UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
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þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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For the quarterly period ended September 30, 2008
or
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o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the transition period from
to
Commission File Number: 001-33297
VERICHIP CORPORATION
(Exact name of registrant as specified in its charter)
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DELAWARE
(State or other jurisdiction of incorporation or
organization)
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06-1637809
(I.R.S. Employer Identification No.)
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1690 South Congress Avenue, Suite 200
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Delray Beach, Florida 33445
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(Address of principal executive offices,
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(561) 805-8008
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including zip code)
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(Registrants telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes
þ
No
o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act.
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Large accelerated filer
o
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Accelerated filer
o
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Non-accelerated filer
þ
(Do not check if smaller reporting company)
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Smaller reporting company
o
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act).
Yes
o
No
þ
The number of shares outstanding of each of the issuers classes of common stock as of the
close of business on November 3, 2008 is as follows:
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Class
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Number of Shares
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Common Stock: $0.01 Par Value
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11,730,209
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VERICHIP CORPORATION
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
Item 1. Financial Statements.
VERICHIP CORPORATION
Condensed Consolidated Balance Sheets
(In thousands, except par value)
(Unaudited)
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September 30,
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December 31,
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2008
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2007
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Assets
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Current Assets:
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Cash
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$
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4,847
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$
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7,221
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Restricted cash
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4,520
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Accounts receivable
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47
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Inventories, net of allowance
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52
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95
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Prepaid expenses and other current assets
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270
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953
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Current assets from discontinued operations
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8,202
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Total Current Assets
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9,689
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16,518
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Equipment, net of accumulated depreciation
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39
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112
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Other assets from discontinued operations
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33,368
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$
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9,728
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$
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49,998
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Liabilities and Stockholders Equity
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Current Liabilities:
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Accounts payable
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$
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131
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$
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338
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Accrued expenses and other current liabilities
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425
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583
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Deferred revenue
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17
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49
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Deferred gain
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4,500
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Note payable to stockholder, current portion
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2,167
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Current liabilities from discontinued operations
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475
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6,708
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Total Current Liabilities
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5,548
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9,845
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Note payable to stockholder, less current portion
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10,753
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Other liabilities of discontinued operations
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3,809
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Total Liabilities
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$
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5,548
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24,407
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Stockholders Equity:
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Capital stock:
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Preferred stock:
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Authorized 5,000 shares of $.001 par value; no shares issued or
outstanding
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Common stock:
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Authorized 40,000 shares, of $.01 par value; issued and
outstanding 11,730 and 10,144 shares at September 30, 2008 and
December 31, 2007, respectively
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117
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101
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Additional paid-in capital
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44,389
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54,486
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Accumulated deficit
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(40,326
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)
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(28,959
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Accumulated other comprehensive loss foreign currency translation
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(37
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)
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Total Stockholders Equity
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4,180
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25,591
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$
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9,728
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$
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49,998
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See notes to condensed consolidated financial statements.
2
VERICHIP CORPORATION
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(unaudited)
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For the Three Months
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For the Nine Months
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Ended September 30,
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Ended September 30,
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2008
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2007
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2008
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2007
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Revenue
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$
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6
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$
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53
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$
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41
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$
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54
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Cost of goods sold
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15
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61
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15
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Gross (loss) profit
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6
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38
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(20
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)
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39
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Operating expenses:
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Selling, general and administrative
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11,924
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3,588
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18,668
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9,166
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Research and development
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8
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212
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106
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Total operating expenses
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11,924
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3,596
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18,880
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9,272
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Operating loss
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(11,918
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)
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(3,558
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)
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(18,900
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)
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(9,233
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)
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Interest (income) and other expense, net
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(610
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)
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(78
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)
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370
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(240
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)
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Interest expense
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40
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368
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879
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1,104
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Gain on sale
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(6,174
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)
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(6,174
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)
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Gain on settlement of debt
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(1,823
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)
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(1,823
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)
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Total other (income) expense
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(8,567
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)
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290
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(6,748
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)
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864
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Loss before income tax provision
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(3,351
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)
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(3,848
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)
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(12,152
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)
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(10,097
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)
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Provision for income taxes
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1
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2
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1
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Loss from continuing operations
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(3,351
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)
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(3,849
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)
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(12,154
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)
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(10,098
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)
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Net (loss) income from discontinued
operations (net of tax (benefit) expense of
$(58), $100, $233 and $145)
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(1,966
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)
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626
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787
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983
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Net loss
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$
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(5,317
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)
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$
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(3,223
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)
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$
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(11,367
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)
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$
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(9,115
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)
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Net loss per common share from continuing
operations
basic and diluted
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$
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(0.30
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)
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$
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(0.41
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)
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$
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(1.19
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)
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$
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(1.19
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)
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Net (loss) income per common share from
discontinued operations basic and diluted
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(0.18
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)
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0.06
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0.08
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0.11
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Net loss per common share basic and diluted
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$
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(0.48
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)
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$
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(0.35
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)
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$
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(1.11
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)
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$
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(1.08
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)
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Weighted average number of shares
outstanding basic and diluted
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11,233
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9,323
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10,217
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8,479
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See notes to condensed consolidated financial statements.
3
VERICHIP CORPORATION
Condensed Consolidated Statement of Stockholders Equity
For the Nine Months Ended September 30, 2008
(In thousands)
(Unaudited)
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Additional
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Total
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Common Shares
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Paid-in
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Accumulated
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Stockholders
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Number
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Amount
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Capital
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Deficit
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Other
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Equity
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Balance December 31, 2007
|
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10,144
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|
$
|
101
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$
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54,486
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|
$
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(28,959
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)
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|
$
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(37
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)
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|
$
|
25,591
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|
Net loss
|
|
|
|
|
|
|
|
|
|
|
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|
|
|
(11,367
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)
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|
|
|
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(11,367
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)
|
Stock based compensation
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|
622
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|
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|
6
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5,005
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5,011
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|
Issuance of shares to lender
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120
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2
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|
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|
300
|
|
|
|
|
|
|
|
|
|
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|
302
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|
Issuance of shares from
option exercises
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|
844
|
|
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|
8
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|
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|
434
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|
|
|
|
|
|
|
|
|
|
|
442
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|
Issuance of dividend to
shareholders
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|
|
|
|
|
|
|
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|
(15,836
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)
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|
|
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|
|
|
|
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(15,836
|
)
|
Sale of Xmark Corporation
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|
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|
|
|
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|
37
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|
|
|
37
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance September 30, 2008
|
|
|
11,730
|
|
|
$
|
117
|
|
|
$
|
44,389
|
|
|
$
|
(40,326
|
)
|
|
$
|
(
|
)
|
|
$
|
4,180
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See notes to condensed consolidated financial statements.
4
VERICHIP CORPORATION
Condensed Consolidated Statements of Cash Flows
(In thousands)
(unaudited)
|
|
|
|
|
|
|
|
|
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|
For the Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(11,367
|
)
|
|
$
|
(9,115
|
)
|
Adjustments to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
43
|
|
|
|
484
|
|
Stock based compensation
|
|
|
5,011
|
|
|
|
2,600
|
|
Asset impairment
|
|
|
110
|
|
|
|
|
|
Non cash interest income
|
|
|
(20
|
)
|
|
|
|
|
Gain on settlement of debt
|
|
|
(1,823
|
)
|
|
|
|
|
Gain on sale of Xmark Corporation
|
|
|
(6,174
|
)
|
|
|
|
|
Accrued interest
|
|
|
|
|
|
|
1,106
|
|
Allowance for inventory excess
|
|
|
|
|
|
|
396
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Decrease (increase) in accounts receivable
|
|
|
32
|
|
|
|
(35
|
)
|
Increase in inventories
|
|
|
(9
|
)
|
|
|
(404
|
)
|
Increase (decrease) in prepaid expenses and other current assets
|
|
|
349
|
|
|
|
(378
|
)
|
Decrease (increase) in accounts payable and accrued expenses
|
|
|
(356
|
)
|
|
|
32
|
|
|
|
|
|
|
|
|
Net cash used in continuing operations
|
|
|
(14,204
|
)
|
|
|
(5,314
|
)
|
|
|
|
|
|
|
|
Net cash (used in) provided by discontinued operations
|
|
|
(2,872
|
)
|
|
|
277
|
|
|
|
|
|
|
|
|
Net cash used in operating activities
|
|
|
(17,076
|
)
|
|
|
(5,037
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Sale of Xmark Corporation
|
|
|
47,863
|
|
|
|
|
|
Restricted cash
|
|
|
(4,500
|
)
|
|
|
|
|
Payments for equipment
|
|
|
(14
|
)
|
|
|
(474
|
)
|
Net cash (used in) provided by discontinued operations
|
|
|
(114
|
)
|
|
|
42
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) investing activities
|
|
|
43,235
|
|
|
|
(432
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
Short-term borrowing
|
|
|
8,000
|
|
|
|
|
|
Repayment of short-term borrowing
|
|
|
(8,000
|
)
|
|
|
|
|
Financing costs
|
|
|
(701
|
)
|
|
|
|
|
Principal payments to stockholder
|
|
|
(10,423
|
)
|
|
|
(3,500
|
)
|
Guarantee fee paid to stockholder
|
|
|
(500
|
)
|
|
|
|
|
Borrowings from stockholder
|
|
|
|
|
|
|
1,293
|
|
Initial public offering costs
|
|
|
|
|
|
|
(2,879
|
)
|
Issuance of
common shares from the exercise of stock options
|
|
|
442
|
|
|
|
291
|
|
Proceeds from initial public offering, net of underwriter fees
|
|
|
|
|
|
|
18,336
|
|
Payment of dividend
|
|
|
(15,836
|
)
|
|
|
|
|
Net cash (used in) provided by discontinued operations
|
|
|
(1,515
|
)
|
|
|
612
|
|
|
|
|
|
|
|
|
Net cash (used in) provided by financing activities
|
|
|
(28,533
|
)
|
|
|
14,153
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (decrease) increase in cash
|
|
|
(2,374
|
)
|
|
|
8,684
|
|
Cash, beginning of period
|
|
|
7,221
|
|
|
|
996
|
|
|
|
|
|
|
|
|
Cash, end of period
|
|
$
|
4,847
|
|
|
$
|
9,680
|
|
|
|
|
|
|
|
|
See notes to condensed consolidated financial statements.
