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As filed with the Securities and Exchange Commission on August 14, 2002
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
-------------------------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2002
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from to
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COMMISSION FILE NUMBER: 0-26020
APPLIED DIGITAL SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
MISSOURI 43-1641533
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
400 ROYAL PALM WAY, SUITE 410
PALM BEACH, FLORIDA 33480
(561) 805-8000
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes /X/ No / /
The number of shares outstanding of each of the issuer's classes of
common stock as of the close of business on August 9, 2002:
Class Number of Shares
Common Stock; $.001 Par Value 277,518,699
APPLIED DIGITAL SOLUTIONS, INC.
TABLE OF CONTENTS
Item Description Page
PART I - FINANCIAL INFORMATION
1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets
June 30, 2002, as restated and December 31, 2001 3
Condensed Consolidated Statements of Operations -
Three and Six Months ended June 30, 2002 and 2001 4
Condensed Consolidated Statement of Stockholders' Equity -
Six Months ended June 30, 2002 5
Condensed Consolidated Statements of Cash Flows -
Six Months ended June 30, 2002 and 2001 6
Notes to Consolidated Financial Statements 7
2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 28
3. Quantitative and Qualitative Disclosures About Market Risk 53
PART II - OTHER INFORMATION
1. Legal Proceedings 53
2. Changes In Securities 55
3. Defaults Upon Senior Securities 56
4. Submission of Matters to a Vote of Security Holders 56
5. Other Information 56
6. Exhibits and Reports on Form 8-K 57
SIGNATURE 58
EXHIBITS 59
2
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
ASSETS
JUNE 30, December 31,
2002 2001
------------------------------
CURRENT ASSETS (UNAUDITED)
Cash and cash equivalents $ 8,024 $ 3,696
Due from buyers of divested subsidiaries - 2,625
Accounts receivable and unbilled receivables (net of allowance
for doubtful accounts of $1,096 in 2002 and $2,581 in 2001) 17,504 21,871
Inventories 6,945 6,174
Notes receivable 2,323 2,256
Other current assets 2,932 4,786
- ----------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 37,728 41,408
PROPERTY AND EQUIPMENT, NET 17,589 20,185
NOTES RECEIVABLE, NET 5,206 4,004
GOODWILL, NET 130,518 90,831
INVESTMENT IN AFFILIATE - 6,779
OTHER ASSETS, NET 6,462 4,282
- ----------------------------------------------------------------------------------------------------------------------
$ 197,503 $ 167,489
======================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable and current maturities of long-term debt $ 82,893 $ 83,836
Accounts payable 11,238 15,441
Accrued expenses 21,572 18,207
Earnout and put accruals 6,806 200
Net liabilities of Discontinued Operations 10,618 9,460
- ----------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 133,357 127,144
LONG-TERM DEBT AND NOTES PAYABLE 2,442 2,586
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TOTAL LIABILITIES 135,569 129,730
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COMMITMENTS AND CONTINGENCIES - -
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MINORITY INTEREST 36,054 4,460
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REDEEMABLE PREFERRED STOCK OPTIONS - SERIES C - 5,180
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PREFERRED STOCK, COMMON STOCK AND OTHER STOCKHOLDERS' EQUITY
Preferred shares: Authorized 5,000 shares in 2002 and 2001 of $10
par value; special voting, no shares issued or outstanding in
2002 and 2001, Class B voting, no shares issued or outstanding
in 2002 and 2001 - -
Common shares: Authorized 345,000 shares in 2002 and 2001, of $.001 par
value; 271,212 shares issued and 270,227 shares outstanding in 2002
and 252,449 shares issued and 251,514 shares outstanding in 2001 271 252
Common and preferred additional paid-in capital 372,983 342,189
Accumulated deficit (348,522) (304,581)
Common stock warrants 4,337 3,293
Treasury stock (carried at cost, 935 shares in 2002 and 2001) (1,777) (1,777)
Accumulated other comprehensive income (loss) (86) (747)
Notes received from shares issued (1,326) (10,510)
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Total Preferred Stock, Common Stock, and Other Stockholders' Equity 25,880 28,119
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$ 197,503 $ 167,489
======================================================================================================================
See the accompanying notes to condensed consolidated financial statements.
SEE NOTES 1, 4 AND 7 REGARDING THE RESTRICTION ON APPLIED DIGITAL SOLUTIONS, INC.'S ABILITY TO EXERCISE CONTROL OVER
THE AFFAIRS, MANAGE THE RESOURCES AND TRANSFER FUNDS FROM A SIGNIFICANT OPERATING SUBSIDIARY.
3
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------------------------------------------
2002 2001 2002 2001
---------------------------------------------------
Product revenue $ 21,237 $ 27,053 $ 44,300 $ 61,436
Service revenue 4,599 12,818 9,755 25,844
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Total revenue 25,836 39,871 54,055 87,280
Cost of products sold 14,901 19,314 31,417 43,158
Cost of services sold 2,207 6,246 4,532 12,463
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Gross profit 8,728 14,311 18,106 31,659
Selling, general and administrative expenses 18,384 16,987 47,753 34,660
Research and development 782 1,704 1,761 3,089
Depreciation and amortization 1,384 7,512 2,388 14,364
Interest and other income (555) (600) (653) (1,087)
Interest expense 4,733 1,839 6,792 3,684
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Loss from continuing operations before taxes,
minority interest and equity in net loss of affiliate (16,000) (13,131) (39,935) (23,051)
Provision (benefit) for income taxes (13) 16,504 95 18,052
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Loss from continuing operations before minority interest, net
loss on subsidiary merger transaction, and equity in net
loss of affiliate (15,987) (29,635) (40,030) (41,103)
Minority interest (402) (353) (438) (446)
Net loss on subsidiary merger transaction, stock issuances and
loss on sale of subsidiary stock 3,888 - 4,282 -
Equity in net loss of affiliate - 64 291 82
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Loss from continuing operations (19,473) (29,346) (44,165) (40,739)
Income from discontinued operations, net of income
taxes of $0 in 2001 - - - 213
Change in estimate on loss on disposal and operating
losses during the phase out period (463) (21,789) 224 (21,789)
- -----------------------------------------------------------------------------------------------------------------------------------
Loss before extraordinary gain (19,936) (51,135) (43,941) (62,315)
Extraordinary gain - 9,465 - 9,465
- -----------------------------------------------------------------------------------------------------------------------------------
Net loss (19,936) (41,670) (43,941) (52,850)
Preferred stock dividends and other - 211 - 1,061
Accretion of beneficial conversion feature of
redeemable preferred stock - series C - 451 - 9,392
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Net loss available to common stockholders $ (19,936) $ (42,332) $ (43,941) $ (63,303)
===================================================================================================================================
Income (loss) per common share - basic and diluted
Income (loss) from continuing operations $ (0.07) $ (0.22) $ (0.17) $ (0.42)
Income from discontinued operations (0.01) (0.16) - (0.18)
Extraordinary gain - 0.07 - 0.08
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Net loss per common share - basic and diluted $ (0.08) $ (0.31) $ (0.17) $ (0.52)
===================================================================================================================================
Weighted average number of common shares outstanding - basic and diluted 265,914 138,589 260,869 121,236
See the accompanying notes to condensed consolidated financial statements.
SEE NOTES 1, 4 AND 7 REGARDING THE RESTRICTION ON APPLIED DIGITAL SOLUTIONS, INC.'S ABILITY TO EXERCISE CONTROL OVER THE AFFAIRS,
MANAGE THE RESOURCES AND TRANSFER FUNDS FROM A SIGNIFICANT OPERATING SUBSIDIARY.
4
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF PREFERRED STOCK,
COMMON STOCK AND OTHER STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2002
(In Thousands)
(Unaudited)
ADDITIONAL
PREFERRED STOCK COMMON STOCK PAID-IN ACCUMULATED
NUMBER AMOUNT NUMBER AMOUNT CAPITAL DEFICIT
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BALANCE - DECEMBER 31, 2001 - $ - 252,449 $ 252 $ 342,189 $ (304,581)
Net loss - - - - - (43,941)
Comprehensive income -
Foreign currency translation - - - - - -
------------
Total comprehensive loss - - - - - (43,941)
------------
Expiration of redeemable preferred
stock options - Series C - - - - 5,180 -
Interest accrued on notes receivable
received for shares issued - - - - - -
Adjustment to notes received
for shares issued - - - - (4,424) -
Allowance for uncollectible portion
of note receivable - - - - -
Collection of notes receivable received
for shares issued - - - - - -
Repurchase of common stock - - - - 1,878 -
Retirement of treasury stock - - - - (1,878) -
Shares issuable for settlement of liability - - - - 63 -
Obligation for shares issuable in settlement
of liability - - - - (63) -
Stock option repricing - - - - 2,907 -
Stock options - Digital Angel Corporation - - - - 18,681 -
Stock options - VeriChip Corporation - - - - 200 -
Issuance of warrants - - - - - -
Remeasurement of warrants -
Digital Angel Corporation - - - - 1,066 -
Issuance of common shares - - 7,192 7 1,417 -
Issuance of common shares and options for
services, compensation and other - - 11,571 12 5,767 -
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BALANCE - JUNE 30, 2002 - $ - 271,212 $ 271 $ 372,983 $ (348,522)
===================================================================================================================================
ACCUMULATED
COMMON OTHER NOTES TOTAL
STOCK TREASURY COMPREHENSIVE RECEIVED FOR STOCKHOLDERS'
WARRANTS STOCK INCOME (LOSS) SHARES ISSUED EQUITY
-----------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2001 $ 3,293 $ (1,777) $ (747) $ (10,510) $ 28,119
Net loss - - - - (43,941)
Comprehensive income -
Foreign currency translation - - 661 - 661
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Total comprehensive loss - - 661 - (43,280)
---------------- --------------
Expiration of redeemable preferred
stock options - Series C - - - - 5,180
Adjustment to notes received
for shares issued - - - 4,424 -
Allowance for uncollectible portion
of note receivable - - - 3,604 3,604
Collection of notes receivable received
for shares issued - - - 1,156 1,156
Repurchase of common stock - (1,878) - - -
Retirement of treasury stock - 1,878 - - -
Shares issuable for settlement of liability - - - - 63
Obligation for shares issuable in settlement
of liability - - - - (63)
Stock option repricing - - - - 2,907
Stock options - Digital Angel Corporation - - - - 18,681
Stock options - VeriChip Corporation - - - - 200
Issuance of warrants 1,044 - - - 1,044
Remeasurement of warrants -
Digital Angel Corporation - - - - 1,066
Issuance of common shares - - - - 1,424
Issuance of common shares and options for
services, compensation and other - - - - 5,779
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BALANCE - JUNE 30, 2002 $ 4,337 $ (1,777) $ (86) $ (1,326) $ 25,880
===================================================================================================================================
See the accompanying notes to condensed consolidated financial statements.
SEE NOTES 1, 4 AND 7 REGARDING THE RESTRICTION ON APPLIED DIGITAL SOLUTIONS, INC.'S ABILITY TO EXERCISE CONTROL OVER THE AFFAIRS,
MANAGE THE RESOURCES AND TRANSFER FUNDS FROM A SIGNIFICANT OPERATING SUBSIDIARY.
5
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
FOR THE SIX MONTHS
ENDED JUNE 30,
-------------------------------
2002 2001
-------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (43,941) $ (52,850)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
(Income) loss from discontinued operations (224) 21,576
Extraordinary gain - (9,465)
Non-cash compensation expense 22,264 -
Issuance of stock for services 2,702 -
Depreciation and amortization 2,388 14,364
Deferred income taxes - 19,650
Impairment of investments and notes receivable 3,940 -
Interest income on notes received for shares issued (475) -
Net loss on subsidiary merger transaction 4,282 -
Minority interest (438) (446)
Equity in net loss of affiliate 291 82
Gain on sale of subsidiaries and business assets (194) -
Loss on sale of equipment 507 85
Change in assets and liabilities:
Decrease in accounts receivable 4,611 5,389
Increase in inventories (703) (142)
Decrease in other current assets 1,953 837
Decrease in other assets 2,214 -
Decrease (increase) in accounts payable and
accrued expenses 2,172 (2,483)
Net cash provided by (used in) discontinued operations 302 (827)
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NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 1,651 (4,230)
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CASH FLOWS FROM INVESTING ACTIVITIES
Decrease in notes receivable 56 199
Received from buyers of divested subsidiaries 2,625 -
Increase in other assets (388) (1,982)
Proceeds from sale of property and equipment 2,481 -
Proceeds from sale of subsidiaries and business assets 1,106 -
Payments for property and equipment (988) (2,578)
Cash acquired (net of payments for costs of
business acquisitions) 40 -
Net cash used in discontinued operations (496) (539)
- --------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 4,436 (4,900)
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CASH FLOWS FROM FINANCING ACTIVITIES
Net amounts repaid on notes payable (3,631) (54)
Proceeds from long-term debt - 7,800
Payments on long-term debt (1,136) (40)
Other financing costs (174) (34)
Issuance of common shares 1,618 240
Collection of notes receivable received for shares issued 1,156 -
Stock issuance costs (193) (235)
Proceeds from subsidiary issuance of common stock 601 126
Net cash provided by (used in) discontinued operations - (309)
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NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (1,759) 7,494
- --------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 4,328 (1,636)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 3,696 8,039
- --------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 8,024 $ 6,403
====================================================================================================================
See the accompanying notes to condensed consolidated financial statements.
SEE NOTES 1, 4 AND 7 REGARDING THE RESTRICTION ON APPLIED DIGITAL SOLUTIONS, INC.'S ABILITY TO EXERCISE CONTROL OVER
THE AFFAIRS, MANAGE THE RESOURCES AND TRANSFER FUNDS FROM A SIGNIFICANT OPERATING SUBSIDIARY.
6
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying financial statements have been prepared on a going
concern basis and do not reflect any adjustments that might result from the
outcome of any uncertainty described in Note 4.
The accompanying unaudited condensed consolidated financial
statements of Applied Digital Solutions, Inc. (the "Company") as of June 30,
2002, and December 31, 2001 (the December 31, 2001 financial information
included herein has been extracted from the Company's audited financial
statements included in the Company's 2001 Annual Report on Form 10-K) and
for the three and six months ended June 30, 2002, and 2001 have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X under the
Securities Exchange Act of 1934. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally
accepted in the United States of America for complete financial statements.
In the opinion of the Company's management, all adjustments (including
normal recurring adjustments) considered necessary to present fairly the
condensed consolidated financial statements have been made.
The condensed consolidated statements of operations for the three
and six months ended June 30, 2002, are not necessarily indicative of the
results that may be expected for the entire year. These statements should be
read in conjunction with the consolidated financial statements and related
notes thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 2001.
Certain items in the condensed consolidated financial statements
for the 2001 period have been reclassified for comparative purposes.
Accounting Policy
- -----------------
Gains and losses on issuance of unissued shares of stock by a
consolidated subsidiary are reflected in the consolidated statement of
operations.
Accounting Changes and Restatement
- ----------------------------------
METHOD OF ACCOUNTING FOR DIGITAL ANGEL CORPORATION
Effective March 27, 2002, the Company's 93% owned subsidiary,
Digital Angel Corporation, which we refer to as pre-merger Digital Angel,
merged with and into a wholly-owned subsidiary of a publicly traded company,
Medical Advisory Systems, Inc. (MAS), and MAS changed its name to Digital
Angel Corporation. Under the terms of the merger agreement, each issued and
outstanding share of common stock of pre-merger Digital Angel (including
each share issued upon exercise of options prior to the effective time of
the merger) was cancelled and converted into the right to receive 0.9375
shares of MAS's common stock. The Company obtained 18.75 million shares of
MAS common stock in the merger (representing approximately 61% of the shares
then outstanding). Prior to the transaction, the Company owned 850,000
shares of MAS, or approximately 16.7%. Upon consummation of the
7
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
transaction, the Company owned 19.6 million shares, or approximately 74.25%
of the shares outstanding on June 30, 2002. Also, pursuant to the merger
agreement, the Company contributed to MAS all of its stock in Timely
Technology Corp., a wholly-owned subsidiary, and Signature Industries,
Limited, an 85% owned subsidiary. Pre-merger Digital Angel, Timely
Technology Corp. and Signature Industries, Limited were collectively
referred to as the Advanced Wireless Group (AWG). The merger has been
treated as a reverse acquisition for accounting purposes, with the AWG
treated as the accounting acquirer.
The total purchase price of the transaction was $31.2 million which
was comprised of the $25.0 million fair value of MAS stock outstanding not
held by the Company immediately preceding the merger, the $3.4 million
estimated fair value of MAS options and warrants outstanding as well as the
direct costs of the acquisition of $3.0 million. The transaction resulted in
Digital Angel Corporation tentatively allocating approximately $29.3 million
of the purchase price to goodwill.
The consolidated financial statements included in this Form 10-Q
include the accounts of Digital Angel Corporation and reflect the
outstanding voting stock not owned by the Trust (as defined in Note 4) as a
minority ownership interest in Digital Angel Corporation on the balance
sheet as of June 30, 2002. Significant intercompany balances and
transactions have been eliminated in consolidation. Digital Angel
Corporation is publicly traded on the AMEX:(DOC), with a closing market
price per share at June 30, 2002, and August 9, 2002, of $3.11 and $2.17,
respectively.
During the six months ended June 30, 2002, the Company recorded a
net loss of $0.4 million occasioned by the merger transaction, comprised of
a loss of approximately $5.1 million resulting from the exercise of 1.5
million pre-merger Digital Angel options (representing the difference
between the carrying amount of the Company's pro-rata share of the
investment in pre-merger Digital Angel and the exercise price of the
options) and a gain of approximately $4.7 million from the deemed sale of
22.85% of the AWG, as a result of the merger with MAS.
During the three and six months ended June 30, 2002, the Company
recorded a loss of $3.9 million on the issuances of 1.0 million shares of
Digital Angel Corporation common stock resulting from the exercise of stock
options and the sale of Digital Angel Corporation stock. The loss represents
the difference between the carrying amount of the Company's pro-rata share
of its investment in Digital Angel Corporation and the net proceeds from the
issuances of the stock and other changes in the Company's minority interest
ownership.
The merger of pre-merger Digital Angel and MAS, "the reverse
acquisition transaction," occurred on the second to the last business day of
the quarter ended March 31, 2002. By operation of the trust agreement, as
more fully discussed in Note 4, the Company's share of Digital Angel
Corporation's net assets is effectively restricted. Although Digital Angel
Corporation may pay dividends, the Company's access to this subsidiary's
funds is restricted. The following condensed consolidating balance sheet
data at June 30, 2002, shows, among other things, the Company's investment
in Digital Angel Corporation. MAS, the accounting acquiree, did not engage
in a significant level of activity immediately after the reverse acquisition
transaction through March 31, 2002. Thus, the restriction on Digital Angel
Corporation's operating results and cash flow became effective at the
beginning of the second quarter of 2002. Accordingly, the following
consolidating financial data on the results of operations for the three and
six-months ended June 30, 2002 and cash flows for the six-months ended June
30, 2002, have been presented.
