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As Filed with the Securities and Exchange Commission on August 14, 2003
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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 ____
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 / /
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Exchange Act).
Yes /X/ No / /
At June 30, 2003, the last business day of our most recently completed
second fiscal quarter, the aggregate market value of the voting and
non-voting common stock held by non-affiliates, based upon the closing price
of our stock on that date of $0.60 per share was approximately $210,156,950.
The number of shares outstanding of each of the issuer's classes of
common stock as of the close of business on August 11, 2003:
Class Number of Shares
Common Stock; $.001 Par Value 352,262,414
APPLIED DIGITAL SOLUTIONS, INC.
TABLE OF CONTENTS
Item Description Page
PART I - FINANCIAL INFORMATION
1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets
June 30, 2003 and December 31, 2002 3
Condensed Consolidated Statements of Operations -
Three and Six Months ended June 30, 2003 and 2002 4
Condensed Consolidated Statement of Stockholders' Equity -
Six Months ended June 30, 2003 5
Condensed Consolidated Statements of Cash Flows -
Six Months ended June 30, 2003 and 2002 6
Notes to Consolidated Financial Statements 7
2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 25
3. Quantitative and Qualitative Disclosures About Market Risk 58
4. Controls and Procedures 58
PART II - OTHER INFORMATION
1. Legal Proceedings 58
2. Changes In Securities 60
3. Defaults Upon Senior Securities 60
4. Submission of Matters to a Vote of Security Holders 61
5. Other Information 62
6. Exhibits and Reports on Form 8-K 62
SIGNATURE 63
EXHIBITS 64
2
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
ASSETS
JUNE 30, December 31,
2003 2002
-----------------------------
CURRENT ASSETS (UNAUDITED)
Cash and cash equivalents $ 6,546 $ 5,818
Accounts receivable and unbilled receivables (net of allowance
for doubtful accounts of $805 in 2003 and $1,263 in 2002) 12,559 16,548
Inventories 8,449 6,409
Notes receivable 1,990 2,801
Other current assets 3,299 2,920
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TOTAL CURRENT ASSETS 32,843 34,496
PROPERTY AND EQUIPMENT, NET 9,479 9,822
NOTES RECEIVABLE, NET 530 758
GOODWILL, NET 68,266 67,818
OTHER ASSETS, NET 4,341 4,339
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$ 115,459 $ 117,233
===========================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Notes payable and current maturities of long-term debt $ 6,493 $ 81,879
Accounts payable 13,444 9,761
Accrued interest - 10,149
Accrued bonuses 4,306 -
Other accrued expenses 17,476 19,145
Put accrual 200 200
Net liabilities of Discontinued Operations 9,769 9,368
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TOTAL CURRENT LIABILITIES 51,688 130,502
LONG-TERM DEBT AND NOTES PAYABLE 6,189 3,346
ACCRUED SEVERANCE 21,866 -
OTHER LONG-TERM LIABILITIES 2,522 1,055
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TOTAL LIABILITIES 82,265 134,903
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COMMITMENTS AND CONTINGENCIES - -
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MINORITY INTEREST 18,880 18,422
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STOCKHOLDERS' EQUITY (DEFICIT)
Preferred shares: Authorized 5,000 shares in 2003 and 2002 of $10 par
value; special voting, no shares issued or outstanding in 2003 and
2002, Class B
voting, no shares issued or outstanding in 2003 and 2002 - -
Common shares: Authorized 435,000 shares in 2003 and 2002, of $.001 par
value; 352,335 shares issued and 351,400 shares outstanding in 2003
and 285,069 shares issued and 284,134 shares outstanding in 2002 352 285
Common and preferred additional paid-in capital 398,874 377,621
Accumulated deficit (387,640) (417,066)
Common stock warrants 5,650 5,650
Treasury stock (carried at cost, 935 shares in 2003 and 2002) (1,777) (1,777)
Accumulated other comprehensive income 79 31
Notes received from shares issued (1,224) (836)
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Total Stockholders' Equity (Deficit) 14,314 (36,092)
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$ 115,459 $ 117,233
===========================================================================================================================
See the accompanying notes to condensed consolidated financial statements.
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,
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2003 2002 2003 2002
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Product revenue $ 17,395 $ 21,237 $ 38,418 $ 44,300
Service revenue 3,494 4,599 7,577 9,755
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Total revenue 20,889 25,836 45,995 54,055
Cost of products sold 13,072 14,901 27,244 31,417
Cost of services sold 1,605 2,207 3,570 4,532
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Gross profit 6,212 8,728 15,181 18,106
Selling, general and administrative expense 12,461 18,384 41,929 47,753
Research and development 1,424 782 2,625 1,761
Depreciation and amortization 611 1,384 1,237 2,388
Interest and other income (218) (555) (438) (653)
Gain on forgiveness of debt (70,392) - (70,392) -
Interest expense 4,571 4,733 9,202 6,792
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Income (loss) from continuing operations before taxes, minority interest,
net loss on subsidiary stock issuances and merger transaction, and equity
in
net loss of affiliate 57,755 (16,000) 31,018 (39,935)
Provision (benefit) for income taxes 967 (13) 775 95
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Income (loss) from continuing operations before minority interest, net loss
on subsidiary stock issuances and
merger transaction, and equity in net loss of affiliate 56,788 (15,987) 30,243 (40,030)
Minority interest (805) (402) (944) (438)
Net loss on subsidiary stock issuances and merger transaction 792 3,888 1,169 4,282
Equity in net loss of affiliate - - - 291
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Income (loss) from continuing operations 56,801 (19,473) 30,018 (44,165)
Change in estimate on loss on disposal of discontinued
operations and operating losses during the phase out
period (435) (463) (592) 224
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Net income (loss) $ 56,366 $(19,936) $ 29,426 $(43,941)
===================================================================================================================================
Income (loss) per common share - basic
Income (loss) from continuing operations $ 0.18 $ (0.07) $ 0.10 $ (0.17)
(Loss) income from discontinued operations - (0.01) - -
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Net income (loss) per common share - basic $ 0.18 $ (0.08) $ 0.10 $ (0.17)
===================================================================================================================================
Income (loss) per common share - diluted
Income (loss) from continuing operations $ 0.18 $ (0.07) $ 0.10 $ (0.17)
(Loss) income from discontinued operations (0.01) (0.01) (0.01) -
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Net income (loss) per common share - diluted $ 0.17 $ (0.08) $ 0.09 $ (0.17)
===================================================================================================================================
Weighted average number of common shares outstanding - basic 309,470 265,914 296,052 260,869
Weighted average number of common shares outstanding - diluted 323,173 265,914 310,394 260,869
See the accompanying notes to condensed consolidated financial statements.
4
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE SIX MONTHS ENDED JUNE 30, 2003
(In Thousands)
(Unaudited)
PREFERRED STOCK COMMON STOCK ADDITIONAL COMMON
----------------------------------- PAID-IN ACCUMULATED STOCK
NUMBER AMOUNT NUMBER AMOUNT CAPITAL DEFICIT WARRANTS
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Balance - December 31, 2002 - $ - 285,069 $ 285 $377,621 $(417,066) $ 5,650
Net income - - - - - 29,426 -
Comprehensive income -
Foreign currency translation - - - - - - -
---------
Total comprehensive income - - - - - 29,426 -
---------
Adjustment to allowance for uncollectible
portion of notes receivable - - - - - - -
Stock option repricing - - - - (1,036) - -
Stock options - VeriChip Corporation 161
Issuance of common shares - - 65,582 65 18,222 - -
Beneficial conversion feature of convertible,
exchangeable debentures - - - - 3,120 - -
Issuance of common shares and options for
services, compensation and other - - 1,684 2 786 - -
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BALANCE - JUNE 30, 2003 - $ - 352,335 $ 352 $398,874 $(387,640) $ 5,650
============================================================================================================================
ACCUMULATED
OTHER NOTES TOTAL
TREASURY COMPREHENSIVE RECEIVED FOR STOCKHOLDERS'
STOCK INCOME SHARES ISSUED EQUITY (DEFICIT)
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Balance - December 31, 2002 $ (1,777) $ 31 $ (836) $(36,092)
Net income - - - 29,426
Comprehensive income -
Foreign currency translation - 48 - 48
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Total comprehensive income - 48 - 29,474
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Adjustment to allowance for uncollectible
portion of notes receivable - - (388) (388)
Stock option repricing - - - (1,036)
Stock options - VeriChip Corporation 161
Issuance of common shares - - - 18,287
Beneficial conversion feature of convertible,
exchangeable debentures - - - 3,120
Issuance of common shares and options for
services, compensation and other - - - 788
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BALANCE - JUNE 30, 2003 $ (1,777) $ 79 $ (1,224) $ 14,314
===============================================================================================================
See the accompanying notes to condensed consolidated financial statements.
5
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
FOR THE SIX MONTHS
ENDED JUNE 30,
--------------------------
2003 2002
--------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 29,426 $(43,941)
Adjustments to reconcile net loss to net cash (used in) provided by
operating activities:
Loss (income) from discontinued operations 592 (224)
Non-cash compensation and administrative expenses (861) 22,264
Issuance of stock for services 112 2,702
Depreciation and amortization 1,237 2,388
Non-cash interest expense 539 2,214
Deferred income taxes (238) -
(Recovery) impairment of notes receivable (347) 3,940
Interest income on notes received for shares issued - (475)
Gain on forgiveness of debt (70,392) -
Net loss on subsidiary merger transaction 1,169 4,282
Minority interest (944) (438)
Equity in net loss of affiliate - 291
Gain on sale of subsidiaries and business assets - (194)
Loss on sale of equipment 17 507
Change in assets and liabilities:
Decrease in accounts receivable 3,989 4,611
Increase in inventories (2,040) (703)
(Increase) decrease in other current assets (466) 1,953
Increase in accounts payable, accrued expenses
and other long-term liabilities 37,746 2,172
Net cash (used in) provided by discontinued operations (201) 302
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NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (662) 1,651
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CASH FLOWS FROM INVESTING ACTIVITIES
Decrease in notes receivable 999 56
Received from buyers of divested subsidiaries - 2,625
Increase in other assets (37) (388)
Proceeds from sale of property and equipment - 2,481
Proceeds from sale of subsidiaries and business assets - 1,106
Payments for property and equipment (599) (988)
Cash acquired (net of payments for costs of business acquisitions) - 40
Net cash provided by (used in) discontinued operations 13 (496)
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NET CASH PROVIDED BY INVESTING ACTIVITIES 376 4,436
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CASH FLOWS FROM FINANCING ACTIVITIES
Net amounts repaid on notes payable (27,448) (3,631)
Payments on long-term debt (77) (1,136)
Proceeds from issuance of debentures 10,035
Other financing costs (15) (174)
Issuance of common shares 18,686 1,618
Collection of notes receivable received for shares issued - 1,156
Stock issuance costs (399) (193)
Proceeds from subsidiary issuance of common stock 232 601
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NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 1,014 (1,759)
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NET INCREASE IN CASH AND CASH EQUIVALENTS 728 4,328
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 5,818 3,696
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CASH AND CASH EQUIVALENTS - END OF PERIOD $ 6,546 $ 8,024
=========================================================================================================
See the accompanying notes to condensed consolidated financial statements.
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,
2003, and December 31, 2002, (the December 31, 2002, financial information
included herein has been extracted from the Company's audited financial
statements included in the Company's 2002 Annual Report on Form 10-K) and
for the three and six-months ended June 30, 2003 and 2002, 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, 2003, 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, 2002.
STOCK-BASED COMPENSATION
As permitted under SFAS No. 123, Accounting for Stock-based
Compensation (SFAS No. 123), the Company has elected to continue to follow
the guidance of APB Opinion No. 25, Accounting for Stock Issued to Employees
(APB No. 25), and Financial Accounting Standards Board Interpretation No.
44, Accounting for Certain Transactions Involving Stock Compensation--an
Interpretation of APB Opinion No. 25 (FIN No. 44), in accounting for its
stock-based employee compensation arrangements. Accordingly, no compensation
cost is recognized for any of the Company's fixed stock options granted to
employees when the exercise price of each option equals or exceeds the fair
value of the underlying common stock as of the grant date for each stock
option. Changes in the terms of stock option grants, such as extensions of
the vesting period or changes in the exercise price, result in variable
accounting in accordance with APB Opinion No. 25. Accordingly, compensation
expense is measured in accordance with APB No. 25 and recognized over the
vesting period. If the modified grant is fully vested, any additional
compensation costs is recognized immediately. The Company accounts for
equity instruments issued to non-employees in accordance with the provisions
of SFAS No. 123.
At June 30, 2003, the Company had four shareholder-approved,
stock-based employee compensation plans, and the Company's subsidiaries had
six stock-based employee compensation plans. On July 25, 2003, the Company's
shareholders approved a fifth stock-based employee compensation plan, the
2003 Flexible Stock Plan. As permitted under SFAS No. 148, Accounting for
Stock-Based Compensation--Transition and Disclosure, which amended SFAS No.
123, the Company has elected to continue to follow the intrinsic value
method in accounting for its stock-based employee compensation arrangements
as defined by APB No. 25
7
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
and related interpretations including FIN No. 44. The following table
illustrates the effect on net income (loss) and earnings (loss) per share if
the Company had applied the fair value recognition provisions of SFAS No.
123 to stock-based employee compensation for options granted under its plans
as well as to the plans of its subsidiaries:
THREE-MONTHS ENDED THREE-MONTHS ENDED SIX-MONTHS ENDED SIX-MONTHS ENDED
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
----------------------------------------------------------------------------------
2003 2002 2003 2002
----------------------------------------------------------------------------------
Net income (loss), as reported $56,366 $(19,936) $29,426 $(43,941)
Deduct: Total stock-based employee
compensation expense determined under fair
value-based method for all awards, net of
related tax effects (1) (1,410) (491) (1,612) (845)
Pro forma net income (loss) $54,956 $(20,427) $27,814 $(44,786)
Income (loss) per share:
Basic--as reported $ 0.18 $ (0.08) $ 0.10 $ (0.17)
Diluted--as reported $ 0.17 $ (0.08) $ 0.09 $ (0.17)
Basic--pro forma $ 0.18 $ (0.08) $ 0.09 $ (0.17)
Diluted--pro forma $ 0.17 $ (0.08) $ 0.09 $ (0.17)
(1) Amount includes $1.3 million, $0.1 million, $1.8 million and $0.5 million
of compensation expense associated with subsidiary options for the
three-months ended June 30, 2003 and 2002, and the six-months ended June
30, 2003 and 2002, respectively.
The weighted average per share fair value of grants made during the
three-months ended June 30, 2003 and 2002, for the Company's incentive plans
was $0.26 and $0.22, respectively. The weighted average per share fair value
of grants made during the six-months ended June 30, 2003 and 2002, for the
Company's incentive plans was $0.26 and $0.20, respectively. The fair value of
the options granted was estimated on the grant date using the Black-Scholes
option-pricing model based on the following weighted average assumptions:
THREE-MONTHS ENDED THREE-MONTHS ENDED SIX-MONTHS ENDED SIX-MONTHS ENDED
JUNE 30, 2003 JUNE 30, 2002 JUNE 30, 2003 JUNE 30, 2002
------------------ ------------------ ---------------- ----------------
Estimated option life 5.5 years 5.5 years 5.5 years 5.5 years
Risk free interest rate 1.51% 2.89% 1.51% 2.89%
Expected volatility 76.00% 76.00% 76.00% 76.00%
Expected dividend yield 0.00% 0.00% 0.00% 0.00%
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
8
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
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 transaction,
the Company owned 19.6 million shares, or approximately 72.9% of the shares
outstanding on June 30, 2003. 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 $32.0 million,
which was comprised of the $25.0 million fair market value of MAS stock
outstanding not held by the Company immediately preceding the merger, the
$3.4 million estimated fair market value of MAS options and warrants
outstanding as well as the direct costs of the acquisition of approximately
$3.6 million. The transaction resulted in Digital Angel Corporation
allocating approximately $28.3 million of the purchase price to goodwill,
$25.9 million of which was deemed to be impaired during the fourth quarter
of 2002 in connection with the Company's annual goodwill impairment review.
Digital Angel Corporation is publicly traded on the American Stock Exchange
under the symbol DOC, with a closing market price per share at June 30,
2003, and August 11, 2003, of $2.64 and $1.98, 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-months ended June 30, 2003 and 2002, and the
six-months ended June 30, 2003, and 2002, the Company recorded a loss of
$0.8 million, $3.9 million $1.2 million and $3.9 million, respectively, on
the issuances of 0.1 million, 1.0 million, 0.4 million and 1.0 million
shares of Digital Angel Corporation common stock, respectively, resulting
from the exercise of stock options and the sale of Digital Angel Corporation
common 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 minority interest ownership.
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 and InfoTech USA, Inc., formerly SysComm International
Corporation. The minority interest represents outstanding voting stock of
the subsidiaries not owned by the Company. All significant intercompany
accounts and transactions have been eliminated in consolidation.
9
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
3. INVENTORY
June 30, December 31,
2003 2002
---------------- ------------------
Raw materials $1,747 $1,725
Work in process 1,714 1,447
Finished goods 6,494 4,659
---------------- ------------------
9,955 7,831
Allowance for excess and obsolescence (1,506) (1,422)
---------------- ------------------
Net inventory for continuing operations $8,449 $6,409
================ ==================
4. FINANCING AGREEMENTS
Payment in Full of Obligations to IBM Credit LLC
------------------------------------------------
The Company's Third Amended and Restated Term Credit Agreement (the
"IBM Credit Agreement") with IBM Credit LLC ("IBM Credit") contained
covenants relating to the Company's financial position and performance, as
well as the financial position and performance of Digital Angel Corporation.
At December 31, 2002, the Company did not maintain compliance with the
revised financial performance covenant under the IBM Credit Agreement. In
addition, under the terms of the IBM Credit Agreement the Company was
required to repay IBM Credit $29.8 million of the $77.2 million outstanding
principal balance currently owed to them, plus $16.4 million of accrued
interest and expenses (totaling approximately $46.2 million), on or before
February 28, 2003. The Company did not make such payment by February 28,
2003, and on March 7, 2003, it received a notice from IBM Credit declaring
the loan in default. Effective April 1, 2003, the Company entered into a
Forbearance Agreement with IBM Credit. In turn, the Company agreed to
dismiss with prejudice a lawsuit it filed against IBM Credit and IBM
Corporation in Palm Beach County, Florida on March 6, 2003. Under the terms
of the Forbearance Agreement, the Company had the right to purchase all of
its outstanding debt obligations to IBM Credit, totaling approximately
$100.4 million (including accrued interest), if it paid IBM Credit $30.0
million in cash by June 30, 2003. As of June 30, 2003, the Company made cash
payments to IBM Credit totaling $30.0 million and, thus, it has satisfied in
full its debt obligations to IBM Credit. As a result, during the quarter
ended June 30, 2003, the Company recorded a gain on the forgiveness of debt
of $70.4 million, exclusive of the bonuses discussed below.
On June 30, 2003, the Company's Board of Directors (through the
Compensation Committee) approved the payment of approximately $4.3 million
in bonuses. The bonuses, which may be paid in cash (subject to availability)
or in shares of the Company's common stock based upon mutual agreement of
the recipient and the Company, subject to any regulatory or necessary
approvals, were awarded to directors, executive officers and other employees
in recognition of their efforts in achieving the successful repayment of all
obligations to IBM Credit. The amount and timing of the payment of these
bonuses will depend on various factors, including (among others) the rate of
the Company's business growth, the Company's research and development
efforts and pipeline, the effort and timing involved in obtaining FDA and
other necessary approval for the Company's VeriChip product's medical
applications, capital equipment needs, the requirements of the Company's
customers, and opportunities discovered or presented to the Company, and
other cash requirements.
10
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Funding for $30.0 Million Payment to IBM Credit
-----------------------------------------------
Funding for the $30.0 million payment to IBM Credit consisted of
$17.8 million in net proceeds from the sales of an aggregate of 50.0 million
shares of the Company's common stock, $10.0 million in net proceeds from the
issuance of the Company's 8.5% Convertible Exchangeable Debentures, and $2.2
million from cash on hand.
The 50.0 million shares of the Company's common stock were
purchased under the Securities Purchase Agreements. The purchases resulted
in net proceeds to the Company of $17.8 million, after deduction of the 3%
fee to the Company's placement agent, J.P. Carey Securities, Inc.