5
1. Business and Basis of Presentation
VeriChip Corporation (the Company, Registrant, us, we, or our) 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. On January 1, 2008, the
Companys wholly-owned subsidiaries, VeriChip Holdings Inc., or VHI, and Xmark Corporation, or
Xmark, were amalgamated with Xmark surviving. As of September 30, 2008, Digital Angel Corporation,
formerly known as Applied Digital Solutions, Inc. (Digital Angel), owned 45.7% of the Companys
common stock.
On May 15, 2008, the Company entered into a stock purchase agreement with The Stanley Works to
sell all of the outstanding capital stock of Xmark for $45 million cash, to be adjusted based on
Xmarks closing balance sheet. The Xmark business includes all of the operations of the previously
reported healthcare security and industrial segments. On July 18, 2008, pursuant to the terms of
the stock purchase agreement, the Company completed the sale of all of the outstanding capital
stock of Xmark to Stanley Canada Corporation, a wholly-owned subsidiary of The Stanley Works
(Stanley Canada), for $47.9 million in cash, which consisted of the $45 million purchase price
plus a balance sheet adjustment of approximately $2.9 million. Under the terms of the stock
purchase agreement, $4.5 million of the proceeds will be held in escrow for a period of 12 months
to provide for indemnification obligations under the stock purchase agreement, if any. As result,
the Company recorded a gain on the sale of Xmark of $6.2 million, with $4.5 million of that gain
deferred until the escrow is settled. The financial position, results of operations and cash flows
of Xmark have been reclassified as discontinued operations in all periods presented.
Following the completion of the sale of Xmark to Stanley Canada, the Company retired all of
its outstanding debt for a combined payment of $13.5 million and settled all contractual payments
to officers and management of the Company and Xmark of $9.1 million.
The accompanying unaudited condensed consolidated financial statements of the Company and its
subsidiaries as of September 30, 2008 and December 31, 2007 (the December 31, 2007, financial
information included in this report has been extracted from our audited financial statements
included in our Annual Report on Form 10-K, as amended, for the year ended December 31, 2007), and
for the three and nine months ended September 30, 2008 and 2007 have been prepared in accordance
with United States (U.S.) generally accepted accounting principles (GAAP) for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation S-X under the
Securities Exchange Act of 1934. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the U.S. for complete financial
statements. In the opinion of our management, all adjustments (including normal recurring
adjustments) considered necessary to present fairly the unaudited condensed consolidated financial
statements have been made. As a result of the Companys sale of Xmark, the financial position,
results of operations and cash flows of Xmark presented in the December 31, 2007 and September 30,
2007 periods have been presented as discontinued operations for comparative purposes (see
Discontinued Operations).
The preparation of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the financial statements and the reported
amounts of sales and expenses during the reporting period. Actual results could differ from those
estimates. Included in these estimates are assumptions about allowances for excess inventory, bad
debt reserves, lives of long lived assets, lives of intangible assets, assumptions used in
Black-Scholes valuation models, estimates of the fair value of acquired assets and assumed
liabilities, the determination of whether any impairment is to be recognized on goodwill or
intangibles, among others.
The unaudited condensed consolidated statements of operations for the three and nine months
ended September 30, 2008 and 2007 are not necessarily indicative of the results that may be
expected for the entire year. These statements should be read in conjunction with the consolidated
financial statements and related notes thereto included in our Annual Report on Form 10-K, as
amended, for the year ended December 31, 2007.
6
The Company develops, markets and sells radio frequency identification, frequently referred to
as RFID, systems used for the identification of people in the healthcare market. As a result of the
Companys sale of its subsidiary, Xmark, the Company now operates in a single segment focused on
the Companys VeriMed Health Link system, formerly known as the VeriMed patient identification
system, which uses an implantable passive RFID microchip that is used in patient identification
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 Health Link system for use in medical applications in the United
States.
Prior to November 12, 2008, the Company obtained 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 9, Related Party Transactions. The technology underlying these
systems was covered, in part, by U.S. Patent No. 5,211,129 Syringe-Implantable Identification
Transponders, which expired in April 2008. 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 two companies. The rights licensed to those
two companies 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. Through September 30, 2008, no intellectual property claims against the Company
have been asserted (see Note 7 Unasserted Claim Potential Intellectual Property Conflict and
Note 9 Related Party Transactions).
As discussed in Note 11, the Supply Agreement with Digital Angel was terminated on November
12, 2008.
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 25, and related interpretations and
provided the disclosure-only provisions of FAS 123. Under the intrinsic value method, no
stock-based compensation had been recognized in our consolidated statement of operations for
options granted to the Companys employees and directors because the exercise price of such stock
options equaled or exceeded the fair market value of the underlying stock on the dates of grant.
We recorded compensation expense, related to stock options, of approximately $0.9 million and
$1.1 million for the three and nine months ended September 30, 2008, respectively, and
approximately $0.1 million and $0.3 million in the three and nine months ended September 30, 2007,
respectively.
In December 2006, the Company issued 0.5 million shares of its restricted common stock to
Scott R. Silverman, its then chairman and chief executive officer, who has since been reappointed
as chairman, which shares were subject to forfeiture in the event that Mr. Silverman terminated his
employment or the Company terminated his employment for cause on or before December 31, 2008. As a
result of a separation agreement entered into between the Company and Mr. Silverman, dated May 15,
2008, Mr. Silvermans restricted stock vested on the closing of the sale of Xmark. The Company
determined the value of the stock to be $4.5 million based on the estimated value of its common
stock on the date of grant. The value of the restricted stock was being amortized as compensation
expense over the vesting period. As a result of the sale of Xmark on July 18, 2008, a charge of
$2.2 million was recorded for the remaining unvested cost of these restricted shares. The Company
recorded compensation expense of approximately $1.1 million and $2.2 million in the three and nine
months ended September 30, 2008, respectively, associated with the restricted stock.
In March 2007, the Company issued 0.1 million shares of its restricted common stock to two
officers, half of which grant was terminated on April 28, 2008 and half of which grant was to vest
on March 2, 2009, but instead vested on the closing of the sale of Xmark. The Company determined
the value of the stock to be $0.6 million based on the value of its common stock on the date of
grant. The value of the outstanding restricted stock was being amortized as compensation expense
over the vesting period. As a result of the sale of Xmark on July 18, 2008, the remaining unvested
cost of these restricted shares was recorded in July 2008. The Company recorded compensation
expense of approximately $0.1 million and $0.2 million in the three and nine months ended September
30, 2008, respectively, associated with this restricted stock.
7
In January, February, and May 2008, the Company issued 0.7 million shares of its restricted
common stock to certain employees and members of the board of directors. One grant of 50,000 shares
of restricted stock was terminated on April 28, 2008 and the remaining balance of the restricted
stock fully vested upon the closing of the Xmark transaction. The Company determined the value of
the stock to be $1.2 million based on the value of its common stock on the dates of grant. The
value of the outstanding restricted stock was being amortized as compensation expense over the
vesting period. As a result of the sale of Xmark on July 18, 2008, the remaining unvested cost of
these restricted shares was recorded in July 2008. The Company recorded compensation expense of
approximately $1.1 million and $1.5 million in the three and nine months ended September 30, 2008
associated with this restricted stock.
Stock-based compensation expense of $5.0 million and $2.6 million for the nine months ended
September 30, 2008 and 2007, respectively, is reflected in the condensed consolidated statement of
operations in selling, general and administrative expense.
2. Inventories
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
Finished goods
|
|
$
|
52
|
|
|
$
|
160
|
|
Allowance for excess and obsolescence
|
|
|
|
|
|
|
(65
|
)
|
|
|
$
|
52
|
|
|
$
|
95
|
|
3. Financing Agreements
$8.0 Million Debt Financing
On February 29, 2008, the Company entered into 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 accrued interest at a rate of 12% per annum, and had a maturity date of March 31,
2009. The terms of the Note allowed for optional redemption by paying 100% of the principal amount
plus $120,000, if such amounts were paid prior to the six month anniversary of February 29, 2008,
or $240,000, if such amounts were 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 was to be amortized over the period of the Note. As a
result of the repayment of this debt on July 18, 2008, the unamortized cost of $0.5 million of this issuance was
expensed in July 2008.
