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As Filed with the Securities and Exchange Commission on November 14, 2003
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
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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 September 30, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from to
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COMMISSION FILE NUMBER: 0-26020
APPLIED DIGITAL SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
MISSOURI 43-1641533
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
400 ROYAL PALM WAY, SUITE 410
PALM BEACH, FLORIDA 33480
(561) 805-8000
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes /X/ No / /
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 November 12, 2003:
Class Number of Shares
Common Stock; $.001 Par Value 406,491,500
APPLIED DIGITAL SOLUTIONS, INC.
TABLE OF CONTENTS
Item Description Page
PART I - FINANCIAL INFORMATION
1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets
September 30, 2003 and December 31, 2002 3
Condensed Consolidated Statements of Operations -
Three and Nine-Months Ended September 30, 2003 and 2002 4
Condensed Consolidated Statement of Stockholders' Equity -
Nine Months-Ended September 30, 2003 5
Condensed Consolidated Statements of Cash Flows -
Nine Months-Ended September 30, 2003 and 2002 6
Notes to Consolidated Financial Statements 7
2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 27
3. Quantitative and Qualitative Disclosures About Market Risk 57
4. Controls and Procedures 57
PART II - OTHER INFORMATION
1. Legal Proceedings 57
2. Changes In Securities 58
3. Defaults Upon Senior Securities 58
4. Submission of Matters to a Vote of Security Holders 59
5. Other Information 59
6. Exhibits and Reports on Form 8-K 59
SIGNATURE 61
EXHIBITS 62
2
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
ASSETS
SEPTEMBER 30, December 31,
2003 2002
--------------------------------
(UNAUDITED)
CURRENT ASSETS
Cash and cash equivalents $ 5,271 $ 5,818
Accounts receivable and unbilled receivables (net of allowance
for doubtful accounts of $748 in 2003 and $1,263 in 2002) 15,102 16,548
Inventories 9,780 6,409
Notes receivable 1,446 2,801
Other current assets 1,876 2,920
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TOTAL CURRENT ASSETS 33,475 34,496
PROPERTY AND EQUIPMENT, NET 9,379 9,822
NOTES RECEIVABLE, NET 530 758
GOODWILL, NET 68,246 67,818
OTHER ASSETS, NET 4,973 4,339
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$ 116,603 $ 117,233
================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Notes payable and current maturities of long-term debt $ 8,789 $ 81,879
Accounts payable 12,631 9,761
Accrued interest 72 10,149
Accrued bonuses 4,264 -
Other accrued expenses 20,175 19,145
Put accrual 200 200
Net liabilities of Discontinued Operations 9,648 9,368
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TOTAL CURRENT LIABILITIES 55,779 130,502
LONG-TERM DEBT AND NOTES PAYABLE 6,305 3,346
OTHER LONG-TERM LIABILITIES 16,970 1,055
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TOTAL LIABILITIES 79,054 134,903
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COMMITMENTS AND CONTINGENCIES - -
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MINORITY INTEREST 17,897 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 560,000 shares in 2003 and 435,000 shares in 2002,
of $.001 par value; 365,370 shares issued and 364,435 shares outstanding
in 2003 and 285,069 shares issued and 284,134 shares outstanding in 2002 365 285
Common and preferred additional paid-in capital 404,873 377,621
Accumulated deficit (388,800) (417,066)
Common stock warrants 5,650 5,650
Treasury stock (carried at cost, 935 shares in 2003 and 2002) (1,777) (1,777)
Accumulated other comprehensive income 157 31
Notes received from shares issued (816) (836)
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Total Stockholders' Equity (Deficit) 19,652 (36,092)
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$ 116,603 $ 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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
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2003 2002 2003 2002
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Product revenue $ 18,747 $ 19,665 $ 57,164 $ 63,811
Service revenue 5,055 4,505 12,633 14,589
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Total revenue 23,802 24,170 69,797 78,400
Cost of products sold 14,968 13,233 42,212 44,581
Cost of services sold 1,562 1,935 5,132 6,536
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Gross profit 7,272 9,002 22,453 27,283
Selling, general and administrative expense 5,075 7,430 47,005 54,635
Research and development 1,839 876 4,464 2,474
Depreciation and amortization 588 1,257 1,824 3,747
Asset impairment - - - 784
Interest and other income (236) (735) (674) (1,388)
(Gain) loss on forgiveness of debt 424 - (69,968) -
Interest expense 1,863 5,782 11,066 12,574
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(Loss) income from continuing operations before taxes,
minority interest, net (gain) loss on subsidiary stock issuances (2,281) (5,608) 28,736 (45,543)
and merger transaction, and equity in net loss of affiliate
(Benefit) provision for income taxes (17) 105 758 200
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(Loss)income from continuing operations before minority interest, net
(gain) loss on subsidiary stock issuances and merger transaction,
and equity in net loss of affiliate (2,264) (5,713) 27,978 (45,743)
Minority interest (737) (324) (1,681) (762)
Net (gain) loss on subsidiary stock issuances and merger transaction (268) 362 901 4,644
Equity in net loss of affiliate - - - 291
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(Loss) income from continuing operations (1,259) (5,751) 28,758 (49,916)
Change in estimate on loss on disposal of discontinued operations
and operating losses during the phase out period 99 (119) (492) 105
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Net (loss) income $ (1,160) $ (5,870) $ 28,266 $(49,811)
=================================================================================================================================
(Loss) income per common share - basic
(Loss) income from continuing operations $ - $ (0.02) $ 0.09 $ (0.19)
(Loss) income from discontinued operations - - - -
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Net (loss) income per common share - basic $ - $ (0.02) $ 0.09 $ (0.19)
=================================================================================================================================
(Loss) income per common share - diluted
(Loss) income from continuing operations $ - $ (0.02) $ 0.09 $ (0.19)
