the Company had reasonable support to
conclude that the acquired EXI and Instantel trademarks had indefinite lives.
F-15
The total purchase prices of EXI and Instantel were allocated as follows:
|
|
|
|
|
|
|
|
|
|
|
EXI
|
|
|
Instantel
|
|
Current assets
|
|
$
|
3,112
|
|
|
$
|
5,678
|
|
Equipment
|
|
|
191
|
|
|
|
493
|
|
Intangibles:
|
|
|
|
|
|
|
|
|
Patented and non-patented proprietary technology
|
|
|
3,710
|
|
|
|
1,720
|
|
Trademarks
|
|
|
1,131
|
|
|
|
3,790
|
|
Customer relationships
|
|
|
895
|
|
|
|
3,390
|
|
Distribution network
|
|
|
816
|
|
|
|
6,000
|
|
Goodwill
|
|
|
4,989
|
|
|
|
10,787
|
|
Current liabilities
|
|
|
(1,057
|
)
|
|
|
(2,748
|
)
|
Deferred tax liability
|
|
|
(504
|
)
|
|
|
(4,622
|
)
|
|
|
$
|
13,283
|
|
|
$
|
24,488
|
|
In determining the purchase prices for EXI and Instantel, the Company considered various
factors including: (i) historical and projected revenue streams and operating cash flows of each
company; (ii) their management teams; (iii) the potential to expand the market for the Companys
existing human implantable microchip business through their existing distribution channels;
(iv) the complementary nature of each of the Companys product offerings as an extension of the
offerings of the other company and of the Companys existing business; (v) similarities in
corporate culture; and (vi) the opportunity for expanded research and development of the combined
product offerings and the potential for new product offerings. Based on the Companys assessments,
it determined that it was appropriate to offer purchase prices for EXI and Instantel that resulted
in the recognition of goodwill. Specifically, the Companys management believed that EXIs business
would grow, in large part because of its industry standing and because its asset/staff location and
identification business, infant protection business, and wander prevention business are, in the
Companys view, poised for growth. The Companys management believed that the growth would
ultimately result in a favorable return on its investment notwithstanding the amount of the
purchase price that included amounts for goodwill. Moreover, the Companys management saw EXIs
customer base, sales force, research and development teams and management as useful in developing
its VeriMed system. The same analysis was undertaken with Instantel, giving recognition that
Instantel and EXI were competitors and that future results could be augmented by eliminating that
competition, better serving customers with the best of both companies and eliminating redundancies.
Based on such assessments, the Company determined that the purchase prices offered were appropriate
for the businesses acquired.
5 Intangible Assets
The information set for the below about the Companys acquired intangible assets as of
December 31, 2006 is based upon purchase price allocations related to the acquisitions of Instantel
and EXI in 2005. The estimated fair values of the acquired intangible assets were determined on
the basis of customer relationships, patents and other proprietary rights for technologies,
contract lives and revenue, distributor relationships and other factors associated with
distribution networks, and using cash flow methodology. Under this method, the Company estimated
the cash flows that each of the intangible assets are expected to generate over the course of their
expected economic lives. Actual cash flows may differ significantly from these estimates.
The expected economic lives of these intangible assets were determined based upon an analysis
of the expected use of the asset, the Companys ability to extend or renew patents and other
contractual provisions associated with the asset, the estimated average life of the associated
products, the stability of the industry, expected changes in or the costs the Company is likely to
incur in finding alternative distribution networks or channels, and other factors deemed
appropriate. In performing the expected life analysis, the Company determined that its trademarks
had indefinite lives. In making this assessment, the Company evaluated whether there were any
legal, regulatory, or contractual factors limiting the useful lives of the acquired trademarks and
it concluded that these factors did not limit the useful lives of the acquired trademarks as of the
dates of their acquisition.
F-16
Intangible assets consist of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
average lives
|
|
|
|
2007
|
|
|
2006
|
|
|
(in years)
|
|
Trademarks
|
|
$
|
4,921
|
|
|
$
|
4,921
|
|
|
Indefinite
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Patented and non-patented proprietary technology
|
|
$
|
5,430
|
|
|
$
|
5,430
|
|
|
|
12.11
|
|
Customer relationships
|
|
|
4,288
|
|
|
|
4,288
|
|
|
|
8.75
|
|
Distribution networks
|
|
|
6,816
|
|
|
|
6,816
|
|
|
|
8.14
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
16,534
|
|
|
$
|
16,534
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
Accumulated amortization
|
|
|
|
|
|
|
|
|
Patented and non-patented proprietary technology
|
|
$
|
1,119
|
|
|
$
|
671
|
|
Customer relationships
|
|
|
1,522
|
|
|
|
980
|
|
Distribution networks
|
|
|
2,064
|
|
|
|
1,237
|
|
|
|
|
|
|
|
|
|
|
$
|
4,704
|
|
|
$
|
2,888
|
|
|
|
|
|
|
|
|
Net intangible assets
|
|
$
|
16,752
|
|
|
$
|
18,567
|
|
|
|
|
|
|
|
|
Estimated amortization expense for definite lived assets for the years ending December 31, is
as follows:
|
|
|
|
|
2008
|
|
$
|
1,790
|
|
2009
|
|
|
1,656
|
|
2010
|
|
|
1,614
|
|
2011
|
|
|
1,614
|
|
2012
|
|
|
1,584
|
|
Thereafter
|
|
|
3,571
|
|
|
|
|
|
|
|
$
|
11,830
|
|
|
|
|
|
6 Goodwill
Goodwill consists of the excess of cost over fair value of net tangible and identifiable
intangible assets of companies purchased. The Company applies the principles of SFAS No. 141,
Business Combinations
or FAS 141, and uses the purchase method of accounting for acquisitions of
subsidiaries.
The carrying amount of Companys goodwill by reporting unit (reporting units are those
businesses for which discrete financial information is available and upon which segment management
makes operating decisions) is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Healthcare
|
|
|
|
|
|
|
|
|
|
|
|
|
Security
|
|
|
Industrial
|
|
|
Implantable
|
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2005
|
|
$
|
13,131
|
|
|
$
|
3,851
|
|
|
$
|
|
|
|
$
|
16,982
|
|
Adjustment to purchase price allocation
|
|
|
(789
|
)
|
|
|
(168
|
)
|
|
|
|
|
|
|
(957
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2006
|
|
|
12,342
|
|
|
|
3,683
|
|
|
|
|
|
|
|
16,025
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjustment to purchase price allocation
|
|
|
(180
|
)
|
|
|
(69
|
)
|
|
|
|
|
|
|
(249
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2007
|
|
$
|
12,162
|
|
|
$
|
3,614
|
|
|
$
|
|
|
|
$
|
15,776
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In the fourth quarter of 2007, the Company tested its goodwill and other intangible assets at
each reporting unit level in accordance with FAS 142. The fair value of the Companys reporting
units, substantially all of the operations of which were acquired during 2005, was based on
valuations prepared by management. Based on these assessments, there was no impairment of goodwill
and other intangible assets at December 31, 2007.
F-17
7 Accrued Expenses and Other Current Liabilities:
Accrued expenses and other current liabilities consist of the following:
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
Accrued wages and payroll expenses
|
|
$
|
1,904
|
|
|
$
|
1,271
|
|
Accrued severance
|
|
|
138
|
|
|
|
390
|
|
Accrued purchases
|
|
|
964
|
|
|
|
353
|
|
Accrued professional fees
|
|
|
116
|
|
|
|
1,079
|
|
Warranty liability
|
|
|
580
|
|
|
|
487
|
|
Income taxes payable
|
|
|
300
|
|
|
|
220
|
|
Deferred revenue
|
|
|
306
|
|
|
|
466
|
|
Deferred purchase price obligation
|
|
|
|
|
|
|
442
|
|
Other accrued expenses
|
|
|
|
|
|
|
260
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
4,308
|
|
|
$
|
4,968
|
|
|
|
|
|
|
|
|
8 Financing Agreements and Liquidity:
VHI and Xmark were parties to a credit agreement with the Royal Bank of Canada, which was
terminated on February 28, 2008. The credit facility provided for borrowings up to CDN $1.5
million, or approximately U.S. $1.5 million at December 31, 2007. Approximately $1.5 million was
outstanding under the credit facility as of December 31, 2007. The annual interest rate on the
facility was the Royal Bank of Canada prime rate of interest plus 1% (6% as of December 31,2007).
The borrowing limit was up to 85% of eligible accounts receivable and up to 25% of eligible
inventory. Under the terms of the agreement, the Company had to comply with certain reporting
covenants and requirements. The loan was collateralized by all of the assets of VHI. At December
31, 2007, VHI had aggregate net assets of approximately $13.1 million.
On October 6, 2006, January 19, 2007, February 8, 2007, February 13, 2007 and February 29,
2008, the Company amended its loan agreement with Digital Angel as more fully described in Note 16.
On February 29, 2008, the Company entered into a new debt financing. This financing
eliminated the credit agreement with RBC, except for a remaining
$0.4 million security interest.
See Note 19, Subsequent Events.
9 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 December 31, 2007, Digital Angel owned 50.8% 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 through the end of 2007. As of
December 31, 2007, 181,000 shares were repurchased at a cost of approximately $0.8 million.
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
December 31, 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 1.4 million of
the options or shares granted were outstanding as of December 31, 2007. Approximately 1.2 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 December 31, 2007, no SARs have been granted and 22,000 shares
may still be granted under the VeriChip 2002 Plan.
F-18
On April 27, 2005, Digital Angels 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
December 31, 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 December 31, 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 December 31, 2007, approximately
0.2 million options and shares have been granted under the VeriChip 2007 Plan. As of December 31,
2007, no SARs have been granted and 0.8 million shares may still be granted under the VeriChip 2007
Plan.
In addition, as of December 31, 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 December 31, 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 year ended December 31, 2007, 0.2 million, 0.3 million, and 0.2 million options and
shares have been granted under the VeriChip 2002 Plan, the VeriChip 2005 Plan, and the VeriChip
2007 Plan, respectively. In the year ended December 31, 2006, 50,000 and 2,012 options were granted
under the 2002 Plan and outside of the Companys plans, respectively.
A summary of stock options for 2007, 2006, and 2005 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
Weighted-
|
|
|
|
Number
|
|
|
Average
|
|
|
Number
|
|
|
Average
|
|
|
Number
|
|
|
Average
|
|
|
|
of
|
|
|
Exercise
|
|
|
of
|
|
|
Exercise
|
|
|
of
|
|
|
Exercise
|
|
|
|
Options
|
|
|
Price
|
|
|
Options
|
|
|
Price
|
|
|
Options
|
|
|
Price
|
|
Outstanding on January 1
|
|
|
2,099
|
|
|
$
|
2.10
|
|
|
|
2,055
|
|
|
$
|
1.91
|
|
|
|
1,826
|
|
|
$
|
0.54
|
|
Granted
(1)
|
|
|
417
|
|
|
|
5.88
|
|
|
|
52
|
|
|
|
9.88
|
|
|
|
428
|
|
|
|
7.11
|
|
Exercised
|
|
|
(536
|
)
|
|
|
0.70
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(17
|
)
|
|
|
5.75
|
|
|
|
(8
|
)
|
|
|
2.61
|
|
|
|
(199
|
)
|
|
|
0.51
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding on December 31
|
|
|
1,963
|
|
|
|
3.26
|
|
|
|
2,099
|
|
|
|
2.10
|
|
|
|
2,055
|
|
|
|
1.92
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable on December 31
(2)
|
|
|
1,530
|
|
|
|
2.42
|
|
|
|
2,049
|
|
|
|
1.91
|
|
|
|
2,055
|
|
|
|
1.92
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares available on December
31 for options that may be
Granted
|
|
|
865
|
|
|
|
|
|
|
|
503
|
|
|
|
|
|
|
|
545
|
|
|
|
|
|
|
|
|
(1)
|
|
The total compensation expense associated with the options granted in 2007 was $0.3
million. The remaining amount of the compensation expense to be recorded over the remaining
vesting period of the options is approximately $0.9 million.
|
|
(2)
|
|
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. The fair value of the Companys common
stock was estimated to be $2.25 at December 31, 2007 based upon its closing price on the NASDAQ. As
of December 31, 2007, the aggregate intrinsic value of all options outstanding was $0.6 million.
|
F-19
The following table summarizes information about stock options at December 31, 2007 (in
thousands, except weighted-average amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding Stock Options
|
|
|
Exercisable Stock Options
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Weighted-
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
Remaining
|
|
|
Average
|
|
|
|
|
|
|
Average
|
|
Range of
|
|
|
|
|
|
Contractual
|
|
|
Exercise
|
|
|
|
|
|
|
Exercise
|
|
Exercise Prices
|
|
Shares
|
|
|
Life
|
|
|
Price
|
|
|
Shares
|
|
|
Price
|
|
$0.0000 to $2.0250
|
|
|
1,087
|
|
|
|
2.5
|
|
|
$
|
0.47
|
|
|
|
1,087
|
|
|
$
|
0.47
|
|
$4.0501 to $6.0750
|
|
|
437
|
|
|
|
8.8
|
|
|
|
5.65
|
|
|
|
67
|
|
|
|
5.12
|
|
$6.0751 to $8.1000
|
|
|
328
|
|
|
|
5.9
|
|
|
|
7.09
|
|
|
|
298
|
|
|
|
7.04
|
|
$8.1001 to $10.1250
|
|
|
105
|
|
|
|
7.0
|
|
|
|
9.23
|
|
|
|
72
|
|
|
|
8.88
|
|
$18.2251 to $20.2500
|
|
|
6
|
|
|
|
6.0
|
|
|
|
20.25
|
|
|
|
6
|
|
|
|
20.25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,963
|
|
|
|
4.7
|
|
|
$
|
3.26
|
|
|
|
1,530
|
|
|
$
|
2.42
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and expected
to vest
|
|
|
1,677
|
|
|
|
4.3
|
|
|
$
|
2.79
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The weighted average per share fair values of grants made in 2007, 2006 and 2005 for the
Companys incentive plans were $3.13, $5.97 and $9.60, respectively.
The Company granted to certain of its employees and directors options to purchase
approximately 0.3 million shares of its common stock during the period January 1, 2005 to
August 11, 2005 that were granted at exercise prices ranging from $6.93 to $8.55 per share and were
equal to or greater than the estimated fair value of the underlying common stock on the date of
each grant, as determined by the Companys management. Options exercisable for approximately 0.2
million shares were granted with an exercise price of $6.93, which was the estimated fair value of
the Companys common stock on the date of grant, and options exercisable for approximately 0.1
million shares were granted at exercise prices greater than the estimated fair value on the dates
of grant. The Companys management determined these values principally based upon internal
valuation estimates as well as arms-length transactions involving the fair value of the businesses
it acquired. The assumptions used by management, include:
|
|
|
the Companys projected operating performance;
|
|
|
|
|
risk of non-achievement of projected operating performance;
|
|
|
|
|
the purchase prices of the two businesses acquired during 2005, including the risk
that the acquisitions may not have been completed at certain interim valuation dates;
and
|
|
|
|
|
trends and comparable valuations in the broad market for privately-held and
publicly-traded technology and medical device companies.
|
Managements valuation methodology, including terminal and enterprise value, was based on the
following factors:
|
|
|
unlevered free cash flows for the Companys implantable microchip business were
projected for five years, which was deemed to be the appropriate valuation period;
|
|
|
|
|
earnings before interest, taxes, depreciation and amortization, or EBITDA, was used
to estimate terminal value;
|
|
|
|
|
management considered the relevant multiples for RFID and medical device companies
in determining the appropriate terminal value multiple;
|
|
|
|
|
a discount rate was applied to the net free cash flows and terminal value. The rate
was determined based on the risk free rate of the 10-year U.S. Treasury Bond plus an
applicable market risk premium and the specific risk premium associated with the
Companys facts and circumstances. (The discount rate the Company utilized by was the
rate of return expected from the market or the rate of return for a similar investment
with similar risks);
|
F-20
|
|
|
the purchase prices of EXI and Instantel, adjusted for the risk that the
acquisitions may not have been completed at certain interim valuation dates, were added
to the value of the implantable microchip business to determine enterprise value; and
|
|
|
|
|
management computed the fully diluted value of each share of the Companys common
stock to factor in the dilutive effect of reflecting in the money stock options and
warrants at each valuation date.
|
In addition, the Company granted options exercisable for approximately 0.1 million shares of
common stock during 2005 to consultants and employees of Digital Angel. In accordance with FAS 123, the Company recorded compensation expense associated with these
options based on an estimate of the fair value on each date of grant (with the fair value of the
Companys common stock for grants from January 1, 2005 to August 11, 2005 being determined by
management as discussed above) and using the Black-Scholes valuation model. The Company was
required to re-measure the compensation expense associated with these options on December 30, 2005,
the date of acceleration of the vesting of these options. (The Company accelerated the vesting of
these options as more fully discussed in Note 1.) This re-measurement was based on the estimated
fair value of the Companys common stock on December 30, 2005, which was assumed to be the then
estimated IPO value, and using the Black-Scholes valuation model. This re-measurement resulted in
compensation expense being recorded in 2005 based upon the fair value of these stock options on the
vesting date. In addition, during 2005 and 2004, the Company granted stock options to employees of
Digital Angel and other non-employees who had provided services to the Company. For these options,
the Company recognized compensation expense using the same methodology as was used for the
comparable 2005 grants discussed above. The Company recorded aggregate compensation expense of
approximately $2.3 million and $0.3 million during the years ended December 31, 2005 and 2004,
respectively, in connection with these stock options.