The Note also contained 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 were subordinated in right of payment and
priority to the payment in full due to the Lender by the Company.
The Company used part of the proceeds of the Note with the Lender to prepay $5.3 million of
debt owed to Digital Angel under the loan agreement. See Note 9,
Related Party Transactions to our condensed consolidated
financial statements for more information. The Company paid $8.2 million to the Lender to satisfy the Note, which
included a prepayment fee of $120,000. The result of this settlement included a $0.7 million
charge on debt settlement. As a result of the satisfaction of the Note, the Lender released all of
its security interests in the assets of the Company.
8
4. 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 of September 30, 2008, Digital Angel owned approximately 45.7% of
the Companys common stock.
On August 8, 2008 the board of directors of the Company approved a special dividend of $1.35
per common share to stockholders of record as of August 18, 2008. The total amount of the dividend
paid on August 28, 2008 was $15.8 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 2.0 million. As of September 30,
2008, 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 0.5 million of the
options or shares granted were outstanding as of September 30, 2008. As a result of the sale of
Xmark, all options are fully vested and expire up to nine years from the vesting date. As of
September 30, 2008, no SARs have been granted and 72,136 shares may still be granted under the
VeriChip 2002 Plan.
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 0.3 million. As of September 30,
2008, approximately 0.3 million options have been granted under the VeriChip 2005 Plan and
0.2 million of the options were outstanding. As a result of the sale of Xmark, all of the options
are fully vested and expire up to nine years from the vesting date. As of September 30, 2008, 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, restricted shares,
SARs or performance shares may be granted is 1.0 million. As of September 30, 2008, approximately
0.9 million options and shares have been granted under the VeriChip 2007 Plan. As of September 30,
2008, no SARs have been granted and approximately 145,000 shares may still be granted under the
VeriChip 2007 Plan.
In addition, as of September 30, 2008, options exercisable for approximately 0.4 million
shares of the Companys common stock have been granted outside of the Companys plans. These
options were granted at exercise prices ranging from $0.23 to $8.55 per share, are fully vested and
are exercisable for a period of up to seven years.
In the nine months ended September 30, 2008, 25,000 options and 0.7 million restricted shares
were granted under the VeriChip 2007 Plan. In the nine months ended September 30, 2008, no options
were granted under the VeriChip 2002 Plan or the VeriChip 2005 Plan. In the nine months ended
September 30, 2007, 0.1 million and 0.2 million options were granted under the 2002 and 2005
VeriChip Plan, respectively.
9
A summary of option activity under our option plans as of September 30, 2008, and changes
during the nine months then ended is presented below (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
Number of
|
|
|
Exercise Price Per
|
|
|
|
Options
|
|
|
Share
|
|
Outstanding on January 1, 2008
|
|
|
1,963
|
|
|
$
|
3.26
|
|
Granted
|
|
|
25
|
|
|
|
.94
|
|
Exercised
|
|
|
(844
|
)
|
|
|
.54
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding on September 30, 2008
|
|
|
1,144
|
|
|
|
5.24
|
|
|
|
|
|
|
|
|
|
Vested at September 30, 2008
|
|
|
1,144
|
|
|
|
5.24
|
|
|
|
|
|
|
|
|
|
Exercisable on September 30, 2008
(1)
|
|
|
1,144
|
|
|
|
5.24
|
|
Shares available on September 30, 2008 for options
and common shares that may be granted
|
|
|
212
|
|
|
|
|
|
|
|
|
(1)
|
|
The intrinsic value of a stock option is the amount by which the fair value of the
underlying stock exceeds the exercise price of the option. Based upon the Companys
closing price on the NASDAQ, the fair value of the underlying stock was $0.35 at
September 30, 2008. As of September 30, 2008, there is no intrinsic value for
outstanding options.
|
The following table summarizes information about stock options at September 30, 2008 (in
thousands, except weighted-average amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding Stock Options
|
|
|
Exercisable Stock Options
|
|
|
|
|
|
|
|
Weighted-
|
|
|
Weighted-
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
Remaining
|
|
|
Exercise
|
|
|
|
|
|
|
Exercise
|
|
Range of
|
|
|
|
|
|
Contractual
|
|
|
Price Per
|
|
|
|
|
|
|
Price Per
|
|
Exercise Prices
|
|
Shares
|
|
|
Life (years)
|
|
|
Share
|
|
|
Shares
|
|
|
Share
|
|
$0.0000 to $2.0250
|
|
|
268
|
|
|
|
2.6
|
|
|
$
|
0.41
|
|
|
|
268
|
|
|
$
|
0.41
|
|
$4.0501 to $6.0750
|
|
|
436
|
|
|
|
8.0
|
|
|
|
5.65
|
|
|
|
436
|
|
|
|
5.65
|
|
$6.0751 to $8.1000
|
|
|
328
|
|
|
|
5.1
|
|
|
|
7.09
|
|
|
|
328
|
|
|
|
7.09
|
|
$8.1001 to $10.1250
|
|
|
106
|
|
|
|
6.3
|
|
|
|
9.23
|
|
|
|
106
|
|
|
|
9.23
|
|
$18.2251 to $20.2500
|
|
|
6
|
|
|
|
4.3
|
|
|
|
20.25
|
|
|
|
6
|
|
|
|
20.25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,144
|
|
|
|
5.8
|
|
|
$
|
5.24
|
|
|
|
1,144
|
|
|
$
|
5.24
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The weighted average per share fair value of grants made in the nine months ended September
30, 2008 and 2007 for the Companys incentive plans was $.94 and
$2.98, respectively. The intrinsic value of the options exercised in
the nine months ended September 30, 2008 was $1.1 million.
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.
10
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:
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Expected dividend yield
|
|
|
|
|
|
|
|
|
Expected stock price volatility
|
|
|
50
|
%
|
|
|
50
|
%
|
Risk-free interest rate
|
|
|
2.58
|
%
|
|
|
4.51
|
%
|
Expected term (in years)
|
|
|
6.0
|
|
|
|
6.0
|
|
The Companys computation of expected life was determined based on the simplified method. The
interest rate was 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.
5. Discontinued Operations
On July 18, 2008, pursuant to the terms of the stock purchase agreement between the Company
and The Stanley Works, the Company completed the sale of all of the outstanding capital stock of
Xmark to Stanley Canada for approximately $47.9 million in cash, which consists of the $45 million
purchase price plus a balance sheet adjustment of approximately $2.9 million. Under the terms of
the stock purchase agreement, $4.5 million of the proceeds will be held in escrow for a period of
12 months to provide for indemnification obligations under the stock purchase agreement, if any.
As a result of the sale of Xmark, the financial condition, results of operations and cash
flows of Xmark have been reported as discontinued operations in our financial statements and prior
period information has been reclassified accordingly.
The condensed results of operations of the Companys discontinued operations for the three
months ended September 30, 2008 (which include the operations of Xmark through July 18, 2008) and
September 30, 2007 were comprised of the following:
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Three Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(in thousands)
|
|
Revenue
|
|
$
|
1,700
|
|
|
$
|
7,863
|
|
Cost of sales
|
|
|
727
|
|
|
|
3,364
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
973
|
|
|
|
4,499
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative expenses
|
|
|
2,726
|
|
|
|
2,504
|
|
Research and development expenses
|
|
|
254
|
|
|
|
1,134
|
|
Interest and other income
|
|
|
17
|
|
|
|
115
|
|
Interest expense
|
|
|
|
|
|
|
20
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income before income taxes
|
|
|
(2,024
|
)
|
|
|
726
|
|
|
|
|
|
|
|
|
|
|
(Benefit) provision for income taxes
|
|
|
(58
|
)
|
|
|
100
|
|
|
|
|
|
|
|
|
|
|
(Loss) income from discontinued operations
|
|
$
|
(1,966
|
)
|
|
$
|
626
|
|
|
|
|
|
|
|
|
11
The condensed results of operations of the Companys discontinued operations for the nine
months ended September 30, 2008 (which include the operations of Xmark through July 18, 2008) and
September 30, 2007 were comprised of the following:
|
|
|
|
|
|
|
|
|
|
|
Nine Months
|
|
|
Nine Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(in thousands)
|
|
Revenue
|
|
$
|
20,002
|
|
|
$
|
23,425
|
|
Cost of sales
|
|
|
8,289
|
|
|
|
10,834
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
11,713
|
|
|
|
12,591
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative expenses
|
|
|
9,093
|
|
|
|
7,667
|
|
Research and development expenses
|
|
|
2,277
|
|
|
|
3,398
|
|
Other (income) expense
|
|
|
(650
|
)
|
|
|
360
|
|
|
|
|
|
|
|
|
|
|
Interest expense (income)
|
|
|
(27
|
)
|
|
|
38
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
1,020
|
|
|
|
1,128
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes
|
|
|
233
|
|
|
|
145
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from discontinued operations
|
|
$
|
787
|
|
|
$
|
983
|
|
|
|
|
|
|
|
|
12
The condensed balance sheets of the Companys discontinued operations as of September 30, 2008
and December 31, 2007 were comprised of the following:
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
|
(in thousands)
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
|
|
|
$
|
|
|
Accounts receivable
|
|
|
|
|
|
|
5,391
|
|
Deferred tax asset
|
|
|
|
|
|
|
216
|
|
Inventory
|
|
|
|
|
|
|
2,247
|
|
Other current assets
|
|
|
|
|
|
|
348
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
|
|
|
|
8,202
|
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
|
|
|
|
|
840
|
|
Intangibles, net
|
|
|
|
|
|
|
16,752
|
|
Goodwill
|
|
|
|
|
|
|
15,776
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
|
|
|
$
|
41,570
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Line of credit
|
|
$
|
|
|
|
$
|
1,515
|
|
Accounts payable
|
|
|
|
|
|
|
1,517
|
|
Accrued expenses and other current liabilities
|
|
|
75
|
|
|
|
3,120
|
|
Income taxes payable
|
|
|
400
|
|
|
|
300
|
|
Deferred revenue
|
|
|
|
|
|
|
256
|
|
Total current liabilities
|
|
|
475
|
|
|
|
6,708
|
|
|
|
|
|
|
|
|
|
|
Deferred taxes
|
|
|
|
|
|
|
3,809
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
475
|
|
|
|
10,517
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (liabilities) assets from discontinued operations
|
|
$
|
(475
|
)
|
|
$
|
31,053
|
|
|
|
|
|
|
|
|
13
6. Income Taxes
We had no effective tax rate for the three and nine months ended September 30, 2008 and 2007,
respectively. We incurred consolidated losses before taxes for the three and nine months ended
September 30, 2008 and 2007. However, we have not recorded a tax benefit for the resulting U.S. net
operating loss carryforwards, as we have determined that a valuation allowance against our net U.S.
