VeriChip's IPO: Losses Ahead for New Implant System

Includes: CHIP, DIGA
by: Bill Simpson

On February 1, Bill Simpson wrote an analysis of VeriChip (CHIP). The IPO began trading on Feb. 9, and the stock opened and closed at a share price of $6.50, from a range of $6.50 to $8.50. The underwriters also cut the size of VeriChip's IPO to 3.1 million shares from 4.3 million shares.

The text of Mr. Simpson's original writeup follows:

VeriChip plans on offering 4.95 million shares at a range of $6.50 - $8.50. Merriman Curhan Ford is lead managing the deal, Kaufman and CE Unterberg are co-managing. As far as I can tell, Merriman as currently structured has not led an offering previously. Post-offering CHIP will have 11 million shares outstanding for a market cap of $82.5 million on a $7 1/2 pricing. IPO proceeds will be used by CHIP to market their VeriMed system as well as for general corporate purposes.

Applied Digital Solutions (ADSX) will own a little over 50% of CHIP's outstanding shares post-ipo. CHIP Chairman of the Board and CEO, Scott R. Silverman was CEO of ADSX from 3/03 - 12/06. He resigned that position in order to take the CEO position with CHIP. Note that Mr. Silverman received a substantial pay package in 2006 as part of this switch. Total 2006 compensation for Mr. Silverman was approximately $4.7 million. ADSX 2006 revenues were a little under $30 million. Yes, approximately $3.5 million of this compensation was part of a deal in which Mr. Silverman waived certain accrued incentives/options with ADSX. Still this was quite a nice payout for the CEO of such a small operation as CHIP. Note also, that Mr. Silverman has a $100,000+ annual expense allowance as CEO of CHIP. This is over/above his salary, bonus and stock awards.

From the prospectus:

We are primarily engaged in the development, marketing and sale of radio frequency identification, or RFID, systems used to identify, locate and protect people and assets. The healthcare industry represents the principal market for our radio frequency identification systems. Our goal is to become the leading provider of radio frequency identification systems in the healthcare industry.

CHIP had no revenues really through 2004. They exist as a combination of two Canadian operations purchased and put together by ADSX.

CHIP derives nearly all their revenues from two RFID based lines and plans to begin marketing a third:

1) Infant protection systems that help to prevent mother-baby mismatching and infant abduction.

2) Wander prevention systems that help to protect and locate residents in nursing homes and assisted living facilities. This one has raised a number of protests as it can involve implants into those being monitored.

3) CHIP has just begun marketing an asset/staff location and identification system to hospitals and other healthcare facilities. Thus far they've sold three of these systems.

RFID Technology: Involves the use of radio frequency, or RF, transmissions, typically achieved through communication between a microchip-equipped transponder and a receiver, for identification, location and other purposes. A 'tag' containing a microchip is attached to the item to be identified or located which wirelessly transmits stored information to a receiver.

VeriMed Patient Identification System:

CHIP is also in the process of rolling out what can be described as a somewhat controversial product, the VeriMed Patient Identification system. This system is the first and only human-implantable radio frequency transponder system cleared for use for patient identification and health information purposes. Yep, chips implanted under the skin in a person’s upper right arm. Unlike in other CHIP products, these implantable chips would be 'passive' meaning they would not transmit to a receiver intermittently. Instead they would only be 'turned on' when scanned by a receiver. The chips would also not contain any patient information themselves, only a 16 digit identification number. That number would then link to medical/identification information stored in the receiver database. Note that CHIP is currently trying to create the market for this device; they've not derived revenues from this thus far.

Target market for The VeriMed system consists of people who are more likely to require emergency medical care, persons with cognitive impairment, persons with chronic diseases and related conditions, and persons with implanted medical devices. CHIP believes their system will be of use for emergency personnel and first responders. Personally, I foresee a myriad of technology issues here. If these systems are sold to healthcare plans, hospitals or individual potential patients, to hold any value whatsoever the unresponsive future patient would have to be at or taken to a facility using the database with that patient’s information. If these were purchased by facilities, they're already going to have medical information readily available for their patients in their existing databases. This system would only have value if a patient is brought in 'cold' meaning a hospital or facility would have no existing information on this patient. That is the entire purpose of reading the implanted chip. In that case, what really would be the odds that an implanted patient would just happen to end up being taken to a facility or hospital that bought the system and has access to the database linking the patients implanted chip with the patient information????
Say this chip was implanted in someone in the target market with say 'cognitive impairment'. How many potential future emergency rooms or first responders are actually going to work for operations that bought this system and able to read the implantable chip in case of emergency? If the person is institutionalized, that institution will already have information readily available for this person in case of an emergency, so an implant would be of little added help. These would work and be of use only in situations in which the responders had no information on an unresponsive patient...and would require a lot of luck in matching up an implanted patient with a facility that purchased access to the database.