Issuance of 8.5% Convertible Exchangeable Debentures
----------------------------------------------------
On June 30, 2003, the Company entered into the Securities Purchase
Agreement (the "Agreement") with certain investors, collectively referred to
herein as "the Purchasers." In connection with the Agreement, the Company
issued to the Purchasers its $10,500,000 aggregate principal amount of 8.5%
Convertible Exchangeable Debentures due November 1, 2005 ("the Debentures").
Subject to the terms under the various agreements, the Debentures are
convertible into shares of the Company's common stock (subject in part to
shareholder approval) or exchangeable for shares of Digital Angel
Corporation common stock owned by the Company, or a combination thereof, at
the Purchasers' option. The Company currently owns 19.6 million shares of
Digital Angel Corporation's common stock, or 72.9% of the shares outstanding
of Digital Angel Corporation's common stock as of June 30, 2003. The
Debentures are convertible or exchangeable at any time at the option of the
Purchasers. The conversion price for the Company's common stock is $0.515
per share also referred to as the Set Price, subject to anti-dilution
provisions. The exchange price for the Digital Angel Corporation common
stock owned by the Company is $2.20 per share as to the first fifty percent
(50%) of the original principal amount of the Debentures and $4.25 per share
as to the remaining fifty percent (50%) of the original principal amount,
subject to anti-dilution provisions.
In addition, the Company has granted to the Purchasers warrants to
acquire approximately 5.35 million shares of the Company's common stock, or
0.95 million shares of the Digital Angel Corporation common stock owned by
the Company, or a combination of shares from both companies, at the
Purchasers' option (the "Warrants"). The exercise prices are $0.564 and
$3.178 for the Company's common stock and the Digital Angel Corporation
common stock, respectively. The Warrants are subject to anti-dilution
provisions, vest immediately and are exercisable through June 30, 2007. The
Company has entered into a Registration Rights Agreement with the Purchasers
whereby it has agreed to register the Company's common shares issuable upon
conversion of the Debentures and Warrants within a specified time period.
11
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
The proceeds upon issuance of the Debentures were allocated as
follows:
Face value of Debentures $10,500
Beneficial conversion feature (3,120)
Relative fair value of Warrants (1,387)
-------------
Relative fair value of Debentures $ 5,993
=============
The beneficial conversion feature was recorded as a reduction in
the value assigned to the Debentures (original issue discount) and an
increase in additional paid-in-capital. The value assigned to the Warrants
was recorded as a reduction in the value assigned to the Debentures
(original issue discount) and an increase in long-term liabilities. The
liability for the Warrants, to the extent potentially settleable in shares
of the Digital Angel Corporation common stock owned by the Company, will be
revalued at each reporting period and any resulting increase will result in
a charge to operations. The Company will be required to record an impairment
loss if the carrying value of the Digital Angel Corporation common stock
underlying the Warrants exceeds the exercise price. Should the Purchasers
elect to exercise the Warrants into shares of the Digital Angel Corporation
common stock, such exercise may result in the Company recording a gain
on the transaction. The original issue discount of $4.5 million will be
accreted over the life of the Debentures as additional interest expense.
Among other provisions under the Agreement and the Debentures, the
Company is required to pay interest at the rate of 8.5% per annum on a
quarterly basis beginning September 1, 2003, and, beginning on November 1,
2003, on a monthly basis as to the principal amount required to be redeemed
each month. A final interest payment is due on the maturity date, which is
November 1, 2005. Interest payments may be made in either cash or in shares
of the Digital Angel Corporation common stock owned by the Company, or a
combination thereof at the Company's option, subject to certain
restrictions. The interest conversion rate for the Digital Angel Corporation
common stock is calculated based upon 90% of the average of the lowest 10 of
the 20 volume-weighted average stock prices immediately prior to the
applicable interest payment date, subject to a late payment adjustment.
Principal redemption payments of $0.4 million are due monthly
beginning November 1, 2003. The principal redemption payments may be made in
cash, the Company's common stock or the Digital Angel Corporation common
stock owned by the Company at the Company's option, subject to certain
limitations regarding the average market value and trading volume of the
Digital Angel Corporation common stock. The conversion/exchange redemption
prices are based upon the lesser of ninety percent (90%) of the lowest 10 of
the 20 volume-weighted average stock prices prior to the redemption date,
and the Set Price/exchangeable prices, subject to anti-dilution provisions.
If the Company elects to make interest and or principal redemption payments
in shares of the Digital Angel Corporation common stock that it owns, such
payments may result in additional interest expense and or a gain or loss on
the deemed sale of the Digital Angel Corporation common shares. If the
Company elects to make principal redemption payments in shares of its common
stock, such payments may result in additional interest expense.
Subject to certain exempt transactions, including among others the
issuances of shares in connection with stock options, share issuances under
severance agreements with former executives, exercises of warrants currently
outstanding including the Warrants, the conversion of the Debentures and
issuances of shares for acquisitions or strategic investments, the Company
is prohibited under the terms of the Agreement to incur, create, guarantee,
assume or to otherwise become liable on account of an
12
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
indebtedness other than with a federally regulated financial institution or
to increase any amounts owing under any existing obligations or to issue or
sell shares of the Company's common stock or equivalents until ninety (90)
days after the effective date of the registration statement registering the
Company's common shares underlying the Debentures and Warrants. In addition,
each Purchaser has the right of first refusal with regard to any financings
made by the Company in shares of its common stock or common stock
equivalents until such time as the Purchaser no longer holds any Debentures.
As collateral for the Debentures and under the terms of a Security
Agreement, the Company and its wholly-owned subsidiary Computer Equity
Corporation have granted to the Purchasers a security interest in all of the
Company's accounts receivable, and under the terms of a Pledge Agreement,
the Company has granted to the Purchasers a security interest in up to 15.0
million shares of the Digital Angel Corporation common stock it currently
owns.
In connection with the Debentures, the Company incurred a placement
agency fee of $430,000 and it reimbursed one of the Purchasers $50,000 for
legal, administrative, due diligence and other expenses incurred to prepare
and negotiate the transaction documents.
Going Concern
- -------------
The repayment of all of the Company's debt obligations to IBM Credit
resolved one of the major factors impacting the Company's ability to
continue as a going concern. The Company's ability to continue as a going
concern is also predicated upon numerous issues including the Company's
ability to:
o Successfully implement its business plans, manage
expenditures according to its budget, and generate positive
cash flow from operations;
o Realize positive cash flow with respect to its investment in
Digital Angel Corporation;
o Develop an effective marketing and sales strategy;
o Obtain the necessary approvals to expand the market for the
VeriChip product;
o Complete the development of the second generation Digital
Angel product; and
o Attract, motivate and/or retain key executives and employees.
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
its shareholders' 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.
13
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
5. EARNINGS (LOSS) PER SHARE
The following is a reconciliation of the numerator and denominator
of basic and diluted earnings (loss) per share:
------------------------------------------------
THREE-MONTHS SIX-MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------------------------------
2003 2002 2003 2002
---- ---- ---- ----
NUMERATOR:
------------------------------------------------
NUMERATOR FOR BASIC EARNINGS (LOSS) PER SHARE -
Net income (loss) from continuing operations available
to common shareholders $56,801 $(19,473) $30,018 $(44,165)
Net income (loss) from discontinued operations available
to common shareholders (435) (463) (592) 224
------------------------------------------------
Net income (loss) available to common shareholders $56,366 $(19,936) $29,426 $(43,941)
================================================
DENOMINATOR:
DENOMINATOR FOR BASIC LOSS PER SHARE -
Weighted-average shares 309,470 265,914 296,052 260,869
------------------------------------------------
Convertible exchangeable debentures 224 -- 113 --
Stock options 9,743 -- 10,684 --
Warrants 3,736 -- 3,545 --
------------------------------------------------
DENOMINATOR FOR DILUTED EARNINGS (LOSS) PER SHARE(1) -
Weighted-average shares 323,173 265,914 310,394 260,869
================================================
BASIC EARNINGS (LOSS) PER SHARE:
CONTINUING OPERATIONS $0.18 $(0.07) $0.10 $(0.17)
DISCONTINUED OPERATIONS -- (0.01) -- --
------------------------------------------------
TOTAL - BASIC $0.18 $(0.08) $0.10 $(0.17)
================================================
DILUTED EARNINGS (LOSS) PER SHARE:
CONTINUING OPERATIONS $0.18 $(0.07) $0.10 $(0.17)
DISCONTINUED OPERATIONS (0.01) (0.01) (0.01) --
------------------------------------------------
TOTAL - DILUTED $0.17 $(0.08) $0.09 $(0.17)
================================================
(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 ENDED SIX-MONTHS ENDED
JUNE 30, JUNE 30,
2002 2002
---- ----
Employee stock options 18,248 19,121
Warrants 2,460 2,281
------------------------------------------
20,708 21,402
==========================================
14
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,
which occurred on March 27, 2002, the significant restructuring of the
Company's business during the past two years and the Company's emergence as
an advanced technology development company, it has re-evaluated and
realigned its reporting segments. Effective January 1, 2002, the Company
operates in three business segments: Advanced Technology, Digital Angel
Corporation and InfoTech USA, Inc. (formerly the segment known as SysComm
International)
Advanced Technology
The Advanced Technology segment represents those businesses that
the Company believes will provide the necessary synergies, support and
infrastructure to allow it to develop, promote and fully integrate its
technology products and services. This segment specializes in
security-related data collection, value-added data intelligence and complex
data delivery systems for a wide variety of end users including government
agencies, commercial operations and consumers. VeriChip, Thermo Life and PLD
products are included in the Advanced Technology segment.
Digital Angel Corporation
The Digital Angel Corporation segment consists of the business
operations of Digital Angel Corporation, the Company's approximately 72.9%
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. Digital Angel Corporation operates in four
divisions: Animal Applications, Wireless and Monitoring, GPS and Radio
Communications, and Medical Systems.
InfoTech USA, Inc. (formerly the segment known as SysComm
International)
The InfoTech USA, Inc. segment consists of the business operations
of the Company's 52.5% owned subsidiary, InfoTech USA, Inc. This segment is
a full service provider of Information Technology, or IT, solutions and
products. This segment provides IT consulting, networking, procurement,
deployment, integration, migration and security services and solutions. It
also provides on-going system and networking maintenance services. During
2002, this segment continued its strategy of moving away from a
product-driven systems integration business model to a customer-oriented IT
solutions-based business model. It has further developed its deliverable IT
solutions by adding new consulting and service offerings, and increasing the
number of strategic alliances with outside technical services firms and
manufacturers of high-end IT products.
Business units that were closed or sold during 2002 are reported as
"All Other."
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 three and six-months ended June 30, 2003,
is a gain on the forgiveness of debt obligations to IBM Credit of $70.4
million and for the six-months ended June 30, 2003, is a severance charge of
$22.0 million associated
15
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
with the termination of certain former officers. 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.
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, 2002,
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, 2003:
SEGMENTS
--------
Digital
Advanced Angel InfoTech All Corporate/
Technology Corporation USA, Inc. Other Eliminations Consolidated
-------------------------------------------------------------------------------
Net revenue from external customers:
Product $ 5,924 $ 8,118 $3,333 $ -- $ 20 $ 17,395
Service 2,615 242 637 -- -- 3,494
Inter-segment revenue-product -- 20 -- -- (20) --
-------------------------------------------------------------------------------
Total revenue $ 8,539 $ 8,380 $3,970 $ -- $ -- $ 20,889
===============================================================================
Income (loss) from continuing operations before taxes, minority interest,
net loss on subsidiary stock
issuances and merger transaction $ (128) $(2,454) $ (163) $ 324 $60,176 $ 57,755
===============================================================================
Total assets $37,312 $70,872 $9,930 $2,737 $(5,392) $115,459
===============================================================================
Following is the selected segment data as of and for the six-months
ended June 30, 2003:
SEGMENTS
--------
Digital
Advanced Angel InfoTech All Corporate/
Technology Corporation USA, Inc. Other Eliminations Consolidated
-------------------------------------------------------------------------------
Net revenue from external customers:
Product $14,255 $18,983 $5,267 $ -- $ (87) $38,418
Service 5,565 775 1,237 7,577
Inter-segment revenue-product -- (87) -- -- 87 --
-------------------------------------------------------------------------------
Total revenue $19,820 $19,671 $6,504 $ -- $ -- $ 45,995
===============================================================================
Income (loss) from continuing operations before taxes, minority interest,
net loss on subsidiary stock issuances and merger
transaction $ 493 $(2,377) $ (623) $ 329 $33,196 $ 31,018
===============================================================================
Total assets $37,312 $70,872 $9,930 $2,737 $(5,392) $115,459
===============================================================================
16
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, 2002:
SEGMENTS
--------
Digital
Advanced Angel InfoTech All Corporate/
Technology Corporation USA, Inc. 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 taxes, minority interest,
net loss on subsidiary stock issuances and merger transaction and equity
in
net loss of affiliate(1) $(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 InfoTech All Corporate/
Technology Corporation USA, Inc. 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 taxes, minority interest,
net loss on subsidiary stock issuances and 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.
17
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
7. ACQUISITIONS AND DISPOSITIONS
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 72.9% of Digital Angel Corporation, as more
fully discussed in Note 1.
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 $(44,855)
Loss available to common stockholders from continuing operations $(44,855)
Loss per common share from continuing operations - basic $ (0.18)
Loss per common share from continuing operations - diluted $ (0.18)
Earnout and Put Agreements
--------------------------
Certain acquisition agreements the Company entered into during 2000
included 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, 2003. At June 30, 2003, the Company is contingently liable under an
earnout agreement with one subsidiary. Based upon the expected performance
of this subsidiary, the Company is contingently liable for additional
consideration of approximately $30,000.
8. 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 2002, and the other was sold in July 2003.
Proceeds from the sales of Discontinued Operations companies were primarily
used to repay amounts outstanding under the IBM Credit Agreement.
18
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Assets and liabilities of discontinued operations are as follows at
June 30, 2003, and December 31, 2002.
June 30, 2003 December 31, 2002
---------------------------------------------
Current Assets
Cash and cash equivalents $ 53 $ 66
Accounts receivable and unbilled receivables, net 87 167
Inventories 38 38
---------------------------------------------
Total Current Assets 178 271
Property and equipment, net 28 56
---------------------------------------------
$ 206 $ 327
=============================================
Current Liabilities
Notes payable and current maturities of long-term debt $ 26 $ 26
Accounts payable 4,178 4,189
Accrued expenses 5,650 5,334
---------------------------------------------
Total Current Liabilities 9,854 9,549
Minority interest 121 146
---------------------------------------------
9,975 9,695
=============================================
Net Liabilities of Discontinued Operations $(9,769) $(9,368)
=============================================
During the three-months ended June 30, 2003 and 2002, and during
the six-months ended June 30, 2003, Discontinued Operations incurred a
change in estimated operating loss on disposal and operating losses during
the phase out period of $0.4 million, $0.5 million and $0.6 million,
respectively. The primary reasons for the increases in the estimated losses
during these periods were (1) an increase in estimated facility lease
cancellation costs and (2) the operations of the two remaining businesses
within this group. One of these businesses was sold in May of 2002, and the
other was sold in July 2003.
During the six-months ended June 30, 2002, the Company recorded a
reduction of its estimated operating loss on disposal and operating losses
during the phase out period of $0.2 million. This reduction was comprised
primarily of an increase in the estimated loss on the sale of the Company's
85% ownership in its Canadian subsidiary, Ground Effects Ltd., which was
sold in January 2002, of $0.2 million, offset by a decrease in carrying
costs as certain of these obligations were settled during the six-months
ended June 30, 2002, for amounts less than previously anticipated. Carrying
costs include the cancellation of facility leases, employment contract
buyouts, sales tax liabilities and litigation reserves.
19
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
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, 2002 through June 30, 2003.
Balance Balance
Type of Cost December 31, 2002 Additions Deductions June 30, 2003
- --------------------------------------------------------------------------------------------------------------------
Estimated loss on sale, net of change in
estimated operating losses $ -- $126 $126 $ --
Carrying costs 4,908 309 -- 5,217
--------------------------------------------------------------
Total $4,908 $435 $126 $5,217
==============================================================
9. NON-CASH COMPENSATION EXPENSE
The Company reduced $0.1 million of non-cash compensation expense
and incurred approximately $3.0 million of non-cash compensation expense
during the three-months ended June 30, 2003 and 2002, respectively, and the
Company reduced approximately $1.0 million of non-cash compensation expense
and incurred approximately $3.3 million of non-cash compensation expense
during the six-months ended June 30, 2003 and 2002, respectively, due 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 been reflected in the condensed consolidated statement of operations as
selling, general and administrative expenses.
In addition, 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 during the
six-months ended June 30, 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.
10. SEVERANCE AGREEMENTS
On March 21, 2003, Richard J. Sullivan, the Company then Chairman
of the Board of Directors and Chief Executive Officer, retired from such
positions. The Company's Board of Directors negotiated a severance agreement
with Richard Sullivan under which he is to receive a one-time payment of
56.0 million shares of the Company's common stock. In addition, stock
options held by him exercisable for approximately 10.9 million shares of the
Company's common stock were re-priced. The options surrendered had exercise
prices ranging from $0.15 to $0.32 per share and were replaced with options
exercisable at $0.01 per share. Richard Sullivan's severance agreement
provides that the payment of shares and re-pricing of options provided for
under that agreement is in lieu of all future compensation and other
benefits that would have been owed to him under his employment agreement.
That agreement required the Company to make payments of approximately
$17 million to him (or approximately $3.9
20
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
million more than is owed under the severance agreement), a portion of such
payments of which could be made in either cash or stock, at the Company's
option.
On March 21, 2003, Jerome C. Artigliere, the Company's then Senior
Vice President and Chief Operating Officer, resigned from such positions.
Under the terms of his severance agreement, Mr. Artigliere is to receive
4.8 million shares of the Company's common stock. In addition, stock options
held by him exercisable for approximately 2.3 million shares of the
Company's common stock were re-priced. The options surrendered had exercise
prices ranging from $0.15 to $0.32 per share and were replaced with options
exercisable at $0.01 per share. Mr. Artigliere's severance agreement
provides that the payment of shares and re-pricing of options provided under
that agreement is in lieu of all future compensation and other benefits that
would have been owed to him under his employment agreement. That agreement
required the Company to make payments of approximately $1.5 million to Mr.
Artigliere.
As a result of the termination of Richard Sullivan's employment
with the Company, a "triggering event" provision in the severance agreement
the Company had entered into with Garrett Sullivan, its former Vice Chairman
of the Board, (who is not related to Richard Sullivan) at the time of his
ceasing to serve in such capacity in December 2001, has been triggered. The
Company negotiated a settlement of its obligations under Garrett Sullivan's
severance agreement that requires the Company to issue to him 7.5 million
shares of its common stock on or before August 31, 2003.
The Company's shareholders have approved the issuance of the common
stock and have ratified the re-pricing of the options under the terms of the
severance agreements with Richard J. Sullivan and Jerome C. Artigliere and
they have approved the issuance of the common stock under the agreements
entered into with Garrett Sullivan. The terms of each of the severance
agreements were subject to shareholder approval, in accordance with
applicable Nasdaq rules, because the agreements (i) are deemed to be
compensatory arrangements under which the Company's common stock may be
acquired by officers or directors, and (ii) in Richard Sullivan's case, it
may have resulted in his potentially holding more than 20% of the
outstanding shares of the Company's common stock following the issuance of
the shares and exercise of options covered by his severance agreement. As a
result of the terminations of Messrs. Sullivan and Artigliere, the Company
recorded severance expense of $22.0 million during the six-months ended June
30, 2003, including $2.5 million resulting from the re-priced options. The
obligation is reflected on the balance sheet as of June 30, 2003, as a
long-term liability since the obligation will be settled in shares of the
Company's common stock. On July 25, 2003, the Company's shareholders
approved the terms of the severance agreement with Richard J. Sullivan, as
discussed above, and, therefore, the Company will reverse approximately $3.9
million of such severance expense during the three-months ending September
30, 2003.