There are inherent uncertainties in making estimates about forecasts of future operating
results and identifying comparable companies and transactions that may be indicative of the fair
value of the Companys securities. The Company believes that the estimates of the fair value of its
common stock at each option grant date were reasonable under the circumstances.
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 option; 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 Digital Angel, and its best
estimation of future conditions.
The weighted average per share fair value of grants made in 2007, 2006 and 2005 for the
Companys stock options was $3.13, $5.97 and $9.60 respectively. 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
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected dividend yield
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected stock price volatility
|
|
|
60
|
%
|
|
|
60
|
%
|
|
|
50
|
%
|
Risk-free interest rate
|
|
|
4.51
|
%
|
|
|
4.29
|
%
|
|
|
3.84
|
%
|
Expected term (in years)
|
|
|
6.0
|
|
|
|
5.0
|
|
|
|
5.5
|
|
F-21
10 Selling, general and administrative expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Salaries and benefits (1)
|
|
$
|
13,856
|
|
|
$
|
7,631
|
|
|
$
|
6,631
|
|
Depreciation and amortization
|
|
|
2,009
|
|
|
|
1,982
|
|
|
|
1,159
|
|
Legal and accounting
|
|
|
980
|
|
|
|
956
|
|
|
|
1,059
|
|
Sales and marketing
|
|
|
2,063
|
|
|
|
2,198
|
|
|
|
700
|
|
Travel and entertainment
|
|
|
1,257
|
|
|
|
1,078
|
|
|
|
743
|
|
Insurance
|
|
|
167
|
|
|
|
448
|
|
|
|
203
|
|
Consulting
|
|
|
1,795
|
|
|
|
2,802
|
|
|
|
907
|
|
Other
|
|
|
1,385
|
|
|
|
525
|
|
|
|
1,040
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
23,514
|
|
|
$
|
17,620
|
|
|
$
|
12,442
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Included in salaries and benefits is $3.4 million, $0.6 million and $2.3 million of equity
compensation expense for the years 2007, 2006 and 2005, respectively,
associated with stock compensation (includes stock options and
restricted stock). See Note 1.
|
11 Income taxes:
The Companys income taxes as presented are calculated on a separate tax return basis,
although until the Companys IPO on February 9, 2007, the Companys U.S. operations are included in
the consolidated federal income tax return that Digital Angel filed. The Companys Canadian
operations are subject to Canadian taxes. The Company accounts for income taxes under the asset and
liability approach. Deferred taxes are recorded based upon the tax impact of items affecting
financial reporting and tax filings in different periods. A valuation allowance is provided against
net deferred tax assets where the Company determines realization is not currently judged to be more
likely than not.
The provision for income taxes consists of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Current:
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Canada
|
|
|
248
|
|
|
|
193
|
|
|
|
127
|
|
|
|
|
|
|
|
|
|
|
|
Current income tax provision
|
|
|
248
|
|
|
|
193
|
|
|
|
127
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Deferred:
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Canada
|
|
|
(1,304
|
)
|
|
|
(160
|
)
|
|
|
(71
|
)
|
|
|
|
|
|
|
|
|
|
|
Current income tax benefit
|
|
|
(1,304
|
)
|
|
|
(160
|
)
|
|
|
(71
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(1,056
|
)
|
|
$
|
33
|
|
|
$
|
56
|
|
|
|
|
|
|
|
|
|
|
|
Xmark files income tax returns in Canada. Upon distribution of foreign subsidiary earnings,
the Company may be subject to U.S. income taxes (subject to an adjustment for foreign tax credits)
and withholding taxes payable to Canada.
F-22
The tax effects of temporary differences and carryforwards that give rise to significant
portions of deferred tax assets and liabilities consist of the following:
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Liabilities and reserves
|
|
$
|
386
|
|
|
$
|
547
|
|
Stock-based compensation
|
|
|
2,662
|
|
|
|
1,557
|
|
Property and equipment
|
|
|
133
|
|
|
|
96
|
|
Research and development tax credit
|
|
|
1,632
|
|
|
|
397
|
|
Net operating loss carryforwards
|
|
|
9,386
|
|
|
|
6,486
|
|
|
|
|
|
|
|
|
Gross deferred tax assets
|
|
|
14,201
|
|
|
|
9,083
|
|
Valuation allowance
|
|
|
(12,966
|
)
|
|
|
(7,930
|
)
|
|
|
|
|
|
|
|
|
|
|
1,233
|
|
|
|
1,153
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Intangible assets
|
|
|
4,826
|
|
|
|
6,044
|
|
Other
|
|
|
|
|
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
4,826
|
|
|
|
6,048
|
|
|
|
|
|
|
|
|
Net deferred tax liability
|
|
$
|
3,593
|
|
|
$
|
4,895
|
|
|
|
|
|
|
|
|
The deferred tax assets and liabilities are included in the following balance sheet captions:
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
Current deferred tax asset
|
|
$
|
216
|
|
|
$
|
520
|
|
Long-term deferred tax liability
|
|
|
3,809
|
|
|
|
5,415
|
|
|
|
|
|
|
|
|
|
|
$
|
3,593
|
|
|
$
|
4,895
|
|
|
|
|
|
|
|
|
The deferred tax liability relates primarily to taxable temporary differences resulting from
allocation of the purchase price for EXI and Instantel.
The valuation allowance for U.S. deferred tax assets increased by approximately $5.0 million
and $3.5 million in 2007 and 2006, respectively, due mainly to the generation of U.S. net operating
losses. The valuation allowance at December 31, 2007 and 2006 has primarily been provided for U.S.
net deferred tax assets that exceeded the level of existing U.S. deferred tax liabilities.
Approximate domestic and international (loss) income before provision for income taxes
consists of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Domestic
|
|
$
|
(13,683
|
)
|
|
$
|
(7,993
|
)
|
|
$
|
(6,621
|
)
|
International
|
|
|
717
|
|
|
|
1,301
|
|
|
|
1,415
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(12,966
|
)
|
|
$
|
(6,692
|
)
|
|
$
|
(5,206
|
)
|
|
|
|
|
|
|
|
|
|
|
The difference between the effective rate reflected in the provision for income taxes on loss
before taxes and the amounts determined by applying the applicable statutory U.S. tax rate are
analyzed below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
%
|
|
|
%
|
|
|
%
|
|
Statutory tax benefit
|
|
|
(34
|
)
|
|
|
(34
|
)
|
|
|
(34
|
)
|
State income taxes, net of federal benefits
|
|
|
(6
|
)
|
|
|
(7
|
)
|
|
|
(4
|
)
|
Foreign income tax rate differential
|
|
|
(14
|
)
|
|
|
(7
|
)
|
|
|
(8
|
)
|
Change in deferred tax asset valuation allowance
|
|
|
46
|
|
|
|
48
|
|
|
|
48
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(8
|
)
|
|
|
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
F-23
On February 14, 2007, the Company completed an initial public offering of its common stock,
which reduced Digital Angels ownership to less than 80%. Therefore, in 2007, the Company was
required to file a separate federal income tax return. At December 31, 2007, the Company had U.S.
federal net operating loss carryforwards of approximately $22.9 million for income tax purposes
that expire in various amounts through 2027. The net operating losses will be allocated in
accordance with Treasury Regulation § 1.1502-21T(b)(2)(iv), at the point that the Company ceases to
be a part of the consolidated tax return of Digital Angel.
Based upon the change
of ownership rules under IRC Section 382, in December 2007 the Company
experienced a change of ownership exceeding the 50% limitation threshold
imposed by that section, and as a result the Companys future
utilization of its net operating loss carryforwards may be significantly
limited as to the amount of use in any particular year.
The Canadian subsidiaries file separate income tax returns in Canada. Effective, January 1,
2006, two of the VHI subsidiaries were amalgamated with Instantel and Instantel was subsequently
renamed Xmark Corporation. Effective, January 1, 2008, VHI and Xmark were amalgamated, with Xmark
surviving. The combined tax attributes, including research and development tax credit
carryforwards, will be available to offset future taxable income of the amalgamated entity.
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) was issued
to clarify the requirements of SFAS 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; 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 company 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 company 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.
|
The Company adopted FIN 48 on January 1, 2007 and there was no impact upon adoption or during
December 31, 2007.
12 Loss per Share
A reconciliation of the numerator and denominator of basic and diluted loss per share
attributable to common stockholders is provided as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator for basic loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(11,910
|
)
|
|
$
|
(6,725
|
)
|
|
$
|
(5,262
|
)
|
Deemed dividend
|
|
|
|
|
|
|
|
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common stockholders
|
|
$
|
(11,910
|
)
|
|
$
|
(6,725
|
)
|
|
$
|
(5,263
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic and diluted loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding basic and diluted
|
|
|
8,756
|
|
|
|
5,556
|
|
|
|
5,279
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted loss per share
|
|
$
|
(1.36
|
)
|
|
$
|
(1.21
|
)
|
|
$
|
(1.00
|
)
|
|
|
|
|
|
|
|
|
|
|
F-24
The following stock options and warrants outstanding as of December 31, 2007, 2006, 2005 were
not included in the computation of dilutive loss per share because the net effect would have been
anti-dilutive:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
Stock options
|
|
|
1,963
|
|
|
|
2,099
|
|
|
|
2,055
|
|
Warrants
|
|
|
33
|
|
|
|
444
|
|
|
|
444
|
|
Restricted common stock
|
|
|
600
|
|
|
|
500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,596
|
|
|
|
3,043
|
|
|
|
2,499
|
|
|
|
|
|
|
|
|
|
|
|
13 Segmented information:
The Company operates in three business segments: Healthcare Security, Implantable and Industrial.
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
|
|
|
|
|
an asset/staff location and identification system used by hospitals and other
healthcare facilities to identify, locate and protect medical staff, patients, visitors
and medical equipment.
|
Implantable
The Companys Implantable segment includes its VeriMed system using the implantable microchip,
a human-implantable RFID microchip that can be used in patient
identification applications and in 2005 and early 2006 was also used
in security applications. 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.
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 used by industrial companies to manage and track their
mobile equipment and tools.
|
F-25
The following is the selected segment data as of and for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Healthcare
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
Security
|
|
|
Implantable
|
|
|
Industrial
|
|
|
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue
|
|
$
|
22,644
|
|
|
$
|
76
|
|
|
$
|
7,321
|
|
|
$
|
|
|
|
$
|
30,041
|
|
Services revenue
|
|
|
549
|
|
|
|
|
|
|
|
1,516
|
|
|
|
|
|
|
|
2,065
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
23,193
|
|
|
$
|
76
|
|
|
$
|
8,837
|
|
|
$
|
|
|
|
$
|
32,106
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
1,652
|
|
|
|
(5,619
|
)
|
|
|
877
|
|
|
|
(7,596
|
)
|
|
|
(11,046
|
)
|
Depreciation and amortization
|
|
|
1,864
|
|
|
|
36
|
|
|
|
519
|
|
|
|
37
|
|
|
|
2,456
|
|
Interest and other income (expense)
|
|
|
(502
|
)
|
|
|
|
|
|
|
|
|
|
|
280
|
|
|
|
(222
|
)
|
Interest expense
|
|
|
25
|
|
|
|
|
|
|
|
|
|
|
|
1,673
|
|
|
|
1,698
|
|
Income (loss) before provision for
income taxes
|
|
|
1,257
|
|
|
|
(5,619
|
)
|
|
|
745
|
|
|
|
(9,349
|
)
|
|
|
(12,966
|
)
|
Goodwill
|
|
|
12,162
|
|
|
|
|
|
|
|
3,614
|
|
|
|
|
|
|
|
15,776
|
|
Segmented assets
|
|
|
37,252
|
|
|
|
960
|
|
|
|
9,444
|
|
|
|
2,342
|
|
|
|
49,998
|
|
Expenditures for property and
equipment
|
|
|
374
|
|
|
|
24
|
|
|
|
220
|
|
|
|
25
|
|
|
|
643
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Healthcare
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
Security
|
|
|
Implantable
|
|
|
Industrial
|
|
|
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue
|
|
$
|
20,035
|
|
|
$
|
116
|
|
|
$
|
5,480
|
|
|
$
|
|
|
|
$
|
25,631
|
|
Services revenue
|
|
|
380
|
|
|
|
|
|
|
|
1,293
|
|
|
|
|
|
|
|
1,673
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
20,415
|
|
|
$
|
116
|
|
|
$
|
6,773
|
|
|
$
|
|
|
|
$
|
27,304
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
781
|
|
|
|
(4,273
|
)
|
|
|
659
|
|
|
|
(3,047
|
)
|
|
|
(5,881
|
)
|
Depreciation and amortization
|
|
|
1,705
|
|
|
|
42
|
|
|
|
640
|
|
|
$
|
41
|
|
|
|
2,428
|
|
Interest and other income
|
|
|
(49
|
)
|
|
|
|
|
|
|
(8
|
)
|
|
|
|
|
|
|
(57
|
)
|
Interest expense
|
|
|
78
|
|
|
|
|
|
|
|
|
|
|
|
790
|
|
|
|
868
|
|
Income (loss) before provision for
income taxes
|
|
|
751
|
|
|
|
(4,273
|
)
|
|
|
667
|
|
|
|
(3,837
|
)
|
|
|
(6,692
|
)
|
Goodwill
|
|
|
12,342
|
|
|
|
|
|
|
|
3,683
|
|
|
|
|
|
|
|
16,025
|
|
Segmented assets
|
|
|
34,641
|
|
|
|
680
|
|
|
|
10,632
|
|
|
|
4,935
|
|
|
|
50,888
|
|
Expenditures for property and
equipment
|
|
|
581
|
|
|
|
27
|
|
|
|
175
|
|
|
|
27
|
|
|
|
810
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Healthcare
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005
|
|
Security
|
|
|
Implantable
|
|
|
Industrial
|
|
|
Corporate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue
|
|
$
|
11,200
|
|
|
$
|
68
|
|
|
$
|
3,252
|
|
|
$
|
|
|
|
$
|
14,520
|
|
Services revenue
|
|
|
849
|
|
|
|
|
|
|
|
500
|
|
|
|
|
|
|
|
1,349
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
12,049
|
|
|
$
|
68
|
|
|
$
|
3,752
|
|
|
$
|
|
|
|
$
|
15,869
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
947
|
|
|
|
(3,604
|
)
|
|
|
488
|
|
|
|
(2,757
|
)
|
|
|
(4,926
|
)
|
Depreciation and amortization
|
|
|
971
|
|
|
|
28
|
|
|
|
971
|
|
|
$
|
28
|
|
|
|
1,383
|
|
Interest and other income
|
|
|
(49
|
)
|
|
|
|
|
|
|
(14
|
)
|
|
|
|
|
|
|
(63
|
)
|
Interest expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
343
|
|
|
|
343
|
|
Income (loss) before provision for
income taxes
|
|
|
996
|
|
|
|
(3,604
|
)
|
|
|
502
|
|
|
|
(3,100
|
)
|
|
|
(5,206
|
)
|
Goodwill
|
|
|
13,131
|
|
|
|
|
|
|
|
3,851
|
|
|
|
|
|
|
|
16,982
|
|
Segmented assets
|
|
|
36,257
|
|
|
|
741
|
|
|
|
10,238
|
|
|
|
1,202
|
|
|
|
48,438
|
|
Expenditures for property and
equipment
|
|
|
285
|
|
|
|
40
|
|
|
|
59
|
|
|
|
40
|
|
|
|
424
|
|
F-26
Revenues are attributed to geographic areas based on the location of the physical operations
producing the revenue. Xmark, the Companys subsidiary, located in Ottawa, Ontario, which includes
the Companys Healthcare Security and Industrial segments earns the majority of the Companys
revenue from sales to customers based in the United States. Information concerning principal
geographic areas for the year ended December 31 were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
|
Canada
|
|
|
Consolidated
|
|
Year ended December 31, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue
|
|
$
|
76
|
|
|
$
|
32,030
|
|
|
$
|
32,106
|
|
Long-lived tangible assets
|
|
|
112
|
|
|
|
840
|
|
|
|
952
|
|
Deferred tax liabilities
|
|
|
|
|
|
$
|
3,809
|
|
|
$
|
3,809
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
|
Canada
|
|
|
Consolidated
|
|
Year ended December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue
|
|
$
|
116
|
|
|
$
|
27,188
|
|
|
$
|
27,304
|
|
Long-lived tangible assets
|
|
|
126
|
|
|
|
824
|
|
|
|
950
|
|
Deferred tax liabilities
|
|
|
|
|
|
$
|
5,415
|
|
|
$
|
5,415
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
|
Canada
|
|
|
Consolidated
|
|
Year ended December 31, 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue
|
|
$
|
68
|
|
|
$
|
15,801
|
|
|
$
|
15,869
|
|
Long-lived tangible assets
|
|
|
132
|
|
|
|
758
|
|
|
|
890
|
|
Deferred tax liabilities
|
|
|
|
|
|
$
|
5,064
|
|
|
$
|
5,064
|
|
14 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.
