##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-K
  þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
 For the fiscal year ended December 31, 2007
 or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
 For the transition period from  to
 Commission file number: 001-33297
 VERICHIP CORPORATION
 (Exact name of registrant as specified in its charter)
 DELAWARE
    
    06-1637809(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 1690 South Congress Avenue, Suite 200
Delray Beach, Florida 33445
(Address of principal executive offices) (Zip code)
 (561) 805-8008
(Registrants telephone number, including area code)
  Common Stock, par value $0.01 per share
    
    The NASDAQ Stock Market LLC(Title of each class)
    
    (Name of each exchange on which registered)
  o þ
 o þ
 þ o
 þ
 
 Large accelerated filer o
    
    Accelerated filer oNon-accelerated filer þ
    
    Smaller reporting company o(Do not check if smaller reporting company)
 o þ




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##### 



Item
    
    Description
    
    PageSpecial Note Regarding Forward-Looking Statements
    
    
    1Part I
    
    
    31.
    
    Business
    
    
    31A.
    
    Risk Factors
    
    
    281B.
    
    Unresolved Staff Comments
    
    
    432.
    
    Properties
    
    
    433.
    
    Legal Proceedings
    
    
    434.
    
    Submission of Matters to a Vote of Security Holders
    
    
    44Part II
    
    
    445.
    
    Market for Registrants Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
    
    
    446.
    
    Selected Financial Data
    
    
    477
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    507A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    768.
    
    Financial Statements and Supplementary Data
    
    
    779.
    
    Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
    
    
    779A(T).
    
    Controls and Procedures
    
    
    779B.
    
    Other Information
    
    
    78Part III
    
    
    7810.
    
    Directors, Executive Officers and Corporate Governance
    
    
    7811.
    
    Executive Compensation
    
    
    7812.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    7813.
    
    Certain Relationships and Related Transactions, and Director Independence
    
    
    7814.
    
    Principal Accounting Fees and Services
    
    
    78Part IV
    
    
    7815.
    
    Exhibits, Financial Statement Schedules
    
    
    78Signatures
    
    
    80Index to Consolidated Financial Statements and Financial Schedules
    
    
    F-1Exhibit 21.1Exhibit 23.1Exhibit 23.2Exhibit 23.3Exhibit 24.1Exhibit 31.1Exhibit 31.2Exhibit 32.1
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Special Note Regarding Forward-Looking Statements
   
    
    our ability to successfully implement our business strategy;
 
    
    our expectation that we will incur losses, on a consolidated basis, for the
foreseeable future;
 
    
    our ability to fund our operations;
 
    
    the impact on our success of the relative maturity in the United States, and limited
size, of the markets for our infant protection and wander prevention systems and
vibration monitoring instruments;
 
    
    the degree of success we have in leveraging our brand reputation, reseller network
and end-use customer base for our infant protection and wander prevention systems to
gain inroads in the emerging market for asset/personnel location and identification
systems;
 
    
    the rate and extent of the U.S. healthcare industrys adoption of radio frequency
identification, or RFID, asset/personnel location and identification systems;
 
    
    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;
 
    
    our ability to complete our efforts to introduce a new vibration monitoring
instrumentation platform;
 
    
    uncertainty as to whether we will be able to increase our sales of infant protection
and wander prevention systems outside of North America;
 
    
    our reliance on third-party dealers to successfully market and sell our products;
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
    
    we may become subject to costly product liability claims and claims that our
products infringe the intellectual property rights of others;
 
    
    our ability to comply with current and future regulations relating to our
businesses;
 
    
    uncertainty as to whether a market for our VeriMed system will
develop and whether we will be able to generate more than a nominal level of revenue
from this business
 
    
    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 partys 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;
 
    
    market acceptance of our VeriMed system, which will depend in large part on the
future availability of insurance reimbursement for the VeriMed system microchip implant
procedure from government and private insurers, and the timing of such reimbursement,
if it, in fact, occurs;
 
    
    a potential disruption to our business, loss of sales and higher expense if we are
unable to obtain the implantable microchip used in our VeriMed and VeriTrace systems
from our largest stockholder, Applied Digital Solutions, Inc. d/b/a Digital Angel, and
other risks related to our supply agreement with Digital Angel;
 
    
    our ability to provide uninterrupted, secure access to the VeriMed database;
 
    
    conflict of interest risks related to our continued affiliation with Digital Angel;
and
 
    
    our ability to establish and maintain proper and effective internal accounting and
financial controls.
   2




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PART I
 
 ITEM 1. BUSINESS
 The Company
      Hugs, Kisses, RoamAlert, Assetrac, Blastmate, Minimate, and BioBond are our registered
trademarks, and HALO, VeriMed, VeriChip, VeriTrace and ToolHound are our trademarks. This Annual
Report on Form 10-K contains trademarks and trade names of other organizations and corporations.
 Available Information
  Overview
   3




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
    
    infant protection systems that help to prevent infant abduction and mother-baby
mismatching; and
 
    
    wander prevention systems that help to protect and locate residents in nursing homes
and assisted living facilities.
    
    
    a tag, containing a microchip-equipped transponder, an antenna and a capacitor,
attached to the item to be identified, located or tracked, which wirelessly transmits
stored information to a receiver;
 
    
    one or more receivers, also referred to as readers, which are devices that read
the tag by sending out an RF signal to which a tag, in the range of the signal,
responds;
 
    
    the equipment, cabling, computer network and software applications to use the
processed data for one or more applications.
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Industry Overview
 RFID and the Healthcare Industry
    
    
    Infant ProtectionAt present, approximately 50% of maternity wards and other
birthing facilities in the United States, and 65-75% of maternity wards with greater
than 1,000 births per year, have some type of infant protection system  though not
necessarily an RFID system. Based on our experience, we anticipate that hospital
maternity wards and birthing centers will continue to upgrade their security measures,
with RFID systems designed for these applications achieving greater market penetration.
The adoption of security measures, such as the implementation of an RFID infant
protection system, has been prompted by problems in dealing with mother-baby
mismatching and infant abduction. The Journal of Healthcare Protection Management has
reported that an estimated 20,000 mismatching incidents occur annually in the United
States. Between 1983 and 2004, 223 infants were recorded as being abducted in the
United States, with over 50% taken from healthcare facilities.
 
    
    Wander PreventionAt present, we estimate that roughly 30% of the long-term care
facilities in the United States have deployed an RFID-type wander prevention system.
The level of system deployment varies by type of facility. Nursing homes reflect the
highest level, followed by assisted living facilities. The implementation of RFID
wander prevention systems has been prompted by the significant number of individuals
residing in long-term care facilities, including nursing homes and assisted living
facilities, who are at risk of wandering away from their care facility. This can result
in danger to the individual and subsequent liability to the healthcare facility and its
insurer. According to the National Institute on Aging of the U.S. National Institutes
of Health, in 2005 there were approximately 37 million people over the age of 65 in the
United States alone, and that number is expected to grow to
approximately 58 million by 2025.
Furthermore, according to the National Nursing Home
Survey,published by the Centers for Disease Control in June 2002, as of 1999, there
were 18,000 nursing homes in the United States in which approximately 27% of the
residents suffered from Alzheimers disease, dementia or related disorders. We believe
that existing and future state regulations applicable to long-term facilities, which
include security and wander prevention requirements, will drive the growth in demand for
wander prevention systems.
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
    
    the cost of deployment, coupled with the limited budgets of many hospitals;
 
    
    the uncertainty or unquantifiable nature of the return on investment;
 
    
    system compatibility issues;
 
    
    the low level of awareness; and
 
    
    privacy concerns.
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Vibration Monitoring
  Our Solutions
   Our Healthcare Security Systems
 Infant Protection
   
    
    a reliable and accurate security system using RFID technology, requiring no manual
checking of infant tags or other devices to make sure they are working (as the system
software continually monitors the status of all key system components, and generates an
alarm if something goes wrong);
 
    
    automatic alerting of mother-baby mismatches (in the case of one of our systems);
 
    
    a proprietary skin-sensing or cut band technology that sounds an alarm if the tag is
removed or tampered with;
 
    
    a reduction of potential liability to hospitals and birthing centers; and
 
    
    an enhanced marketability of a hospital or birthing center.
 The Hugs System
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
    
    someone tries to exit via a monitored door or elevator with a protected infant,
without authorization;
 
    
    The band is cut or tampered with;
 
    
    the tags signal is not detected by the system for a specified period of time;
 
    
    the tags battery power is low;
 
    
    an authorized exit occurs but someone tries to piggyback through the protected
exit with another infant; or
 
    
    an authorized exit occurs, but the infant is not returned to the designated safe
area in a specified time.
    The Halo System
    Wander Prevention
   8




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
    
    the protection of residents without physical restraint, providing them freedom to
move throughout their place of residence;
 
    
    the reduction of staffing requirements and the increased ability to focus on care
rather than protection; and
 
    
    the reduction of potential liability to long-term care and related facilities.
     Asset/Personnel Location and Identification
   
    
    tracking patients for identification purposes prior to the administration of
medications or surgery;
 
    
    tracking the location of caregivers in healthcare facilities to ensure timely
response to emergencies; and
 
    
    facilitating staff alarms in the event of patient violence.
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Our VeriMed System
  
    
    a glass-encapsulated microchip-equipped transponder, antenna, and capacitor;
 
    
    a fixed location, or a wireless handheld, scanner; and
 
    
    a secure, web-enabled database containing patient-approved information.
 TM
   
    
    public safety personnel, including local police, fire and rescue workers;
 
    
    emergency medical personnel, including EMTs and paramedics;
 
    
    medical facilities, including hospitals, urgent care centers and physician offices;
and
 
    
    law enforcement personnel, including sheriffs departments, state police and the
FBI.
   
    
    uncertainty as to whether a market for the VeriMed system will develop and whether
we will be able to generate more than a nominal level of revenue from the sale of such
systems;
  10




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
    
    uncertainty as to the future availability of insurance reimbursement for the
microchip implant procedure from government and private insurers;
 
    
    a potential disruption in our operations, loss of sales and higher expense in the
event we are unable to obtain the implantable microchip from Digital Angel, our sole
supplier of the microchip, or have to make alternative arrangements for the manufacture
of the microchip;
 
    
    our obligation to meet annual minimum purchase requirements in 2008 under our supply
agreement with Digital Angel, as a condition to maintaining the exclusivity of our
supply arrangement, that may exceed our sales of the microchip; and
 
    
    possible third-party claims asserting that we hold no rights for the use of the
implantable microchip technology and are violating the third partys intellectual
property rights. If such a claim were successful, we could be enjoined from marketing
this technology and could be required to pay substantial damages.
  Our Industrial Systems
 Vibration Monitoring Instruments
    Our Strategy
  Healthcare Security System Offerings
   11




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
    
    Market and sell these systems internationally through distribution relationships. We
are only just beginning to penetrate geographic markets outside of North America for
our infant protection and wander prevention systems. In an effort to accelerate this
process, we have entered into distribution agreements with a combination of both local
distributors who have an in-depth knowledge of the relevant geographic region, as well
as larger distributors with a global or near-global reach.
 
    
    Leverage our established brand recognition, reseller network and extensive end-use
customer base for our infant protection and wander prevention systems to gain inroads
in the emerging market for asset/personnel location, identification and protection
systems. We intend to leverage our established brand reputation, reseller network and
extensive end-use customer base for our infant protection and wander prevention systems
to gain inroads in the emerging market for RFID location, identification and protection
systems for assets, patients and staff in the healthcare industry. We are in the
process of building out our distribution network for our asset/personnel location and
identification system and providing the requisite training to certain dealers in an
effort to be on the forefront of the emerging market for these systems in the
healthcare sector. We effected a limited commercial launch of our asset/personnel
location and identification system to our dealer channel for this system in the first
quarter of 2007. We believe that it is important for our asset/personnel location and
identification system to capture market share in this emerging market within the next
12-24 months, as we expect that a significant factor in hospitals choice of system
vendors will be referrals to other healthcare facilities that have deployed, and are
pleased with, such systems. To achieve this, we will need to be on the forefront of the
effort to educate the healthcare industry regarding the benefits, including the return
on investment, achievable through implementation of RFID location, identification and
protection systems.
 The VeriMed System and Other Applications for Our Implantable Microchip
  Healthcare Application
   12




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
    
    A lack of direct to consumer advertising to educate the patient population to the
benefits of the VeriMed system.
 
    
    Many people who fit the profile for which the VeriMed system was designed may not be
willing to have a microchip implanted in their upper right arms.
 
    
    Physicians may be reluctant to discuss the implant procedure with their patients
until a greater number of hospital emergency rooms have adopted the VeriMed system as
part of their standard protocol.
 
    
    The media has from time to time reported, and may continue to report, on the VeriMed
system in an unfavorable and, on occasion, an inaccurate manner. For example, there
have been articles published asserting, despite at least one study to the contrary,
that the implanted microchip is not MRI compatible. There have also been articles
published asserting, despite numerous studies to the contrary, that the implanted
microchip causes malignant tumor formation in animals.
  13




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
    
    Privacy concerns may influence individuals to refrain from undergoing the implant
procedure or dissuade physicians from recommending the VeriMed system to their
patients. Misperceptions that a microchip-implanted person can be tracked and that
the microchip itself contains a persons basic information and personal health records
may contribute to such concerns.
 
    
    Misperceptions and/or negative publicity may prompt legislative or administrative
efforts by politicians or groups opposed to the development and use of
human-implantable RFID microchips. In that regard, in 2006 and 2007, a number of states
have introduced, and at least three states have enacted, legislation that would
prohibit any requirement that an individual undergo a microchip-implant procedure.
While we support all pending and enacted legislation that would preclude anything other
than voluntary implantation, legislative bodies or government agencies may determine to
go further, and their actions may have the effect, directly or indirectly, of delaying,
limiting or preventing the use of human-implantable RFID microchips or the sale,
manufacture or use of RFID systems utilizing such microchips.
 
    
    At present, the cost of the microchip implant procedure is not covered by Medicare,
Medicaid or private health insurance.
 
    
    At present, no studies to assess the impact of the VeriMed system on the quality of
emergency department care have been completed and publicly released.
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Other Applications
    15




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Industrial System Offerings
  Technology
 Active Tags and Readers
   Technology Platform/Application Software
  Research and Development
  Intellectual Property
   16




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
    
    U.S. Patent No. 6,144,303, Tag and System for Patient Safety Monitoring, applies
to infant protection tags that sense when they are in contact with the skin. The tag
can generate an alarm when it is removed. The U.S. patent expires in 2019. The
corresponding issued patent in Canada is Canadian Patent No. 2,260,577, which expires
in 2019.
 
    
    U.S. Patent No. 5,977,877, Multiple Conductor Security Tag, which is licensed from
BI Incorporated, applies to tags attached with bands that can detect unauthorized
cutting of a band attached to a person or object. This patent expires in 2018.
 
    
    U.S. Patent No. 5,374,921, Fiber Optic Security and Communications Link applies to
security tags with an optical fiber in the band to detect unauthorized removal. This
patent expires in 2011. The corresponding issued patent in Canada is Canadian Patent
No. 2,055,266, which expires in 2011.
 
    
    U.S. Patent No. 6,137,414, Asset Security Tag, applies to asset protection tags
that can generate an alarm if the asset to which it is attached (such as a piece of
hospital equipment) is moved to an unauthorized area or if the tag is removed without
authorization. This patent expires in 2019.
 
    
    U.S. Patent No. 6,456,191, Tag System with Anti-Collision Features, applies to
RFID tags with communication features that allow communications with multiple tags in
close proximity to one another. The U.S. patent expires in 2019. The corresponding
issued patent in Canada is Canadian Patent No. 2,266,337, which expires in 2019.
 
    
    U.S. Patent No. 7,116,230, Asset Location System, applies to an RFID tagging
system that utilizes a portable receiver, instead of a network of fixed receivers, to
track, analyze and prioritize information on the location of tagged assets within a
building or warehouse. This patent expires in 2025.
     17




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Sales, Marketing and Distribution
    
    
    sales and inventory levels for the preceding month;
 
    
    sales analyses within the dealers territories;
 
    
    forecasts for future sales on a rolling one month, three month and annual basis; and
 
    
    service and support activity.
    18




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Our Healthcare Security Systems
 Infant Protection/Wander Prevention
   Asset/Personnel Location and Identification System
  Our VeriMed System
   Our Industrial Systems
 Vibration Monitoring Instruments
  Competition
   19




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Manufacturing; Supply Arrangements
    
    
    Digital Angel has agreed to sell to us and our resellers, on an exclusive basis, the
transponders and reader equipment for our VeriMed system, as well any upgrades,
enhancements and improvements, which are to be used for the primary purpose of secure
human identification. Digital Angel has committed not to sell these products to any
other party if Digital Angel knows or should know that such products are to be used
principally for secure identification applications.
  20




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
    
    Digital Angel has committed to use its best efforts to supply all of our
requirements for the transponders and reader equipment as and when required. However,
if Digital Angel is unable or unwilling to meet our requirements, we may obtain
additional suppliers and Digital Angel is obligated to permit the use of the underlying
intellectual property for that purpose. We also have the right to design and build, or
cause to be designed and built, and sell, our own readers, to be used for human
applications only, and Digital Angel has granted to us a fully-paid, royalty-free,
non-exclusive license to utilize one of its patents for that purpose.
 
    
    Digital Angel may not supply human implantable microchips to other parties if we
meet certain minimum purchase requirements, specifically: $0 in 2007; $0.9 million in
2008 less purchases made in 2006 and 2007; $1.8 million in 2009; $2.5 million in 2010;
and $3.8 million in each year thereafter, subject to the parties reaching agreement on
a different amount. If during any year we purchase in excess of the minimum purchase
requirement for that year, the excess will be credited against the minimum purchase
requirement for the following year or years. We purchased $0.4 million and nil of
implantable microchips from Digital Angel in 2006 and 2007, respectively.
 
    
    In the event a competitor makes, uses, sells or offers any similar product or
service, the price we are required to pay for products is subject to downward
adjustment to enable us to more effectively compete.
 
    
    The term of the agreement ends on March 4, 2014, subject to earlier termination in
the event of either partys default or bankruptcy. However, so long as we meet the
minimum purchase obligations under the agreement, the term is to be automatically
renewed on an annual basis until the expiration of the last of the patents covering any
of the supplied products.
 
    
    If we desire to have a third party manufacture any of the products, product
upgrades, enhancements or improvements, or any new products  for reasons other than
Digital Angels inability or unwillingness to supply us  we have the right to do so.
In such event, we are obligated to pay Digital Angel a royalty on each product
manufactured by third parties that would otherwise infringe Digital Angels underlying
intellectual property rights.
  Environmental Regulation
   21




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Government Regulation
 Laws and Regulations Pertaining to RFID Technologies
  U.S. Federal Communications Commission Regulations
   Industry Canada Regulations
    22




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Regulation by the FDA
  FDA Premarket Clearance and Approval Requirements
 Guidance for Industry and FDA Staff, Class
II Special Controls Guidance Document: Implantable Radiofrequency Transponder System for Patient
Identification and Health Information
 Radio-Frequency Wireless
Technology in Medical Devices.
  23




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Pervasive and Continuing Regulation
 
    
    quality system regulations, or QSR, which require manufacturers, including
third-party manufacturers, to follow stringent design, testing, control, documentation
and other quality assurance procedures during all aspects of the manufacturing process;
 
    
    labeling regulations and FDA prohibitions against the promotion of regulated
products for uncleared, unapproved or off-label uses;
 
    
    clearance or approval of product modifications that could significantly affect
safety or effectiveness or that would constitute a major change in intended use;
 
    
    medical device reporting, or MDR, regulations, which require that a manufacturer
report to the FDA if the manufacturers device may have caused or contributed to a
death or serious injury or malfunctioned in a way that would likely cause or contribute
to a death or serious injury if the malfunction were to recur; and
 
    
    post-market surveillance regulations, which apply when necessary to protect the
public health or to provide additional safety and effectiveness data for the device.
   