deferred tax assets was appropriate based primarily on our historical operating results.
FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes,
(FIN 48) was issued
to clarify the requirements of Statement of Financial Accounting Standards No. 109,
Accounting for
Income Taxes
, relating to the recognition of income tax benefits.
FIN 48 provides a two-step approach to recognizing and measuring tax benefits when the
benefits realization is uncertain. The first step is to determine whether the benefit is to be
recognized, and the second step is to determine the amount to be recognized:
|
|
|
income tax benefits should be recognized when, based on the technical
merits of a tax position, the entity believes that if a dispute arose
with the taxing authority and were taken to a court of last resort, it
is more likely than not (i.e., a probability of greater than
50 percent) that the tax position would be sustained as filed; and
|
|
|
|
|
if a position is determined to be more likely than not of being
sustained, the reporting enterprise should recognize the largest
amount of tax benefit that is greater than 50 percent likely of being
realized upon ultimate settlement with the taxing authority.
|
Effective January 1, 2007, we adopted FIN 48. The implementation of FIN 48 did not result in
any adjustment to the Companys beginning tax positions. The Company continues to fully recognize
its tax benefits which are offset by a valuation allowance to the extent that it is more likely
than not that the deferred tax assets will not be realized.
The Companys former wholly owned subsidiary, Xmark, filed federal and provincial income tax
returns in Canada and filed federal and state income tax returns in the U.S. The Company is
generally no longer subject to federal and provincial income tax examinations by Canadian tax
authorities for years before 2001 and to federal and state income tax examinations by U.S. tax
authorities for years before 2003. Management does not anticipate that adjustments, if any, which
may be proposed by the Canadian Revenue Agency would result in a material change to its financial
position. The Company is responsible for the tax obligations of Xmark through the date of sale,
July 18, 2008. The estimated tax liability has been accrued in the Companys balance sheet as of
September 30, 2008. Xmark had an effective tax rate of 22.8%
and 12.9% for the nine months ended September 30, 2008 and 2007,
respectively.
The Company recognizes any interest accrued related to unrecognized tax benefits or exposures
in interest expense and penalties in operating expenses. During the nine months ended September 30,
2008 and 2007, there was no such interest or penalty.
7. Unasserted ClaimPotential Intellectual Property Conflict
Either of the two companies to whom Digital Angel granted licenses, 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 have been required to cease
its efforts to create a market for its implantable microchip until the patent expired in
April 2008. In addition, the Company could be required to pay damages, which may be substantial.
If the Company or Digital Angel was denied use of the patented technology in applications
involving the identification of human beings, the Company would not have been able to purchase or
sell any of its products that incorporate the implantable microchip before the patent expired. 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.
14
The Company has been publicly marketing and selling the implantable microchip for human
identification and security applications for approximately five years. Through September 30, 2008,
there are no pending or threatened intellectual property claims challenging the Companys marketing
or selling activities. In October 2007, Digital Angel and the successor to one of Digital Angels
two licensees executed a cross-license which includes Digital Angel obtaining a royalty free
non-exclusive license to its rights to the implantable human applications of the 129 patent, for
which it purports certain ownership rights to. Digital Angel has, in turn, conveyed those rights to
the Company.
Under the circumstances, the accompanying financial statements make no provision with respect
to the unasserted claim described above.
8. Legal proceedings
The Company is engaged in certain legal actions and management believes that the ultimate
outcome of these actions will not have a material adverse effect on the Companys operating
results, liquidity or financial position.
Metro Risk
On January 10, 2005, the Company commenced an action in the Circuit Court for Palm Beach
County, Florida, against Metro Risk Management Group, LLC, or Metro Risk. In this suit, the Company
has claimed that Metro Risk breached the parties three international distribution agreements by
failing to meet required minimum purchase obligations and by repudiating the agreements. 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 three international distribution
agreements by later signing a different distribution agreement with a large distributor of medical
supplies. Metro Risk alleged that the distribution agreement with this other distributor included
the same areas covered in the Companys three international distribution agreements with Metro
Risk. Moreover, regarding its claim for fraud in the inducement, Metro Risk alleged that the
Company fraudulently induced Metro Risk into signing the three international distribution
agreements by promising millions of dollars in profits, only later to sign another distribution
agreement with a competitor for the same countries. By virtue of its counterclaim, Metro Risk seeks
reliance damages in the amount of $155,000, which allegedly represents the amount of money advanced
by Metro Risk for the project, lost profits, and attorneys fees.
On July 23, 2008, the court granted a motion for summary judgment filed by the Company on
Metro Risks counterclaim, and thus denied Metro Risks counterclaim. Metro Risk may appeal the
decision. The Court has also previously granted summary judgment on the issue of Metro Risks
liability for breaching the three international distribution agreements. Therefore, at present,
the remaining issue in the lawsuit is the Companys damages resulting from Metro Risks breach of
the three international distribution agreements. The parties have taken minimal 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. Given the potential for an appeal, counsel is currently unable to assess the ultimate
outcome.
Stock Option Plans
The Company has received demand letters from attorneys for several former employees and/or
consultants of the Company and Digital Angel, asserting claims related to stock options to acquire
approximately 500 thousand shares of the Companys common stock that management believes that such
employees and/or consultants had forfeited when they ceased their employment or relationship with
the Company and/or Digital Angel. 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.
15
On July 8, 2008, a lawsuit was filed against the Company and Digital Angel by one of the
above-referenced former employees, Jerome C. Artigliere, a former executive of the Company and
Digital Angel. The lawsuit was filed in the Circuit Court of the 15th Judicial Circuit in Palm
Beach County, Florida, and alleges that Mr. Artigliere holds options to acquire 950,000 shares of
common stock of the Company at an exercise price of $0.05 per share and that he has been denied the
right to exercise those options. The complaint alleges causes of action for breach of contract
against the Company and Digital Angel, seeks declaratory judgments clarifying Mr. Artiglieres
alleged contractual rights, and sought an injunction enjoining the vote of the stockholders at
special meeting of Company shareholders that took place on July 17, 2008, on the sale of Xmark. On
September 12, 2008, Mr. Artigliere amended his complaint to add a claim for unpaid wages against
the Company and Digital Angel and to add related claims against several former officers and
directors of the Company and Digital Angel. The Company believes that Mr. Artiglieres claim for
950,000 Company stock options is factually incorrect and, at best, he would be entitled to only
211,111 Company stock options due to the Companys 2-for-3 reverse stock split that occurred in
December of 2005 and the 1-for-3 reverse stock split that occurred in December of 2006. The
Company believes the amended complaint includes multiple inaccuracies, is without merit and intends
to defend the lawsuit. On October 7, 2008, the Company and its co-defendants filed a motion to
dismiss seven of the nine counts asserted in the amended complaint.
The Company is a party to various legal actions, as either plaintiff or defendant, including
the matters identified above, arising in the ordinary course of business, none of which is expected
to have a material adverse effect on its 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 the Company relating to it or to its
intellectual property rights and intellectual property licenses could have a material adverse
effect on the Companys business, financial condition and operating results.
9. Related Party Transactions
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.
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.
16
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 aggregate costs of these
services to the Company were $36,000, and $86,000 in the three and nine months ended September 30,
2008, respectively, and $0.1 million and $0.4 million in the three and nine months ended September
30, 2007, respectively.