If the Company or Digital Angel is denied use of the patented technology in applications
involving the identification of human beings and security applications, 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. Through December 31, 2007,
there have been and are no pending or threatened intellectual property claims challenging the
Companys marketing or selling activities. 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. 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 the Company
Under the circumstances, the accompanying financial statements make no provision with respect
to the unasserted claim described above.
15 Commitments and Contingencies
Operating Lease Commitments
The Company has entered into an operating lease with a remaining term through 2009 in Ottawa,
Ontario. Minimum lease payments due under the operating lease for the next five years and
thereafter are presented in the table below. The lease provides for escalation payments for certain
operating expenses.
F-27
Rentals of space, vehicles, and office equipment under operating leases amounted to
approximately $0.6 million, $2.0million and $1.9 million for the years ended December 31, 2007, 2006 and 2005, respectively.
Purchase Commitments
On
March 4, 2002, the Company entered into a supply agreement with
Digital Angel to supply the Companys human-implantable microchip and RFID technology. Digital Angel
is the Companys sole supplier of the implantable microchips relating to the Companys business.
Digital Angel may sell the human-implantable microchips and RFID technology to third parties if the
Company does not purchase certain prescribed minimum quantities or the Company defaults in any
obligation under the agreement, including the payment of money, and the default is not cured within
90 days after receipt of written notice. On December 28, 2005, the agreement was amended and
restated. The amended and restated agreement was further amended on May 9, 2007 and is more fully
discussed in Note 16.
The approximate minimum payments required under operating leases, purchase commitments and
employment contracts that have initial or remaining terms in excess of one year at December 31,
2007, are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating lease
|
|
|
Purchase
|
|
|
Employment
|
|
Year
|
|
Commitments
|
|
|
Commitments
|
|
|
Contracts
|
|
2008
|
|
$
|
514
|
|
|
$
|
2,542
|
|
|
$
|
462
|
|
2009
|
|
|
212
|
|
|
|
3,333
|
|
|
|
508
|
|
2010
|
|
|
|
|
|
|
4,623
|
|
|
|
508
|
|
2011
|
|
|
|
|
|
|
4,664
|
|
|
|
508
|
|
2012
|
|
|
|
|
|
|
3,750
|
|
|
|
|
|
Thereafter
|
|
|
|
|
|
|
34,119
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
726
|
|
|
$
|
53,031
|
|
|
$
|
2,406
|
|
|
|
|
|
|
|
|
|
|
|
Employment Contract
Effective December 5, 2006, the Company and Mr. Silverman entered into the VeriChip
Corporation Employment and Non-Compete Agreement, or the VeriChip Employment Agreement. The
VeriChip Employment Agreement terminates five years from the effective date. The VeriChip
Employment agreement provides for an annual base salary of $420,000 with minimum annual increases
for the first two years of 10% of the base salary and a discretionary annual increase thereafter.
Mr. Silverman is also entitled to a discretionary annual bonus and other fringe benefits. In
addition, it provides for the grant of 500,000 shares of restricted stock of the Company. The
Company is required to register the shares as soon as practicable. The stock is restricted and is
accordingly subject to substantial risk of forfeiture in the event that Mr. Silverman terminates
his employment or the Company terminates his employment for cause on or before December 31, 2008.
If Mr. Silvermans employment is terminated prior to the expiration of the term of the VeriChip
Employment Agreement, certain significant payments become due to Mr. Silverman. The amount of such
significant payments depends on the nature of the termination. In addition, the employment
agreement contains a change of control provision that provides for the payment of five times the
then current base salary and five times the average bonus paid to Mr. Silverman for the three full
calendar years immediately prior to the change of control, or the number of years that were
completed commencing on the effective date of the agreement and ending on the date of the change of
control if less than three calendar years. Any outstanding stock options held by Mr. Silverman as
of the date of his termination or a change of control become vested and exercisable as of such
date, and remain exercisable during the remaining life of the option. All severance and change of
control payments made in connection with the VeriChip Employment Agreement must be paid in cash,
except for a termination due to Mr. Silvermans total disability, death, a constructive
termination, or termination without cause, which may be paid in shares of the Companys common
stock, subject to necessary approvals, or in cash at Mr. Silvermans option.
Legal proceedings
The Company is engaged in certain legal actions in the ordinary course of business and we
believe that the ultimate outcome of these actions will not have a material adverse effect on our
operating results, liquidity or financial position. The Company has accrued an estimate of the
probable costs for the resolution of these claims, and as of December 31, 2007, the Company has
recorded a nominal reserve with respect to such claims. This estimate has been developed in
consultation with outside counsel handling our defense in these matters and is based upon an
analysis of potential results, assuming a combination of litigation and settlement strategies.
F-28
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. By virtue of its
counterclaim, Metro Risk seeks reliance damages in the amount of $155,000, which represents the
amount of money allegedly advanced by Metro Risk for the project, lost profits, and attorneys
fees. The parties have taken very little discovery at the present time. Metro Risk has propounded
no discovery on the Company, and the Company has propounded a request for production and a request
for admissions on Metro Risk. The parties have not taken any depositions yet. Given the early
stage of the matter and because discovery has recently begun, counsel is currently unable to assess
the ultimate outcome.
The Company has received demand letters from attorneys for several former employees and/or
consultants, asserting claims related to stock options to acquire approximately 540 thousand shares
of the Companys common stock that management believes such employees and/or consultants had
forfeited when they ceased their employment or relationship with the Company. 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 matter identified above, 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.
However, litigation is inherently unpredictable, and the costs and other effects of pending or
future litigation, governmental investigations, legal and administrative cases and proceedings,
whether civil or criminal, settlements, judgments and investigations, claims or charges in any such
matters, and developments or assertions by or against us relating to us or to our intellectual
property rights and intellectual property licenses could have a material adverse effect on our
business, financial condition and operating results.
16 Related Party Transactions
During the year ended December 31, 2005, Digital Angel 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, was
determined based on the Companys use of such services. In determining the estimated use by the
Company, Digital Angel determined the actual cost incurred for each of the services provided and
determined the allocation of each of such costs that were attributable to the Companys operations.
The services provided and the basis of allocation were as follows:
|
|
|
Accounting, finance and payroll services
these costs were allocated based upon
a percentage of the total labor dollars incurred by Digital Angels accounting,
finance and payroll staff in performing such functions for the Company;
|
|
|
|
|
Legal services
the costs were allocated based upon a percentage of Digital
Angels general counsels salary and benefits based upon the estimated time spent by
its general counsel on the Companys legal issues;
|
|
|
|
|
Accounting fees
these costs were allocated based upon a percentage of the total
fees charged by third party accountants and considering the amount of such
accounting fees that the Company would have incurred if it was a stand-along entity
until December 27, 2005. Subsequent to December 27, 2005, the Company paid actual
costs incurred;
|
|
|
|
|
Rent
the cost was determined based upon the amount of office space square
footage used by the Companys employees; and
|
|
|
|
|
Telephone, office supplies and other costs
these costs were allocated based
upon a percentage of the services or supplies that were deemed to be incurred by the
Company.
|
Transition Services Agreement
On December 27, 2005, the Company entered into a transition services agreement with Digital
Angel under which Digital Angel agreed to provide the Company with certain administrative
transition services, including payroll, legal, finance, accounting, information technology, tax
services, and services related to this offering. As compensation for these services,
the Company agreed to pay Digital Angel (i) approximately $62,000 per month for fixed costs
allocable to these services, (ii) Digital Angels reasonable out-of-pocket direct expenses incurred
in connection with providing these services that are not included in the agreement as a monthly
fixed cost, (iii) Digital Angels expenses incurred in connection with services provided to the
Company in connection with the initial public offering of the Companys common stock, and (iv) any
charges by third party service providers that may or may not be incurred as part of the offering
and that are attributable to transition services provided to or for the Company.
F-29
On December 21, 2006, the Company and Digital Angel 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 Digital Angel to cease performing
transition services, provided that Digital Angel 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 Digital Angel 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 Digital Angels delivery of the transition services or in the Companys payment
for those services. The services provided by Digital Angel 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, in early
2007, to approximately $72,000 per month, primarily as the result of an increased allocation for
office space. In April 2007 the monthly charge was reduced to $40,000, primarily as the result of
reductions in shared personnel costs. Effective January, 1, 2008, the monthly cost was further
reduced to $10,000 per month.
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 Digital Angel. The Companys and Digital Angels executive officers were independent of
one another and the terms of the agreement were based upon historical amounts incurred by Digital
Angel 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 would be incurred by the Company as an independent stand
alone entity.
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 $0.5 million, $0.8 million and $0.5 million in 2007, 2006, and 2005, respectively.
Loan Agreement with Digital Angel
Digital Angel funded and financed the Companys operations from the Companys inception to its
IPO, which resulted in an amount due to Digital Angel totaling $13.6 million (which included $0.8
million of accrued interest) and $8.9 at December 31, 2006 and 2005, respectively. On December 27,
2005, the Company and Digital Angel converted the amounts due to Digital Angel, 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 changed
the interest rate to a fixed rate of 12% per annum. Previously, our indebtedness to Digital Angel
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 Digital Angel through December 27, 2010.
On January 19, 2007, February 8, 2007 and February 13, 2007 and February 29, 2008, 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. 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 Digital Angel 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, we used $3.5 million of the net proceeds of our
initial public offering to repay a portion of our indebtedness to Digital Angel 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
that 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. At December 31, 2007, the current amount due to Digital Angel was the
contractual principal amount due less the $0.5 million prepaid in December as discussed below.
F-30
On February 29, 2008, we completed an $8.0 million debt financing and with a portion of these
proceeds, prepaid $5.3 million of our Digital Angel indebtedness and therefore the Company is not
obligated to make debt service payments on the loan until September 1, 2009. (See Note 19
Subsequent Events)
The loan with Digital Angel is subordinated to the obligations of the Company under its credit
agreement with Valens Offshore SPV II, Corp. (see Note 19 Subsequent Events) and is
collateralized by security interests in all property and assets of the Company, except as otherwise
encumbered by the rights of Valens Offshore SPV II, Corp.
In December 2007, we entered into a letter agreement, which was subsequently amended February
29, 2008, with Digital Angel pursuant to which we prepaid $0.5 million of principal and in exchange
received an option, through October 2008, to prepay in full the entire outstanding principal amount
of the Digital Angel indebtedness for $10.0 million, less the $0.5 million paid and less any
additional principal payments made subsequent to October 1, 2007, plus any accrued and unpaid
interest. At December 31, 2007 the amount of outstanding principal under the loan with Digital
Angel was $12.9 million dollars. If the Company prepaid the $10.0 million (inclusive of the $0.5
million paid in December 2007) prior to October 30, 2008, the Company will extinguish their total
obligation of $12.9 million due to Digital Angel. In February 2008, the Company prepaid an
additional $5.3 million to Digital Angel. If the Company pays Digital Angel an additional $4.2
million prior to October 30, 2008, plus accrued interest, the Company will extinguish its entire obligation to Digital
Angel. See Note 19 Subsequent Events for more information.
Interest expense incurred under the loan for the year ended December 31, 2007, 2006, and 2005
was $1.5 million, $0.9 and $0.3 million, respectively. The previously floating rate of interest
negotiated between the parties was based upon the rate that Digital Angel 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 Digital Angel 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.
Funding of Instantel Acquisition
Digital Angel agreed to fund the cost of the Instantel acquisition in order for the Company to
effect the acquisition. Given that the Company did not provide Digital Angel with any specific
consideration for the transaction, the Company does not believe that the terms are comparable to
terms that could be obtained in transaction with independent third parties.
Supply Agreement
The Company executed a supply and development agreement dated March 4, 2002 with Digital Angel
covering the manufacture and supply of its implantable microchip.
On December 27, 2005, the Company entered into an amended and restated supply and development
agreement with Digital Angel, which was further amended on May 9, 2007. Under this agreement,
Digital Angel is the Companys sole supplier of human-implantable microchips.
The Companys purchases of product under the supply and development agreement were
approximately nil, $0.4 million, $0.7 million for years ended December 31, 2007, 2006 and 2005
respectively. The supply and development agreement with Digital Angel continues until March 2014,
and, as long as the Company continues to meet minimum purchase requirements (the minimum purchase
requirements were nil in 2006 and 2007 and are approximately $0.9 million in 2008), the agreement
will automatically renew annually under its terms until the expiration of the last of the patents
covering any of the supplied products. The 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 agreement.
Further, the agreement provides that Digital Angel shall, 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, nor
does it intend to. A termination of the Companys supply and development agreement or the ability
of Digital Angel to supply third parties due to failure by the Company to meet its minimum purchase
requirements or for any other reason would have a material adverse effect on the Companys business
prospects.
The terms of the predecessor supply and development agreement and the amended and restated
supply and development agreement were negotiated by the executive officers of the respective
companies and approved by the independent members of each companys board of directors.
F-31
Digital Angel relies solely on a production agreement with a subsidiary of Raytheon Company
for the manufacture of the human-implantable microchip products. The subsidiary utilizes Digital
Angels equipment in the production of the
microchips. On April 28, 2006, Digital Angel entered into a new production agreement with the
subsidiary related to the manufacture and distribution of glass-encapsulated syringe-implantable
transponders, including the human-implantable microchip products sold by the Company. This new
agreement expires on June 30, 2010. (See Notes 1 and 14.)
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 December 31, 2007,
holds fully vested options to purchase 55,556 shares of the Companys common stock.
Pledge Agreement
On August 24, 2006, Digital Angel pledged 65% of its ownership in the Companys common stock
to its lender under the terms of a note and pledge agreement. The note is due in August 2009. This
note replaced a previous note issued by Digital Angel which was due in June 2007. On August 31,
2007, Digital Angel pledged 80% of its ownership in the Companys common stock to its lender under
the terms of a note and pledge agreement. The note is due in August 2009.
17 Supplementary Cash Flow Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Income taxes paid
|
|
$
|
280
|
|
|
$
|
437
|
|
|
$
|
143
|
|
Interest paid
|
|
|
25
|
|
|
|
46
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
305
|
|
|
$
|
483
|
|
|
$
|
145
|
|
|
|
|
|
|
|
|
|
|
|
In 2007, 2006 and 2005, the Company had the following non-cash investing and financing
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Offering costs
|
|
|
|
|
|
|
1,015
|
|
|
|
714
|
|
Issuance of common shares to Digital Angel for the contribution of VeriChip Holdings
Inc. to VeriChip Corporation
|
|
|
|
|
|
|
|
|
|
|
12,719
|
|
Contribution of Instantel Inc. to VeriChip Inc. by Digital Angel
|
|
|
|
|
|
|
|
|
|
|
21,043
|
|
Deferred purchase obligation
|
|
|
|
|
|
|
(500
|
)
|
|
|
3,000
|
|
Warrant exercise
|
|
|
4
|
|
|
|
|
|
|
|
|
|
Issuance of warrants
|
|
|
|
|
|
|
|
|
|
|
1
|
|
18 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 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, the Company has recorded charges of $0.3 and
$0.9 million, in 2007 and 2006, respectively, primarily 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.
19 Subsequent Events
$8.0 Million Debt Financing
On February 29, 2008, the Company closed an $8.0 million debt financing (the Agreement) with
Valens Offshore SPV II, Corp. (the Lender). Under the terms of the Agreement, the Lender
extended financing to the Company in the form of an $8.0 million secured term note (the Note).
The Note accrues interest at a rate of 12% per annum, and has a maturity date of March 31, 2009.
The terms of the Note allow for optional redemption by paying 100% of the principal amount plus
$120,000, if such amounts are paid prior to the six month anniversary of February 29, 2008, or
$240,000, if such amounts are paid on or after the six month anniversary of February 29, 2008.
Pursuant to the Agreement, the Company issued to the Lender 120,000 shares of its common stock. The
cost of this issuance was $0.3 million, which will be amortized over the period of the Note.