(Loss) income from discontinued operations - - - -
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Net (loss) income per common share - diluted $ - $ (0.02) $ 0.09 $ (0.19)
=================================================================================================================================
Weighted average number of common shares outstanding - basic 353,558 274,934 315,380 265,001
Weighted average number of common shares outstanding - diluted 382,354 274,934 334,625 265,001
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 NINE MONTHS ENDED SEPTEMBER 30, 2003
(In Thousands)
(Unaudited)
PREFERRED STOCK COMMON STOCK ADDITIONAL
------------------ ------------------- PAID-IN ACCUMULATED
NUMBER AMOUNT NUMBER AMOUNT CAPITAL DEFICIT
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BALANCE - DECEMBER 31, 2002 - $ - 285,069 $ 285 $ 377,621 $ (417,066)
Net income - - - - - 28,266
Comprehensive income -
Foreign currency translation - - - - - -
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Total comprehensive income - - - - - 28,266
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Adjustment to allowance for uncollectible
portion of notes receivable - - - - - -
Stock option repricing - - - - (1,495) -
Stock options - VeriChip Corporation - - - - 188 -
Issuance of Digital Angel Corporation warrants - - - - 1,055 -
Issuance of common shares - - 71,117 71 20,081 -
Liability to be settled in common stock - - - - 3,518 -
Beneficial conversion feature of convertible,
exchangeable debentures - - - - 3,120 -
Issuance of common shares and options for
services, compensation and other - - 9,184 9 785 -
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BALANCE - SEPTEMBER 30, 2003 - $ - 365,370 $ 365 $ 404,873 $ (388,800)
=================================================================================================================================
ACCUMULATED
COMMON OTHER NOTES TOTAL
STOCK TREASURY COMPREHENSIVE RECEIVED FOR STOCKHOLDERS'
WARRANTS STOCK INCOME SHARES ISSUED EQUITY (DEFICIT)
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BALANCE - DECEMBER 31, 2002 $ 5,650 $ (1,777) $ 31 $ (836) $ (36,092)
Net income - - - - 28,266
Comprehensive income -
Foreign currency translation - - 126 - 126
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Total comprehensive income - - 126 - 28,392
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Adjustment to allowance for uncollectible
portion of notes receivable - - - 20 20
Stock option repricing - - - - (1,495)
Stock options - VeriChip Corporation - - - - 188
Issuance of Digital Angel Corporation warrants - - - - 1,055
Issuance of common shares - - - - 20,152
Liability to be settled in common stock - - - - 3,518
Beneficial conversion feature of convertible,
exchangeable debentures - - - - 3,120
Issuance of common shares and options for
services, compensation and other - - - - 794
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BALANCE - SEPTEMBER 30, 2003 $ 5,650 $ (1,777) $ 157 $ (816) $ 19,652
==================================================================================================================================
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 NINE MONTHS
ENDED SEPTEMBER 30,
--------------------------
2003 2002
--------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 28,266 $ (49,811)
Adjustments to reconcile net income (loss) to net cash (used in)
provided by operating activities:
Loss (income) from discontinued operations 492 (105)
Non-cash compensation and administrative expenses 16,679 19,660
Goodwill and asset impairment - 784
Issuance of stock for services 112 2,871
Depreciation and amortization 1,824 3,747
Non-cash interest expense 1,907 4,335
Deferred income taxes (309) -
Impairment of notes receivable 61 4,134
Interest income on notes received for shares issued - (475)
Gain on forgiveness of debt (69,968) -
Net loss on subsidiary merger transaction 901 4,644
Minority interest (1,681) (762)
Equity in net loss of affiliate - 291
Gain on sale of subsidiaries and business assets - (194)
Loss on sale of equipment 15 89
Change in assets and liabilities:
Decrease in accounts receivable 1,446 3,805
Increase in inventories (3,371) (679)
Decrease in other current assets 1,022 1,996
Increase in accounts payable, accrued expenses
and other long-term liabilities 17,846 6,184
Net cash (used in) provided by discontinued operations (209) 211
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NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (4,967) 725
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CASH FLOWS FROM INVESTING ACTIVITIES
Decrease in notes receivable 1,543 1,020
Received from buyers of divested subsidiaries - 2,625
Increase in other assets (250) (308)
Proceeds from sale of property and equipment 11 2,510
Proceeds from sale of subsidiaries and business assets - 1,106
Payments for property and equipment (968) (1,367)
Cash acquired (net of payments for costs of business acquisitions) - (73)
Net cash used in discontinued operations (5) (493)
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NET CASH PROVIDED BY INVESTING ACTIVITIES 331 5,020
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CASH FLOWS FROM FINANCING ACTIVITIES
Net amounts repaid on notes payable (27,641) (5,066)
Proceeds from long-term debt 2,000 1,258
Payments on long-term debt (150) (1,349)
Proceeds from issuance of debentures 10,035 -
Other financing costs (554) (276)
Issuance of common shares 20,752 1,681
Collection of notes receivable received for shares issued - 1,156
Stock issuance costs (600) (312)
Proceeds from subsidiary issuance of common stock 247 631
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NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 4,089 (2,277)
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NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (547) 3,468
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 5,818 3,696
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CASH AND CASH EQUIVALENTS - END OF PERIOD $ 5,271 $ 7,164
========================================================================================================================
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
September 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 nine-months ended September 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 nine-months ended September 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.
Certain items in the three and nine-months ended September 30,
2002, have been reclassified for comparative purposes.
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 cost is recognized immediately. The Company accounts for
equity instruments issued to non-employees in accordance with the provisions
of SFAS No. 123.