    
    FDA Form 483s, warning letters, fines, injunctions, consent decrees and civil
penalties;
 
    
    repair, replacement, refunds, recall or seizure of products;
 
    
    operating restrictions, partial suspension or total shutdown of production;
 
    
    refusing requests for 510(k) clearance or premarket approval of new products, new
intended uses or modifications to existing products;
 
    
    withdrawing 510(k) clearance or premarket approvals that have already been granted;
and
 
    
    criminal prosecution.
 Fraud and Abuse
   24




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Anti-Kickback Laws
  Federal False Claims Act
  State Laws and Regulations
  Privacy Laws and Regulations
  U.S. Federal Trade Commission Oversight
   25




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State Legislation
   The European Union
 Directive 95/46/EC of the European
Parliament and of the Council of 24 October 1995 on the Protection of Individuals With Regard to
the Processing of Personal Data and On the Free Movement of Such Data
   26




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Health Insurance Portability and Accountability Act of 1996
  Employees
  Financial Information About Segments and Geographic Areas
   27




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ITEM 1A. RISK FACTORS
 The following risks and the risks described elsewhere in this Annual Report on Form 10-K ,
including the section entitled Managements Discussion and Analysis of Financial Condition and
Results of Operations, could materially affect our business, prospects, financial condition,
operating results and cash flows. If any these risks materialize, the trading price of our common
stock could decline, and you may lose all or part of your investment.
 Risks Related to Our Business
 If we cannot successfully implement our business strategy, we expect that our business, results of
operations and potential for growth will be adversely affected.
   
    
    endeavoring to market and sell, through international distributors, an increasing
number of our infant protection, wander prevention and asset/personnel location and
identification systems outside of North America, where the market for these products is
largely undeveloped;
 
    
    leveraging our established brand recognition, reseller network and extensive end-use
customer base for our infant protection and wander prevention systems to gain inroads
in the emerging market for asset/personnel location and identification systems; and
 
    
    introducing a new vibration monitoring instrumentation platform that better
integrates with contemporary data communications protocols so as to improve our
vibration monitoring instruments remote monitoring capabilities.
   We have a history of losses, and expect to incur additional losses in the future. We are unable to
predict the extent of future losses or when we will become profitable.
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Our expense levels will increase over the next several years, contributing to our expectation that
we will incur losses for the foreseeable future.
  
    
    the expansion of our sales and marketing efforts to create a market for our VeriMed
system as we expect to continue the buildout of our VeriMed infrastructure in the
geographies in which we currently operate and to expand our geographical reach during
2008; and
 
    
    our having become an SEC-reporting and Nasdaq-listed company and, as such, being
subject to the requirements of the Sarbanes-Oxley Act of 2002, SEC rules and
regulations to implement certain of the Acts provisions, including the requirement to
have in place, and evaluate, internal control over financial reporting, and Nasdaq
listing standards. This Annual Report on Form 10-K does not include an attestation
report of our registered public accounting firm due to a transition period established
by rules of the SEC for newly public companies. Our independent registered public
accounting firm will not be engaged to attest to managements assessment of our
internal control over financial reporting until our annual report on Form 10-K for our
fiscal year ending December 31, 2008.
  We may need additional funding and may be unable to raise capital when needed, which would force us
to delay, reduce or eliminate our product development programs or efforts to create a market for
our VeriMed system.
   The markets for our infant protection and wander prevention systems in the United States and for
our vibration monitoring instruments internationally are relatively mature markets of limited size,
which may limit our ability to increase our sales of these systems.
   29




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As of December 31, 2007, we have sold and had installed a limited number of our asset/personnel
location and identification systems. There are a number of factors beyond our control that may
limit future sales of these systems.
  
    
    the cost of deployment, coupled with the limited budgets of many hospitals;
 
    
    the uncertainty or unquantifiable nature of the return on investment;
 
    
    system compatibility issues;
 
    
    the low level of awareness; and
 
    
    privacy concerns.
  We may be unable to increase our sales of infant protection and wander prevention systems outside
of North America.
  
    
    unexpected changes in regulatory requirements, taxes, trade laws, tariffs, import
and export controls, customs duties and other trade restrictions or barriers;
 
    
    more stringent regulations relating to data privacy and the unauthorized use of, or
access to, commercial and personal information, particularly in Europe;
 
    
    regulations, such as with respect to radio frequency bands, that require us to
redesign our existing systems or develop new systems to comply;
 
    
    restrictions on the transfer of funds;
 
    
    changes in governmental policies and regulations;
  30




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##### Table of Contents




    
    limitations on the level of intellectual property protections; and
 
    
    political unrest, terrorism and war.
  Sales of our vibration monitoring instruments will be adversely affected if the introduction of our
new instrumentation platform for these instruments is delayed or if the new platform does not
achieve market acceptance.
  Our competitors, including those who have greater resources and experience than we do, may
commercialize technologies that make ours obsolete or noncompetitive.
    We rely upon third-party dealers to market and sell, as well as install, service and maintain, our
infant protection, wander prevention and asset/personnel location and identification systems, and
to market and sell our vibration monitoring instruments. As such, our revenue from sales of these
products significantly depends on their efforts, as does the level of end-use customer
satisfaction.
   31




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We may be subject to costly product liability claims from the use of our systems, which could
damage our reputation, impair the marketability of our systems and force us to pay costs and
damages that may not be covered by adequate insurance.
  If others assert that our products infringe their intellectual property rights, including rights to
the patent covering our implantable microchip, we may be drawn into costly disputes and risk paying
substantial damages or losing the right to sell our products.
   
    
    pay actual damages, royalties, lost profits and/or increased damages and the third
partys attorneys fees, which may be substantial;
 
    
    cease the development, manufacture, use and/or sale of products that use the
intellectual property in question through a court-imposed sanction called an
injunction;
 
    
    expend significant resources to modify or redesign our products, manufacturing
processes or other technology so that it does not infringe others intellectual
property rights or to develop or acquire non-infringing technology, which may not be
possible; or
 
    
    obtain licenses to the disputed rights, which could require us to pay substantial
upfront fees and future royalty payments and may not be available to us on acceptable
terms, if at all, or to cease marketing the challenged products.
 See also Item 1A. Risks Related to Our Businesses Which Utilize the Implantable
MicrochipOur sales of systems that incorporate our implantable microchip may be
enjoined by third parties who have rights to the intellectual property used in these systems
and we may be required to pay damages which could have an adverse effect on our business.
  32




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Our inability to safeguard our intellectual property may adversely affect our business by causing
us to lose a competitive advantage or by forcing us to engage in costly and time-consuming
litigation to defend or enforce our rights.
   Our efforts to protect our intellectual property may be less effective in some foreign countries
where intellectual property rights are not as well protected as in the United States.
  We may not be successful in our efforts to obtain federal registration of our trademarks containing
the Veri prefix with the U.S. Patent and Trademark Office.
   33




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##### Table of Contents



We depend on key personnel to manage our business effectively, and, if we are unable to hire,
retain or motivate qualified personnel, our ability to design, develop, market and sell our systems
could be harmed.
  We are subject to various environmental laws and regulations that could impose substantial costs
upon us.
  Risks Related to Our VeriMed Business Which Utilizes the Implantable Microchip
 We are endeavoring to create a market for our VeriMed system. We may never achieve market
acceptance or significant sales of this system.
   
    
    Many people who fit the profile for which the VeriMed system was designed may not be
willing to have a microchip implanted in their upper right arm.
 
    
    Physicians may be reluctant to discuss the implant procedure with their patients
until a greater number of hospital emergency rooms have adopted the VeriMed system as
part of their standard protocol.
 
    
    Physicians may be reluctant to discuss the implant procedure with their patients
because of the cost to their patients.
 
    
    The media has from time to time reported, and may continue to report, on the VeriMed
system in an unfavorable and, on occasion, an inaccurate manner. For example, there
have been articles published asserting, despite at least one study to the contrary,
that the implanted microchip is not magnetic resonance imaging, or MRI, compatible.
There have also been articles published asserting, despite numerous studies to the
contrary, that the implanted microchip causes malignant tumor formation in laboratory
animals.
  34




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##### Table of Contents




    
    Privacy concerns may influence individuals to refrain from undergoing the implant
procedure or dissuade physicians from recommending the VeriMed system to their
patients. Misperceptions that a microchip-implanted person can be tracked and that
the microchip itself contains a persons basic information, such as name, contact
information, and personal health records, may contribute to such concerns.
 
    
    Misperceptions and/or negative publicity may prompt legislative or administrative
efforts by politicians or groups opposed to the development and use of
human-implantable RFID microchips. In 2006 and 2007, a number of states introduced, and
at least three states (Wisconsin, California and North Dakota) have enacted,
legislation that would prohibit any requirement that an individual undergo a
microchip-implant procedure. While we support all pending and enacted legislation that
would preclude anything other than voluntary implantation, legislative bodies or
government agencies may determine to go further, and their actions may have the effect,
directly or indirectly, of delaying, limiting or preventing the use of
human-implantable RFID microchips or the sale, manufacture or use of RFID systems
utilizing such microchips.
 
    
    At present, the cost of the microchip implant procedure is not covered by Medicare,
Medicaid or private health insurance.
 
    
    At present, no studies to assess the impact of the VeriMed system on the quality of
emergency department care have been completed and publicly released.
  We believe that sales of our implantable microchip, and the extent to which our VeriMed system
achieves market acceptance, will depend, in part, on the availability of insurance reimbursement
from third-party payers, including federal and state governments under programs, such as Medicare
and Medicaid, and private insurance plans. Insurers may not determine to cover the cost of the
implant procedure, or it may take a considerable period of time for this to occur.
  Our sales of systems that incorporate our implantable microchip may be enjoined by third parties
who have rights to the intellectual property used in these systems and we may be required to pay
damages which would have an adverse effect on our business.
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Even if our VeriMed system achieves some level of market acceptance, the anticipated significant
and growing recurrent revenue from microchip-implanted persons subscribing to our database may not
be realized.
    36




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##### Table of Contents



If we do not meet the minimum purchase requirements under our agreement with Digital Angel, Digital
Angel may sell implantable microchips for secure human identification applications to third
parties. Our loss of this exclusive supply arrangement may result in our facing competition with
respect to our implantable microchip-based systems, which could have a material adverse effect on
the expected growth of our business.
   MinimumPurchaseYear
    
    Requirement2007
    
    $
    02008
    
    $
    875,0002009
    
    $
    1,750,0002010
    
    $
    2,500,0002011 and thereafter
    
    $
    3,750,000
   If Digital Angel were to terminate its agreement with us, we would not be able to obtain our
implantable microchip. This would make it difficult to fulfill our expectations for future revenue
and revenue growth from the sale of systems that use the implantable microchip.
  
    
    our default in the performance of any of our obligations under the agreement (e.g.,
our failure to take delivery and pay for products) that is not cured within 90 days of
receiving written notice of the default;
  37




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
    
    either party to the agreement filing a petition in bankruptcy; or
    
    a petition in bankruptcy is filed against us and is not discharged within 30 days.
  Implantation of our implantable microchip may be found to cause risks to a persons health, which
could adversely affect sales of our systems which incorporate the implantable microchip.
  If we are required to effect a recall of our implantable microchip, our reputation could be
materially and adversely affected and the cost of any such recall could be substantial, which could
adversely affect our results of operations and financial condition.
  Interruptions in access to, or the hacking into, our VeriMed patient information database may have
a negative impact on our revenue, damage our reputation and expose us to litigation.
    38




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Regulation of products and services that collect personally-identifiable information or otherwise
monitor an individuals activities may make the provision of our services more difficult or
expensive and could jeopardize our growth prospects.
    If we fail to comply with anti-kickback and false claims laws, we could be subject to costly and
time-consuming litigation and possible fines or other penalties.
     39




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Risks Related to Our Continued Affiliation with Digital Angel
 Digital Angel maintains significant voting control over us. This may delay, prevent or deter
corporate actions that may be in the best interest of our stockholders.
  Conflicts of interest may arise among Digital Angel and us that could be resolved in a manner
unfavorable to us.
   Cross directorships and stock ownership.
 
    
    the nature, quality and cost of services rendered to us by Digital Angel;
    
    the desirability of a potential acquisition or joint venture opportunity;
    
    employee retention or recruiting; or
    
    our dividend policy.
 Intercompany transactions
 Intercompany agreements
 
    
    a transition services agreement under which Digital Angel provides us certain
management, administrative, accounting, tax, legal and other services;
  40




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##### Table of Contents




    
    a tax allocation agreement setting forth Digital Angels and our rights and
obligations with respect to the handling and allocation of taxes and related matters
for all periods prior to the consummation of our initial public offering, which
occurred on February 14, 2007;
    
    a loan agreement; and
    
    letter agreements amending financing terms entered into with Digital Angel.
  Risks Related to Our Common Stock
 We expect that our stock price will fluctuate significantly due to events and developments unique
to our business or the healthcare industry generally.
  
    
    false and/or defamatory comments made about our product made in the press;
    
    failure of any of our products, particularly our asset/personnel location and
identification system and our VeriMed system, to achieve commercial success;
    
    FDA or international regulatory actions;
    
    announcements of new products by our competitors;
    
    market conditions in the healthcare sector;
    
    litigation or public concern about the efficacy or safety of existing, new or
potential products or technologies;
    
    comments by securities analysts; and
    
    rumors relating to us or our competitors.
  Provisions of our second amended and restated certificate of incorporation or our amended and
restated bylaws could delay or prevent an acquisition of our company, even if the acquisition would
be beneficial to our stockholders, and could make it more difficult for you to change management.
   41




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
    
    prohibit cumulative voting in the election of directors, which might otherwise allow
holders of less than a majority of our outstanding shares of voting stock to elect one
or more director candidates;
    
    permit our board of directors to issue, without further action by our stockholders,
up to 5,000,000 shares of blank check preferred stock, with any rights, preferences
and privileges as they may designate (including the right to approve an acquisition or
other change in control);
    
    establish advance notice procedures with respect to stockholder proposals and the
nomination of candidates for election as directors, other than nominations made by or
at the direction of our board of directors;
    
    prohibit stockholders from calling special meetings of stockholders;
    
    prohibit stockholder action by written consent, thereby requiring all actions to be
taken at a meeting of the stockholders; and
    
    provide that members of our board of directors may only be removed for cause by the
affirmative vote of holders of at least a majority of the voting power of all then
outstanding shares of capital stock entitled to vote generally in the election of
directors, voting together as a single class.
  We will need to dedicate significant time and expense to enhancing, documenting, testing and
certifying our internal control over financial reporting.
      42




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ITEM 1B. UNRESOLVED STAFF COMMENTS
  
 ITEM 2. PROPERTIES
     
 ITEM 3. LEGAL PROCEEDINGS
     43




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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  
 PART II
 
 ITEM 5.
    MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER
PURCHASES OF EQUITY SECURITIES
  High
    
    
    LowQuarter ended December 31, 2007
    
    $
    4.40
    
    
    $
    2.14Quarter ended September 30, 2007
    
    $
    10.62
    
    
    $
    3.25Quarter ended June 30, 2007
    
    $
    9.75
    
    
    $
    4.27Quarter ended March 31, 2007
    
    $
    6.99
    
    
    $
    4.80
 Holders
  Dividend Policy
   44




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##### Table of Contents



Equity Compensation Plan Information
  (c)Number ofsecuritiesremaining(a)
    
    
    (b)
    
    
    available forNumber of
    
    
    Weighted-
    
    
    future issuancesecurities to be
    
    
    average
    
    
    under equityissued upon
    
    
    exercise price
    
    
    compensationexercise of
    
    
    per share of
    
    
    plansoutstanding
    
    
    outstanding
    
    
    (excludingoptions,
    
    
    options,
    
    
    securitieswarrants and
    
    
    warrants and
    
    
    reflected inPlan Category(1)
    
    rights
    
    
    rights
    
    
    column (a))Equity compensation plans approved by security holders
    
    
    1,649,728
    
    
    $
    2.28
    
    
    
    864,940Equity compensation plans not approved by security holders(2)
    
    
    313,122
    
    
    $
    6.83
    
    
    
    Total
    
    
    1,962,850
    
    
    $
    3.00
    
    
    
    864,940
 (1)
    
    A narrative description of the material terms of our equity compensation plans is
set forth in Note 9 to our consolidated financial statements for the year ended December
31, 2007.(2)
    
    In addition, we have made grants outside of our equity plans and have outstanding
options exercisable for 313,122 shares of our common stock. These options were granted as
an inducement for employment or for the rendering of consulting services. Recent Sales of Unregistered Securities
  ISSUER PURCHASES OF EQUITY SECURITIES DURING THE FOURTH QUARTER OF 2007(1)(c)
    
    
    (d)Total
    
    
    ApproximateNumber of
    
    
    DollarShares
    
    
    Value of(or Units)
    
    
    Shares(a)
    
    
    (b)
    
    
    Purchased
    
    
    (or Units) thatTotal
    
    
    Average
    
    
    as Part of
    
    
    May Yet BeNumber
    
    
    Price Paid
    
    
    Publicly
    
    
    Purchasedof Shares
    
    
    per
    
    
    Announced
    
    
    Under the(or Units)
    
    
    Share
    
    
    Plans or
    
    
    Plans orPeriod
    
    Purchased (2)
    
    
    (or Unit) (3)
    
    
    Programs
    
    
    Programs10/1/2007 - 10/31/2007
    
    
    163,199
    
    
    $
    4.18
    
    
    
    163,199
    
    
    $
    0Total
    
    
    163,199
    
    
    $
    4.18
    
    
    
    163,199
    
    
    $
    0
 (1)
    
    Our stock repurchase program was announced on September 20, 2007. Our board of
directors unanimously authorized the repurchase of up to $1.5 million of our common
stock over a four month period.(2)
    
    All shares were purchased through our publicly announced stock repurchase plan. The
purchases were made in open market transactions.(3)
    
    The average price paid per share includes commissions paid to effect the transactions.  45




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Performance Graph
 The following graph compares our cumulative total stockholder return since the date our common stock began trading
on the Nasdaq Stock Market on February 9, 2007 with the the Russell 2000 Stock Index, Nasdaq Stock Market® -
U.S., and the AMEX  U.S. The graph assumes that the value of the investment in our common stock and each index was
$100 on February 9, 2007. We caution that the stock performance shown in the graph below is not indicative of or
intended to forecast our potential future performance. Comparison of Cumulative Total Return
Based on Investment of $100
February 9, 2007  December 31, 2007 
 Notwithstanding anything to the contrary set forth in any of our previous or future filings under the Securities
Act of 1933, as amended, or Securities Exchange Act of 1934, as amended, that might incorporate this Annual Report on
Form 10-K or future filings made by us under those statutes, the Stock Performance Graph shall not be deemed filed with
the Securities and Exchange Commission and shall not be deemed incorporated by reference into any of those prior
filings or into any future filings made by us under those statutes.  46




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##### Table of Contents



ITEM 6. SELECTED FINANCIAL DATA
 VeriChip Corporation
   Consolidated Statements of Operations Data
 Year Ended December 31,2005 Pro2007
    
    
    2006
    
    
    forma
    
    
    2005
    
    
    2004
    
    
    2003Historical
    
    
    Historical
    
    
    (unaudited)
    
    
    Historical
    
    
    Historical
    
    
    Historical(in thousands, except per share data)Consolidated Statements of Operations Data:Total revenue
    