F-32
The Note also contains certain customary representations and warranties events of default,
including, among other things, failure to pay, violation of covenants, and certain other expressly
enumerated events. To secure the Companys obligations under the Agreement, the Company granted
the Lender a security interest in substantially all of the Companys assets, including all of the
issued and outstanding capital stock in Xmark. The Company previously granted a security interest
in all of its assets, including the outstanding capital stock in Xmark, to Digital Angel. The
Lender entered into a Subordination Agreement with Digital Angel, dated February 29, 2008, under
which obligations of the Company to Digital Angel are subordinated in right of payment and priority
to the payment in full due to the Lender by the Company.
Letter Agreement with Digital Angel
The Company used part of the proceeds of the financing with the Lender to prepay $5.3 million
of debt owed to Digital Angel. In connection with the financing, the Company entered into a letter
agreement with Digital Angel, dated February 29, 2008, under which the Company agreed, among other
things, to prepay the $5.3 million to Digital Angel, and to amend that certain letter agreement
between the Company and Digital Angel dated as of December 20, 2007 (the December 2007 Letter
Agreement), to provide that the Company will have until October 30, 2008 to prepay in full the
entire outstanding principal amount to Digital Angel by paying to Digital Angel $10 million, less
the $500,000 paid pursuant to the December 2007 Letter Agreement, less the $5.3 million paid in
connection with this financing, less other principal payments made to reduce the outstanding
principal amount between the date of the December 2007 Letter Agreement and the date of such
prepayment, plus any accrued and unpaid interest between October 1, 2007 and the date of such
prepayment. As a result of the $5.3 million payment, the Company will not be required to make any
further debt service payments to Digital Angel until September 1, 2009.
20 Summarized Quarterly Data (unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First
|
|
|
Second
|
|
|
Third
|
|
|
Fourth
|
|
|
Full
|
|
2007
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Year
|
|
|
Total revenue
|
|
$
|
7,373
|
|
|
$
|
8,190
|
|
|
$
|
7,916
|
|
|
$
|
8,627
|
|
|
$
|
32,106
|
|
Gross profit
|
|
|
3,863
|
|
|
|
4,230
|
|
|
|
4,536
|
|
|
|
4,517
|
|
|
|
17,146
|
|
Net loss
|
|
|
(3,313
|
)
|
|
|
(2,579
|
)
|
|
|
(3,223
|
)
|
|
|
(2,795
|
)
|
|
|
(11,910
|
)
|
Basic and diluted net loss per share (1)
|
|
$
|
(0.47
|
)
|
|
$
|
(0.29
|
)
|
|
$
|
(0.35
|
)
|
|
$
|
(0.29
|
)
|
|
$
|
(1.36
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First
|
|
|
Second
|
|
|
Third
|
|
|
Fourth
|
|
|
Full
|
|
2006
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Year
|
|
|
Total revenue
|
|
$
|
6,550
|
|
|
$
|
6,976
|
|
|
$
|
6,818
|
|
|
$
|
6,960
|
|
|
$
|
27,304
|
|
Gross profit
|
|
|
3,981
|
|
|
|
4,101
|
|
|
|
3,768
|
|
|
|
3,675
|
|
|
|
15,525
|
|
Net loss attributable to common
stockholder
|
|
|
(1,021
|
)
|
|
|
(1,169
|
)
|
|
|
(1,261
|
)
|
|
|
(3,274
|
)
|
|
|
(6,725
|
)
|
Basic and diluted net loss per share
attributable to common stockholder (1)
|
|
$
|
(0.18
|
)
|
|
$
|
(0.21
|
)
|
|
$
|
(0.23
|
)
|
|
$
|
(0.59
|
)
|
|
$
|
(1.21
|
)
|
|
|
|
(1)
|
|
Loss per share is computed independently for each of the quarters presented.
|
F-33
FINANCIAL STATEMENT SCHEDULE
Valuation and Qualifying Accounts (in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions
|
|
|
|
|
|
|
|
|
|
|
Balance at
|
|
|
charged to
|
|
|
|
|
|
|
Balance at
|
|
|
|
beginning
|
|
|
cost and
|
|
|
|
|
|
|
end of
|
|
Description
|
|
of period
|
|
|
expenses
|
|
|
Deductions
|
|
|
period
|
|
Valuation reserve deducted in the balance
sheet from the asset to which it applies:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007 Allowance for doubtful accounts
|
|
$
|
146
|
|
|
$
|
|
|
|
|
2
|
|
|
$
|
144
|
|
2006 Allowance for doubtful accounts
|
|
|
12
|
|
|
|
134
|
|
|
|
|
|
|
|
146
|
|
2005 Allowance for doubtful accounts
|
|
|
|
|
|
|
22
|
|
|
|
10
|
|
|
|
12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventory:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007 Allowance for excess and obsolescence
|
|
$
|
165
|
|
|
$
|
427
|
|
|
$
|
|
|
|
$
|
592
|
|
2006 Allowance for excess and obsolescence
|
|
|
96
|
|
|
|
69
|
|
|
|
|
|
|
|
165
|
|
2005 Allowance for excess and obsolescence
|
|
|
79
|
|
|
|
17
|
|
|
|
|
|
|
|
96
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred taxes:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007 Valuation reserve
|
|
$
|
7,930
|
|
|
$
|
5,036
|
|
|
$
|
|
|
|
$
|
12,966
|
|
2006 Valuation reserve
|
|
|
4,385
|
|
|
|
3,545
|
|
|
|
|
|
|
|
7,930
|
|
2005 Valuation reserve
|
|
|
1,899
|
|
|
|
2,486
|
|
|
|
|
|
|
|
4,385
|
|
F-34
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
EXI Wireless Inc.
We have audited the accompanying consolidated balance sheet of EXI Wireless Inc. and subsidiaries
as of March 31, 2005, and the related consolidated statements of operations, stockholders equity,
and cash flows for the three month period then ended. These consolidated financial statements are
the responsibility of the Companys management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of EXI Wireless Inc. and subsidiaries as of March 31,
2005, and the results of their operations and their cash flows for the three month period then
ended in conformity with U.S. generally accepted accounting principles.
The comparative figures for the three month period ended March 31, 2004 are unaudited.
KPMG LLP (signed)
Chartered Accountants
Vancouver, Canada
November 9, 2005
F-35
EXI WIRELESS INC.
Consolidated Balance Sheets
(Expressed in United States dollars)
(Prepared in accordance with United States GAAP)
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2005
|
|
|
2004
|
|
Assets
|
|
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
553,783
|
|
|
$
|
1,126,642
|
|
Accounts receivable, net of allowance for doubtful accounts of $25,009
(2004 - $22,514)
|
|
|
1,981,918
|
|
|
|
1,709,173
|
|
Inventory (note 3)
|
|
|
413,420
|
|
|
|
409,731
|
|
Prepaid expenses
|
|
|
31,114
|
|
|
|
60,411
|
|
|
|
|
|
|
|
|
|
|
|
2,980,235
|
|
|
|
3,305,957
|
|
|
|
|
|
|
|
|
|
|
Goodwill (note 4)
|
|
|
1,440,697
|
|
|
|
1,449,806
|
|
Property, plant and equipment (note 5)
|
|
|
190,865
|
|
|
|
189,455
|
|
Other intangible assets (note 6)
|
|
|
188,799
|
|
|
|
217,402
|
|
Deferred income taxes (note 7)
|
|
|
174,202
|
|
|
|
175,304
|
|
|
|
|
|
|
|
|
|
|
$
|
4,974,798
|
|
|
$
|
5,337,924
|
|
|
|
|
|
|
|
|
Liabilities and Stockholders Equity
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
618,926
|
|
|
$
|
714,666
|
|
Accrued liabilities
|
|
|
184,842
|
|
|
|
393,551
|
|
Deferred revenue
|
|
|
200,490
|
|
|
|
204,301
|
|
|
|
|
|
|
|
|
|
|
|
1,004,258
|
|
|
|
1,312,518
|
|
|
|
|
|
|
|
|
|
|
Stockholders equity:
|
|
|
|
|
|
|
|
|
Preferred stock:
|
|
|
|
|
|
|
|
|
Authorized unlimited shares with no par value; nil outstanding
in 2005 and 2004
|
|
|
|
|
|
|
|
|
Common stock:
|
|
|
|
|
|
|
|
|
Authorized unlimited shares with no par value; 10,265,178 (2004
- 10,080,360) issued and outstanding
|
|
|
|
|
|
|
|
|
Share capital (note 8)
|
|
|
4,554,076
|
|
|
|
4,396,803
|
|
Additional paid in capital
|
|
|
124,363
|
|
|
|
124,363
|
|
Accumulated other comprehensive income cumulative translation adjustment
|
|
|
821,384
|
|
|
|
847,098
|
|
Accumulated deficit
|
|
|
(1,529,283
|
)
|
|
|
(1,342,858
|
)
|
|
|
|
|
|
|
|
|
|
|
3,970,540
|
|
|
|
4,025,406
|
|
|
|
|
|
|
|
|
|
|
$
|
4,974,798
|
|
|
$
|
5,337,924
|
|
|
|
|
|
|
|
|
Commitments (note 11)
Subsequent events (note 14).
See accompanying notes to consolidated financial statements.
F-36
EXI WIRELESS INC.
Consolidated Statements of Operations
(Expressed in United States dollars)
(Prepared in accordance with United States GAAP)
Three month periods ended March 31, 2005 and 2004
|
|
|
|
|
|
|
|
|
|
|
2005
|
|
|
2004
|
|
|
|
|
|
|
(unaudited)
|
|
Sales
|
|
$
|
1,985,934
|
|
|
$
|
1,533,525
|
|
Cost of sales
|
|
|
574,504
|
|
|
|
424,098
|
|
|
|
|
|
|
|
|
|
|
|
1,411,430
|
|
|
|
1,109,427
|
|
|
|
|
|
|
|
|
|
|
Expenses:
|
|
|
|
|
|
|
|
|
Research and development
|
|
|
261,881
|
|
|
|
223,450
|
|
Depreciation and amortization
|
|
|
61,546
|
|
|
|
66,617
|
|
General and administrative
|
|
|
931,565
|
|
|
|
418,743
|
|
Selling and marketing
|
|
|
363,233
|
|
|
|
315,410
|
|
|
|
|
|
|
|
|
|
|
|
1,618,225
|
|
|
|
1,024,220
|
|
|
|
|
|
|
|
|
Earnings (loss) before undernoted
|
|
|
(206,795
|
)
|
|
|
85,207
|
|
|
|
|
|
|
|
|
|
|
Other earnings (expenses):
|
|
|
|
|
|
|
|
|
Interest
|
|
|
2,405
|
|
|
|
1,084
|
|
Foreign exchange gain
|
|
|
17,965
|
|
|
|
13,021
|
|
|
|
|
|
|
|
|
|
|
|
20,370
|
|
|
|
14,105
|
|
|
|
|
|
|
|
|
Earnings (loss) before income taxes
|
|
|
(186,425
|
)
|
|
|
99,312
|
|
|
|
|
|
|
|
|
|
|
Income taxes (note 7):
|
|
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
|
|
|
Future
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings (loss) for the period
|
|
$
|
(186,425
|
)
|
|
$
|
99,312
|
|
|
|
|
|
|
|
|
Earnings (loss) per share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.02
|
)
|
|
$
|
0.01
|
|
Diluted
|
|
|
(0.02
|
)
|
|
|
0.01
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding:
|
|
|
|
|
|
|
|
|
Basic
|
|
|
10,265,178
|
|
|
|
10,080,360
|
|
Diluted
|
|
|
10,265,178
|
|
|
|
10,117,188
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
F-37
EXI WIRELESS INC.
Consolidated Statements of Stockholders Equity
(Expressed in United States dollars)
(Prepared in accordance with United States GAAP)
Three month period ended March 31, 2005 and 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
other
|
|
|
Additional
|
|
|
Total
|
|
|
|
Common stock
|
|
|
Accumulated
|
|
|
comprehensive
|
|
|
paid
|
|
|
stockholders
|
|
|
|
Number
|
|
|
Amount
|
|
|
deficit
|
|
|
income (loss)
|
|
|
in capital
|
|
|
equity
|
|
Balance, December 31,
2003
|
|
|
10,080,360
|
|
|
$
|
4,396,803
|
|
|
$
|
(1,013,873
|
)
|
|
$
|
567,819
|
|
|
$
|
119,571
|
|
|
$
|
4,070,320
|
|
Net earnings
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
99,312
|
|
|
|
|
|
|
|
|
|
|
|
99,312
|
|
Foreign currency
translation
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(55,667
|
)
|
|
|
|
|
|
|
(55,667
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
43,645
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, March 31,
2004 (unaudited)
|
|
|
10,080,360
|
|
|
$
|
4,396,803
|
|
|
$
|
(914,561
|
)
|
|
$
|
512,152
|
|
|
$
|
119,571
|
|
|
$
|
4,113,965
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31,
2004
|
|
|
10,080,360
|
|
|
$
|
4,396,803
|
|
|
$
|
(1,342,858
|
)
|
|
$
|
847,098
|
|
|
$
|
124,363
|
|
|
$
|
4,025,406
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
(186,425
|
)
|
|
|
|
|
|
|
|
|
|
|
(186,425
|
)
|
Foreign currency
translation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(25,714
|
)
|
|
|
|
|
|
|
(25,714
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(212,139
|
)
|
Stock option exercised
|
|
|
120,169
|
|
|
|
85,760
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
85,760
|
|
Common shares issued
in lieu of signing
bonus and consulting
fees
|
|
|
64,649
|
|
|
|
71,513
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
71,513
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, March 31,
2005
|
|
|
10,265,178
|
|
|
$
|
4,554,076
|
|
|
$
|
(1,529,283
|
)
|
|
$
|
821,384
|
|
|
$
|
124,363
|
|
|
$
|
3,970,540
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
F-38
EXI WIRELESS INC.
Consolidated Statements of Cash Flows
(Expressed in United States dollars)
(Prepared in accordance with United States GAAP)
Three month periods ended March 31, 2005 and 2004
|
|
|
|
|
|
|
|
|
|
|
2005
|
|
|
2004
|
|
|
|
|
|
|
|
(unaudited)
|
|
Cash provided by (used in):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flow from operating activities:
|
|
|
|
|
|
|
|
|
Net earnings (loss) for the period
|
|
$
|
(186,425
|
)
|
|
$
|
99,312
|
|
Adjustments to reconcile net earnings (loss) to net cash used in
operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
61,546
|
|
|
|
66,617
|
|
Common shares issued in lieu of bonus and consulting fees
|
|
|
71,513
|
|
|
|
|
|
Changes in non-cash working capital:
|
|
|
|
|
|
|
|
|
Decrease in accounts receivable
|
|
|
(279,456
|
)
|
|
|
(278,534
|
)
|
Decrease (increase) in prepaid expenses
|
|
|
16,656
|
|
|
|
(34,274
|
)
|
Decrease (increase) in inventory
|
|
|
5,676
|
|
|
|
(10,525
|
)
|
Increase (decrease) in accounts payable
|
|
|
(89,954
|
)
|
|
|
14,721
|
|
Increase (decrease) in accrued liabilities
|
|
|
(203,306
|
)
|
|
|
31,848
|
|
Increase (decrease) in deferred revenue
|
|
|
(2,492
|
)
|
|
|
(15,904
|
)
|
|
|
|
|
|
|
|
|
|
|
(606,242
|
)
|
|
|
(126,739
|
)
|
Cash flow from investing activities:
|
|
|
|
|
|
|
|
|
Payments for property, plant and equipment
|
|
|
(33,354
|
)
|
|
|
(23,933
|
)
|
Proceeds on sale of property, plant and equipment
|
|
|
(3,906
|
)
|
|
|
(1,921
|
)
|
|
|
|
|
|
|
|
|
|
|
(37,260
|
)
|
|
|
(25,854
|
)
|
Cash flow from financing activities:
|
|
|
|
|
|
|
|
|
Common shares issued for cash
|
|
|
85,760
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of exchange rate changes on cash
|
|
|
(15,117
|
)
|
|
|
(14,864
|
)
|
|
|
|
|
|
|
|
Decrease in cash
|
|
|
(572,859
|
)
|
|
|
(167,457
|
)
|
|
|
|
|
|
|
|
|
|
Cash, beginning of period
|
|
|
1,126,642
|
|
|
|
1,025,292
|
|
|
|
|
|
|
|
|
Cash, end of period
|
|
$
|
553,783
|
|
|
$
|
857,835
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplementary information:
|
|
|
|
|
|
|
|
|
Interest expense paid
|
|
$
|
|
|
|
$
|
526
|
|
Non-cash transaction:
|
|
|
|
|
|
|
|
|
Common shares issued in lieu of bonus and consulting fees
|
|
$
|
71,513
|
|
|
$
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
F-39
1. Operations:
EXI Wireless Inc. (the Company) was incorporated under the Alberta Business Corporation Act
on July 12, 1996 and was continued under the Canada Business Corporation Act on June 2, 1999.
