VeriChip Off the Old Block

VERICHIP, A TINY MAKER of microchips that can be implanted in humans, continues to face stiff opposition over privacy issues as its parent company forges ahead with plans for an initial public offering.

In the latest challenge, Wisconsin on Tuesday became the first state to prohibit businesses and government agencies from forcing individuals to be implanted with microchips. While VeriChip, a subsidiary of Applied Digital (ADSX), wasn't the explicit target of the legislation, it is the only company with federal approval to implant chips into humans. In December, Applied Digital registered with the Securities and Exchange Commission to spin off VeriChip in an IPO. Those plans were amended for a second time last week, but the company still hasn't released details on the size, timing or pricing of the stock offering.

VeriChip, based in Delray Beach, Fla., sells radio frequency identification, or RFID, systems that can be used for tracking and identification. For example, these chips can be inserted into the hospital wristbands of newborns to deter abductions and ensure that babies go to the right mothers. RFID chips can also be used by retailers to track inventory or by ranchers to track cattle. But it's the glass-encapsulated RFID microchip that can be injected into a person's arm that's causing such an uproar.

VeriChip says this controversial application is well suited for people with dementia, Alzheimer's disease or those likely to be brought into a hospital emergency room unconscious or unable to speak. To read the chip a doctor or nurse waves a handheld scanner over a patient's arm. The chip, about the size of a grain of rice and implanted just under the skin, doesn't contain personal information. Rather, it transmits a 16-digit number to the scanner. The medical staff then inputs the number into a secured database to retrieve the patient's medical records.

Other applications are getting under the skin of privacy activists too. Apparel maker Levi's is testing RFIDs in its products, and a British amusement park wants customers to wear a wristband that will allow cameras to track them in the park. But when a Cincinnati company, CityWatcher.com, which stores surveillance-camera footage, earlier this year implanted employees with chips to allow them access to high-security areas, Big Brother opponents went ballistic.

"This is an insidious, way-beyond-Orwellian way to control people's lives," says Rep. Marlin Schneider, a Wisconsin Democrat and the bill's author. "[The legislation] doesn't preclude a person from requesting a chip, but it precludes government bureaucracies and corporations from forcing people to use it. Members of Congress better wake up to the fact that the biggest threat to our liberty isn't Al-Qaeda, but technology."

A violator could be fined up to $10,000 each day a chip remains in a recipient.

"The new law won't affect our business. In theory we are in agreement with Wisconsin," says Scott Silverman, chairman and chief executive of Applied Digital and chairman of VeriChip. "No one should be forced to get a microchip. Our policy is that the human application should be voluntary and every distributor has to sign an agreement saying that."

Considering the story didn't get much notice outside Madison, Applied Digital's stock barely budged. However, the shares are down 71% since they peaked at $7.41 on Dec. 7, 2004. Back then Applied Digital's stock price shot up in the wake of the Food and Drug Administration's approval of VeriChip. Shares have experienced a steep, steady slide since, and Applied Digital closed Thursday at $2.15 — almost exactly where it stood right before the FDA cleared the microchips for use in humans.

CEO Silverman's appearance on the Fox News Channel last month failed to rally bulls. In the televised interview he said federal officials had met with him to discuss RFIDs as a way to tackle the illegal immigrant problem. Silverman suggested guest workers could use the chips as ID at border crossings. No agreement has been announced.

A government contract would definitely help. According to SEC filings, the VeriChip subsidiary posted a first-quarter loss of $1.02 million, or six cents a share, on revenue of $6.6 million, compared with the year-ago quarter's loss of $1.08 million, or eight cents, on just $15,000 in sales. For 2005, VeriChip lost $5.2 million on sales of $15.9 million. It has just $594,000 in cash and negative $6.7 million in working capital. Silverman says 100 hospitals currently use VeriChip products. About 50 people have been implanted with the microchips.

Thirteen-year-old parent company Applied Digital is also operating in the red. For the first quarter, it posted a net loss of $3.0 million, or four cents a share, reversing a profit of $1.6 million, or three cents, a year ago. The loss occurred even as revenues surged 48% to $32 million. Cash fell by $1.5 million to $20.9 million as of March 31. The cash burn is $1.5 million to $2.0 million per quarter.

Half of Applied Digital's revenues came from Digital Angel (DOC), in which it holds a 57% stake. Digital Angel actually manufactures the chips sold by VeriChip. The South St. Paul, Minn., company also sells chips used for tracking pets and livestock.

Privacy advocate Liz McIntyre says in addition to privacy issues, there are concerns about VeriChip's reliability. In SEC filings, VeriChip admitted that it's "experienced short periods of inaccessibility to the patient information database" because of system maintenance and power outages. The company can't guarantee that future disruptions won't result in lost revenue and even possible litigation.

"They say throw away your Medic Alert bracelet, but what if you rely on this chip, enter an emergency room and the database is down?" asks McIntyre, the co-author of "Spychips," a book analyzing RFID systems. "And will all emergency personnel check for the chip? Because you can't put an unconscious person with a chip into an MRI machine. In addition, it might not work in an ambulance or helicopter where there are competing radio frequencies. While you might accept uncomfortable side affects from a drug you need to live, this is an optional device, not something people need."