21
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
11. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (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)
---------------------------- ---------------------------
2003 2002 2003 2002
---- ---- ---- ----
---------------------------- ---------------------------
Net income (loss) $56,366 $(19,936) $29,426 $(43,941)
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments 86 201 48 661
---------------------------- ---------------------------
Total comprehensive income (loss) $56,452 $(19,735) $29,474 $(43,280)
============================ ===========================
12. RELATED PARTY TRANSACTION
On June 27, 2003, the Company borrowed $1.0 million from InfoTech
USA, Inc. under the terms of a commercial loan agreement and term note. The
loan accrues interest at an annual rate of 16% and interest is payable
monthly beginning on July 31, 2003, with principal and accrued interest due
June 30, 2004. Under the terms of a Stock Pledge Agreement, the Company has
pledged 750,000 shares of Digital Angel Corporation common stock that it
owns as collateral for the loan. The proceeds of the loan are being used to
fund operations.
13. OTHER EVENTS
On July 25, 2003, the Company's shareholders approved an increase
in the number of common shares authorized from 435.0 million to 560.0
million. The increase will become effective upon the acceptance of an
amendment to the Company's articles of incorporation by the State of
Missouri.
The Staff of the Securities and Exchange Commission's Southeast
Regional Office is conducting an informal inquiry concerning the Company.
The Company is fully and voluntarily cooperating with the informal inquiry.
At this point, the Company is unable to determine whether the informal
investigation may lead to potentially adverse action.
The Company's common stock has traded on the Nasdaq SmallCap Market
("SmallCap") since November 12, 2002, under the symbol "ADSX." Prior to
November 12, 2002, the Company's common stock traded on the Nasdaq National
Market at all times, except for the period between July 12, 2002 and July
30, 2002, when its common stock traded on the Pink Sheets under the symbol
"ADSX.PK." To maintain its SmallCap listing, the Company must continue to
comply with the SmallCap's listing requirements and, prior to October 2003,
regain the minimum bid requirement of at least $1.00 per share for a minimum
of ten (10) consecutive trading days. The Company have included a proposal
in its proxy statement for a special meeting of shareholders to be held on
September 10, 2003, to solicit shareholder approval to effect a reverse
stock split of all of the issued and outstanding shares of its common stock,
and granting of discretionary authority to its Board of Directors for a
period of twelve months after the
22
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
date its shareholders approve the proposal to determine the reverse stock
split ratio, not to exceed a ratio of 1-for-25, and the effective date of
the reverse stock split or to determine not to proceed with the reverse
stock split. The Company's Board of Directors currently believes that it
should implement a reverse stock split to reduce the number of issued and
outstanding shares, which are a result, in part, of the Company's past
acquisitions, the payment of debt obligations to IBM Credit and preferred
stock conversions. In addition, the Company's Board of Directors believes
that a reverse stock split may facilitate the continued listing of the
Company's common stock on the SmallCap and may enhance the desirability and
marketability of its common stock to the financial community and the
investing public.
The Company is planning to offer up to 30,000,000 shares of its
common stock in a public offering registered under the Securities Act of
1933, subject to shareholder approval. The shares of the Company's common
stock will be offered on a best efforts basis and may be sold through the
efforts of a placement agent, J.P. Carey Securities, Inc.
Effective May 9, 2003, Michael Zarriello joined the Company's Board
of Directors. Mr. Zarriello was most recently a Senior Managing Director of
Jesup & Lamont Securities Corporation and served as President of Jesup and
Lamont Merchant Partners LLC. Prior to that, he was Managing Director and
Principal of Bear Stearns & Co., Inc. He has extensive financial experience
having served earlier in his career as Chief Financial Officer of the
Principal Activities Group that invested the Bear Stearns & Co., Inc.
capital in middle market companies, Chief Financial Officer of United States
Leather Holdings, Inc. and Chief Financial Officer of Avon Products, Inc.
Healthcare Division. He serves on the Audit Committee of the Company's Board
of Directors.
Effective May 12, 2003, Kevin H. McLaughlin was appointed President
and Chief Operating Officer of the Company. Prior to his appointment as
President, Mr. McLaughlin served as the Company's Senior Vice President and
Chief Operating Officer.
Effective June 4, 2003, Arthur F. Noterman resigned from the
Company's Board of Directors to pursue other interests. Mr. Noterman's term
was due to expire at the Company's Annual Meeting of Shareholders, which was
held on July 25, 2003. At present, the Company has not filled the position
vacated by Mr. Noterman.
On July 31, 2003, Digital Angel Corporation entered into a
securities purchase agreement to sell securities to Laurus Master Fund, Ltd.
("Laurus"). Under the terms of the securities purchase agreement, Digital
Angel Corporation issued and sold to Laurus a two-year secured convertible
note in the original principal amount of $2.0 million and a common stock
warrant to purchase up to 0.1 million shares of Digital Angel Corporation's
common stock. The note is convertible, at Laurus' option, into shares of
Digital Angel Corporation's common stock at a per share price of $2.33,
subject to limitations. The note accrues interest at an annual rate equal to
prime plus 1.75% but shall not be less than 6% per annum. The exercise
prices of the warrant range from $2.68 to $3.38 per share and the warrant is
exercisable for five years. In connection with the note, Digital Angel
Corporation and Laurus entered into a security agreement granting to Laurus
a lien and security interest in Digital Angel Corporation's assets (having a
net book value of $53.1 million as of June 30, 2003), which is subject to a
lien and security interest held by Wells Fargo Business Credit, Inc. ("Wells
Fargo").
On August 14, 2003, the Company entered into a Stock Purchase
Agreement with Digital Angel Corporation. The Stock Purchase Agreement
represents a strategic investment in Digital Angel Corporation, whereby the
Company is increasing its ownership interest. The Stock Purchase Agreement
provides for the Company to purchase 3.0 million shares of Digital Angel
Corporation's common stock at $2.64 per share and for the Company to receive
a warrant to purchase up to 1.0 million shares of Digital Angel
Corporation's common stock. The aggregate purchase price for the 3.0 million
shares of $7.9 million is payable in shares of the Company's common stock
equal to the aggregate purchase price divided by the average of the volume
weighted average price of the Company's common stock for the ten trading
days immediately proceeding the closing date (the "Per Share Exchange
Price"). If the Per Share Exchange Price is less than $0.40, the Company
shall have the option to postpone the closing date for a period not to
exceed thirty calendar days or to terminate the Stock Purchase Agreement.
The warrant gives the Company the right to purchase a total of 1.0 million
shares of Digital Angel Corporation's common stock for a period of five
years from February 1, 2004. The exercise price of the warrant will be equal
to the daily volume weighted average price of Digital Angel Corporation's
common stock for the first 10 consecutive trading days of 2004 starting on
January 2, 2004. As a related part of this transaction, negotiations are
taking place with the Purchasers, which may result in Digital Angel
Corporation's issuing a five-year warrant to the Purchasers to acquire up to
0.5 million shares of its common stock at an exercise price of $2.64 per
share.
14. LEGAL PROCEEDINGS
The Company is party to various legal proceedings, and accordingly,
has recorded $1.2 million in
23
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
reserves in its financial statements at June 30, 2003. In the opinion of
management, these proceedings are not likely to have a material adverse
affect on the financial position or overall trends in results of the
Company. The estimate of potential impact on the Company's financial
position, overall results of operations or cash flows for the above legal
proceedings could change in the future.
In May 2002, a class action was filed against the Company and one
of its former directors. Fourteen virtually identical complaints were
consolidated into a single action, in re Applied Digital Solutions
Litigation, which was filed in the United States District Court for the
Southern District of Florida. In March 2003, the Company entered into a
memorandum of understanding to settle the pending lawsuit. The settlement of
$5.6 million, which is subject to approval by the District Court and review
by an independent special litigation committee, is expected to be covered by
proceeds from insurance.
24
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 2002 Annual Report on Form 10-K.
Our company, Applied Digital Solutions, Inc., together with our
subsidiaries, is an advanced technology development company. We have grown
significantly through acquisitions. Since 1996, we have completed 51
acquisitions. During the last half of 2001 and during 2002, we sold or
closed many of the businesses that we had acquired that we believed did not
enhance our strategy of becoming a leading advanced technology development
company. We have emerged from being a supplier of computer hardware,
software and telecommunications products and services to becoming an
advanced technology company that focuses on a range of life enhancing,
personal safeguard technologies, early warning systems, miniaturized power
sources and security monitoring systems combined with comprehensive data
management services required to support them. To date, we have five such
products in various states of development. They are:
o Digital Angel(TM), for monitoring and tracking people and
objects;
o Thermo Life(TM), a thermoelectric generator powered by body
heat;
o VeriChip(TM), an implantable radio frequency verification
device that can be used for security, financial, personal
identification/safety and other applications;
o Bio-Thermo(TM), a temperature-sensing implantable microchip
for use in pets, livestock and other animals; and
o Personal Locating Device (PLD), an implantable global
positioning satellite (GPS) location device.
Several years ago, we developed a proprietary location and
monitoring system that combines advanced biosensor technology and location
technology (such as global positioning satellite (GPS)), in a watch/pager
device that communicates through proprietary software to a secure 24/7
operations center in California. This system is covered under the United
States patent registration # 5,629,678, which we acquired in 1999. We filed
an International Patent Application directed to the system, which has been
published under publication no. W/0 02/44865. The application, which is in
the name of Digital Angel Corporation, is currently pending in several
countries. 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, personal
digital assistant (PDA) or wireless telephone. 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,
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 Corporation, which we refer to as pre-merger
Digital Angel. Digital Angel, the product, is now developed and was launched
on November 26, 2001. Effective March 27, 2002, pre-merger Digital Angel
became its own public company through its merger into Medical Advisory
Systems, Inc. (MAS) (AMEX:DOC). Currently we are the beneficial owner of
approximately 72.9% of this new company which has been renamed Digital Angel
Corporation.
25
Our wholly-owned subsidiary, Thermo Life Energy Corp. will develop,
market and license our product, Thermo Life, a small 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 were successfully generated by Thermo Life in
laboratory tests. We expect to begin marketing Thermo Life during the latter
part of 2003.
We have developed a miniaturized, implantable identification chip,
called VeriChip that can be used in a variety of security, financial,
personal identification/safety and other applications. On February 7, 2002,
we announced that we had created a wholly-owned subsidiary, VeriChip
Corporation, which will develop, market and license VeriChip. About the size
of a grain of rice, each VeriChip product contains a unique verification
number. Utilizing our proprietary external radio frequency identification
(RFID) scanner, radio frequency passes through the skin energizing the
dormant VeriChip, which then emits a radio frequency signal transmitting the
verification number contained in the VeriChip.
On October 22, 2002, we announced that the Food and Drug
Administration (FDA) had determined that VeriChip is not a regulated medical
device for security, financial and personal identification/safety
applications. The FDA specified in its ruling that VeriChip is a regulated
medical device for health information applications when marketed to provide
information to assist in the diagnosis or treatment of injury or illness. On
November 8, 2002, we received a letter from the FDA, based upon
correspondence from us to the FDA, warning us not to market VeriChip for
medical applications. We currently intend to market and distribute the
VeriChip product for security, financial and personal identification/safety
applications and, in the future, we plan to expand our marketing and
distribution efforts to health information applications of the product,
subject to any and all necessary FDA and other approvals. We are currently
in the process of preparing a 510-K application to obtain FDA approval to
market VeriChip for certain health information applications. We intend to
submit the 510-K application to the FDA within the next several months.
We began marketing VeriChip for security, financial and personal
identification/safety applications within the United States on October 24,
2002.
On February 1l, 2003, we announced that we received written
clearances from the FDA and the United States Department of Agriculture to
market our new product, Bio-Thermo, for use in pets, livestock and other
animals. Bio-Thermo is our first fully integrated implantable bio-sensing
microchip that can transmit a signal containing accurate temperature
readings to our proprietary RFID scanners. With this new technology,
accurate temperature readings can be obtained by simply passing the RFID
handheld scanner over the animal or by having the animal walk through a
portal scanner. We believe that Bio-Thermo and other biosensors developed in
the future will provide vital internal diagnostics about the health of
animals more efficiently and accurately than the invasive techniques used in
the industry today.
On May 13, 2003, we announced that we have developed and
successfully field-tested a working prototype of, what is to our knowledge,
the first-ever sub-dermal GPS personal location device called PLD. The
dimensions of this initial PLD prototype are 2.5 inches in diameter by 0.5
inches in depth, roughly the size of a pacemaker. As the process of
miniaturization proceeds in the coming months, we expect to be able to
shrink the size of the device to at least one-half and perhaps to as little
as one-tenth of the current size. The PLD is charged by an induction-based
power-recharging method which is similar to that used to recharge
implantable pacemakers. This recharging technique functions without
requiring any physical connection between the power source and the implant.
The exact timing of the commercial availability of PLD is unclear pending
further technological refinements and the obtainment of any and all required
regulatory clearances. The PLD technology builds on our United States patent
registration # 5,629,678.
26
RECENT/OTHER DEVELOPMENTS
Payment in Full of Obligations to IBM Credit LLC
Our Third Amended and Restated Term Credit Agreement (the "IBM
Credit Agreement") with IBM Credit LLC ("IBM Credit") contained covenants
relating to our financial position and performance, as well as the financial
position and performance of Digital Angel Corporation. At December 31, 2002,
we did not maintain compliance with the revised financial performance
covenant under the IBM Credit Agreement. In addition, under the terms of the
IBM Credit Agreement we were required to repay IBM Credit $29.8 million of
the $77.2 million outstanding principal balance currently owed to them, plus
$16.4 million of accrued interest and expenses (totaling approximately $46.2
million), on or before February 28, 2003. We did not make such payment by
February 28, 2003, and on March 7, 2003, we received a notice from IBM
Credit declaring the loan in default. Effective April 1, 2003, we entered
into a Forbearance Agreement with IBM Credit. In turn, we agreed to dismiss
with prejudice a lawsuit we filed against IBM Credit and IBM Corporation in
Palm Beach County, Florida on March 6, 2003. Under the terms of the
Forbearance Agreement, we had the right to purchase all of our outstanding
debt obligations to IBM Credit, totaling approximately $100.4 million
(including accrued interest), if we paid IBM Credit $30.0 million in cash by
June 30, 2003. As of June 30, 2003, we made cash payments to IBM Credit
totaling $30.0 million and, thus, we have satisfied in full our debt
obligations to IBM Credit. As a result, during the quarter ended June 30,
2003, we expect to record a gain on the forgiveness of debt of approximately
$70.4 million, exclusive of the bonuses discussed below.
On June 30, 2003, our Board of Directors (through the Compensation
Committee) approved the payment of approximately $4.3 million in bonuses.
The bonuses, which may be paid in cash (subject to availability) or in
shares of our common stock based upon mutual agreement of the recipient and
us, subject to any regulatory or necessary approvals, were awarded to
directors, executive officers and other employees in recognition of their
efforts in achieving the successful repayment of all obligations to IBM
Credit. The amount and timing of the payment of these bonuses will depend on
various factors, including (among others) the rate of our business growth,
our research and development efforts and pipeline, the effort and timing
involved in obtaining FDA and other necessary approval for our VeriChip
product's medical applications, capital equipment needs, the requirements of
our customers, and opportunities discovered or presented to us, and other
cash requirements.
Funding for $30.0 Million Payment to IBM Credit
Funding for the $30 million payment to IBM Credit consisted of
$17.8 million in net proceeds from the sales of an aggregate of 50.0 million
shares of our common stock, $10.0 million in net proceeds from the issuance
of our 8.5% Convertible Exchangeable Debentures, and $2.2 million from cash
on hand.
The 50.0 million shares of our common stock were purchased under
the Securities Purchase Agreements. The purchases resulted in net proceeds
to us of $17.8 million, after deduction of the 3% fee to our placement
agent, J.P. Carey Securities, Inc.
27
Issuance of 8.5% Convertible Exchangeable Debentures
On June 30, 2003, we entered into the Securities Purchase Agreement
(the "Agreement") with certain investors, collectively referred to herein as
"the Purchasers." In connection with the Agreement, we issued to the
Purchasers the $10.5 million aggregate principal amount of 8.5% Convertible
Exchangeable Debentures (the "Debentures"). Subject to the terms under the
various agreements, the Debentures are convertible into shares of our common
stock (subject in part to shareholder approval) or exchangeable for shares
of the Digital Angel Corporation common stock owned by us, or a combination
thereof, at the Purchasers' option. We currently own 19.6 million shares of
Digital Angel Corporation's common stock, or approximately 72.9% of the
shares outstanding of Digital Angel Corporation's common stock as of June
30, 2003. The Debentures are convertible or exchangeable at any time at the
option of the Purchasers. The conversion price for our common stock is
$0.515 per share also referred to as the Set Price, subject to anti-dilution
provisions. The exchange price for the Digital Angel Corporation common
stock owned by us is $2.20 per share as to the first fifty percent (50%) of
the original principal amount of the Debentures and $4.25 per share as to
the remaining fifty percent (50%) of the original principal amount, subject
to anti-dilution provisions.
In addition, we have granted to the Purchasers warrants to acquire
approximately 5.35 million shares of our common stock, or 0.95 million
shares of the Digital Angel Corporation common stock currently and owned by
us, or a combination of shares from both companies, at the Purchasers'
option (the "Warrants"). The exercise prices are $0.564 and $3.178 for our
common stock and the Digital Angel Corporation common stock owned by us,
respectively. The Warrants are subject to anti-dilution provisions, vest
immediately and are exercisable through June 30, 2007. We have entered into
a Registration Rights Agreement with the Purchasers whereby we have agreed
to register our common shares issuable upon conversion of the Debentures and
Warrants within a specified time period.
The proceeds upon issuance of the Debentures were allocated as
follows:
Face value of Debentures $10,500
Beneficial conversion feature (3,120)
Relative fair value of Warrants (1,387)
-------------
Relative fair value of Debentures $ 5,993
=============
The beneficial conversion feature was recorded as a reduction in
the value assigned to the Debentures (original issue discount) and an
increase in additional paid-in-capital. The value assigned to the Warrants
was recorded as a reduction in the value assigned to the Debentures
(original issue discount) and an increase in long-term liabilities. The
liability for the Warrants, to the extent potentially settleable in shares
of the Digital Angel Corporation common stock owned by us, will be revalued
at each reporting period and any resulting increase will result in a charge
to operations. We will be required to record an impairment loss if the
carrying value of the Digital Angel Corporation common stock underlying the
Warrants exceeds the exercise price. Should the Purchasers elect to exercise
the Warrants into shares of the Digital Angel Corporation common stock, such
exercise may result in our recording a gain on the transaction. The original
issue discount of $4.5 million will be accreted over the life of the
Debentures as additional interest expense.
Among other provisions under the Agreement and the Debentures, we
are required to pay interest at the rate of 8.5% per annum on a quarterly
basis beginning September 1, 2003, and, beginning on November 1, 2003, on a
monthly basis as to the principal amount required to be redeemed each month.
A final interest payment is due on the maturity date, which is November 1,
2005. Interest payments may be made
28
in either cash or in shares of the Digital Angel Corporation common stock
owned by us, or a combination thereof at our option, subject to certain
restrictions. The interest conversion rate for the Digital Angel Corporation
common stock is calculated based upon 90% of the average of the lowest 10 of
the 20 volume-weighted average stock prices immediately prior to the
applicable interest payment date, subject to a late payment adjustment.
Principal redemption payments of $0.4 million are due monthly beginning
November 1, 2003. The principal redemption payments may be made in cash, our
common stock or the Digital Angel Corporation common stock owned by us at
our option, subject to certain limitations regarding the average market
value and trading volume of the Digital Angel Corporation common stock. The
conversion/exchange redemption prices are based upon the lesser of ninety
percent (90%) of the lowest 10 of the 20 volume-weighted average stock
prices prior to the redemption date, and the Set Price/exchangeable prices,
subject to anti-dilution provisions. If we elect to make interest and or
principal redemption payments in shares of the Digital Angel Corporation
common stock that we own, such payments may result in additional interest
expense and or a gain or loss on the deemed sale of the Digital Angel
Corporation common shares. If we elect to make principal redemption payments
in shares of our common stock, such payments may result in additional
interest expense.