The Company is a radio frequency identification (RFID) based asset management and security
company. The Companys principal business activity is the development and marketing of solutions,
which help organizations extract the greatest value from their assets and manage them to their
highest potential and secure them from theft or loss. The Company currently derives its revenue
from the sale of security-based wireless tagging solutions and inventory and asset tracking system
software into healthcare, construction and energy markets.
2. Significant accounting policies:
(a) Consolidation:
The consolidated financial statements include the accounts of the Company and its wholly owned
subsidiaries, EXI Wireless Systems Inc. and EXI Solutions Inc. (formerly Advanced Delivery
Solutions Limited (ADSL)) and HOUNDware Corporation. All significant inter-company transactions
and balances have been eliminated. These interim financial statements, in the opinion of
management, reflect all adjustments (which include reclassification and normal recurring
adjustments), necessary for a fair presentation of the results for the interim periods presented.
(b) Inventory:
Raw materials inventory is valued at the lower of cost and replacement cost. Finished goods
inventory is valued at the lower of cost and net realizable value. The cost of finished goods
includes the cost of raw material and direct labour.
(c) Property, plant and equipment:
Property, plant and equipment are stated at cost, net of government assistance received.
Depreciation of property, plant and equipment is recorded on a straight-line basis using the
following estimated useful life:
|
|
|
|
|
|
|
|
|
Asset
|
|
Estimated useful life
|
|
|
Rate
|
|
Furniture, fixtures and equipment
|
|
5 years
|
|
|
20
|
%
|
Computer equipment
|
|
3 5 years
|
|
|
20% 33
|
%
|
Computer software
|
|
2 years
|
|
|
50
|
%
|
Leasehold improvements are amortized on a straight-line basis over the lease term or five
years, whichever is shorter.
(d) Acquired technology and other intangible assets:
Acquired core technology and other intangible assets are stated at cost and are amortized by
the straight-line method over their estimated useful life of three to five years. Acquired
technology and intangible assets used solely for the purpose of research and development are
expensed immediately in the year of acquisition.
(e) Goodwill:
Goodwill is the residual amount that results when the purchase price of an acquired business
exceeds the sum of the amounts allocated to the identifiable assets acquired, less liabilities
assumed, based on their fair values. Goodwill is allocated as of the date of the business
combination to the Companys reporting units that are expected to benefit from the synergies of the
business combination.
Goodwill has an indefinite use, is not amortized and is tested for impairment annually, or
more frequently if events or changes in circumstances indicate that the goodwill might be impaired.
The impairment test is carried out in two steps. In the first step, the carrying amount of the
reporting unit is compared with its fair value. When the fair value of a reporting unit exceeds its
carrying amount, goodwill of the reporting unit is considered not to be impaired and the second
step of impairment test is unnecessary. The second step is carried out when the carrying amount of
a reporting unit exceeds its fair value, in which case the implied fair value of the reporting
units goodwill is compared with its carrying amount to measure the amount of the impairment loss,
if any. The implied fair value of the reporting units goodwill is determined in the same manner as
the value of goodwill is determined at the time of a business combination described in the
preceding paragraph, using the fair value of the reporting unit as if it was the purchase price.
When the carrying amount of goodwill exceeds the implied fair value of the goodwill, an impairment
loss is recognized in an amount equal to the excess and is presented as a separate line item in the
earnings statement before extraordinary items and discontinued operations.
F-40
The Company performed its annual goodwill impairment test on December 31, 2004 and concluded
that no impairment charge was required for goodwill related to continuing operations. As at
March 31, 2005, the Company is operating in two operating segments and reporting units (see note
10).
(f) Impairment of long-lived assets:
The Company monitors the recoverability of long-lived assets, based on estimates using factors
such as expected future asset utilization, economic outlook and future cash flows expected to
result from the use of the related assets or be realized on sale. The Company recognizes an
impairment loss if the projected undiscounted aggregate future cash flows are less than the
carrying amount. The amount of impairment charge, if any, is defined as the excess of the carrying
value over its fair value.
(g) Foreign currency translation:
The Companys functional or primary operating currency is the Canadian dollar. The Companys
financial statements are prepared in Canadian dollars before translation to the US dollar reporting
currency. The Company translates transactions in currencies other than the Canadian dollar at the
exchange rate in effect on the transaction date. Monetary assets and liabilities denominated in a
currency other than the Canadian dollar are translated at the exchange rates in effect at the
balance sheet date. The resulting exchange gains and losses are recognized in earnings.
Amounts reported in Canadian dollars have been translated into the US dollar reporting
currency as follows: assets and liabilities are translated into US dollars at the rate of exchange
in effect at the balance sheet date and revenue and expense items are translated at the average
rates for the period. Unrealized gains and losses resulting from the translation into the reporting
currency are accumulated in accumulated other comprehensive income (loss), a separate component of
stockholders equity.
(h) Research and development costs:
Research and development costs are expensed as incurred.
(i) Warranty:
The Company provides certain warranties on its products. Provisions for future warranty costs
based on managements best estimates are recorded when revenue on product sales is recognized. The
warranty period for the majority of the products ranges between one and three years. Management
determines the warranty based on known product failures (if any), historical experience, and other
currently available evidence.
|
|
|
|
|
|
|
|
|
|
|
Three months
|
|
|
Three months
|
|
|
|
ended
|
|
|
ended
|
|
|
|
March 31,
|
|
|
March 31,
|
|
|
|
2005
|
|
|
2004
|
|
|
|
|
|
|
|
(unaudited)
|
|
Balance, January 1
|
|
$
|
66,739
|
|
|
$
|
66,546
|
|
Accruals for warranties issued
|
|
|
16,140
|
|
|
|
49,834
|
|
Settlements made (in cash or kind)
|
|
|
(16,611
|
)
|
|
|
(54,623
|
)
|
|
|
|
|
|
|
|
Balance, March 31
|
|
$
|
66,268
|
|
|
$
|
61,757
|
|
|
|
|
|
|
|
|
(j) Pension plan:
The Company has a defined contribution plan for its employees. The Company accrues its
obligations under pension plans as the employees render the services necessary to earn the pension
benefits. During the three months ended March 31, 2005, the Company expensed $10,758 (Three months
ended March 31, 2004 $8,042) for the defined contribution plan.
(k) Use of estimates:
The preparation of financial statements in conformity with generally accepted accounting
principles 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 revenue and expenses during the reporting period.
Actual amounts may ultimately differ from these estimates. Significant areas requiring the use of
management estimates relate to the determination of collectibility of accounts receivable, net
recoverable amounts of property, plant and equipment, goodwill and other intangibles, useful lives
for depreciation and amortization, investment tax credits recoverable and provisions for
warranties.
F-41
(l) Revenue recognition:
Hardware and software revenue is recognized when persuasive evidence of an arrangement exists,
the goods are shipped and title passes, the price is fixed or determinable and collection of the
sales proceeds is reasonably assured.
Revenue from the sale of software implementation services and consulting services is
recognized as the services are performed. Revenue from post-contract support services is recognized
over the term of the agreement.
When software arrangements include multiple elements to which contract accounting does not
apply, the individual elements are accounted for separately if vendor specific objective evidence
(VSOE) of fair value exists for the undelivered elements. Generally, the Company applies the
residual method in allocating revenue between delivered and undelivered elements. If VSOE does not
exist, the revenue on the completed arrangement is deferred until the earlier of (a) VSOE being
established or (b) all of the undelivered elements are delivered or performed, with the following
exceptions: if the only undelivered element is post-contract support (PCS), the entire fee is
recognized ratably over the PCS period, and if the only undelivered element is service, the entire
fee is recognized as the services are performed.
Maintenance revenue is deferred and recognized ratably over the terms of the maintenance
agreements.
(m) Stock-based compensation:
As permitted under SFAS No.123,
Accounting for Stock-based Compensation
(FAS 123), the
Company has elected to apply Accounting Principles Board (APB) Opinion No. 25 and related
Interpretations in accounting for its stock-based compensation arrangements. Accordingly, no
compensation cost is recognized for any of the Companys equity instruments granted to directors
and employees when the exercise price equals or exceeds fair value of the underlying common stocks
as of the grant date for each stock option. FAS 123 uses a fair value method of calculating the
cost of stock option grants. Had compensation cost for employee stock option plan been determined
by the fair value method, net income (loss) and earnings (loss) per share would have been as
follows:
|
|
|
|
|
|
|
|
|
|
|
Three months
|
|
|
Three months
|
|
|
|
ended
|
|
|
ended
|
|
|
|
March 31,
|
|
|
March 31,
|
|
|
|
2005
|
|
|
2004
|
|
|
|
|
|
|
|
(unaudited)
|
|
Reported net income (loss)
|
|
$
|
(186,425
|
)
|
|
$
|
99,312
|
|
Stock-based employee compensation expense
determined under the fair value based method
|
|
|
(20,578
|
)
|
|
|
(15,504
|
)
|
|
|
|
|
|
|
|
Pro forma net income (loss)
|
|
$
|
(207,003
|
)
|
|
$
|
83,808
|
|
|
|
|
|
|
|
|
Earnings (loss) per share basic and diluted:
|
|
|
|
|
|
|
|
|
As reported
|
|
$
|
(0.02
|
)
|
|
$
|
0.01
|
|
Pro forma
|
|
$
|
(0.02
|
)
|
|
$
|
0.01
|
|
|
|
|
|
|
|
|
The fair value of each option is estimated as at the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions: dividend yield 0%, expected
volatility 110%, risk-free interest rate 4.46% and expected average option term of five years. The
weighted-average fair value of the value of the options granted to employees during the three month
period ended March 31, 2005 was nil per option (Three months ended March 31, 2004 $0.60).
(n) Income taxes:
Income taxes are accounted for in accordance with SFAS No. 109,
Accounting for Income Taxes
,
which requires the use of the asset and liability method. Under this method, deferred income taxes
are recognized for the future tax consequences attributable to differences between the financial
statements carrying value and their respective income tax bases (temporary differences). Changes in
the net deferred tax asset or liability are generally included in earnings. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable income in the years
in which temporary differences are expected to be recovered or settled. The effect on deferred
income tax assets and liabilities of a change in tax rates is included in income in the period that
includes the enactment date. Deferred income tax assets are evaluated and if their realization is
not considered more likely then not, a valuation allowance is provided.
(o) Investment tax credits:
Investment tax credits are accounted for using the flow-through method whereby such credits
are accounted for as a reduction of income tax expense in the period in which the credit arises.
F-42
(p) Earnings (loss) per share:
Basic earnings (loss) per common share are computed by dividing net earnings by the weighted
average number of common shares outstanding during the period.
Diluted earnings per common share is calculated using the treasury stock method and reflects
the potential dilution of securities by including stock options in the weighted average number of
common shares outstanding for a period, if dilutive.
(q) Comprehensive Income (loss)
Comprehensive income (loss) is recognized and measured pursuant to SFAS No. 130,
Reporting
Comprehensive Income
. This standard defines comprehensive income as all changes in equity other
than those resulting from investments by owners and distributions to owners. Comprehensive income
is comprised of two components, net earnings (loss) and other comprehensive income (OCI). OCI
refers to amounts that are recorded as an element of stockholders equity but are excluded from net
income because these transactions or events were attributed to changes from non-owner sources.
(r) Comparative figures:
Certain comparative figures have been reclassified to conform with the basis of presentation
adopted in the current year.
(s) Recent accounting pronouncements:
In December 2004, the Financial Accounting Standards Board (FASB) issued revised Statement
of Financial Accounting Standards No. 123 (Revised 2004) entitled
Share-Based Payment
(FAS
No. 123). This revised statement addresses accounting for stock-based compensation and results in
the fair value of all stock-based compensation arrangements, including options, being recognized as
an expense in a companys financial statements as opposed to supplemental disclosure in the notes
to financial statements. The revised Statement eliminates the ability to account for stock-based
compensation transactions using APB Opinion No. 25. FAS No. 123R will be effective for the Company
as of January 1, 2006.
In December 2004, the FASB issued FASB Statement No. 153,
Exchanges of Nonmonetary Assets
,
which eliminates an exception in APB 29 for nonmonetary exchanges of similar productive assets and
replaces it with a general exception for exchanges of nonmonetary assets that do not have
commercial substance. This Statement will be effective for the Company for nonmonetary asset
exchanges occurring on or after January 1, 2006.
In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 151 entitled
Inventory Costs an amendment of ARB No. 43,
Chapter 4
(FAS No. 151). This statement amends the guidance in ARB No. 43 to clarify the
accounting for abnormal amounts of idle facility expense, freight, handling costs and spoilage. FAS
No. 151 requires that these items be recognized as current period charges. The Company has adopted
FAS No. 151, which had no effect on the consolidated financial statements.
3. Inventory:
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2005
|
|
|
2004
|
|
Finished goods
|
|
$
|
462,049
|
|
|
$
|
454,149
|
|
Reserve for obsolete inventory
|
|
|
(48,629
|
)
|
|
|
(44,418
|
)
|
|
|
|
|
|
|
|
|
|
$
|
413,420
|
|
|
$
|
409,731
|
|
|
|
|
|
|
|
|
4. Goodwill:
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2005
|
|
|
2004
|
|
Cost
|
|
$
|
2,195,941
|
|
|
$
|
2,209,825
|
|
Accumulated amortization
|
|
|
755,244
|
|
|
|
760,019
|
|
|
|
|
|
|
|
|
Net book value
|
|
$
|
1,440,697
|
|
|
$
|
1,449,806
|
|
|
|
|
|
|
|
|
The change in goodwill and its components is solely due to foreign exchange fluctuations.
F-43
5. Property, plant and equipment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
Net book
|
|
March 31, 2005
|
|
Cost
|
|
|
depreciation
|
|
|
value
|
|
Furniture, fixtures and equipment
|
|
$
|
464,886
|
|
|
$
|
390,774
|
|
|
$
|
74,112
|
|
Computer equipment
|
|
|
440,669
|
|
|
|
357,332
|
|
|
|
83,337
|
|
Computer software
|
|
|
276,009
|
|
|
|
253,749
|
|
|
|
22,260
|
|
Leasehold improvements
|
|
|
103,181
|
|
|
|
92,025
|
|
|
|
11,156
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,284,745
|
|
|
$
|
1,093,880
|
|
|
$
|
190,865
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
Net book
|
|
December 31, 2004
|
|
Cost
|
|
|
depreciation
|
|
|
value
|
|
Furniture, fixtures and equipment
|
|
$
|
466,106
|
|
|
$
|
381,817
|
|
|
$
|
84,289
|
|
Computer equipment
|
|
|
415,936
|
|
|
|
346,196
|
|
|
|
69,740
|
|
Computer software
|
|
|
272,945
|
|
|
|
250,354
|
|
|
|
22,591
|
|
Leasehold improvements
|
|
|
103,834
|
|
|
|
90,999
|
|
|
|
12,835
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,258,821
|
|
|
$
|
1,069,366
|
|
|
$
|
189,455
|
|
|
|
|
|
|
|
|
|
|
|
6. Other intangible assets:
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2005
|
|
|
2004
|
|
Acquired technology and other intangible assets
|
|
$
|
695,322
|
|
|
$
|
699,719
|
|
Accumulated amortization
|
|
|
506,523
|
|
|
|
482,317
|
|
|
|
|
|
|
|
|
Net book value
|
|
$
|
188,799
|
|
|
$
|
217,402
|
|
|
|
|
|
|
|
|
Intangible amortization expense for the three month period ended March 31, 2005 was $30,707
(Three months ended March 31, 2004 $28,326).
7. Income taxes:
As at March 31, 2005, the Company has non-capital losses carried forward of approximately
$734,000, federal and provincial investment tax credits available for carry forward of
approximately $1,073,000 and scientific research and experimental development expenditures
available for carry forward of approximately $663,000. Non-capital losses and investment tax
credits available will begin to expire in 2007 and 2009 respectively. Scientific research and
development expenses can be carried forward indefinitely and deducted against future taxable income
otherwise calculated.
The provision for income tax differs from the amount obtained by applying the combined federal
and provincial income tax rates to the earnings before income taxes and discontinued operations.