8
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
CONDENSED CONSOLIDATING BALANCE SHEET DATA
JUNE 30, 2002
(UNAUDITED)
APPLIED DIGITAL DIGITAL ANGEL CONSOLIDATION
SOLUTIONS, INC. CORPORATION ELIMINATIONS CONSOLIDATED
-----------------------------------------------------------------
(in thousands)
Current Assets
Cash and cash equivalents $ 7,440 $ 584 $ 8,024
Accounts receivable, net 13,010 4,494 17,504
Inventories 1,371 5,574 6,945
Notes receivable 2,323 -- 2,323
Intercompany receivable 153 -- $ (153) --
Other current assets 1,775 1,157 2,932
-----------------------------------------------------------------
Total Current Assets 26,072 11,809 (153) 37,728
Property and Equipment 2,638 14,951 17,589
Notes Receivable, net 5,206 -- 5,206
Goodwill, net 19,481 106,258 4,779 130,518
Investment in Digital Angel Corporation 96,161 -- (96,161) --
Other Assets, net 5,659 803 6,462
-----------------------------------------------------------------
Total Assets $155,217 $133,821 $(91,535) $197,503
=================================================================
Current Liabilities
Notes payable and current maturities of
long-term debt $82,506 $387 $82,893
Accounts payable and accrued expenses 25,053 7,757 32,810
Earnout and put accruals 6,806 -- 6,806
Intercompany payable -- 153 (153) --
Net liabilities of Discontinued Operations 10,618 -- 10,618
-----------------------------------------------------------------
Total Current Liabilities 124,983 8,297 (153) 133,127
Long-Term Debt and Notes Payable 32 2,410 2,442
-----------------------------------------------------------------
Total Liabilities 125,015 10,707 (153) 135,569
Minority Interest 3,992 351 31,711 36,054
-----------------------------------------------------------------
Accumulated other comprehensive loss 244 (330) (86)
Other Stockholders' Equity 25,966 123,093 (123,093) 25,966
-----------------------------------------------------------------
Total Stockholders' Equity 26,210 122,763 (123,093) 25,880
-----------------------------------------------------------------
Total Liabilities and Stockholders' Equity $155,217 $133,821 $(91,535) $197,503
=================================================================
9
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS DATA
THREE-MONTHS ENDED JUNE 30, 2002
(UNAUDITED)
APPLIED DIGITAL DIGITAL ANGEL CONSOLIDATION
SOLUTIONS, INC. CORPORATION ELIMINATIONS CONSOLIDATED
-----------------------------------------------------------------
(in thousands)
Product revenue $12,653 $8,662 $(78) $21,237
Service revenue 4,022 577 4,599
-----------------------------------------------------------------
Total revenue 16,675 9,239 (78) $25,836
Cost of products sold 10,144 4,835 (78) 14,901
Cost of services sold 1,960 247 2,207
-----------------------------------------------------------------
Gross profit 4,571 4,157 -- 8,728
Selling, general and administrative expense 14,671 3,713 18,384
Research and development -- 782 782
Depreciation and amortization 289 1,095 1,384
Interest and other income (555) -- (555)
Interest income and expense, net Interest expense 4,666 67 4,733
-----------------------------------------------------------------
Loss from continuing operations before taxes,
minority interest, net loss on subsidiary/merger
transaction, and equity in net loss of affiliate (14,500) (1,500) (16,000)
Benefit for income taxes (13) -- (13)
-----------------------------------------------------------------
Loss from continuing operations before minority
interest, net loss on subsidiary/merger
transaction, and equity in net loss of affiliate (14,487) (1,500) (15,987)
Minority interest (400) (2) (402)
Net loss on subsidiary merger transaction, stock
issuances and loss on sale of subsidiary stock 3,888 -- 3,888
-----------------------------------------------------------------
Loss from continuing operations $(17,975) $(1,498) $ -- $(19,473)
=================================================================
10
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS DATA
SIX-MONTHS ENDED JUNE 30, 2002
(UNAUDITED)
APPLIED DIGITAL DIGITAL ANGEL CONSOLIDATION
SOLUTIONS, INC. CORPORATION ELIMINATIONS CONSOLIDATED
-------------------------------------------------------------------
(in thousands)
Product revenue $ 28,265 $ 16,113 $ (78) $ 44,300
Service revenue 8,875 880 - 9,755
------------------------------------------------------------------
Total revenue 37,140 16,993 (78) 54,055
Cost of products sold 22,360 9,135 (78) 31,417
Cost of services sold 4,034 498 - 4,532
------------------------------------------------------------------
Gross profit 10,746 7,360 - 18,106
Selling, general and administrative expense 22,038 25,715 - 47,753
Research and development 116 1,645 - 1,761
Depreciation and amortization 558 1,830 - 2,388
Interest and other income (653) - - (653)
Interest expense 6,667 1,931 (1,806) 6,792
------------------------------------------------------------------
Loss from continuing operations before taxes, minority
interest, net loss on subsidiary/merger transaction,
and equity in net loss of affiliate (17,980) (23,761) 1,806 (39,935)
Benefit for income taxes 95 - - 95
------------------------------------------------------------------
Loss from continuing operations before minority interest,
net loss on subsidiary/merger transaction, and equity
in net loss of affiliate (18,075) (23,761) 1,806 (40,030)
Minority interest (395) (43) - (438)
Net loss on subsidiary stock issuances (4,282) - - (4,282)
Equity in net loss of affiliate - 291 291
------------------------------------------------------------------
Loss from continuing operations $ (21,962) $ (24,009) $ 1,806 $ (44,165)
==================================================================
11
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS DATA
SIX-MONTHS ENDED JUNE 30, 2002
(UNAUDITED)
APPLIED
DIGITAL DIGITAL ANGEL CONSOLIDATION
SOLUTIONS, INC. CORPORATION ELIMINATIONS CONSOLIDATED
-----------------------------------------------------------------
(in thousands)
Cash Flows From Operating Activities
Net loss $(19,280) $(24,009) $ 1,806 $(43,941)
Adjustment to reconcile net loss to net cash
provided by (used in) operating activities:
Non-cash adjustments 11,623 22,768 (1,806) 35,043
Change in assets and liabilities:
Decrease in accounts receivable 3,277 1,181 153 4,611
(Increase) decrease in inventories (1,015) 312 -- (703)
(Increase) decrease in other current assets 2,498 (545) -- 1,953
(Increase) decrease in other assets 2,214 -- -- 2,214
Decrease in accounts payable and other
accrued expenses 2,886 (561) (153) 2,172
Net cash provided by (used in)
discontinued operations 302 -- -- 302
-----------------------------------------------------------------
Net Cash Provided by Operating Activities 2,505 (854) -- 1,651
-----------------------------------------------------------------
Cash Flows From Investing Activities
Decrease in notes receivable 2,681 -- -- 2,681
(Increase) decrease in other assets (451) 63 -- (388)
Proceeds from sale of property and equipment 2,458 23 -- 2,481
Proceeds from sale of subsidiaries and business
assets 1,106 -- -- 1,106
Payment for property and equipment (315) (673) -- (988)
Investment in subsidiaries (684) -- 684 --
Cash acquired through acquisition, net of
acquisition costs -- 40 -- 40
Net cash used in discontinued operations (496) -- -- (496)
-----------------------------------------------------------------
Net Cash Used In Investing Activities 4,299 (547) 684 4,436
-----------------------------------------------------------------
Cash Flows From Financing Activities
Net amounts borrowed (repaid) on notes payable (3,767) 136 -- (3,631)
Payments on long-term debt (1,104) (32) -- (1,136)
Other financing costs (174) -- -- (174)
Issuance of common shares 1,618 601 (601) 1,618
Collection of notes receivable received for
shares issued 1,156 -- -- 1,156
Stock issuance costs (193) -- -- (193)
Proceeds from subsidiary issuance -- -- 601 601
Intercompany transactions -- 684 (684) --
Net cash used in discontinued operations -- -- -- --
-----------------------------------------------------------------
Net Cash Used In Financing Activities (2,464) 1,389 (684) (1,759)
-----------------------------------------------------------------
Net Increase in Cash and Cash Equivalents 4,340 (12) -- 4,328
Cash and Cash Equivalents - Beginning of Period 3,100 596 -- 3,696
-----------------------------------------------------------------
Cash and Cash Equivalents - End of Period $ 7,440 $ 584 $ -- $ 8,024
-----------------------------------------------------------------
12
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
There are no restrictions on Digital Angel Corporation's ability to
declare or pay dividends under the IBM Credit Agreement (defined in Note 4).
All of the consolidated assets of the Company, exclusive of the assets of
Digital Angel Corporation, are collateral under the IBM Credit Agreement. In
addition, the shares of Digital Angel Corporation common stock held in the
Trust also collateralize the amounts outstanding under the IBM Credit
Agreement.
CHANGE IN METHOD OF ACCOUNTING FOR GOODWILL
Effective January 1, 2002, the Company adopted Statement of
Financial Accounting Standard No. 142 Goodwill and Other Intangible Assets
(FAS 142). FAS 142 requires that goodwill and certain intangibles no longer
be amortized, but instead tested for impairment at least annually. There was
no impairment of goodwill upon adoption of FAS 142. However, there can be no
assurance that future goodwill impairment tests will not result in
impairment charges.
The following table presents the impact of FAS 142 on net loss and
net loss per share had the standard been in effect beginning January 1,
2001:
Three Six
Months Ended Months Ended
June 30, 2001 June 30, 2001
----------------------------------------
Net loss available to common stockholders:
Net loss available to common stockholders as reported $ (42,332) $ (63,303)
Goodwill amortization 5,571 11,160
Equity method investment amortization 339 451
----------------------------------------
Adjusted net loss $ (36,422) $ (51,692)
========================================
Basic and diluted loss per share:
Net loss per share, basic and diluted, as reported $ (0.31) $ (0.52)
Goodwill amortization 0.04 0.09
Equity method investment amortization -- --
----------------------------------------
Adjusted net loss per share, basic and diluted $ (0.27) $ (0.43)
========================================
2. PRINCIPLES OF CONSOLIDATION
The financial statements include the accounts of the Company and
its wholly-owned and majority-owned subsidiaries, including Digital Angel
Corporation. The minority interest represents outstanding voting stock of
the subsidiaries not owned by the Company or the Trust. All significant
intercompany accounts and transactions have been eliminated in
consolidation.
13
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
3. INVENTORY
June 30, December 31,
2002 2001
---------------- ----------------
Raw materials $1,641 $1,474
Work in process 980 176
Finished goods 5,966 6,226
---------------- ----------------
8,587 7,876
Allowance for excess and obsolescence (1,642) (1,702)
---------------- ----------------
Net inventory for continuing operations $6,945 $6,174
================ ================
4. FINANCING AGREEMENTS
On January 31, 2002, and again on February 27, 2002, the Company
entered into amendments to its prior credit agreement with IBM Credit. These
amendments extended the principal and interest payments, which were due to
April 2, 2002, including principal payments that were initially due on July
1, 2001.
On March 1, 2002, the Company, Digital Angel Share Trust, a newly
created Delaware business trust (Trust) and IBM Credit entered into a Third
Amended and Restated Term Credit Agreement (IBM Credit Agreement). The IBM
Credit Agreement became effective on March 27, 2002, the effective date of
the merger between pre-merger Digital Angel and MAS. Amounts outstanding
under the IBM Credit Agreement bear interest at an annual rate of 17% and
initially mature on February 28, 2003. No principal or interest payments are
due until the maturity date. However, the maturity date will be
automatically extended to February 28, 2004, if the Company repays at least
40% of the original principal amount outstanding, plus accrued interest and
expenses, prior to February 28, 2003. If the maturity date is extended to
February 28, 2004, the maturity date will be automatically extended again to
February 28, 2005, if the Company pays an additional 40% of the original
principal amount outstanding plus accrued interest and expenses prior to
February 28, 2004. Any amounts outstanding at February 28, 2005, must be
repaid by August 31, 2005. If all amounts are not repaid by February 28,
2003, the unpaid amount will accrue interest at an annual rate of 25%. If
all amounts are not repaid by February 28, 2004, the interest rate increases
to 35%.
On June 30, 2002, the principal amount outstanding under the IBM
Credit Agreement was $82.1 million. As part of the amendments to the IBM
Credit Agreement, the Company incurred bank fees of $0.3 million in March
2002, and agreed to re-price warrants that were previously issued to IBM
Credit in April 2001. The re-priced warrants were valued at $1.0 million. In
addition, as a result of the merger between pre-merger Digital Angel and
MAS, warrants convertible into common stock of Digital Angel Corporation
that were previously issued to IBM Credit were revalued using the Black
Scholes method, resulting in additional deferred financing costs of $1.1
million. The bank fees and fair value of the warrants have been recorded as
deferred financing fees and are being amortized over the life of the debt as
interest expense.
14
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
The Company's covenants under the IBM Credit Agreement are as
follows: (The Company's Current Asset to Current Liabilities covenant is
measured monthly and the Minimum Cumulative EBITDA, as defined, is measured
quarterly). (Minimum Cumulative Modified EBITDA, as defined in the IBM
Credit Agreement, excludes non-cash compensation expense, one-time charges,
impairment losses and any liability or claim that will be satisfied by
issuance of the Company's common stock):
COVENANT COVENANT REQUIREMENT
-----------------------------------------------------------------------------------------------------------
As of the following date not less than:
Current Assets to Current
Liabilities June 30, 2002 .14:1
September 30, 2002 .11:1
December 31, 2002 .11:1
-----------------------------------------------------------------------------------------------------------
Minimum Cumulative
Modified EBITDA June 30, 2002 121,000
September 30, 2002 817,000
December 31, 2002 1,286,000
-----------------------------------------------------------------------------------------------------------
In addition, the IBM Credit Agreement contains covenants for
Digital Angel Corporation, as follows. If these Digital Angel Corporation
covenants are not met, the Company will be in default under the IBM Credit
Agreement. (Digital Angel Corporation's Current Asset to Current Liabilities
covenant and its Minimum Cumulative Modified EBITA, as defined is measured
quarterly):
COVENANT COVENANT REQUIREMENT
-----------------------------------------------------------------------------------------------------------
As of the following date not less than:
Current Assets to Current
Liabilities June 30, 2002 1.8:1
September 30, 2002 1.8:1
December 31, 2002 2.0:1
-----------------------------------------------------------------------------------------------------------
Minimum Cumulative
Modified EBITDA June 30, 2002 $577,000
September 30, 2002 1,547,000
December 31, 2002 3,329,000
-----------------------------------------------------------------------------------------------------------
The IBM Credit Agreement also contains restrictions on the
declaration and payment of dividends by the Company and its subsidiaries,
excluding Digital Angel Corporation.
At June 30, 2002, the Company was not in compliance with its
Minimum Cumulative Modified EBITDA debt covenant and with other provisions
of the debt agreement. In addition, Digital Angel Corporation was not in
compliance with the Minimum Cumulative Modified EBITDA and Current Assets to
Current Liabilities debt covenants. IBM has agreed to provide the Company
with a waiver of such noncompliance, the documentation of which will be
formalized no later than August 21, 2002. As consideration for the waiver,
the Company will issue to IBM a five year warrant to acquire 2.9 million
shares of the Company's Common Stock at $.15 per share, as well as other
consideration. However, the Company believes that when the third quarter
results are finalized, it will not be in compliance with certain financial
ratios for the third quarter of 2002. Although the Company will again
request a waiver from IBM Credit, there can be no assurances that a waiver
will be obtained.
15
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
In the future, if business conditions are other than as anticipated or other
unforeseen events or circumstances occur, these may impact the Company's
ability to remain in compliance with the covenants. In the absence of waiver
or amendment to the financial covenants, such noncompliance would constitute
an event of default under the IBM Credit Agreement, and IBM Credit would be
entitled to accelerate the maturity of all amounts the Company owes them. In
the event such noncompliance appears likely, or occurs, the Company will
seek to renegotiate the covenants and/or obtain waivers, as required. There
can be no assurance, however, that the Company would be successful in
negotiating such amendments or obtaining such waivers.
Amounts outstanding under the IBM Credit Agreement are
collateralized by a security interest in substantially all of the Company's
assets, excluding the assets of Digital Angel Corporation. The shares of the
Company's subsidiaries, including the Digital Angel Corporation common stock
held in the Digital Angel Share Trust, also collateralize the amounts
outstanding under the IBM Credit Agreement.
The IBM Credit Agreement prohibits the Company from borrowing funds
from other lenders without the approval of IBM Credit, and does not provide
for any further advances by IBM Credit. Accordingly, there can be no
assurance that the Company will have access to funds necessary to provide
for its ongoing operating expenses to the extent not provided from its
ongoing operating revenue.
The Company is continually seeking operational efficiencies and
synergies within each of its operating segments as well as evaluating
acquisitions of businesses and customer bases which complement its
operations. These strategic initiatives may include acquisitions, raising
additional funds through equity offerings, or the divestiture of non-core
business units that are not critical to the Company's long-term strategy or
other restructurings or rationalization of existing operations. The Company
will continue to review all alternatives to ensure maximum appreciation of
our shareholder's investments. There can be no assurance, however, that any
initiative will be found, or if found, that they will be on terms favorable
to the Company.