    $
    32,106
    
    
    $
    27,304
    
    
    $
    24,554
    
    
    $
    15,869
    
    
    $
    247
    
    
    $
    545Total cost of products and services
    
    
    14,960
    
    
    
    11,779
    
    
    
    10,332
    
    
    
    6,395
    
    
    
    199
    
    
    
    200Gross profit
    
    
    17,146
    
    
    
    15,525
    
    
    
    14,222
    
    
    
    9,474
    
    
    
    48
    
    
    
    345Selling, general and administrative
    
    
    23,514
    
    
    
    17,620
    
    
    
    16,990
    
    
    
    12,442
    
    
    
    1,930
    
    
    
    1,977Research and development
    
    
    4,678
    
    
    
    3,786
    
    
    
    3,260
    
    
    
    1,958
    
    
    
    
    
    
    
    Other income
    
    
    (222
    )
    
    
    (57
    )
    
    
    (83
    )
    
    
    (63
    )
    
    
    (15
    )
    
    
    Interest expense
    
    
    1,698
    
    
    
    868
    
    
    
    343
    
    
    
    343
    
    
    
    144
    
    
    
    78Loss before benefit for income taxes
    
    
    (12,966
    )
    
    
    (6,692
    )
    
    
    (6,288
    )
    
    
    (5,206
    )
    
    
    (2,011
    )
    
    
    (1,710
    )(Benefit from) provision for income taxes
    
    
    (1,056
    )
    
    
    33
    
    
    
    (761
    )
    
    
    56
    
    
    
    
    
    
    
    Net loss
    
    
    (11,910
    )
    
    
    (6,725
    )
    
    
    (5,527
    )
    
    
    (5,262
    )
    
    
    (2,011
    )
    
    
    (1,710
    )Deemed dividends
    
    
    
    
    
    
    
    
    
    
    (1
    )
    
    
    (1
    )
    
    
    
    
    
    
    Net loss attributable to common stockholder
    
    $
    (11,910
    )
    
    $
    (6,725
    )
    
    $
    (5,528
    )
    
    $
    (5,263
    )
    
    $
    (2,011
    )
    
    $
    (1,710
    )Net loss attributable to common stockholder per
common share- basic and diluted
    
    $
    (1.36
    )
    
    $
    (1.21
    )
    
    $
    (0.99
    )
    
    $
    (1.00
    )
    
    $
    (0.45
    )
    
    $
    (0.38
    )Weighted average number of common shares
outstanding: Basic and diluted
    
    
    8,756
    
    
    
    5,556
    
    
    
    5,556
    
    
    
    5,279
    
    
    
    4,444
    
    
    
    4,444
 At December 31,2007
    
    
    2006
    
    
    2005
    
    
    2004
    
    
    2003Historical (in thousands)Consolidated Balance Sheet Data:Cash
    
    $
    7,250
    
    
    $
    996
    
    
    $
    1,440
    
    
    $
    23
    
    
    $
    269Equipment, net of accumulated depreciation and amortization
    
    
    952
    
    
    
    950
    
    
    
    890
    
    
    
    131
    
    
    
    147Goodwill
    
    
    15,776
    
    
    
    16,025
    
    
    
    16,982
    
    
    
    
    
    
    
    Total assets
    
    
    49,998
    
    
    
    50,888
    
    
    
    48,438
    
    
    
    283
    
    
    
    782Long-term debt
    
    
    10,753
    
    
    
    13,635
    
    
    
    
    
    
    
    
    
    
    
    Total debt
    
    
    14,435
    
    
    
    14,488
    
    
    
    6,975
    
    
    
    4,221
    
    
    
    2,864Stockholders equity (deficit)
    
    
    25,591
    
    
    
    22,345
    
    
    
    28,527
    
    
    
    (4,012
    )
    
    
    (2,258
    )
  47




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EXI Wireless Inc.
   Three monthsendedMarch 31,
    
    
    Year Ended December 31,2005
    
    
    2004
    
    
    2003
    
    
    2002(in thousands)Consolidated Statements of Operations Data:Sales
    
    $
    1,986
    
    
    $
    6,004
    
    
    $
    6,118
    
    
    $
    6,383Cost of sales
    
    
    575
    
    
    
    1,763
    
    
    
    1,735
    
    
    
    1,754Gross profit
    
    
    1,411
    
    
    
    4,241
    
    
    
    4,383
    
    
    
    4,629Selling, general and administrative expense and depreciation and amortization
    
    
    1,355
    
    
    
    3,524
    
    
    
    3,222
    
    
    
    3,276Research and development
    
    
    262
    
    
    
    918
    
    
    
    741
    
    
    
    728Interest and other income
    
    
    (2
    )
    
    
    (17
    )
    
    
    (4
    )
    
    
    (7
    )Foreign exchange loss (gain)
    
    
    (18
    )
    
    
    169
    
    
    
    334
    
    
    
    36Earnings (loss) before income taxes
    
    
    (186
    )
    
    
    (353
    )
    
    
    90
    
    
    
    596Benefit from income taxes
    
    
    
    
    
    
    (24
    )
    
    
    (55
    )
    
    
    (75
    )Loss from discontinued operations net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (512
    )Net income (loss)
    
    
    (186
    )
    
    
    (329
    )
    
    
    145
    
    
    
    159
 AtMarch 31,2005
    
    
    2004
    
    
    2003
    
    
    2002Consolidated Balance Sheet Data:Cash
    
    
    554
    
    
    
    1,127
    
    
    
    1,025
    
    
    
    1,296Property, plant and equipment
    
    
    191
    
    
    
    189
    
    
    
    294
    
    
    
    318Goodwill
    
    
    1,441
    
    
    
    1,450
    
    
    
    1,348
    
    
    
    1,103Total assets
    
    
    4,975
    
    
    
    5,338
    
    
    
    5,203
    
    
    
    4,847Long-term debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 Three monthsendedMarch 31,
    
    
    Year Ended December 31,2005
    
    
    2004
    
    
    2003
    
    
    2002Total debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stockholders equity
    
    
    3,971
    
    
    
    4,025
    
    
    
    4,070
    
    
    
    3,184
  48




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Instantel Inc.
   Period EndedJune 9,
    
    
    Year Ended December 31,2005
    
    
    2004
    
    
    2003
    
    
    2002(in thousands)Consolidated Statements of Operations Data:Revenue
    
    $
    6,759
    
    
    $
    13,595
    
    
    $
    11,382
    
    
    $
    11,344Cost of goods sold
    
    
    3,226
    
    
    
    5,450
    
    
    
    4,645
    
    
    
    4,430Gross profit
    
    
    3,533
    
    
    
    8,145
    
    
    
    6,737
    
    
    
    6,914Selling, general and administrative expense
    
    
    4,205
    
    
    
    6,928
    
    
    
    6,281
    
    
    
    6,447Research and development
    
    
    1,040
    
    
    
    1,688
    
    
    
    1,397
    
    
    
    1,138Interest and other income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Interest expense
    
    
    367
    
    
    
    943
    
    
    
    1,055
    
    
    
    1,265Loss before income taxes
    
    
    (2,079
    )
    
    
    (1,414
    )
    
    
    (1,996
    )
    
    
    (1,935
    )Benefit from income taxes
    
    
    (1,221
    )
    
    
    (660
    )
    
    
    (795
    )
    
    
    (697
    )Net loss
    
    
    (858
    )
    
    
    (754
    )
    
    
    (1,201
    )
    
    
    (1,238
    )At June 9,
    
    
    At December 31,2005
    
    
    2004
    
    
    2003
    
    
    2002(in thousands)Consolidated Balance Sheet Data:Cash and cash equivalents
    
    $
    4
    
    
    $
    46
    
    
    $
    167
    
    
    $
    659Property and Equipment
    
    
    493
    
    
    
    474
    
    
    
    278
    
    
    
    273Goodwill
    
    
    593
    
    
    
    593
    
    
    
    593
    
    
    
    593Total Assets
    
    
    10,280
    
    
    
    11,593
    
    
    
    14,418
    
    
    
    17,925Long-term debt
    
    
    
    
    
    
    5,500
    
    
    
    5,500
    
    
    
    8,633Total debt
    
    
    6,214
    
    
    
    6,087
    
    
    
    8,133
    
    
    
    9,892Stockholders (deficit) equity
    
    
    (222
    )
    
    
    634
    
    
    
    1,382
    
    
    
    2,463
  49




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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 The following discussion and analysis of our financial condition and results of operations
should be read in conjunction with the Selected Financial Data and our audited annual financial
statements and the notes to those financial statements included elsewhere in this Annual Report on
Form 10-K. Our discussion contains forward-looking statements based upon current expectations that
involve risks and uncertainties. Our actual results and the timing of events could differ
materially from those anticipated in, or implied by, these forward-looking statements as a result
of various factors, including those set forth under Item 1A. Risk Factors, Item 1. Business,
and elsewhere in this Annual Report on Form 10-K . Due to our limited operating history and our
acquisition of two Canadian-based businesses in the first half of 2005 which significantly expanded
our operations and product offerings, period to period comparisons of or changes in financial data
are not necessarily indicative of, and you should not rely upon them as an indicator of, our future
financial performance.
 Overview
 Our History
      50




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Recent Events
      Our Business
  Healthcare Security Segment
  
    
    infant protection systems used in hospital maternity wards and birthing
centers to prevent infant abduction and mother-baby mismatching;
    
    wander prevention systems used by long-term care facilities to locate and
protect their residents; and
    
    an asset/personnel location and identification system used by hospitals
and other healthcare facilities to identify, locate and protect medical staff,
patients, visitors and medical equipment.
 Infant Protection Systems
   51




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Wander Prevention Systems
   Asset/Personnel Location and Identification Systems
    52




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Implantable Segment
   VeriMed Patient Identification System
   Systems Incorporating the Implantable Microchip for Other Applications
 ®
   53




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Industrial Segment
  
    
    vibration monitoring instruments used by engineering, construction and
mining professionals to monitor the effects of human induced vibrations, such as
blasting activity; and
    
    asset management systems used by industrial companies to manage and track
their mobile equipment and tools.
 Vibration Monitoring Instruments
    Asset Management Systems
  Basis of Presentation
  Our Acquisitions of the Businesses Located in Canada
   54




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Efforts to Create Markets for Our Systems that Utilize the Implantable Microchip
  Transition Services Agreement with Digital Angel
  Critical Accounting Policies and Estimates
  Revenue Recognition
   55




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Revenue Recognition Policy for Our Healthcare Security Systems and Industrial Systems
  
    
    persuasive evidence of an arrangement exists (e.g., a purchase order has
been received or a contract has been executed);
    
    the system components are shipped;
    
    title has transferred;
    
    the price is fixed or determinable; and
    
    collection of the sales proceeds is reasonably assured.
   
    
    If the only undelivered element is post-contract support, the deferred
amount is recognized ratably over the post-contract support period.
    
    If the only undelivered element is services that do not require
significant production, modification or customization of the software, the deferred
amount is recognized as the services are performed.
  Revenue Recognition Policy for Systems Using Our Implantable Microchip
  
    
    a purchase order has been received or a contract has been executed;
    
    the product is shipped;
    
    title has transferred;
    
    the price is fixed or determinable;
    
    there are no uncertainties regarding customer acceptance;
    
    collection of the sales proceeds is reasonably assured; and
    
    the period during which the distributor or physician has a right to
return the product has elapsed.
  56




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Revenue Recognition Policy for VeriMed Services
   Inventory
  Goodwill and Other Intangible Assets
 Goodwill and Other Intangible Assets
     57




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
    
    the future level of royalty cash flows related to the trademarks;
    
    the relief from royalty rate applied to the future revenue;
    
    the discount rate used to bring the future cash flows to present value;
and
    
    any changes in our determination regarding the estimated useful life of
the trademarks.
   Scenario 1:
 EXI Wireless Trademarks:
  
  $1,266,000 (11.9% greater than acquisition date valuation)Instantel Trademarks:
  
  $4,290,000 (13.2% greater than acquisition date valuation) Scenario 2:
 EXI Wireless Trademarks:
  
  $1,001,000 (11.5% less than acquisition date valuation)Instantel Trademarks:
  
  $3,310,000 (12.7% less than acquisition date valuation)   58




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Stock-Based Compensation
          
    
    our projected operating performance;
    
    risk of non-achievement of projected operating performance;
  59




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
    
    the purchase prices of the two businesses acquired during the first half
of 2005, including the risk that the acquisitions might not have been completed at
certain interim valuation dates; and
    
    trends and comparable valuations in the broad market for privately-held
and publicly-traded technology and medical device companies.
  
    
    Unlevered free cash flows for our implantable microchip business were
projected for five years, which was deemed to be the appropriate valuation period.
    
    Earnings before interest, taxes, depreciation and amortization, or
EBITDA, was used to estimate terminal value.
    
    Management considered the relevant multiples for RFID and medical device
companies to determine the appropriate terminal value multiple.
    
    A discount rate was applied to the net free cash flows and terminal
value. The rate was determined based on the risk-free rate of the 10-year U.S.
Treasury Bond plus an applicable market risk premium and the specific risk premium
associated with our facts and circumstances. The discount rate utilized by us was
the rate of return expected from the market or the rate of return for a similar
investment with similar risks.
    
    The purchase prices of the acquired businesses, adjusted for the risk
that the acquisitions might not have been completed at certain interim valuation
dates, were added to the value of the implantable microchip business to determine
enterprise value.
    
    Management computed the fully diluted value of each share of our common
stock in order to factor in the dilutive effect of reflecting in-the-money stock
options and warrants at each valuation date.
     60




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
    
    the estimated value of our common stock;
    
    the expected life of issued stock options;
    
    the expected volatility of our stock price;
    
    the expected dividend yield to be realized over the life of the stock
options; and
    
    the risk-free interest rate over the expected life of the stock options.
   
    
    Certain hospital emergency rooms adopted our VeriMed system beginning in
the latter part of the third quarter of 2005. Specifically, as of August 1, 2005,
five hospitals had agreed to adopt our VeriMed system in their emergency departments
and we had a goal of having 20 to 25 hospitals agree to adopt our VeriMed system by
December 31, 2005. Having an infrastructure of hospitals that have adopted the
VeriMed system as part of their standard protocol is considered a necessary step in
the commercialization of the VeriMed system, because, without that infrastructure,
those persons who fit the profile for which the VeriMed system was designed have
little or no reason to undergo the microchip implant procedure. After our attendance
at the American College of Emergency Physicians Scientific Assembly, which took
place in Washington D.C. from September 26 to 29, 2005, 49 hospitals had agreed to
adopt our VeriMed system in their emergency rooms. As of December 15, 2005, 66
hospitals had agreed to do so.
    
    We came to the view that there is a significant market opportunity for
our asset/personnel location and identification system. Today, our asset/personnel
location and identification system is essentially a new product. It was the first
healthcare security application adapted to our technology platform. The new platform
has expanded the deployment options for our asset/personnel location and
identification system, which can range from a portal-based system to a full,
real-time location system.
    
    We identified additional strategic markets for the implantable microchip.
For example, during the second half of 2005 and specifically in the wake of
Hurricane Katrina, we donated implantable microchips to FEMAs Department of
Mortuary Services in Mississippi and Louisiana to help with FEMAs efforts to
identify corpses. The acceptance of this new use for the implantable microchip has
led to the development of VeriTrace, the only end-to-end implantable tagging
solution for the accurate tracking and identification of human remains and
associated evidentiary items.
    
    We used the enterprise value to forward-looking revenue valuation
approach to determine the estimated IPO value on December 30, 2005. Under this
approach, fair value was determined based upon a range of multiples of projected
future revenue. The multiples used represented those multiples of revenue that our
peers common stock were trading for in the public markets. This
approach was deemed appropriate because revenue multiples for publicly traded
companies provide the highest correlation of public company trading values.
Specifically, publicly-traded companies in comparable industries tend to have similar
revenue multiples, whereas their EBITDA and net income multiples are not deemed to be
as consistent in part because certain companies in comparable industries are not
EBITDA positive or do not earn net income.
  61




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Accounting for Income Taxes
    62




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Results of Operations
     63




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Year Ended December 31,2007
    
    
    2006
    
    
    2005Product revenue
    
    
    93.6
    %
    
    
    93.9
    %
    
    
    91.5
    %Service revenue
    
    
    6.4
    %
    
    
    6.1
    %
    
    
    8.5
    %Total revenue
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of products sold
    
    
    42.6
    %
    
    
    40.0
    %
    
    
    34.4
    %Cost of services sold
    
    
    4.0
    %
    
    
    3.1
    %
    
    
    5.9
    %Gross profit
    
    
    46.6
    %
    
    
    56.9
    %
    
    
    59.7
    %Selling, general and administrative expense
    
    
    73.2
    %
    
    
    64.5
    %
    
    
    78.4
    %Research and development
    
    
    14.6
    %
    
    
    13.9
    %
    
    
    12.3
    %Gain/ loss on exchange
    
    
    1.6
    %
    
    
    
    
    
    
    Other income
    
    
    (0.9
    )%
    
    
    (0.2
    )%
    
    
    (0.4
    )%Interest expense
    
    
    5.3
    %
    
    
    3.1
    %
    
    
    2.2
    %Loss before provision for income taxes
    
    
    (40.4
    )%
    
    
    (24.5
    )%
    
    
    (32.8
    )%Benefit (provision) for income taxes
    
    
    3.3
    %
    
    
    (0.1
    )%
    
    
    (0.4
    )%Net loss
    
    
    (43.7
    )%
    
    
    (24.6
    )%
    
    
    (33.2
    )%
 Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
  2007HealthcareSecurity
    
    
    Implantable
    
    
    Industrial
    
    
    Corporate
    
    
    Total(in thousands)Product revenue
    
    $
    22,644
    
    
    $
    76
    
    
    $
    7,321
    
    
    $
    
    
    
    $
    30,041Service revenue
    
    
    549
    
    
    
    
    
    
    
    1,516
    
    
    
    
    
    
    
    2,065Total revenue
    
    
    23,193
    
    
    
    76
    
    
    
    8,837
    
    
    
    
    
    
    
    32,106Gross profit (loss)
    
    
    12,489
    
    
    
    (285
    )
    
    
    4,942
    
    
    
    
    
    
    
    17,146Selling, general and
administrative
    
    
    7,858
    
    
    
    5,229
    
    
    
    2,471
    
    
    
    7,956
    
    
    
    23,514Research and development
    
    
    2,979
    
    
    
    105
    
    
    
    1,594
    
    
    
    
    
    
    
    4,678Total operating expenses
    
    
    10,837
    
    
    
    5,334
    
    
    
    4,065
    
    
    
    7,956
    
    
    
    28,192Operating income (loss)
    
    $
    1,652
    
    
    $
    (5,619
    )
    
    $
    877
    
    
    $
    (7,956
    )
    
    $
    (11,046
    )
 2006HealthcareSecurity
    
    
    Implantable
    
    
    Industrial
    
    
    Corporate
    
    
    Total(in thousands)Product revenue
    
    $
    20,035
    
    
    $
    116
    
    
    $
    5,480
    
    
    $
    
    
    
    $
    25,631Service revenue
    
    
    380
    
    
    
    
    
    
    
    1,293
    
    
    
    
    
    
    
    1,673Total revenue
    
    
    20,415
    
    
    
    116
    
    
    
    6,773
    
    
    
    
    
    
    
    27,304Gross profit (loss)
    
    
    11,717
    
    
    
    (340
    )
    
    
    4,148
    
    
    
    
    
    
    
    15,525Selling, general and
administrative
    
    
    8,328
    
    
    
    3,933
    
    
    
    2,312
    
    
    
    3,047
    
    
    