The difference relates to the following items:
|
|
|
|
|
|
|
|
|
|
|
Three months
|
|
|
Three months
|
|
|
|
ended
|
|
|
ended
|
|
|
|
March 31,
|
|
|
March 31,
|
|
|
|
2005
|
|
|
2004
|
|
|
|
|
|
|
|
(unaudited)
|
|
Combined Canadian federal and provincial
income taxes at expected rates of 35.6%
(March 31, 2004 - 35.6%)
|
|
$
|
(66,367
|
)
|
|
$
|
35,355
|
|
Non-deductible permanent and other differences
|
|
|
14,579
|
|
|
|
1,217
|
|
Investment tax credits
|
|
|
(90,600
|
)
|
|
|
|
|
Change in valuation allowance
|
|
|
142,388
|
|
|
|
(36,572
|
)
|
|
|
|
|
|
|
|
Tax expense
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
F-44
The tax effects of temporary differences that give rise to significant portions of the
deferred tax assets and liabilities at March 31, 2005 and December 31, 2004 are presented below:
|
|
|
|
|
|
|
|
|
|
|
Three month
|
|
|
|
|
|
|
period ended
|
|
|
Year ended
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2005
|
|
|
2004
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Non-capital losses
|
|
$
|
261,261
|
|
|
$
|
185,540
|
|
Scientific research and experimental development expenditures
|
|
|
236,067
|
|
|
|
170,170
|
|
Warranty and inventory valuation reserves
|
|
|
40,755
|
|
|
|
39,580
|
|
Property, plant and equipment
|
|
|
29,679
|
|
|
|
26,204
|
|
|
|
|
|
|
|
|
Total gross deferred tax assets
|
|
|
567,762
|
|
|
|
421,494
|
|
Valuation allowance
|
|
|
(350,770
|
)
|
|
|
(208,382
|
)
|
|
|
|
|
|
|
|
Deferred tax assets
|
|
|
216,992
|
|
|
|
213,112
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Intangible assets
|
|
|
(42,790
|
)
|
|
|
(37,808
|
)
|
|
|
|
|
|
|
|
Net deferred tax asset
|
|
$
|
174,202
|
|
|
$
|
175,304
|
|
|
|
|
|
|
|
|
The net deferred tax assets related to discontinued operations, which are not included above,
as at March 31, 2005 are $59,953 (December 31, 2004 $60,334). The Company believes that
realization of certain of their net deferred tax asset is more likely than not. In assessing the
realization of their deferred tax assets, the Company considered whether it is more likely than not
that some portion of all of their deferred tax assets will not be realized. The ultimate
realization of their deferred tax assets is dependent upon the generation of future taxable income
during the period in which temporary differences become deductible.
The Company considered projected taxable income and tax planning strategies in making their
assessment.
8. Share capital:
(a) Stock options:
On October 29, 1999, the Company authorized a special granting of 900,000 options to purchase
common shares. All options relating to this special grant were granted as at December 31, 2001.
Additionally, on May 30, 2000, the Company adopted a 2000 Share Option Plan (the Plan) which
provides for a maximum of 530,593 options to purchase common shares to be allocated to directors,
officers, employees, and consultants of the Company. Stock options are granted having exercise
prices based on market prices at the date of grant.
For each of the periods presented, the following stock options to employees, directors and
officers were outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2005
|
|
|
December 31, 2004
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Weighted
|
|
|
|
Number
|
|
|
average
|
|
|
Number
|
|
|
average
|
|
|
|
of shares
|
|
|
exercise price
|
|
|
of shares
|
|
|
exercise price
|
|
Outstanding, beginning of year
|
|
|
893,000
|
|
|
$
|
0.84
|
|
|
|
1,263,500
|
|
|
$
|
0.81
|
|
Granted
|
|
|
|
|
|
|
|
|
|
|
258,000
|
|
|
|
0.71
|
|
Exercised
|
|
|
(120,000
|
)
|
|
|
0.99
|
|
|
|
|
|
|
|
|
|
Cancelled
|
|
|
(15,500
|
)
|
|
|
0.65
|
|
|
|
(628,500
|
)
|
|
|
0.83
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, end of year
|
|
|
757,500
|
|
|
$
|
0.85
|
|
|
|
893,000
|
|
|
$
|
0.84
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At March 31, 2005, 617,000 (December 31, 2004 617,000) of the stock options outstanding are
held by officers and directors of the Company with the remainder held by consultants and key
employees of the Company. The average vesting period for all options is three years.
F-45
Details of options outstanding at March 31, 2005 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Number of
|
|
|
average
|
|
|
Number of
|
|
|
|
options
|
|
|
remaining
|
|
|
options
|
|
Exercise prices
|
|
outstanding
|
|
|
contractual life
|
|
|
exercisable
|
|
$0.00 0.41
|
|
|
231,502
|
|
|
|
2.92
|
|
|
|
144,336
|
|
$0.41 0.82
|
|
|
150,166
|
|
|
|
3.96
|
|
|
|
47,506
|
|
$0.82 1.24
|
|
|
232,332
|
|
|
|
3.36
|
|
|
|
129,171
|
|
$1.24 1.66
|
|
|
71,000
|
|
|
|
0.80
|
|
|
|
71,000
|
|
$1.66 2.07
|
|
|
13,000
|
|
|
|
0.37
|
|
|
|
13,000
|
|
$2.07 2.50
|
|
|
59,500
|
|
|
|
0.01
|
|
|
|
59,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
757,500
|
|
|
|
2.58
|
|
|
|
464,513
|
|
|
|
|
|
|
|
|
|
|
|
(b) Warrants:
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2005
|
|
|
2004
|
|
Warrants issued and outstanding
|
|
|
40,000
|
|
|
|
40,000
|
|
|
|
|
|
|
|
|
The exercise price of the warrants is $2.08 per common share. The warrants expire on
October 31, 2005.
(c) The Company has a Share Compensation Arrangement (the Arrangement) for non-management
directors. The total compensation for the three month period ended March 31, 2005 is $5,501 (Three
months ended March 31, 2004 $1,317) which could be settled in cash or shares of the Company at
the option of the Company. If settled in shares, under the Arrangement, the deemed price per share
will be based upon the average closing price of the Companys shares for fifteen days prior to
issuance. The Company has accrued this compensation in accrued liabilities as at March 31, 2005.
9. Per share amounts:
Per share amounts are based on the weighted average number of common shares issued and
outstanding during the year. Fully diluted earnings per share assumes all outstanding options have
been exercised at the later of the beginning of the fiscal period or the date of issuance. Where
the impact of the conversion or exercise is anti-dilutive, the conversions are not included in the
calculation of fully diluted per share amounts. The weighted average number of shares outstanding
used in the computation of earnings (loss) per share were as follows:
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
March 31,
|
|
|
|
2005
|
|
|
2004
|
|
Weighted average shares used in computation of basic earnings (loss) per share
|
|
|
10,265,178
|
|
|
|
10,080,360
|
|
Weighted average shares from assumed conversion of dilutive options
|
|
|
|
|
|
|
36,828
|
|
|
|
|
|
|
|
|
Computation of diluted earnings (loss) per share
|
|
|
10,265,178
|
|
|
|
10,117,188
|
|
|
|
|
|
|
|
|
10. Segmented reporting:
(a) Business segments:
The Company has divided its operations into two separate business segments: Healthcare,
which involves the research and development, design, marketing and related consulting services for
radio frequency identification systems for the healthcare industry; Industrial which involves
research and development, design, marketing, and related consulting services for industrial
inventory and asset tracking software systems.
The accounting policies for each of these segments are the same as described in note 2. The
following represents information used by management in assessing the performance of its operating
business segments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2005
|
|
Healthcare
|
|
|
Industrial
|
|
|
Corporate
|
|
|
Total
|
|
Sales
|
|
$
|
1,726,208
|
|
|
$
|
259,726
|
|
|
$
|
|
|
|
$
|
1,985,934
|
|
Depreciation and amortization
|
|
|
48,025
|
|
|
|
2,076
|
|
|
|
11,445
|
|
|
|
61,546
|
|
Interest expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
(1,106
|
)
|
|
|
(1,299
|
)
|
|
|
|
|
|
|
(2,405
|
)
|
Income tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings (loss) for the year
|
|
|
43,892
|
|
|
|
44,598
|
|
|
|
(274,915
|
)
|
|
|
(186,425
|
)
|
Additions to property, plant and equipment
|
|
|
33,354
|
|
|
|
|
|
|
|
|
|
|
|
33,354
|
|
Segment assets
|
|
|
4,079,334
|
|
|
|
596,976
|
|
|
|
298,488
|
|
|
|
4,974,798
|
|
Goodwill
|
|
|
1,440,697
|
|
|
|
|
|
|
|
|
|
|
|
1,440,697
|
|
F-46
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2004
|
|
Healthcare
|
|
|
Industrial
|
|
|
Corporate
|
|
|
Total
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
1,388,725
|
|
|
$
|
144,800
|
|
|
$
|
|
|
|
$
|
1,533,525
|
|
Depreciation and amortization
|
|
|
53,063
|
|
|
|
2,655
|
|
|
|
10,899
|
|
|
|
66,617
|
|
Interest expense
|
|
|
310
|
|
|
|
10
|
|
|
|
|
|
|
|
320
|
|
Interest income
|
|
|
(738
|
)
|
|
|
(346
|
)
|
|
|
|
|
|
|
(1,084
|
)
|
Income tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings (loss) for the year
|
|
|
265,575
|
|
|
|
(69,292
|
)
|
|
|
(96,971
|
)
|
|
|
99,312
|
|
Additions to property, plant and equipment
|
|
|
20,284
|
|
|
|
3,649
|
|
|
|
|
|
|
|
23,933
|
|
Segment assets
|
|
|
3,614,894
|
|
|
|
513,739
|
|
|
|
1,176,873
|
|
|
|
5,305,506
|
|
Goodwill
|
|
|
1,329,773
|
|
|
|
|
|
|
|
|
|
|
|
1,329,773
|
|
The segment assets noted above are net of the assets of discontinued operations of nil (March
31, 2004 $34,131).
(b) Geographic segments:
All of the Companys assets and operations are located in Canada. The following table
summarizes the Companys sales from continuing operations by geographic area:
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
March 31,
|
|
|
|
2005
|
|
|
2004
|
|
|
|
|
|
|
|
(unaudited)
|
|
Canada
|
|
$
|
246,169
|
|
|
$
|
201,108
|
|
United States
|
|
|
1,730,377
|
|
|
|
1,292,232
|
|
Other
|
|
|
9,388
|
|
|
|
40,185
|
|
|
|
|
|
|
|
|
|
|
$
|
1,985,934
|
|
|
$
|
1,533,525
|
|
|
|
|
|
|
|
|
(c) Major customers:
Sales during the three month period ended March 31, 2005 to major customers included sales to
one customer of $563,805 (Three months ended March 31, 2004 nil) and to another customer of
$462,929 (Three months ended March 31, 2004 $488,072).
11. Commitments:
Future minimum annual rental payments for operating leases are payable over the next four
years are approximately as follows:
|
|
|
|
2005
|
|
$
|
57,088
|
2006
|
|
|
163,255
|
2007
|
|
|
145,633
|
2008
|
|
|
155,240
|
2009
|
|
|
66,348
|
12. Related party transactions:
During the three month period ended March 31, 2005, the Company paid legal fees of nil (Three
months ended March 31, 2004 $9,940) to the Companys legal counsel, of which one of the partners
is a Director of the Company. This transaction is in the normal course of operations and are
measured at the exchange amount, which is the amount of consideration established and agreed by the
related parties.
13. Financial instruments:
(a) Credit risk:
The Company, in its normal course of business, evaluates the financial condition of its
customers on a regular basis and examines credit history for any new customer. In addition, the
Company engaged the Export Development Corporation to insure its receivables as of October 2000.
This coverage provides insurance for 90% of certain receivables.
F-47
(b) Fair values of financial instruments:
The methods and assumptions used to estimate the fair value of each class of financial
instruments for which it is practical to estimate a value are as follows:
(i) Short-term financial instruments:
The carrying amounts of these financial assets and liabilities are a reasonable
estimate of their fair values because of the short maturity of these instruments.
Short-term financial assets comprise cash and accounts receivable. Short-term financial
liabilities comprise accounts payable, accrued liabilities and income taxes payable.
(c) Foreign exchange risk:
Foreign exchange risk reflects the risk that the Companys earnings will decline due to
fluctuations in exchange rates. Contracts billed in United States dollars by the Company are
collected in the short-term and, accordingly, the Company has determined there is no significant
exposure to foreign currency fluctuations.
14. Subsequent Events
On March 31, 2005, the Company was acquired by Applied Digital Solutions (ADSX) where ADSX
paid $1.33 (CAD$1.60) for each outstanding share of the Company (10,265,178 shares outstanding)
payable in shares of ADSXs common stock based on the daily weighted-average closing price of its
common stock quoted on the Nasdaq Small Cap Market for the ten consecutive trading days that ended
three trading days before the closing.
Included in general and administrative expenses for the three month period ended March 31,
2005 is $532,176 (2004-nil) for acquisition costs.
Subsequent to the acquisition, the Company was renamed VeriChip Holdings Inc.
Subsequent to March 31, 2005, all outstanding stock options of the Company were exchanged for
stock options of ADSX.
F-48
Report of Independent Registered Public Accounting Firm
To the Board of Directors and the Shareholder of Instantel Inc.
We have audited the accompanying balance sheet of Instantel Inc. (The Company) as of June 9,
2005 and the statements of operations, shareholders equity and cash flows for the period January 1
to June 9, 2005. These financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on our audit. The
balance sheet of the Company as at December 31, 2004 was audited by other auditors whose report
dated January 21, 2005, except for notes 13 and 14 which were as of December 15, 2005, expressed an
unqualified opinion on those statements. The comparative figures for the period of January 1, 2004
to June 9, 2004 are unaudited.
We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform an audit to
obtain reasonable assurance whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material
respects, the financial position of the Company as of June 9, 2005 and the results of its
operations and its cash flows for the period then ended in accordance with accounting principles
generally accepted in the United States of America.
MEYERS NORRIS PENNY LLP
Chartered Accountants
Calgary, Alberta
November 17, 2005
F-49
INSTANTEL INC.
Balance Sheets at
|
|
|
|
|
|
|
|
|
|
|
June 9,
|
|
|
December 31,
|
|
|
|
2005
|
|
|
2004
|
|
|
|
|
|
|
|
(restated)
|
|
ASSETS
|
|
|
|
|
|
|
|
|
CURRENT ASSETS
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
3,669
|
|
|
$
|
46,481
|
|
Accounts receivable
|
|
|
2,307,540
|
|
|
|
2,273,482
|
|
Inventories
|
|
|
1,710,891
|
|
|
|
1,529,993
|
|
Current portion of deferred income taxes
|
|
|
126,936
|
|
|
|
|
|
Other current assets
|
|
|
286,178
|
|
|
|
406,532
|
|
|
|
|
|
|
|
|
TOTAL CURRENT ASSETS
|
|
|
4,435,215
|
|
|
|
4,256,488
|
|
|
|
|
|
|
|
|
|
|
CAPITAL ASSETS
|
|
|
492,649
|
|
|
|
474,145
|
|
INTANGIBLE ASSETS
|
|
|
4,759,500
|
|
|
|
6,270,000
|
|
GOODWILL
|
|
|
592,547
|
|
|
|
592,547
|
|
|
|
|
|
|
|
|
|
|
|
10,279,910
|
|
|
|
11,593,180
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS (DEFICIT) EQUITY
|
|
|
|
|
|
|
|
|
CURRENT LIABILITIES
|
|
|
|
|
|
|
|
|
Bank indebtedness
|
|
|
714,263
|
|
|
|
586,697
|
|
Accounts payable
|
|
|
81,496
|
|
|
|
515,299
|
|
Accrued liabilities
|
|
|
714,814
|
|
|
|
357,495
|
|
Deferred revenue
|
|
|
149,000
|
|
|
|
60,000
|
|
Taxes payable
|
|
|
122,464
|
|
|
|
328,711
|
|
Salary and benefits payable
|
|
|
1,682,253
|
|
|
|
935,965
|
|
Current portion of long term debt
|
|
|
5,500,000
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL CURRENT LIABILITIES
|
|
|
8,964,290
|
|
|
|
2,784,167
|
|
|
|
|
|
|
|
|
|
|
DEFERRED TAXES
|
|
|
1,537,900
|
|
|
|
2,674,706
|
|
LONG TERM DEBT
|
|
|
|
|
|
|
5,500,000
|
|
|
|
|
|
|
|
|
TOTAL LIABILITIES
|
|
|
10,502,190
|
|
|
|
10,958,873
|
|
|
|
|
|
|
|
|
COMMITMENTS & CONTINGENCIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SHAREHOLDERS (DEFICIT) EQUITY
|
|
|
|
|
|
|
|
|
Preferred stock : Authorized unlimited
shares in 2005 and 2004, of $0 par
value; 0 shares issued and outstanding
in 2005 and 2004
|
|
|
|
|
|
|
|
|
Common stock : Authorized unlimited
shares in 2005 and 2004, of $0 par
value; 6,251,601 shares issued and
outstanding in 2005 and 2004
|
|
|
4,000,001
|
|
|
|
4,000,001
|
|
Deficit
|
|
|
(4,222,281
|
)
|
|
|
(3,365,694
|
)
|
|
|
|
|
|
|
|
TOTAL SHAREHOLDERS (DEFICIT) EQUITY
|
|
|
(222,280
|
)
|
|
|
634,307
|
|
|
|
|
|
|
|
|
|
|
$
|
10,279,910
|
|
|
$
|
11,593,180
|
|
|
|
|
|
|
|
|
See the accompanying notes to financial statements.