On August 20, 2008, the Transition Services Agreement was terminated effective as of September
30, 2008, with the Company making a final payment of $45,000 to Digital Angel, with no further
obligation by either party.
Loan Agreement with Digital Angel
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.
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 accrued 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 accrued on the loan as of the last day of each
month, commencing with February 2007, was 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 was due and payable on February 1, 2010.
The loan with Digital Angel was subordinated to our obligations under our credit agreement
with the Lender, which is further described in Note 3 Financing Agreements, to our condensed
consolidated financial statements, and was collateralized by security interests in all of our
property and assets, except as otherwise encumbered by the rights of the Lender.
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
$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 was not required to make any further debt service payments to Digital Angel
until September 1, 2009.
17
On July 18, 2008, the Company paid $4.8 million to Digital Angel to satisfy the Companys
obligations under the loan agreement. As a result of this payment in July 2008, the Company
recognized a $2.5 million gain on debt settlement in the third quarter of 2008 and Digital Angel
released all security interests it had in the assets of the Company.
Interest expense incurred under the loan for the three and nine months ended September 30,
2008 was nil and $0.5 million, respectively, and $0.4 million and $1.1 million for the three and
nine months ended September 30, 2007, respectively.
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 purchase of product under the supply and development agreement was nil for the
nine month periods ended September 30, 2008 and 2007. 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 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.
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 Note 1)
As discussed in Note 11, the Supply Agreement with Digital Angel was terminated on November
12, 2008.
Letter Agreement with Digital Angel
On May 15, 2008, the Company entered into a Letter Agreement, or the May 2008 Agreement, with
Digital Angel under which the Company agreed, in exchange for Digital Angels consent to a voting
agreement and guarantee agreement with The Stanley Works, to pay $250,000 as a fee for Digital
Angels guarantee of certain obligations under the Stock Purchase Agreement and $250,000 for
reimbursement of transactional costs incurred by Digital Angel in connection with the Xmark
Transaction. These costs were accounted for as transactional costs which were netted against the
gain on the sale of Xmark in the three months ended September 30, 2008.
18
The May 2008 Agreement provides that the Stock Purchase Agreement and the transactions
contemplated thereby do not constitute an event of default under the loan agreement with Digital
Angel, described above, and allows Digital Angel to designate up to three members of the Companys
board of directors, all of which shall be independent with the exception of Joseph J. Grillo,
Digital Angels President and Chief Executive Officer. Upon the closing of the Xmark Transaction,
Mr. Grillo joined the Companys board of directors as the chairman. The May 2008 Agreement also
provides, among other things, that (i) the Company will limit payments and any changes to existing
compensation arrangements are subject to pre-approval by Digital Angel, (ii) Mr. Silverman will
enter into a separation agreement with the Company, which was executed on May 15, 2008 and amended
on July 9, 2008, and (iii) Digital Angel will have reasonable access to the Companys financial
information.
As discussed in Note 11, the May 2008 Agreement with Digital Angel was terminated on November
12, 2008.
Pledge Agreement of Digital Angel
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 February 2010.
This note replaced a previous note issued by Digital Angel, which was due in June 2007. On
August 31, 2007 and October 2, 2008, Digital Angel pledged 80% and 100%, respectively, of its
ownership in the Companys common stock to its lender under the terms two separate notes entered
into with its lender. Each note is due in February 2010.
As a result of Digital Angels sale of all of its shares of the Company to R & R Consulting
Partners, LLC, which is further discussed in Note 11, on November 12, 2008, Digital Angels lender
released the shares of the Company owned by Digital Angel from the pledge agreements between
Digital Angel and its lender.
10. Supplementary Cash Flow Information
|
|
|
|
|
|
|
|
|
|
|
For the Nine Months Ended
|
|
|
|
September 30,
|
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|
|
2008
|
|
|
2007
|
|
Income taxes paid
|
|
$
|
|
|
|
$
|
|
|
Interest paid
|
|
|
285
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
285
|
|
|
$
|
|
|
|
|
|
|
|
|
|
In the nine months ended September 30, 2008 and 2007, the Company had the following non-cash
investing and financing activities:
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|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
Non-cash financing and investing activities:
|
|
|
|
|
|
|
|
|
Offering costs
|
|
$
|
|
|
|
$
|
440
|
|
Debt financing costs
|
|
|
331
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
331
|
|
|
$
|
440
|
|
|
|
|
|
|
|
|
11. Subsequent Events
Continued Listing on Nasdaq Stock Market
On October 21, 2008, the Company received a letter from the Nasdaq Stock Market (the Nasdaq)
indicating that the Company is not in compliance with the Nasdaqs requirements for continued
listing because, for the 30 consecutive business days prior to October 16, 2008, the bid price of
the Companys common stock closed below the minimum $1.00 per share price requirement for continued
listing under Nasdaq Marketplace Rule 4450(a) (the Rule) and, the Companys common stock had not
maintained a minimum market value of publicly held shares (MVPHS) of $5,000,000 as required for
continued inclusion by the Rule.
19
Given the current market conditions, Nasdaq has determined to suspend enforcement of the bid
price and market value of publicly held shares requirements through Friday, January 16, 2009. These
rules will be reinstated on Monday, January 19, 2009 and the first relevant trade date will be
Tuesday, January 20, 2009. Following the reinstatement of these rules, and in accordance with
Marketplace Rule 4450(e)(2), the Company will be provided 180 calendar days from Tuesday
January 20, 2009, or until July 20, 2009, to regain compliance with the bid price requirement, if
it has not already regained compliance prior to January 20, 2009. Following the reinstatement of
these rules, and in accordance with Marketplace Rule 4450(e)(1), the Company will be provided 90
calendar days, or until April 20, 2009, to regain compliance with the market value requirements, if
it has not already regained compliance prior to January 20, 2009. For more information, see Item
1A Risk Factors.
Transactions with Digital Angel
On November 12, 2008, the Company entered into an Asset Purchase Agreement (APA) with
Digital Angel and Destron Fearing Corporation, a wholly-owned subsidiary of Digital Angel, which
collectively are referred to as, Digital Angel. The terms of the APA included the sale to the
Company of patents related to an embedded bio-sensor system for use in humans, and the assignment
of any rights of Digital Angel under a development agreement associated with the development of an
implantable glucose sensing microchip. The Company also received covenants from Digital Angel and
Destron Fearing that will permit the use of intellectual property of Digital Angel related to the
Companys VeriMed Health Link business without payment of ongoing royalties, as well as inventory
and a limited period of technology support by Digital Angel. The Company paid Digital Angel
$500,000 at the closing of the APA.
Also pursuant to the APA, on November 12, 2008, Mr. Grillo resigned as a director of the
Company and the parties terminated the May 2008 Agreement, except for certain provision relating to
indemnification in connection with the stock purchase agreement with The Stanley Works.
Additionally, the Supply Agreement was terminated, except that product warranties continue to apply
to products sold to the Company under that agreement subject to certain limitations, and the
indemnification provisions survive through March 4, 2013 for claims associated with the products
purchased under the Supply Agreement (for more information on the May 2008 Agreement and the Supply
Agreement, see Note 9 Related Party Transactions).
On November 12, 2008, Digital Angel sold the 5.4 million shares of the Companys common stock
it owned to R & R Consulting Partners, LLC, an entity owned and controlled by Scott R. Silverman,
the Companys chairman and former chief executive officer, in a private transaction. As a result
of the transaction, R & R Consulting Partners, LLC and Mr. Silverman now own 53% of the outstanding
common stock of the Company, and Mr. Silverman was re-appointed as chairman of the board of the
Company effective November 12, 2008.
On
November 14, 2008, the Company purchased from Digital Angel the
remaining inventory owned by Digital Angel related to the
Companys VeriMed Health Link business for $161 thousand.
Departure of Directors; Election of Directors
In connection with the APA, effective November 12, 2008, Mr. Grillo resigned as chairman of
the board of directors and Mr. Silverman was appointed chairman of the board of directors.
Effective November 13, 2008, Paul Green resigned as a director of the Company and Michael Krawitz
was appointed as a director of the Company.
20
Special Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements, within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended, that reflect our current estimates, expectations and projections about our
future results, performance, prospects and opportunities. Forward-looking statements include,
without limitation, statements about our market opportunities, our business and growth strategies,
our projected revenue and expense levels, possible future consolidated results of operations, the
adequacy of our available cash resources, our financing plans, our competitive position and the
effects of competition and the projected growth of the industries in which we operate. This
Quarterly Report on Form 10-Q also contains forward-looking statements attributed to third parties
relating to their estimates regarding the size of the future market for products and systems such
as our products and systems, and the assumptions underlying such estimates. Forward-looking
statements include all statements that are not historical facts and can be identified by
forward-looking statements such as may, might, should, could, will, intends,
estimates, predicts, projects, potential, continue, believes, anticipates, plans,
expects and similar expressions. Forward-looking statements are only predictions based on our
current expectations and projections, or those of third parties, about future events and involve
risks and uncertainties.
Although we believe that the expectations reflected in the forward-looking statements
contained in this Quarterly Report on Form 10-Q are based upon reasonable assumptions, no assurance
can be given that such expectations will be attained or that any deviations will not be material.