    17,620Research and development
    
    
    2,609
    
    
    
    
    
    
    
    1,177
    
    
    
    
    
    
    
    3,786Total operating expenses
    
    
    10,937
    
    
    
    3,933
    
    
    
    3,489
    
    
    
    3,047
    
    
    
    21,406Operating income (loss)
    
    $
    780
    
    
    $
    (4,273
    )
    
    $
    659
    
    
    $
    (3,047
    )
    
    $
    (5,881
    )
  64




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Revenue
     Gross Profit and Gross Profit Margin
       65




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Selling, General and Administrative Expense
          66




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Research and Development
    Interest Expense
  Income Taxes
  Year Ended December 31, 2006 Compared to Year Ended December 31, 2005
  2006HealthcareSecurity
    
    
    Implantable
    
    
    Industrial
    
    
    Corporate
    
    
    Total(in thousands)Product revenue
    
    $
    20,035
    
    
    $
    116
    
    
    $
    5,480
    
    
    $
    
    
    
    $
    25,631Service revenue
    
    
    380
    
    
    
    
    
    
    
    1,293
    
    
    
    
    
    
    
    1,673Total revenue
    
    
    20,415
    
    
    
    116
    
    
    
    6,773
    
    
    
    
    
    
    
    27,304Gross profit (loss)
    
    
    11,717
    
    
    
    (340
    )
    
    
    4,148
    
    
    
    
    
    
    
    15,525Selling, general and
administrative
    
    
    8,328
    
    
    
    3,933
    
    
    
    2,312
    
    
    
    3,047
    
    
    
    17,620Research and development
    
    
    2,609
    
    
    
    
    
    
    
    1,177
    
    
    
    
    
    
    
    3,786Total operating expenses
    
    
    10,937
    
    
    
    3,933
    
    
    
    3,489
    
    
    
    3,047
    
    
    
    21,406Operating income (loss)
    
    $
    780
    
    
    $
    (4,273
    )
    
    $
    659
    
    
    $
    (3,047
    )
    
    $
    (5,881
    )
  67




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2005HealthcareSecurity
    
    
    Implantable
    
    
    Industrial
    
    
    Corporate
    
    
    Total(in thousands)Product revenue
    
    $
    11,200
    
    
    $
    68
    
    
    $
    3,252
    
    
    $
    
    
    
    $
    14,520Service revenue
    
    
    849
    
    
    
    
    
    
    
    500
    
    
    
    
    
    
    
    1,349Total revenue
    
    
    12,049
    
    
    
    68
    
    
    
    3,752
    
    
    
    
    
    
    
    15,869Gross profit
    
    
    7,115
    
    
    
    33
    
    
    
    2,326
    
    
    
    
    
    
    
    9,474Selling, general and
administrative
    
    
    4,855
    
    
    
    3,637
    
    
    
    1,195
    
    
    
    2,757
    
    
    
    12,444Research and development
    
    
    1,313
    
    
    
    
    
    
    
    643
    
    
    
    
    
    
    
    1,956Total operating expenses
    
    
    6,168
    
    
    
    3,637
    
    
    
    1,838
    
    
    
    2,757
    
    
    
    14,400Operating income (loss)
    
    $
    947
    
    
    $
    (3,604
    )
    
    $
    488
    
    
    $
    (2,757
    )
    
    $
    (4,926
    )
 Revenue
        68




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Gross Profit and Gross Profit Margin
       Selling, General and Administrative Expense
    69




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Research and Development
   70




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Interest Expense
 The Wall
Street Journal
 Income Taxes
  Liquidity and Capital Resources
  Cash Flows Used in Operating Activities
    71




---



##### Table of Contents



Cash Flows from Investing Activities
  Cash Flows from Financing Activities
  Credit Facilities
  The Wall Street Journal
   72




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73




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Financial Condition
   Contractual Obligations
  Less than
    
    
    
    
    
    
    
    
    
    
    More thanTotal
    
    
    1 Year
    
    
    1-3 Years
    
    
    3-5 Years
    
    
    5 YearsContractual ObligationsAmount due Digital Angel(1)
    
    $
    12,920
    
    
    $
    2,167
    
    
    $
    6,800
    
    
    $
    3,953
    
    
    $
    Other debt(2)
    
    
    1,515
    
    
    
    1,515
    
    
    
    
    
    
    
    
    
    
    
    Employment related contract
    
    
    1,986
    
    
    
    462
    
    
    
    1,016
    
    
    
    508
    
    
    
    Operating lease obligations(3)
    
    
    726
    
    
    
    514
    
    
    
    212
    
    
    
    
    
    
    
    Purchase commitments(4)
    
    
    53,031
    
    
    
    2,542
    
    
    
    7,956
    
    
    
    8,414
    
    
    
    34,119Total
    
    $
    70,178
    
    
    $
    7,200
    
    
    $
    15,984
    
    
    $
    12,875
    
    
    $
    34,119
 
 (1)
    
    The approximately $12.9 million reflected in the table represents the amount owed to Digital
Angel as of December 31, 2007, including accrued interest. Per the terms of a letter agreement dated February 29, 2008,
we agreed to prepay $5.3 million of the debt owed to Digital Angel. As a result of the $5.3
million payment, we will not be required to make any further debt service payments to Digital
Angel until September 1, 2009. Interest on the outstanding principal amount of the loan will
continue to accrue at the rate of 12% per annum. Commencing on September 1, 2009 through
January 1, 2010, we must repay $300,000 on the first day of each month. On February 1, 2010,
a balloon payment equal to the outstanding principal amount then due under the loan plus all
accrued and unpaid interest is due. Accordingly, the amount to be due during the 2008-2009
period, will be approximately $6.8 million and the amount to be due during the 2010-2011
period, including the balloon payment, will be approximately $4.0 million. For a description
of the material terms of the loan agreement with Digital Angel, see Credit Facilities above.(2)
    
    Represents borrowings under our revolving credit facility with Royal Bank of Canada, which
was terminated on February 28, 2008. The table assumes the accrual of interest through
December 31, 2007. For a description of the terms of the loan agreement with Royal Bank of
Canada, see Credit Facilities above.  74




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(3)
    
    For further discussion on operating leases, see Item 2  Properties.(4)
    
    Includes the minimum purchase requirements for our implantable microchips under our supply
agreement with Digital Angel and for our custom straps under our supply agreement with Emerson
& Cuming Microwave Products. Our exclusivity rights under the supply agreement with Digital
Angel can be terminated if we do not purchase the prescribed minimum quantities. Under the
agreement with Digital Angel, if during any year we purchase in excess of the minimum purchase
requirement for that year, the excess will be credited against the minimum purchase
requirement for the following year or years. The agreement with Digital Angel ends in 2014,
subject to earlier termination in the event of either partys default or bankruptcy, except
that, so long as we meet the minimum purchase obligations under the agreement, the term is
automatically renewed on an annual basis until the expiration of the last patents covering any
of the supplied products (currently in 2021). Accordingly, the amount shown in the After 2012
column includes the annual purchase commitment of $3,750,000 through 2021. See Item 1.
Business  Manufacturing; Supply Arrangements. Impact of Recently Issued Accounting Standards
  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 Effective Date of FASB Statement No. 157 Accounting for
Leases
  The Fair Value Option for Financial Assets and
Financial Liabilities
  75




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##### Table of Contents



Accounting for Collaborative
Arrangements Related to the Development and Commercialization of Intellectual Property Reporting Revenue Gross as a Principal versus Net as an Agent
 
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    76




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December 31, 2007(dollars in thousands)Loan due Digital Angel
    
    $
    12,477Credit agreement with Royal Bank of Canada
    
    $
    1,019Weighted-average interest rate for the year ended December 31, 2007
    
    
    11.5
    %
     
 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
  
 ITEM 9. CHANGES IN
AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
  
 ITEM 9A(T). CONTROLS AND PROCEDURES
 Disclosure Controls and Procedures
 Evaluation of Disclosure Controls
 Objective of Controls.
 Conclusion
  77




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Changes in Internal Control Over Financial Reporting
  Managements Annual Report on Internal Control Over Financial Reporting
    
 ITEM 9B. OTHER INFORMATION
  
 PART III
  
 PART IV
 
 ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
  (a)(1)
    
    List of Financial Statements Filed as Part of this Annual Report on Form 10-K:A list of the consolidated financial statements, notes to consolidated financial
statements, and accompanying report of independent registered public accounting firm
appears on page F-1 of the Index to Consolidated Financial Statements and Financial
Statement Schedules, which is filed as part of this Annual Report on Form 10-K.
  78




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(a)(2)
    
    Financial Statement Schedules:Schedule II  Valuation and Qualifying Accounts, for each of the fiscal years ended
December 31, 2007, 2006 and 2005, which appears on page F-34, is filed as part
of this Annual Report on Form 10-K.All other schedules are omitted because they are not applicable, the amounts are not
significant, or the required information is shown in our consolidated financial
statements or the notes thereto.(a)(3)
    
    Exhibits:See the Exhibit Index filed as part of this Annual Report on Form 10-K.
  79




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SIGNATURES
  VERICHIP CORPORATIONDate: March 28, 2008
    By:
    /s/ Scott R. SilvermanScott R. Silverman*Chairman of the Board and Chief Executive Officer  Signature
    
    Title
    
    Date/s/ SCOTT R. SILVERMANScott R. Silverman*
    
    Chairman of the Board and Chief
Executive Officer (Principal
Executive Officer)
    
    March 28, 2008/s/ WILLIAM J. CARAGOL
William J. Caragol
    
    President and Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
    
    March 28, 2008/s/ JEFFREY S. COBB
Jeffrey Cobb*
    
    Director
    
    March 28, 2008/s/ BARRY M. EDELSTEIN
Barry Edelstein*
    
    Director
    
    March 28, 2008/s/ PAUL C. GREEN
Paul C. Green*
    
    Director
    
    March 28, 2008/s/ STEVEN R. FOLAND
Steven R. Foland*
    
    Director
    
    March 28, 2008
 *By:
    William J. CaragolWilliam J. CaragolAttorney-in-Fact  80




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##### Table of Contents



INDEX TO FINANCIAL STATEMENTS
 CONTENTS
 PageVERICHIP CORPORATIONReport of Independent Registered Public Accounting Firm
    
    
    F-2Consolidated Balance Sheets as of December 31, 2007 and 2006
    
    
    F-3Consolidated Statements of Operations for each of the years in
the three-year period ended December 31, 2007
    
    
    F-4Consolidated Statements of Stockholders Equity for each of the
years in the three-year period ended December 31, 2007
    
    
    F-5Consolidated Statements of Cash Flows for each of the years in
the three-year period ended December 31, 2007
    
    
    F-6Notes to Consolidated Financial Statements
    
    
    F-7EXI WIRELESS INC.Report of Independent Registered Public Accounting Firm
    
    
    F-35Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004
    
    
    F-36Consolidated Statements of Operations for the three-month periods
ended March 31, 2005 (audited) and 2004 (unaudited)
    
    
    F-37Consolidated Statements of Stockholders Equity for the three-month
periods ended March 31, 2005 (audited) and 2004 (unaudited)
    
    
    F-38Consolidated Statements of Cash Flows for the three-month period
periods ended March 31, 2005 (audited) and 2004 (unaudited)
    
    
    F-39Notes to Consolidated Financial Statements
    
    
    F-40INSTANTEL INC.Report of Independent Registered Public Accounting Firm
    
    
    F-49Balance Sheets at June 9, 2005 and December 31, 2004
    
    
    F-50Statements of Operations for the periods beginning January 1, 2005 and ending June 9,
2005 (audited) and beginning January 1, 2004 and ending June 9, 2004 (unaudited)
    
    
    F-51Statements of Shareholders Equity (Deficit) for the period ended June 9, 2005 and
the year December 31, 2004
    
    
    F-52Statements of Cash Flows for the periods beginning January 1, 2005 and ending June 9,
2005 (audited) and beginning January 1, 2004 and ending June 9, 2004 (unaudited)
    
    
    F-53Notes to Financial Statements
    
    
    F-54
  F-1




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
  .
  Accounting for Uncertainty in Income
Taxes- an interpretation of FASB No. 109 Share-Based Payment
  
  F-2




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##### Table of Contents



VERICHIP CORPORATION
 
 Consolidated Balance Sheets
 December 31,
    
    
    December 31,2007
    
    
    2006AssetsCurrent Assets:Cash
    
    $
    7,221
    
    
    $
    996Accounts receivable, net of allowance for
doubtful accounts of $144 (2006 - $146)
    
    
    5,438
    
    
    
    4,486Inventories, net of allowance
    
    
    2,343
    
    
    
    3,698Prepaid expenses and other current assets
    
    
    1,300
    
    
    
    567Deferred tax asset
    
    
    216
    
    
    
    520Total Current Assets
    
    
    16,518
    
    
    
    10,267Equipment, net of accumulated depreciation and amortization
    
    
    952
    
    
    
    950Intangible assets, net of accumulated amortization
    
    
    16,752
    
    
    
    18,567Goodwill
    
    
    15,776
    
    
    
    16,025Deferred offering costs
    
    
    
    
    
    
    5,079$
    49,998
    
    
    $
    50,888Liabilities and Stockholders EquityCurrent Liabilities:Bank indebtedness
    
    $
    1,515
    
    
    $
    853Accounts payable
    
    
    1,855
    
    
    
    3,671Accrued expenses and other current liabilities
    
    
    4,308
    
    
    
    4,968Note payable to stockholder, current portion
    
    
    2,167
    
    
    
    Total Current Liabilities
    
    
    9,845
    
    
    
    9,492Deferred tax liability
    
    
    3,809
    
    
    
    5,415Note payable to stockholder, less current portion
    
    
    10,753
    
    
    
    13,635Total Liabilities
    
    
    24,407
    
    
    
    28,542Commitments and contingenciesStockholders Equity:Capital stock:Preferred stock:Authorized 5,000 shares of $.001 par value; no shares issued
or outstanding
    
    
    
    
    
    
    Common stock:Authorized 40,000 shares, of $.01 par value; 10,144 and 6,056 shares
issued and outstanding at December 31, 2007 and 2006, respectively
    
    
    101
    
    
    
    61Additional paid-in capital
    
    
    54,486
    
    
    
    39,371Accumulated deficit
    
    
    (28,959
    )
    
    
    (17,049
    )Other comprehensive loss  foreign currency translation
    
    
    (37
    )
    
    
    (37
    )Total Stockholders Equity
    
    
    25,591
    
    
    
    22,346$
    49,998
    
    
    $
    50,888
   F-3




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##### Table of Contents



VERICHIP CORPORATION
 
 Consolidated Statements of Operations
 For the Years Ended December 31,2007
    
    
    2006
    
    
    2005Product revenue
    
    $
    30,041
    
    
    $
    25,631
    
    
    $
    14,520Service revenue
    
    
    2,065
    
    
    
    1,673
    
    
    
    1,349Total revenue
    
    
    32,106
    
    
    
    27,304
    
    
    
    15,869Cost of product
    
    
    13,678
    
    
    
    10,918
    
    
    
    5,455Cost of services
    
    
    1,282
    
    
    
    861
    
    
    
    940Total cost of products and services
    
    
    14,960
    
    
    
    11,779
    
    
    
    6,395Gross profit
    
    
    17,146
    
    
    
    15,525
    
    
    
    9,474Operating expenses:Selling, general and administrative
    
    
    23,514
    
    
    
    17,620
    
    
    
    12,442Research and development
    
    
    4,678
    
    
    
    3,786
    
    
    
    1,958Total operating expenses
    
    
    28,192
    
    
    
    21,406
    
    
    
    14,400Operating loss
    
    
    (11,046
    )
    
    
    (5,881
    )
    
    
    (4,926
    )Interest income and other expense, net
    
    
    222
    
    
    
    (57
    )
    
    
    (63
    )Interest expense
    
    
    1,698
    
    
    
    868
    
    
    
    343Total other expense
    
    
    1,920
    
    
    
    811
    
    
    
    280Loss before income tax provision
    
    
    (12,966
    )
    
    
    (6,692
    )
    
    
    (5,206
    )(Benefit) provision for income taxes
    
    
    (1,056
    )
    
    
    33
    
    
    
    56Net loss
    
    $
    (11,910
    )
    
    $
    (6,725
    )
    
    $
    (5,262
    )Deemed dividend
    
    
    
    
    
    
    
    
    
    
    (1
    )Net loss attributable to common stockholders
    
    $
    (11,910
    )
    
    $
    (6,725
    )
    
    $
    (5,263
    )Net loss  basic and diluted
    
    $
    (1.36
    )
    
    $
    (1.21
    )
    
    $
    (1.00
    )Weighted average number of shares outstanding  basic and diluted
    
    
    8,756
    
    
    
    5,556
    
    
    
    5,279
   F-4




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##### Table of Contents



VERICHIP CORPORATION
 
 Consolidated Statement of Stockholders Equit
 For the Years Ended December 31, 2007, 2006 and 2005
 AccumulatedAdditional
    
    
    
    
    
    
    Other
    
    
    TotalCommon Shares
    
    
    Paid-in
    
    
    Accumulated
    
    
    Comprehensive
    
    
    StockholdersNumber
    
    
    Amount
    
    
    Capital
    
    
    Deficit
    
    
    Loss
    
    
    EquityBalance December 31, 2004
    
    
    4,444
    
    
    $
    44
    
    
    $
    1,006
    
    
    $
    (5,062
    )
    
    $
    
    
    
    $
    (4,012
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,262
    )
    
    
    
    
    
    
    (5,262
    )Comprehensive loss -
Foreign currency
translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (37
    )
    
    
    (37
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,262
    )
    
    
    (37
    )
    
    
    (5,299
    )Issuance of common shares
to Digital Angel
for the contribution of
VeriChip Holdings Inc.
to the Company
    
    
    1,111
    
    
    
    11
    
    
    
    13,272
    
    
    
    
    
    
    
    
    
    
    
    13,283Contribution of Instantel
Inc. by Digital Angel
    
    
    
    
    
    
    
    
    
    
    22,272
    
    
    
    
    
    
    
    
    
    
    
    22,272Issuance of warrants to
investors
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    1Deemed dividend (value of
warrants issued to
investors)
    
    
    
    
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    (1
    )Issuance of options at fair
value for services
    
    
    
    
    
    
    
    
    
    
    2,283
    
    
    
    
    
    
    
    
    
    
    
    2,283Balance December 31, 2005
    
    
    5,556
    
    
    $
    55
    
    
    $
    38,833
    
    
    $
    (10,324
    )
    
    $
    (37
    )
    
    $
    28,527Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,725
    )
    
    
    
    
    
    
    (6,725
    )Stock based compensation
    
    
    
    
    
    
    
    
    
    
    579
    
    
    
    
    
    
    
    
    
    
    
    579Adjustment to Instantel
purchase price
    
    
    
    
    
    
    
    
    
    
    (35
    )
    
    
    
    
    
    
    
    
    
    
    (35
    )Issuance of restricted
stock
    
    
    500
    
    
    
    6
    
    
    
    (6
    )
    
    
    
    
    
    
    
    
    
    
    Balance December 31, 2006
    
    
    6,056
    
    
    $
    61
    
    
    $
    39,371
    
    
    $
    (17,049
    )
    
    $
    (37
    )
    
    $
    22,346Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11,910
    )
    
    
    
    
    
    
    (11,910
    )Issuance of shares in
public offering, net
of costs of $8,033
    
    
    3,100
    
    
    
    31
    
    
    
    12,076
    
    
    
    
    
    
    
    
    
    
    
    12,107Issuance of restricted
stock
    
    
    100
    
    
    
    1
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    Warrant exercise
    
    
    395
    
    
    
    4
    
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    Issuance of shares from
option exercises
    