16
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
5. LOSS PER SHARE
The following is a reconciliation of the numerator and denominator
of basic and diluted loss per share:
------------------------------------------------
THREE-MONTHS SIX-MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------------------------------
2002 2001 2002 2001
---- ---- ---- ----
NUMERATOR:
Loss from continuing operations $(19,936) $(29,346) $(43,941) $(40,739)
Preferred stock dividends -- (211) -- (1,061)
Accretion of beneficial conversion feature of redeemable preferred stock -- (451) -- (9,392)
------------------------------------------------
NUMERATOR FOR BASIC LOSS PER SHARE -
Net loss from continuing operations available to commons shareholders $(19,473) $(30,008) $(43,941) $(51,192)
Net income (loss) from discontinued operations available to common
shareholders (463) (21,789) 224 (21,576)
Extraordinary gain -- 9,465 9,465
------------------------------------------------
Net loss available to common shareholders $(19,936) $(42,332) $(43,941) $(63,303)
================================================
DENOMINATOR:
DENOMINATOR FOR BASIC LOSS PER SHARE -
Weighted-average shares 265,914 138,589 260,869 121,236
------------------------------------------------
Denominator for diluted earnings (loss) per share(1) 265,914 138,589 260,869 121,236
------------------------------------------------
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE:
CONTINUING OPERATIONS $(0.07) $(0.22) $(0.17) $(0.42)
DISCONTINUED OPERATIONS (0.01) (0.16) -- (0.18)
EXTRAORDINARY GAIN -- 0.07 -- 0.08
------------------------------------------------
TOTAL - BASIC AND DILUTED $(0.08) $(0.31) $(0.17) $(0.52)
================================================
(1) The weighted average shares listed below were not included in the
computation of diluted loss per share because to do so would have
been anti-dilutive for the periods presented:
-----------------------------------------------------
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-----------------------------------------------------
2002 2001 2002 2001
---- ---- ---- ----
Redeemable preferred stock -- 39,989 -- 46,868
Employee stock options 18,248 1,233 19,121 2,628
Warrants 2,460 -- 2,281 102
-----------------------------------------------------
20,708 41,222 21,402 49,598
=====================================================
17
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
6. SEGMENT INFORMATION
As a result of the merger of pre-merger Digital Angel and MAS, the
significant restructuring of the Company's business during the past several
months and the Company's emergence as an advanced technology development
company, the Company has re-evaluated and realigned its reporting segments.
The Company currently operates in three business segments - Advanced
Technology, Digital Angel Corporation and SysComm International.
The business units comprising the Advanced Technology segment
represent those businesses that management believes will provide the
necessary synergies, support and infrastructure to allow the Company to
develop, promote and fully-integrate its life-enhancing technology products
and services.
The Digital Angel Corporation segment consists of the business
operations of Digital Angel Corporation, the Company's 74.25% owned
subsidiary and is engaged in the business of developing and bringing to
market proprietary technologies used to identify, locate and monitor people,
animals and objects. Before March 27, 2002, the business of Digital Angel
Corporation was operated in four divisions: Animal Tracking, Digital Angel
Technology, Digital Angel Delivery System, and Radio Communications and
Other. With the acquisition of MAS on March 27, 2002, Digital Angel
Corporation re-organized into four new divisions: Animal Applications
(formerly Animal Tracking), Digital Angel Systems, GPS and Radio
Communications, and Physician Call Center and Other. Physician Call Center
and Other reflect the newly acquired MAS business.
The SysComm International segment consists of the business
operations of SysComm International Corporation (OTC:SYCM), the Company's
52.5% owned subsidiary. This segment provides professional services in the
areas of systems integration, information technology (IT) procurement and
logistics, and technology strategy. Doing business as "InfoTech," this
segment provides integrated eBusiness strategy and technology implementation
services on a regional basis to enterprise and small to medium businesses
who want to fully leverage eBusiness technologies as part of their overall
business strategy. Its service offerings includes technology strategy and
due diligence consulting, systems architecture and design, application and
technology infrastructure deployment, enterprise security, IT product
procurement and logistics, and provisioning.
Business units that were closed or sold during the 2001 and 2002
are reported as "All Other."
Prior to January 1, 2002, the Company's business units were
organized into three segments: Applications, Services and Advanced Wireless.
Prior period information has been restated to present the Company's
reportable segments on a comparative basis.
The "Corporate/Eliminations" category includes all amounts
recognized upon consolidation of the Company's subsidiaries such as the
elimination of intersegment revenues, expenses, assets and liabilities.
"Corporation/Eliminations" also includes certain interest expense and other
expenses associated with corporate activities and functions. Included in
"Corporate/Eliminations" for the six-months ended June 30, 2002, is a
non-cash compensation charge of $18.7 million associated with pre-merger
Digital Angel options, which were converted into options to acquire shares
of MAS in connection with the merger of pre-merger Digital Angel and MAS.
Additionally, the Company's previously reported Intellesale and all
other non-core business segments are reported as discontinued operations.
18
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
The accounting policies of the segments are the same as those
described in the summary of significant accounting policies in the Company's
Annual Report on Form 10-K filed for the year-ended December 31, 2001,
except that intersegment sales and transfers are generally accounted for as
if the sales or transfers were to third parties at current market prices. It
is on this basis that management utilizes the financial information to
assist in making internal operating decisions. The Company evaluates
performance based on segment operating income.
Following is the selected segment data as of and for the
three-months ended June 30, 2002:
SEGMENTS
--------
Digital
Advanced Angel SysComm All Corporate/
Technology Corporation International Other Eliminations Consolidated
---------------------------------------------------------------------------------
Net revenue from external customers:
Product $8,528 $8,662 $4,127 $-- $(80) $21,237
Service 3,368 577 668 -- (14) 4,599
Inter-segment revenue - product -- (78) -- -- 78 --
---------------------------------------------------------------------------------
Total revenue $11,896 $9,161 $4,795 $-- $(16) $25,836
=================================================================================
Income (loss) from continuing operations
before income taxes, minority interest,
net loss on subsidiary merger transaction
and equity in net loss of affiliate $(1,116) $(1,500) $(54) $10 $(13,340) $(16,000)
=================================================================================
Total assets (2) $41,837 $138,600 $13,008 $2,849 $1,209 $197,503
=================================================================================
Following is the selected segment data as of and for the six-months
ended June 30, 2002:
SEGMENTS
--------
Digital
Advanced Angel SysComm All Corporate/
Technology Corporation International Other Eliminations Consolidated
---------------------------------------------------------------------------------
Net revenue from external customers:
Product $13,431 16,113 $13,820 $1,014 $(78) $44,300
Service 6,984 880 1,480 375 36 9,755
Inter-segment revenue - product -- (78) -- -- 78 --
---------------------------------------------------------------------------------
Total revenue $20,415 $16,915 $15,300 $1,389 $36 $54,055
=================================================================================
Income (loss) from continuing operations
before income taxes, minority interest,
net loss on subsidiary merger transaction
and equity in net loss of affiliate (1) $(25) $(3,318) $(29) $144 $(36,707) $(39,935)
=================================================================================
Total assets (2) $41,837 $138,600 $13,008 $2,849 $1,209 $197,503
=================================================================================
(1) For Digital Angel Corporation, amount excludes $1.8 million of
interest expense associated with the Company's obligation to IBM
Credit and $18.7 million of non-cash compensation expense
associated with pre-merger Digital Angel options which were
converted into options to acquire MAS stock, both of which have
been reflected as additional expense in the separate financial
statements of Digital Angel Corporation included in its Form 10Q.
(2) For Digital Angel Corporation, amount includes $4.8 million of
goodwill associated with the Company's initial 16.6% investment in
MAS.
19
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Following is the selected segment data as of and for the
three-months ended June 30, 2001:
SEGMENTS
--------
Digital
Advanced Angel SysComm All Corporate/
Technology Corporation International Other Eliminations Consolidated
---------------------------------------------------------------------------------
Net revenue from external customers:
Product $8,096 $7,619 $6,096 $5,326 $(84) $27,053
Service 4,264 830 1,369 6,943 (588) 12,818
Inter-segment revenue - product (89) 89 --
Inter-segment revenue - service -- -- -- (615) 615 --
---------------------------------------------------------------------------------
Total revenue $12,360 $8,449 $7,465 $11,565 $32 $39,871
=================================================================================
Loss from continuing operations before
income taxes, minority interest and equity
in net loss of affiliate $(808) $(3,564) $(510) $(4,016) $(4,233) $(13,131)
=================================================================================
Total assets $85,192 $112,901 $15,175 $69,123 $20,524 $302,915
=================================================================================
Following is the selected segment data as of and for the six-months
ended June 30, 2001:
SEGMENTS
--------
Digital
Advanced Angel SysComm All Corporate/
Technology Corporation International Other Eliminations Consolidated
---------------------------------------------------------------------------------
Net revenue from external customers:
Product $17,020 $16,752 $15,147 $12,601 $(84) $61,436
Service 8,730 1,900 1,708 14,203 (697) 25,844
Inter-segment revenue - product (89) 89 --
Inter-segment revenue - service -- -- -- (782) 782 --
---------------------------------------------------------------------------------
Total revenue $25,750 $18,652 $16,855 $25,933 $90 $87,280
=================================================================================
Loss from continuing operations before
income taxes, minority interest and equity
in net loss of affiliate $(1,834) $(5,358) $(634) $(6,356) $(8,869) $(23,051)
=================================================================================
Total assets $85,192 $112,901 $15,175 $69,123 $20,524 $302,915
=================================================================================
20
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
7. ACQUISITIONS AND DISPOSITIONS
On February 27, 2001, the Company acquired 16.6% of the capital
stock of MAS, a provider of medical assistance and technical products and
services, in a transaction valued at approximately $8.3 million in
consideration for 3.3 million shares of its common stock. The Company became
the single largest shareholder and controlled two of the seven board seats.
The Company accounted for this investment under the equity method of
accounting. The excess of the purchase price over the net book value
acquired was approximately $6.8 million and was being amortized on a
straight-line basis over five years. Under Financial Accounting Standards
No. 142, which the Company adopted on January 1, 2002, the goodwill embedded
in the Company's equity investment in MAS is no longer amortized. As a
result of no longer amortizing this goodwill, the Company's net income
increased by $0.3 million and $0.6 million for the three and six-months
ended June 30, 2002, respectively.
Effective March 27, 2002, the Company's 93% owned subsidiary,
pre-merger Digital Angel, merged with MAS. As a result of the merger, the
Company now owns approximately 74.25% of Digital Angel Corporation, as more
fully discussed in Note 1.
In satisfaction of a condition to the consent to the merger by IBM
Credit, the Company's lender, the Company transferred to a Delaware business
trust controlled by an advisory board all of the shares of MAS common stock
owned by it and, as a result, the trust has legal title to approximately
74.25% of the Digital Angel Corporation common stock. The trust has voting
rights with respect to the Digital Angel Corporation common stock until the
Company's obligations to IBM Credit are repaid in full. The trust may be
obligated to liquidate the shares of Digital Angel Corporation common stock
owned by it for the benefit of IBM Credit in the event the Company fails to
make payments, or otherwise defaults, under its IBM Credit Agreement which
became effective on the date of the merger. See Note 4. The Company has
retained beneficial ownership of the shares.
Unaudited pro forma results of operations for the six-months ended
June 30, 2002, are included below. Such pro forma information assumes that
the merger of pre-merger Digital Angel and MAS had occurred as of January 1,
2002.
--------------------------
SIX-MONTHS ENDED
JUNE 30,
--------------------------
2002
----
Net operating revenue from continuing operations $54,941
Loss from continuing operations $(42,397)
Loss available to common stockholders from continuing operations $(42,397)
Loss per common share from continuing operations - basic $(0.15)
Loss per common share from continuing operations - diluted $(0.15)
21
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Earnout and Put Agreements
--------------------------
Certain acquisition agreements the Company entered into during 2000
include additional consideration contingent on profits of the acquired
subsidiary. Upon earning this additional consideration, the value is
recorded as additional goodwill. The financial statements include the value of
shares earned upon attainment of certain profits by subsidiaries through
June 30, 2002. At June 30, 2002, based upon the expected performance of
these acquired subsidiaries, the Company is contingently liable for
additional consideration of approximately $30,000.
8. REDEEMABLE PREFERRED STOCK
The Preferred Stock. On October 26, 2000, the Company issued 26,000
shares of Series C convertible preferred stock to a select group of
institutional investors in a private placement. The stated value of the
preferred stock was $1,000 per share, or an aggregate of $26.0 million, and
the purchase price of the preferred stock and the related warrants was an
aggregate of $20.0 million. The preferred stock was convertible into shares
of the Company's common stock. The holders of the preferred stock were
entitled to receive annual dividends of 4% of the stated value (or 5.2% of
the purchase price) payable in either cash or additional shares of preferred
stock. As of December 31, 2001, all of the preferred shares have been
converted into shares of the Company's Common Stock.
The Company had revised its calculation of the beneficial
conversion feature (BCF) associated with its redeemable preferred stock for
the three months ended March 31, 2001. The effect of the change does not
impact reported net loss in the period, but it does reduce income available
to common shareholders, as follows:
PREVIOUSLY
REPORTED REVISED
MARCH 31, 2001 MARCH 31, 2001
Net income (loss) $(11,180) $(11,180)
Net loss available to common shareholders $(13,869) $(20,359)
Total basic earnings per share $ (0.13) $ (0.20)
Total diluted earnings per share $ (0.13) $ (0.20)
In the quarter ended June 30, 2001, the Company recorded an
additional BCF charge to earnings per share of $0.5 million to recognize a
deemed dividend to the holders of the Series C preferred stock equal to the
alternative conversion rate, which can be realized by the holders at June
30, 2001. For the six months ended June 30, 2001, the additional BCF charge
to earnings per share was $9.4 million. As a result, the Company has
cumulatively recorded a charge to earnings per share of $13.2 million, since
the issuance of the preferred stock. As of June 30, 2001, the BCF was fully
accreted. The BCF was recorded as a reduction in the value assigned to the
preferred stock and an increase in additional paid-in capital. The Company
recorded the accretion of the BCF over the period from the date of issuance
to the earliest beneficial conversion date available through equity,
reducing the income available to common stockholders and earnings per share.
Option to Acquire Additional Preferred Stock. The investors had the
option to purchase up to an additional $26.0 million in stated value of
Series C convertible preferred stock and warrants with an
22
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
initial conversion price of $5.00 per share, for an aggregate purchase price
of $20.0 million, at any time up to ten months following the effective date
of the Company's registration statement relating to the common stock
issuable on conversion of the initial series of the preferred stock. The
additional preferred stock would have had the same preferences,
qualifications and rights as the initial preferred stock. The fair value of
the option was estimated using the Black-Scholes option pricing model with
the following assumptions: dividend yield of 0%, expected volatility of 40%
and a risk free interest rate of 5.5%. The investors elected not to exercise
the option, which expired on February 24, 2002, and accordingly, the fair
value of the option was recorded as an increase in
additional-paid-in-capital.
9. DISCONTINUED OPERATIONS
On March 1, 2001, the Company's board of directors approved a plan
to offer for sale its Intellesale business segment and all of its other
"non-core businesses." Accordingly, the operating results of these entities
have been reclassified and reported as discontinued operations for all
periods presented. As of March 1, 2002, the Company had sold or closed
substantially all of the businesses comprising Discontinued Operations and
there were two insignificant companies remaining. One of the remaining
businesses was sold effective May 23, 2002, and the Company anticipates
selling the remaining company within the next several months. Revenue and
net loss for the remaining business was $0.7 million and $41 thousand,
respectively, for the six months ended June 30, 2002. Proceeds from the
sales of Discontinued Operations companies were used to repay amounts
outstanding under the IBM Credit Agreement. Any additional proceeds on the
sale of the remaining business will also be used to repay the IBM debt.
The following discloses the results of Intellesale and all other
non-core businesses comprising discontinued operations for the period from
January 1, 2001, through March 1, 2001:
January 1, through
March 1,
----------------------------
2001
----
Product revenue $13,039
Service revenue 846
----------------------------
Total revenue 13,885
Cost of products sold 10,499
Cost of services sold 259
----------------------------
Total cost of products and services sold 10,758
----------------------------
Gross profit 3,127
Selling, general and administrative expenses 2,534
Depreciation and amortization 264
Interest, net 29
Provision for income taxes 34
Minority interest 53
----------------------------
Income from discontinued operations $213
============================
23
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
The above results do not include any allocated or common overhead
expenses. Included in Interest, net, above are interest charges based on the
debt of one of these businesses. A purchaser assumed this debt when the
business was sold on January 31, 2002.
Assets and liabilities of discontinued operations are as follows at
June 30, 2002, and December 31, 2001.
June 30, 2002 December 31, 2001
-------------------------------------------------
(In thousands)
Current Assets
Cash and cash equivalents $218 $ --
Accounts receivable and unbilled receivables, net 145 5,745
Inventories 38 4,430
Prepaid expenses and other current assets -- 291
-------------------------------------------------
Total Current Assets 401 10,466
Property and equipment, net 121 3,553
Other assets 59 242
-------------------------------------------------
$581 $14,261
=================================================
Current Liabilities
Notes payable and current maturities of long-term debt $ 4 $ 5,040
Accounts payable 4,186 8,670
Accrued expenses 6,810 9,610
-------------------------------------------------
Total Current Liabilities 11,000 23,320
Long-term debt 22 --
Minority interest 177 401
-------------------------------------------------
11,199 23,721
=================================================
Net Liabilities of Discontinued Operations $(10,618) $(9,460)
=================================================
24
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
The Company recorded a provision for operating losses, estimated
loss on sale and carrying costs during the phase-out period including
operating and other disposal costs to be incurred in selling the businesses.
Carrying costs primarily include the cancellation of facility leases,
employment contract buyouts and litigation reserves. During the six-months
ended June 30, 2002, the Company increased its estimated loss on sale of its
85% ownership in its Canadian subsidiary, Ground Effects, Ltd., which was
sold on January 31, 2002, by $0.2 million, and it increased its estimated
loss on the sale of certain business assets of U.S. Electrical Products
Corp, which were sold on May 23, 2002, by $0.2 million. Proceeds on the sale
of Ground Effects, Ltd. approximated $1.6 million plus the assumption of the
Canadian portion of the IBM debt and proceeds on the sale of U.S. Electrical
Products Corp.'s assets were $0.1 million. Offsetting the increase in the
estimated loss on sale was net operating income for the first half of 2002.
This net income was primarily due to a change in estimated carrying costs as
certain of these obligations were settled for amounts less than previously
anticipated.
The following table sets forth the roll forward of the liabilities
for estimated loss on sale and operating losses and carrying costs from
December 31, 2001 through June 30, 2002.
Balance Balance
Type of Cost December 31, 2001 Additions Deductions June 30, 2002
- -------------------------------------------------------------------------------------------------------------------
Estimated loss on sale, net of change in
Estimated operating losses $1,173 $479 $1,652 $--
Carrying costs 7,218 (703) 124 6,391
------------------------------------------------------------
Total $8,391 $(224) $1,776 $6,391
============================================================
10. NON-CASH COMPENSATION EXPENSE ASSOCIATED WITH OPTIONS
Pursuant to the terms of the pre-merger Digital Angel and MAS
merger agreement, effective March 27, 2002, options to acquire shares of
pre-merger Digital Angel common stock were converted into options to acquire
shares of MAS common stock. The transaction resulted in a new measurement
date for the options and, as a result, the Company recorded a non-cash
compensation expense of approximately $18.7 million on March 27, 2002. As
all of the option holders were employees or directors of the Company, these
options were considered fixed awards under APB Opinion No. 25 and expense
was recorded for the intrinsic value of the options converted. This charge
is included in the condensed consolidated statement of operations in
selling, general and administrative expenses.