In light of these risks, uncertainties and assumptions, the forward-looking statements, events and
circumstances discussed in this Quarterly Report on Form 10-Q may not occur and actual results
could differ materially and adversely from those anticipated or implied in the forward-looking
statements. Important factors that could cause our actual results, level of performance or
achievements to differ materially from those expressed or forecasted in, or implied by, the
forward-looking statements we make in this Quarterly Report on Form 10-Q are discussed under Item
1A. Risk Factors and elsewhere in our Annual Report on Form 10-K, as amended, for the year ended
December 31, 2007, 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 rate and extent of the U.S. healthcare industrys adoption of radio frequency identification, or
RFID, 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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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 business;
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uncertainty as to whether a market for our VeriMed Health Link system will develop and whether we
will be able to generate more than a nominal level of revenue from such 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 Health Link system, which will depend in large part on the future
availability of insurance reimbursement for the VeriMed Health Link system microchip implant
procedure from government and private insurers, and the timing of such reimbursement, if it, in fact,
occurs;
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21
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our ability to provide uninterrupted, secure access to the VeriMed database;
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our ability to pay a special dividend; and
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our ability to establish and maintain proper and effective internal accounting and financial controls.
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You should not place undue reliance on any forward-looking statements. In addition, past
financial or operating performance is not necessarily a reliable indicator of future performance,
and you should not use our historical performance to anticipate future results or future period
trends. Except as otherwise required by federal securities laws, we disclaim any obligation or
undertaking to disseminate any updates or revisions to any forward-looking statement contained in
this Quarterly Report on Form 10-Q to reflect any change in our expectations or any change in
events, conditions or circumstances on which any such statement is based. All forward-looking
statements attributable to us, or persons acting on our behalf, are expressly qualified in their
entirety by the cautionary statements included in this Quarterly Report on Form 10-Q and under the
section entitled Risk Factors in our Annual Report on Form 10-K, as amended, for the year ended
December 31, 2007. These are factors that could cause our actual results to differ materially from
expected results. Other factors besides those listed could also adversely affect us.
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations
should be read in conjunction with the accompanying financial statements and related notes included
in Item 1 of this Quarterly Report on the 10-Q as well as our Annual Report on Form 10-K, as
amended, for the year ended December 31, 2007.
On May 15, 2008, the Company entered into a stock purchase agreement with The Stanley Works to
sell all of the outstanding capital stock of its subsidiary, Xmark, for $45 million cash, to be
adjusted based on Xmarks closing balance sheet. The Xmark business includes all of the operations
of the previously reported healthcare security and industrial segments. On July 18, 2008, pursuant
to the terms of the stock purchase agreement between the Company and The Stanley Works, the Company
completed the sale of all of the outstanding capital stock of Xmark to Stanley Canada for
approximately $47.9 million in cash, which consists of the $45 million purchase price plus a
balance sheet adjustment of approximately $2.9 million. Under the terms of the stock purchase
agreement, $4.5 million of the proceeds will be held in escrow for a period of 12 months to provide
for indemnification obligations under the stock purchase agreement, if any. As a result of the sale
of Xmark, the financial condition, results of operations and cash flows of Xmark have been reported
as discontinued operations in our financial statements and prior period information has been
reclassified accordingly.
The Company now operates in a single segment, focused on its VeriMed Health Link system which
uses an implantable FDA-cleared passive RFID microchip that is used in 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 Health Link system for
patient identification and health information purposes in the United States.
Results of Operations
Three Months Ended September 30, 2008 Compared to Three Months Ended September 30, 2007
Effective with the sale of Xmark in July 2008, the Company significantly reduced its selling,
general and administrative costs while exploring opportunities related to its remaining business,
the VeriMed Health Link business. As a result, it does not expect past levels of operating
expenditures, described below, to continue through the remainder of 2008.
22
Revenue
Through September 30, 2008, we have recorded nominal revenue from sales of our VeriMed Health
Link system. In the three months ended September 30, 2008, we recorded revenue of $6,000.
Gross Profit and Gross Profit Margin
Our cost of sales consists of finished goods and inventory valuation charges. The implantable
microchips used in our VeriMed Health Link system are purchased as finished goods under the terms
of our former agreement with Digital Angel.
Our gross profit decreased from $38,000 for the three months ended September 30, 2007 to
$6,000 for the three months ended September 30, 2008. The decrease is attributable to decreased
revenue for the three months ended September 30, 2008.
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 $8.4 million to $11.9 million for the
three months ended September 30, 2008 as compared to $3.5 million for the three months ended
September 30, 2007. This increase was primarily driven by contractual payments of $7.0 million to
management of the Company as a result of the sale of Xmark to The Stanley Works. The remainder of
the increase was due to transactional expenses associated with our sale of Xmark, the marketing of
our VeriMed Health Link business and the costs resulting from equity based compensation. Effective
with the closing of the sale of Xmark, our chairman and chief executive officer separated from the
Company and became an unpaid consultant focused on the sale of the VeriMed Health Link business or
the Company as a whole. Additionally, during the process of marketing the Company for sale, sales
and marketing expenditures have been reduced significantly from prior periods.
During the three months ended September 30, 2008 and 2007, we incurred stock-based
compensation expense of $3.5 million and $1.3 million, respectively. On July 18, 2008, as a result
of the Companys sale of Xmark Corporation, all outstanding unvested options and restricted shares
became fully vested. As a result, the Company recorded $3.5 million as an expense, reflecting the
unamortized balance at July 18, 2008.
Included in selling, general and administrative expense was $36,000 and $0.1 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 three
months ended September 30, 2008 and 2007, respectively.
Selling, general and administrative expense included depreciation and amortization expense of
approximately $8,000 and $16,000 for the three months ended September 30, 2008 and 2007,
respectively.
Research and Development
Our research and development expense consists primarily of costs associated with various
projects, including testing, developing prototypes and related expenses.
Research and development expense was nil for the three months ended September 30, 2008
compared to $8,000 for the three months ended September 30, 2007. The Companys research and
development costs represent payments to its project partner in the development of a glucose sensing
microchip.
23
Interest Expense
Interest expense was $40,000 and $0.4 million for the three months ended September 30, 2008
and 2007, respectively. During the three months ended September 30, 2008 and 2007, the interest
rate under our two financings was 12% per annum.
Nine Months Ended September 30, 2008 Compared to the Nine Months Ended September 30, 2007
Effective with the sale of Xmark in July 2008, the Company has significantly reduced its
selling, general and administrative costs while exploring opportunities related to its remaining
business, the VeriMed Health Link business. As a result, it does not expect past levels of
operating expenditures, described below, to continue through the end of 2008.
Revenue
Through September 30, 2008, we have recorded nominal revenue from sales of our VeriMed Health
Link system. In the nine months ended September 30, 2008, we recorded revenue of $41,000.
Gross Profit and Gross Profit Margin
Our cost of sales consists of finished goods and inventory valuation charges. The implantable
microchips used in our VeriMed Health Link system are purchased as finished goods under the terms
of our agreement with Digital Angel.
Our gross profit decreased from $39,000 for the nine months ended September 30, 2007 to a loss
of $20,000 for the nine months ended September 30, 2008. The loss is attributable to inventory
valuation reserves.
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 $9.5 million to $18.7 million for the
nine months ended September 30, 2008 as compared to $9.2 million for the nine months ended
September 30, 2007. This increase was primarily driven by contractual payments of $7.0 million to
management of the Company as a result of the sale of Xmark to The Stanley Works. The increase was
also due to marketing costs associated with our VeriMed Health Link business, the additional costs
resulting from equity based compensation and increased costs related to operating as a public
entity as the result of our initial public offering in February 2007. Effective with the closing of
the sale of Xmark, our chairman and chief executive officer separated from the Company and became
an unpaid consultant focused on the sale of the VeriMed Health Link business or the Company as a
whole. Additionally, during the process of marketing the Company for sale, sales and marketing
expenditures have been reduced significantly from prior periods.
During the nine months ended September 30, 2008 and 2007, we incurred stock-based compensation
expense of $5.0 million and $2.6 million, respectively. On July 18, 2008, as a result of the
Companys sale of Xmark Corporation, all outstanding unvested options and restricted shares became
fully vested. As a result, the Company recorded $3.5 million as an expense, reflecting the
unamortized balance at July 18, 2008.
Included in selling, general and administrative expense was $86,000 and $0.4 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 nine
months ended September 30, 2008 and 2007, respectively.
Selling, general and administrative expense included depreciation and amortization expense of
approximately $43,000 and $56,000 for the nine months ended September 30, 2008 and 2007,
respectively.
24
Research and Development
Our research and development expense consists primarily of costs associated with various
projects, including testing, developing prototypes and related expenses.
Research and development expense was $0.2 million for the nine months ended September 30, 2008
compared to $0.1 million for the nine months ended September 30, 2007. The Companys research and
development costs represent payments to its project partner in the development of a glucose sensing
microchip.