    
    536
    
    
    
    5
    
    
    
    486
    
    
    
    
    
    
    
    
    
    
    
    375Stock issuance costs
    
    
    
    
    
    
    
    
    
    
    (11
    )
    
    
    
    
    
    
    
    
    
    
    (11
    )Stock based compensation
    
    
    109
    
    
    
    1
    
    
    
    3,445
    
    
    
    
    
    
    
    
    
    
    
    3,446Repurchase of shares
    
    
    (181
    )
    
    
    (2
    )
    
    
    (760
    )
    
    
    
    
    
    
    
    
    
    
    (762
    )Balance December 31, 2007
    
    
    10,144
    
    
    $
    101
    
    
    $
    54,486
    
    
    $
    (28,959
    )
    
    $
    (37
    )
    
    $
    25,591
   F-5




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##### Table of Contents



VERICHIP CORPORATION
 
 Consolidated Statements of Cash Flows
 For the Years Ended December 31,2007
    
    
    2006
    
    
    2005Cash flows from operating activities:Net loss
    
    $
    (11,910
    )
    
    $
    (6,725
    )
    
    $
    (5,262
    )Adjustments to reconcile net loss to
net cash used in operating activities:Depreciation and amortization
    
    
    2,456
    
    
    
    2,428
    
    
    
    1,383Stock based compensation
    
    
    3,446
    
    
    
    579
    
    
    
    2,283Accrued interest
    
    
    1,491
    
    
    
    687
    
    
    
    343Deferred income taxes
    
    
    (1,304
    )
    
    
    (160
    )
    
    
    (71
    )Allowance for doubtful accounts
    
    
    (2
    )
    
    
    134
    
    
    
    12Allowance for inventory excess and obsolescence
    
    
    427
    
    
    
    69
    
    
    
    17Disposal of equipment
    
    
    
    
    
    
    150
    
    
    
    22Changes in operating assets and liabilities, net of effects of
acquired businesses:Accounts receivable
    
    
    (950
    )
    
    
    644
    
    
    
    (877
    )Inventories
    
    
    864
    
    
    
    (1,290
    )
    
    
    (137
    )Prepaid expenses and other current assets
    
    
    (665
    )
    
    
    (304
    )
    
    
    119Accounts payable and accrued expenses
    
    
    (305
    )
    
    
    2,310
    
    
    
    242Net cash used in operating activities
    
    
    (6,452
    )
    
    
    (1,478
    )
    
    
    (1,926
    )Cash flows from investing activities:Payments for equipment
    
    
    (643
    )
    
    
    (810
    )
    
    
    (424
    )Cash acquired in businesses contributed by the Stockholder
    
    
    
    
    
    
    
    
    
    
    1,783Payment of purchase price installment
    
    
    (193
    )
    
    
    (2,058
    )
    
    
    Net cash (used in) provided by investing activities
    
    
    (836
    )
    
    
    (2,868
    )
    
    
    1,359Cash flows from financing activities:Short term borrowings, net
    
    
    662
    
    
    
    759
    
    
    
    94Note payment to stockholder
    
    
    (3,500
    )
    
    
    
    
    
    
    Borrowings from stockholder
    
    
    1,293
    
    
    
    6,067
    
    
    
    2,316Proceeds from stock option exercises
    
    
    363
    
    
    
    
    
    
    
    Proceeds from initial public offering, net of underwriter fees
    
    
    18,336
    
    
    
    
    
    
    
    Offering costs, exclusive of underwriter fees
    
    
    (2,879
    )
    
    
    (2,924
    )
    
    
    (426
    )Share repurchase
    
    
    (762
    )
    
    
    
    
    
    
    Net cash provided by financing activities
    
    
    13,513
    
    
    
    3,902
    
    
    
    1,984Net increase(decrease) in cash
    
    
    6,225
    
    
    
    (444
    )
    
    
    1,417Cash, beginning of year
    
    
    996
    
    
    
    1,440
    
    
    
    23Cash, end of year
    
    $
    7,221
    
    
    $
    996
    
    
    $
    1,440
    F-6




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##### Table of Contents



VERICHIP CORPORATION
 
 Notes to Consolidated Financial Statements
(tabulated amounts in thousands of dollars, except per share amounts)
 1 Basis of Presentation
         F-7




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##### Table of Contents



Significant Accounting Policies
 Principles of Consolidation
  Use of Estimates
  Foreign Currency
    Inventories
  Equipment
   F-8




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##### Table of Contents



Advertising Costs
  Goodwill and Other Intangible Assets
 Goodwill
and Intangible Assets
    Accounting for the Impairment or Disposal of Long-Lived
Assets,
 Revenue Recognition
  Revenue Recognition Policy for Healthcare Security and Industrial Systems
   F-9




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##### Table of Contents



Revenue Recognition Policy for VeriMed and Other Implantable Systems and Services
   Product Revenue
    Services Revenue
   Warranties
 
   F-10




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##### Table of Contents



Stock-Based Compensation
 Share Based Payment,
           F-11




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##### Table of Contents



Income Taxes
   Loss Per Common Share and Common Share Equivalent
  Impact of Recently Issued Accounting Standards
  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 Effective Date of FASB Statement No. 157 Accounting for
Leases
  F-12




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##### Table of Contents



The Fair Value Option for Financial Assets and
Financial Liabilities
   Accounting for Collaborative
Arrangements Related to the Development and Commercialization of Intellectual Property Reporting Revenue Gross as a Principal versus Net as an Agent
  F-13




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##### Table of Contents



Research and Development
  2 Inventories
 December 31,
    
    
    December 31,2007
    
    
    2006Raw materials
    
    $
    1,412
    
    
    $
    1,489Work in process
    
    
    512
    
    
    
    1,255Finished goods
    
    
    1,011
    
    
    
    1,1192,935
    
    
    
    3,863Allowance for excess and obsolescence
    
    
    (592
    )
    
    
    (165
    )$
    2,343
    
    
    $
    3,698
 3 Equipment
 December 31,
    
    
    December 31,2007
    
    
    2006Leasehold improvements
    
    $
    130
    
    
    $
    128Equipment
    
    
    2,251
    
    
    
    1,639Software
    
    
    220
    
    
    
    2272,601
    
    
    
    1,994Less accumulated depreciation
    
    
    (1,649
    )
    
    
    (1,044
    )$
    952
    
    
    $
    950
  4 Acquisitions
 Goodwill andother
    
    
    Other netAcquisition
    
    
    intangible
    
    
    assets andCompany acquired
    
    Date Acquired
    
    
    Price
    
    
    assets
    
    
    liabilitiesVHI, formerly EXI Wireless Inc.
    
    
    3/31/05
    
    
    $
    13,283
    
    
    $
    11,541
    
    
    $
    1,742Instantel Inc.
    
    
    6/10/05
    
    
    $
    24,488
    
    
    $
    25,687
    
    
    $
    (1,199
    )
 VeriChip Holdings Inc.
    F-14




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##### Table of Contents



Instantel Inc.
         F-15




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##### Table of Contents



EXI
    
    
    InstantelCurrent assets
    
    $
    3,112
    
    
    $
    5,678Equipment
    
    
    191
    
    
    
    493Intangibles:Patented and non-patented proprietary technology
    
    
    3,710
    
    
    
    1,720Trademarks
    
    
    1,131
    
    
    
    3,790Customer relationships
    
    
    895
    
    
    
    3,390Distribution network
    
    
    816
    
    
    
    6,000Goodwill
    
    
    4,989
    
    
    
    10,787Current liabilities
    
    
    (1,057
    )
    
    
    (2,748
    )Deferred tax liability
    
    
    (504
    )
    
    
    (4,622
    )$
    13,283
    
    
    $
    24,488
  5 Intangible Assets
    F-16




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##### Table of Contents



WeightedDecember 31,
    
    
    December 31,
    
    
    average lives2007
    
    
    2006
    
    
    (in years)Trademarks
    
    $
    4,921
    
    
    $
    4,921
    
    
    IndefinitePatented and non-patented proprietary technology
    
    $
    5,430
    
    
    $
    5,430
    
    
    
    12.11Customer relationships
    
    
    4,288
    
    
    
    4,288
    
    
    
    8.75Distribution networks
    
    
    6,816
    
    
    
    6,816
    
    
    
    8.14$
    16,534
    
    
    $
    16,534
 December 31,
    
    
    December 31,2007
    
    
    2006Accumulated amortizationPatented and non-patented proprietary technology
    
    $
    1,119
    
    
    $
    671Customer relationships
    
    
    1,522
    
    
    
    980Distribution networks
    
    
    2,064
    
    
    
    1,237$
    4,704
    
    
    $
    2,888Net intangible assets
    
    $
    16,752
    
    
    $
    18,567
  2008
    
    $
    1,7902009
    
    
    1,6562010
    
    
    1,6142011
    
    
    1,6142012
    
    
    1,584Thereafter
    
    
    3,571$
    11,830
 6 Goodwill
 Business Combinations
  HealthcareSecurity
    
    
    Industrial
    
    
    Implantable
    
    
    ConsolidatedBalance, December 31, 2005
    
    $
    13,131
    
    
    $
    3,851
    
    
    $
    
    
    
    $
    16,982Adjustment to purchase price allocation
    
    
    (789
    )
    
    
    (168
    )
    
    
    
    
    
    
    (957
    )Balance, December 31, 2006
    
    
    12,342
    
    
    
    3,683
    
    
    
    
    
    
    
    16,025Adjustment to purchase price allocation
    
    
    (180
    )
    
    
    (69
    )
    
    
    
    
    
    
    (249
    )Balance, December 31, 2007
    
    $
    12,162
    
    
    $
    3,614
    
    
    $
    
    
    
    $
    15,776
   F-17




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##### Table of Contents



7 Accrued Expenses and Other Current Liabilities:
  December 31,2007
    
    
    2006Accrued wages and payroll expenses
    
    $
    1,904
    
    
    $
    1,271Accrued severance
    
    
    138
    
    
    
    390Accrued purchases
    
    
    964
    
    
    
    353Accrued professional fees
    
    
    116
    
    
    
    1,079Warranty liability
    
    
    580
    
    
    
    487Income taxes payable
    
    
    300
    
    
    
    220Deferred revenue
    
    
    306
    
    
    
    466Deferred purchase price obligation
    
    
    
    
    
    
    442Other accrued expenses
    
    
    
    
    
    
    260$
    4,308
    
    
    $
    4,968
 8 Financing Agreements and Liquidity:
    9 Stockholders Equity
   Stock Option Plans
   F-18




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##### Table of Contents



2007
    
    
    2006
    
    
    2005Weighted-
    
    
    
    
    
    
    Weighted-
    
    
    
    
    
    
    Weighted-Number
    
    
    Average
    
    
    Number
    
    
    Average
    
    
    Number
    
    
    Averageof
    
    
    Exercise
    
    
    of
    
    
    Exercise
    
    
    of
    
    
    ExerciseOptions
    
    
    Price
    
    
    Options
    
    
    Price
    
    
    Options
    
    
    PriceOutstanding on January 1
    
    
    2,099
    
    
    $
    2.10
    
    
    
    2,055
    
    
    $
    1.91
    
    
    
    1,826
    
    
    $
    0.54Granted (1)
    
    
    417
    
    
    
    5.88
    
    
    
    52
    
    
    
    9.88
    
    
    
    428
    
    
    
    7.11Exercised
    
    
    (536
    )
    
    
    0.70
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Forfeited
    
    
    (17
    )
    
    
    5.75
    
    
    
    (8
    )
    
    
    2.61
    
    
    
    (199
    )
    
    
    0.51Outstanding on December 31
    
    
    1,963
    
    
    
    3.26
    
    
    
    2,099
    
    
    
    2.10
    
    
    
    2,055
    
    
    
    1.92Exercisable on December 31 (2)
    
    
    1,530
    
    
    
    2.42
    
    
    
    2,049
    
    
    
    1.91
    
    
    
    2,055
    
    
    
    1.92Shares available on December
31 for options that may be
Granted
    
    
    865
    
    
    
    
    
    
    
    503
    
    
    
    
    
    
    
    545
 (1)
    
    The total compensation expense associated with the options granted in 2007 was $0.3
million. The remaining amount of the compensation expense to be recorded over the remaining
vesting period of the options is approximately $0.9 million.(2)
    
    The intrinsic value of a stock option is the amount by which the fair value of the
underlying stock exceeds the exercise price of the option. The fair value of the Companys common
stock was estimated to be $2.25 at December 31, 2007 based upon its closing price on the NASDAQ. As
of December 31, 2007, the aggregate intrinsic value of all options outstanding was $0.6 million.  F-19




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##### Table of Contents



Outstanding Stock Options
    
    
    Exercisable Stock OptionsWeighted-Average
    
    
    Weighted-
    
    
    
    
    
    
    Weighted-Remaining
    
    
    Average
    
    
    
    
    
    
    AverageRange of
    
    
    
    
    
    Contractual
    
    
    Exercise
    
    
    
    
    
    
    ExerciseExercise Prices
    
    Shares
    
    
    Life
    
    
    Price
    
    
    Shares
    
    
    Price$0.0000 to $2.0250
    
    
    1,087
    
    
    
    2.5
    
    
    $
    0.47
    
    
    
    1,087
    
    
    $
    0.47$4.0501 to $6.0750
    
    
    437
    
    
    
    8.8
    
    
    
    5.65
    
    
    
    67
    
    
    
    5.12$6.0751 to $8.1000
    
    
    328
    
    
    
    5.9
    
    
    
    7.09
    
    
    
    298
    
    
    
    7.04$8.1001 to $10.1250
    
    
    105
    
    
    
    7.0
    
    
    
    9.23
    
    
    
    72
    
    
    
    8.88$18.2251 to $20.2500
    
    
    6
    
    
    
    6.0
    
    
    
    20.25
    
    
    
    6
    
    
    
    20.251,963
    
    
    
    4.7
    
    
    $
    3.26
    
    
    
    1,530
    
    
    $
    2.42Vested and expected
to vest
    
    
    1,677
    
    
    
    4.3
    
    
    $
    2.79
   
    
    the Companys projected operating performance;
    
    risk of non-achievement of projected operating performance;
    
    the purchase prices of the two businesses acquired during 2005, including the risk
that the acquisitions may not have been completed at certain interim valuation dates;
and
    
    trends and comparable valuations in the broad market for privately-held and
publicly-traded technology and medical device companies.
  
    
    unlevered free cash flows for the Companys implantable microchip business were
projected for five years, which was deemed to be the appropriate valuation period;
    
    earnings before interest, taxes, depreciation and amortization, or EBITDA, was used
to estimate terminal value;
    
    management considered the relevant multiples for RFID and medical device companies
in determining the appropriate terminal value multiple;
    
    a discount rate was applied to the net free cash flows and terminal value. The rate
was determined based on the risk free rate of the 10-year U.S. Treasury Bond plus an
applicable market risk premium and the specific risk premium associated with the
Companys facts and circumstances. (The discount rate the Company utilized by was the
rate of return expected from the market or the rate of return for a similar investment
with similar risks);
  F-20




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##### Table of Contents




    
    the purchase prices of EXI and Instantel, adjusted for the risk that the
acquisitions may not have been completed at certain interim valuation dates, were added
to the value of the implantable microchip business to determine enterprise value; and
    
    management computed the fully diluted value of each share of the Companys common
stock to factor in the dilutive effect of reflecting in the money stock options and
warrants at each valuation date.
    
    
    the estimated value of the Companys common stock;
    
    the expected life of issued stock options;
    
    the expected volatility of the Companys 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.
   2007
    
    
    2006
    
    
    2005Expected dividend yield
    
    
    
    
    
    
    
    
    
    
    Expected stock price volatility
    
    
    60
    %
    
    
    60
    %
    
    
    50
    %Risk-free interest rate
    
    
    4.51
    %
    
    
    4.29
    %
    
    
    3.84
    %Expected term (in years)
    
    
    6.0
    
    
    
    5.0
    
    
    
    5.5
  F-21




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##### Table of Contents



10 Selling, general and administrative expense:
 For the Years Ended December 31,2007
    
    
    2006
    
    
    2005Salaries and benefits (1)
    
    $
    13,856
    
    
    $
    7,631
    
    
    $
    6,631Depreciation and amortization
    
    
    2,009
    
    
    
    1,982
    
    
    
    1,159Legal and accounting
    
    
    980
    
    
    
    956
    
    
    
    1,059Sales and marketing
    
    
    2,063
    
    
    
    2,198
    
    
    
    700Travel and entertainment
    
    
    1,257
    
    
    
    1,078
    
    
    
    743Insurance
    
    
    167
    
    
    
    448
    
    
    
    203Consulting
    
    
    1,795
    
    
    
    2,802
    
    
    
    907Other
    
    
    1,385
    
    
    
    525
    
    
    
    1,040$
    23,514
    
    
    $
    17,620
    
    
    $
    12,442
 (1)
    
    Included in salaries and benefits is $3.4 million, $0.6 million and $2.3 million of equity
compensation expense for the years 2007, 2006 and 2005, respectively,
associated with stock compensation (includes stock options and
restricted stock). See Note 1. 11 Income taxes:
   For the Years Ended December 31,2007
    
    
    2006
    
    
    2005Current:United States
    
    $
    
    
    
    $
    
    
    
    $
    Canada
    
    
    248
    
    
    
    193
    
    
    
    127Current income tax provision
    
    
    248
    
    
    
    193
    
    
    
    127
 2007
    
    
    2006
    
    
    2005Deferred:United States
    
    $
    
    
    
    $
    
    
    
    $
    Canada
    
    
    (1,304
    )
    
    
    (160
    )
    
    
    (71
    )Current income tax benefit
    
    
    (1,304
    )
    
    
    (160
    )
    
    
    (71
    )$
    (1,056
    )
    
    $
    33
    
    
    $
    56
   F-22




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##### Table of Contents



December 31,2007
    
    
    2006Deferred tax assets:Liabilities and reserves
    
    $
    386
    
    
    $
    547Stock-based compensation
    
    
    2,662
    
    
    
    1,557Property and equipment
    
    
    133
    
    
    
    96Research and development tax credit
    
    
    1,632
    
    
    
    397Net operating loss carryforwards
    
    
    9,386
    
    
    
    6,486Gross deferred tax assets
    
    
    14,201
    
    
    
    9,083Valuation allowance
    
    
    (12,966
    )
    
    
    (7,930
    )1,233
    
    
    
    1,153Deferred tax liabilities:Intangible assets
    
    
    4,826
    
    
    
    6,044Other
    
    
    
    
    
    
    44,826
    
    
    
    6,048Net deferred tax liability
    
    $
    3,593
    
    
    $
    4,895
  December 31,2007
    
    
    2006Current deferred tax asset
    
    $
    216
    
    
    $
    520Long-term deferred tax liability
    
    
    3,809
    
    
    
    5,415$
    3,593
    
    
    $
    4,895
    For the Years Ended December 31,2007
    
    
    2006
    
    
    2005Domestic
    
    $
    (13,683
    )
    
    $
    (7,993
    )
    
    $
    (6,621
    )International
    
    
    717
    
    
    
    1,301
    
    
    
    1,415$
    (12,966
    )
    
    $
    (6,692
    )
    
    $
    (5,206
    )
  2007
    
    
    2006
    
    
    2005%
    
    
    %
    
    
    %Statutory tax benefit
    
    
    (34
    )
    
    
    (34
    )
    
    
    (34
    )State income taxes, net of federal benefits
    
    
    (6
    )
    
    
    (7
    )
    
    
    (4
    )Foreign income tax rate differential
    
    
    (14
    )
    
    
    (7
    )
    
    
    (8
    )Change in deferred tax asset valuation allowance
    
    
    46
    
    
    