In addition, the Company incurred non-cash compensation expense of
approximately $3.0 million and $3.3 million during the three and six-months
ended June 30, 2002, respectively, due primarily to re-pricing 19.3 million
stock options during 2001. The re-priced options had original exercise
prices ranging from $0.69 to $6.34 per share and were modified to change the
exercise price to $0.15 per share. Due to the modification, these options
are being accounted for as variable options under APB Opinion No. 25 and
fluctuations in the Company's common stock price will result in increases
and decreases of non-cash compensation expense until the options are
exercised, forfeited or expired. This expense has also been reflected in the
condensed consolidated statement of operations as selling, general and
administrative expenses.
25
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
11. COMPREHENSIVE LOSS
Comprehensive loss represents all non-owner changes in
stockholders' equity and consists of the following:
THREE-MONTHS ENDED SIX-MONTHS ENDED
JUNE 30, JUNE 30,
(In thousands) (In thousands)
----------------------------- ----------------------------
2002 2001 2002 2001
---- ---- ---- ----
----------------------------- ----------------------------
Net loss $(19,936) $(43,332) $(43,941) $(63,303)
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments 201 (13) 661 (1,025)
----------------------------- ----------------------------
Total comprehensive loss $(19,735) $(43,345) $(43,280) $(64,328)
============================= ============================
12. RECENT DEVELOPMENTS
On June 8, 2002, the Company's shareholders approved an increase in
the number of common shares authorized from 345.0 million to 435.0 million.
On July 22, 2002, the Company announced that SysComm has
conditionally offered to merge with the Company's wholly-owned subsidiary,
VeriChip Corporation, in a stock transaction. The merger is subject to all
necessary approvals, including but not limited to, approval by SysComm's
stockholders and the Company's lender, IBM Credit. Upon completion of the
transaction, SysComm is expected to change its name to VeriChip Corporation.
From July 12, 2002, to July 30, 2002, the Company's shares were
traded on the Pink Sheets under the symbol "ADSX.PK." Prior to that time,
the Company's shares were traded on Nasdaq. Effective July 31, 2002, the
Company's shares were relisted on the Nasdaq under the symbol "ADSX."
13. LEGAL PROCEEDINGS
In the fourth quarter of 2000, the Company entered into an
agreement to acquire an interest in Connect Intelligence Limited, an Irish
company. A dispute between the Connect Intelligence sellers and us ensued
and the sellers filed several lawsuits in Ireland and the United States. The
lawsuits have been settled under the terms of a settlement agreement dated
March 21, 2002. The settlement resulted in approximately 3.2 million shares
of the Company's common stock being issued to the sellers and resulted in a
charge to the Company of approximately $1.0 million, which was accrued at
December 31, 2001, and a payment to the Company of approximately $1.4
million, which it received in May 2002. At the time of the settlement
agreement, the closing price of our common stock was $0.45 per share.
In May 2002, a shareholders action was filed against the Company
and one of its directors (the Childs litigation). In the following weeks,
fourteen more complaints were filed that have identical or near identical
allegations as those alleged in the Childs litigation. The Childs
litigation's primary allegations relate to (i) claims that the company
failed to disclose improper accounting procedures related
26
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
to two subsidiaries, (ii) claims that statements in a Los Angeles Times
article on May 9, 2002, about the Company's VeriChip Corporation subsidiary
were false, and (iii) that statements by the Company as quoted in other
newspaper articles were misleading. The Company expects that the various
cases will be consolidated into one case. The Company believes that the
allegations in the Childs litigation and the later-filed cases are without
merit and it will defend them vigorously.
In July 2002, SRZ Trading LLC filed a derivative complaint in the
Circuit Court of Cole County, Missouri against the Company, and several of
its officers and directors. The complaint alleges that the Company
misrepresented its financial condition and disseminated false and misleading
statements about VeriChip. The Company believes the action is without merit
and intends to vigorously defend against it.
On May 29, 2001, Janet Silva, individually and as Guardian ad Litem
for Jonathan Silva, a minor, and the Estate of Clarence William Silva, Jr.
(collectively, "Plaintiffs") filed suit against Customized Services
Administrators, Incorporated ("CSA"), Pricesmart, Inc. ("Pricesmart"),
Commercial Union Insurance Company ("Commercial Union"), CGU Insurance
Group, and the Digital Angel Corporation (collectively the "Defendants") in
the Superior Court of the State of California in and for the County of Santa
Clara. The allegations of the complaint arise from a vacation guarantee
insurance policy (the "Insurance Contract") allegedly purchased by
Plaintiffs from Defendants on March 6, 2000. The complaint alleges, among
other things, that Defendants breached the Insurance Contract, defrauded
Plaintiffs, acted in bad faith, engaged in deceptive and unlawful business
practices, resulting in the wrongful death of Clarence William Silva, Jr.
(the "Deceased") and the intentional infliction of emotional distress on
Plaintiffs. The complaint seeks the cost of funeral and burial expenses of
the Deceased and amounts constituting the loss of financial support of the
Deceased, general damages, attorney's fees and costs, and exemplary damages.
CSA has filed a cross-claim against the Digital Angel Corporation alleging
that it should be held liable for any liability that CSA may have to
Plaintiffs. Digital Angel Corporation has denied the allegations of the
complaint and the CSA cross-claim and is vigorously contesting all aspects
of this action.
On July 15, 2002, the Company entered into a settlement and release
agreement by and between certain former shareholders of Computer Equity
Corporation, also referred to as Compec, on behalf of themselves and on
behalf of the former shareholders of Compec. The Company acquired Compec
under the terms of a merger agreement entered into effective June 1, 2000.
Certain former shareholders of Compec had filed claims against the Company
in connection with the earnout provisions of the merger agreement and
damages relating to the registration of shares previously issued to them as
result of the merger. Under the terms of the settlement agreement and in
satisfaction of all claims relating to the merger agreement, the Company
issued 8 million shares of its common stock to the former stockholders of
Compec. The shares were valued at $3.0 million and have been reflected as
additional goodwill at June 30, 2002.
The Company is party to various other legal actions as either a
plaintiff or a defendant. In its opinion, as of the date of this Form 10-Q,
these proceedings will not have a material adverse effect on the Company's
financial position, its cash flows or its overall trends in results. The
estimate of the potential impact on the Company's financial position, its
overall results of operations or its cash flows for these proceedings could
change in the future.
27
ITEM 2. 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 accompanying
financial statements and related notes included in Item 1 of this report as
well as our 2001 Annual Report on Form 10-K.
We are an advanced technology development company. We focus on
developing advanced life-enhancing technology products and services. To
date, we have developed three such products: (i) Digital Angel, for
monitoring and tracking people and objects; (ii) VeriChip, an implantable
radio frequency verification device that can be used for security, emergency
and healthcare applications; and (iii) Thermo Life, a thermoelectric
generator.
Approximately two years ago, we developed a patent for what we believe
is the world's first combination of advanced biosensor technology and
web-enabled wireless telecommunications linked to GPS in a watch/pager
device that communicates through proprietary software to a secure 24/7
operations center in California. This technology provides "where-you-are"
and "how-you-are" information about loved ones (particularly elderly
relatives and children), their location and their vital signs via the
subscriber's computer, PDA or wireless phone. We branded this technology
Digital Angel and merged the technology with a company formerly known as
Destron Fearing Corporation. Our goal was to create a new corporation
underpinned by the patented technology and complemented by the products and
services and revenues of our existing business segments. We united our
existing GPS, application service provider and animal tracking business
units to form Digital Angel, the company. Effective March 27, 2002,
pre-merger Digital Angel became its own public company through the merger of
Medical Advisory Systems, Inc. (MAS) (AMEX:DOC). Currently, we are the
beneficial owner of approximately 74.25% of this new company which has been
renamed Digital Angel Corporation. We launched Digital Angel, the product,
on November 26, 2001.
In October, 2001, we announced our new wholly-owned subsidiary, Thermo
Life Energy Corp, formerly Advanced Power Solutions, Inc., which will
develop, market and license our new product, Thermo Life, the world's
smallest thermoelectric generator powered by body heat. Thermo Life is
intended to provide a miniaturized power source for a wide range of consumer
electronic devices including attachable or implantable medical devices and
wristwatches. On July 9, 2002, we announced that we had achieved an
important breakthrough: 3.0-volts of electrical power successfully generated
by Thermo Life in laboratory tests. We expect to begin marketing Thermo Life
during the last half of 2002.
In December, 2001, we announced the development of a miniaturized,
implantable verification chip, called VeriChip that can be used in a variety
of security, emergency and healthcare applications. On February 7, 2002, we
created a new wholly-owned subsidiary, VeriChip Corporation, which will
develop, market and license VeriChip. About the size of the point of a
typical ballpoint pen, each VeriChip will contain a unique verification
number. Utilizing an external scanner, radio frequency energy passes through
the skin energizing the dormant VeriChip, which then emits a radio frequency
signal transmitting the verification number contained in the VeriChip. We
expect to begin marketing VeriChip during the last half of 2002.
As a result of the merger of pre-merger Digital Angel and MAS, which
occurred on March 27, 2002, the significant restructuring of our business
during the past year and our emergence as an advanced technology development
company, we have re-evaluated and realigned our reporting segments.
Effective January 1, 2002, we currently operate in three business segments:
Advanced Technology, Digital Angel Corporation and SysComm International.
The business units comprising our Advanced Technology segment represent
those business units that
28
we believe will provide the necessary synergies, support and infrastructure
to allow us to develop, promote and fully-integrate our life-enhancing
technology products and services.
Our Digital Angel Corporation segment consists of the business
operations of Digital Angel Corporation and is engaged in the business of
developing and bringing to market proprietary technologies used to identify,
locate and monitor people, animals and objects. Before March 27, 2002, the
business of Digital Angel Corporation was operated in four divisions: Animal
Tracking, Digital Angel Technology, Digital Angel Delivery System, and Radio
Communications and Other. With the acquisition of MAS on March 27, 2002,
Digital Angel Corporation re-organized into four new divisions: Animal
Applications (formerly Animal Tracking), Digital Angel Systems, GPS and
Radio Communications, and Physician Call Center and Other. Physician Call
Center and Other reflects the newly acquired MAS business.
Our SysComm International segment consists of the business operations
of our 52.5% owned subsidiary, SysComm International Corporation. This
segment provides professional services in the areas of systems integration,
information technology (IT) procurement and logistics, and technology
strategy. Doing business as "InfoTech," this segment provides integrated
eBusiness strategy and technology implementation services on a regional
basis to enterprise and small to medium businesses who want to fully
leverage eBusiness technologies as part of their overall business strategy.
Its service offerings includes technology strategy and due diligence
consulting, systems architecture and design, application and technology
infrastructure deployment, enterprise security, IT product procurement and
logistics, and provisioning.
Business units that were part of our continuing operations and that
were closed or sold during 2001 and 2002 are reported as All Other.
Prior to January 1, 2002, our business was organized into three
segments: Applications, Services and Advanced Wireless. Prior period
information has been restated to present our reportable segments on a
comparative basis.
Additionally, our previously reported Intellesale and all other
non-core business segments are reported as Discontinued Operations.
29
RECENT DEVELOPMENTS
- -------------------
Digital Angel/MAS Merger
On March 27, 2002, Digital Angel, which we refer to as pre-merger
Digital Angel, merged with MAS and MAS changed its name to Digital Angel
Corporation. Also, pursuant to the merger agreement, we contributed all of
our stock in Timely Technology Corp., our wholly-owned subsidiary, and
Signature Industries, Limited, an 85% owned subsidiary. Pre-merger Digital
Angel, Timely Technology Corp. and Signature Industries, Limited were
collectively referred to as the Advanced Wireless Group (AWG). In
satisfaction of a condition to the consent to the merger by IBM Credit, we
transferred all shares of Digital Angel Corporation common stock owned by us
to a Delaware business trust controlled by an advisory board and, as a
result, the trust has legal title to approximately 74.25% of the Digital
Angel Corporation common stock. The trust has voting rights with respect to
the Digital Angel Corporation common shares until we repay our obligations
to IBM Credit in full. We have retained beneficial ownership of the shares.
The trust may be obligated to liquidate the shares of Digital Angel
Corporation common stock owned by it for the benefit of IBM Credit in the
event we fail to make payments, or otherwise default, under our IBM Credit
Agreement with IBM Credit, as discussed below. Such liquidation of the
shares of Digital Angel Corporation common stock will be in accordance with
the Securities and Exchange Commission's (SEC) rules and regulations
governing affiliates.
On March 27, 2002, we recorded a net loss of $0.4 million arising from
the merger transaction. The net loss was comprised of a loss of
approximately $5.1 million resulting from the exercise of 1.5 million
pre-merger Digital Angel options, partially offset by a gain of
approximately $4.7 million from the deemed sale of approximately 22.85% of
pre-merger Digital Angel and the other subsidiaries comprising the AWG as a
result of the merger with MAS.
During the three and six-months ended June 30, 2002, we recorded a loss
of $3.9 million on the issuances of 1.0 million shares of Digital Angel
Corporation common stock resulting primarily from the exercise of stock
options and the sale of Digital Angel Corporation stock. The loss represents
the difference between the carrying amount of our pro-rata share of our
investment in Digital Angel Corporation and the net proceeds from the
issuances of the stock and other changes in our minority interest ownership.
Our investment in Digital Angel Corporation is being accounted for
under the consolidation method of accounting.
Credit Agreement
On January 31, 2002, and again on February 27, 2002, we entered into
amendments to our prior credit agreement with IBM Credit. These amendments
extended the principal and interest payments, which were due to April 2,
2002, including principal payments that were initially due on July 1, 2001.
Effective March 27, 2002, we entered into a new credit agreement, the
(IBM Credit Agreement), with IBM Credit. Amounts outstanding under the IBM
Credit Agreement of $82.1 million at March 31, 2002 bear interest at an
annual rate of 17% and mature on February 28, 2003. No principal or interest
payments are due until the maturity date. However, the maturity date will be
automatically extended to February 28, 2004, if we repay at least 40% of the
original principal amount outstanding, plus accrued interest and expenses,
prior to February 28, 2003. If the maturity date is extended to February 28,
2004, the maturity date will be automatically extended again to February 28,
2005, if we repay an additional 40% of the original principal amount
outstanding, plus accrued interest and expenses, prior to February 28, 2004.
Any amounts outstanding at February 28, 2005, must be repaid by August 31,
2005. If all amounts are not repaid by February 28, 2003, the unpaid amount
will accrue interest at an annual rate of 25%. If all amounts are not repaid
by February 28, 2004, the interest rate increases to 35%.
The IBM Credit Agreement contains covenants relating to our financial
position and
30
performance, as well as the financial position and performance of Digital
Angel Corporation. At June 30, 2002, we were not in compliance with our
Minimum Cumulative Modified EBITDA debt covenant and with other provisions
of the IBM Credit Agreement. In addition, Digital Angel Corporation was not
in compliance with the Minimum Cumulative Modified EBITDA and Current Assets
to Current Liabilities debt covenants. IBM has agreed to provide the Company
with a waiver of such noncompliance, the documentation of which will be
formalized no later than August 21, 2002. As consideration for the waiver,
the Company will issue to IBM a five year warrant to acquire 2.9 million
shares of the Company's Common Stock at $.15 per share, as well as other
consideration. However, we believe that when the third quarter results are
finalized, we will not be in compliance with certain financial ratios for
the third quarter of 2002. Although we will again request a waiver from IBM
Credit, there can be no assurances that a waiver will be obtained. In the
future, if business conditions are other than as anticipated or other
unforeseen events or circumstances occur, these may impact our ability to
remain in compliance with the covenants. In the absence of waiver or
amendment to the financial covenants, such noncompliance would constitute an
event of default under the IBM Credit Agreement, and IBM Credit would be
entitled to accelerate the maturity of all amounts we owe them. In the event
such noncompliance appears likely, or occurs, we will seek to renegotiate
the covenants and/or obtain waivers, as required. There can be no assurance,
however, that we would be successful in negotiating such amendments or
obtaining such waivers.
The IBM Credit Agreement also prohibits us from borrowing funds from
other lenders, and does not provide for any additional advances.
Other
On June 8, 2002, our stockholders approved an increase in the number of
common shares authorized from 345.0 million to 435.0 million.
On July 22, 2002, we announced that SysComm has conditionally offered
to merge with the Company's wholly-owned subsidiary, VeriChip Corporation,
in a stock transaction. The merger is subject to all necessary approvals,
including but not limited to, approval by SysComm's stockholders and the
Company's lender, IBM Credit. Upon completion of the transaction, SysComm is
expected to change its name to VeriChip Corporation.
From July 12, 2002, to July 30, 2002, the our common stock was traded
on the Pink Sheets under the symbol "ADSX.PK." Prior to that time, our
shares were traded on Nasdaq. Effective July 31, 2002, our shares were
relisted on the Nasdaq under the symbol "ADSX."
31
RESULTS OF CONTINUING OPERATIONS
The following table summarizes our results of operations as a
percentage of net operating revenue for the three and six-month periods
ended June 30, 2002 and 2001 and is derived from the unaudited consolidated
statements of operations in Part I, Item 1 of this report.
------------------------ ------------------------
RELATIONSHIP TO RELATIONSHIP TO
REVENUE REVENUE
THREE-MONTHS ENDED SIX-MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
2002 2001 2002 2001
---- ---- ---- ----
% %
- -
Product revenue 82.2 67.9 82.0 70.4
Service revenue 17.8 32.1 18.0 29.6
------------------------ ------------------------
Total revenue 100.0 100.0 100.0 100.0
Cost of products sold 57.7 48.4 58.1 49.4
Cost of services sold 8.5 15.7 8.4 14.3
------------------------ ------------------------
Total cost of products and services sold 66.2 64.1 66.5 63.7
------------------------ ------------------------
Gross profit 33.8 35.9 33.5 36.3
Selling, general and administrative expenses (71.2) (42.6) (88.3) (39.7)
Research and development (3.0) (4.3) (3.3) (3.5)
Depreciation and amortization (5.4) (18.8) (4.4) (16.5)
Interest income 2.1 1.5 1.2 1.1
Interest expense (18.3) (4.6) (12.5) (4.2)
------------------------ ------------------------
Loss from continuing operations before benefit for income
taxes, minority interest, net loss on subsidiary
transactions and equity in net loss of affiliate (62.0) (32.9) (73.9) (26.5)
Provision (benefit) for income taxes -- 41.4 0.2 20.7
------------------------ ------------------------
Loss from continuing operations before minority interest (62.0) (74.3) (74.1) (47.2)
Minority interest (1.6) (0.9) (0.8) (0.5)
Net loss on subsidiary merger transaction and subsidiary
stock issuances 15.0 -- 7.9 --
Equity in net loss of affiliate -- 0.2 0.5 --
------------------------ ------------------------
Loss from continuing operations (75.4) (73.6) (81.7) (46.7)
(Loss) income from discontinued operations, net of income
taxes (1.8) (54.6) 0.4 (24.7)
Extraordinary gain -- 23.7 -- 10.8
------------------------ ------------------------
Net loss (77.2) (104.5) (81.3) (60.5)
Preferred stock dividends and other -- (0.5) -- (1.2)
Accretion of beneficial conversion feature of redeemable
preferred stock - series C -- (1.1) -- (10.8)
------------------------ ------------------------
Net loss available to common shareholders (77.2) (106.1) (81.3) (72.5)
======================== ========================
32
REVENUE
Revenue from continuing operations for the three-months ended June 30,
2002, decreased $14.1 million, or 35.3%, to $25.8 million from $39.9 million
in the three-months ended June 30, 2001. Revenue from continuing operations
for the six-months ended June 30, 2002, decreased $33.2 million, or 38.0%,
to $54.1 million from $87.3 million in the six-months ended June 30, 2001.