Subject to certain exempt transactions, including among others the
issuances of shares in connection with stock options, share issuances under
severance agreements with former executives, exercises of warrants currently
outstanding including the Warrants, the conversion of the Debentures and
issuances of shares for acquisitions or strategic investments, we are
prohibited under the terms of the Agreement to incur, create, guarantee,
assume or to otherwise become liable on account of an indebtedness other
than with a federally regulated financial institution or to increase any
amounts owing under any existing obligations or to issue or sell shares of
our common stock or equivalents until ninety (90) days after the effective
date of the registration statement registering our common shares underlying
the Debentures and Warrants. In addition, each Purchaser has the right of
first refusal with regard to any financings made by us in shares of our
common stock or common stock equivalents until such time as the Purchaser no
longer holds any Debentures.
As collateral for the Debentures and under the terms of a Security
Agreement, we and our wholly-owned subsidiary Computer Equity Corporation
have granted to the Purchasers a security interest in all of our accounts
receivable, and under the terms of a Pledge Agreement, we have granted to
the Purchasers a security interest in up to 15.0 million shares of the
Digital Angel Corporation common stock we currently own.
In connection with the Debentures, we incurred a placement agency
fee of $430,000 and we reimbursed one of the Purchasers $50,000 for legal,
administrative, due diligence and other expenses incurred to prepare and
negotiate the transaction documents.
SEC Inquiry
The Staff of the Securities and Exchange Commission's Southeast
Regional Office is conducting an informal inquiry concerning us. We are
fully and voluntarily cooperating with the informal inquiry. At this point,
we are unable to determine whether the informal investigation may lead to
potentially adverse action.
Nasdaq SmallCap Listing
Our common stock has traded on the SmallCap since November 12,
2002, under the symbol "ADSX." Prior to November 12, 2002, the our common
stock traded on the Nasdaq National Market at all times, except for the
period between July 12, 2002 and July 30, 2002, when our common stock traded
on the Pink Sheets under the symbol "ADSX.PK." To maintain its SmallCap
listing, we must continue to comply with the SmallCap's listing requirements
and, prior to October 2003, regain the minimum bid
29
requirement of at least $1.00 per share for a minimum of ten (10)
consecutive trading days. We have included a proposal in our proxy statement
for a special meeting of shareholders to be held on September 10, 2003, to
solicit shareholder approval to effect a reverse stock split of all of the
issued and outstanding shares of our common stock, and granting of
discretionary authority to our Board of Directors for a period of twelve
months after the date its shareholders approve the proposal to determine the
reverse stock split ratio, not to exceed a ratio of 1-for-25, and the
effective date of the reverse stock split or to determine not to proceed
with the reverse stock split. Our Board of Directors currently believes that
it should implement a reverse stock split to reduce the number of issued and
outstanding shares, which are a result, in part, of our past acquisitions,
the payment of debt obligations to IBM Credit and preferred stock
conversions. In addition, our Board of Directors believes that a reverse
stock split may facilitate the continued listing of our common stock on the
SmallCap and may enhance the desirability and marketability of our common
stock to the financial community and the investing public.
Severance Agreements
On March 21, 2003, Richard J. Sullivan, our then Chairman of the
Board of Directors and Chief Executive Officer, retired from such positions.
Our Board of Directors negotiated a severance agreement with Richard
Sullivan under which he is to receive a one-time payment of 56.0 million
shares of our common stock. In addition, stock options held by him
exercisable for approximately 10.9 million shares of our common stock were
re-priced. The options surrendered had exercise prices ranging from $0.15 to
$0.32 per share and were replaced with options exercisable at $0.01 per
share. Richard Sullivan's severance agreement provides that the payment of
shares and re-pricing of options provided for under that agreement is in
lieu of all future compensation and other benefits that would have been owed
to him under his employment agreement. That agreement required us to make
payments of approximately $17 million to him (or approximately $3.9 million
more than is owed under the severance agreement), a portion of such payments
of which could be made in either cash or stock, at our option.
On March 21, 2003, Jerome C. Artigliere, our then Senior Vice
President and Chief Operating Officer, resigned from such positions. Under
the terms of his severance agreement, Mr. Artigliere is to receive 4.8
million shares of our common stock. In addition, stock options held by him
exercisable for approximately 2.3 million shares of our common stock were
re-priced. The options surrendered had exercise prices ranging from $0.15 to
$0.32 per share and were replaced with options exercisable at $0.01 per
share. Mr. Artigliere's severance agreement provides that the payment of
shares and re-pricing of options provided under that agreement is in lieu of
all future compensation and other benefits that would have been owed to him
under his employment agreement. That agreement required us to make payments
of approximately $1.5 million to Mr. Artigliere.
As a result of the termination of Richard Sullivan's employment
with us, a "triggering event" provision in the severance agreement we had
entered into with Garrett Sullivan, our former Vice Chairman of the Board,
(who is not related to Richard Sullivan) at the time of his ceasing to serve
in such capacity in December 2001, has been triggered. We negotiated a
settlement of our obligations under Garrett Sullivan's severance agreement
that requires us to issue to him 7.5 million shares of our common stock on
our before August 31, 2003.
Our shareholders have approved the issuance of our common stock and
have ratified the re-pricing of the options under the terms of the severance
agreements with Richard J. Sullivan and Jerome C. Artigliere and they have
approved the issuance of our common stock under the agreements entered into
with Garrett Sullivan. The terms of each of the severance agreements were
subject to shareholder approval, in accordance with applicable Nasdaq rules,
because the agreements (i) are deemed to be compensatory arrangements under
which our common stock may be acquired by officers or directors, and (ii) in
Richard Sullivan's case, it may have resulted in his potentially holding
more than 20% of the
30
outstanding shares of our common stock following the issuance of the shares
and exercise of options covered by his severance agreement. As a result of
the terminations of Messrs. Sullivan and Artigliere, we recorded severance
expense of $22.0 million during the six-months ended June 30, 2003,
including $2.5 million resulting from the re-priced options. On July 25,
2003, our shareholders approved the terms of the severance agreement with
Richard J. Sullivan, as discussed above, and, therefore, we will reverse
approximately $3.9 million of such severance expense during the three-months
ending September 30, 2003.
Other
On July 25, 2003, our shareholders approved an increase in the
number of common shares authorized from 435.0 million to 560.0 million. The
increase will become effective upon the acceptance of an amendment to our
articles of incorporation by the State of Missouri.
We are planning to offer up to 30,000,000 shares of our common
stock in a public offering registered under the Securities Act of 1933,
subject to shareholder approval. The shares of our common stock will be
offered on a best efforts basis and may be sold through the efforts of a
placement agent, J.P. Carey Securities, Inc.
Effective May 9, 2003, Michael Zarriello joined our Board of
Directors. Mr. Zarriello was most recently a Senior Managing Director of
Jesup & Lamont Securities Corporation and served as President of Jesup and
Lamont Merchant Partners LLC. Prior to that, he was Managing Director and
Principal of Bear Stearns & Co., Inc. He has extensive financial experience
having served earlier in his career as Chief Financial Officer of the
Principal Activities Group that invested the Bear Stearns & Co., Inc.
capital in middle market companies, Chief Financial Officer of United States
Leather Holdings, Inc. and Chief Financial Officer of Avon Products, Inc.
Healthcare Division. He serves on the Audit Committee of our Board of
Directors.
Effective May 12, 2003, Kevin H. McLaughlin was appointed President
and Chief Operating Officer. Prior to his appointment as President, Mr.
McLaughlin served as our Senior Vice President and Chief Operating Officer.
Effective June 4, 2003, Arthur F. Noterman resigned from our Board
of Directors to pursue other interests. Mr. Noterman's term was due to
expire at our Annual Meeting of Shareholders, which was held on July 25,
2003. At present, we have not filled the position vacated by Mr. Noterman.
On July 31, 2003, Digital Angel Corporation entered into a
securities purchase agreement to sell securities to Laurus Master Fund, Ltd.
("Laurus"). Under the terms of the securities purchase agreement, Digital
Angel Corporation issued and sold to Laurus a two-year secured convertible
note in the original principal amount of $2.0 million and a common stock
warrant to purchase up to 0.1 million shares of Digital Angel Corporation's
common stock. The note is convertible, at Laurus' option, into shares of
Digital Angel Corporation's common stock at a per share price of $2.33,
subject to limitations. The note accrues interest at an annual rate equal to
prime plus 1.75% but shall not be less than 6% per annum. The exercise
prices of the warrant range from $2.68 to $3.38 per share and the warrant is
exercisable for five years. In connection with the note, Digital Angel
Corporation and Laurus entered into a security agreement granting to Laurus
a lien and security interest in Digital Angel Corporation's assets (having a
net book value of $53.1 million as of June 30, 2003), which is subject to a
lien and security interest held by Wells Fargo.
On August 14, 2003, we entered into a Stock Purchase Agreement with
Digital Angel Corporation. The Stock Purchase Agreement represents a
strategic investment in Digital Angel Corporation, whereby we are increasing
our ownership interest. The Stock Purchase Agreement provides for us to
purchase 3.0 million shares of Digital Angel Corporation's common stock at
$2.64 per share and for us to receive a warrant to purchase up to 1.0
million shares of Digital Angel Corporation's common stock. The aggregate
purchase price for the 3.0 million shares of $7.9 million is payable in
shares of our common stock equal to the aggregate purchase price divided by
the average of the volume weighted average price for our common stock for
the ten trading days immediately proceeding the closing date (the "Per Share
Exchange Price"). If the Per Share Exchange Price is less than $0.40, we
shall have the option to postpone the closing date for a period not to
exceed thirty calendar days or to terminate the Stock Purchase Agreement.
The warrant gives us the right to purchase a total of 1.0 million shares of
Digital Angel Corporation's common stock for a period of five years from
February 1, 2004. The exercise price of the warrant will be equal to the
daily volume weighted average price of Digital Angel Corporation's common
stock for the first 10 consecutive trading days of 2004 starting on January
2, 2004. As a related part of this transaction, negotiations are taking
place with the Purchasers, which may result in Digital Angel Corporation's
issuing a five-year warrant to the Purchasers to acquire up to 0.5 million
shares of its common stock at an exercise price of $2.64 per share.
31
BUSINESS SEGMENTS
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 began operating in three business
segments: Advanced Technology, Digital Angel Corporation and InfoTech USA,
Inc. (formerly the segment known as SysComm International).
Advanced Technology
Our Advanced Technology segment represents those businesses that 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. This segment specializes in
security-related data collection, value-added data intelligence and complex
data delivery systems for a wide variety of end users including government
agencies, commercial operations and consumers. Our VeriChip, Thermo Life and
PLD products are included in the Advanced Technology segment.
Digital Angel Corporation
Our Digital Angel Corporation segment consists of the business
operations of Digital Angel Corporation, our approximately 72.9% 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. Digital Angel Corporation operates in four divisions:
Animal Applications, Wireless and Monitoring, GPS and Radio Communications,
and Medical Systems. Our Digital Angel and Bio-Thermo products are included
in the Digital Angel Corporation segment.
InfoTech USA, Inc. (formerly SysComm International)
Our InfoTech USA, Inc. segment consists of the business operations
of our 52.5% owned subsidiary, InfoTech USA, Inc. This segment is a full
service provider of Information Technology (IT) solutions and provides IT
consulting, networking, procurement, deployment, integration, migration and
security services and solutions. It also provides on-going system and
networking maintenance services. During 2002, this segment continued its
strategy of moving away from a product-driven systems integration business
model to a customer-oriented IT solutions-based business model. It has
further developed its deliverable IT solutions by adding new consulting and
service offerings, and increasing the number of strategic alliances with
outside technical services firms and manufacturers of high-end IT products.
All Other
Business units that were part of our continuing operations and that
were closed or sold during 2002 are reported as "All Other."
"Corporate/Eliminations"
The "Corporate/Eliminations" category includes all amounts
recognized upon consolidation of our 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 three and six-months ended June 30, 2003,
is gain on the forgiveness of the IBM debt of $70.4 million and for the
six-months
32
ended June 30, 2003, is a severance charge of $22.0 million associated with
the termination of certain former officers. 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.
Discontinued Operations
On March 1, 2001, our Board of Directors approved a plan to sell
Intellesale, Inc. and all of our other non-core businesses. The results of
operations, financial condition and cash flows of Intellesale and all of our
other non-core businesses have been reported as Discontinued Operations in
our financial statements.
33
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, 2003 and 2002 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,
-------------------------- ---------------------
2003 2002 2003 2002
---- ---- ---- ----
% % % %
- - - -
Product revenue 83.3 82.2 83.5 82.0
Service revenue 16.7 17.8 16.5 18.0
-------------------------- ---------------------
Total revenue 100.0 100.0 100.0 100.0
Cost of products sold 62.6 57.7 59.2 58.1
Cost of services sold 7.7 8.5 7.8 8.4
-------------------------- ---------------------
Total cost of products and services sold 70.3 66.2 67.0 66.5
-------------------------- ---------------------
Gross profit 29.7 33.8 33.0 33.5
Selling, general and administrative expenses (59.7) (71.2) (91.2) (88.3)
Research and development (6.8) (3.0) (5.7) (3.3)
Depreciation and amortization (2.9) (5.4) (2.7) (4.4)
Gain on forgiveness of debt 337.0 -- 153.0 --
Interest and other income 1.0 2.1 1.0 1.2
Interest expense (21.9) (18.3) (20.0) (12.6)
-------------------------- ---------------------
Income (loss) from continuing operations before taxes, minority
interest, net loss on subsidiary stock issuances and merger
transaction and equity in net loss of affiliate 276.4 (62.0) 67.4 (73.9)
Provision (benefit) for income taxes 4.6 -- 1.7 0.2
-------------------------- ---------------------
Income (loss) from continuing operations before minority
interest, net loss on subsidiary stock issuances and
merger transaction and equity in net loss of affiliate 271.8 (62.0) 65.7 (74.1)
Minority interest (3.9) (1.6) (2.1) (0.8)
Net loss on subsidiary stock issuances and merger
transaction 3.8 15.0 2.5 7.9
Equity in net loss of affiliate -- -- -- 0.5
-------------------------- ---------------------
Income (loss) from continuing operations 271.9 (75.4) 65.3 (81.7)
(Loss) income from discontinued operations, net of income
taxes (2.1) (1.8) (1.3) 0.4
-------------------------- ---------------------
Net loss 269.8 (77.2) 64.0 (81.3)
========================== ======================
34
REVENUE
Revenue from continuing operations for the three-months ended June
30, 2003, decreased $4.9 million, or 19.1%, to $20.9 from $25.8 million in
the three-months ended June 30, 2002. Revenue from continuing operations for
the six-months ended June 30, 2003, decreased $8.1 million, or 14.9%, to
$46.0 from $54.1 million in the six-months ended June 30, 2002.
Revenue from continuing operations during the three and six-months
ended June 30, 2003, and 2002 by segment was as follows:
THREE-MONTHS ENDED JUNE 30,
(IN THOUSANDS)
------------------------------------------------------------------------------------
2003 2002
---- ----
------------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
Advanced Technology $ 5,924 $2,615 $ 8,539 $ 8,528 $3,368 $11,896
Digital Angel Corporation 8,138 242 8,380 8,584 577 9,161
InfoTech USA, Inc. 3,333 637 3,970 4,127 668 4,795
All Other -- -- -- -- -- --
Corporate / Eliminations -- -- -- (2) (14) (16)
------------------------------------------------------------------------------------
Total $17,395 $3,494 $20,889 $21,237 $4,599 $25,836
=========================================== ========================================
SIX-MONTHS ENDED JUNE 30,
(IN THOUSANDS)
------------------------------------------------------------------------------------
2003 2002
---- ----
------------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
Advanced Technology $14,255 $5,565 $19,820 $13,431 $6,984 $20,415
Digital Angel Corporation 18,896 775 19,671 16,035 880 16,915
InfoTech USA, Inc. 5,267 1,237 6,504 13,820 1,480 15,300
All Other -- -- -- 1,014 375 1,389
Corporate / Eliminations -- -- -- -- 36 36
------------------------------------------------------------------------------------
Total $38,418 $7,577 $45,995 $44,300 $9,755 $54,055
=========================================== ========================================
Advanced Technology's revenue decreased $3.4 million and $0.6
million in the three and six-month periods ended June 30, 2003,
respectively, when compared to the three and six-month period ended June 30,
2002. When compared to the amounts for the three-months ended June 30, 2003,
product revenue decreased by $2.6 million, or 30.5%, and service revenue
decreased by $0.8 million, or 22.4%. When compared to the amounts for the
six-months ended June 30, 2003, product revenue increased by $0.8 million,
or 6.1%, and service revenue decreased by $1.4 million, or 20.3%. We
attribute the decrease in product revenue during the three-months ended June
30, 2003, primarily to a delay in government contract projects. We attribute
the increase in product revenue during the six-months ended June 30, 2003 to
an increase in government contract sales during the first three months of
2003. We attribute the decreases in service revenues to reduced sales of
software and other technology services and to the sale of one of the
businesses in this group during the fourth quarter of 2002.
Digital Angel Corporation's revenue decreased $0.8 million and
increased $2.8 million in the three and six-month periods ended June 30,
2003, respectively, when compared to the three and six-month periods ended
June 30, 2002. When compared to the amounts for the three-months ended June
30, 2002, product revenue decreased by $0.4 million, or 5.2%, and service
revenue decreased by $0.3 million, or 58.1%. When compared to the amounts
for the six-months ended June 30, 2002, product revenue increased by $2.9
million, or 17.8%, and service revenue decreased by $0.1 million, or 11.9%.
We attribute the decrease in product revenue for the three months ended June
30, 2003, primarily to higher
35
sales in the three-months ended June 30, 2002, as sales were delayed in the
first quarter of 2002. We attribute the increase in product sales for the
six-months ended June 30, 2003, primarily to an increase in sales to fish
and wildlife industry customers and companion animal microchip sales in
North America and Europe. We attribute the decreases in service revenue to
the cancellation of a significant software contract in February 2003.
InfoTech USA, Inc.'s revenue decreased $0.8 million and $8.8
million in the three and six-months ended June 30, 2003, respectively, when
compared the three and six-month periods ended June 30, 2002. When compared
to the amounts for the three-months ended June 30, 2002, product revenue
decreased by $0.8 million, or 19.2%, and service revenue decreased by $0.0
million, or 4.6%. When compared to the amounts for the six-months ended June
30, 2002, product revenue decreased by $8.6 million, or 61.9%, and service
revenue decreased by $0.2 million, or 16.4%. The decreases in both periods
were due to a continued soft market in both product sales and service sales
combined with our decision in April 2002 to cease selling some of our lower
margin computer hardware and focus on the higher margin products and related
technical services.
All Other had no revenue for the three-months ended June 30, 2003
and 2002, and the six-months ended June 30, 2003, compared to revenue of
$1.4 million during the six-months ended June 30, 2002, 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, 2003, decreased $2.5 million, or 28.8%, to $6.2 million from $8.7
million for the three-months ended June 30, 2002. Gross profit from
continuing operations for the six-months ended June 30, 2003, decreased $2.9
million, or 16.1%, to $15.2 million from $18.1 million in six-months ended
June 30, 2002. Our gross profit margin was 29.7% and 33.0% of revenue,
respectively, for the three and six-months ended June 30, 2003, and 33.8%
and 33.5% of revenue, respectively, for the three and six-months ended June
30, 2002.