At September 30, 2003, the Company had five shareholder-approved,
stock-based employee compensation plans, and the Company's subsidiaries had
six stock-based employee compensation plans. As permitted under SFAS No.
148, Accounting for Stock-Based Compensation--Transition and Disclosure,
7
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
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 and related
interpretations including FIN No. 44. The following table illustrates the
effect on net (loss) income and (loss) earnings 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 NINE-MONTHS ENDED NINE-MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
----------------------------------------------------------------------------------
2003 2002 2003 2002
----------------------------------------------------------------------------------
Net (loss) income, as reported $(1,160) $ (5,870) $28,266 $(49,811)
Add Back: Total stock-based employee
compensation expense determined under APB 25
for all awards, net of related tax effects (1) (460) (2,684) (1,459) 14,873
Deduct: Total stock-based employee
compensation expense determined under fair
value-based method for all awards, net of
related tax effects (2) (1,210) (1,814) (4,089) (17,383)
Pro forma net (loss) income $(2,830) $(10,368) $22,718 $(52,321)
(Loss) earnings per share:
Basic--as reported $ -- $ (0.02) $ 0.09 $ (0.19)
Diluted--as reported $ -- $ (0.02) $ 0.09 $ (0.19)
Basic--pro forma $ (0.01) $ (0.04) $ 0.07 $ (0.20)
Diluted--pro forma $ (0.00) $ (0.04) $ 0.07 $ (0.20)
(1) Amount includes $0.0 million, $0.1 million, $0.0 million and $0.2
million of compensation expense associated with subsidiary options for the
three-months ended September 30, 2003 and 2002, and the nine-months ended
September 30, 2003 and 2002, respectively.
(2) Amount includes $1.1 million, $1.3 million, $3.7 million and $1.6 million
of compensation expense associated with subsidiary options for the three-
months ended September 30, 2003 and 2002, and the nine-months ended
September 30, 2003 and 2002, respectively.
8
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
The Company did not grant options during the three-months ended
September 30, 2003. The weighted average per share fair value of grants made
during the three-months ended September 30, 2002, and the nine-months ended
September 30, 2003 and 2002, for the Company's incentive plans was $0.18,
$0.26 and $0.19, 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 NINE-MONTHS ENDED NINE-MONTHS ENDED
SEPTEMBER 30, 2003 SEPTEMBER 30, 2002 SEPTEMBER 30, 2003 SEPTEMBER 30, 2002
-------------------- -------------------- -------------------- --------------------
Estimated option life -- 5.5 years 5.5 years 5.5 years
Risk free interest rate -- 2.89% 1.51% 2.89%
Expected volatility -- 76.00% 76.00% 76.00%
Expected dividend yield -- 0.00% 0.00% 0.00%
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.
3. INVENTORY
September 30, December 31,
2003 2002
----------------- ----------------
Raw materials $ 1,720 $ 1,725
Work in process 3,277 1,447
Finished goods 6,336 4,659
----------------- ----------------
11,333 7,831
Allowance for excess and obsolescence (1,553) (1,422)
----------------- ----------------
Net inventory for continuing operations $ 9,780 $ 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
9
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
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 $100.0 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 nine-months ended
September 30, 2003, the Company recorded a gain on the forgiveness of debt
of $70.0 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 the United
States Food and Drug Administration ("FDA") and other necessary approvals
for the Company's VeriChip product's healthcare information applications,
capital equipment needs, the requirements of the Company's customers,
opportunities discovered or presented to the Company, and other cash
requirements.
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.
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 or exchangeable for
shares of Digital Angel Corporation common stock owned by the Company, or a
combination thereof, at any time at the Purchasers' option prior to the
maturity date of November 1, 2005.
On November 12, 2003, the Company announced that it had entered in
a letter agreement with the Purchasers. Under the letter agreement, the
Purchasers were required to convert a minimum of 50% of the outstanding
principal amount of the Debentures plus all accrued and unpaid interest into
shares of the Company's common stock on November 12, 2003, the First
Conversion Date. The conversion price was $0.35 per share. In addition, per
the terms of the letter agreement the Purchasers are required to convert any
remaining outstanding principal amount of the Debentures plus
10
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
accrued interest on or before November 19, 2003, the Second Conversion Date.
The conversion price for the Second Conversion Date is 84% of the volume
weighted average trading price of the Company's common stock for the five
trading days prior to November 17, 2003, (the "Discounted VWAP"). If the
Discounted VWAP is less than $0.35 per share, the conversion price shall be
$0.35 per share and not the Discounted VWAP and the Purchasers shall not be
obligated to purchase any remaining principal amount. As of the First
Conversion Date, the Purchasers have converted approximately 93% of the
original principal amount of the Debentures. The Company has issued 23.8
million shares of its common stock in connection with the conversions taking
place on the First Conversion Date. In addition, as of November 12, 2003,
the Debenture holders have exchanged $0.7 million of principal amount of the
Debentures into 0.3 million shares of the Digital Angel Corporation common
stock owned by the Company. Following these exchanges, the Company currently
owns 19.3 million shares of Digital Angel Corporation's common stock, or
approximately 71.4% of the shares of Digital Angel Corporation's common
stock outstanding as of November 12, 2003. Any Debenture that is not
converted under the terms of the letter agreement will continue in
accordance with the terms of the Debentures and related agreements as
discussed below, except that a Debenture holder electing not to convert its
Debenture under the offer may not deem the participation in the offer by the
other Debenture holders to change the price or cause other adjustment to the
Debentures.
Terms of the Debentures and Related Agreements
----------------------------------------------
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 us, for each individual holder of the Debentures, subject to
anti-dilution provisions 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,
such fifty percent calculation being made on the basis of each individual
Debenture holder's principal amount of Debentures purchased.