Revenue from continuing operations during the three and six-months
ended June 30, 2002, and 2001 by segment was as follows:
THREE-MONTHS ENDED JUNE 30,
(IN THOUSANDS)
------------------------------------------------------------------------------------
2002 2001
---- ----
------------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
Advanced Technology $8,528 $3,368 $11,896 $8,096 $4,264 $12,360
Digital Angel Corporation 8,584 577 9,161 7,619 830 8,449
SysComm International 4,127 668 4,795 6,096 1,369 7,465
All Other -- -- -- 5,237 6,328 11,565
Corporate / Eliminations (2) (14) (16) 5 27 32
------------------------------------------------------------------------------------
Total $21,237 $4,599 $25,836 $27,053 $12,818 $39,871
========================================== =========================================
SIX-MONTHS ENDED JUNE 30,
(IN THOUSANDS)
------------------------------------------------------------------------------------
2002 2001
---- ----
------------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
Advanced Technology $13,431 $6,984 $20,415 $17,020 $8,730 $25,750
Digital Angel Corporation 16,035 880 16,915 16,752 1,900 18,652
SysComm International 13,820 1,480 15,300 15,147 1,708 16,855
All Other 1,014 375 1,389 12,512 13,421 25,933
Corporate / Eliminations -- 36 36 5 85 90
------------------------------------------------------------------------------------
Total $44,300 $9,755 $54,055 $61,436 $25,844 $87,280
========================================== =========================================
Advanced Technology's revenue decreased $0.5 million and $5.3 million
in the three and six-month periods ended June 30, 2002, respectively, when
compared to the three and six-month period ended June 30, 2001. When
compared to the amounts for the three-months ended June 30, 2002, product
revenue increased by $.04 million, or 5.3%, and service revenue decreased by
$0.9 million, or 21.0%. When compared to the amounts for the six-months
ended June 30, 2002, product revenue decreased by $3.6 million, or 21.1%,
and service revenue decreased by $1.7 million, or 20.0%. We attribute the
increase in product revenue primarily to government contract projects, which
we had expected to complete in the first quarter of 2002, but were not
completed until the second quarter of 2002. We attribute the decreases to
reduced sales of software and other technology services.
Digital Angel Corporation's revenue increased $0.7 million and
decreased $1.7 million in the three and six-month periods ended June 30,
2002, respectively, when compared to the three and six-month periods ended
June 30, 2001. When compared to the amounts for the three-months ended June
30, 2001, product revenue increased by $1.0 million, or 12.7%, and service
revenue decreased by $0.3 million, or 30.5%. When compared to the amounts
for the six-months ended June 30, 2001, product revenue decreased by $0.7
million, or 42.9%, and service revenue decreased by $1.0 million, or 53.7%.
We attribute the increase in product revenue for the three months ended June
30, 2002, primarily to sales of transponders to the fisheries industry
customers and revenues associated with MAS, which merged with pre-merger
Digital Angel on March 27, 2002. We attribute the decreases in product sales
for the six-
33
months ended June 30, 2002, primarily to higher sales in the first quarter
of 2001 to a large customer to prepare for the launch of pet identification
products in France. We attribute the decreases in service revenue to
completed client assignments that were not replaced.
SysComm International's revenue decreased $2.7 million and $1.6 million
in the three and six-months ended June 30, 2002, respectively, when compared
the three and six-month periods ended June 30, 2001. When compared to the
amounts for the three-months ended June 30, 2001, product revenue decreased
by $2.0 million, or 32.3%, and service revenue decreased by $0.7 million, or
51.2%. When compared to the amounts for the six-months ended June 30, 2001,
product revenue decreased by $1.3 million, or 8.8%, and service revenue
decreased by $0.2 million, or 13.3%. We attribute the decreases to a soft
market in both product and services sales. Additionally, we made a decision
in April 2002 to exit the lower margin mid-range platform computer equipment
business and to focus our efforts on the higher margin Intel based products
and related technical services.
All Other's revenue decreased $11.6 million, or 100.0%, and $24.5
million, or 94.6%, in the three and six-month periods ended June 30, 2002,
respectively, when compared to the three and six-months ended June 30, 2001.
The decreases were due to the sale or closure of all of the business units
comprising this group during the last half of 2001 and the first half of
2002.
GROSS PROFIT AND GROSS PROFIT MARGIN
Gross profit from continuing operations for the three-months ended June
30, 2002, decreased $5.6 million, or 39.2%, to $8.7 million from $14.3
million for the three-months ended June 30, 2001. Gross profit from
continuing operations for the six-months ended June 30, 2002, decreased
$13.6 million, or 42.9%, to $18.1 million from $31.7 million in six-months
ended June 30, 2001. Our gross profit margin was 33.8% and 33.5% of revenue,
respectively, for the three and six-months ended June 30, 2002, and 35.9%
and 36.3% of revenue, respectively, for the three and six-months ended June
30, 2001.
Gross profit from continuing operations during the three and six-months
ended June 30, 2002, and 2001 by segment was as follows:
THREE-MONTHS ENDED JUNE 30,
(IN THOUSANDS)
---------------------------------------------------------------------------------
2002 2001
---- ----
---------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
Advanced Technology $1,817 $1,805 $3,622 $2,867 $1,977 $4,844
Digital Angel Corporation 3,827 330 4,157 3,019 372 3,391
SysComm International 691 273 964 109 628 737
All Other -- -- -- 1,739 3,568 5,307
Corporate / Eliminations -- (15) (15) 5 27 32
---------------------------------------------------------------------------------
Total $6,335 $2,393 $8,728 $7,739 $6,572 $14,311
=========================================== =====================================
SIX-MONTHS ENDED JUNE 30,
(IN THOUSANDS)
---------------------------------------------------------------------------------
2002 2001
---- ----
---------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
Advanced Technology $3,428 $3,787 $7,215 $4,874 $4,295 $9,169
Digital Angel Corporation 6,978 382 7,360 6,791 894 7,685
SysComm International 1,651 679 2,330 1,809 851 2,660
All Other 826 339 1,165 4,799 7,256 12,055
Corporate / Eliminations -- 36 36 5 85 90
---------------------------------------------------------------------------------
Total $12,883 $5,223 $18,106 $18,278 $13,381 $31,659
=========================================== =====================================
34
Gross profit margin from continuing operations during the three and
six-months ended June 30, 2002, and 2001 by segment was as follows:
THREE-MONTHS ENDED JUNE 30,
---------------------------------------------------------------------------------
2002 2001
---- ----
---------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
% % % % % %
- - - - - -
Advanced Technology 21.3 53.6 30.4 35.4 46.4 39.2
Digital Angel Corporation 44.6 57.2 45.4 39.4 44.8 40.1
SysComm International 16.7 40.9 20.1 1.8 45.9 9.9
All Other -- -- -- 33.2 56.4 45.9
Corporate / Eliminations -- N/A N/A 100.0 100.0 100.0
---------------------------------------------------------------------------------
Total 29.8 52.0 33.8 28.6 51.3 35.9
============================================ ====================================
SIX-MONTHS ENDED JUNE 30,
---------------------------------------------------------------------------------
2002 2001
---- ----
---------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
% % % % % %
- - - - - -
Advanced Technology 25.5 54.2 35.3 28.6 49.2 35.6
Digital Angel Corporation 43.5 43.4 43.5 40.5 47.1 41.2
SysComm International 11.9 45.9 15.2 11.9 49.8 15.8
All Other 81.5 90.4 83.9 38.4 54.1 46.5
Corporate / Eliminations -- 100.0 100.0 100.0 100.0 100.0
---------------------------------------------------------------------------------
Total 29.1 53.5 33.5 29.8 51.8 36.3
============================================ ====================================
Advanced Technology's gross profit decreased $1.2 million in the
three-months ended June 30, 2002, and margin decreased to 30.4% from 39.2%
when compared to the three-months ended June 30, 2001. Gross profit decreased
$2.0 million in the six-months ended June 30, 2002, and margin decreased
slightly to 35.3% from 35.6% when compared to the six-months ended June 30,
2001. We attribute the decrease in gross profit primarily to the reduction
in sales during the first three and six-months of 2002, and the decrease in
margin primarily to the reduction in sales of software and other
higher-margin products and services.
Digital Angel Corporation's gross profit decreased $.08 million in the
three-months ended June 30, 2002, while margins increased to 45.4% in the
three-months ended June 30, 2002. from 40.1% in the three-months ended June
30, 2001. Gross profit decreased $0.3 million in the six-months ended June
30, 2002, while margins increased to 43.5% in the six-months ended June 30,
2002. from 41.2% in the six-months ended June 30, 2001. We attribute the
increase in gross profit for the three months ended June 30, 2002, primarily
to higher sales for transponders. We attribute the decrease in gross profit
for the six months ended June 30, 2002, primarily to the reduction in
service revenues during the six months ended June 30, 2002. We attribute the
increases in gross margin in the three and six-months ended June 30, 2002,
to a higher margin product mix.
SysComm International's gross profit increased $.02 million in the
three-months ended June 30, 2002, and margin decreased to 20.1% in the
three-months ended June 30, 2002, from 9.9% in the three-months ended June
30, 2001. Gross profit decreased $.03 million in the six-months ended June
30, 2002, and margin decreased to 15.2% in the six-months ended June 30,
2002, from 15.8% in the six-months ended June 30, 2001. We attribute the
increase in gross profit and margin for the three-months ended June 30,
2002, to a reduced number of lower margin sales and dollars received from
manufacturers. Another contributing factor was our decision, in April 2002,
to exit the lower margin mid-range platform
35
computer equipment business and focus our efforts on the higher margin Intel
based products. We attribute the decrease in gross profit and margin for the
six-months ended June 30, 2002, to high volume, lower margin sales to a
major customer during the six-months ended June 30, 2002.
All Other's gross profit decreased $5.3 million, or 100%, in the
three-months ended June 30, 2002, as we did not earn any gross profit or
margin in the three-months ended June 30, 2002 compared to gross margin of
45.9% in the three-months ended June 30, 2001. Gross profit decreased $10.9
million in the six-months ended June 30, 2002, and margin increased to 83.9%
in the six-months ended June 30, 2002 from 46.5% in the six-months ended
June 30, 2001. The decrease in gross profit resulted from the sale or
closure of all of the business units comprising this group during the last
half of 2001 and the first six-months of 2002. We attribute the increase in
gross margin during the six months ended June 30, 2002 to the sale and
closure of business units within this group. The majority of the business
units that were sold or closed earned lower gross margins on average than
the remaining business unit comprising the group during the first six-months
of 2002.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expenses from continuing operations
was $18.4 million in the three-months ended June 30, 2002, an increase of
$1.4 million, or 8.2%, from the $17.0 million in the three-months ended June
30, 2001. Selling, general and administrative expenses from continuing
operations was $47.8 million in the six-months ended June 30, 2002, an
increase of $13.1 million, or 37.8%, from the $34.7 million in the
six-months ended June 30, 2001. As a percentage of total revenue, selling,
general and administrative expenses from continuing operations increased to
68.6% in the three-months ended June 30, 2002, from 42.6% in the
three-months ended June 30, 2001 and increased to 87.1% in the six-months
ended June 30, 2002, from 39.7% in the six-months ended June 30, 2001.
Selling, general and administrative expense from continuing operations
during the three and six-months ended June 30, 2002, and 2001 by segments
was as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
(In thousands) (In thousands)
----------------------------- --------------------------
2002 2001 2002 2001
---- ---- ---- ----
Advanced Technology $4,366 $2,876 $6,718 $5,409
Digital Angel Corporation 3,713 2,347 6,841 4,749
SysComm International 917 1,047 2,100 2,874
All Other (33) 7,055 880 13,885
Corporate / Eliminations 9,421 3,662 31,214 7,743
--------------- ------------- ------------- ------------
Total $18,384 $16,987 $47,753 $34,660
=============== ============= ============= ============
Selling, general and administrative expense as a percentage of revenue
for each of the operating segments was:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------- -------------------------
2002 2001 2000 2001
---- ---- ---- ----
% % % %
- - - -
Advanced Technology 36.7 23.3 32.9 21.0
Digital Angel Corporation 40.5 27.8 40.4 25.5
SysComm International 19.1 14.0 13.7 17.1
All Other N/A 61.0 63.4 53.5
Corporate / Eliminations (1) 36.5 9.2 57.7 8.9
--------------- ------------- ------------- -----------
Total 71.2 42.6 88.3 39.7
=============== ============= ============= ===========
(1) Corporate's percentage has been calculated as a percentage of total revenue.
36
Advanced Technology's selling general and administrative expense
increased $1.5 million, or 51.7%, to $4.4 million in the three-months ended
June 30, 2002 from $2.9 million in the three-months ended June 30, 2001.
Selling general and administrative expense increased $1.3 million, or 24.1%,
to $6.7 million in the six-months ended June 30, 2002 from $5.4 million in
the six-months ended June 30, 2001. We attribute the increases primarily to
legal and other costs associated with a lawsuit that was settled on July 15,
2002. As a percentage of revenue, selling, general and administrative
expense increased in the three and six-month periods ended June 30, 2002 due
to the increased cost associated with the lawsuit and a reduction in sales
during the three and six-month period ended June 30, 2002.
Digital Angel Corporation's selling general and administrative expense
increased $1.4 million, or 60.9%, to $3.7 million in the three-months ended
June 30, 2002, from $2.3 million in the three-months ended June 30, 2001.
Selling general and administrative expense increased $2.1 million, or 44.7%,
to $6.8 million in the six-months ended June 30, 2002, from $4.7 million in
the six-months ended June 30, 2001. We attribute the increases primarily to
expenses associated with the merger of pre-merger Digital Angel and MAS
during the first quarter of 2002. As a percentage of revenue, selling,
general and administrative expense increased in the three and six-month
periods ended June 30, 2002, due primarily to the increase in expenses
associated with the merger, and a reduction in sales during the three and
six-months ended June 30, 2002.
SysComm International's selling general and administrative expense
decreased $0.1 million, or 10.0%, to $.09 million in the three-months ended
June 30, 2002, from $1.0 million in the three-months ended June 30, 2001.
Selling general and administrative expense decreased $0.8 million, or 38.1%,
to $2.1 million in the six-months ended June 30, 2002, from $2.9 million in
the six-months ended June 30, 2001. We attribute the decreases primarily to
layoffs, the elimination of expenses related to the Shirley, New York
facility, which was sold in January 2002, and other cost control programs.
As a percentage of revenue, selling general and administrative expense
increased in the three-months period ended June 30, 2002, and decreased in
the six-months ended June 20, 2002.
All Other's selling, general and administrative expenses decreased $7.1
million, or 100.0%, in the three-months ended June 30, 2002, from $7.1
million in the three-months ended June 30, 2001. Selling general and
administrative expense decreased $13.0 million, or 93.5%, to $0.9 million in
the six-months ended June 30, 2002, from $13.9 million in the six-months
ended June 30, 2001. The decreases resulted from the sale or closure of all
of the business units comprising this group during the last half of 2001 and
the first six-months of 2002.
"Corporate / Eliminations" selling, general and administrative expenses
increased $5.7 million, or 154.1%, to $9.4 million in the three-months ended
June 30, 2002, from $3.7 million in the three-months ended June 30, 2001.
Selling, general and administrative expenses increased $23.5 million, or
305.2%, to $31.2 million in the six-months ended June 30, 2002, from $7.7
million in the six-months ended June 30, 2001. We attribute the increases
primarily to three factors as follows: 1). We incurred approximately $3.1
million and $3.4 million in non-cash compensation expense for the three and
six-month periods ended June 30, 2002, respectively, due primarily to
re-pricing 19.3 million stock options during 2001. The options had original
exercise prices ranging from $0.69 to $6.34 per share and were modified to
change the exercise price to $0.15 per share. Due to the modification, these
options are being accounted for as variable options under APB Opinion No. 25
and fluctuations in our common stock price will result in increases and
decreases of non-cash compensation expense until the options are exercised,
forfeited or expired. 2). Pursuant to the terms of the pre-merger Digital
Angel and MAS merger agreement, which became effective March 27, 2002,
options to acquire shares of pre-merger Digital Angel common stock were
converted into options to acquire shares of MAS common stock. The
transaction resulted in a new measurement date for the options and, as a
result, we recorded non-cash compensation expense of approximately $18.7
million during the six-months ended June 30, 2002. As all of the option
holders
37
were our employees or directors, these options were considered fixed
awards under APB Opinion No. 25 and expense was recorded for the intrinsic
value of the options converted. 3). We incurred approximately $3.4 million
in the three and six-month periods ended June 30, 2002, for valuation
reserves associated with notes receivable for stock issuances. Excluding the
effects of the non-cash compensation expense associated with options and the
valuation reserves, "Corporate / Eliminations" selling, general and
administrative expenses decreased $0.8 million, or 21.6%, for the
three-months ended June 30, 2002, from the $3.7 million reported in the
three-months ended June 30, 2001, and decreased $2.0 million, or 26.0%, for
the six-months ended June 30, 2002, from the $7.7 million reported in the
six-months ended June 30, 2001. The decrease resulted primarily from the
cost saving initiatives and staff reductions that we began during the last
nine months of 2001.
RESEARCH AND DEVELOPMENT
Research and development expense from continuing operations was $0.8
million and $1.7 million for the three months ended June 30, 2002, and 2001,
respectively. Research and development expense from continuing operations
was $1.8 million and $3.1 million for the six months ended June 30, 2002 and
2001, respectively. Research and development expense decreased to 3.0% of
revenue in the three-months ended June 30, 2002, from 4.3% of revenue in the
three-months ended June 30, 2001 and decreased to 3.3% of revenue in the
six-months ended June 30, 2002, from 3.5% of revenue in the six months ended
June 30, 2001. Research and development expense relates primarily to the
development of our products, Digital Angel and VeriChip.