F-50
INSTANTEL INC.
Statements of Operations
|
|
|
|
|
|
|
|
|
|
|
For the Period Ended June 9,
|
|
|
|
2005
|
|
|
2004
|
|
|
|
|
|
|
|
(Unaudited)
|
|
Revenue
|
|
$
|
6,759,291
|
|
|
$
|
5,539,772
|
|
|
|
|
|
|
|
|
Cost of goods sold
|
|
|
3,226,520
|
|
|
|
2,315,057
|
|
|
|
|
|
|
|
|
Gross margin
|
|
|
3,532,771
|
|
|
|
3,224,715
|
|
|
|
|
|
|
|
|
|
|
Research & development
|
|
|
1,039,504
|
|
|
|
676,401
|
|
Selling
|
|
|
648,786
|
|
|
|
377,083
|
|
Marketing
|
|
|
1,091,808
|
|
|
|
509,025
|
|
Administration
|
|
|
952,401
|
|
|
|
472,152
|
|
Amortization of intangible assets
|
|
|
1,510,500
|
|
|
|
1,510,500
|
|
Interest expense
|
|
|
367,086
|
|
|
|
443,643
|
|
|
|
|
|
|
|
|
Loss from operations before income taxes
|
|
|
(2,077,314
|
)
|
|
|
(764,089
|
)
|
|
|
|
|
|
|
|
|
|
Current income taxes
|
|
|
(43,015
|
)
|
|
|
(137,973
|
)
|
Deferred income taxes
|
|
|
1,263,742
|
|
|
|
545,588
|
|
|
|
|
|
|
|
|
Net loss for the period
|
|
$
|
(856,587
|
)
|
|
$
|
(356,474
|
)
|
|
|
|
|
|
|
|
Net loss per share
|
|
$
|
(0.14
|
)
|
|
$
|
(0.06
|
)
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
|
6,251,601
|
|
|
|
6,251,601
|
|
|
|
|
|
|
|
|
See the accompanying notes to financial statements.
F-51
INSTANTEL INC.
Statements of Shareholders Equity (Deficit)
For the Period Ended June 9, 2005 and the Year Ended December 31, 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retained
|
|
|
|
|
|
|
Total
|
|
|
|
Common stock
|
|
|
Earnings
|
|
|
Accumulated other
|
|
|
Shareholders
|
|
|
|
Shares
|
|
|
Amount
|
|
|
(Deficit)
|
|
|
comprehensive loss
|
|
|
Equity
|
|
Balance December 31, 2003
|
|
|
6,251,601
|
|
|
$
|
4,000,001
|
|
|
$
|
(2,611,195
|
)
|
|
$
|
(6,698
|
)
|
|
$
|
1,382,108
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss for the year
|
|
|
|
|
|
|
|
|
|
|
(754,499
|
)
|
|
|
|
|
|
|
(754,499
|
)
|
Change in value of
interest rate swap
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
126,530
|
|
|
|
126,530
|
|
Change in fair value of
financial instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(119,832
|
)
|
|
|
(119,832
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance December 31, 2004
|
|
|
6,251,601
|
|
|
|
4,000,001
|
|
|
|
(3,365,694
|
)
|
|
|
|
|
|
|
634,307
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss for the period
|
|
|
|
|
|
|
|
|
|
|
(856,587
|
)
|
|
|
|
|
|
|
(856,587
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance June 9, 2005
|
|
|
6,251,601
|
|
|
$
|
4,000,001
|
|
|
$
|
(4,222,281
|
)
|
|
$
|
|
|
|
$
|
(222,280
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See the accompanying notes to financial statements.
F-52
INSTANTEL INC.
Statements of Cash Flows
|
|
|
|
|
|
|
|
|
|
|
For the Period Ended June 9,
|
|
|
|
2005
|
|
|
2004
|
|
|
|
|
|
|
|
(Unaudited)
|
|
OPERATING ACTIVITIES
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(856,587
|
)
|
|
$
|
(356,474
|
)
|
Items not affecting cash:
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
132,656
|
|
|
|
85,605
|
|
Provision for doubtful accounts
|
|
|
25,000
|
|
|
|
|
|
Provision for obsolete inventory
|
|
|
395,000
|
|
|
|
|
|
Amortization of intangible assets
|
|
|
1,510,500
|
|
|
|
1,510,500
|
|
Deferred income taxes
|
|
|
(1,263,742
|
)
|
|
|
(545,588
|
)
|
|
|
|
|
|
|
|
|
|
|
(57,173
|
)
|
|
|
694,043
|
|
Changes in non-cash operating working capital items
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(59,058
|
)
|
|
|
111,133
|
|
Income taxes recoverable
|
|
|
|
|
|
|
25,053
|
|
Inventories
|
|
|
(575,898
|
)
|
|
|
(198,029
|
)
|
Other current assets
|
|
|
120,354
|
|
|
|
166,291
|
|
Accounts payable
|
|
|
(433,803
|
)
|
|
|
(314,170
|
)
|
Accrued liabilities
|
|
|
357,319
|
|
|
|
95,232
|
|
Deferred revenue
|
|
|
89,000
|
|
|
|
|
|
Income taxes payable
|
|
|
(206,246
|
)
|
|
|
79,802
|
|
Salary and benefits payable
|
|
|
746,288
|
|
|
|
151,588
|
|
Other
|
|
|
|
|
|
|
(45,776
|
)
|
|
|
|
|
|
|
|
Cash (used in) provided by operating activities
|
|
|
(19,217
|
)
|
|
|
765,167
|
|
|
|
|
|
|
|
|
INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
|
Purchase of capital assets
|
|
|
(151,160
|
)
|
|
|
(67,227
|
)
|
|
|
|
|
|
|
|
Cash used in investing activities
|
|
|
(151,160
|
)
|
|
|
(67,227
|
)
|
|
|
|
|
|
|
|
FINANCING ACTIVITIES
|
|
|
|
|
|
|
|
|
Increase in bank indebtedness
|
|
|
127,565
|
|
|
|
|
|
Repayment of long term debt
|
|
|
|
|
|
|
(417,351
|
)
|
|
|
|
|
|
|
|
Cash provided by (used in) financing activities
|
|
|
127,565
|
|
|
|
(417,351
|
)
|
|
|
|
|
|
|
|
INCREASE IN CASH AND CASH EQUIVALENTS
|
|
|
(42,812
|
)
|
|
|
280,589
|
|
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
|
|
|
46,481
|
|
|
|
167,451
|
|
|
|
|
|
|
|
|
CASH AND CASH EQUIVALENTS, END OF PERIOD
|
|
$
|
3,669
|
|
|
$
|
448,040
|
|
|
|
|
|
|
|
|
Supplementary information
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
367,885
|
|
|
$
|
476,552
|
|
Income taxes paid
|
|
$
|
279,828
|
|
|
$
|
43,055
|
|
See the accompanying notes to financial statements.
F-53
1. DESCRIPTION OF THE BUSINESS
The Company is incorporated under the laws of Ontario, Canada and is engaged in the
manufacture and sale of electronic monitoring and security equipment. Instantels quality system is
certified to the ISO 9001 quality standard. The company manufactures high-quality remote monitoring
products in the areas of healthcare security and vibration monitoring for a diverse customer base.
Instantel Inc.s Xmark
®
division specializes in smart tag technology for protecting
people and assets in healthcare environments. Its Hugs
®
product line is a popular RFID
system for preventing the abduction of newborn infants in hospitals, while the
WatchMate
®
system is used in long-term care facilities to protect wander-prone
residents.
Instantel Inc. is a wholly owned subsidiary of Instantel s. àr. l.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Management responsibility
The preparation of the accompanying financial statements is the responsibility of management.
This responsibility includes the selection of appropriate accounting policies and the exercise of
careful judgment in establishing reasonable and accurate estimates in accordance with accounting
principles generally accepted in the United States of America, applied on a consistent basis and as
appropriate in the circumstances.
Cash and cash equivalents
The Company considers all highly liquid investments with an original maturity of three months
or less to be cash equivalents.
Accounts receivable
Accounts receivable are stated at the amount management expects to collect from outstanding
balances. Management provides for probable uncollected amounts through a charge to earnings and a
credit to a valuation account based on its assessment of the current status of individual accounts.
Inventories
All inventories are valued at the lower of cost or net realizable value, which includes a
related portion of overhead. Inventories are reviewed periodically to determine if an allowance for
obsolete and slow moving inventory is required.
Capital assets
Capital assets are recorded at cost less accumulated depreciation. Depreciation and
amortization are recorded on the straight-line basis, designed to amortize the respective assets
over their estimated useful lives. Application software is depreciated over twelve months,
equipment over thirty-six months and leasehold improvements over sixty months.
Expenditures for additions and improvements are capitalized; expenditures for maintenance and
repairs are charged to expense as incurred. When assets are retired or otherwise disposed of, the
cost of assets and related accumulated amortization are eliminated from the accounts and any
resulting gain or loss is reflected in the results of operations.
Goodwill and intangible assets
Goodwill is not subject to amortization but tested for impairment annually or more often if
events or changes in circumstances indicate that it might be impaired. To date, it is managements
opinion that there has been no impairment in the carrying value of goodwill. Therefore, no amount
of impairment has been charged to earnings.
Acquired trademarks, customer relationships and technology are being amortized on a
straight-line basis over a five-year period.
Intellectual property costs
Patent costs and other costs such as legal opinions and licensing fees are expensed as
incurred.
Revenue recognition
The Company sells through distribution channels and revenue is recognized at the time of
product shipment to customers and when all significant contractual obligations have been satisfied
and collection is reasonably assured.
The Company does not accept purchase orders or contracts with return clauses although it may,
at its sole discretion, choose to accept customer returns.
F-54
Accruals for potential warranty claims and estimated sales returns, if any, are made at the
time of shipment and are based on contract terms and prior claims experience.
Deferred Revenue Policy
Post contract support (PCS) revenue is recognized, ratably, over the term of the agreement,
since the selling price of the appropriate maintenance portion of the contract price can be
reasonably determined at the time of sale of the initial license.
Income taxes
Income taxes are recorded using the asset and liability method. Deferred tax assets and
liabilities are recognized for the future tax consequences attributable to differences between the
financial statement carrying amount of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the years in which the
temporary differences are expected to be recovered or settled. The measurement of deferred tax
assets is reduced, if necessary, by a valuation allowance for any tax benefits that are not
expected to be realized.
Investment tax credits
The company is entitled to investment tax credits (ITCs) based on qualifying research and
experimental development costs incurred. These credits are recognized when there is reasonable
assurance of their recovery using the income tax reduction method. The ITCs are subject to
assessment and approval by the Canada Revenue Agency. Adjustments, if any, are reflected in the
year when such assessments are received.
Financial instruments
The Companys financial instruments, including cash, short-term investments, accounts
receivable, income taxes receivable, accounts payable and accrued liabilities are carried at values
that approximate their fair values due to their relatively short maturity period. The carrying
amount of the long-term debt approximates its market value because the debt bears interest at rates
consistent with market rates for similar instruments.
Use of estimates
The preparation of financial statements in accordance with generally accepted accounting
principles requires management to make estimates and assumptions, such as allowance for doubtful
accounts and allowance for slow moving and obsolete inventory that affect the reported amounts of
assets and liabilities and disclosure of contingent liabilities at the date of the financial
statements. Actual results could differ from such estimates.
Derivative instruments and hedging activities
Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities (SFAS 133) and the corresponding amendments requires all derivatives,
whether designated in hedging relationships or not, to be recorded on the balance sheet at fair
value. If the derivative is designated in a cash-flow hedge, changes in the fair value of the
derivative will be recorded in other comprehensive income (OCI) and will be recognized in the
statement of operations when the hedged items affect earnings. See Note 10.
Foreign currency translation
Effective October 21, 2001, the US dollar became the Companys functional currency as a result
of the continued growth of the Companys business outside of Canada and the US dollar financing
raised by the Company.
Monetary assets and liabilities denominated in currencies other than US dollars are translated
at exchange rates in effect at the balance sheet date. Revenue and expense items are translated at
average rates of exchange for the period. Transaction gains or losses are included in the
determination of net earnings for the period. The Company recorded a gain of $36,866 in the current
period and (2004 $nil).
Change in company estimates
During the period ended June 9, 2005, the Company revised its policy relating to the provision
for obsolete and slow moving inventory from three years to one year. The result of this change in
estimate increased the amount of the inventory allowance in the period ended June 9, 2005 by
$188,000.
F-55
During the period ended June 9, 2005, the company changed its estimate relating to the
collectibility of its accounts receivable. As a result of this review, the Company increased its
allowance for doubtful accounts by $25,000.
3. INVENTORIES
|
|
|
|
|
|
|
|
|
|
|
June 9, 2005
|
|
|
December 31, 2004
|
|
Materials
|
|
$
|
710,320
|
|
|
$
|
809,701
|
|
Work in process
|
|
|
539,501
|
|
|
|
349,162
|
|
Finished goods.
|
|
|
461,070
|
|
|
|
371,130
|
|
|
|
|
|
|
|
|
|
|
$
|
1,710,891
|
|
|
$
|
1,529,993
|
|
|
|
|
|
|
|
|
Inventories include an allowance for obsolete inventory of $395,000 (2004 $190,000).
4. CAPITAL ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 9, 2005
|
|
|
|
|
|
|
|
Accumulated
|
|
|
Net Book
|
|
|
|
Cost
|
|
|
Amortization
|
|
|
Value
|
|
Application software
|
|
$
|
24,952
|
|
|
$
|
22,522
|
|
|
$
|
2,430
|
|
Equipment
|
|
|
860,531
|
|
|
|
400,961
|
|
|
|
459,570
|
|
Leasehold improvements
|
|
|
40,406
|
|
|
|
9,757
|
|
|
|
30,649
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
925,889
|
|
|
$
|
433,240
|
|
|
$
|
492,649
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2004
|
|
|
|
|
|
|
|
Accumulated
|
|
|
Net Book
|
|
|
|
Cost
|
|
|
Amortization
|
|
|
Value
|
|
Application software
|
|
$
|
33,393
|
|
|
$
|
23,626
|
|
|
$
|
9,767
|
|
Equipment
|
|
|
878,877
|
|
|
|
414,499
|
|
|
|
464,378
|
|
Leasehold improvements
|
|
|
57,319
|
|
|
|
57,319
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
969,589
|
|
|
$
|
495,444
|
|
|
$
|
474,145
|
|
|
|
|
|
|
|
|
|
|
|
5. INTANGIBLE ASSETS
Intangible assets consist of:
|
|
|
|
|
|
|
|
|
|
|
June 9, 2005
|
|
|
December 31, 2004
|
|
Trademarks
|
|
$
|
4,600,000
|
|
|
$
|
4,600,000
|
|
Customer relationships
|
|
|
6,200,000
|
|
|
|
6,200,000
|
|
Technology
|
|
|
6,300,000
|
|
|
|
6,300,000
|
|
|
|
|
|
|
|
|
|
|
|
17,100,000
|
|
|
|
17,100,000
|
|
|
|
|
|
|
|
|
|
|
Less accumulated amortization
|
|
|
(12,340,500
|
)
|
|
|
(10,830,000
|
)
|
|
|
|
|
|
|
|
|
|
$
|
4,759,500
|
|
|
$
|
6,270,000
|
|
|
|
|
|
|
|
|
During the period ended June 9, 2005, amortization of intangible assets in the amount of
$1,510,500 (2004 $3,420,000), was charged to earnings.
The estimated charge to earnings in the future will be $1,909,500 and $2,850,000 in the
balance of 2005 and 2006 respectively.
6. BANK LINE OF CREDIT
The Company has a bank line of credit up to a maximum of $2,000,000 bearing interest at prime
plus 1/2%. The line of credit is secured by a general security agreement representing a first
charge on all assets other than real property. The company owed $714,263 as at June 9, 2005 and
$586,697 as at December 31, 2004 under this credit facility.