    48
    
    
    
    48(8
    )
    
    
    
    
    
    
    1
  F-23




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##### Table of Contents




    
    Income tax benefits should be recognized when, based on the technical merits of a
tax position, the company believes that if a dispute arose with the taxing authority
and were taken to a court of last resort, it is more likely than not (i.e., a
probability of greater than 50 percent) that the tax position would be sustained as
filed; and
    
    If a position is determined to be more likely than not of being sustained, the
reporting company should recognize the largest amount of tax benefit that is greater
than 50 percent likely of being realized upon ultimate settlement with the taxing
authority.
  12 Loss per Share
  For the Years Ended December 31,2007
    
    
    2006
    
    
    2005Numerator:Numerator for basic loss per share:Net loss
    
    $
    (11,910
    )
    
    $
    (6,725
    )
    
    $
    (5,262
    )Deemed dividend
    
    
    
    
    
    
    
    
    
    
    (1
    )Net loss attributable to common stockholders
    
    $
    (11,910
    )
    
    $
    (6,725
    )
    
    $
    (5,263
    )Denominator:Denominator for basic and diluted loss per share:Weighted average shares outstanding basic and diluted
    
    
    8,756
    
    
    
    5,556
    
    
    
    5,279Basic and diluted loss per share
    
    $
    (1.36
    )
    
    $
    (1.21
    )
    
    $
    (1.00
    )
  F-24




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##### Table of Contents



For the Years Ended December 31,2007
    
    
    2006
    
    
    2005Stock options
    
    
    1,963
    
    
    
    2,099
    
    
    
    2,055Warrants
    
    
    33
    
    
    
    444
    
    
    
    444Restricted common stock
    
    
    600
    
    
    
    500
    
    
    
    2,596
    
    
    
    3,043
    
    
    
    2,499
 13 Segmented information:
  Healthcare Security
  
    
    infant protection systems used in hospital maternity wards and birthing centers to
prevent infant abduction and mother-baby mismatching;
    
    wander prevention systems used by long-term care facilities to locate and protect
their residents; and
    
    an asset/staff location and identification system used by hospitals and other
healthcare facilities to identify, locate and protect medical staff, patients, visitors
and medical equipment.
 Implantable
  Industrial
  
    
    vibration monitoring instruments used by engineering, construction and mining
professionals to monitor the effects of human induced vibrations, such as blasting
activity; and
    
    asset management systems used by industrial companies to manage and track their
mobile equipment and tools.
  F-25




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##### Table of Contents



Healthcare2007
    
    Security
    
    
    Implantable
    
    
    Industrial
    
    
    Corporate
    
    
    TotalProduct revenue
    
    $
    22,644
    
    
    $
    76
    
    
    $
    7,321
    
    
    $
    
    
    
    $
    30,041Services revenue
    
    
    549
    
    
    
    
    
    
    
    1,516
    
    
    
    
    
    
    
    2,065$
    23,193
    
    
    $
    76
    
    
    $
    8,837
    
    
    $
    
    
    
    $
    32,106Operating income (loss)
    
    
    1,652
    
    
    
    (5,619
    )
    
    
    877
    
    
    
    (7,596
    )
    
    
    (11,046
    )Depreciation and amortization
    
    
    1,864
    
    
    
    36
    
    
    
    519
    
    
    
    37
    
    
    
    2,456Interest and other income (expense)
    
    
    (502
    )
    
    
    
    
    
    
    
    
    
    
    280
    
    
    
    (222
    )Interest expense
    
    
    25
    
    
    
    
    
    
    
    
    
    
    
    1,673
    
    
    
    1,698Income (loss) before provision for
income taxes
    
    
    1,257
    
    
    
    (5,619
    )
    
    
    745
    
    
    
    (9,349
    )
    
    
    (12,966
    )Goodwill
    
    
    12,162
    
    
    
    
    
    
    
    3,614
    
    
    
    
    
    
    
    15,776Segmented assets
    
    
    37,252
    
    
    
    960
    
    
    
    9,444
    
    
    
    2,342
    
    
    
    49,998Expenditures for property and
equipment
    
    
    374
    
    
    
    24
    
    
    
    220
    
    
    
    25
    
    
    
    643
 Healthcare2006
    
    Security
    
    
    Implantable
    
    
    Industrial
    
    
    Corporate
    
    
    TotalProduct revenue
    
    $
    20,035
    
    
    $
    116
    
    
    $
    5,480
    
    
    $
    
    
    
    $
    25,631Services revenue
    
    
    380
    
    
    
    
    
    
    
    1,293
    
    
    
    
    
    
    
    1,673$
    20,415
    
    
    $
    116
    
    
    $
    6,773
    
    
    $
    
    
    
    $
    27,304Operating income (loss)
    
    
    781
    
    
    
    (4,273
    )
    
    
    659
    
    
    
    (3,047
    )
    
    
    (5,881
    )Depreciation and amortization
    
    
    1,705
    
    
    
    42
    
    
    
    640
    
    
    $
    41
    
    
    
    2,428Interest and other income
    
    
    (49
    )
    
    
    
    
    
    
    (8
    )
    
    
    
    
    
    
    (57
    )Interest expense
    
    
    78
    
    
    
    
    
    
    
    
    
    
    
    790
    
    
    
    868Income (loss) before provision for
income taxes
    
    
    751
    
    
    
    (4,273
    )
    
    
    667
    
    
    
    (3,837
    )
    
    
    (6,692
    )Goodwill
    
    
    12,342
    
    
    
    
    
    
    
    3,683
    
    
    
    
    
    
    
    16,025Segmented assets
    
    
    34,641
    
    
    
    680
    
    
    
    10,632
    
    
    
    4,935
    
    
    
    50,888Expenditures for property and
equipment
    
    
    581
    
    
    
    27
    
    
    
    175
    
    
    
    27
    
    
    
    810
 Healthcare2005
    
    Security
    
    
    Implantable
    
    
    Industrial
    
    
    Corporate
    
    
    TotalProduct revenue
    
    $
    11,200
    
    
    $
    68
    
    
    $
    3,252
    
    
    $
    
    
    
    $
    14,520Services revenue
    
    
    849
    
    
    
    
    
    
    
    500
    
    
    
    
    
    
    
    1,349$
    12,049
    
    
    $
    68
    
    
    $
    3,752
    
    
    $
    
    
    
    $
    15,869Operating income (loss)
    
    
    947
    
    
    
    (3,604
    )
    
    
    488
    
    
    
    (2,757
    )
    
    
    (4,926
    )Depreciation and amortization
    
    
    971
    
    
    
    28
    
    
    
    971
    
    
    $
    28
    
    
    
    1,383Interest and other income
    
    
    (49
    )
    
    
    
    
    
    
    (14
    )
    
    
    
    
    
    
    (63
    )Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    343
    
    
    
    343Income (loss) before provision for
income taxes
    
    
    996
    
    
    
    (3,604
    )
    
    
    502
    
    
    
    (3,100
    )
    
    
    (5,206
    )Goodwill
    
    
    13,131
    
    
    
    
    
    
    
    3,851
    
    
    
    
    
    
    
    16,982Segmented assets
    
    
    36,257
    
    
    
    741
    
    
    
    10,238
    
    
    
    1,202
    
    
    
    48,438Expenditures for property and
equipment
    
    
    285
    
    
    
    40
    
    
    
    59
    
    
    
    40
    
    
    
    424
  F-26




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##### Table of Contents



United States
    
    
    Canada
    
    
    ConsolidatedYear ended December 31, 2007:Net revenue
    
    $
    76
    
    
    $
    32,030
    
    
    $
    32,106Long-lived tangible assets
    
    
    112
    
    
    
    840
    
    
    
    952Deferred tax liabilities
    
    
    
    
    
    $
    3,809
    
    
    $
    3,809
 United States
    
    
    Canada
    
    
    ConsolidatedYear ended December 31, 2006:Net revenue
    
    $
    116
    
    
    $
    27,188
    
    
    $
    27,304Long-lived tangible assets
    
    
    126
    
    
    
    824
    
    
    
    950Deferred tax liabilities
    
    
    
    
    
    $
    5,415
    
    
    $
    5,415
 United States
    
    
    Canada
    
    
    ConsolidatedYear ended December 31, 2005:Net revenue
    
    $
    68
    
    
    $
    15,801
    
    
    $
    15,869Long-lived tangible assets
    
    
    132
    
    
    
    758
    
    
    
    890Deferred tax liabilities
    
    
    
    
    
    $
    5,064
    
    
    $
    5,064
 14 Unasserted ClaimPotential Intellectual Property Conflict
     15 Commitments and Contingencies
 Operating Lease Commitments
  F-27




---



##### Table of Contents



Purchase Commitments
   Operating lease
    
    
    Purchase
    
    
    EmploymentYear
    
    Commitments
    
    
    Commitments
    
    
    Contracts2008
    
    $
    514
    
    
    $
    2,542
    
    
    $
    4622009
    
    
    212
    
    
    
    3,333
    
    
    
    5082010
    
    
    
    
    
    
    4,623
    
    
    
    5082011
    
    
    
    
    
    
    4,664
    
    
    
    5082012
    
    
    
    
    
    
    3,750
    
    
    
    Thereafter
    
    
    
    
    
    
    34,119
    
    
    
    $
    726
    
    
    $
    53,031
    
    
    $
    2,406
 Employment Contract
  Legal proceedings
   F-28




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##### Table of Contents



Metro Risk
    16 Related Party Transactions
   
    
    Accounting, finance and payroll services these costs were allocated based upon
a percentage of the total labor dollars incurred by Digital Angels accounting,
finance and payroll staff in performing such functions for the Company;
    
    Legal services the costs were allocated based upon a percentage of Digital
Angels general counsels salary and benefits based upon the estimated time spent by
its general counsel on the Companys legal issues;
    
    Accounting fees these costs were allocated based upon a percentage of the total
fees charged by third party accountants and considering the amount of such
accounting fees that the Company would have incurred if it was a stand-along entity
until December 27, 2005. Subsequent to December 27, 2005, the Company paid actual
costs incurred;
    
    Rent the cost was determined based upon the amount of office space square
footage used by the Companys employees; and
    
    Telephone, office supplies and other costs these costs were allocated based
upon a percentage of the services or supplies that were deemed to be incurred by the
Company.
 Transition Services Agreement
 
  F-29




---



##### Table of Contents



Loan Agreement with Digital Angel
  The Wall
Street Journal
   F-30




---



##### Table of Contents



Funding of Instantel Acquisition
  Supply Agreement
      F-31




---



##### Table of Contents



Legal Services
  Pledge Agreement
  17 Supplementary Cash Flow Information
 For the Years Ended December 31,2007
    
    
    2006
    
    
    2005Income taxes paid
    
    $
    280
    
    
    $
    437
    
    
    $
    143Interest paid
    
    
    25
    
    
    
    46
    
    
    
    2$
    305
    
    
    $
    483
    
    
    $
    145
  Year Ended December 31,2007
    
    
    2006
    
    
    2005Non-cash financing activities:Offering costs
    
    
    
    
    
    
    1,015
    
    
    
    714Issuance of common shares to Digital Angel for the contribution of VeriChip Holdings
Inc. to VeriChip Corporation
    
    
    
    
    
    
    
    
    
    
    12,719Contribution of Instantel Inc. to VeriChip Inc. by Digital Angel
    
    
    
    
    
    
    
    
    
    
    21,043Deferred purchase obligation
    
    
    
    
    
    
    (500
    )
    
    
    3,000Warrant exercise
    
    
    4
    
    
    
    
    
    
    
    Issuance of warrants
    
    
    
    
    
    
    
    
    
    
    1
 18 Exit and Disposal Activity
  19 Subsequent Events
 $8.0 Million Debt Financing
   F-32




---



##### Table of Contents



Letter Agreement with Digital Angel
  20 Summarized Quarterly Data (unaudited)
 First
    
    
    Second
    
    
    Third
    
    
    Fourth
    
    
    Full2007
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    YearTotal revenue
    
    $
    7,373
    
    
    $
    8,190
    
    
    $
    7,916
    
    
    $
    8,627
    
    
    $
    32,106Gross profit
    
    
    3,863
    
    
    
    4,230
    
    
    
    4,536
    
    
    
    4,517
    
    
    
    17,146Net loss
    
    
    (3,313
    )
    
    
    (2,579
    )
    
    
    (3,223
    )
    
    
    (2,795
    )
    
    
    (11,910
    )Basic and diluted net loss per share (1)
    
    $
    (0.47
    )
    
    $
    (0.29
    )
    
    $
    (0.35
    )
    
    $
    (0.29
    )
    
    $
    (1.36
    )First
    
    
    Second
    
    
    Third
    
    
    Fourth
    
    
    Full2006
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    YearTotal revenue
    
    $
    6,550
    
    
    $
    6,976
    
    
    $
    6,818
    
    
    $
    6,960
    
    
    $
    27,304Gross profit
    
    
    3,981
    
    
    
    4,101
    
    
    
    3,768
    
    
    
    3,675
    
    
    
    15,525Net loss attributable to common
stockholder
    
    
    (1,021
    )
    
    
    (1,169
    )
    
    
    (1,261
    )
    
    
    (3,274
    )
    
    
    (6,725
    )Basic and diluted net loss per share

attributable to common stockholder (1)
    
    $
    (0.18
    )
    
    $
    (0.21
    )
    
    $
    (0.23
    )
    
    $
    (0.59
    )
    
    $
    (1.21
    )
 (1)
    
    Loss per share is computed independently for each of the quarters presented.  F-33




---



##### Table of Contents



FINANCIAL STATEMENT SCHEDULE
 Valuation and Qualifying Accounts (in thousands)
 AdditionsBalance at
    
    
    charged to
    
    
    
    
    
    
    Balance atbeginning
    
    
    cost and
    
    
    
    
    
    
    end ofDescription
    
    of period
    
    
    expenses
    
    
    Deductions
    
    
    periodValuation reserve deducted in the balance
sheet from the asset to which it applies:Accounts receivable:2007 Allowance for doubtful accounts
    
    $
    146
    
    
    $
    
    
    
    
    2
    
    
    $
    1442006 Allowance for doubtful accounts
    
    
    12
    
    
    
    134
    
    
    
    
    
    
    
    1462005 Allowance for doubtful accounts
    
    
    
    
    
    
    22
    
    
    
    10
    
    
    
    12Inventory:2007 Allowance for excess and obsolescence
    
    $
    165
    
    
    $
    427
    
    
    $
    
    
    
    $
    5922006 Allowance for excess and obsolescence
    
    
    96
    
    
    
    69
    
    
    
    
    
    
    
    1652005 Allowance for excess and obsolescence
    
    
    79
    
    
    
    17
    
    
    
    
    
    
    
    96Deferred taxes:2007 Valuation reserve
    
    $
    7,930
    
    
    $
    5,036
    
    
    $
    
    
    
    $
    12,9662006 Valuation reserve
    
    
    4,385
    
    
    
    3,545
    
    
    
    
    
    
    
    7,9302005 Valuation reserve
    
    
    1,899
    
    
    
    2,486
    
    
    
    
    
    
    
    4,385
  F-34




---



##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
     KPMG LLP (signed)
 
  F-35




---



##### Table of Contents



EXI WIRELESS INC.
 
 Consolidated Balance Sheets
(Expressed in United States dollars)
(Prepared in accordance with United States GAAP)
 March 31,
    
    
    December 31,2005
    
    
    2004AssetsCurrent assets:Cash
    
    $
    553,783
    
    
    $
    1,126,642Accounts receivable, net of allowance for doubtful accounts of $25,009
(2004 - $22,514)
    
    
    1,981,918
    
    
    
    1,709,173Inventory (note 3)
    
    
    413,420
    
    
    
    409,731Prepaid expenses
    
    
    31,114
    
    
    
    60,4112,980,235
    
    
    
    3,305,957Goodwill (note 4)
    
    
    1,440,697
    
    
    
    1,449,806Property, plant and equipment (note 5)
    
    
    190,865
    
    
    
    189,455Other intangible assets (note 6)
    
    
    188,799
    
    
    
    217,402Deferred income taxes (note 7)
    
    
    174,202
    
    
    
    175,304$
    4,974,798
    
    
    $
    5,337,924Liabilities and Stockholders EquityCurrent liabilities:Accounts payable
    
    $
    618,926
    
    
    $
    714,666Accrued liabilities
    
    
    184,842
    
    
    
    393,551Deferred revenue
    
    
    200,490
    
    
    
    204,3011,004,258
    
    
    
    1,312,518Stockholders equity:Preferred stock:Authorized unlimited shares with no par value; nil outstanding
in 2005 and 2004Common stock:Authorized unlimited shares with no par value; 10,265,178 (2004
- 10,080,360) issued and outstandingShare capital (note 8)
    
    
    4,554,076
    
    
    
    4,396,803Additional paid in capital
    
    
    124,363
    
    
    
    124,363Accumulated other comprehensive income  cumulative translation adjustment
    
    
    821,384
    
    
    
    847,098Accumulated deficit
    
    
    (1,529,283
    )
    
    
    (1,342,858
    )3,970,540
    
    
    
    4,025,406$
    4,974,798
    
    
    $
    5,337,924
 
   F-36




---



##### Table of Contents



EXI WIRELESS INC.
 
 Consolidated Statements of Operations
(Expressed in United States dollars)
(Prepared in accordance with United States GAAP)
Three month periods ended March 31, 2005 and 2004
 2005
    
    
    2004(unaudited)Sales
    
    $
    1,985,934
    
    
    $
    1,533,525Cost of sales
    
    
    574,504
    
    
    
    424,0981,411,430
    
    
    
    1,109,427Expenses:Research and development
    
    
    261,881
    
    
    
    223,450Depreciation and amortization
    
    
    61,546
    
    
    
    66,617General and administrative
    
    
    931,565
    
    
    
    418,743Selling and marketing
    
    
    363,233
    
    
    
    315,4101,618,225
    
    
    
    1,024,220Earnings (loss) before undernoted
    
    
    (206,795
    )
    
    
    85,207Other earnings (expenses):Interest
    
    
    2,405
    
    
    
    1,084Foreign exchange gain
    
    
    17,965
    
    
    
    13,02120,370
    
    
    
    14,105Earnings (loss) before income taxes
    
    
    (186,425
    )
    
    
    99,312Income taxes (note 7):Current
    
    
    
    
    
    
    Future
    
    
    
    
    
    
    
    
    
    
    Net earnings (loss) for the period
    
    $
    (186,425
    )
    
    $
    99,312Earnings (loss) per share:Basic
    
    $
    (0.02
    )
    
    $
    0.01Diluted
    
    
    (0.02
    )
    
    
    0.01Weighted average number of common shares outstanding:Basic
    
    
    10,265,178
    
    
    
    10,080,360Diluted
    
    
    10,265,178
    
    
    
    10,117,188
   F-37




---



##### Table of Contents



EXI WIRELESS INC.
 