Gross profit from continuing operations during the three and
six-months ended June 30, 2003, and 2002 by segment was as follows:
THREE-MONTHS ENDED JUNE 30,
(IN THOUSANDS)
------------------------------------------------------------------------------------
2003 2002
---- ----
------------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
Advanced Technology $ 779 $1,621 $2,400 $1,817 $1,805 $3,622
Digital Angel Corporation 3,231 26 3,257 3,827 330 4,157
InfoTech USA, Inc. 313 242 555 691 273 964
All Other -- -- -- -- -- --
Corporate / Eliminations -- -- -- -- (15) (15)
------------------------------------------------------------------------------------
Total $4,323 $1,889 $6,212 $6,335 $2,393 $8,728
=========================================== ========================================
SIX-MONTHS ENDED JUNE 30,
(IN THOUSANDS)
------------------------------------------------------------------------------------
2003 2002
---- ----
------------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
Advanced Technology $ 2,078 $3,390 $ 5,468 $ 3,428 $3,787 $ 7,215
Digital Angel Corporation 8,506 164 8,670 6,978 382 7,360
InfoTech USA, Inc. 590 453 1,043 1,651 679 2,330
All Other -- -- -- 826 339 1,165
Corporate / Eliminations -- -- -- -- 36 36
------------------------------------------------------------------------------------
Total $11,174 $4,007 $15,181 $12,883 $5,223 $18,106
=========================================== ========================================
36
Gross profit margin from continuing operations during the three and
six-months ended June 30, 2003 and 2002, by segment was as follows:
THREE-MONTHS ENDED JUNE 30,
------------------------------------------------------------------------------------
2003 2002
---- ----
------------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
% % % % % %
- - - - - -
Advanced Technology 13.1 62.0 28.1 21.3 53.6 30.4
Digital Angel Corporation 39.7 10.7 38.9 44.6 57.2 45.4
InfoTech USA, Inc. 9.4 38.1 14.0 16.7 40.9 20.1
All Other -- -- -- -- -- --
Corporate / Eliminations -- -- -- -- N/A N/A
------------------------------------------------------------------------------------
Total 24.9 54.1 29.7 29.8 52.0 33.8
========================================== =========================================
SIX-MONTHS ENDED JUNE 30,
------------------------------------------------------------------------------------
2003 2002
---- ----
------------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
% % % % % %
- - - - - -
Advanced Technology 14.6 60.9 27.6 25.5 54.2 35.3
Digital Angel Corporation 45.0 21.2 44.1 43.5 43.4 43.5
InfoTech USA, Inc. 11.2 36.7 16.1 11.9 45.9 15.2
All Other -- -- -- 81.5 90.4 83.9
Corporate / Eliminations -- -- -- -- N/A N/A
-----------------------------------------------------------------------------------
Total 29.1 52.9 33.0 29.1 53.5 33.5
========================================= =========================================
Advanced Technology's gross profit decreased $1.2 million in the
three-months ended June 30, 2003, and margin increased to 28.1% from 30.4%
when compared to the three-months ended June 30 2002. Gross profit decreased
$1.7 million in the six-months ended June 30, 2003, and margin decreased to
27.6% from 35.3% when compared to the six-months ended June 30, 2002. We
attribute the overall decrease in gross profit primarily to the reduction in
sales during the first three and six-months of 2003, and the decrease in
margin primarily to the reduction in sales of software and other
higher-margin products.
Digital Angel Corporation's gross profit decreased $0.9 million in
the three-months ended June 30, 2003, and margins decreased to 38.9% in the
three-months ended June 30, 2003 from 45.4% in the three-months ended June
30, 2002. Gross profit increased $1.3 million in the six-months ended June
30, 2003, while margins decreased to 44.1% in the six-months ended June 30,
2003 from 43.5% in the six-months ended June 30, 2002. We attribute the
decrease in gross profit for the three months ended June 30, 2003, primarily
to the reduced sales during the three months ended June 30, 2003. We
attribute the increase in gross profit for the six months ended June 30,
2002, primarily to the previously mentioned sales increase. We attribute the
decreases in gross profit margins primarily to lower margins on service
revenue.
InfoTech USA, Inc.'s gross profit decreased $0.4 million in the
three-months ended June 30, 2003, and margin decreased to 14.0% in the
three-months ended June 30, 2003, from 20.1% in the three-months ended June
30, 2002. Gross profit decreased $1.3 million in the six-months ended June
30, 2003, and margin increased to 16.1% in the six-months ended June 30,
2003, from 15.2% in the six-months ended June 30, 2002. The decrease in
gross profit was primarily due to the overall decrease in revenue. The
37
decrease in gross margin to 14.0% in the three-months ended June 30, 2003,
from 20.1% in the three-months ended June 30, 2002, was primarily a result
of a large volume low margin sale during the current quarter.
All Other had no gross margin for the three-months ended June 30,
2003 and 2002, and the six-months ended June 30, 2003, compared to gross
margin of $1.2 million during the six-months ended June 30, 2002, 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.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expenses from continuing
operations was $12.5 million in the three-months ended June 30, 2003, a
decrease of $5.9 million, or 32.2%, from $18.4 million in the three-months
ended June 30, 2002. Selling, general and administrative expenses from
continuing operations was $41.9 million in the six-months ended June 30,
2003, a decrease of $5.8 million, or 12.2%, from $47.8 million in the
six-months ended June 30, 2002. As a percentage of total revenue, selling,
general and administrative expenses from continuing operations decreased to
59.7% in the three-months ended June 30, 2003, from 71.2% in the
three-months ended June 30, 2002 and increased to 91.2% in the six-months
ended June 30, 2003, from 88.3% in the six-months ended June 30, 2002.
Selling, general and administrative expense from continuing
operations during the three and six-months ended June 30, 2003 and 2002, by
segments was as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
(In thousands) (In thousands)
---------------------------- -------------------------
2003 2002 2003 2002
---- ---- ---- ----
Advanced Technology $ 2,405 $ 4,366 $ 4,681 $ 6,718
Digital Angel Corporation 3,897 3,713 7,899 6,841
InfoTech USA, Inc. 667 917 1,562 2,100
All Other (325) (33) (328) 880
Corporate / Eliminations 5,817 9,421 28,115 31,214
---------------------------- -------------------------
Total $12,461 $18,384 $41,929 $47,753
============================ =========================
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,
(In thousands) (In thousands)
---------------------------- ------------------------
2003 2002 2003 2002
---- ---- ---- ----
% % % %
- - - -
Advanced Technology 28.2 36.7 23.6 32.9
Digital Angel Corporation 46.5 40.5 40.2 40.4
InfoTech USA, Inc. 16.8 19.1 24.0 13.7
All Other -- N/A -- 63.4
Corporate / Eliminations(1) 27.9 36.5 61.1 57.7
---------------------------- ------------------------
Total 59.7 71.2 91.2 88.3
============================ ========================
(1) Corporate's percentage has been calculated as a percentage of total
revenue.
Advanced Technology's selling general and administrative expense
decreased $2.0 million, or 44.9%, to $2.4 million in the three-months ended
June 30, 2003 from $4.4 million in the three-months ended June 30, 2002.
Selling general and administrative expense decreased $2.0 million, or 30.3%,
to $4.7 million in the six-months ended June 30, 2003 from $6.7 million in
the six-months ended June 30, 2002. As a percentage of revenue, selling,
general and administrative expense decreased in the three and six-month
periods ended June 30, 2003. We attribute the decreases primarily to
decreased legal and
38
other costs associated with a lawsuit that was settled on July 15, 2002, and
to the sale of one of the businesses in this group during the fourth quarter
of 2002.
Digital Angel Corporation's selling general and administrative
expense increased $0.2 million, or 5.0%, to $3.9 million in the three-months
ended June 30, 2003, from $3.7 million in the three-months ended June 30,
2002. Selling general and administrative expense increased $1.1 million, or
15.5%, to $7.9 million in the six-months ended June 30, 2003, from $6.8
million in the six-months ended June 30, 2002. We attribute the increases
primarily to additional consulting expenses associated with the VeriChip
product distribution and licensing agreement and additional board of
director related expenses. As a percentage of revenue, selling, general and
administrative expense increased during the three-month period ended June
30, 2003, due primarily to the reduction in sales during the period. As a
percentage of revenue, selling, general and administrative expense remained
relatively constant during the six-months ended June 30, 2003, as compared
to the six-months ended June 30, 2002.
InfoTech USA, Inc.'s selling general and administrative expense
decreased $0.3 million, or 27.3%, to $0.7 million in the three-months ended
June 30, 2003, from $0.9 million in the three-months ended June 30, 2002.
Selling general and administrative expense decreased $0.5 million, or 25.6%,
to $1.6 million in the six-months ended June 30, 2003, from $2.1 million in
the six-months ended June 30, 2002. 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
decreased in the three-months period ended June 30, 2003, and increased in
the six-months ended June 30, 2003.
All Other's selling, general and administrative expenses decreased
$0.3 million, or 884.8%, in the three-months ended June 30, 2003, from $0.0
million in the three-months ended June 30, 2002. Selling general and
administrative expense decreased $1.2 million, or 137.3%, to $0.3) million
in the six-months ended June 30, 2003, from $0.9 million in the six-months
ended June 30, 2002. The decreases resulted primarily from the settlement of
certain litigation for less than anticipated during the three-months ended
June 30, 2003, and 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.
"Corporate / Eliminations" selling, general and administrative
expenses decreased $3.6 million, or 38.1%, to $5.8 million in the
three-months ended June 30, 2003, from $9.4 million in the three-months
ended June 30, 2002. We attribute the decrease primarily to the following
factors: 1). We incurred a charge of approximately $3.4 million during the
three-months ended June 30, 2002, for valuation reserves associated with
notes receivable for stock issuances; 2). We reduced approximately $0.1
million and incurred approximately $3.1 million in non-cash compensation
expense during the three-months ended June 30, 2003 and 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; and 3). We eliminated
approximately $1.0 million in expenses primarily from the cost reduction
programs initiated during 2002. Partially offsetting the decrease was bonus
expense of approximately $4.3 million during the three-months ended June 30,
2003. The bonuses, which may be paid in cash (subject to availability) or in
shares of our common stock based upon mutual agreement of the recipient and
us, subject to any regulatory or necessary approvals, were awarded to
directors, executive officers and other employees in recognition of their
efforts in achieving the successful repayment of all obligations to IBM
Credit. The amount and timing of the payment of these bonuses will depend on
various factors, including (among others) the rate of our business growth,
our research and development efforts and pipeline, the effort and timing
involved in obtaining FDA and other necessary
39
approval for our VeriChip product's medical applications, capital equipment
needs, the requirements of our customers, and opportunities discovered or
presented to us.
Selling, general and administrative expenses decreased $3.1
million, or 9.9%, to $28.1 million in the six-months ended June 30, 2003,
from $31.2 million in the six-months ended June 30, 2002. We attribute the
decrease to the following factors: 1). We incurred a charge of approximately
$4.3 million during the six-months ended June 30, 2002, for valuation
reserves associated with notes receivable for stock issuances and other bad
debts; 2). We reduced approximately $1.0 million and incurred approximately
$3.3 million in non-cash compensation expense during the six-months ended
June 30, 2003 and 2002, respectively, due primarily to re-pricing 19.3
million stock options during 2001; 3). We recorded non-cash compensation
expense associated with pre-merger Digital Angel options of approximately
$18.7 million during the six-months ended June 30, 2002. Under the terms of
the merger, 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. As all of
the option holders 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; and 4). We eliminated
approximately $1.7 million in expenses primarily from the cost reduction
programs initiated during 2002. Partially offsetting these decreases were
the following: 1). We incurred $4.3 million in bonus expense during the
six-months ended June 30, 2003, as discussed above; and 2). We incurred
approximately $21.8 million in severance expenses during the six-months
ended June 30, 2003, which resulted from the termination of executive
officers and director during the six-months ended June 30, 2003, including
$2.5 million resulting from re-pricing stock options. (An additional $0.2
million of severance expense associated with these terminations is included
in the Advance Technology segment's selling, general and administrative
expense for the six-months ended June 30, 2003).
RESEARCH AND DEVELOPMENT
Research and development expense from continuing operations was
$1.4 million and $0.8 million for the three months ended June 30, 2003, and
2002, respectively. Research and development expense from continuing
operations was $2.6 million and $1.8 million for the six months ended June
30, 2003 and 2002, respectively. Research and development expense increased
to 6.8% of revenue in the three-months ended June 30, 2003, from 3.0% of
revenue in the three-months ended June 30, 2002 and increased to 5.7% of
revenue in the six-months ended June 30, 2003, from 3.3% of revenue in the
six months ended June 30, 2002. Research and development expense relates
primarily to the development of our products, Digital Angel and VeriChip,
Thermo Life and PLD.
Research and development expense from continuing operations during
the three and six-months ended June 30, 2003 and 2002, by segments was as
follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
(In thousands) (In thousands)
--------------------------- --------------------------
2003 2002 2003 2002
---- ---- ---- ----
Advanced Technology $ 46 $ -- $ 101 $ 116
Digital Angel Corporation 1,172 782 2,083 1,645
InfoTech USA, Inc. -- -- -- --
All Other -- -- -- --
Corporate / Eliminations 206 -- 441 --
--------------------------- --------------------------
Total $1,424 $782 $2,625 $1,761
=========================== ==========================
40
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense from continuing operations
was $0.6 million and $1.4 million for the three months ended June 30, 2003,
and 2002, respectively. Depreciation and amortization expense from
continuing operations was $1.2 million and $2.4 million for the six months
ended June 30, 2003, and 2002, respectively. Depreciation and amortization
expense decreased to 2.9% of revenue in the three-months ended June 30,
2003, from 5.4% of revenue in the three-months ended June 30, 2002, and
decreased to 2.7% of revenue in the six-months ended June 30, 2003, from
4.4% of revenue in the six months ended June 30, 2002.
Depreciation and amortization expense from continuing operations
during the three and six-months ended June 30, 2003, and 2002 by segments
was as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
(In thousands) (In thousands)
--------------------------- --------------------------
2003 2002 2003 2002
---- ---- ---- ----
Advanced Technology $ 64 $ 144 $ 133 $ 250
Digital Angel Corporation 435 1,095 869 1,830
InfoTech USA, Inc. 55 69 111 143
All Other -- -- -- 9
Corporate / Eliminations 57 76 124 156
--------------------------- --------------------------
Total $611 $1,384 $1,237 $2,388
=========================== ==========================
Advanced Technology's depreciation and amortization expense
decreased by $0.1 million, or 55.6%, to $0.1 million in the three-months
ended June 30, 2003 from $0.1 million in the three-months ended June 30,
2002. Depreciation and amortization expense decreased by $0.1 million, or
46.8%, to $0.1 million in the six-months ended June 30, 2003 from $0.3
million in the six-months ended June 30, 2002. We attribute the decrease to
fully depreciating certain assets during 2002 and our decision to limit our
expenditures for property and equipment.
Digital Angel Corporation's depreciation and amortization expense
depreciation and amortization expense decreased by $0.7 million, or 60.3%,
to $0.4 million in the three-months ended June 30, 2003 from $1.1 million in
the three-months ended June 30, 2002. Depreciation and amortization expense
decreased by $1.0 million, or 52.5%, to $0.9 million in the six-months ended
June 30, 2003 from $1.8 million in the six-months ended June 30, 2002. We
attribute the decrease primarily to the exclusion of depreciation expense
for a license to a digital encryption and distribution software system that
Digital Angel Corporation impaired during the fourth quarter of 2002.
InfoTech USA, Inc.'s depreciation and amortization expense
depreciation and amortization expense decrease slightly in the three and
six-months ended June 30, 2003, as compared to the three and six-months
ended June 30, 2002. We attribute the decreases primarily to the sale of the
Shirley, New York facility during the three-months ended March 31, 2002.
All Other's depreciation and amortization expense decreased 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.
Corporate/Elimination's depreciation and amortization expense
decrease slightly in the three and six-months ended June 30, 2003, as
compared to the three and six-months ended June 30, 2002. We attribute the
decreases primarily to our decision to limit our expenditures for property
and equipment.
41
INTEREST INCOME AND EXPENSE
Interest income was $0.2 million and $0.6 million, for the
three-month ended June 30, 2003 and 2002, respectively, and $0.4 million and
$0.7 million for the six-months ended June 30, 2003 and 2002, respectively.
Interest income is earned primarily from short-term investments and notes
receivable.
Interest expense was $4.6 million and $4.7 million, for the
three-month ended June 30, 2003 and 2002, respectively, and $9.2 million and
$6.8 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 the associated interest rate, and is principally associated with the IBM
Credit Agreement. Our obligations under the IBM Credit Agreement were repaid
as of June 30, 2003.
INCOME TAXES
Our effective income tax rates were 1.7% and (0.1)% in the
three-months ended June 30, 2003 and 2002, respectively, and 2.5% and 0.2%
in the six-months ended June 30, 2003 and 2002, 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 and
state taxes net of federal benefits. In addition, during the three and
six-months ended June 30, 2003, we recorded approximately $1.0 million in
alternative minimum tax.
RESULTS OF DISCONTINUED OPERATIONS
On March 1, 2001, our 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, 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 2002, and the other was sold in July 2003. Proceeds from the
sales of Discontinued Operations companies were primarily used to repay
amounts outstanding under the IBM Credit Agreement.
During the three months ended June 30, 2003 and 2002 and during the
six-months ended June 30, 2003, Discontinued Operations incurred a change in
estimated operating loss on disposal and operating losses during the phase
out period of $0.4 million, $0.5 million and $0.6 million, respectively. The
primary reasons for the increases in the estimated losses during these
periods were (1) an increase in estimated facility lease cancellation costs
and (2) the operations of the two remaining businesses within this group.
One of these businesses was sold in May of 2002, and the other was sold in
July 2003.
During the six-months ended June 30, 2002, we recorded a reduction
of its estimated operating loss on disposal and operating losses during the
phase out period of $0.2 million. This reduction was comprised primarily of
an increase in the estimated loss on the sale of the Company's 85% ownership
in its Canadian subsidiary, Ground Effects Ltd., which was sold in January
2002, of $0.2 million, offset by a decrease in carrying costs as certain of
these obligations were settled during the six-months ended June 30, 2002,
for amounts less than previously anticipated. Carrying costs include the
cancellation of facility leases, employment contract buyouts, sales tax
liabilities and litigation reserves.
42
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, 2002 through June 30, 2003.
Balance Balance
Type of Cost December 31, 2002 Additions Deductions June 30, 2003
- -----------------------------------------------------------------------------------------------------------
Estimated loss on sale, net of change in
estimated operating losses $ -- $126 $126 $ --
Carrying costs 4,908 309 -- 5,217
--------------------------------------------------------------
Total $4,908 $435 $126 $5,217
==============================================================
LIQUIDITY AND CAPITAL RESOURCES FROM CONTINUING OPERATIONS
As of June 30, 2003, cash and cash equivalents totaled $6.5
million, an increase of $0.7 million, or 12.1%, from $5.8 million at
December 31, 2002.
Cash of $0.7 million was used by operations and cash of $1.7
million was provided by operations during the first six-months of 2003, and
2002, respectively. In the six-months ended June 30, 2003, cash was used to
purchase inventory. 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.
Accounts and unbilled receivables, net of allowance for doubtful
accounts, decreased by $3.9 million, or 23.6%, to $12.6 million at June 30,
2003, from $16.5 million at December 31, 2002. We attribute the increase
primarily to a reduction in sales during the current period.
Inventory levels increased by $2.0 million, or 31.2%, to $8.4
million at June 30, 2003, from $6.4 million at December 31, 2002. We
attribute the increase primarily to the accumulation of inventory by Digital
Angel Corporation in anticipation of current year sales.
Accounts payable increased by $3.6 million, or 36.7%, to $13.4
million at June 30, 2003, from $9.8 million at December 31, 2002, due
primarily to the increase in inventory.
Accrued interest decreased by $10.1 million, or 100.0%, from $10.1
million at December 31, 2002, due to the payment in full of all obligations
to IBM Credit as of June 30, 2003.
Investing activities provided cash of $0.4 million and $4.4 million
in the first six-months of 2003 and 2002, respectively. In the first six
months of 2003, cash was provided primarily by collections on notes
receivable of $1.0 million and used primarily to purchase property and
equipment of $0.6 million. 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.
Financing activities provided cash of $1.0 million in the first
six-months of 2003, and used cash of $1.8 million in the first six-months of
2002. In the first six-months of 2003, cash of $18.9 million was provided
primarily from the issuances of our and Digital Angel Corporation's common
stock, $10.0 million was provided by from the issuance of the Debentures and
cash of $27.4 million was used primarily to repay notes payable. 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-
43
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 stock
issued.
Debt Covenant Compliance and Liquidity
On March 1, 2002, we and the Digital Angel 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. At December 31, 2002, we failed to maintain compliance with the
financial performance covenant under the IBM Credit Agreement. In addition,
as of June 30, 2003, March 31, 2003 and December 31, 2002, Digital Angel
Corporation did not maintain compliance with certain financial covenants
under its credit agreement with its lender, Wells Fargo. Well Fargo provided
Digital Angel Corporation with waivers of such non-compliance. IBM did not
provide a waiver.
Under the terms of the IBM Credit Agreement we were required to
repay IBM Credit $29.8 million of the $77.2 million outstanding principal
balance owed to them plus $16.4 million of accrued interest and expenses
(totaling approximately $46.2 million), on or before February 28, 2003. We
did not make such payment by February 28, 2003, and on March 3, 2003, IBM
Credit notified us that we had until March 6, 2003, to make the payment. Our
failure to comply with the payment terms imposed by the IBM Credit Agreement
and our failure to maintain compliance with the financial performance
covenant constitute events of default under the IBM Credit Agreement. On
March 7, 2003, we received a letter from IBM Credit declaring the loan in
default and indicating that IBM Credit would exercise any and/or all of its
remedies.