Interest Expense
Interest expense was approximately $0.9 million for the nine months ended September 30, 2008
compared to $1.1 million for the nine months ended September 30, 2007. During the nine months ended
September 30, 2008, the interest rate under our loan agreement with Valens Offshore SPV II, Corp.
was 12% per annum. During the nine months ended September 30, 2008 and 2007, the interest rate
under our loan agreement with Digital Angel was 12% per annum.
Liquidity and Capital Resources
As of September 30, 2008, unrestricted cash totaled $4.8 million compared to cash of
$7.2 million at December 31, 2007.
Cash Flows Used in Operating Activities
Net cash used in operating activities totaled $17.1 million and $5.0 million during the nine
months ended September 30, 2008 and 2007, respectively. For each of the periods presented, cash was
used to fund operating losses, primarily resulting from the marketing expenses of the Companys
VeriMed Health Link business. On July 18, 2008, the Company sold its Xmark subsidiary to The
Stanley Works for $47.9 million. In conjunction with that transaction the Company paid $9.1
million for contractual payments to management of the Company and Xmark and paid $0.6 million for
transaction related costs.
Historically, the Companys Xmark business generated significant operating cash flows, a
portion of which was used to fund the operating expenditures for marketing and other development
costs related to the VeriMed Health Link business. On November 12, 2008 the Company announced its
intention to continue to explore potential strategic transactions with third parties, while
continuing to operate its VeriMed Health Link business.
Cash Flows from Investing Activities
Investing activities provided (used) cash of $43.2 million and $(0.4) million during the nine
months ended September 30, 2008 and 2007, respectively. Cash provided by investing activities
during 2008 includes the $47.9 million of proceeds from the sale of Xmark, net of the $4.5 million
of the proceeds that will be held in escrow for twelve months following the close of the
transaction to provide for indemnification obligations, if any.
Cash Flows from Financing Activities
Financing activities provided (used) cash of $(28.5) million and $14.2 million during the nine
months ended September 30, 2008 and 2007, respectively. During the first nine months of 2008 the
Company borrowed $8.0 million from Valens Offshore SPV II, Corp. (the Lender), a portion of which
was used to repay Digital Angel and the Royal Bank of Canada, which had previously provided a
working capital line to the Companys subsidiary, Xmark. In conjunction with the sale of Xmark,
the Company retired all of its outstanding debt to Digital Angel and to Lender. On August 28,
2008, the Company paid a special dividend of $15.8 million, or $1.35 per share, to all stockholders
of record on August 18, 2008. In the first nine months of 2007 the Company raised net proceeds
from its initial public offering of $15.5 million, net of costs, a portion of which was used to
repay principal to Digital Angel and to pay costs of financing.
25
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.
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 continued 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 accrued on the loan as of the last day of each
month, commencing with February 2007, was 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 was due and payable on February 1, 2010.
The loan with Digital Angel was subordinated to our obligations under our credit agreement
with Valens Offshore SPV II, Corp., which is discussed below, and was collateralized by security
interests in all of our property and assets, except as otherwise encumbered by the rights of the
Lender.
On February 29, 2008, we closed an $8.0 million debt financing (the Agreement) with 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 accrued interest at a rate of 12% per annum
and had a maturity date of March 31, 2009. The terms of the Note allowed for optional redemption by
paying 100% of the principal amount plus $120,000, if such amounts were paid prior to the six month
anniversary of February 29, 2008, or $240,000, if such amounts were 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 were not required to make any further debt service payments to Digital Angel until
September 1, 2009. If we paid Digital Angel an additional $4.2 million, plus accrued interest,
prior to October 30, 2008, we would be discharged from our remaining obligation to Digital Angel.
26
On July 18, 2008, the Company used part of the proceeds from the sale of Xmark to pay $4.8
million to Digital Angel to satisfy the Companys obligations under the loan agreement. As a
result of this payment, the Company recognized a $2.5 million gain on debt settlement and Digital
Angel released all security interests it had in the assets of the Company.
On July 18, 2008, the Company used part of the proceeds of the sale of Xmark to repay all of
its outstanding obligations under the Note by paying 100% of the principal amount plus any amounts
then owing under the Note plus $120,000, for a total of $8.2 million. The result of this repayment
included a $0.3 million loss on debt settlement. As a result of the satisfaction of the Note, the
Lender released all of its security interests against the Company.
Financial Condition
As of September 30, 2008, we had working capital of $4.1 million and an accumulated deficit of
$40.3 million compared to working capital of $6.7 million and an accumulated deficit of
$29.0 million as of December 31, 2007. The decrease in working capital was primarily due to funding
operating losses related to the marketing costs of our VeriMed Health Link business and
transactional costs related to our sale of Xmark to The Stanley Works.
On July 18, 2008, pursuant to the terms of the stock purchase agreement, the Company completed
the sale of all of the outstanding capital stock of Xmark to Stanley Canada Corporation, a
wholly-owned subsidiary of The Stanley Works, for approximately $47.9 million in cash, which
consists of the $45 million purchase price plus a balance sheet adjustment of approximately $2.9
million. Under the terms of the stock purchase agreement, $4.5 million of the proceeds will be held
in escrow for a period of 12 months to provide for indemnification obligations under the stock
purchase agreement, if any. Following the close of the transaction the Company paid $13.5 million
to retire all of its outstanding debt and $9.1 million for contractual payments due on the close of
the Xmark sale to management personnel of the Company and Xmark.
Contractual Obligations
On February 29, 2008, the Company entered into the Agreement with 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, which bears interest at a rate of 12% per annum, and has a maturity date of
March 31, 2009. On July 18, 2008, the Company used the proceeds of the sale of Xmark to repay all
of its outstanding obligations under the term note. The term note allowed for optional redemption
by paying 100% of the principal amount plus any amounts then owing under the Note plus $120,000,
for a total of $8.2 million. The terms and conditions of the financing are further discussed above.
The Company was a party to an amended and restated supply and development agreement with
Digital Angel, which is further discussed in Note 9, Related Party Transactions, to the Companys
unaudited condensed consolidated financial statements in this Form 10-Q. The agreement was
terminated on November 12, 2008, in connection with the execution of an Asset Purchase Agreement,
which is further discussed in Note 11, Subsequent Events, to the Companys unaudited condensed
consolidated financial statements in this Form 10-Q.
Impact of Recently Issued Accounting Standards
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 adoption of FSP SFAS 157-1 did not have a material
impact to its consolidated results of operations and financial position.
27
In March 2008, FASB issued SFAS No. 161,
Disclosures about Derivative Instruments and Hedging
Activities
(FAS 161). FAS 161 requires enhanced disclosures about an entitys derivative and
hedging activities and thereby improves the transparency of financial reporting. Entities are
required to provide enhanced disclosures about; (1) how and why an entity uses derivative
instruments, (2) how derivative instruments and related hedged items are accounted for under SFAS
No. 133,
Accounting for Derivative Instruments and Hedging Activities
, and its related
interpretations, and (3) how derivative instruments and related hedged items affect an entitys
financial position, financial performance and cash flows. This statement is effective for financial
statement issued for fiscal years and interim periods beginning after November 15, 2008, with early
application encouraged. Comparative disclosures for earlier periods at initial adoption is
encouraged but not required. The Company does not expect the adoption of FAS 161 to have a material
impact to its consolidated results of operations and financial position.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We presently do not use any derivative financial instruments to hedge our exposure to adverse
fluctuations in interest rates, foreign exchange rates, fluctuations in commodity prices or other
market risks, nor do we invest in speculative financial instruments. Our 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.
Item 4T. Controls and Procedures.
Disclosure Controls and Procedures
Evaluation of Disclosure Controls
. We evaluated the effectiveness of the design and operation
of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities
Exchange Act of 1934, as amended (the Exchange Act) as of September 30, 2008. This evaluation
(the disclosure controls evaluation) was done under the supervision and with the participation of
management, including the persons performing the functions of chief executive officer (CEO) and
chief financial officer (CFO). Rules adopted by the SEC require that in this section of our
Quarterly Report on Form 10-Q we present the conclusions of the CEO and CFO about the effectiveness
of our disclosure controls and procedures as of September 30, 2008 based on the disclosure controls
evaluation.
Objective of Controls.
Our disclosure controls and procedures are designed so that information
required to be disclosed in our reports filed under the Exchange Act, such as this Quarterly Report
on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in
the SECs rules and forms. Our disclosure controls and procedures are also intended to ensure that
such information is accumulated and communicated to our management, including the CEO and CFO, as
appropriate to allow timely decisions regarding required disclosure. There are inherent limitations
to the effectiveness of any system of disclosure controls and procedures, including the possibility
of human error and the circumvention or overriding of the controls and procedures. Accordingly,
even effective disclosure controls and procedures can only provide reasonable assurance of
achieving their control objectives, and management necessarily is required to use its judgment in
evaluating the cost-benefit relationship of possible disclosure controls and procedures.
Conclusion
. Based upon the disclosure controls evaluation, our CEO and CFO have concluded
that, as of September 30, 2008, our disclosure controls and procedures were effective to provide
reasonable assurance that the foregoing objectives are achieved.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting identified in
connection with the evaluation required by paragraph (d) of Rule 13a-15 under the Exchange Act that
occurred during the quarter ended September 30, 2008 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting.
28
PART II OTHER INFORMATION
Item 1. Legal Proceedings.