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 registered its common shares issuable upon conversion of the
Debentures and Warrants in accordance with the terms of a Registration
Rights Agreement entered into among the Company and the Purchasers.
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
11
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
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, is being revalued at
each reporting period and any resulting increase will result in a charge to
operations. The revaluation as of September 30, 2003, did not result in an
increase in the liability. 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 is
being accreted over the life of the Debentures as additional interest
expense. During the three and nine-months ended September 30, 2003, the
Company incurred approximately $0.5 million of interest expense as a result
of the accretion of the original issue discount. As a result of the
conversions under the letter agreement announced on November 12, 2003, as
discussed above, the Company will accrete a minimum of 93% of the remaining
original issue discount as interest expense during the fourth quarter of
2003.
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 makes principal redemption and interest payments in shares of
its common stock, such payments may result in additional interest expense.
To date, the Company has made interest payments in cash on September 1, 2003
and November 1, 2003, and in shares of its common stock on the First
Conversion Date. The principal payment due November 1, 2003, was paid $0.3
million in cash and $1.0 million through the exchange of Digital Angel
Corporation common stock. A diminutive gain was recorded on the exchange.
The conversions under the terms of the letter agreement will also result in
additional interest expense during the fourth quarter of 2003.
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 and certain
other exempt transactions, the
12
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Company is 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 the Company's common stock or equivalents until December 28,
2003, which is ninety (90) days after the effective date of the registration
statement registering the Company's common shares underlying the Debentures
and Warrants or until such time as the Purchasers no longer hold any
debentures. 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
14.9 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.
Digital Angel Corporation Financing Transactions
------------------------------------------------
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 $50.6 million as of September 30, 2003. On August 28,
2003, Digital Angel Corporation entered into another security agreement with
Laurus under which it may borrow from Laurus the lesser of $5.0 million or
an amount that is determined based on percentages of Digital Angel
Corporation's eligible accounts receivable and inventory as prescribed by
the terms of the Security Agreement. Under the Security Agreement, Digital
Angel Corporation issued to Laurus a Secured Revolving Convertible Note (the
"Revolving Note") in the original principal amount of $3.5 million and a
Secured Minimum Borrowing Convertible Note (the "Minimum Borrowing Note") in
the original principal amount of $1.5 million. The notes accrue interest at
an annual rate equal to prime plus 2.50%. Digital Angel Corporation used
proceeds from the loans from Laurus to satisfy in full its credit facility
with Wells Fargo Business Credit, Inc., ("Wells Fargo") which was cancelled
effective August 28, 2003. As of September 30, 2003, the aggregate amount
outstanding under the Minimum Borrowing Note and Revolving Note was $2.7
million and the availability under the Revolving Note was $0.9 million.
Beginning May 28, 2004, the Minimum Borrowing Note and the Revolving Note
are convertible, at Laurus' option, into shares of Digital Angel
Corporation's common stock at a price per share of $2.64, subject to
adjustments upward following each conversion of $2.0 million.
13
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
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;
o Attract, motivate and/or retain key executives and employees; and
o Maintain compliance with the covenants under the Debentures and
related agreements.
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
initiatives will be found, or if found, that they will be on terms favorable
to the Company.
14
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 ENDED NINE-MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------------
2003 2002 2003 2002
---- ---- ---- ----
NUMERATOR:
---------------------------------------------------
NUMERATOR FOR BASIC EARNINGS (LOSS) PER SHARE -
Net (loss) income from continuing operations $ (1,259) $ (5,751) $ 28,758 $(49,916)
Net income (loss) from discontinued operations 99 (119) (492) 105
---------------------------------------------------
Net (loss) income $ (1,160) $ (5,870) $ 28,266 $(49,811)
===================================================
NUMERATOR FOR DILUTED EARNINGS (LOSS) PER SHARE -
Net (loss) income from continuing operations $ (1,259) $ (5,751) $ 28,758 $(49,916)
Add back interest on convertible exchangeable debentures 1,558 -- 1,558 --
---------------------------------------------------
Adjusted net income (loss) from continuing operations 299 (5,751) 30,316 (49,916)
Net income (loss) from discontinued operations 99 (119) (492) 105
---------------------------------------------------
Adjusted net income (loss) for diluted earnings (loss) per share $ 398 $ (5,870) $ 29,824 $(49,811)
===================================================
DENOMINATOR:
DENOMINATOR FOR BASIC EARNINGS (LOSS) PER SHARE -
Weighted-average shares 353,558 274,934 315,380 265,001
---------------------------------------------------
Convertible exchangeable debentures 20,388 -- 6,871 --
Stock options 4,629 -- 8,745 --
Warrants 3,779 -- 3,629 --
---------------------------------------------------
DENOMINATOR FOR DILUTED EARNINGS (LOSS) PER SHARE (1) -
Weighted-average shares 382,354 274,934 334,625 265,001
===================================================
BASIC EARNINGS (LOSS) PER SHARE:
CONTINUING OPERATIONS $ -- $ (0.02) $ 0.09 $ (0.19)
DISCONTINUED OPERATIONS -- -- -- --
---------------------------------------------------
TOTAL - BASIC $ -- $ (0.02) $ 0.09 $ (0.19)
===================================================
DILUTED EARNINGS (LOSS) PER SHARE:
CONTINUING OPERATIONS $ -- $ (0.02) $ 0.09 $ (0.19)
DISCONTINUED OPERATIONS -- -- -- --
---------------------------------------------------
TOTAL - DILUTED $ -- $ (0.02) $ 0.09 $ (0.19)
===================================================
(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 NINE-MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2002
---- ----
Stock options 9,161 10,010
Warrants 2,917 2,542
--------------------------------------------
12,078 12,552
============================================
15
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
6. SEGMENT INFORMATION
Effective January 1, 2002, the Company operates in three business
segments: Advanced Technology, Digital Angel Corporation and InfoTech USA, Inc.