 Consolidated Statements of Stockholders Equity
(Expressed in United States dollars)
(Prepared in accordance with United States GAAP)
Three month period ended March 31, 2005 and 2004
 Accumulatedother
    
    
     Additional
    
    
    TotalCommon stock
    
    
    Accumulated
    
    
    comprehensive
    
    
    paid
    
    
    stockholdersNumber
    
    
    Amount
    
    
    deficit
    
    
    income (loss)
    
    
    in capital
    
    
    equityBalance, December 31,
2003
    
    
    10,080,360
    
    
    $
    4,396,803
    
    
    $
    (1,013,873
    )
    
    $
    567,819
    
    
    $
    119,571
    
    
    $
    4,070,320Net earnings
(unaudited)
    
    
    
    
    
    
    
    
    
    
    99,312
    
    
    
    
    
    
    
    
    
    
    
    99,312Foreign currency
translation
(unaudited)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (55,667
    )
    
    
    
    
    
    
    (55,667
    )Comprehensive income
(unaudited)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    43,645Balance, March 31,
2004 (unaudited)
    
    
    10,080,360
    
    
    $
    4,396,803
    
    
    $
    (914,561
    )
    
    $
    512,152
    
    
    $
    119,571
    
    
    $
    4,113,965Balance, December 31,
2004
    
    
    10,080,360
    
    
    $
    4,396,803
    
    
    $
    (1,342,858
    )
    
    $
    847,098
    
    
    $
    124,363
    
    
    $
    4,025,406Net loss
    
    
    
    
    
    
    
    
    
    
    (186,425
    )
    
    
    
    
    
    
    
    
    
    
    (186,425
    )Foreign currency
translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (25,714
    )
    
    
    
    
    
    
    (25,714
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (212,139
    )Stock option exercised
    
    
    120,169
    
    
    
    85,760
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    85,760Common shares issued
in lieu of signing
bonus and consulting
fees
    
    
    64,649
    
    
    
    71,513
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    71,513Balance, March 31,
2005
    
    
    10,265,178
    
    
    $
    4,554,076
    
    
    $
    (1,529,283
    )
    
    $
    821,384
    
    
    $
    124,363
    
    
    $
    3,970,540
   F-38




---



##### Table of Contents



EXI WIRELESS INC.
 
 Consolidated Statements of Cash Flows
(Expressed in United States dollars)
(Prepared in accordance with United States GAAP)
Three month periods ended March 31, 2005 and 2004
 2005
    
    
    2004(unaudited)Cash provided by (used in):Cash flow from operating activities:Net earnings (loss) for the period
    
    $
    (186,425
    )
    
    $
    99,312Adjustments to reconcile net earnings (loss) to net cash used in
operating activities:Depreciation and amortization
    
    
    61,546
    
    
    
    66,617Common shares issued in lieu of bonus and consulting fees
    
    
    71,513
    
    
    
    Changes in non-cash working capital:Decrease in accounts receivable
    
    
    (279,456
    )
    
    
    (278,534
    )Decrease (increase) in prepaid expenses
    
    
    16,656
    
    
    
    (34,274
    )Decrease (increase) in inventory
    
    
    5,676
    
    
    
    (10,525
    )Increase (decrease) in accounts payable
    
    
    (89,954
    )
    
    
    14,721Increase (decrease) in accrued liabilities
    
    
    (203,306
    )
    
    
    31,848Increase (decrease) in deferred revenue
    
    
    (2,492
    )
    
    
    (15,904
    )(606,242
    )
    
    
    (126,739
    )Cash flow from investing activities:Payments for property, plant and equipment
    
    
    (33,354
    )
    
    
    (23,933
    )Proceeds on sale of property, plant and equipment
    
    
    (3,906
    )
    
    
    (1,921
    )(37,260
    )
    
    
    (25,854
    )Cash flow from financing activities:Common shares issued for cash
    
    
    85,760
    
    
    
    Effect of exchange rate changes on cash
    
    
    (15,117
    )
    
    
    (14,864
    )Decrease in cash
    
    
    (572,859
    )
    
    
    (167,457
    )Cash, beginning of period
    
    
    1,126,642
    
    
    
    1,025,292Cash, end of period
    
    $
    553,783
    
    
    $
    857,835Supplementary information:Interest expense paid
    
    $
    
    
    
    $
    526Non-cash transaction:Common shares issued in lieu of bonus and consulting fees
    
    $
    71,513
    
    
    $
    
   F-39




---



##### Table of Contents



1. Operations:
   2. Significant accounting policies:
 (a) Consolidation:
  (b) Inventory:
  (c) Property, plant and equipment:
  Asset
    
    Estimated useful life
    
    
    RateFurniture, fixtures and equipment
    
    5 years
    
    
    20
    %Computer equipment
    
    3  5 years
    
    
    20%  33
    %Computer software
    
    2 years
    
    
    50
    %
  (d) Acquired technology and other intangible assets:
  (e) Goodwill:
    F-40




---



##### Table of Contents



(f) Impairment of long-lived assets:
  (g) Foreign currency translation:
   (h) Research and development costs:
  (i) Warranty:
  Three months
    
    
    Three monthsended
    
    
    endedMarch 31,
    
    
    March 31,2005
    
    
    2004(unaudited)Balance, January 1
    
    $
    66,739
    
    
    $
    66,546Accruals for warranties issued
    
    
    16,140
    
    
    
    49,834Settlements made (in cash or kind)
    
    
    (16,611
    )
    
    
    (54,623
    )Balance, March 31
    
    $
    66,268
    
    
    $
    61,757
 (j) Pension plan:
  (k) Use of estimates:
   F-41




---



##### Table of Contents



(l) Revenue recognition:
     (m) Stock-based compensation:
 Accounting for Stock-based Compensation
 Three months
    
    
    Three monthsended
    
    
    endedMarch 31,
    
    
    March 31,2005
    
    
    2004(unaudited)Reported net income (loss)
    
    $
    (186,425
    )
    
    $
    99,312Stock-based employee compensation expense
determined under the fair value based method
    
    
    (20,578
    )
    
    
    (15,504
    )Pro forma net income (loss)
    
    $
    (207,003
    )
    
    $
    83,808Earnings (loss) per share  basic and diluted:As reported
    
    $
    (0.02
    )
    
    $
    0.01Pro forma
    
    $
    (0.02
    )
    
    $
    0.01
  (n) Income taxes:
 Accounting for Income Taxes
 (o) Investment tax credits:
   F-42




---



##### Table of Contents



(p) Earnings (loss) per share:
   (q) Comprehensive Income (loss)
 Reporting
Comprehensive Income
 (r) Comparative figures:
  (s) Recent accounting pronouncements:
 Share-Based Payment
 Exchanges of Nonmonetary Assets
 Inventory Costs  an amendment of ARB No. 43,
Chapter 4
 3. Inventory:
 March 31,
    
    
    December 31,2005
    
    
    2004Finished goods
    
    $
    462,049
    
    
    $
    454,149Reserve for obsolete inventory
    
    
    (48,629
    )
    
    
    (44,418
    )$
    413,420
    
    
    $
    409,731
 4. Goodwill:
 March 31,
    
    
    December 31,2005
    
    
    2004Cost
    
    $
    2,195,941
    
    
    $
    2,209,825Accumulated amortization
    
    
    755,244
    
    
    
    760,019Net book value
    
    $
    1,440,697
    
    
    $
    1,449,806
   F-43




---



##### Table of Contents



5. Property, plant and equipment:
 Accumulated
    
    
    Net bookMarch 31, 2005
    
    Cost
    
    
    depreciation
    
    
    valueFurniture, fixtures and equipment
    
    $
    464,886
    
    
    $
    390,774
    
    
    $
    74,112Computer equipment
    
    
    440,669
    
    
    
    357,332
    
    
    
    83,337Computer software
    
    
    276,009
    
    
    
    253,749
    
    
    
    22,260Leasehold improvements
    
    
    103,181
    
    
    
    92,025
    
    
    
    11,156$
    1,284,745
    
    
    $
    1,093,880
    
    
    $
    190,865
 Accumulated
    
    
    Net bookDecember 31, 2004
    
    Cost
    
    
    depreciation
    
    
    valueFurniture, fixtures and equipment
    
    $
    466,106
    
    
    $
    381,817
    
    
    $
    84,289Computer equipment
    
    
    415,936
    
    
    
    346,196
    
    
    
    69,740Computer software
    
    
    272,945
    
    
    
    250,354
    
    
    
    22,591Leasehold improvements
    
    
    103,834
    
    
    
    90,999
    
    
    
    12,835$
    1,258,821
    
    
    $
    1,069,366
    
    
    $
    189,455
 6. Other intangible assets:
 March 31,
    
    
    December 31,2005
    
    
    2004Acquired technology and other intangible assets
    
    $
    695,322
    
    
    $
    699,719Accumulated amortization
    
    
    506,523
    
    
    
    482,317Net book value
    
    $
    188,799
    
    
    $
    217,402
  7. Income taxes:
   Three months
    
    
    Three monthsended
    
    
    endedMarch 31,
    
    
    March 31,2005
    
    
    2004(unaudited)Combined Canadian federal and provincial
income taxes at expected rates of 35.6%
(March 31, 2004 - 35.6%)
    
    $
    (66,367
    )
    
    $
    35,355Non-deductible permanent and other differences
    
    
    14,579
    
    
    
    1,217Investment tax credits
    
    
    (90,600
    )
    
    
    Change in valuation allowance
    
    
    142,388
    
    
    
    (36,572
    )Tax expense
    
    $
    
    
    
    $
    
  F-44




---



##### Table of Contents



Three monthperiod ended
    
    
    Year endedMarch 31,
    
    
    December 31,2005
    
    
    2004Deferred tax assets:Non-capital losses
    
    $
    261,261
    
    
    $
    185,540Scientific research and experimental development expenditures
    
    
    236,067
    
    
    
    170,170Warranty and inventory valuation reserves
    
    
    40,755
    
    
    
    39,580Property, plant and equipment
    
    
    29,679
    
    
    
    26,204Total gross deferred tax assets
    
    
    567,762
    
    
    
    421,494Valuation allowance
    
    
    (350,770
    )
    
    
    (208,382
    )Deferred tax assets
    
    
    216,992
    
    
    
    213,112Deferred tax liabilities:Intangible assets
    
    
    (42,790
    )
    
    
    (37,808
    )Net deferred tax asset
    
    $
    174,202
    
    
    $
    175,304
   8. Share capital:
 (a) Stock options:
    March 31, 2005
    
    
    December 31, 2004Weighted
    
    
    
    
    
    
    WeightedNumber
    
    
    average
    
    
    Number
    
    
    averageof shares
    
    
    exercise price
    
    
    of shares
    
    
    exercise priceOutstanding, beginning of year
    
    
    893,000
    
    
    $
    0.84
    
    
    
    1,263,500
    
    
    $
    0.81Granted
    
    
    
    
    
    
    
    
    
    
    258,000
    
    
    
    0.71Exercised
    
    
    (120,000
    )
    
    
    0.99
    
    
    
    
    
    
    
    Cancelled
    
    
    (15,500
    )
    
    
    0.65
    
    
    
    (628,500
    )
    
    
    0.83Outstanding, end of year
    
    
    757,500
    
    
    $
    0.85
    
    
    
    893,000
    
    
    $
    0.84
   F-45




---



##### Table of Contents



WeightedNumber of
    
    
    average
    
    
    Number ofoptions
    
    
    remaining
    
    
    optionsExercise prices
    
    outstanding
    
    
    contractual life
    
    
    exercisable$0.00  0.41
    
    
    231,502
    
    
    
    2.92
    
    
    
    144,336$0.41  0.82
    
    
    150,166
    
    
    
    3.96
    
    
    
    47,506$0.82  1.24
    
    
    232,332
    
    
    
    3.36
    
    
    
    129,171$1.24  1.66
    
    
    71,000
    
    
    
    0.80
    
    
    
    71,000$1.66  2.07
    
    
    13,000
    
    
    
    0.37
    
    
    
    13,000$2.07  2.50
    
    
    59,500
    
    
    
    0.01
    
    
    
    59,500757,500
    
    
    
    2.58
    
    
    
    464,513
 (b) Warrants:
 March 31,
    
    
    December 31,2005
    
    
    2004Warrants issued and outstanding
    
    
    40,000
    
    
    
    40,000
   9. Per share amounts:
  March 31,
    
    
    March 31,2005
    
    
    2004Weighted average shares used in computation of basic earnings (loss) per share
    
    
    10,265,178
    
    
    
    10,080,360Weighted average shares from assumed conversion of dilutive options
    
    
    
    
    
    
    36,828Computation of diluted earnings (loss) per share
    
    
    10,265,178
    
    
    
    10,117,188
 10. Segmented reporting:
 (a) Business segments:
   March 31, 2005
    
    Healthcare
    
    
    Industrial
    
    
    Corporate
    
    
    TotalSales
    
    $
    1,726,208
    
    
    $
    259,726
    
    
    $
    
    
    
    $
    1,985,934Depreciation and amortization
    
    
    48,025
    
    
    
    2,076
    
    
    
    11,445
    
    
    
    61,546Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Interest income
    
    
    (1,106
    )
    
    
    (1,299
    )
    
    
    
    
    
    
    (2,405
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net earnings (loss) for the year
    
    
    43,892
    
    
    
    44,598
    
    
    
    (274,915
    )
    
    
    (186,425
    )Additions to property, plant and equipment
    
    
    33,354
    
    
    
    
    
    
    
    
    
    
    
    33,354Segment assets
    
    
    4,079,334
    
    
    
    596,976
    
    
    
    298,488
    
    
    
    4,974,798Goodwill
    
    
    1,440,697
    
    
    
    
    
    
    
    
    
    
    
    1,440,697
  F-46




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##### Table of Contents



March 31, 2004
    
    Healthcare
    
    
    Industrial
    
    
    Corporate
    
    
    Total(Unaudited)Sales
    
    $
    1,388,725
    
    
    $
    144,800
    
    
    $
    
    
    
    $
    1,533,525Depreciation and amortization
    
    
    53,063
    
    
    
    2,655
    
    
    
    10,899
    
    
    
    66,617Interest expense
    
    
    310
    
    
    
    10
    
    
    
    
    
    
    
    320Interest income
    
    
    (738
    )
    
    
    (346
    )
    
    
    
    
    
    
    (1,084
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net earnings (loss) for the year
    
    
    265,575
    
    
    
    (69,292
    )
    
    
    (96,971
    )
    
    
    99,312Additions to property, plant and equipment
    
    
    20,284
    
    
    
    3,649
    
    
    
    
    
    
    
    23,933Segment assets
    
    
    3,614,894
    
    
    
    513,739
    
    
    
    1,176,873
    
    
    
    5,305,506Goodwill
    
    
    1,329,773
    
    
    
    
    
    
    
    
    
    
    
    1,329,773
  (b) Geographic segments:
  March 31,
    
    
    March 31,2005
    
    
    2004(unaudited)Canada
    
    $
    246,169
    
    
    $
    201,108United States
    
    
    1,730,377
    
    
    
    1,292,232Other
    
    
    9,388
    
    
    
    40,185$
    1,985,934
    
    
    $
    1,533,525
 (c) Major customers:
  11. Commitments:
  2005
    
    $
    57,0882006
    
    
    163,2552007
    
    
    145,6332008
    
    
    155,2402009
    
    
    66,348
 12. Related party transactions:
  13. Financial instruments:
 (a) Credit risk:
   F-47




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##### Table of Contents



(b) Fair values of financial instruments:
  (i) Short-term financial instruments:
  (c) Foreign exchange risk:
  14. Subsequent Events
      F-48




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##### Table of Contents



Report of Independent Registered Public Accounting Firm
     MEYERS NORRIS PENNY LLP
  F-49




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##### Table of Contents



INSTANTEL INC.
 
 Balance Sheets at
 June 9,
    
    
    December 31,2005
    
    
    2004(restated)ASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    3,669
    
    
    $
    46,481Accounts receivable
    
    
    2,307,540
    
    
    
    2,273,482Inventories
    
    
    1,710,891
    
    
    
    1,529,993Current portion of deferred income taxes
    
    
    126,936
    
    
    
    Other current assets
    
    
    286,178
    
    
    
    406,532TOTAL CURRENT ASSETS
    
    
    4,435,215
    
    
    
    4,256,488CAPITAL ASSETS
    
    
    492,649
    
    
    
    474,145INTANGIBLE ASSETS
    
    
    4,759,500
    
    
    
    6,270,000GOODWILL
    
    
    592,547
    
    
    
    592,54710,279,910
    
    
    
    11,593,180LIABILITIES AND SHAREHOLDERS (DEFICIT) EQUITYCURRENT LIABILITIESBank indebtedness
    
    
    714,263
    
    
    
    586,697Accounts payable
    
    
    81,496
    
    
    
    515,299Accrued liabilities
    
    
    714,814
    
    
    
    357,495Deferred revenue
    
    
    149,000
    
    
    
    60,000Taxes payable
    
    
    122,464
    
    
    
    328,711Salary and benefits payable
    
    
    1,682,253
    
    
    
    935,965Current portion of long term debt
    
    
    5,500,000
    
    
    
    TOTAL CURRENT LIABILITIES
    
    
    8,964,290
    
    
    
    2,784,167DEFERRED TAXES
    
    
    1,537,900
    
    
    
    2,674,706LONG TERM DEBT
    
    
    
    
    
    
    5,500,000TOTAL LIABILITIES
    
    
    10,502,190
    
    
    
    10,958,873COMMITMENTS & CONTINGENCIESSHAREHOLDERS (DEFICIT) EQUITYPreferred stock : Authorized unlimited
shares in 2005 and 2004, of $0 par
value; 0 shares issued and outstanding
in 2005 and 2004
    
    
    
    
    
    
    Common stock : Authorized unlimited
shares in 2005 and 2004, of $0 par
value; 6,251,601 shares issued and
outstanding in 2005 and 2004
    
    
    4,000,001
    
    
    
    4,000,001Deficit
    
    
    (4,222,281
    )
    
    
    (3,365,694
    )TOTAL SHAREHOLDERS (DEFICIT) EQUITY
    
    
    (222,280
    )
    
    
    634,307$
    10,279,910
    
    
    $
    11,593,180
   F-50




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##### Table of Contents



INSTANTEL INC.
 
 Statements of Operations
 For the Period Ended June 9,2005
    
    
    2004(Unaudited)Revenue
    
    $
    6,759,291
    
    
    $
    5,539,772Cost of goods sold
    
    
    3,226,520
    
    
    
    2,315,057Gross margin
    
    
    3,532,771
    
    
    
    3,224,715Research & development
    
    
    1,039,504
    
    
    
    676,401Selling
    
    
    648,786
    
    
    
    377,083Marketing
    
    
    1,091,808
    
    
    
    509,025Administration
    
    
    952,401
    
    
    
    472,152Amortization of intangible assets
    
    
    1,510,500
    
    
    
    1,510,500Interest expense
    
    
    367,086
    
    
    
    443,643Loss from operations before income taxes
    
    
    (2,077,314
    )
    
    
    (764,089
    )Current income taxes
    
    
    (43,015
    )
    
    
    (137,973
    )Deferred income taxes
    
    
    1,263,742
    
    
    
    545,588Net loss for the period
    
    $
    (856,587
    )
    
    $
    (356,474
    )Net loss per share
    
    $
    (0.14
    )
    
    $
    (0.06
    )Weighted average common shares outstanding
    
    
    6,251,601
    
    
    
    6,251,601
   F-51




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##### Table of Contents



INSTANTEL INC.
 
 Statements of Shareholders Equity (Deficit)
 For the Period Ended June 9, 2005 and the Year Ended December 31, 2004
 Retained
    
    
    
    
    
    
    TotalCommon stock
    
    
    Earnings
    
    
    Accumulated other
    
    
    ShareholdersShares
    
    
    Amount
    
    
    (Deficit)
    
    
    comprehensive loss
    
    
    EquityBalance  December 31, 2003
    
    
    6,251,601
    
    
    $
    4,000,001
    
    
    $
    (2,611,195
    )
    
    $
    (6,698
    )
    
    $
    1,382,108Net loss for the year
    
    
    
    
    
    
    
    
    
    
    (754,499
    )
    
    
    
    
    
    
    (754,499
    )Change in value of
interest rate swap
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    126,530
    
    
    
    126,530Change in fair value of
financial instruments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (119,832
    )
    
    
    (119,832
    )Balance  December 31, 2004
    
    
    6,251,601
    
    
    
    4,000,001
    
    
    
    (3,365,694
    )
    
    
    
    
    
    
    634,307Net loss for the period
    
    
    
    
    
    
    
    
    
    
    (856,587
    )
    
    
    
    
    
    
    (856,587
    )Balance  June 9, 2005
    
    
    6,251,601
    
    
    $
    4,000,001
    
    
    $
    (4,222,281
    )
    
    $
    
    
    
    $
    (222,280
    )
   F-52




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##### Table of Contents



INSTANTEL INC.
 