I'm at a real loss here in trying to determine where revenues will be derived from this implantable VeriMed Patient Identification System. Apparently so is CHIP. The system was cleared in 2004, yet to date, CHIP has been unable to generate really any revenues from this implantable system. From the prospectus: 'To date, we have only generated approximately $0.1 million in revenue from sales of the microchip inserted kits, significantly less than we had projected at the beginning of 2006'. Note that CHIP does not expect more than nominal revenues from the VeriMed Patient Identification System over the next 18 months. Between the lines: CHIP thought they were onto something, projected sales for this product to begin ramping in 2006. It hasn't happened and now CHIP doesn't expect much revenue from this system through 2008. Not pretty. CHIP however will be devoting substantial expenses to the implantable system.

In the prospectus, CHIP mentions negative publicity as one reason for the lack of revenues from this implantable system. To me, logistics are the big problem here. It just isn't workable as designed and for the cases in which it would be workable, the facilities don't need an implantable system as they've already got information/identification for their patients readily accessible. Really, the CHIP business plan for these implantable systems seems quite poorly constructed. According to CHIP- ' Our plan also anticipates our deriving significant and growing recurrent revenue from subscriptions to our database by persons implanted with our microchip.' Somehow chronically ill and/or those with mental illness and/or incapacitated will somehow pay CHIP annually for this service? Really, huh. Good luck with that one CHIP. This is one of the more ridiculous business plans I've ever seen. These are the people most likely unable to pay for additional medical costs, let alone monthly for one, on the random and unlikely chance that in case of emergency they'll be taken to a hospital emergency room that just happens to have access to the CHIP database! This company is really building a business around this plan??????

There is also another reason why this implantable system of CHIP's is dead on arrival: cost of the microchip implant procedure is not covered by Medicare, Medicaid or private health insurance. If that doesn't change (and it doesn't appear imminent) CHIP will never derive significant revenues from their implantable system. No health care operator will buy and operate this identification system without third party payer reimbursement, period. Really that is the end of the story with this ipo and CHIP's grand plans for their implantable system. The fact that internally CHIP apparently projected significant revenues from this product in 2006 without 3rd party reimbursement would lead me to question management.

CEO and Chairman of the Board, Mr. Silverman really seems to be 'earning' his $4.7 million in 2006 compensation and that additional $100,000 annual expense allotment.

Patent rights to the VeriMed technology appear hazy. It doesn't appear as if CHIP is infringing on patents, but CHIP also will not have any patent protection in this area either.


$2 per share in cash.

Revenues again have been thus far derived almost entirely from the infant bracelet protection systems and the nursing home and assisted facility wander prevention bracelets. It appears revenue for 2007/2008 will also be derived predominantly from these two.

Revenues for 2005 (assuming the companies added were purchased 1/1/05) were $25 million. For 2006, revenues were $27 million, actually slowing in the back half of the year. Gross margins for 2005/2006 were 58%. GSA expenses ate up all gross margins each year. CHIP lost $0.55 per share in 2005 and $0.50-$0.55 per share in 2006.

I would not expect revenues to grow much at all here next few years as their revenue drivers are in mature slower growing businesses. CHIP does not expect to make money over the next few years. In fact they should continue to lose at least $0.50 per share through 2008.

Conclusion - Market cap here is quite small and VeriChip has apparently gained some sort of cult status out there. For the life of me I can't see why anyone would take their implantable system seriously as it really looks to me to be built upon a number of faulty assumptions... plus it is a moot point anyway without 3rd party reimbursement, which it does not have nor appears to be coming anytime in the foreseeable future. What CHIP does have is a stable business selling RFID monitoring systems for infant monitoring and to nursing homes and long-term care facilities. Unfortunately CHIP appears set on throwing a lot of expense money into their implantable system, which should ensure significant losses per share into the foreseeable future. This ipo is ugly, simply for the fact I don't see the implantable system of CHIP's ever gaining traction or bringing in much in revenue. Pass here. Note: this is a micro cap small float single digit ipo with some attention focused on it. It is conceivable it does okay in the short term due to this, however this is as shaky a business model/plan as I've seen for a company coming public.