Research and development expense from continuing operations during the
three and six-months ended June 30, 2002, and 2001 by segments was as
follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
(In thousands) (In thousands)
------------------------- --------------------------
2002 2001 2002 2001
---- ---- ---- ----
Advanced Technology $-- $247 $116 $548
Digital Angel Corporation 782 1,330 1,645 2,414
SysComm International -- -- -- --
All Other -- 127 -- 127
Corporate / Eliminations -- -- -- --
----------- ------------- ------------- ------------
Total $782 $1,704 $1,761 $3,089
=========== ============= ============= ============
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense from continuing operations was
$1.4 million and $7.5 million for the three months ended June 30, 2002, and
2001, respectively. Depreciation and amortization expense from continuing
operations was $2.4 million and $14.4 million for the six months ended June
30, 2002, and 2001, respectively. Depreciation and amortization expense
decreased to 5.4% of revenue in the three-months ended June 30, 2002, from
18.8% of revenue in the three-months ended June 30, 2001, and decreased to
4.4% of revenue in the six-months ended June 30, 2002, from 16.5% of revenue
in the six months ended June 30, 2001.
38
Depreciation and amortization expense from continuing operations during
the three and six-months ended June 30, 2002, and 2001 by segments was as
follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
(In thousands) (In thousands)
--------------------------- --------------------------
2002 2001 2002 2001
---- ---- ---- ----
Advanced Technology $144 $2,156 $250 $4,305
Digital Angel Corporation 1,095 3,002 1,830 5,355
SysComm International 69 153 143 306
All Other -- 1,552 9 3,175
Corporate / Eliminations 76 649 157 1,223
------------- ------------- ------------- ------------
Total $1,384 $7,512 $2,389 $14,364
============= ============= ============= ============
Under FAS 142, which we adopted on January 1, 2002, goodwill and certain
other intangible assets are no longer amortized. This resulted in a
reduction in depreciation and amortization expense of approximately $5.9
million and $11.6 million during the three and six-months ended June 30,
2002, respectively.
Advanced Technology's depreciation and amortization expense decreased
by $2.1 million, or 95.5%, to $0.1 million in the three-months ended June
30, 2002 from $2.2 million in the three-months ended June 30, 2001.
Depreciation and amortization expense decreased by $4.0 million, or 93.0%,
to $0.3 million in the six-months ended June 30, 2002 from $4.3 million in
the six-months ended June 30, 2001. We attribute the decreases to a
reduction in goodwill amortization as a result of the adoption of FAS 142.
Digital Angel Corporation's depreciation and amortization expense
depreciation and amortization expense decreased by $1.9 million, or 63.3%,
to $1.1 million in the three-months ended June 30, 2002 from $3.0 million in
the three-months ended June 30, 2001. Depreciation and amortization expense
decreased by $3.5 million, or 64.8%, to $1.9 million in the six-months ended
June 30, 2002 from $5.4 million in the six-months ended June 30, 2001. We
attribute the decrease to a reduction in goodwill amortization as a result
of the adoption of FAS 142.
SysComm International's depreciation and amortization expense
depreciation and amortization expense decreased by $0.1 million, or 50.0%,
to $0.1 million in the three-months ended June 30, 2002 from $0.2 million in
the three-months ended June 30, 2001. Depreciation and amortization expense
decreased by $0.2 million, or 66.7%, to $0.1 million in the six-months ended
June 30, 2002 from $0.3 million in the six-months ended June 30, 2001. We
attribute the decrease primarily to a reduction of goodwill amortization as
a result of the adoption of FAS 142 and management's decision to offer for
sale the Shirley, New York facility thus ceasing depreciation of the
building and equipment.
All Other's depreciation and amortization expense decreased primarily
due to the sale or closure of all of the business units comprising this
group during the last half of 2001 and the first six months of 2002.
"Corporate / Eliminations" depreciation and amortization expense
decreased $0.5 million, or 83.3%, to $0.1 million in the three-months ended
June 30, 2002 from $0.6 million in the three-months ended June 30, 2001.
Depreciation and amortization expense decreased $1.0 million, or 83.3%, to
$0.2 million in the six-months ended June 30, 2002 from $1.2 million in the
six-months ended June 30, 2001. We attribute the decreases primarily to the
impairment and sale of software and other corporate assets during the last
half of 2001.
39
INTEREST INCOME AND EXPENSE
Interest income was $0.6 million and $0.6 million, for the three-months
ended June 30, 2002 and 2001, respectively, and $.07 million and $1.1
million for the six-months ended June 30, 2002 and 2001, respectively.
Interest income is earned primarily from short-term investments and notes
receivable.
Interest expense was $4.7 million and $1.8 million, for the three-month
ended June 30, 2002 and 2001, respectively, and $6.9 million and $3.7
million for the six-months ended June 30, 2002 and 2001, respectively.
Interest expense is primarily a function of the level of outstanding debt
and is principally associated with notes payable and term loans.
INCOME TAXES
Our effective income tax rates were (0.1)% and 129.0% in the
three-months ended June 30, 2002 and 2001, respectively, and 0.2% and 79.9%
in the six-months ended June 30, 2002 and 2001, respectively. Differences in
the effective income tax rate from the statutory federal income tax rate
arise primarily from the recognition of net operating loss carryforwards,
non-deductible goodwill amortization associated with acquisitions and state
taxes net of federal benefits. In addition, the rates for the three and
six-month periods ended June 30, 2001 were impacted by an increase in our
deferred tax valuation allowance of $19.7 million, as it became more likely
than not that certain deferred tax assets would not be realized. This was
the result of the losses incurred during the three and six-month periods
ended June 30, 2001 and our projections of future taxable income.
RESULTS OF DISCONTINUED OPERATIONS
On March 1, 2001, our Board of Directors approved a plan to offer for
sale our Intellesale business segment and all of our other "non-core
businesses". Accordingly, the operating results of these entities have been
reclassified and reported as Discontinued Operations for all periods
presented. As of March 1, 2002, we had sold or closed substantially all of
the businesses comprising Discontinued Operations, and there were two
insignificant companies remaining. One of the remaining businesses was sold
effective May 23, 2002 and we anticipate selling the remaining company
within the next several months. Revenue and net loss for the remaining
business was $0.7 million and $41 thousand, respectively, for the six months
ended June 30, 2002. We used the proceeds from the sales of companies
classified as Discontinued Operations to repay amounts outstanding under the
IBM Agreement.
40
The following discloses the results of Intellesale and all other
non-core businesses comprising discontinued operations for the period from
January 1, 2001 through March 1, 2001, the measurement date:
January 1, through
March 1,
----------------------
2001
----
(amounts in thousands)
Product revenue $13,039
Service revenue 846
----------------------
Total revenue 13,885
Cost of products sold 10,499
Cost of services sold 259
----------------------
Total cost of products and services sold 10,758
----------------------
Gross profit 3,127
Selling, general and administrative expenses 2,534
Depreciation and amortization 264
Interest, net 29
Provision for income taxes 34
Minority interest 53
----------------------
Income from discontinued operations $213
======================
The above results do not include any allocated or common overhead
expenses. Included in Interest, net, above are interest charges based on the
debt of one of these businesses. A purchaser assumed this debt when the
business was sold on January 31, 2002.
We recorded a provision for operating losses, estimated loss on
sale and carrying costs during the phase-out period including operating and
other disposal costs to be incurred in selling the businesses. Carrying
costs primarily include the cancellation of facility leases, employment
contract buyouts and litigation reserves. During the quarter ended March 31,
2002, we increased the estimated loss on sale of our 85% ownership in our
Canadian subsidiary, Ground Effects, Ltd, which we sold on January 31, 2002
by $0.2 million, and we increased our estimated loss on the sale of certain
business assets of U.S. Electrical Products Corp, which were sold on May 23,
2002, by $0.2 million. Proceeds on the sale of Ground Effects, Ltd.
approximated $1.6 million plus the assumption of the Canadian portion of the
IBM debt and proceeds on the sale of U.S. Electrical Products Corp.'s assets
were $0.1 million. Offsetting the increase in the estimated loss on sale was
net operating income for the first quarter of 2002. This net income was
primarily due to a change in estimated carrying costs as certain of these
obligations were settled during the first half of 2002 for amounts less than
previously anticipated.
The following table sets forth the roll forward of the liabilities for
estimated loss on sale and operating losses and carrying costs from December
31, 2001 through June 30, 2002.
Balance Balance
Type of Cost December 31, 2001 Additions Deductions June 30, 2002
- ---------------------------------------------------------------------------------------------------------------------
Estimated loss on sale, net of change in
Estimated operating losses $1,173 $479 $1,652 $--
Carrying costs 7,218 (703) 124 6,391
---------------------------------------------------------------
Total $8,391 $(224) $1,776 $6,391
===============================================================
41
LIQUIDITY AND CAPITAL RESOURCES FROM CONTINUING OPERATIONS
As of June 30, 2002, cash and cash equivalents totaled $8.0 million, an
increase of $4.3 million, or 116.2%, from $3.7 million at December 31, 2001.
Cash of $1.7 million was provided by operations and cash of $4.2
million was used by operations during the first six months of 2002, and
2001, respectively. In the six months ended June 30, 2002, cash was provided
primarily by collections on accounts receivable and a decrease in current
and other assets and cash was used primarily to purchase inventory. In the
six months ended June 30, 2001, cash was used primarily to decrease accounts
payable and accrued expenses and to fund discontinued operations. Partially
offsetting the uses of cash were increases in cash from the collection of
accounts receivable and decreases in inventory.
Due from buyers of divested subsidiaries represented the deferred
purchase price due on the sale of several businesses during the fourth
quarter of 2001. We collected these proceeds during the first half of 2002.
Accounts and unbilled receivables, net of allowance for doubtful
accounts, decreased by $4.4 million, or 20.1%, to $17.5 million at June 30,
2002 from $21.9 million at December 31, 2001. We attribute the decrease
primarily to increased collection efforts during the first half of 2002.
Inventory levels remained relatively constant at $2.3 million at June
30, 2002 and December 31, 2001.
Accounts payable decreased by $4.2 million, or 27.3%, to $11.2 million
at June 30, 2002 from $15.4 million at December 31, 2001. Cash generated
during the first half of 2002 was used to bring certain payables current.
Also, accounts payable decreased for various business units classified as
All Other, since all of these business units had ceased operations as of
June 30, 2002.
Accrued expenses remained relatively constant at $21.6 million at June
30, 2002, compared to $18.2 million at December 31, 2001, primarily due to
accrued interest.
Investing activities provided cash of $4.4 million in the first
six-months of 2002, and used cash of $4.9 million in the first six-months of
2001. In the first six-months of 2002, cash was provided primarily by
collections of amounts due from buyers of divested subsidiaries of $2.6
million, proceeds from the sale of property and equipment of $2.5 million
and proceeds from the sale of subsidiaries and business assets of $1.1
million. Partially offsetting the amounts provided were cash used by
discontinued operations of $0.5 million and cash used to purchase property
and equipment of $1.0 million. In the first six-months of 2001, $2.6 million
was used to acquire property and equipment, $0.5 million was used by
discontinued operations and $2.0 million was used to increase other assets.
Financing activities in the first six-months of 2002 used cash of $1.8
million and financing activities in the first six-months of 2001 provided
cash of $7.5 million. In the first six-months of 2002, cash was used
primarily to repay $4.8 million against long-term debt and notes payable.
Partially offsetting the use of cash during the first six-months of 2002 was
cash of $1.6 million provided from the issuance of common shares and $1.2
million from collection of notes receivable for shares issued.
42
The primary source of cash in the first six-months of 2001 was borrowings of
$7.8 million against notes payable.
Debt, Covenant Compliance and Liquidity
On March 1, 2002, we and Digital Angel Share Trust, a newly created
Delaware business trust, entered into the IBM Credit Agreement with IBM
Credit, which became effective on March 27, 2002, the effective date of the
merger between pre-merger Digital Angel and MAS. Amounts outstanding under
the IBM Credit Agreement of $82.1 million at May 10, 2002, bear interest at
an annual rate of 17% and mature on February 28, 2003. No principal or
interest payments are due until the maturity date. However, the maturity
date will be automatically extended to February 28, 2004, if we repay at
least $32.8 million, or 40%, of the original principal amount outstanding,
plus accrued interest and expenses, prior to February 28, 2003. If the
maturity date is extended to February 28, 2004, the maturity date will be
automatically extended again to February 28, 2005, if we repay an additional
40% of the original principal amount outstanding, plus accrued interest and
expenses, prior to February 28, 2004. Any amounts outstanding at February
28, 2005, must be repaid by August 31, 2005. If all amounts are not repaid
by February 28, 2003, the unpaid amount will accrue interest at an annual
rate of 25%. If all amounts are not repaid by February 28, 2004, the
interest rate increases to 35%.
The IBM Credit Agreement contains debt covenants relating to our
financial position and performance, as well as the financial condition and
performance of the Digital Angel Corporation. Our covenants under the IBM
Credit Agreement are as follows: (The Current Asset to Current Liabilities
covenant is measured monthly and the Minimum Cumulative EBITDA, as defined,
is measured quarterly). (Minimum Cumulative Modified EBITDA, as defined in
the IBM Credit Agreement, excludes non-cash compensation expense, one-time
charges, impairment losses and any liability or claim that will be satisfied
by issuances of our common stock):
COVENANT COVENANT REQUIREMENT
----------------------------------------------------------------------------------------------------------
As of the following date not less than:
Current Assets to Current
Liabilities June 30, 2002 .14:1
September 30, 2002 .11:1
December 31, 2002 .11:1
----------------------------------------------------------------------------------------------------------
Minimum Cumulative
Modified EBITDA June 30, 2002 $ 121,000
September 30, 2002 817,000
December 31, 2002 1,286,000
----------------------------------------------------------------------------------------------------------
43
Digital Angel Corporation's covenants under the IBM Credit
Agreement are as follows. (Digital Angel Corporation's Current Asset to
Current Liabilities covenant and its Minimum Cumulative Modified EBITA, as
defined, is measured quarterly):
COVENANT COVENANT REQUIREMENT
----------------------------------------------------------------------------------------------------------
As of the following date not less than:
Current Assets to Current
Liabilities June 30, 2002 1.8:1
September 30, 2002 1.8:1
December 31, 2002 2.0:1
-----------------------------------------------------------------------------------------------------------
Minimum Cumulative
Modified EBITDA June 30, 2002 $577,000
September 30, 2002 1,547,000
December 31, 2002 3,329,000
-----------------------------------------------------------------------------------------------------------
In satisfaction of a condition to the consent of the merger by IBM
Credit, we transferred to the Digital Angel Share Trust, which is controlled
by an advisory board, all shares of Digital Angel Corporation common stock
owned by us and, as a result, the trust has legal title to approximately
74.25% of the Digital Angel Corporation common stock. The trust has voting
rights with respect to the Digital Angel Corporation common stock until we
repay our obligations to IBM Credit in full. We retained beneficial
ownership of the shares. The trust may be obligated to liquidate the shares
of Digital Angel Corporation common stock owned by it for the benefit of IBM
Credit in the event we fail to make payments, or otherwise default, under
the IBM Credit Agreement. Such liquidation of the shares of Digital Angel
Corporation common stock will be in accordance with the SEC rules and
regulations governing affiliates.
At June 30, 2002, we were not in compliance with our Minimum Cumulative
Modified EBITDA debt covenant and with other provisions of the IBM Credit
Agreement. In addition, Digital Angel Corporation was not in compliance with
the Minimum Cumulative Modified EBITDA and Current Assets to Current
Liabilities debt covenants. IBM has agreed to provide the Company with a
waiver of such noncompliance, the documentation of which will be formalized
no later than August 21, 2002. As consideration for the waiver, the Company
will issue to IBM a five year warrant to acquire 2.9 million shares of the
Company's Common Stock at $.15 per share, as well as other consideration.
However, we believe that when our third quarter results are finalized, we
will not be in compliance with certain financial ratios for the third
quarter of 2002. Although we will again request a waiver from IBM Credit,
there can be no assurances that a waiver will be obtained. In the future, if
business conditions are other than as anticipated or other unforeseen events
or circumstances occur, these may impact our ability to remain in compliance
with the covenants. In the absence of waiver or amendment to the financial
covenants, such noncompliance would constitute an event of default under the
IBM Credit Agreement, and IBM Credit would be entitled to accelerate the
maturity of all amounts we owe them. In the event such noncompliance appears
likely, or occurs, we will seek to renegotiate the covenants and/or obtain
waivers, as required. There can be no assurance, however, that we would be
successful in negotiating such amendments or obtaining such waivers.
The IBM Credit Agreement prohibits us from borrowing funds from other
lenders without the approval of IBM Credit, and does not provide for any
further advances by IBM Credit. The IBM Credit Agreement also limits the
amount we may pay our Chief Executive Officer, Richard Sullivan, in cash,
and prevents us from making certain cash incentive and perquisite payments,
including cash payment arising upon a change in control, to various other
executive officers.
Amounts outstanding under the IBM Credit Agreement are secured by a
security interest in substantially all of our assets, excluding the assets
of Digital Angel Corporation. The shares of our
44
subsidiaries, including the Digital Angel Corporation common stock held in
the Digital Angel Share Trust, also secure the amounts outstanding under the
IBM Credit Agreement.
Sources of Liquidity
If we are unable to generate the funds that will be required for the
payments under the IBM Credit Agreement, as discussed above, shares of
Digital Angel Corporation common stock initially owned by us upon completion
of the merger between pre-merger Digital Angel and MAS and transferred to
the Digital Angel Share Trust may be liquidated, if so directed by IBM
Credit, to provide funds necessary to make these payments. The IBM Credit
Agreement prohibits us from borrowing funds from other lenders, and does not
provide for any further advances by IBM Credit. In addition, our prior
accountants have expressed doubt about our ability to continue as a going
concern. Accordingly, there can be no assurance that we will have access to
funds necessary to repay IBM Credit or to provide for our ongoing operating
expenses to the extent not provided from our ongoing operating revenue. In
addition, we may be able to use proceeds from the sale of businesses,
proceeds from the sale of common and preferred shares, proceeds from the
exercise of stock options and warrants, and the raising of other forms of
debt or equity through private placement or public offerings to fund ongoing
operations. There can be no assurance, however, that these options will be
available, or if available, on favorable terms. Our capital requirements
depend on a variety of factors, including but not limited to, the rate of
increase or decrease in our existing business base; the success, timing, and
amount of investment required to bring new products on-line; revenue growth
or decline; and potential acquisitions.