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 71.4%
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 2001 and 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-months ended September 30, 2003, is a
reversal of approximately $3.9 million of severance expense associated with
the termination of a former officer and director and included in the
nine-months ended September 30, 2003, is a gain on the forgiveness of debt
obligations to IBM Credit of $70.0 million, $4.3 million of bonuses awarded
for the successful repayment of all obligations to IBM Credit and a
severance charge of approximately $18.1 million associated with the
termination of certain former officers and director. Included in
"Corporate/Eliminations" for the nine-months ended September 30, 2002, is a
non-
16
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
cash compensation charge of $18.7 million associated with pre-merger Digital
Angel options, which were converted into options to acquire shares of
Medical Advisory Systems Inc. ("MAS") in connection with the merger of
pre-merger Digital Angel and MAS. The merger is more fully discussed in Note 7.
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 September 30, 2003:
SEGMENTS
--------
Digital
Advanced Angel InfoTech All Corporate/
Technology Corporation USA, Inc. Other Eliminations Consolidated
----------------------------------------------------------------------------------
Net revenue from external customers:
Product $ 8,514 $ 6,832 $3,419 $ -- $ (18) $ 18,747
Service 2,737 1,512 806 -- -- 5,055
Inter-segment revenue-product -- (18) -- -- 18 --
----------------------------------------------------------------------------------
Total revenue $11,251 $ 8,326 $4,225 $ -- $ -- $ 23,802
==================================================================================
Income (loss) from continuing operations
before taxes, minority interest,
net (gain) loss on subsidiary stock
issuances and merger transaction $ 481 $(2,625) $ (108) $ 44 $ (73) $ (2,281)
==================================================================================
Total assets $40,618 $70,920 $9,228 $2,737 $(6,900) $116,603
==================================================================================
Following is the selected segment data as of and for the
three-months ended September 30, 2002:
SEGMENTS
--------
Digital
Advanced Angel InfoTech All Corporate/
Technology Corporation USA, Inc. Other Eliminations Consolidated
----------------------------------------------------------------------------------
Net revenue from external customers:
Product $ 7,019 $ 8,780 $3,850 $ -- $ 16 $ 19,665
Service 2,970 826 691 -- 18 4,505
Inter-segment revenue-product -- 16 -- -- (16) --
----------------------------------------------------------------------------------
Total revenue $ 9,989 $ 9,622 $4,541 $ -- $ 18 $ 24,170
==================================================================================
Income (loss) from continuing operations
before income taxes, minority interest,
net (gain) loss on subsidiary merger
transaction and equity in net loss of
affiliate $ (90) $ (976) $ (33) $ (27) $(4,482) $ (5,608)
==================================================================================
Total assets (2) $41,540 $140,154 $9,757 $2,778 $ 783 $195,012
==================================================================================
17
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
nine-months ended September 30, 2003:
SEGMENTS
--------
Digital
Advanced Angel InfoTech All Corporate/
Technology Corporation USA, Inc. Other Eliminations Consolidated
----------------------------------------------------------------------------------
Net revenue from external customers:
Product $22,768 $25,816 $ 8,686 $ -- $ (106) $ 57,164
Service 8,303 2,287 2,043 -- 12,633
Inter-segment revenue-product -- (106) -- -- 106 --
----------------------------------------------------------------------------------
Total revenue $31,071 $27,997 $10,729 $ -- $ -- $ 69,797
==================================================================================
Income (loss) from continuing operations
before taxes, minority interest,
net (gain) loss on subsidiary stock
issuances and merger transaction $ 974 $(5,038) $ (731) $ 373 $33,158 $ 28,736
==================================================================================
Total assets $40,618 $70,920 $ 9,228 $2,737 $(6,900) $116,603
==================================================================================
Following is the selected segment data as of and for the
nine-months ended September 30, 2002:
SEGMENTS
--------
Digital
Advanced Angel InfoTech All Corporate/
Technology Corporation USA, Inc. Other Eliminations Consolidated
----------------------------------------------------------------------------------
Net revenue from external customers:
Product $20,451 $ 24,739 $17,670 $1,014 $ (63) $ 63,811
Service 9,954 2,035 2,171 375 54 14,589
Inter-segment revenue-product -- (63) -- -- 63 --
----------------------------------------------------------------------------------
Total revenue $30,405 $ 26,711 $19,841 $1,389 $ 54 $ 78,400
==================================================================================
Income (loss) from continuing operations
before income taxes, minority interest,
net (gain) loss on subsidiary merger
transaction and equity in net loss of
affiliate (1) $ (113) $ (4,250) $ (62) $ 117 $(41,235) $(45,543)
==================================================================================
Total assets (2) $41,540 $140,154 $ 9,757 $2,778 $ 783 $195,012
==================================================================================
(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.
18
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
7. ACQUISITIONS
Effective March 27, 2002, the Company's then 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,
MAS, and MAS changed its name to Digital Angel Corporation. Under the terms
of the merger agreement, each issued and outstanding share of common stock
of pre-merger Digital Angel (including each share issued upon exercise of
options prior to the effective time of the merger) was cancelled and
converted into the right to receive 0.9375 shares of MAS's common stock. The
Company obtained 18.75 million shares of MAS common stock in the merger
(representing approximately 61% of the shares then outstanding). Prior to
the transaction, the Company owned 850,000 shares of MAS, or approximately
16.7%. Upon consummation of the transaction, the Company owned 19.6 million
shares, or approximately 77% of the shares then outstanding. As of November
12, 2003, the Company owned 19.3 million shares of Digital Angel Corporation
common stock, or approximately 71.4% of the shares outstanding. 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 September 30,
2003, and November 12, 2003, of $2.08 and $2.58, respectively.