Effective April 1, 2003, we entered into a Forbearance Agreement
with IBM Credit. Under the terms of the Forbearance Agreement, we had the
right to purchase all of our outstanding debt obligations to IBM Credit,
totaling approximately $100.1 million (including accrued interest), if we
paid IBM Credit $30 million in cash by June 30, 2003. As of June 30, 2003,
we have made cash payments to IBM Credit totaling $30.0 million and, thus,
we have satisfied in full our debt obligations to IBM Credit. As a result,
we recorded a gain on the forgiveness of debt of approximately $70.4 million
in the quarter ended June 30, 2003.
Funding for the $30.0 million payment to IBM Credit consisted of
$17.8 million in net proceeds from the sales of an aggregate of 50.0 million
shares of our common stock, $10.0 million in net proceeds from the issuance
of the Debentures, and $2.2 million from cash on hand.
The 50.0 million shares of our common stock were purchased under
the Securities Purchase Agreements. The purchases resulted in net proceeds
to us of $17.8 million, after deduction of the 3% fee to our placement
agent, J.P. Carey Securities, Inc.
On June 30, 2003, we entered into the Agreement with certain
Purchasers. In connection with the Agreement, we issued to the Purchasers
Debentures due November 1, 2005. Subject to the terms under the various
agreements, the Debentures are convertible into shares of our common stock
(subject in part to shareholder approval) or exchangeable for shares of
Digital Angel Corporation common stock owned by us, or a combination
thereof, at the Purchasers' option. We currently own 19.6 million shares of
Digital Angel Corporation's common stock, or approximately 73% of the shares
outstanding of Digital Angel Corporation's common stock as of June 30, 2003.
The Debentures are convertible or exchangeable at any time at the option of
the Purchasers. The conversion price for our common stock is $0.515 per
share also referred to as the Set Price, subject to anti-dilution
provisions. The exchange price for the Digital Angel Corporation common
stock owned by us is $2.20 per share as to the first fifty percent (50%) of
the original principal amount of the Debentures and $4.25 per share as to
the remaining fifty percent (50%) of the original principal amount, subject
to anti-dilution provisions.
44
Among other provisions under the Agreement and the Debenture, we
are required to pay interest at the rate of 8.5% per annum on a quarterly
basis beginning September 1, 2003, and, beginning on November 1, 2003, on a
monthly basis as to the principal amount required to be redeemed each month.
A final interest payment is due on the maturity date. Interest payments may
be made in either cash or in shares of the Digital Angel Corporation common
stock owned by us, or a combination thereof at our option, subject to
certain restrictions. The interest conversion rate for the Digital Angel
Corporation common stock is calculated based upon 90% of the average of the
lowest 10 of the 20 volume-weighted average stock prices immediately prior
to the applicable interest payment date, subject to a late payment
adjustment. Principal redemption payments of $0.4 million are due monthly
beginning November 1, 2003. The principal redemption payments may be made in
cash, our common stock or the Digital Angel Corporation common stock owned
by us at our option, subject to certain limitations regarding the average
market value and trading volume of the Digital Angel Corporation common
stock. The conversion prices are based upon the lesser of ninety percent
(90%) of the lowest 10 of the 20 volume-weighted average stock prices prior
to the redemption date, and the set prices as defined in the Agreement. If
we elect to make interest and or principal redemption payments in shares of
the Digital Angel Corporation common stock that we own, such payments may
result in additional interest expense and or a gain or loss on the deemed
sale of the Digital Angel Corporation common shares. If we elect to make
principal redemption payments in shares of our common stock, such payments
may result in additional interest expense.
The repayment of all of our debt obligations to IBM Credit resolved
one of the major factors impacting our ability to continue as a going
concern. Our ability to continue as a going concern is also predicated upon
numerous issues including our ability to:
o Successfully implement our business plans, manage
expenditures according to our budget, and generate positive
cash flow from operations;
o Realize positive cash flow with respect to our investment in
Digital Angel Corporation;
o Develop an effective marketing and sales strategy;
o Obtain the necessary approvals to expand the market for the
VeriChip product;
o Complete the development of the second generation Digital
Angel product; and
o Attract, motivate and/or retain key executives and employees.
Sources of Liquidity
Our operating activities did not provide positive cash flow during
the six-months ending June 30, 2003, or during 2002 and 2001. In addition,
during the six-months ended June 30, 2003, we used $2.2 million of our cash
on hand to fund a portion of the $30 million debt payment to IBM Credit
under the terms of the Forbearance Agreement. Accordingly, there can be no
assurance that we will have access to funds necessary to provide for our
ongoing operations or to make the required interest and redemption payments
associated with the Debentures. Our sources of liquidity may include
proceeds from the sale of common stock and preferred shares, proceeds for
the sale of businesses, proceeds from the sale of the unrestricted Digital
Angel Corporation common stock owned by us, 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. There can be no assurance
however, that these options will be available, or if available, on
45
favorable terms. Our capital requirements depend on a variety of factors,
including but not limited to, repayment obligations under the Debentures,
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.
Failure to obtain additional funding, to generate positive cash
flow from operations and to comply with the payment and other provisions of
the Debentures will have a materially adverse effect on our business,
financial condition and results of operations.
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 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 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 (FAS No. 145). FAS No. 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. Also, the exception to applying Opinion 30 is
eliminated. 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. The adoption of FAS No. 145 had the effect
of reducing our loss from continuing operations and eliminating an
extraordinary gain as previously reported for the year ended December 31,
2001, and of reducing our income from continuing operations and eliminating
an extraordinary loss as previously reported for the year ended December 31,
1999.
In June 2002, the FASB issued SFAS 146, Accounting for costs
Associated with Exit or Disposal Activities (FAS No. 146). This statement
requires recording costs associated with exit or disposal activities at
their fair values when a liability has been incurred. Under previous
guidance, certain exit costs were accrued upon management's commitment to an
exit plan. Adoption of this Statement is required with the beginning of
fiscal year 2003. We adopted this statement on January 1, 2003. The adoption
of FAS No. 146 did not have a material impact on our operations or financial
position.
In December 2002, the FASB issued SFAS 148, Accounting for
Stock-Based Compensation -- Transition and Disclosure, an amendment of FASB
Statement No. 123 (FAS No. 148). This Statement amends SFAS 123, Accounting
for Stock-Based Compensation (FAS No. 123), to provide alternative methods
of transition for an entity that voluntarily changes to the fair value based
method of accounting for stock-based employee compensation. It also amends
the disclosure provisions of that Statement to require prominent disclosure
about the effects on reported net income of an entity's accounting policy
decisions with respect to stock-based employee compensation. Finally, this
Statement amends APB Opinion No. 28, Interim Financial Reporting, to require
disclosure about those effects in interim financial
46
information. We intend to continue to account for stock-based compensation
based on the provisions of APB Opinion No. 25. FAS No. 148's amendment of
the transition and annual disclosure provisions of FAS No. 123 are effective
for fiscal years ending after December 15, 2002, and the disclosure
requirements for interim financial statements are effective for interim
periods beginning after December 15, 2002. We have adopted the disclosure
provisions of FAS No. 148 effective December 31, 2002.
In May 2003, the FASB issued SFAS 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity
(FAS No. 150). FAS No. 150 establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics
of both liabilities and equity. It requires that an issuer classify a
financial instrument that is within its scope as a liability (or an asset in
some circumstances). Many of those instruments were previously classified as
equity. FAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of
the first interim period beginning after June 15, 2003. It is to be
implemented by reporting the cumulative effect of a change in accounting
principle for financial instruments created before the issuance date of the
statement and still existing at the beginning of the interim period of
adoption. Restatement is not permitted. We will adopt the provisions of FAS
No. 150 effective July 1, 2003. We have not yet determined the impact, if
any, of the adoption of FAS No. 150 on our financial position.
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 our products and services including Digital
Angel(TM), Thermo Life(TM), VeriChip(TM), Bio-Thermo(TM) and
PLD;
o anticipated trends in our business and demographics;
o the ability to hire and retain skilled personnel;
o relationships with and dependence on technological partners;
o uncertainties relating to customer plans and commitments;
o our ability to successfully integrate the business operations
of acquired companies;
o our future profitability and liquidity;
o governmental export and import policies, global trade
policies, worldwide political stability and economic growth;
47
o regulatory, competitive or other economic influences; and
o all statements referring to the future or future events.
In some cases, 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. Also, these
forward-looking statements represent our estimates and assumptions only as
of the date the statement was made.
OUR FAILURE TO OBTAIN ADDITIONAL FUNDING WILL HAVE A SUBSTANTIAL
NEGATIVE IMPACT ON OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
Our operating activities did not provide positive cash flow during
the first six months of 2003 and during 2002 and 2001. In addition, during
the first six months of 2003, we used $2.2 million of our cash on hand to
fund a portion of a $30 million debt payment to IBM Credit under the terms
of a Forbearance Agreement with IBM Credit. Accordingly, there can be no
assurance that we will have access to funds necessary to provide for our
ongoing operations. Our sources of liquidity may include proceeds from the
sale of common stock and preferred shares, proceeds from the sale of
businesses, proceeds from the sale of the unrestricted Digital Angel
Corporation common stock owned by us, 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. There can be no assurance
however, that these options will be available, or if available, on favorable
terms. Failure to obtain additional funding and to generate positive cash
flow from operations will have a materially adverse effect on our business,
financial condition and results of operations.
IF WE DO NOT OBTAIN SHAREHOLDER APPROVAL AT THE SEPTEMBER 10, 2003,
SPECIAL MEETING OF SHAREHOLDERS WE WILL NOT BE ABLE TO ISSUE SHARES (BEYOND
7,210,679) IN CONNECTION WITH THE DEBENTURES AND RELATED WARRANTS AND WE MAY
ONLY BE ABLE TO MAKE PRINCIPAL REDEMPTION PAYMENTS IN CASH, OR SUBJECT TO
CERTAIN CONDITIONS, IN SHARES THAT WE BENEFICIALLY OWN IN DIGITAL ANGEL
CORPORATION.
The Nasdaq rules generally require shareholder approval for the
issuance of securities representing 20% or more of an issuer's outstanding
listed securities. Nasdaq has taken the position that the 50,000,000 shares
we issued under three separate securities purchase agreements dated May 8,
2003, May 22, 2003 and June 4, 2003 (the "Securities Purchase Agreements"),
and any issuance of our common stock under the Debentures and Warrants
should be combined and treated as one transaction for determining the 20%
threshold, since the purpose of and the proceeds from these transactions
were used to pay our debt obligation to IBM Credit. We had 286,053,403
shares of our common stock outstanding just prior to the initial issuance of
shares under the Securities Purchase Agreements. Therefore, 57,210,680
shares are equal to 20% of our outstanding shares on a pre-transaction
basis. Thus, any issuance of our common stock under the Debentures and
Warrants in excess of 7,210,679 shares would result in an issuance of
securities representing 20% or more of our common stock under Nasdaq's
rules. In connection with the Debentures, we have agreed to seek shareholder
approval at a special meeting of shareholders being held on September 10,
2003, for the potential issuance of more than 7,210,679 shares of our common
stock issuable upon conversion of the Debentures and Warrants to satisfy
Nasdaq's requirements of shareholder approval. No shares have been issued in
connection with the Debentures and Warrants as of the date of this filing.
If shareholder approval were attained, the number of shares that could be
issued upon the conversion of the Debentures and exercise of the Warrants
would not be limited by the Nasdaq 20% limitation.
48
If we do not obtain shareholder approval, we will not be able to
issue shares (beyond 7,210,679) upon conversion of the Debentures, exercise
of the Warrants, or in connection with monthly principal redemptions
payments and we will only be able to make such payments in cash, or subject
to certain conditions, in shares that we own in Digital Angel Corporation.
Although the failure to obtain shareholder approval would not affect the
terms of the Debentures or Warrants or otherwise have an adverse economic
effect, we might prefer to have the Debentures convert into shares of our
common stock or we might prefer to make our monthly principal redemption
payments in shares of our common stock in order to conserve cash and to
preserve our ownership of Digital Angel Corporation.
OUR FINANCIAL STATEMENTS HAVE BEEN PREPARED ON A GOING CONCERN
BASIS, AND HAVE INDICATED THAT SUBSTANTIAL DOUBT EXISTS ABOUT OUR ABILITY TO
CONTINUE AS A GOING CONCERN.
On June 30, 2003, we repaid of all of our debt obligations to IBM
Credit, which resolved one of the major factors impacting our ability to
continue as a going concern. Our ability to continue as a going concern is
also predicated upon numerous issues including our ability to:
o Successfully implement our business plans, manage
expenditures according to our budget, and generate positive
cash flow from operations;
o Realize positive cash flow with respect to our investment in
Digital Angel Corporation;
o Develop an effective marketing and sales strategy;
o Obtain the necessary approvals to expand the market for our
VeriChip product;
o Complete the development of our second generation Digital
Angel product; and
o Attract, motivate and/or retain key executives and employees.
We are continually seeking operational efficiencies and synergies
within each of our operating segments 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
restructurings 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
initiative will be found, or if found, that they will be on terms favorable
to us.
A CHANGE OF CONTROL OF DIGITAL ANGEL CORPORATION WOULD HAVE A
NEGATIVE IMPACT ON OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
Under the terms of the employment agreement dated March 8, 2002, as
amended, by and between Digital Angel Corporation and Randolph K. Geissler
(the President and Chief Executive Officer of Digital Angel Corporation), a
"change in control" occurs under that employment agreement if any person
becomes the "beneficial owner" (as defined in Rule 13d-3 under the
Securities Exchange Act of 1934), directly or indirectly, of securities of
Digital Angel Corporation representing 20% or more of the combined voting
power of the then outstanding shares of common stock. Therefore, if we were
required to sell more than approximately 5.3 million shares of Digital Angel
Corporation's common stock that we
49
currently own, such sale would constitute a change in control under the
employment agreement with Mr. Geissler. Upon the occurrence of a change in
control, Mr. Geissler, at his sole option and discretion, may terminate his
employment with Digital Angel Corporation at any time within one year after
such change in control upon 15 days' notice. In the event of such
termination, the employment agreement provides that Digital Angel
Corporation must pay to Mr. Geissler a severance payment equal to three
times the base amount as defined in Section 280G(b)(3) of the Internal
Revenue Code of 1986, as amended ("Code") minus $1.00 (or a total of
approximately $750,000), which would be payable no later than one month
after the effective date of Mr. Geissler's termination of employment. In
addition, upon the occurrence of a change of control under the employment
agreement, all outstanding stock options held by Mr. Geissler would become
fully exercisable.
The employment agreement also provides that upon:
o a change of control;
o the termination of Mr. Geissler's employment for any reason
other than due to his material default under the employment
agreement; or
o if Mr. Geissler ceases to be Digital Angel Corporation's
President and Chief Executive Officer for any reason other
than termination due to his material default under the
employment agreement.
Within 10 days of the occurrence of any such events, Digital Angel
Corporation is to pay to Mr. Geissler $4,000,000. Digital Angel Corporation
may pay such amount in cash or in its common stock or with a combination of
cash and common stock. The employment agreement also provides that if the
$4,000,000 is paid in cash and stock, the amount of cash paid must be
sufficient to cover the tax liability associated with such payment, and such
payment shall otherwise be structured to maximize tax efficiencies to both
Digital Angel Corporation and Mr. Geissler.
Also, effective October 30, 2002, Digital Angel Corporation entered
into a Credit and Security Agreement with Wells Fargo. The Credit and
Security Agreement provides that a "change in control" under that agreement
results in a default. A change in control is defined as either Mr. Geissler
ceasing to actively manage Digital Angel Corporation's day-to-day business
activities or the transfer of at least 25% of the outstanding shares of
Digital Angel Corporation's common stock. Also, if Digital Angel Corporation
owes Mr. Geissler $4,000,000 under his employment agreement, the obligation
would most likely result in a breach of Digital Angel Corporation's
financial covenants under the Credit and Security Agreement. If these
defaults occurred and were not waived by Wells Fargo, and if Wells Fargo
were to enforce these defaults under the terms of the Credit and Security
Agreement and related agreements, Digital Angel Corporation's and our
business and financial condition would be materially and adversely affected,
and it may force Digital Angel Corporation to cease operations.
WE ARE REQUIRED TO ISSUE ADDITIONAL SHARES OF COMMON STOCK IN
CONNECTION WITH SEVERANCE AGREEMENTS WITH OUR FORMER EXECUTIVE OFFICERS AND
DIRECTORS AND, AS A RESULT, YOUR INVESTMENT IN OUR COMMON STOCK WILL BE
FURTHER DILUTED.
On March 21, 2003, we entered into severance agreements with
Richard J. Sullivan, our then Chairman of the Board of Directors and Chief
Executive Officer, and Jerry C. Artigliere, our then Senior Vice President
and Chief Operating Officer. The severance agreements provide for the
payment of 56.0 million and 4.8 million shares of our common stock to
Richard Sullivan and Jerome Artigliere, respectively. In addition, stock
options held by Richard Sullivan and Jerome Artigliere, which were
exercisable for approximately 10.9 and 2.3 million shares of our common
stock, respectively, were re-
50
priced. The options surrendered had exercise prices ranging from $0.15 to
$0.32 per share and were replaced with options exercisable at $0.01 per
share. As a result of the termination of Richard Sullivan's employment with
us, a "triggering event" provision in the severance agreement we entered
into with Garrett Sullivan, our former Vice Chairman of the Board (who is
not related to Richard Sullivan), at the time of Garrett Sullivan's ceasing
to serve in such capacity in December 2001, has been triggered. We recently
negotiated a settlement of our obligations under Garrett Sullivan's
severance agreement that requires us to issue to him 7.5 million shares of
our common stock on our before August 31, 2003. The issuance of these shares
to our former executive officers and directors, and the exercise of the
re-priced options, which have been approved by our shareholders, will result
in an increase in the total number of our shares outstanding and may result
in investors in the shares being offered by this prospectus experiencing a
dilution in the net tangible book value per share of our common stock.
WE CANNOT BE CERTAIN OF FUTURE FINANCIAL RESULTS.
We incurred income from continuing operations of $29.4 million
during the six-months ended June 30, 2003, which included a loss from
continuing operations of $41.0 million, offset by a gain on the forgiveness
of debt of $70.4 million. We incurred losses from continuing operations of
$113.9 million, $198.1 million and $29.2 million for the years ended
December 31, 2002, 2001 and 2000, respectively. Our business plan depends on
our attaining and maintaining profitability; however, we cannot predict
whether we will be 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. As of June 30,
2003, we reported no revenues from the sale of our Bio Thermo, Thermo Life
and PLD products and we have had minimal sales of our Digital Angel and
VeriChip products. We can give no assurance that we will be able to achieve
profitable operations. In addition, if we fail to experience profits within
the time frame expected by investors, this could have a detrimental effect
on the market price of our common stock and there would be substantial doubt
that we would be able to continue operations in the normal course of
business.
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 $0.03. The price of our common
stock has been, and may continue to be, highly volatile and subject to wide
fluctuations in response to factors, including the following:
o Significant changes to our business resulting from
acquisitions and/or expansions into different product lines;
o quarterly fluctuations in our financial results or cash
flows;
o changes in investor perception of us or the market for our
products and services;
o changes in economic and capital market conditions for other
companies in our market sector; and
o 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
51
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 March 2003, we
settled subject to court approval a purported securities fraud class action,
which was filed against us and one of our former directors. While the class
action was tentatively settled in March 2003, additional litigation of this
type could result in substantial costs and a diversion of management's
attention and resources, which could significantly harm our business
operations and financial condition.
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.
WE CANNOT PROVIDE ASSURANCES THAT WE WILL BE ABLE TO MAINTAIN OUR
LISTING ON THE SMALLCAP.