Outlook
We are constantly looking for ways to maximize shareholder value. As
such, we are continually seeking operational efficiencies and synergies
within our operating segment as well as evaluating acquisitions of
businesses and customer bases which complement our operations. These
strategic initiatives may include acquisitions, raising additional funds
through debt or equity offerings, or the divestiture of non-core business
units that are not critical to our long-term strategy or other restructuring
or rationalization of existing operations. We will continue to review all
alternatives to ensure maximum appreciation of our shareholders'
investments. There can be no assurance, however, that any initiatives will
be found, or if found, that they will be on terms favorable to us.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2001, the FASB issued FAS No. 141 Business Combinations and
FAS No. 142 Goodwill and Other Intangible Assets. FAS 141 requires business
combinations initiated after June 30, 2001 to be accounted for using the
purchase method of accounting, and broadens the criteria for recording
intangible assets separate from goodwill. Recorded goodwill and intangibles
will be evaluated against these new criteria and may result in certain
intangibles being included in goodwill, or alternatively, amounts initially
recorded as goodwill may be separately identified and recognized apart from
goodwill. FAS 142 requires the use of a non-amortization approach to account
for purchased goodwill and certain intangibles. Under a non-amortization
approach, goodwill and certain intangibles will not be amortized into
results of operations, but instead would be reviewed for impairment and
written down and charged to results of operations only in the periods in
which the recorded value of goodwill and certain intangibles is more than
its fair value. We adopted the provisions of each statement, which apply to
goodwill and certain intangibles acquired prior to June 30, 2001, on January
1, 2002. The adoption of these standards had the impact of reducing our
amortization of goodwill commencing January 1, 2002. There was no impairment
of goodwill upon adoption of FAS 142. However, future impairment reviews may
result in periodic write-downs.
In August 2001, the FASB issued FAS 144, Accounting for the Impairment
or Disposal of Long-
45
Lived Assets. This standard supersedes FAS 121, Accounting for the
Impairment of Long-Lived Assets to Be Disposed Of, and provides a single
accounting model for long-lived assets to be disposed of. This standard
significantly changes the criteria that would have to be met to classify an
asset as held-for-sale. This distinction is important because assets to be
disposed of are stated at the lower of their fair values or carrying amounts
and depreciation is no longer recognized. The new rules will also supercede
the provisions of APB Opinion 30, Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions,
with regard to reporting the effects of a disposal of a segment of a
business and will require expected future operating losses from Discontinued
Operations to be displayed in Discontinued Operations in the period in which
the losses are incurred, rather than as of the measurement date as presently
required by APB 30. This statement is effective for fiscal years beginning
after December 15, 2001. We adopted this statement on January 1, 2002. The
adoption of FAS 144 did not have a material impact on our operations or
financial position.
In May 2002, the FASB issued SFAS 145, Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS 145 eliminates Statement 4 (and Statement 64, as it amends
Statement 4), which requires gains and losses from extinguishments of debt
to be aggregated and, if material, classified as an extraordinary item, and
thus, also the exception to applying Opinion 30 is eliminated as well. This
statement is effective for years beginning after May 2002 for the provisions
related to the rescission of Statements 4 and 64, and for all transactions
entered into beginning May 2002 for the provision related to the amendment
of Statement 13. We have not yet determined what impact the adoption of FAS
145 will have on our operations and financial position.
46
FORWARD LOOKING STATEMENTS AND ASSOCIATED RISKS
RISK FACTORS
You should carefully consider the risk factors listed below. These risk
factors may cause our future earnings to be less or our financial condition
to be less favorable than we expect. You should read this section together
with the other information contained herein.
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISK.
This Form 10-Q contains forward-looking statements within the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995
with respect to our financial condition, results of operations and business,
and include statements relating to:
o our growth strategies including, without limitation, our ability
to deploy the products and services in our Advanced Wireless and
Digital Angel Corporation segments;
o anticipated trends in our business and demographics;
o our ability to successfully integrate the business operations of
recently acquired companies and successfully complete the
divestitures of our discontinued operations;
o our future profitability and liquidity; and
o regulatory, competitive or other economic influences.
In some cased, you can identify forward-looking statements by terms
such as "may," "should," "could," "would," "anticipates," "expects,"
"intends," "plans," "believes," "seeks," "estimates" and similar expressions
intended to identify forward-looking statements. These forward-looking
statements are not guarantees of future performance and are subject to risks
and uncertainties that could cause actual results to differ materially from
estimates or forecasts contained in the forward-looking statements. Some of
these risks and uncertainties are beyond our control.
WE CANNOT BE CERTAIN OF FUTURE FINANCIAL RESULTS.
We reported losses from continuing operations of $44.2 million and
$40.7 million for the six-months of 2002 and 2001, respectively. We incurred
losses of $198.1 million and $29.2 million from continuing operations for
the years ended December 31, 2001 and 2000, respectively. We reported income
from continuing operations of $2.6 million for the year ended December 31,
1999 which included a loss from continuing operations of $17.4 million,
offset by a gain of $20.0 million from the sale of our Canadian subsidiary,
TigerTel, Inc. Our business plan depends on our attaining and maintaining
profitability; however, we cannot predict whether we will remain profitable
in the future. Our profitability depends on many factors, including the
success of our marketing programs, the maintenance and reduction of expenses
and our ability to successfully develop and bring to market new products and
technologies. We may not be able to sustain or increase profitability on a
quarterly or annual basis. In addition, if we fail to experience profits
within the time frame expected by investors, the market price of our common
stock may fall.
OUR STOCK PRICE MAY CONTINUE TO BE VOLATILE, AND YOU MAY BE UNABLE TO
RESELL YOUR SHARES AT OR ABOVE THE PRICE AT WHICH YOU ACQUIRE THEM.
Since January 1, 2000, the price per share of our common stock has
ranged from a high of $18.00 to a low of $0.11. The price of our common
stock has been, and may continue to be, highly volatile and
47
subject to wide fluctuations in response to factors, including the
following:
(i) Significant changes to our business resulting from
acquisitions and/or expansions into different product lines;
(ii) quarterly fluctuations in our financial results or cash flows;
(iii) changes in investor perception of us or the market for our
products and services;
(iv) changes in economic and capital market conditions for other
companies in our market sector; and
(v) changes in general economic and market conditions.
In addition, the stock market in general, and stocks of technology
companies in particular, have often experienced extreme price and volume
fluctuations. This volatility is often unrelated or disproportionate to the
operating performance of these companies. Broad market and industry factors
may decrease the market price of our common stock, regardless of our actual
operating performance. Declines in the market price of our common stock
could also harm employee morale and retention, our access to capital and
other aspects of our business. If our share price is volatile, we may be the
target of additional securities litigation, which is costly and
time-consuming to defend. Because of recent periods of volatility in the
market price of our securities, we face a heightened risk of securities
class action litigation. In May 2002, a shareholders action was filed
against us and one of our directors and several more complaints were filed
that have identical or near identical allegations. Litigation of this type
could result in substantial costs and a diversion of management's attention
and resources, which would harm our business.
WE MAY ISSUE PREFERRED STOCK, WHICH WILL RANK SENIOR TO THE SHARES OF
OUR COMMON STOCK AND WHICH MAY DELAY OR PREVENT A CHANGE IN CONTROL OF US.
Preferred stock may be created and issued from time to time by our
board of directors, with such rights and preferences as our board of
directors may determine. Because of our board of directors' broad discretion
with respect to the creation and issuance of any series of preferred stock
without shareholder approval, our board of directors could adversely affect
the voting power of our common stock. The issuance of preferred stock may
also have the effect of delaying, deferring or preventing a change in
control of us.
IF WE ARE UNABLE TO RE-LIST OUR COMMON STOCK, TRADING IN OUR SHARES
COULD DECREASE AND THE MARKET PRICE OF OUR SHARES COULD DECLINE AND, EVEN IF
WE DO REGAIN LISTING STATUS, WE MAY BE UNABLE TO CONTINUE TO SATISFY THE
APPLICABLE LISTING REQUIREMENTS.
Our ability to remain listed on Nasdaq depends on our ability to
satisfy applicable Nasdaq criteria including our ability to maintain a
minimum bid price of $1.00 per share. The market price for our common stock
has recently been below the minimum bid price required by Nasdaq. Because
the condensed financial statements in our Current Report on Form 10-Q for
the three months ended March 31, 2002, which was filed with the SEC on May
20, 2002, had not been reviewed by an independent public accountant, we were
delisted from Nasdaq from July 12, 2002 to July 30, 2002. We filed an
amended Current Report on From 10-Q/A on July 18, 2002, which contained
reviewed condensed financial statements, and on July 31, 2002, we were
relisted on Nasdaq. However, as a condition of our relisting, Nasdaq has
advised us that we have until October 25, 2002, to regain compliance with
the minimum bid price requirement. If we are unable to satisfy the minimum
bid price requirement, Nasdaq may once again commence procedures to remove
our common stock from Nasdaq.
If we are delisted from Nasdaq in the future, an active trading market
for our common stock may no longer exist. As a result, trading in our shares
of common stock could decrease substantially, and the price of our shares of
common stock may decline.
48
IF WE ARE REQUIRED TO ISSUE ADDITIONAL SHARES OF COMMON STOCK IN
CONNECTION WITH PRIOR ACQUISITIONS, OUR STOCK MAY BE FURTHER DILUTED.
As of June 30, 2002, there were 269,292,046 shares of our common stock
outstanding. Since January 1, 2001, we have issued a net aggregate of
167,805,345 shares of common stock, of which 83,759,195 shares were issued
in connection with acquisitions of businesses and assets and 64,810,635
shares were issued upon conversion of our Series C preferred stock. We have
effected, and will likely continue to effect, acquisitions or contract for
services through the issuance of common stock or our other equity
securities. In addition, we have agreed to future earnout and "price
protection" provisions in prior acquisition and other agreements, which may
result in additional shares of common stock being issued. Such issuances of
additional securities may be dilutive to the value of our common stock and
may have an adverse impact on the market price of our common stock.
COMPETITION COULD REDUCE OUR MARKET SHARE AND DECREASE OUR REVENUE.
Each of our business units operates in a highly competitive
environment, and we expect that competitive pressures will continue in the
future. Many of our competitors have far greater financial, technological,
marketing, personnel and other resources than us. The areas which we have
identified for continued growth and expansion are also target market
segments for some of the largest and most strongly capitalized companies in
the United States and Europe. In response to competitive pressures, we may
be required to reduce prices or increase spending in order to retain or
attract customers or to pursue new market opportunities. As a result, our
revenue, gross profit and market share may decrease, each of which could
significantly harm our results of operations. In addition, increased
competition could prevent us from increasing our market share, or cause us
to lose our existing market share, either of which would harm our revenues
and profitability. We cannot assure you that we will have the financial,
technical, marketing and other resources required to successfully compete
against current and future competitors or that competitive pressures faced
by us will not harm our business, financial condition or results of
operations.
IF WE DEFAULT ON OUR OBLIGATIONS UNDER THE IBM CREDIT AGREEMENT, OUR
BUSINESS OPERATION MAY BE MATERIALLY ADVERSELY AFFECTED.
On several occasions during 2001, we failed to comply with the
covenants contained in our previous credit agreement with IBM Credit, and,
as a result, at times we were in default under that agreement. We entered
into the IBM Credit Agreement, which became effective on March 27, 2002,
upon the completion of the merger between pre-merger Digital Angel and MAS.
The IBM Credit Agreement contains various financial and other restrictive
covenants that, among other things, limit our ability to borrow additional
funds and declare and pay dividends, and requires us, and Digital Angel
Corporation to, among other things, maintain various financial ratios and
comply with various other financial covenants. At June 30, 2002, we, and
Digital Angel Corporation, were not in compliance with certain of the
financial ratios contained in the IBM Credit Agreement and we were not in
compliance with other provisions of the IBM Credit Agreement. IBM has agreed
to provide the Company with a waiver of such noncompliance, the
documentation of which will be formalized no later than August 21, 2002. As
consideration for the waiver, the Company will issue to IBM a five year
warrant to acquire 2.9 million shares of the Company's Common Stock at $.15
per share, as well as other consideration. However, we believe that when our
third quarter results are finalized, we will not be in compliance with
certain financial ratios for the third quarter of 2002. Although we will
again request a waiver from IBM Credit, there can be no assurances that a
waiver will be obtained. In the future, if business conditions are other
than as anticipated or other unforeseen events or circumstances occur, these
may impact our ability to remain in compliance with the covenants. In the
absence of waiver or amendment to the financial covenants, such
noncompliance would constitute an event of default under the IBM Credit
Agreement, and IBM Credit would be entitled to accelerate the maturity of
all amounts we owe them. We do not currently have available funds to repay
the amounts owed to IBM Credit if the maturity of the obligation is
accelerated. If IBM Credit were to accelerate these obligations and enforce
its rights against the collateral securing these obligations, without
additional financing resources, there would be substantial doubt we would be
able to continue operations in the normal course of business.
49
IF WE NEED ADDITIONAL CAPITAL FOR OUR ONGOING OPERATIONS OR TO REPAY
IBM CREDIT, WE MAY NOT BE ABLE TO CONTINUE OPERATIONS IN THE NORMAL COURSE
OF BUSINESS.
We may require additional capital for our ongoing operations or to
repay IBM Credit the amounts owed it. Under the terms of the IBM Credit
Agreement, amounts outstanding bear interest at an annual rate of 17% and
mature on February 28, 2003. No principal or interest payments are due until
the maturity date. However, the maturity date will be automatically extended
to February 28, 2004, if we repay at least $32.8 million, or 40%, of the
original principal amount outstanding, plus accrued interest and expenses,
prior to February 28, 2003. If the maturity date is extended to February 28,
2004, the maturity date will be automatically extended again to February 28,
2005, if we repay an additional $32.8 million, or 40%, of the original
principal amount outstanding, plus accrued interest and expenses, prior to
February 28, 2004. Any amounts outstanding at February 28, 2005, must be
repaid by August 31, 2005. If all amounts are not repaid by February 28,
2003, the unpaid amount will accrue interest at an annual rate of 25%. If
all amounts are not repaid by February 28, 2004, the interest rate increases
to 35%. We do not currently have the funds that will be required for such
payments, and there is no likelihood that the funds will be available when
required for these payments. Shares of MAS common stock, which we
transferred to a Delaware business trust may be liquidated, if so directed
by IBM Credit, to provide funds necessary to make these payments. Such
liquidation of the shares of MAS common stock will be made in accordance
with the SEC rules and regulations governing affiliates.
The IBM Credit Agreement prohibits us from borrowing funds from other
lenders, and will not provide for any further advances by IBM Credit.
Accordingly, there can be no assurance that we will have access to funds
necessary to provide for our ongoing operating expenses to the extent not
provided from our ongoing operating revenue.
WE DEPEND ON OUR SMALL TEAM OF SENIOR MANAGEMENT, AND WE MAY HAVE
DIFFICULTY ATTRACTING AND RETAINING ADDITIONAL PERSONNEL.
The success of our business depends on the continued service of our
executive officers and key personnel. We have entered into employment
contracts ranging for periods of one to five years through February 2006
with our key officers and employees. Some of these employment contracts call
for bonus arrangements based on earnings. There can be no assurance that we
will be successful in retaining our key employees or that we can attract and
retain additional skilled personnel as required. The loss of the services of
any of our central management team could harm our business, financial
condition and results of operations. In addition, the operations of any of
our individual facilities could be adversely affected if the services of the
local managers should be unavailable.
WE FACE THE RISKS THAT THE VALUE OF OUR INVENTORY MAY DECLINE BEFORE WE
SELL IT OR THAT WE MAY NOT BE ABLE TO SELL THE INVENTORY AT THE PRICES WE
ANTICIPATE.
Our success will depend on our ability to purchase inventory at
attractive prices relative to its resale value and our ability to turn our
inventory rapidly through sales. If we pay too much or hold inventory too
long, we may be forced to sell our inventory at a discount or at a loss or
write down its value, and our business could be materially adversely
affected.
BECAUSE WE WILL NOT PAY DIVIDENDS ON OUR COMMON STOCK FOR THE
FORESEEABLE FUTURE, SHAREHOLDERS MUST RELY ON STOCK APPRECIATION FOR ANY
RETURN ON THEIR INVESTMENT IN THE COMMON STOCK.
We have never declared or paid dividends on our common stock, and we
cannot assure you that any dividends will be paid in the foreseeable future.
Our IBM Credit Agreementplaces restrictions on the declaration and payment
of dividends. We intend to use any earnings which we generate to finance our
operations and to repay the amounts outstanding under the IBMCredit
Agreement, and, therefore, we do not anticipate paying cash dividends in the
future. As a result, only appreciation of the price of our common stock will
provide a return to our shareholders.
50
PROVISIONS IN OUR EMPLOYMENT AGREEMENTS MAY MAKE IT DIFFICULT FOR A
THIRD PARTY TO ACQUIRE US, DESPITE THE POSSIBLE BENEFITS TO OUR
SHAREHOLDERS.
Our employment or other agreements with Richard Sullivan and Jerome
Artigliere include change of control provisions under which the employees
may terminate their employment within one year after a change of control and
are entitled to receive specified severance payments and/or continued
compensation payments for sixty months. The employment agreement for Richard
Sullivan also provides for supplemental compensation payments for sixty
months upon termination of employment, even if there is no change in
control, unless his employment is terminated due to a material breach of the
terms of the employment agreement. Also, our agreements with Richard
Sullivan and Garrett Sullivan, our former president, provide for certain
"triggering events," which include a change in control, the termination of
Richard Sullivan's employment other than for cause, or if Richard Sullivan
ceases to hold his current positions with us for any reason other than a
material breach of the terms of his employment agreement. In that case, we
would be obligated to pay, in cash and/or in stock, $12.1 million and $3.5
million, respectively, to Richard Sullivan and to Garrett Sullivan, in
addition to certain other compensation. Finally, the employment agreements
provide for a gross up for excise taxes which are payable by these executive
officers if any payments upon a change of control are subject to such taxes
as excess parachute payments.
Under the terms of the IBM Credit Agreement, we are prevented from
making cash payments to various executive officers, including certain
portions of Richard J. Sullivan's salary and bonus in cash and, including
the payments described in the preceding paragraph in cash to Richard
Sullivan, Garrett Sullivan and Jerome Artigliere until our obligations to
IBM Credit are repaid in full. Nevertheless, our obligation to make the
payments described in the preceding paragraph could adversely affect our
financial condition or could discourage other parties from entering into
transactions with us, which might be treated as a change in control or
triggering event for purposes of these agreements.