During the nine-months ended September 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 September 30, 2003 and 2002, and the
nine-months ended September 30, 2003 and 2002, the Company recorded a gain
(loss) of $0.3 million, ($0.4) million, ($0.9) million and ($4.2) million,
respectively, on the issuances of 0.1 million, 0.1 million, 0.5 million and
1.0 million shares of Digital Angel Corporation common stock, respectively,
resulting primarily from the exercise of Digital Angel Corporation stock
options. The gain (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.
Unaudited pro forma results of operations for the nine-months ended
September 30, 2002, are included below. Such pro forma information assumes
that the merger of pre-merger Digital Angel and
19
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
MAS had occurred as of January 1, 2002:
---------------------
NINE-MONTHS ENDED
SEPTEMBER 30,
---------------------
2002
----
Net operating revenue from continuing operations $ 78,844
Loss from continuing operations $(50,605)
Loss available to common stockholders from continuing operations $(50,605)
Loss per common share from continuing operations - basic $ (0.19)
Loss per common share from continuing operations - diluted $ (0.19)
Stock Purchase Agreement
------------------------
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. Upon closing of the transaction, the Company
will own approximately 74.2% of the outstanding shares of Digital Angel
Corporation's common stock, provided that Laurus has not exercised its
rights of conversion as more fully discussed in Note 4. The aggregate
purchase price for the 3.0 million shares is $7.9 million. The purchase
price 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").
Under the terms of the Stock Purchase Agreement, the closing date is
scheduled to occur on the business day following the effective date of the
registration statement filed with the SEC on October 6, 2003, registering
the Company's common stock to be issued to Digital Angel Corporation in
payment of the 3.0 million shares. If the Per Share Exchange Price is less
than $0.40, the Company has 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. Digital Angel Corporation has granted a
five-year warrant to the Debenture holders to acquire up to 0.5 million
shares of its common stock at an exercise price of $2.64 per share. The
warrant was issued in consideration for a waiver from the Debenture holders
allowing the Company to register the shares being issued in connection with
this transaction. The value of the warrant of $0.8 million has been
included in interest expense during the three- and nine-months ended
September 30, 2003.
20
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Earnout 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
September 30, 2003. At September 30, 2003, the Company is contingently
liable under one earnout agreement. Based upon the expected performance of
this subsidiary, it is currently estimated that the Company is contingently
liable for additional consideration of approximately $30 thousand.
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.
Assets and liabilities of discontinued operations are as follows at
September 30, 2003, and December 31, 2002.
September 30, 2003 December 31, 2002
---------------------------------------------
Current Assets
Cash and cash equivalents $ 6 $ 66
Accounts receivable and unbilled receivables, net 91 167
Inventories -- 38
---------------------------------------------
Total Current Assets 97 271
Property and equipment, net -- 56
---------------------------------------------
$ 97 $ 327
=============================================
Current Liabilities
Notes payable and current maturities of long-term debt $ 26 $ 26
Accounts payable 4,178 4,189
Accrued expenses 5,541 5,334
---------------------------------------------
Total Current Liabilities 9,745 9,549
Minority interest -- 146
---------------------------------------------
9,745 9,695
=============================================
Net Liabilities of Discontinued Operations $(9,648) $(9,368)
=============================================
21
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
During the three-months ended September 30, 2003 and 2002,
Discontinued Operations incurred a (decrease) increase in the estimated loss
on disposal and operating losses during the phase out period of $(0.1)
million and $0.1 million, respectively, and during the nine-months ended
September 30, 2003 and 2002, Discontinued Operations incurred an increase
(decrease) in the estimated operating loss on disposal and operating losses
during the phase out period of $0.5 million and $(0.1) million,
respectively. The primary reason for the reduction in estimated losses
during the three-months ended September 30, 2003, and the nine-months ended
September 30, 2002, was a reduction in carrying costs as certain of these
obligations were settled during the periods for amounts less than previously
anticipated. Carrying costs include the cancellation of facility leases,
employment contract buyouts, sales tax liabilities and litigation reserves.
The primary reasons for the increase in estimated losses during the
nine-months ended September 30, 2003, were an increase in carrying costs and
the loss of $0.1 million on the sale of the one remaining business unit,
which was sold in July 2003, as well as the operations of the remaining
business, and the primary reason for the increase in the three-months ended
September 30, 2002, was the operations of the one remaining business unit.
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 September 30, 2003.
Balance Balance
December 31, September 30,
Type of Cost 2002 Additions Deductions 2003
- -----------------------------------------------------------------------------------------------------------
Estimated loss on sale, net of change in
estimated operating losses $ -- $176 $176 $ --
Carrying costs 4,908 316 111 5,113
-------------------------------------------------------------
Total $4,908 $492 $287 $5,113
=============================================================
9. NON-CASH COMPENSATION EXPENSE
The Company reduced approximately $0.5 million and $2.9 million of
non-cash compensation expense during the three-months ended September 30,
2003 and 2002, respectively, and the Company reduced approximately $1.5
million and incurred approximately $0.5 million of non-cash compensation
expense during the nine-months ended September 30, 2003 and 2002,
respectively, due primarily to re-pricing 19.3 million stock options during
2001. The re-priced options had original exercise prices ranging from $0.69
to $6.34 per share and were modified to change the exercise price to $0.15
per share. Due to the modification, these options are being accounted for as
variable options under APB Opinion No. 25 and fluctuations in the Company's
common stock price result in increases and decreases of non-cash
compensation expense until the options are exercised, forfeited or expired.
This expense (credit) is included in the condensed consolidated statement of
operations in selling, general and administrative expense.
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
nine-months ended September 30, 2002. As all of the option holders were
employees or directors of the Company, these options were considered fixed
awards
22
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
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
expense.