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. Our common stock has traded on the
SmallCap since November 12, 2002, under the symbol "ADSX." Prior to November
12, 2002, our common stock traded on the Nasdaq National Market at all
times, except for the period between July 12, 2002 and July 30, 2002, when
our common stock traded on the Pink Sheets under the symbol "ADSX.PK." To
maintain our SmallCap listing, we must continue to comply with the
SmallCap's listing requirements and, prior to October 2003, regain the
minimum bid requirement of at least $1.00 per share for a minimum of ten
(10) consecutive trading days. We have included a proposal in our proxy
statement for a special meeting of shareholders being held on September 10,
2003, to solicit shareholder approval to effect a reverse stock split of all
of the issued and outstanding shares of our common stock, and granting of
discretionary authority to our Board of Directors for a period of twelve
months after the date our shareholders approve the proposal to determine the
reverse stock split ratio, not to exceed a ratio of 1-for-25, and the
effective date of the reverse stock split or to determine not to proceed
with the reverse stock split. Our Board of Directors believes that a reverse
stock split may facilitate the continued listing of our common stock on the
SmallCap and may enhance the desirability and marketability of our common
stock to the financial community and the investing public. However, we
cannot assure you that if our shareholders approve the reverse stock split
that it will be effected or if effected that it will facilitate the
continued listing of our common stock on the SmallCap.
IF WE ARE REQUIRED TO ISSUE ADDITIONAL SHARES OF COMMON STOCK IN
CONNECTION WITH PRIOR ACQUISITIONS, YOUR INVESTMENT IN OUR COMMON STOCK MAY
BE FURTHER DILUTED. IN ADDITION, WE MAY ISSUE ADDITIONAL SECURITIES, WHICH
WOULD ALSO DILUTE THE VALUE OF YOUR INVESTMENTS IN OUR COMMON STOCK.
As of August 11, 2003, there were 352,262,414 shares of our common
stock outstanding. Since January 1, 2001, we have issued a net aggregate of
250,775,713 shares of common stock, of which 97,261,634 shares were issued
in connection with acquisitions of businesses and assets, 64,810,635
52
shares were issued upon conversion of our Series C preferred stock and
50,000,000 shares were issued in connection with an offering of our common
stock on a best efforts basis through the efforts of a placement agent J.P.
Carey Securities, Inc. under the terms of a placement agency agreement. In
addition, the Debentures are convertible into shares of our common stock (or
exchangeable into the shares of common stock of Digital Angel Corporation
that we own) at the option of the Purchasers (subject in part to shareholder
approval), and we are currently planning to sell an additional 30,000,000
shares of our common stock in connection with a best efforts offering, some
or all of which may be offered through J.P. Carey Securities, Inc. We are
currently seeking shareholder approval at a special meeting of shareholders
being held on September 10, 2003, which will allow us to sell the shares
under this offering.
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 and we have agreed to future earnout and "price
protection" provisions in prior acquisition and other agreements. Such
issuances of additional securities may be dilutive to the value of our
common stock and may have a material adverse impact on the market price of
our common stock.
Certain events over which you will have no control could result in
the issuance of additional shares of our common stock or other securities,
which could dilute the value of your shares of common stock. We may issue
additional shares of common stock:
o to raise additional capital;
o upon the exercise of outstanding options and stock purchase
warrants or additional options and warrants issued in the
future;
o in connection with severance agreements;
o in connection with loans or other capital raising
transactions; and
o in connection with acquisitions of other businesses or
assets.
As of August 11, 2003, there were outstanding warrants and options
to acquire up to 30,454,289 additional shares of our common stock. If
exercised, these securities could dilute the value of the shares of common
stock. In addition, we have the authority to issue up to a total of
560,000,000 shares of common stock and up to 5,000,000 shares of preferred
stock without further shareholder approval, including shares that could be
convertible into our common stock, subject to applicable SmallCap
requirements for issuing additional shares of stock. Were we to issue any
such shares, or enter into any other financing transactions, the terms may
have the effect of significantly diluting or adversely affecting the
holdings or the rights of the holders of the 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 that 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
53
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 have a material adverse effect on
our business, financial condition or results of operations.
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. 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.
WE DEPEND ON A SINGLE PRODUCTION ARRANGEMENT WITH RAYTHEON
CORPORATION FOR OUR PATENTED SYRINGE-INJECTABLE MICROCHIPS WITHOUT THE
BENEFIT OF A FORMAL WRITTEN AGREEMENT, AND THE LOSS OF OR ANY SIGNIFICANT
REDUCTION IN THE PRODUCTION COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS.
We rely solely on a production arrangement with Raytheon
Corporation for the manufacture of our patented syringe-injectable
microchips that are used in all of our implantable electronic identification
products, but we do not have a formal written agreement with Raytheon.
Raytheon utilizes our proprietary technology and our equipment in the
production of our syringe-injectable microchips. The termination, or any
significant reduction, by Raytheon of the assembly of our microchips or a
material increase in the price charged by Raytheon for the assembly of our
microchips could have an adverse effect on our financial condition and
results of operations. In addition, Raytheon may not be able to produce
sufficient quantities of the microchips to meet any significant increased
demand for our products or to meet any such demand on a timely basis. Any
inability or unwillingness of Raytheon to meet our demand for microchips
would require us to utilize an alternative production arrangement and remove
our automated assembly production machinery from the Raytheon facility,
which would be costly and could delay production. Moreover, if Raytheon
terminates our production arrangement, we cannot ensure that the assembly of
our microchips from another source would be on comparable or acceptable
terms. The failure to make such an alternative production arrangement could
have an adverse effect on our business.
WE MAY NOT BE ABLE TO MAINTAIN COMPLIANCE WITH THE COVENANTS UNDER
THE DEBENTURES AND RELATED AGREEMENTS.
Under the terms of the Debentures and related agreements, failure
to make timely interest or principal redemption payments, commencement of
bankruptcy against us, failure of our common stock to be eligible for
quotation on or quoted for trading on a principal market as defined, and a
change in control as defined, among others, constitute events of default
under the Debentures. We cannot assure you that we will be able to maintain
compliance with these covenants. Failure to maintain compliance
54
could have a material adverse impact on our financial position, results of
operations and cash flow.
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. The Agreement entered into in connection with the Debentures places
restrictions on the declaration and payment of dividends. We intend to use
any earnings that we generate to finance our operations and to repay debt
obligations, and, 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.
WE MAY NOT PREVAIL IN ONGOING LITIGATION AND MAY BE REQUIRED TO PAY
SUBSTANTIAL DAMAGES.
In addition to the litigation described under Legal Proceedings, 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 CANNOT ENSURE THE VALIDITY OR PROTECTION OF OUR INTELLECTUAL
PROPERTY RIGHTS OR PATENT RIGHTS.
Our ability to commercialize any of our products under development
will depend, in part, on our ability to obtain patents, enforce those
patents, preserve trade secrets, and operate without infringing on the
proprietary rights of third parties. There can be no assurance that the
patent applications licensed to or owned by us will result in issued
patents, that patent protection will be secured for any particular
technology, that any patents that have been or may be issued to us will be
valid or enforceable or that any patents will provide meaningful protection
to us. Furthermore, we do not own the VeriChip technology that is produced
under patents #6,400,338 and #5,211,129. This technology is owned by Digital
Angel Corporation and licensed to VeriChip under an exclusive product and
technology license with a remaining term of approximately ten years. We
cannot provide assurances that VeriChip Corporation will retain licensing
rights to the use of these patents beyond the licensing period or that the
license will not be terminated early.
THERE CAN BE NO ASSURANCE THAT THE PATENTS OWNED AND LICENSED BY
US, OR ANY FUTURE PATENTS, WILL PREVENT OTHER COMPANIES FROM DEVELOPING
SIMILAR OR EQUIVALENT PRODUCTS.
Furthermore, there can be no assurance that any of our future
products or methods will be patentable, that such products or methods will
not infringe upon the patents of third parties, or that our patents or
future patents will give us an exclusive position in the subject matter
claimed by those patents. We may be unable to avoid infringement of third
party patents and may have to obtain a license, defend an infringement
action, or challenge the validity of the patents in court. There can be no
assurance that a license will be available to us, if at all, on terms and
conditions acceptable to us, or that we will prevail in any patent
litigation. Patent litigation is costly and time consuming, and there can be
no assurance that we will have or will devote sufficient resources to pursue
such litigation. If we do not obtain a license under such patents and if we
are found liable for infringement or if we are not able to have such patents
declared invalid, we may be liable for significant money damages, may
encounter significant delays in bringing products to market, or may be
precluded from participating in the manufacture, use, or sale of products
requiring such licenses.
55
We also rely on trade secrets and other unpatented proprietary
information in our product development activities. To the extent that we
rely on trade secrets and unpatented know-how to maintain our competitive
technological position, there can be no assurance that others may not
independently develop the same or similar technologies. We seek to protect
trade secrets and proprietary knowledge in part through confidentiality
agreements with our employees, consultants, advisors and collaborators.
Nevertheless, these agreements may not effectively prevent disclosure of our
confidential information and may not provide us with an adequate remedy in
the event of unauthorized disclosure of such information.
OUR BUSINESS IS SUBJECT TO GOVERNMENT REGULATION.
Some of our current or future products may be subject to government
regulation and, in some cases, pre-approval. By letter dated October 17,
2002, the Food and Drug Administration (the "FDA") issued a determination
that the VeriChip product is not a medical device under Section 513(g) of
the Federal Food, Drug and Cosmetic Act with respect to the intended
security, financial and personal identification/safety applications.
However, the FDA further stated in its determination letter that with
respect to the use of the VeriChip product in health information
applications, VeriChip is a medical device subject to the FDA's
jurisdiction. On November 8, 2002, we received a letter from the FDA, based
upon correspondence from us to the FDA, warning us not to market VeriChip
for medical applications. While we currently intend to market and distribute
the VeriChip product for security, financial and personal
identification/safety applications, in the future, we plan to expand our
marketing and distribution efforts to health information applications of the
product, subject to any and all necessary FDA and other approvals. We are
currently in the process of preparing a 510-K application to obtain FDA
approval to market VeriChip for certain health information applications. We
intend to submit the 510-K application to the FDA within the next several
months. There can be no assurances that the required FDA regulatory reviews
will be conducted in a timely manner or that regulatory approvals will be
obtained. Our future failure to comply with the applicable regulatory
requirements can, among other things, result in fines, suspensions of
regulatory approvals, product recalls, operating restrictions and criminal
prosecution, any of which could have a material adverse effect on us.
Digital Angel Corporation is subject to federal, state and local
regulation in the United States and other countries, and it cannot predict
the extent to which it may be affected by future legislative and other
regulatory developments concerning its products and markets. Digital Angel
Corporation develops, assembles and markets a broad line of electronic and
visual identification devices for the companion animal, livestock and
wildlife markets. Digital Angel Corporation's readers must and do comply
with the FCC Part 15 Regulations for Electromagnetic Emissions, and the
insecticide products purchased and resold by Digital Angel Corporation have
been approved by the U.S. Environmental Protection Agency (EPA) and are
produced under EPA regulations. Sales of insecticide products are incidental
to Digital Angel Corporation's primary business and do not represent a
material part of its operations or revenues. Digital Angel Corporation's
products also are subject to compliance with foreign government agency
requirements. Digital Angel Corporation's contracts with its distributors
generally require the distributor to obtain all necessary regulatory
approvals from the governments of the countries into which they sell Digital
Angel Corporation's products. However, any such approval may be subject to
significant delays. Some regulators also have the authority to revoke
approval of previously approved products for cause, to request recalls of
products and to close manufacturing plants in response to violations. Any
actions by these regulators could materially adversely affect Digital Angel
Corporation's business.
WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS FROM THE USE OF OUR
PRODUCTS.
Manufacturing, marketing, selling, and testing our products under
development entails a risk of
56
product liability. We could be subject to product liability claims in the
event our products or products under development fail to perform as
intended. Even unsuccessful claims could result in the expenditure of funds
in litigation and the diversion of management time and resources and could
damage our reputation and impair the marketability of our products. While we
maintain liability insurance, there can be no assurance that a successful
claim could not be made against us, that the amount of indemnification
payments or insurance would be adequate to cover the costs of defending
against or paying such a claim, or that damages payable by us would not have
a material adverse effect on our business, financial condition, and results
of operations and on the price of our common stock.
THE THERMO LIFE AND PLD TECHNOLOGIES HAVE NOT YET BEEN DEVELOPED
FOR COMMERCIAL DEPLOYMENT.
The Thermo Life and PLD technologies have been successfully tested
in the laboratory. Our ability to develop and commercialize products based
on these proprietary technologies will depend on our ability to develop our
products internally on a timely basis. No assurances can be given as to when
or if the Thermo Life and PLD technologies will be successfully marketed.
OUR SUCCESS DEPENDS ON OUR ABILITY TO SELL INCREASING QUANTITIES OF
OUR PRODUCTS.
Our success currently depends primarily upon our ability to
successfully market and sell increasing quantities of our products. Our
ability to successfully sell increasing quantities of our products will
depend significantly on increased market acceptance of our products. Our
failure to sell our products would have a material adverse effect on us.
Unfavorable publicity concerning our products or technology also could have
an adverse effect on our ability to obtain regulatory approvals and to
achieve acceptance by intended users any of which would have a material
adverse effect on us.
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 worsened 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
quarters of 2001, which resulted in a decrease in our revenues during 2002.
Also, letters of intent that we had received during the last half of 2001
and the first and second quarters 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. In addition, based upon our annual
goodwill impairment review performed during the fourth quarter of 2002, we
impaired certain goodwill and software related to Digital Angel Corporation.
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.
57
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Digital Angel Corporation has a foreign subsidiary operating in the
United Kingdom. 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
Debentures and Digital Angel Corporations borrowing under its credit
agreement with Wells Fargo bear interest at fixed rates. 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.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
The Company's Chief Executive Officer and Chief Financial Officer
have reviewed and evaluated the effectiveness of the Company's disclosure
controls and procedures (as defined in Exchange Act Rules 240.13a - 15(e)
and 15d - 15(e)) as of the end of the quarter. Based on that evaluation,
they have concluded that the Company's current disclosure controls and
procedures are effective in timely providing them with material information
relating to the Company required to be disclosed in the reports the Company
files or submits under the Exchange Act. It should be noted that the design
of any system of controls is based in part upon certain assumptions about
the likelihood of future events and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future
conditions, regardless of how remote.
(b) Changes in Internal Controls
There have not been any significant changes in the Company's
internal controls or in other factors that could significantly affect these
controls subsequent to August 13, 2003, the date of evaluation. There were
no significant deficiencies or material weaknesses, and therefore no
corrective actions were taken.
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 our financial statements as of June 30, 2003. 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 January 31, 2002, Treeline, Inc. filed a complaint in the Common
Pleas Court of Cuyahoga County, Ohio against us, and one of our
subsidiaries, STR, Inc., now known as ARJANG, Inc. ("STR") and another
defendant who was formerly an executive of STR, alleging that STR breached
its lease
58
agreement with Treeline, Inc. in connection with a facility no longer being
used by us. On May 15, 2003, we settled the dispute with Treeline, Inc.,
subject to certain conditions subsequent. The settlement provided for the
issuance of 1.1 million shares of our common stock.
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 we vacated prior to the expiration of the lease
and which is no longer in use. The trial date, which was reset for July
2003, has been postponed and has not yet been rescheduled.
In May 2002, a purported securities fraud class action was filed
against us and one of our former directors. In the following weeks, fourteen
virtually identical complaints were consolidated into a single action, In re
Applied Digital Solutions Litigation, which was filed in the United States
District Court for the Southern District of Florida. In March 2003, we
entered into a memorandum of understanding to settle the pending lawsuit.
The settlement of $5.6 million will be entirely covered by proceeds from
insurance, and is subject to approval by the District Court and review by an
independent special litigation committee.
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 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 terms of the insurance policy,
defrauded Plaintiffs, acted in bad faith, and 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 outsources its travel assistance services
to Medical Advisory Systems. CSA filed a cross-claim against Digital Angel
Corporation alleging that Digital Angel Corporation 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 the action. Digital Angel Corporation
filed motions for summary judgment/adjudication, which were heard by the
Court on June 10, 2003. The motions for summary adjudication or Plaintiffs'
causes of action for fraud, insurance, bad faith and unlawful business
practices were granted. Digital Angel Corporation's motion for summary
adjudication of Plaintiffs' cause of action for breach of insurance contract
also was granted. However, the Court gave the Plaintiffs permission to amend
their complaint on or before June 13, 2003 with respect to this cause of
action. Digital Angel Corporation's motion for summary adjudication of
plaintiffs' cause of action for intentional infliction of emotional distress
was taken under submission. Its motions for summary adjudication of
plaintiffs' cause of action for wrongful death and prayer for punitive
damages were denied, but the Plaintiffs agreed that the punitive damages
claim applied only to their cause of action for intentional infliction of
emotional distress. Therefore, if the Court grants Digital Angel
Corporation's motion for summary adjudication of this cause of action, the
punitive damage claim should be stricken in its entirety. The Court has set
a Mandatory Settlement Conference for August 20, 2003 and has set the case
for trial on August 25, 2003 in the Santa Clara County Superior Court.
Digital Angel Corporation believes this lawsuit is defensible, and it
intends to defend this matter vigorously. However, if there is an
unfavorable outcome of this matter, Digital Angel Corporation believes that
its exposure could be in excess of what it has been advised to be the
applicable limits of insurance.
59
ITEM 2. CHANGES IN SECURITIES
Recent Sales of Unregistered Securities
The following table lists all unregistered securities sold by the
Company between April 1, 2003 and June 30, 2003. These shares were issued
for services or settlement of legal disputes. 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.
AGGREGATE AMOUNT NUMBER OF NUMBER OF
NAME/ENTITY/NATURE DATE OF SALE OF CONSIDERATION PERSONS NOTE ISSUED FOR COMMON SHARES
==========================================================================================================================
Ronald Kaplan April 2003 $ 90,870 1 1 Settlement 233,000
Ovations International, Inc. May 2003 35,950 1 2 Services 81,415
Sherri Sheerr May 2003 44,212 1 3 Settlement 112,500
Peter Ciofani May - June 2003 25,000 1 4 Settlement 62,500
Treeline, Inc. June 2003 484,000 1 5 Settlement 1,100,000
Robert Munson June 2003 25,000 1 6 Settlement 62,500
---------------
Total 1,651,915
===============
1. Represents shares issued in connection with the settlement of a
dispute between Mr. Kaplan 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.
2. Represents shares issued in connection with consulting services
provided, 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 much 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. Matthew Cossolotto, President, has sole
voting and dispositive power with respect to the shares held by
Ovations International, Inc.
3. Represents shares issued in connection with the settlement of a
dispute between Ms. Sheerr 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.
4. Represents shares issued in connection with the settlement of a
dispute between Mr. Ciofani 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.
5. Represents shares issued in connection with the settlement of a
dispute between Treeline, Inc. 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. Parviz Boudjeh, President, has
sole voting and dispositive power with respect to the shares held
by Treeline, Inc.
6. Represents shares issued in connection with the settlement of a
dispute between Mr. Munson 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
Under the terms of the IBM Credit Agreement we were required to
repay IBM Credit $29.8 million of the $77.2 million outstanding principal
balance currently owed to them, plus $16.4 million of accrued interest and
expenses (totaling approximately $46.2 million), on or before February 28,
2003. We did not make such payment by February 28, 2003. On March 3, 2003,
IBM Credit notified us that we had until March 6, 2003, to make the payment.
We did not make the payment on March 6, 2003, as required. Our failure to
comply with the payment terms imposed by the IBM Credit Agreement and to
60
maintain compliance with the financial performance covenant constituted
events of default under the IBM Credit Agreement. On March 7, 2003, we
received a letter from IBM Credit declaring the loan in default and
indicating that IBM Credit would exercise any and/or all of its remedies.