See note 8, Legal Proceedings, to the Companys unaudited condensed consolidated financial
statements in this Form 10-Q for information regarding material developments in our legal
proceedings during the quarterly period ended September 30, 2008.
Item 1A. Risk Factors.
Our Annual Report on
Form 10-K
for the fiscal year ended December 31, 2007, as amended,
includes a detailed discussion of the risk factors that could materially affect our business,
financial condition or future results. The information presented below is a discussion of the
material changes and updates to these risk factors and should be read in conjunction with the risk
factors and information disclosed in the
Form 10-K
, as amended.
If we fail to continue to meet all applicable Nasdaq Stock Market requirements, our stock
could be delisted by the Nasdaq Stock Market. If delisting occurs, it would adversely affect the
market liquidity of our common stock and harm our businesses.
On October 21, 2008, the Company received a letter from the Nasdaq Stock Market (the Nasdaq)
indicating that the Company is not in compliance with the Nasdaqs requirements for continued
listing because, for the 30 consecutive business days prior to October 16, 2008, the bid price of
the Companys common stock closed below the minimum $1.00 per share price requirement for continued
listing under Nasdaq Marketplace Rule 4450(a) (the Rule) and, the Companys common stock had not
maintained a minimum market value of publicly held shares (MVPHS) of $5,000,000 as required for
continued inclusion by the Rule.
Given the current market conditions, Nasdaq has determined to suspend enforcement of the bid
price and market value of publicly held shares requirements through Friday, January 16, 2009. These
rules will be reinstated on Monday, January 19, 2009 and the first relevant trade date will be
Tuesday, January 20, 2009. Following the reinstatement of these rules, and in accordance with
Marketplace Rule 4450(e)(2), the Company will be provided 180 calendar days from Tuesday
January 20, 2009, or until July 20, 2009, to regain compliance with the bid price requirement, if
it has not already regained compliance prior to January 20, 2009. Following the reinstatement of
these rules, and in accordance with Marketplace Rule 4450(e)(1), the Company will be provided 90
calendar days, or until April 20, 2009, to regain compliance with the market value requirements, if
it has not already regained compliance prior to January 20, 2009.
If, at anytime before July 20, 2009, including during the suspension period, the bid price of
the Companys common stock closes at $1.00 per share or more for a minimum of ten (10) consecutive
business days, the Nasdaq staff will provide written notification that the Company has achieved
compliance with the Rule. However, if the Company does not regain compliance with the Rule by
July 20, 2009, the Nasdaq staff will provide written notification that the Companys securities
will be delisted. At that time, the Company may appeal the Nasdaq staffs determination to delist
its securities to a Listing Qualifications Panel.
If, at anytime before April 20, 2009, the MVPHS of the Companys common stock is $5,000,000 or
greater for a minimum of ten (10) consecutive trading days, the Nasdaq staff will provide written
notification that the Company complies with the Rule. If compliance with the Rule cannot be
demonstrated by April 20, 2009, the Nasdaq staff will provide written notification that the
Companys securities will be delisted. At that time, the Company may appeal Nasdaq staffs
determination to a Listing Qualifications Panel.
If the Companys common stock is delisted from the Nasdaq Stock Market, trading of its common
stock most likely will be conducted in the over-the-counter market on an electronic bulletin board
established for unlisted securities, such as the Pink Sheets or the OTC Bulletin Board. Delisting
would adversely affect the market liquidity of the Companys common stock and harm its business.
Such delisting could also adversely affect the Companys ability to obtain financing for the
continuation of its operations and could result in the loss of confidence by investors, suppliers
and employees.
29
Item 4. Submission of Matters to a Vote of Security Holders.
On July 17, 2008, the Company held a special meeting of stockholders to approve the stock
purchase agreement, dated May 15, 2008, between the Company and The Stanley Works and the
transactions contemplated by the stock purchase agreement. The proposal received 7,737,480 votes
for, 50,550 votes against, 5,750 abstained and no broker non-votes.
For more information on the stock purchase agreement, see Item 2 Managements Discussion and
Analysis of Financial Condition and Results of Operations.
Item 5. Other Information.
Entry Into a Material Definitive Agreement
On November 12, 2008, the Company entered into an Asset Purchase Agreement (APA) with
Digital Angel, the former approximately 46% owner of the Company, and Destron Fearing Corporation,
a wholly-owned subsidiary of Digital Angel, which collectively are referred to as, Digital Angel.
The terms of the APA included the sale to the Company of patents related to an embedded bio-sensor
system for use in humans, and the assignment of any rights of Digital Angel under a development
agreement associated with the development of an implantable glucose sensing microchip. The Company
also received covenants from Digital Angel and Destron Fearing that will permit the use of
intellectual property of Digital Angel related to the Companys VeriMed Health Link business
without payment of ongoing royalties, as well as inventory and a limited period of technology
support by Digital Angel. The Company paid Digital Angel $500,000 at the closing of the APA.
Also pursuant to the APA, on November 12, 2008, the parties terminated a Letter Agreement,
dated May 15, 2008, between the Company and Digital Angel except for certain provision relating to
indemnification in connection with the stock purchase agreement with The Stanley Works.
Additionally, the amended and restated supply and development agreement (the Supply Agreement)
between the Company and Digital Angel was terminated, except that product warranties continue to
apply to products sold to the Company under that agreement subject to certain limitations, and the
indemnification provisions survive through March 4, 2013 for claims associated with the products
purchased under the Supply Agreement (for more information on the Letter Agreement and the Supply
Agreement, see Note 9 Related Party Transactions to the Companys unaudited condensed
consolidated financial statements in this Form 10-Q).
Termination of a Definitive Agreement
Pursuant to the APA, the Letter Agreement and Supply Agreement were terminated effective
November 12, 2008. For more information on the Letter Agreement and the Supply Agreement, see Note
9 Related Party Transactions to the Companys unaudited condensed consolidated financial
statements in this Form 10-Q.
30
Changes in Control of Registrant
On November 12, 2008, Digital Angel sold the 5.4 million shares of the Companys common stock
it owned to R & R Consulting Partners, LLC, an entity owned and controlled by Scott R. Silverman,
the Companys chairman and former chief executive officer, in a private transaction in exchange for
$750,000 provided by the working capital of R & R Consulting Partners, LLC. As a result of the
transaction, R & R Consulting Partners, LLC and Mr. Silverman now own 53% of the outstanding common
stock of the Company, and Mr. Silverman was re-appointed as chairman of the board of the Company
effective November 12, 2008.
Departure of Directors; Election of Directors
In connection with the APA, effective November 12, 2008, Mr. Grillo resigned as chairman of
the board of directors and Mr. Silverman was appointed chairman of the board of directors.
Effective November 13, 2008, Paul Green resigned as a director of the Company and Michael Krawitz
was appointed as a director of the Company. There are no
related party transactions, as provided for in Item 404(a) of Regulation S-K, between Mr. Silverman
or Mr. Krawitz and the Company.
Item 6. Exhibits.
We have listed the exhibits by numbers corresponding to the Exhibit Table of Item 601 in
Regulation S-K on the Exhibit list attached to this report.
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
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VERICHIP CORPORATION
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(Registrant)
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Date: November 14, 2008
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By:
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/s/ William J. Caragol
William J. Caragol
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President, Chief Financial Officer,
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Treasurer and Secretary
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(Duly Authorized Officer)
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32
Exhibit Index
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Exhibit
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Number
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Description
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2.1
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Stock Purchase Agreement, dated May 15, 2008, between VeriChip Corporation and The Stanley
Works
(1)
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2.2
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Voting Agreement, dated May 15, 2008, between Digital Angel Corporation and The Stanley Works
(1)
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2.3
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Voting Agreement, dated May 15, 2008, between Scott R. Silverman and The Stanley Works
(1)
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3.1
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Second Amended and Restated Certificate of Incorporation of VeriChip Corporation filed with the
Secretary of State of Delaware on December 18, 2006
(2)
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3.2
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Amended and Restated By-laws of VeriChip Corporation adopted as of December 12, 2005
(1)
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4.1
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Form of Specimen Common Stock Certificate
(2)
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10.1
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*
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Asset Purchase Agreement, dated November 12, 2008, among VeriChip Corporation, Digital Angel
Corporation and Destron Fearing Corporation
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10.2
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Amendment to Separation Agreement, dated July 9, 2008, between VeriChip Corporation and Scott R.
Silverman
(3)
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31.1
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*
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Certification by William J. Caragol, acting Chief Executive Officer, pursuant to Exchange Act Rules
13A-14(a) and 15d-14(a)
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31.2
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*
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Certification by William J. Caragol, Chief Financial Officer, pursuant to Exchange Act Rules
13A-14(a) and 15d-14(a)
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32.1
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*
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Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
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*
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Filed herewith.
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(1)
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Incorporated by reference to the Form 8-K previously filed by VeriChip Corporation on May 16, 2008.
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(2)
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Incorporated by reference to the Registration Statement on Form S-1 previously filed by VeriChip Corporation (Registration No. 333-130754).
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(3)
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Incorporated by reference to the Form 10-Q previously filed by VeriChip Corporation on August 14, 2008.
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33
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