10. SEVERANCE AGREEMENTS
On March 21, 2003, Richard J. Sullivan, the Company's 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, all of which have been exercised. 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 $17.0 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 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, all of which have been exercised. 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. We issued the shares to Garrett Sullivan on
August 19, 2003. In September 2003, Garrett Sullivan surrendered the shares
to us. We will reissue the shares to him upon the effectiveness of the
registration statement filed with the SEC on October 6, 2003, registering
the shares.
The Company's shareholders have approved the issuance of the common
stock and 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 agreement
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) were 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
23
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
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 three-months ended March 31, 2003, including $2.5 million resulting from
the re-priced options. 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 reversed approximately $3.9 million of
such severance expense during the three-months ending September 30, 2003.
11. COMPREHENSIVE (LOSS) INCOME
Comprehensive (loss) income represents all non-owner changes in
stockholders' equity and consists of the following:
THREE-MONTHS ENDED NINE-MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- ----------------------------
2003 2002 2003 2002
---- ---- ---- ----
----------------------------- ----------------------------
Net (loss) income $(1,160) $(5,870) $28,266 $(49,811)
Other comprehensive income, net of tax:
Foreign currency translation adjustments 78 49 126 710
----------------------------- ----------------------------
Total comprehensive (loss) income $(1,082) $(5,821) $28,392 $(49,101)
============================= ============================
12. NASDAQ SMALLCAP MARKET LISTING
Since November 12, 2002, the Company's common stock has traded on
the Nasdaq SmallCap Market (the "SmallCap") under the symbol "ADSX." Since
being traded on the SmallCap, the minimum bid price of the Company's common
stock has been less than the SmallCap's minimum bid price requirement. To
maintain its SmallCap listing, the Company had until October 27, 2003, for
its common stock to regain the minimum bid requirement of at least $1.00 per
share for a minimum of ten (10) consecutive trading days. The Company's
common stock did not regain the minimum bid price requirement and on October
28, 2003, the Nasdaq Stock Market informed the Company by letter that its
securities would be delisted from the SmallCap. The Company has filed an
appeal and an oral hearing request. The hearing request will stay the
delisting of the Company's securities pending a decision by the Nasdaq's
Listing Qualifications Panel ("Panel"). Since the Company complies with all
of the SmallCap's listing requirements with the exception of the minimum bid
price requirement, and since the Board of Directors has the authority to
effect a reverse stock split which may enable the Company to meet the
minimum bid price requirement as more fully discussed below, the Company
does not expect to be delisted from the SmallCap. However, the Company
cannot provide assurances that the decision of the Panel will result in the
continued listing of the Company's common stock on the SmallCap. If the
Company's stock is delisted from the SmallCap, it may trade on the OTC
Bulletin Board or another market or quotation system.
On September 10, 2003, the Company's shareholders approved the
granting of discretionary authority to its Board of Directors for a period
of twelve months to effect a reverse stock split not to exceed a ratio of
1-for 25, or to determine not to proceed with a reverse stock split. The
Company's Board
24
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
of Directors may decide to 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. 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 the Company's common stock to the financial community and
the investing public.
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, which increase became effective on August 26, 2003.
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 is offering up to 30.0 million shares of its common
stock in a public offering registered under the Securities Act of 1933. To
date, the Company has sold an aggregate of 22.0 million shares of its common
stock under the offering, pursuant to the terms of three separate securities
purchase agreements entered into on September 19, 2003. J.P. Carey
Securities, Inc. acted as the Company's placement agent. The sales of its
common stock resulted in gross proceeds to the Company of $8.0 million
before deduction of a 2.0% placement agency fee.
On September 5, 2003, Digital Angel Corporation announced that
Randolph Geissler resigned from his position of Chief Executive Officer of
Digital Angel Corporation and that Mr. Geissler had accepted the position of
Chief Executive Officer of the Animal Applications and Information/Medical
Divisions. In accepting the new position, Mr. Geissler voluntarily agreed to
terminate his existing employment agreement with Digital Angel Corporation,
which included a change-of-control triggering event provision that would
have required a minimum cash payment of $4.0 million to Mr. Geissler. In his
new position, Mr. Geissler has been granted a stock option of 1.0 million
shares of Digital Angel Corporation common stock at the current market
price. Kevin McLaughlin, the Company's President and Chief Operating
Officer, was named Interim Chief Executive Officer of Digital Angel
Corporation. Mr. Geissler resigned from Digital Angel Corporation
effective November 6, 2003. In addition, on September 12, 2003, Michael
Zarriello, a member of the Company's Board of Directors, was appointed
to the Board of Directors of Digital Angel Corporation.
On November 2, 2003, Digital Angel Corporation signed an agreement
and plan of merger pursuant to which it will acquire OuterLink Corporation
("OuterLink") of Concord, Massachusetts, subject to certain conditions.
OuterLink manufactures and markets a suite of satellite tracking systems,
operates a mobile satellite data communications service, and supplies
tracking software systems for mapping and messaging. The OuterLink "CP-2
system" provides real-time automated tracking, wireless data transfer, and
two-way messaging with large fleets of vehicles -- including utility trucks,
helicopters and fixed-wing aircraft, long haul trucks, service vehicles,
short haul trucks, and ships. OuterLink's current customer base includes
various branches of the Department of Homeland Security (for example, U.S.
Border Patrol and U.S. Customs Service). The transaction consideration is
the issuance of a zero coupon preferred stock instrument that is convertible
into 4.0 million shares of Digital Angel Corporation's common stock as
such time as Digital Angel Corporation's common shares close at or
25
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
above $4.00 per share for ten consecutive trading days. OuterLink's Chief
Executive Officer, Mr. Van Chu, was appointed Chief Executive Officer of
Digital Angel Corporation replacing Kevin McLaughlin, Digital Angel
Corporation's interim Chief Executive Officer. Mr. Chu also joined Digital
Angel Corporation's Board of Directors.