Effective April 1, 2003, we entered into a Forbearance Agreement
with IBM Credit. Under the terms of the Forbearance Agreement, we had the
right to purchase all of our outstanding debt obligations to IBM Credit,
totaling approximately $100.4 million (including accrued interest), if we
paid IBM Credit $30.0 million in cash by June 30, 2003. As of June 30, 2003,
we made cash payments to IBM Credit totaling $30.0 million and, thus, we
have satisfied in full our debt obligations to IBM Credit.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
An annual meeting of our shareholders was held on July 25, 2003 to:
(1) Elect one director to hold office until the 2006 annual meeting
of shareholders and until her successor has been elected or appointed, to
ratify the appointment of one director to hold office until the 2004 annual
meeting of the shareholders and until his successor is elected and qualified
and to ratify the appointment of one director to hold office until the 2005
annual meeting of the shareholders and until his successor is elected and
qualified. Other directors whose term of office continued after the meeting
include Scott R. Silverman and Daniel E. Penni. The results of the vote to
elect one director and to ratify the appointment of two directors were as
follows:
NAME OF DIRECTOR FOR WITHHELD
Constance K. Weaver, nominee 300,667,883 3,979,557
Michael S. Zarriello, appointee 301,146,297 3,501,143
Dennis G. Rawan, appointee 301,219,923 3,427,517
(2) Ratify Eisner LLP as independent auditors of the Company for
the year ending December 31, 2003. The proposal received 301,671,803 votes
for, 2,187,032 votes against, and 788,605 abstentions;
(3) Approve a proposal to change the Company's state of
incorporation from Missouri to Florida through the merger of the Company
into a newly-formed, wholly-owned Florida subsidiary. The proposal received
43,790,291 votes for, 5,275,088 votes against, and 968,676 abstentions;
(4) Approve and adopt the Company's 2003 Flexible Stock Plan. The
proposal received 35,329,919 votes for, 13,052,644 votes against and
1,651,492 abstentions;
(5) Ratify options granted in 2002 under certain of the Company's
stock plans. The proposal received 289,051,082 votes for, 13,750,300 votes
against and 1,846,057 abstentions;
(6) Approve the issuance of the Company's common stock and to
ratify the re-pricing of stock options under the severance agreement entered
into with Richard J. Sullivan. The proposal received 32,929,180 votes for,
14,657,424 votes against and 2,447,451 abstentions;
(7) Approve of the issuance of the Company's common stock and to
ratify the re-pricing of stock options under the severance agreement entered
into with Jerome C. Artigliere. The proposal received 34,035,509 votes for,
13,996,458 votes against and 2,002,088 abstentions;
(8) Approve the issuance of the Company's common stock under
agreements entered into with Garrett Sullivan (no relation to Richard J.
Sullivan). The proposal received 35,252,980 votes for, 13,134,253 votes
against and 1,646,822 abstentions; and
(9) Approve an amendment to the Company's Third Restated Articles
of Incorporation, as amended, to increase the number of authorized shares of
common stock from 435,000,000 to 560,000,000 shares. The proposal
61
received 291,633,096 votes for, 12,125,753 votes against and 888,590
abstentions.
All of the proposals were approved except for Item 3, which did not
receive two-thirds of the votes as required by Missouri law for that item.
ITEM 5. OTHER INFORMATION
None
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 3, 2003, we filed a Current Report on Form
8-K, which contained our earning release dated April 1,
2003.
(ii) On May 15, 2003, we filed a Current Report on Form
8-K, which contained our earning release dated May 15,
2003.
(iii) On June 30, 2003, we filed a Current Report on Form
8-K, which contained our press release dated June 30,
2003, announcing a $30 million payment to IBM Credit LLC
in satisfaction of all outstanding debt obligations to IBM
Credit LLC.
(iv) On July 9, 2003, we filed a Current Report on Form
8-K announcing the fulfillment of all obligations to IBM
Credit LLC, the Securities Purchase Agreement and the
issuance of our $10.5 Million Aggregate Principal Amount
of 8.5% Convertible Exchangeable Debentures and Warrants.
62
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, 2003 By: /S/ EVAN C. MCKEOWN
-----------------------------------------
Evan C. McKeown
Senior Vice President, Chief
Financial Officer
63
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
2.1 Agreement of Purchase and Sale dated as of June 4, 1999 by and
among Intellesale.com, Inc., Applied Cellular Technology, Inc.,
David Romano and Eric Limont (incorporated by reference to Exhibit
99.1 to the registrant's Current Report on Form 8-K filed with the
Commission on June 11, 1999, as amended on August 12, 1999)
2.2 Amendment No. 1 to the Agreement of Purchase and Sale, dated as of
June 9, 1999 by and among Intellesale.com, Inc., Applied Cellular
Technology, Inc., David Romano and Eric Limont (incorporated by
reference to Exhibit 99.2 to the registrant's Current Report on
Form 8-K filed with the Commission on June 11, 1999, as amended on
August 12, 1999)
2.3 Agreement and Plan of Merger, dated April 24, 2000, by and among
the Applied Digital Solutions, Inc., Digital Angel Corporation and
Destron Fearing Corporation (incorporated by reference to Exhibit
2.1 to the registrant's Current Report on Form 8-K filed with the
Commission on May 1, 2000)
2.4 Agreement dated as of November 28, 1999 by and between AT&T Canada
Corp. and TigerTel, Inc. (incorporated by reference to Exhibit 99.1
to the registrant's Current Report on Form 8-K filed with the
Commission on December 13, 1999, as amended on December 22, 1999
and January 11, 2000)
2.5 Agreement and Plan of Merger dated as of June 30, 2000 by and among
the Applied Digital Solutions, Inc. and Compec Acquisition Corp.
and Computer Equity Corporation and John G. Ballenger, Christopher
J. Ballenger and Frederick M. Henschel (incorporated by reference
to Exhibit 2 to the registrant's Current Report on Form 8-K filed
with the Commission on July 14, 2000, as amended on September 11,
2000)
2.6 Agreement and Plan of Merger dated as of October 18, 2000, by and
among the Applied Digital Solutions, Inc. and PDS Acquisition
Corp., and Pacific Decision Sciences Corporation, and H&K Vasa
Family 1999 Limited Partnership, H&K Vasa Family 2000 Limited
Partnership, David Dorret, and David Englund (incorporated by
reference to Exhibit 2 to the registrant's Current Report on Form
8-K filed with the Commission on November 1, 2000, as amended on
December 29, 2000)
2.7 MCY Agreement dated as of October 19, 2000 by and between MCY.com,
Inc. and Applied Digital Solutions, Inc. (incorporated by reference
to Exhibit 2 to the registrant's Current Report on Form 8-K filed
with the Commission on December 5, 2000)
3.1 Amended and Restated Bylaws of the Company dated March 31, 1998
(incorporated by reference to Exhibit 3.4 to the registrant's
Quarterly Report on Form 10-Q for the Quarter Ended June 30, 2002
filed with the Commission on August 14, 2002)
3.2 Amendment to Bylaws of the Company dated April 4, 2002
(incorporated by reference to Exhibit 3.4 to the registrant's
Quarterly Report on Form 10-Q for the Quarter Ended June 30, 2002
filed with the Commission on August 14, 2002)
3.3 Second Restated Articles of Incorporation of the Registrant
(incorporated herein by reference to Exhibit 4.1 to the
registrant's Post-Effective Amendment No. 1 on Form S-1 to
Registration Statement (Form S-3 File No. 333-64605) filed with the
Commission on June 24, 1999)
3.4 Amendment of Articles of Incorporation of the Registrant 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
Registrant'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)
3.5 Amendment of Second Restated Articles of Incorporation of the
Registrant filed with the Secretary of State of Missouri on July
18, 2001 (incorporated herein by reference to Exhibit 4.3 to the
Registrant's Quarterly Report on Form 10-Q filed with the
Commission on August 17, 2001)
4.1 Second Restated Articles of Incorporation, of the Registrant
(incorporated herein by reference to Exhibit 4.1 to
64
the registrant's Post-Effective Amendment No. 1 on Form S-1 to
Registration Statement (Form S-3 File No. 333-64605) filed with the
Commission on June 24, 1999)
4.2 Amendment of Articles of Incorporation of the Registrant 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
registrant'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)
4.3 Amendment of Second Restated Articles of Incorporation of the
Registrant filed with the Secretary of State of Missouri on July
18, 2001 (incorporated herein by reference to Exhibit 4.3 to the
registrant's Quarterly Report on Form 10-Q filed with the
Commission on August 17, 2001)
4.4 Third Restated Articles of Incorporation of the Registrant filed
with the Secretary of State of Missouri on December 20, 2002
(incorporated by reference to Exhibit 4.4 to the registrant's
Pre-Effective Amendment No. 1 to Registration Statement on Form S-1
(File No. 333-102165) filed with the Commission on February 6,
2003)
4.5 Certificate of Designation of Preferences of Series C Convertible
Preferred Stock (incorporated herein by reference to Exhibit 3.1 to
the registrant's Current Report on Form 8-K filed with the
Commission on October 26, 2000)
4.6 Amended and Restated Bylaws of the Registrant dated March 31, 1998
(incorporated by reference to Exhibit 3.4 to the registrant's
Quarterly Report on Form 10-Q for the Quarter Ended June 30, 2002
filed with the Commission on August 14, 2002)
4.7 Amended and Restated Bylaws of the Registrant dated March 31, 1998
(incorporated by reference to Exhibit 4.7 to the registrant's
Post-Effective Amendment No. 1 to Registration Statement on Form
S-1 (File No. 333-102165) filed with the Commission on April 11,
2003)
10.1 1996 Non-Qualified Stock Option Plan of Applied Cellular
Technology, Inc., as amended through June 13, 1998 (incorporated
herein by reference to Exhibit 4.1 to the registrant's Registration
Statement on Form S-8 (File No. 333-91999) filed with the
Commission on December 2, 1999)
10.2 Applied Digital Solutions, Inc. 1999 Employees Stock Purchase Plan,
as amended through September 23, 1999 (incorporated herein by
reference to Exhibit 10.1 to the registrant's Registration
Statement on Form S-8 (File No. 333-88421) filed with the
Commission on October 4, 1999)
10.3 Applied Digital Solutions, Inc. 1999 Flexible Stock Plan
(incorporated herein by reference to Exhibit 4.1 to the
registrant's Registration Statement on Form S-8 (File No.
333-92327) filed with the Commission on December 8, 1999)
10.4 Credit Agreement between Applied Digital Solutions, Inc. and State
Street Bank and Trust Company dated as of August 25, 1998
(incorporated herein by reference to Exhibit 10.2 to the
registrant's Quarterly Report on Form 10-Q filed with the
Commission on November 16, 1998)
10.5 First Amendment to Credit Agreement between Applied Digital
Solutions, Inc. and State Street Bank and Trust Company dated as of
February 4, 1999 (incorporated by reference to Exhibit 10.3 the
registrant's Annual Report on Form 10-K filed with the Commission
on March 31, 1999)
10.6 Richard J. Sullivan Employment Agreement (incorporated by reference
to Exhibit 10.8 to the registrant's Annual Report on Form 10-K
filed with the Commission on March 30, 2000)
10.7 Garrett A. Sullivan Employment Agreement (incorporated by reference
to Exhibit 10.9 to the registrant's Annual Report on Form 10-K
filed with the Commission on March 30, 2000)
10.8 Letter Agreement, dated December 30, 2001, between Applied Digital
Solutions, Inc. and Garrett A. Sullivan (incorporated by reference
to Exhibit 10.13 to the registrant's Amendment to the Registration
Statement on Form S-1 (File No. 333-75928) filed with the
Commission on February 8, 2002)
65
10.9 Jerome C. Artigliere Employment Agreement (incorporated by
reference to Exhibit 10.11 to the registrant's Annual Report on
Form 10-K filed with the Commission on April 10, 2001)
10.10 Mercedes Walton Employment Agreement (incorporated by reference to
Exhibit 10.12 to the registrant's Annual Report on Form 10-K filed
with the Commission on April 10, 2001)
10.11 David I. Beckett Employment Agreement (incorporated by reference to
Exhibit 10.13 to the registrant's Annual Report on Form 10-K filed
with the Commission on April 10, 2001)
10.12 Michael E. Krawitz Employment Agreement (incorporated by reference
to Exhibit 10.14 to the registrant's Annual Report on Form 10-K
filed with the Commission on April 10, 2001)
10.13 Dr. Peter Zhou Employment Agreement (incorporated by reference to
Exhibit 10.19 to the registrant's Amendment to the Registration
Statement on Form S-1 (File No. 333-75928) filed with the
Commission on February 8, 2002)
10.14 Securities Purchase Agreement, dated as of October 24, 2000,
relating to the Registrant's Series C Convertible Preferred Stock
(incorporated by reference to Exhibit 10.1 to the registrant's
Current Report on Form 8-K filed with the Commission on October 26,
2000)
10.15 Form of warrant to purchase common stock of the Registrant issued
to the holders of the Series C Convertible Preferred Stock
(incorporated by reference to Exhibit 4.1 to the registrant's
Current Report on Form 8-K filed with the Commission on October 26,
2000)
10.16 Registration Rights Agreement between the Registrant and the
holders of the Series C Convertible Preferred Stock (incorporated
by reference to Exhibit 10.2 to the registrant's Current Report on
Form 8-K filed with the Commission on October 26, 2000)
10.17 Lock-Up Agreement dated as of November 28, 1999 by and among AT&T
Canada Corp. and Applied Digital Solutions, Inc. (incorporated by
reference to the Exhibit 99.2 to the registrant's Current Report on
Form 8-K filed with the Commission on December 13, 1999, as amended
on December 22, 1999 and January 11, 2000)
10.18 Voting Agreement by and among Applied Digital Solutions, Inc. and
certain security holders of Destron Fearing Corporation
(incorporated by reference to Exhibit 10.1 to the registrant's
Current Report on Form 8-K filed with the Commission on May 1,
2000)
10.19 Third Amended and Restated Term Credit Agreement dated March 1,
2002 among Applied Digital Solutions, Inc., Digital Angel Share
Trust and IBM Credit Corporation (incorporated by reference to
Exhibit 10.2 to the registrant's Current Report on Form 8-K filed
with the Commission on March 8, 2002)
10.20 Waiver Agreement from IBM Credit Corporation, waiving existing
defaults under the Third Amended and Restated Term Credit Agreement
as of June 30, 2002 (incorporated herein by reference to Exhibit
10.20 to the registrant's Registration Statement on Form S-1 (File
No. 333-98799) filed with the Commission on August 27, 2002)
10.21 Amendment to The Third Amended and Restated Term Credit Agreement
dated as of September 30, 2002, amending certain financial
covenants under the Third Amended and Restated Term Credit
Agreement (incorporated herein by reference to Exhibit 10.21 to the
registrant's Post-Effective Amendment No. 1 to Registration
Statement on Form S-1 (File No. 333-98799) filed with the
Commission on November 5, 2002)
10.22 Amendment to The Third Amended and Restated Term Credit Agreement
dated as of November 1, 2002, amending certain financial covenants
under the Third Amended and Restated Term Credit Agreement
(incorporated herein by reference to Exhibit 10.22 to the
registrant's Post-Effective Amendment No. 1 to Registration
Statement on Form S-1 (File No. 333-98799) filed with the
Commission on November 5, 2002)
10.23 Warrant Agreement between Applied Digital Solutions, Inc. and IBM
Credit Corporation dated August 21, 2002 (incorporated herein by
reference to Exhibit 10.21 to the registrant's Registration
Statement on Form S-1 (File No. 333-98799) filed with the
Commission on August 27, 2002)
10.24 Warrant Agreement between VeriChip Corporation and IBM Credit
Corporation dated August 21, 2002
66
(incorporated herein by reference to Exhibit 10.22 to the registrant's
Registration Statement on Form S-1 (File No. 333-98799) filed with
the Commission on August 27, 2002)
10.25 Agreement of Settlement and Release by and between Applied Digital
Solutions, Inc. and John G. Ballenger, Christopher J. Ballenger and
Frederick M. Henschel, dated July 17, 2002 (incorporated herein by
reference to Exhibit 10.23 to the registrant's Registration
Statement on Form S-1 (File No. 333-98799) filed with the Commission
on August 27, 2002)
10.26 Amendment to Agreement of Settlement and Release by and between
Applied Digital Solutions, Inc. and John G. Ballenger, Christopher
J. Ballenger and Frederick M. Henschel, dated August 23, 2002
(incorporated herein by reference to Exhibit 10.24 to the
registrant's Registration Statement on Form S-1 (File No.
333-98799) filed with the Commission on August 27, 2002)
10.27 Summary of Terms and Conditions setting forth the terms and
conditions of the Forbearance Agreement among IBM Credit LLC,
Applied Digital Solutions, Inc., Digital Angel Share Trust, and
their applicable subsidiaries (if any) dated March 24, 2003
(incorporated herein by reference to Exhibit 10.2 to the
registrant's Current Report on Form 8-K filed with the Commission
on March 27, 2002)
10.28 Forbearance Agreement, Consent and Amendment, dated as of April 2,
2003, with respect to the Third Amended and Restated Credit
Agreement, dated as of March 1, 2002 and amended as of September
30, 2002 and November 1, 2002 (as amended, supplemented, restated
or otherwise modified through the date hereof, the "Credit
Agreement"), among IBM Credit LLC, a Delaware limited liability
company, formerly IBM Credit Corporation ("IBM Credit"), Applied
Digital Solutions, Inc., a Missouri corporation ("ADS" or the
"Tranche B Borrower"), Digital Angel Share Trust, a Delaware
statutory business trust (in such capacity, the "Trust"; in its
capacity as a Borrower, the "Tranche A Borrower"; and together with
the Tranche B Borrower, the "Borrowers") and the other Loan Parties
party thereto (incorporated herein by reference to Exhibit 10.27 to
the registrant's Post-Effective Amendment No. 1 to Registration
Statement on Form S-1 (File No. 333-102165) filed with the
Commission on April 11, 2003)
10.29 Letter Agreement between Applied Digital Solutions, Inc. and R.J.
Sullivan dated March 24, 2003 (incorporated herein by reference to
Exhibit 10.3 to the registrant's Current Report on Form 8-K filed
with the Commission on March 27, 2003)
10.30 Letter Agreement between Applied Digital Solutions, Inc. and J.C.
Artigliere dated March 24, 2003 (incorporated herein by reference
to Exhibit 10.29 to the registrant's Annual Report on Form 10-K
filed with the Commission on March 31, 2003)
10.31 Placement Agency Agreement by and between Applied Digital
Solutions, Inc. and J.P. Carey Securities Inc.(incorporated herein
by reference to Exhibit 10.31 to the registrant's Post-Effective
Amendment No. 2 to Registration Statement on Form S-1 (File No.
333-102165) filed with the Commission on April 17, 2003)
10.32 Securities Purchase Agreement among Applied Digital Solutions, Inc.
and the Purchasers, dated June 30, 2003 (incorporated herein by
reference to Exhibit 10.1 to the registrant's Current Report on
Form 8-K filed with the Commission on July 9, 2003)
10.33 Form of 8.5% Convertible Exchangeable Debentures Due November 1,
2005, between Applied Digital Solutions, Inc. and each of the
Purchasers (incorporated herein by reference to Exhibit 10.2 to the
registrant's Current Report on Form 8-K filed with the Commission
on July 9, 2003)
10.34 Stock Purchase Warrant (incorporated herein by reference to Exhibit
10.3 to the registrant's Current Report on Form 8-K filed with the
Commission on July 9, 2003)
10.35 Amend and Restated Trust Agreement dated June 30, 2003, between
Wilmington Trust Company and Applied Digital Solutions, Inc.
(incorporated herein by reference to Exhibit 10.4 to the
registrant's Current Report on Form 8-K filed with the Commission
on July 9, 2003)
10.36 Security Agreement among Applied Digital Solutions, Inc., Computer
Equity Corporation and the Secured
67
Parties (incorporated herein by reference to Exhibit 10.5 to the
registrant's Current Report on Form 8-K filed with the Commission
on July 9, 2003)
10.37 Pledge Agreement made by Applied Digital Solution, Inc. in favor of
the investors (incorporated herein by reference to Exhibit 10.6 to
the registrant's Current Report on Form 8-K filed with the
Commission on July 9, 2003)
10.38 Registration Rights Agreement among Applied Digital Solutions, Inc.
and the Purchasers (incorporated herein by reference to Exhibit
10.7 to the registrant's Current Report on Form 8-K filed with the
Commission on July 9, 2003)
31.1 Certification by Scott R. Silverman, Chief Executive Officer,
pursuant to Exchange Act Rules 13A-14(a) and 15d-14(a)
31.2 Certification by Evan C. McKeown, Chief Financial Officer, pursuant
to Exchange Act Rules 13A-14(a) and 15d-14(a)
32.1 Certification by Scott R. Silverman, Chief Executive Officer,
pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
32.2 Certification by Evan C. McKeown, Chief Financial Officer, pursuant
to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
68