WE MAY NOT PREVAIL IN ONGOING LITIGATION AND MAY BE REQUIRED TO PAY
SUBSTANTIAL DAMAGES.
In May 2002, a shareholders action was filed against us and one of our
directors (the Childs litigation). In the following weeks, several more
complaints were filed that have identical or near identical allegations as
those alleged in the Childs litigation. The Childs litigation's primary
allegations relate to (i) claims that we failed to disclose improper
accounting procedures related to two subsidiaries, (ii) claims that
statements in a Los Angeles Times article on May 9, 2002 about the Company's
VeriChip Corporation subsidiary were false, and (iii) that statements by us
as quoted in other newspaper articles were misleading. We expect that the
various cases will be consolidated into one case. We believe that the
allegations in the Childs litigation and the later-filed cases are without
merit and we will defend them vigorously.
In addition to the shareholders action discussed above, we are party to
various legal actions as either plaintiff or defendant in the ordinary
course of business. While we believe that the final outcome of these
proceedings will not have a material adverse effect on our financial
position, cash flows or results of operations, we cannot assure the ultimate
outcome of these actions and the estimates of the potential future impact on
our financial position, cash flows or results of operations for these
proceedings could change in the future. In addition, we will continue to
incur additional legal costs in connection with pursuing and defending such
actions.
WE HAVE BEEN, AND MAY CONTINUE TO BE, ADVERSELY AFFECTED BY RECENT
EVENTS.
The events of September 11, 2001, in New York City and Washington, D.C.
have, and are likely to continue to have, a negative effect on the economic
condition of the U.S. financial markets in general and on the technology
sector in particular. As a result of the current economic slowdown, which
was exacerbated by the events of September 11, 2001, we have experienced
deteriorating sales for certain of our businesses. This resulted in the shut
down of several of our businesses during the third and fourth
51
quarters of 2001. Also, letters of intent that we had received during the
last half of 2001 and the first quarter of 2002 related to the sales of
certain of our businesses indicated a decline in their fair values. As a
result, we recorded asset impairment charges and increased inventory
reserves during the third and fourth quarters of 2001. If the economic
condition of the U.S. financial markets in general and of the technology
sector in particular do not improve in the near term, and if the current
economic slowdown continues, we may be forced to shut down additional
businesses, causing us to incur additional charges, which could have a
material adverse effect on our business, operating results and financial
condition.
52
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Digital Angel Corporation has a foreign subsidiary operating in the
United Kingdom, which has very limited foreign currency related
transactions. Our United States companies may export and import to and from
other countries. Our operations may therefore be subject to volatility
because of currency fluctuations, inflation and changes in political and
economic conditions in these countries.
We presently do not use any derivative financial instruments to hedge
our exposure to adverse fluctuations in interest rates, foreign exchange
rates, fluctuations in commodity prices or other market risks, nor do we
invest in speculative financial instruments. Borrowings under the IBM Credit
Agreement bear interest at a fixed rate. Our interest income is sensitive to
changes in the general level of U.S. interest rates, particularly since the
majority of our investments are in short-term investments.
Due to the nature of our borrowings and our short-term investments, we
have concluded that there is no material market risk exposure and,
therefore, no quantitative tabular disclosures are required.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We, and certain of our subsidiaries, are parties to various legal
actions as either plaintiff or defendant and accordingly, have recorded
certain reserves in its financial statements at December 31, 2001. In our
opinion, these proceedings are not likely to have a material adverse affect
on our financial position, our cash flows or our overall trends in results.
The estimate of the potential impact on our financial position, our overall
results of operations or our cash flows for these proceedings could change
in the future.
On April 7, 2000, we and Intellesale filed a counterclaim against
David Romano and Eric Limont, the former owners of Bostek, Inc. and Micro
Components International Incorporated, two companies acquired by Intellesale
in June 1999, in the U.S. District Court for the District of Delaware for,
generally, breach of contract, breach of fiduciary duty and fraud. Messrs.
Romano and Limont had filed their claim generally alleging that their
earnout payment from Intellesale was inadequate. In July 2000, we and
Intellesale amended our counterclaim in the U.S. District Court for the
District of Delaware to seek damages for, among other things, securities law
violations. In addition, on May 19, 2000, Intellesale and two of its
subsidiaries, Bostek, Inc. and Micro Components International Incorporated,
filed suits against Messrs. Romano and Limont in Superior Court of
Massachusetts to recover damages. In July 2000, Messrs. Romano and Limont
amended their complaint in the U.S. District Court for the District of
Delaware to add a claim for $10 million for the $10 million payment not made
to them. As of January 16, 2001, we, Intellesale, Bostek, Inc. and Micro
Components International Incorporated settled all claims with Messrs. Romano
and Limont. As part of the settlement agreement, Messrs. Romano and Limont
agreed to acquire shares of our common stock and to indemnify us against
various other litigation filed against Bostek, Inc. The settlement
agreement, which was consummated on April 12, 2002, provides for Messrs.
Romano and Limont to purchase approximately 2.0 million shares of our common
stock for a note receivable of $1.6 million due on October 12, 2003.
On June 8, 2001, three individuals filed suit against us and four
of our officers in the United States District Court for Delaware seeking
equitable relief and damages. The plaintiffs had acquired our stock when the
company in which they were shareholders, Computer Equity Corporation, was
merged into one of our subsidiaries in 2000. The suit alleged, inter alia,
that, because of asserted violations of federal and state securities laws
and breach of a contract by us, the merger transaction should be rescinded.
The suit was not served until August 6, by which time, a First Amended
Complaint had been
53
filed. As amended, the suit now has eight plaintiffs, all of whom had
formerly owned stock in Computer Equity Corporation, and no longer seeks
rescission. The various counts of the complaint assert violations of federal
and state securities laws for our alleged failure to register timely the
shares issued in connection with the merger; breach of contract by us for
allegedly failing to comply with a registration rights agreement regarding
the shares; and breach of a covenant of good faith and fair dealing arising
from the same matters. In addition, in two counts the plaintiffs seek a
declaratory judgment that any future payments due to them under the merger
agreement, so called "earnout" payments, due on or before September 30,
2001, and 2002, must be made in cash instead of through issuance of stock,
as is permitted in the agreement, because of our alleged failures with
regard to registration of shares in the past. The damages sought are those
which allegedly arose because of the claimed delay in the registration of
the stock issued in connection with the merger in 2000 and are described in
the First Amended Complaint as being "not less than $1 million." On October
18, 2001, the eight plaintiffs filed a motion for leave to file a second
amended complaint. The proposed second amended complaint adds Computer
Equity Corporation as a defendant. It continues to assert claims for
violation of federal securities law, breach of contract for failure to
comply with a registration rights agreement, and breach of the covenant of
good faith and fair dealing. The proposed second amended complaint adds a
breach of contract claim for failure to make the September 30, 2001
"earnout" payment. All other claims were eliminated. Plaintiffs seek over
$10 million in damages and rescission, as they ask the Court to return the
shares of Computer Equity Corporation. In January 2002, the Delaware court
dismissed the action without prejudice. Certain of the plaintiffs filed a
new law suit in Delaware Chancery Court, claiming amounts in connection with
the earnout and claiming damages relating to the registration of the shares
previously issued to them. On July 15, 2002, we entered into a settlement
and release agreement with the plaintiffs on behalf of themselves and on
behalf of the former shareholders of Computer Equity Corporation. Under the
terms of the settlement agreement and in satisfaction of all claims relating
to the merger agreement, we issued 8 million shares of our common stock to
the former stockholders of Computer Equity Corporation. The shares were
valued at $3.0 million and have been reflected as additional goodwill at
June 30, 2002.
On January 31, 2002, Treeline, Inc., filed a Complaint in the
Common Pleas Court of Cuyahoga County, Ohio against us, one of our
subsidiaries, STR, Inc, nka ARJANG, Inc. ("STR") and another defendant who
was formerly an executive of STR, alleging that STR breached its lease
agreement with Treeline, Inc. in connection with a facility no longer being
used by us. The Complaint alleges that we, and the former executive, are
liable as Guarantors of the lease for damages sustained by Treeline as a
result of the alleged breach. There have been no material developments in
this proceeding during the three months ended June 30, 2002.
During the quarter ended March 31, 2002, 510 Ryerson Road Inc.
filed a lawsuit against us and one of our subsidiaries in connection with a
lease for a facility that is no longer in use. There have been no material
developments in this proceeding during the three months ended June 30, 2002.
In the fourth quarter of 2000, we entered into an agreement to
acquire an interest in Connect Intelligence Limited, an Irish company. A
dispute between the Connect Intelligence sellers and us ensued and the
sellers filed several litigations in Ireland and the United States. The
litigations have been settled under the terms of a settlement agreement
dated March 21, 2002. The settlement resulted in approximately 3.2 million
shares of our common stock being issued to the sellers and resulted in a
charge to us of approximately $1.0 million, which was accrued at December
31, 2001, and a payment to us of approximately $1.4 million, which we
received in May 2002. At the time of the settlement agreement, the closing
price of our common stock was $0.45 per share.
In May 2002, a shareholders action was filed against us and one of
our directors (the Childs litigation). In the following weeks, fourteen more
complaints were filed that have identical or near
54
identical allegations as those alleged in the Childs litigation. The Childs
litigation's primary allegations relate to (i) claims that we failed to
disclose improper accounting procedures related to two subsidiaries, (ii)
claims that statements in a Los Angeles Times article on May 9, 2002 about
the Company's VeriChip Corporation subsidiary were false, and (iii) that
statements by us as quoted in other newspaper articles were misleading. We
expect that the various cases will be consolidated into one case. We believe
that the allegations in the Childs litigation and the later-filed cases are
without merit and we will defend them vigorously.
In July 2002, SRZ Trading LLC filed a derivative complaint in the
Circuit Court of Cole County, Missouri against us, and several of our
officers and directors. The complaint alleges that we misrepresented our
financial condition and disseminated false and misleading statements about
VeriChip. We believe the action is without merit and intends to vigorously
defend against it.
On May 29, 2001, Janet Silva, individually and as Guardian ad Litem for
Jonathan Silva, a minor, and the Estate of Clarence William Silva, Jr.
(collectively, "Plaintiffs") filed suit against Customized Services
Administrators, Incorporated ("CSA"), Pricesmart, Inc. ("Pricesmart"),
Commercial Union Insurance Company ("Commercial Union"), CGU Insurance
Group, and the Digital Angel Corporation (collectively the "Defendants") in
the Superior Court of the State of California in and for the County of Santa
Clara. The allegations of the complaint arise from a vacation guarantee
insurance policy (the "Insurance Contract") allegedly purchased by
Plaintiffs from Defendants on March 6, 2000. The complaint alleges, among
other things, that Defendants breached the Insurance Contract, defrauded
Plaintiffs, acted in bad faith, engaged in deceptive and unlawful business
practices, resulting in the wrongful death of Clarence William Silva, Jr.
(the "Deceased") and the intentional infliction of emotional distress on
Plaintiffs. The complaint seeks the cost of funeral and burial expenses of
the Deceased and amounts constituting the loss of financial support of the
Deceased, general damages, attorney's fees and costs, and exemplary damages.
CSA has filed a cross-claim against the Digital Angel Corporation alleging
that it should be held liable for any liability that CSA may have to
Plaintiffs. Digital Angel Corporation has denied the allegations of the
complaint and the CSA cross-claim. There have been no material developments
in this proceeding during the three months ended June 30, 2002.
ITEM 2. CHANGES IN SECURITIES
Recent Sales of Unregistered Securities
The following table lists all unregistered securities sold by the
Company between April 1, 2002 and June 30, 2002. These shares were issued in
(a) for settlement of legal disputes, or (b) for employment or consulting
services. These shares were issued without registration in reliance upon the
exemption provided by Section 4(2) of the Securities Act of 1933, as
amended, or Rule 506 of Regulation D promulgated thereunder.
Number of
Aggregate Amount Number of Common
Name/Entity/Nature Date of Sale of Consideration Persons Note Issued For Shares
- -----------------------------------------------------------------------------------------------------------------
Fahnestock & Co. Inc. June, 2002 $100,000 1 1 Services 205,000
John Munshour June, 2002 $14,000 1 2 Settlement 10,870
----------
Total 215,870
==========
1. Represents shares issued in connection with investment banking services
provided in connection with the restructure of our credit facility with
IBM Credit Corporation, which transaction was exempt from registration
pursuant to Section 4(2) of the Securities Act. The transaction
document included an acknowledgment that the sale was not registered,
that shares were acquiring for investment and not for resale, and that
the shares must be held until and unless registered or transferred in
another transaction exempt from registration. In addition, certificates
representing the shares were legended to indicate that they were
restricted. Albert G. Lowenthal, Chairman, has sole voting and
dispositive power with respect to the shares held by Fahnestock
& Co. Inc.
55
2. Represents shares issued in connection with the settlement of a dispute
between Mr. Munshour and us, which transaction was exempt from
registration pursuant to Section 4(2) of the Securities Act. The
transaction document included an acknowledgment that the sale was not
registered, that the purchaser was acquiring the shares for investment
and not for resale, and that the purchaser acknowledged that he must
hold the shares until and unless registered or transferred in another
transaction exempt from registration. In addition, certificates
representing the shares were legended to indicate that they were
restricted.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
An annual meeting of shareholders of the Company was held on June
8, 2002 to:
(a) Elect two directors, each to hold office until the 2005 annual
meeting of shareholders, or in each case until their respective successors
have been elected or appointed, and to ratify the appointment one director
to hold office until the 2004 annual meeting of the shareholders, or until
his successor is elected and qualified. Other directors whose term of office
continued after the meeting include Richard J. Sullivan, Arthur F. Noterman,
and Constance K. Weaver. The results of the vote to elect the two directors
and to ratify the appointment of one director were as follows:
VOTES RECEIVED
NAME FOR AGAINST ABSTENTIONS
---- --- ------- -----------
Daniel E. Penni 231,589,092 -- 4,329,994
Angela M. Sullivan 229,005,029 -- 6,914,057
Scott R. Silverman 231,540,058 -- 4,379,028
(b) Approval of certain amendments to the Company's 1999 Flexible
Stock Plan and ratification of the options granted thereunder. The proposal
received 216,490,906 votes for, 17,391,247 votes against, and 2,036,933
abstentions.
(c) Approval of certain amendments to the Company's 1999 Employees
Stock Purchase Plan and ratification of options granted thereunder. The
proposal received 222,541,063 votes for, 12,371,949 votes against, and
1,006,074 abstentions.
(d) Approval of the amendment to the Company's Second Restated
Articles of Incorporation, as amended, to increase the number of authorized
shares of common stock of Applied Digital by 90,000,000. The proposal
received 220,570,899 votes for, 14,584,026 votes against, and 764,161
abstentions.
ITEM 5. OTHER INFORMATION
On April 30, 2002, Richard Friedland resigned as a member of our board
of directors. He currently serves on the board of Digital Angel Corporation.
On June 30, 2002, a second board member, Angela Sullivan, gave notice of her
resignation from the board for personal reasons. Her resignation was
effective as of June 30, 2002.
56
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
WE HAVE LISTED THE EXHIBITS BY NUMBERS CORRESPONDING TO THE EXHIBIT TABLE OF
ITEM 601 IN REGULATION S-K ON THE EXHIBIT LIST ATTACHED TO THIS REPORT.
(B) REPORTS ON FORM 8-K
(i) On April 18, 2002, we filed a Current Report on Form 8-K, which
announced the termination of PricewaterhouseCoopers LLP as
our independent accountants and our engagement of Grant
Thornton LLP as our new independent accountants. On April 22,
2002, we filed a Form 8-K/A amending our Current Report on
Form 8-K filed on April 18, 2002 which included a letter from
PricewaterhouseCoopers LLP addressed to the SEC.
(ii) On May 21, 2002, we filed a Current Report on Form 8-K dated
May 14, 2002, which announced the resignation of Grant Thornton
LLP as our independent accountants due to a disagreement on
the proper accounting treatment with respect to a non-cash
item in connection with the merger of a subsidiary of Medical
Advisory Systems, Inc. and Digital Angel Corporation, in which
we owned a controlling interest. On May 23, 2002, we filed a
Form 8-K/A dated May 21, 2002, amending our Current Report
on Form 8-K filed on May 14, 2002, which included a letter
from Grant Thornton LLP addressed to the SEC.
(iii) On May 24, 2002, we filed a Current Report on Form 8-K dated
May 22, 2002, which set forth a press release announcing that
as a result of our filing our Form 10Q on May 20, 2002 without
an auditor's review our ticker symbol had an "E" appended to it.
(iv) On May 28, 2002, we filed a Current Report on Form 8-K dated
May 23, 2002, which announced the engagement of Eisner LLP as
our independent accountant.
57
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
APPLIED DIGITAL SOLUTIONS, INC.
(Registrant)
Dated: August 14, 2002 By: /S/ EVAN C. MCKEOWN
---------------------------------------
Evan C. McKeown
Vice President, Chief Financial Officer
58
EXHIBITS
Exhibit
Number Description
- ------ -----------
3.1 Second Restated Articles of Incorporation of the Company
(incorporated herein by reference to Exhibit 4.1 to the
Company's Registration Statement on Form S-1 (Form S-3 File
No. 333-64605) filed with the Commission on June 23, 1999).
3.2 Amendment of Second Restated Articles of Incorporation of
the Company filed with the Secretary of State of the State
of Missouri on September 5, 2000 (incorporated herein by
reference to Exhibit 4.3 to the Company's Post-Effective
Amendment No. 3 on Form S-3 to Registration Statement on
Form S-4 (File No. 333-38420-02) filed with the Commission
on September 29, 2000).
3.3 Amendment of Second Restated Articles of Incorporation of
the Company filed with the Secretary of State of the State
of Missouri on July 18, 2001 (incorporated herein by
reference to Exhibit 4.3 to the Company's Quarterly Report
on Form 10-Q for the Quarter Ended June 30, 2001 filed with
the Commission on August 18, 2001).
3.4 Amended and Restated Bylaws of the Company dated March 31, 1998.*
3.5 Amendment to Bylaws of the Company dated April 4, 2002.*
10.1 Third Amended and Restated Term Credit Agreement dated March 1,
2002 between Applied Digital Solutions, Inc., Digital Angel Share
Trust and IBM Credit Corporation (incorporated by reference to
Exhibit 10.2 to the Company's Current Report on Form 8-K filed
with the Commission on March 8, 2002.
10.2 Letter dated August 13, 2002 from IBM Corporation discussing
the waiver of certain existing defaults under the Third Amended
and Restated Term Credit Agreement.*
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
* Filed herewith
59