 Statements of Cash Flows
 For the Period Ended June 9,2005
    
    
    2004(Unaudited)OPERATING ACTIVITIESNet loss
    
    $
    (856,587
    )
    
    $
    (356,474
    )Items not affecting cash:Depreciation
    
    
    132,656
    
    
    
    85,605Provision for doubtful accounts
    
    
    25,000
    
    
    
    Provision for obsolete inventory
    
    
    395,000
    
    
    
    Amortization of intangible assets
    
    
    1,510,500
    
    
    
    1,510,500Deferred income taxes
    
    
    (1,263,742
    )
    
    
    (545,588
    )(57,173
    )
    
    
    694,043Changes in non-cash operating working capital itemsAccounts receivable
    
    
    (59,058
    )
    
    
    111,133Income taxes recoverable
    
    
    
    
    
    
    25,053Inventories
    
    
    (575,898
    )
    
    
    (198,029
    )Other current assets
    
    
    120,354
    
    
    
    166,291Accounts payable
    
    
    (433,803
    )
    
    
    (314,170
    )Accrued liabilities
    
    
    357,319
    
    
    
    95,232Deferred revenue
    
    
    89,000
    
    
    
    Income taxes payable
    
    
    (206,246
    )
    
    
    79,802Salary and benefits payable
    
    
    746,288
    
    
    
    151,588Other
    
    
    
    
    
    
    (45,776
    )Cash (used in) provided by operating activities
    
    
    (19,217
    )
    
    
    765,167INVESTING ACTIVITIESPurchase of capital assets
    
    
    (151,160
    )
    
    
    (67,227
    )Cash used in investing activities
    
    
    (151,160
    )
    
    
    (67,227
    )FINANCING ACTIVITIESIncrease in bank indebtedness
    
    
    127,565
    
    
    
    Repayment of long term debt
    
    
    
    
    
    
    (417,351
    )Cash provided by (used in) financing activities
    
    
    127,565
    
    
    
    (417,351
    )INCREASE IN CASH AND CASH EQUIVALENTS
    
    
    (42,812
    )
    
    
    280,589CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
    
    
    46,481
    
    
    
    167,451CASH AND CASH EQUIVALENTS, END OF PERIOD
    
    $
    3,669
    
    
    $
    448,040Supplementary informationInterest paid
    
    $
    367,885
    
    
    $
    476,552Income taxes paid
    
    $
    279,828
    
    
    $
    43,055
   F-53




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##### Table of Contents



1. DESCRIPTION OF THE BUSINESS
 ® ® ®
  2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 Management responsibility
  Cash and cash equivalents
  Accounts receivable
  Inventories
  Capital assets
   Goodwill and intangible assets
   Intellectual property costs
  Revenue recognition
    F-54




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##### Table of Contents



Deferred Revenue Policy
  Income taxes
  Investment tax credits
  Financial instruments
  Use of estimates
  Derivative instruments and hedging activities
  Foreign currency translation
   Change in company estimates
   F-55




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##### Table of Contents



3. INVENTORIES
 June 9, 2005
    
    
    December 31, 2004Materials
    
    $
    710,320
    
    
    $
    809,701Work in process
    
    
    539,501
    
    
    
    349,162Finished goods.
    
    
    461,070
    
    
    
    371,130$
    1,710,891
    
    
    $
    1,529,993
  4. CAPITAL ASSETS
 June 9, 2005Accumulated
    
    
    Net BookCost
    
    
    Amortization
    
    
    ValueApplication software
    
    $
    24,952
    
    
    $
    22,522
    
    
    $
    2,430Equipment
    
    
    860,531
    
    
    
    400,961
    
    
    
    459,570Leasehold improvements
    
    
    40,406
    
    
    
    9,757
    
    
    
    30,649$
    925,889
    
    
    $
    433,240
    
    
    $
    492,649
 December 31, 2004Accumulated
    
    
    Net BookCost
    
    
    Amortization
    
    
    ValueApplication software
    
    $
    33,393
    
    
    $
    23,626
    
    
    $
    9,767Equipment
    
    
    878,877
    
    
    
    414,499
    
    
    
    464,378Leasehold improvements
    
    
    57,319
    
    
    
    57,319
    
    
    
    $
    969,589
    
    
    $
    495,444
    
    
    $
    474,145
 5. INTANGIBLE ASSETS
  June 9, 2005
    
    
    December 31, 2004Trademarks
    
    $
    4,600,000
    
    
    $
    4,600,000Customer relationships
    
    
    6,200,000
    
    
    
    6,200,000Technology
    
    
    6,300,000
    
    
    
    6,300,00017,100,000
    
    
    
    17,100,000Less accumulated amortization
    
    
    (12,340,500
    )
    
    
    (10,830,000
    )$
    4,759,500
    
    
    $
    6,270,000
   6. BANK LINE OF CREDIT
   F-56




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##### Table of Contents



7. INCOME TAXES
 June 9, 2005
    
    
    December 31, 2004Income taxes payable from prior period
    
    $
    (328,711
    )
    
    $
    (5,947
    )Provision for current income taxes, net of tax Credits
    
    
    (302,484
    )
    
    
    (909,893
    )Provision for investment tax credits
    
    
    246,151
    
    
    
    392,545Current year investment tax credits  capital
    
    
    13,268
    
    
    
    33,732(43,015
    )
    
    
    (483,616
    )Capital taxes
    
    
    (22,000
    )
    
    
    (15,302
    )Installments
    
    
    192,000
    
    
    
    240,000Payments and refunds
    
    
    87,828
    
    
    
    (66,241
    )Adjustments
    
    
    (8,566
    )
    
    
    2,395(206,247
    )
    
    
    (322,764
    )Income taxes payable
    
    $
    (122,464
    )
    
    $
    (328,711
    )
  June 9, 2005
    
    
    December 31, 2004Deferred tax liabilitiesIntangible assets
    
    $
    1,623,941
    
    
    $
    2,389,706Long term debt
    
    
    
    
    
    
    285,000Other
    
    
    (86,041
    )
    
    
    1,537,900
    
    
    
    2,674,706Deferred tax assets  current portion
    
    
    126,936
    
    
    
    $
    1,410,964
    
    
    
    2,674,706
 8. LONG-TERM DEBT
 June 9, 2005
    
    
    December 31, 2004Senior subordinated note, bearing
interest at 14% per annum repayable in
twelve equal quarterly principal
installments of $458,333 beginning
December 31, 2006. Interest is payable
quarterly
    
    $
    5,500,000
    
    
    $
    5,500,000Less: current portion of long term debt
    
    
    (5,500,000
    )
    
    
    $
    
    
    
    $
    5,500,000
   9. LEASE COMMITMENT
  Balance of 2005
    
    $
    56,0002006
    
    
    285,0002007
    
    
    298,0002008
    
    
    304,0002009
    
    
    127,000Total
    
    $
    1,070,000
  F-57




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##### Table of Contents



10. FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
 Interest rate risk
  Foreign exchange risk
  11. CONTINGENCIES
  12. RELATED PARTY TRANSACTIONS
  13. SUBSEQUENT EVENT
   F-58




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##### Table of Contents



Exhibit Index
 ExhibitNumber
    
    Description2.1
    
    Acquisition Agreement dated as of January 25, 2005 between Applied Digital Solutions, Inc. and EXI
Wireless Inc. (1)2.2
    
    Amendment to Acquisition Agreement dated as of March 11, 2005 between Applied Digital Solutions,
Inc. and EXI Wireless Systems Inc. (1)2.3
    
    Exchange Agreement dated as of June 9, 2005 between Applied Digital Solutions, Inc. and VeriChip
Corporation (1)2.4
    
    Waiver and Release between Applied Digital Solutions, Inc. and VeriChip Corporation (1)2.5
    
    Share Purchase Agreement dated as of June 10, 2005 among Instantel Inc., Instantel Holding Company
s.ár.l., Perceptis, L.P., VeriChip Inc., Applied Digital Solutions, Inc. and VeriChip Corporation (1)2.6
    
    Letter Agreement dated as of December 21, 2005, by and among VeriChip Corporation, VeriChip Inc.,
and Applied Digital Solutions, Inc. (1)3.1
    
    Second Amended and Restated Certificate of Incorporation of VeriChip Corporation filed with the
Secretary of State of Delaware on December 18, 2006 (1)3.2
    
    Amended and Restated By-laws of VeriChip Corporation adopted as of December 12, 2005 (1)4.1
    
    Form of Specimen Common Stock Certificate (1)10.1*
    
    VeriChip Corporation 2002 Flexible Stock Plan, as amended through December 21, 2006 (4)10.2*
    
    VeriChip Corporation 2005 Flexible Stock Plan, as amended through December 21, 2006 (4)10.3*
    
    Form of Restricted Stock Award Agreement (4)10.4*
    
    Form of Non-Qualified Stock Option Award Agreement (4)10.5
    
    Commercial Loan Agreement dated as of December 27, 2005 between VeriChip Corporation and Applied
Digital Solutions, Inc. (1)10.6
    
    Revolving Line of Credit Note Working Capital of VeriChip Corporation dated as of December 27,
2005 (1)10.7
    
    Security Agreement dated as of December 27, 2005 between VeriChip Corporation and Applied Digital
Solutions, Inc. (1)10.8
    
    First Amendment to Commercial Loan Agreement dated as of October 6, 2006 between Applied Digital
Solutions, Inc. and VeriChip Corporation (1)10.9
    
    First Amendment to Security Agreement dated as of October 6, 2006 between Applied Digital
Solutions, Inc. and VeriChip Corporation (1)10.10
    
    Second Amendment to Commercial Loan Agreement dated as of January 19, 2007 between Applied Digital
Solutions, Inc. and VeriChip Corporation (1)




---



##### Table of Contents



ExhibitNumber
    
    Description10.11
    
    Second Amendment to Security Agreement dated as of January 19, 2007 between Applied Digital Solutions,
Inc. and VeriChip Corporation (1)10.12
    
    Third Amendment to Commercial Loan Agreement dated as of February 8, 2007 between Applied Digital
Solutions, Inc. and VeriChip Corporation (1)10.13
    
    Third Amended and Restated Revolving Line of Credit Note dated as of February 8, 2007 between Applied
Digital Solutions, Inc. and VeriChip Corporation (1)10.14
    
    Amendment to Third Amended and Restated Revolving Line of Credit Note dated as of February 29, 2008
between VeriChip Corporation and Applied Digital Solutions, Inc. (11)10.15
    
    Third Amendment to Security Agreement dated as of February 8, 2007 between Applied Digital Solutions,
Inc. and VeriChip Corporation (1)10.16
    
    Fourth Amendment to Commercial Loan Agreement and Security Agreement dated as of February 13, 2007
between Applied Digital Solutions, Inc. and VeriChip Corporation (2)10.17
    
    Letter Agreement dated as of April 18, 2005 between Royal Bank of Canada and EXI
Wireless Inc. (1)10.18
    
    Credit Facility Agreement dated as of March 15, 2006 between VeriChip Holdings Inc. and Royal Bank of
Canada (1)10.19
    
    General Security Agreement dated as of March 27, 2006 between Royal Bank of Canada and VeriChip Holdings
Inc. (1)10.20
    
    Guarantee and Postponement of Claim dated as of March 27, 2006 between Royal Bank of Canada and VeriChip
Corporation, a Canadian corporation (1)10.21
    
    Amended and Restated Supply, License and Development Agreement dated as of December 27, 2005 between
VeriChip Corporation and Digital Angel Corporation (1)10.22
    
    First Amendment to Amended and Restated Supply, License and Development Agreement dated as of May 9,
2007 between the Registrant and Digital Angel Corporation. (5)10.23
    
    Amended and Restated Transition Services Agreement dated as of December 21, 2006 between VeriChip
Corporation and Applied Digital Solutions, Inc. (1)10.24
    
    Lease dated as of July 6, 1998 between Kanata Research Park Corporation and Instantel Inc. (1)10.25
    
    Agreement regarding Lease dated as of September 30, 1999 between Kanata Research Park Corporation and
Instantel Inc. (1)10.26
    
    Agreement regarding Lease dated as of October 5, 1999 between Kanata Research Park Corporation and
Instantel Inc. (1)10.27
    
    Amendment to Lease dated as of October 28, 2003 between Kanata Research Park Corporation and Instantel
Inc. (1)10.28
    
    Second Amendment to Lease dated as of May 19, 2006 between Kanata Research Park Corporation and VeriChip
Corporation (1)10.29
    
    Lease dated as of August 16, 2000 between Princeton Developments Ltd., Gratrend Holdings Ltd. and
Software Integration Services Ltd. (1)10.30
    
    Lease Agreement dated as of December 18, 2000 between Bentall Properties Ltd., Westminster Management
and EXI Wireless Systems Inc. (1)10.31
    
    Lease Extension and Amending Agreement dated as of June 1, 2004 between BTC Properties II Ltd.,
Westminster Management Corporation and EXI Wireless Systems Inc. (1)10.32
    
    Strategic Alliance Agreement dated as of October 25, 2004 by and among Agility Healthcare Solutions LLC,
Trenstar Inc. and VeriChip Inc. (1)10.33
    
    Patient Security Systems Capital Equipment Supplier Agreement dated as of April 18, 2005 between
Novation, LLC and EXI Wireless Systems, Inc. (1)




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##### Table of Contents



ExhibitNumber
    
    Description10.34*
    
    Letter Agreement dated as of August 11, 2005 between VeriChip Corporation and Daniel A.
Gunther (1)10.35*
    
    Amendment to Letter Agreement dated as of March 2, 2007 between VeriChip Corporation and Daniel A.
Gunther (3)10.36*
    
    Executive Agreement dated as of December 17, 2001 between EXI Wireless Inc. and Nurez
Khimji (1)10.37*
    
    Amendment to Executive Agreement dated as of April 29, 2004 between VeriChip Inc. and Nurez
Khimji (1)10.38*
    
    Executive Agreement Addendum dated as of April 1, 2005 between VeriChip Inc. and Nurez
Khimji (1)10.39
    
    VeriChip Authorized Dealer Agreement dated as of January 4, 2006, by and between VeriChip Corporation
and Ingersoll Rand Security Technologies (1)10.40
    
    Trademark Assignment Agreement dated as of December 21, 2006 between Applied Digital Solutions, Inc. and
VeriChip Corporation (1)10.41*
    
    Letter Agreement dated as of August 2, 2006 between VeriChip Corporation and William J.
Caragol (1)10.42*
    
    2007 Senior Management Incentive Plan for Daniel A. Gunther dated as of March 2, 2007 (3)10.43
    
    2006 Tax Allocation Agreement dated as of December 21, 2006 between VeriChip Corporation, Applied
Digital Solutions, Inc. and the Consolidated Group (4)10.44*
    
    Employment and Non-Compete Agreement dated as of December 5, 2006 between Scott R. Silverman and
VeriChip Corporation (1)10.45
    
    BI Patent License Agreement dated as of March 6, 2000 between BI Incorporated and Instantel
Inc. (1)10.46
    
    Amendment No. 1 to BI Patent License Agreement dated as of March 6, 2000 between BI Incorporated and
Instantel Inc. (1)10.47*
    
    VeriChip Corporation Executive Management Change in Control Plan dated March 2, 2007 (3)10.48*
    
    VeriChip Corporation Executive Management Incentive Plan dated April 2, 2007 (4)10.49*
    
    VeriChip Corporation 2007 Incentive Stock Plan (6)10.50*
    
    Form of Non-Qualified Option Award Agreement under the VeriChip Corporation 2007 Stock Incentive
Plan (7)10.51
    
    Consulting Agreement dated as of August 8, 2007 between VeriChip Corporation and Randolph K.
Geissler (7)10.52
    
    Registration Rights Agreement between VeriChip Corporation and Kallina Corporation, dated August 31,
2007 (8)10.53*
    
    Form of Stock Award Agreement (9)10.54
    
    Letter Agreement, dated December 20, 2007, between VeriChip Corporation and Applied Digital Solutions,
Inc. (10)10.55
    
    Securities Purchase Agreement dated as of February 29, 2008 among VeriChip Corporation, Xmark
Corporation, Valens Offshore SPV II, Corp. and LV Administrative Services, Inc. (11)10.56
    
    Secured Term Note dated as of February 29, 2008 by VeriChip Corporation and Xmark Corporation in favor
of Valens Offshore SPV II, Corp. (11)10.57
    
    Master Security Agreement dated as of February 29, 2008 among VeriChip Corporation, Xmark Corporation
and LV Administrative Services, Inc. (11)10.58
    
    Stock Pledge Agreement dated as of February 29, 2008 among VeriChip Corporation, Xmark Corporation and
LV Administrative Services, Inc. (11)10.59
    
    Intellectual Property Security Agreement dated as of February 29, 2008 among VeriChip Corporation, Xmark
Corporation and LV Administrative Services, Inc. (11)




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##### Table of Contents



ExhibitNumber
    
    Description10.60
    
    Letter Agreement dated as of February 29, 2008 between VeriChip Corporation and Applied Digital
Solutions, Inc. (11)21.1
    
    List of Subsidiaries of VeriChip Corporation23.1
    
    Consent of Eisner LLP23.2
    
    Consent of KPMG LLP23.3
    
    Consent of Meyers Norris Penny LLP24.1
    
    Powers of Attorney31.1
    
    Certification by Scott R. Silverman, Chief Executive Officer, pursuant to Exchange Act Rules 13A-14(a)
and 15d-14(a)31.2
    
    Certification by William J. Caragol, Chief Financial Officer, pursuant to Exchange Act Rules 13A-14(a)
and 15d-14(a)32.1
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
 (1)
    
    Incorporated by reference to the Registration Statement on Form S-1 previously filed by
VeriChip Corporation (Registration No. 333-130754).(2)
    
    Incorporated by reference to the Form 8-K previously filed by VeriChip Corporation on
February 15, 2007.(3)
    
    Incorporated by reference to the Form 8-K previously filed by VeriChip Corporation on March 8,
2007.(4)
    
    Incorporated by reference to the Annual Report on Form 10-K previously filed by VeriChip
Corporation on April 2, 2007.(5)
    
    Incorporated by reference to the Quarterly Report on Form 10-Q previously filed by VeriChip
Corporation on May 15, 2007.(6)
    
    Incorporated by reference to the Form 8-K previously filed by VeriChip Corporation on June 20,
2007.(7)
    
    Incorporated by reference to the Quarterly Report on Form 10-Q previously filed by VeriChip
Corporation on August 8, 2007.(8)
    
    Incorporated by reference to the Form 8-K previously filed by VeriChip Corporation on September
7, 2007.(9)
    
    Incorporated by reference to the Quarterly Report on Form 10-Q previously filed by VeriChip
Corporation on November 8, 2007.(10)
    
    Incorporated by reference to the Form 8-K previously filed by VeriChip Corporation on December
21, 2007.(11)
    
    Incorporated by reference to the Form 8-K previously filed by VeriChip Corporation on March 5,
2008.*
    
    Management contract or compensatory plan.
    
    Confidential treatment has been obtained with respect to certain
portions of this exhibit. Omitted portions have been filed separately
with the Securities and Exchange Commission.