F-56
7. INCOME TAXES
|
|
|
|
|
|
|
|
|
|
|
June 9, 2005
|
|
|
December 31, 2004
|
|
Income taxes payable from prior period
|
|
$
|
(328,711
|
)
|
|
$
|
(5,947
|
)
|
|
|
|
|
|
|
|
Provision for current income taxes, net of tax Credits
|
|
|
(302,484
|
)
|
|
|
(909,893
|
)
|
Provision for investment tax credits
|
|
|
246,151
|
|
|
|
392,545
|
|
Current year investment tax credits capital
|
|
|
13,268
|
|
|
|
33,732
|
|
|
|
|
|
|
|
|
|
|
|
(43,015
|
)
|
|
|
(483,616
|
)
|
Capital taxes
|
|
|
(22,000
|
)
|
|
|
(15,302
|
)
|
Installments
|
|
|
192,000
|
|
|
|
240,000
|
|
Payments and refunds
|
|
|
87,828
|
|
|
|
(66,241
|
)
|
Adjustments
|
|
|
(8,566
|
)
|
|
|
2,395
|
|
|
|
|
|
|
|
|
|
|
|
(206,247
|
)
|
|
|
(322,764
|
)
|
|
|
|
|
|
|
|
Income taxes payable
|
|
$
|
(122,464
|
)
|
|
$
|
(328,711
|
)
|
|
|
|
|
|
|
|
The tax effect of components of the deferred tax liabilities are as follows:
|
|
|
|
|
|
|
|
|
|
|
June 9, 2005
|
|
|
December 31, 2004
|
|
Deferred tax liabilities
|
|
|
|
|
|
|
|
|
Intangible assets
|
|
$
|
1,623,941
|
|
|
$
|
2,389,706
|
|
Long term debt
|
|
|
|
|
|
|
285,000
|
|
Other
|
|
|
(86,041
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,537,900
|
|
|
|
2,674,706
|
|
Deferred tax assets current portion
|
|
|
126,936
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,410,964
|
|
|
|
2,674,706
|
|
|
|
|
|
|
|
|
8. LONG-TERM DEBT
|
|
|
|
|
|
|
|
|
|
|
June 9, 2005
|
|
|
December 31, 2004
|
|
Senior subordinated note, bearing
interest at 14% per annum repayable in
twelve equal quarterly principal
installments of $458,333 beginning
December 31, 2006. Interest is payable
quarterly
|
|
$
|
5,500,000
|
|
|
$
|
5,500,000
|
|
|
|
|
|
|
|
|
|
|
Less: current portion of long term debt
|
|
|
(5,500,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
|
|
|
$
|
5,500,000
|
|
|
|
|
|
|
|
|
The full amount of the debt was guaranteed by the companys parent company Instantel (sarl).
The debt was secured by an assignment of all capital assets excluding real estate.
The full amount of the debt was extinguished from the proceeds of the sale of common shares on
June 9, 2005. See Note 13.
9. LEASE COMMITMENT
The Company rents office and manufacturing space. The Company is committed under an operating
lease for office and manufacturing space to pay monthly amounts in Canadian dollars. The payment in
U.S. dollars for the next five years will be approximately:
|
|
|
|
|
Balance of 2005
|
|
$
|
56,000
|
|
2006
|
|
|
285,000
|
|
2007
|
|
|
298,000
|
|
2008
|
|
|
304,000
|
|
2009
|
|
|
127,000
|
|
|
|
|
|
Total
|
|
$
|
1,070,000
|
|
|
|
|
|
F-57
10. FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
Interest rate risk
There is a risk to the Companys earnings that arises from fluctuation in interest rates and
the degree of volatility of these rates. To effectively manage this risk, the Company entered into
an interest rate swap contract that expired during fiscal 2004. The contract had been designated as
a hedge for reporting purposes. The Company has established strict guidelines that are monitored
regularly and does not hold or issue derivative financial instruments for trading or speculative
purposes.
Foreign exchange risk
The Companys earnings and cash flows may be negatively impacted by fluctuations in foreign
exchange rates. The exposure is primarily limited to the Canadian dollar.
11. CONTINGENCIES
The Company is involved in defending legal actions. In Managements opinion these claims are
without merit. The outcomes, however, are undetermined as to the result or the total cost of the
defense. The costs incurred are charged to the period in which they occur.
12. RELATED PARTY TRANSACTIONS
The parent company provided a guarantee, for all payments when due, to the holder of the
Senior Subordinated Promissory Note in the amount of $5,500,000. During the period ended June 9,
2005, the Company paid the parent company $55,632 (2004 $52,050) for management services and
$35,604 (2004 $33,334) for expenses incurred on the Companys behalf.
13. SUBSEQUENT EVENT
On June 10, 2005, through a sale purchase agreement, the Company became a wholly-owned
subsidiary of VeriChip Inc. The purchase price of the company was approximately US$22,500,000 paid
in cash and up to an additional $3.0 million to be paid in the future in some combination of cash,
VeriChip Corporation common stock and Applied Digital Solutions Inc. common stock, depending on
whether VeriChip Corporation completes an initial public offering of its common stock.
F-58
Exhibit Index
|
|
|
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 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)
|
|
|
|
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
|
|
Form of Specimen Common Stock Certificate
(1)
|
|
|
|
10.1*
|
|
VeriChip Corporation 2002 Flexible Stock Plan, as amended through December 21, 2006
(4)
|
|
|
|
10.2*
|
|
VeriChip Corporation 2005 Flexible Stock Plan, as amended through December 21, 2006
(4)
|
|
|
|
10.3*
|
|
Form of Restricted Stock Award Agreement
(4)
|
|
|
|
10.4*
|
|
Form of Non-Qualified Stock Option Award Agreement
(4)
|
|
|
|
10.5
|
|
Commercial Loan Agreement dated as of December 27, 2005 between VeriChip Corporation and Applied
Digital Solutions, Inc.
(1)
|
|
|
|
10.6
|
|
Revolving Line of Credit Note Working Capital of VeriChip Corporation dated as of December 27,
2005
(1)
|
|
|
|
10.7
|
|
Security Agreement dated as of December 27, 2005 between VeriChip Corporation and Applied Digital
Solutions, Inc.
(1)
|
|
|
|
10.8
|
|
First Amendment to Commercial Loan Agreement dated as of October 6, 2006 between Applied Digital
Solutions, Inc. and VeriChip Corporation
(1)
|
|
|
|
10.9
|
|
First Amendment to Security Agreement dated as of October 6, 2006 between Applied Digital
Solutions, Inc. and VeriChip Corporation
(1)
|
|
|
|
10.10
|
|
Second Amendment to Commercial Loan Agreement dated as of January 19, 2007 between Applied Digital
Solutions, Inc. and VeriChip Corporation
(1)
|
|
|
|
Exhibit
|
|
|
Number
|
|
Description
|
|
|
|
10.11
|
|
Second Amendment to Security Agreement dated as of January 19, 2007 between Applied Digital Solutions,
Inc. and VeriChip Corporation
(1)
|
|
|
|
10.12
|
|
Third Amendment to Commercial Loan Agreement dated as of February 8, 2007 between Applied Digital
Solutions, Inc. and VeriChip Corporation
(1)
|
|
|
|
10.13
|
|
Third Amended and Restated Revolving Line of Credit Note dated as of February 8, 2007 between Applied
Digital Solutions, Inc. and VeriChip Corporation
(1)
|
|
|
|
10.14
|
|
Amendment to Third Amended and Restated Revolving Line of Credit Note dated as of February 29, 2008
between VeriChip Corporation and Applied Digital Solutions, Inc.
(11)
|
|
|
|
10.15
|
|
Third Amendment to Security Agreement dated as of February 8, 2007 between Applied Digital Solutions,
Inc. and VeriChip Corporation
(1)
|
|
|
|
10.16
|
|
Fourth Amendment to Commercial Loan Agreement and Security Agreement dated as of February 13, 2007
between Applied Digital Solutions, Inc. and VeriChip Corporation
(2)
|
|
|
|
10.17
|
|
Letter Agreement dated as of April 18, 2005 between Royal Bank of Canada and EXI
Wireless Inc.
(1)
|
|
|
|
10.18
|
|
Credit Facility Agreement dated as of March 15, 2006 between VeriChip Holdings Inc. and Royal Bank of
Canada
(1)
|
|
|
|
10.19
|
|
General Security Agreement dated as of March 27, 2006 between Royal Bank of Canada and VeriChip Holdings
Inc.
(1)
|
|
|
|
10.20
|
|
Guarantee and Postponement of Claim dated as of March 27, 2006 between Royal Bank of Canada and VeriChip
Corporation, a Canadian corporation
(1)
|
|
|
|
10.21
|
|
Amended and Restated Supply, License and Development Agreement dated as of December 27, 2005 between
VeriChip Corporation and Digital Angel Corporation
(1)
|
|
|
|
10.22
|
|
First Amendment to Amended and Restated Supply, License and Development Agreement dated as of May 9,
2007 between the Registrant and Digital Angel Corporation.
(5)
|
|
|
|
10.23
|
|
Amended and Restated Transition Services Agreement dated as of December 21, 2006 between VeriChip
Corporation and Applied Digital Solutions, Inc.
(1)
|
|
|
|
10.24
|
|
Lease dated as of July 6, 1998 between Kanata Research Park Corporation and Instantel Inc.
(1)
|
|
|
|
10.25
|
|
Agreement regarding Lease dated as of September 30, 1999 between Kanata Research Park Corporation and
Instantel Inc.
(1)
|
|
|
|
10.26
|
|
Agreement regarding Lease dated as of October 5, 1999 between Kanata Research Park Corporation and
Instantel Inc.
(1)
|
|
|
|
10.27
|
|
Amendment to Lease dated as of October 28, 2003 between Kanata Research Park Corporation and Instantel
Inc.
(1)
|
|
|
|
10.28
|
|
Second Amendment to Lease dated as of May 19, 2006 between Kanata Research Park Corporation and VeriChip
Corporation
(1)
|
|
|
|
10.29
|
|
Lease dated as of August 16, 2000 between Princeton Developments Ltd., Gratrend Holdings Ltd. and
Software Integration Services Ltd.
(1)
|
|
|
|
10.30
|
|
Lease Agreement dated as of December 18, 2000 between Bentall Properties Ltd., Westminster Management
and EXI Wireless Systems Inc.
(1)
|
|
|
|
10.31
|
|
Lease Extension and Amending Agreement dated as of June 1, 2004 between BTC Properties II Ltd.,
Westminster Management Corporation and EXI Wireless Systems Inc.
(1)
|
|
|
|
10.32
|
|
Strategic Alliance Agreement dated as of October 25, 2004 by and among Agility Healthcare Solutions LLC,
Trenstar Inc. and VeriChip Inc.
(1)
|
|
|
|
10.33
|
|
Patient Security Systems Capital Equipment Supplier Agreement dated as of April 18, 2005 between
Novation, LLC and EXI Wireless Systems, Inc.
(1)
|
|
|
|
Exhibit
|
|
|
Number
|
|
Description
|
|
|
|
10.34*
|
|
Letter Agreement dated as of August 11, 2005 between VeriChip Corporation and Daniel A.
Gunther
(1)
|
|
|
|
10.35*
|
|
Amendment to Letter Agreement dated as of March 2, 2007 between VeriChip Corporation and Daniel A.
Gunther
(3)
|
|
|
|
10.36*
|
|
Executive Agreement dated as of December 17, 2001 between EXI Wireless Inc. and Nurez
Khimji
(1)
|
|
|
|
10.37*
|
|
Amendment to Executive Agreement dated as of April 29, 2004 between VeriChip Inc. and Nurez
Khimji
(1)
|
|
|
|
10.38*
|
|
Executive Agreement Addendum dated as of April 1, 2005 between VeriChip Inc. and Nurez
Khimji
(1)
|
|
|
|
10.39
|
|
VeriChip Authorized Dealer Agreement dated as of January 4, 2006, by and between VeriChip Corporation
and Ingersoll Rand Security Technologies
(1)
|
|
|
|
10.40
|
|
Trademark Assignment Agreement dated as of December 21, 2006 between Applied Digital Solutions, Inc. and
VeriChip Corporation
(1)
|
|
|
|
10.41*
|
|
Letter Agreement dated as of August 2, 2006 between VeriChip Corporation and William J.
Caragol
(1)
|
|
|
|
10.42*
|
|
2007 Senior Management Incentive Plan for Daniel A. Gunther dated as of March 2, 2007
(3)
|
|
|
|
10.43
|
|
2006 Tax Allocation Agreement dated as of December 21, 2006 between VeriChip Corporation, Applied
Digital Solutions, Inc. and the Consolidated Group
(4)
|
|
|
|
10.44*
|
|
Employment and Non-Compete Agreement dated as of December 5, 2006 between Scott R. Silverman and
VeriChip Corporation
(1)
|
|
|
|
10.45
|
|
BI Patent License Agreement dated as of March 6, 2000 between BI Incorporated and Instantel
Inc.
(1)
|
|
|
|
10.46
|
|
Amendment No. 1 to BI Patent License Agreement dated as of March 6, 2000 between BI Incorporated and
Instantel Inc.
(1)
|
|
|
|
10.47*
|
|
VeriChip Corporation Executive Management Change in Control Plan dated March 2, 2007
(3)
|
|
|
|
10.48*
|
|
VeriChip Corporation Executive Management Incentive Plan dated April 2, 2007
(4)
|
|
|
|
10.49*
|
|
VeriChip Corporation 2007 Incentive Stock Plan
(6)
|
|
|
|
10.50*
|
|
Form of Non-Qualified Option Award Agreement under the VeriChip Corporation 2007 Stock Incentive
Plan
(7)
|
|
|
|
10.51
|
|
Consulting Agreement dated as of August 8, 2007 between VeriChip Corporation and Randolph K.
Geissler
(7)
|
|
|
|
10.52
|
|
Registration Rights Agreement between VeriChip Corporation and Kallina Corporation, dated August 31,
2007
(8)
|
|
|
|
10.53*
|
|
Form of Stock Award Agreement
(9)
|
|
|
|
10.54
|
|
Letter Agreement, dated December 20, 2007, between VeriChip Corporation and Applied Digital Solutions,
Inc.
(10)
|
|
|
|
10.55
|
|
Securities Purchase Agreement dated as of February 29, 2008 among VeriChip Corporation, Xmark
Corporation, Valens Offshore SPV II, Corp. and LV Administrative Services, Inc.
(11)
|
|
|
|
10.56
|
|
Secured Term Note dated as of February 29, 2008 by VeriChip Corporation and Xmark Corporation in favor
of Valens Offshore SPV II, Corp.
(11)
|
|
|
|
10.57
|
|
Master Security Agreement dated as of February 29, 2008 among VeriChip Corporation, Xmark Corporation
and LV Administrative Services, Inc.
(11)
|
|
|
|
10.58
|
|
Stock Pledge Agreement dated as of February 29, 2008 among VeriChip Corporation, Xmark Corporation and
LV Administrative Services, Inc.
(11)
|
|
|
|
10.59
|
|
Intellectual Property Security Agreement dated as of February 29, 2008 among VeriChip Corporation, Xmark
Corporation and LV Administrative Services, Inc.
(11)
|
|
|
|
Exhibit
|
|
|
Number
|
|
Description
|
|
|
|
10.60
|
|
Letter Agreement dated as of February 29, 2008 between VeriChip Corporation and Applied Digital
Solutions,
Inc.
(11)
|
|
|
|
21.1
|
|
List of Subsidiaries of VeriChip Corporation
|
|
|
|
23.1
|
|
Consent of Eisner LLP
|
|
|
|
23.2
|
|
Consent of KPMG LLP
|
|
|
|
23.3
|
|
Consent of Meyers Norris Penny LLP
|
|
|
|
24.1
|
|
Powers of Attorney
|
|
|
|
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
|
|
|
|
(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 Form 8-K previously filed by VeriChip Corporation on
February 15, 2007.
|
|
(3)
|
|
Incorporated by reference to the Form 8-K previously filed by VeriChip Corporation on March 8,
2007.
|
|
(4)
|
|
Incorporated by reference to the Annual Report on Form 10-K previously filed by VeriChip
Corporation on April 2, 2007.
|
|
(5)
|
|
Incorporated by reference to the Quarterly Report on Form 10-Q previously filed by VeriChip
Corporation on May 15, 2007.
|
|
(6)
|
|
Incorporated by reference to the Form 8-K previously filed by VeriChip Corporation on June 20,
2007.
|
|
(7)
|
|
Incorporated by reference to the Quarterly Report on Form 10-Q previously filed by VeriChip
Corporation on August 8, 2007.
|
|
(8)
|
|
Incorporated by reference to the Form 8-K previously filed by VeriChip Corporation on September
7, 2007.
|
|
(9)
|
|
Incorporated by reference to the Quarterly Report on Form 10-Q previously filed by VeriChip
Corporation on November 8, 2007.
|
|
(10)
|
|
Incorporated by reference to the Form 8-K previously filed by VeriChip Corporation on December
21, 2007.
|
|
(11)
|
|
Incorporated by reference to the Form 8-K previously filed by VeriChip Corporation on March 5,
2008.
|
|
*
|
|
Management contract or compensatory plan.
|
|
|
|
Confidential treatment has been obtained with respect to certain
portions of this exhibit. Omitted portions have been filed separately
with the Securities and Exchange Commission.
|
Verichip (MM) (NASDAQ:CHIP)
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