14. LEGAL PROCEEDINGS
The Company is party to various legal proceedings, and accordingly,
has recorded $1.2 million in reserves in its financial statements as of
September 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.
During the quarter ended March 31, 2002, 510 Ryerson Road Inc.
filed a lawsuit against the Company and one of its Discontinued Operations
subsidiaries in connection with a lease for a facility that the subsidiary
vacated prior to the expiration of the lease and which is no longer in use.
The trial date has been set for November 2003.
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 arose from a vacation guarantee
insurance policy (the "Insurance Contract") allegedly purchased by
Plaintiffs from the Defendants on March 6, 2000. The complaint alleged,
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. and the intentional infliction of emotional distress on
Plaintiffs. Effective September 9, 2003, this lawsuit was settled and the
Plaintiffs executed a Full Release and Covenant Not to Sue in which the
Plaintiffs agreed to forgo any action against Digital Angel Corporation in
consideration for a payment within Digital Angel Corporation's insurance
limits.
26
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.
RECENT/OTHER DEVELOPMENTS
Payment in Full of Obligations to IBM Credit LLC
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 $100.0 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 nine-months ended September 30, 2003, we recorded a gain on the
forgiveness of debt of approximately $70.0 million, exclusive of certain
bonuses. The repayment of the obligations to IBM Credit and the bonuses are
more fully discussed in Note 4 to our condensed consolidated financial
statements.
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 our $10.5 million aggregate principal amount of 8.5% Convertible
27
Exchangeable Debentures (the "Debentures"), the proceeds of which were used
to repay a portion of our obligations to IBM Credit. 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 owned by us, or a combination of shares
from both companies, at the Purchasers' option (the "Warrants"). The
Debentures and Warrants are more fully described in Note 4 to our condensed
consolidated financial statements.
Securities Purchase Agreements
We are offering up to 30.0 million shares of our common stock in a
public offering registered under the Securities Act of 1933. To date, we
have sold an aggregate of 22.0 million shares of our common stock under the
offering, pursuant to the terms of three separate securities purchase
agreements entered into on September 19, 2003. J.P. Carey Securities, Inc.
acted as our placement agent. The sales resulted in gross proceeds to us of
$8.0 million before deduction of a 2.0% placement agency fee.
Nasdaq SmallCap Listing
Since November 12, 2002, our common stock has traded on the
SmallCap under the symbol "ADSX." Since being traded on the SmallCap, the
minimum bid price of our common stock has been less than the SmallCap's
minimum bid price requirement. To maintain our SmallCap listing, we had
until October 27, 2003, for our common stock to regain compliance with the
SmallCap's minimum bid requirement of at least $1.00 per share for a minimum
of ten (10) consecutive trading days. Our common stock did not regain the
minimum bid price requirement and on October 28, 2003, the Nasdaq Stock
Market informed us by letter that our securities would be delisted from the
SmallCap. We have filed an appeal and an oral hearing request. The hearing
request will stay the delisting of our securities pending a decision by the
Nasdaq's Listing Qualifications Panel ("Panel"). Since we comply with all of
the SmallCap's listing requirements with the exception of the minimum
bid price requirement, and since our Board of Directors has the authority to
effect a reverse stock split which may enable us to meet the minimum bid
price requirement as more fully discussed below, we do not expect to be
delisted from the SmallCap. However, we cannot provide assurances that the
decision of the Panel will result in the continued listing of our common
stock on the SmallCap. If our stock is delisted from the SmallCap, it may
trade on the OTC Bulletin Board or another market or quotation system.
On September 10, 2003, our shareholders approved the granting of
discretionary authority to its Board of Directors for a period of twelve
months to effect a reverse stock split not to exceed a ratio of 1-for-25, or
to determine not to proceed with a reverse stock split. Our Board of
Directors may decide to 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. 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.
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.
28
Severance Agreements
On March 21, 2003, Richard J. Sullivan, our then Chairman of the
Board of Directors and Chief Executive Officer, retired and Jerome C.
Artigliere, our then Senior Vice President and Chief Operating Officer,
resigned. Our Board of Directors negotiated severance agreements with
Richard Sullivan and Jerome Artigliere under which they are to receive a
one-time payment of 56.0 million shares and 4.8 million shares of our common
stock, respectively. In addition, stock options held by them exercisable for
approximately 10.9 million shares and 2.3 million shares of our common
stock, respectively, were re-priced and exercised. 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 roughly
$17 million to him, or approximately $3.9 million more than is owed under
the severance agreement. In addition, 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, was
triggered. We negotiated a settlement of our obligations under Garrett
Sullivan's severance agreement that required us to issue to him 7.5 million
shares of our common stock. As a result of the terminations of Messrs.
Sullivan and Artigliere, we recorded severance expense of $22.0 million
during the first quarter of 2003, including $2.5 million resulting from the
re-priced options. On July 25, 2003, our shareholders approved the terms of
the severance agreements. Since our obligation to Richard Sullivan under his
severance agreement was less than our obligation to him under his employment
agreement, we reversed approximately $3.9 million of such severance expense
during the three-months ending September 30, 2003. The severance agreements
are more fully discussed in Note 10 to our condensed consolidated financial
statements.
Appointments, Resignations and Acquisitions
On September 5, 2003, Digital Angel Corporation announced that
Randolph Geissler resigned from his position of Chief Executive Officer
of Digital Angel Corporation and that Mr. Geissler had accepted the position
of Chief Executive Officer of the Animal Applications and
Information/Medical Divisions. In accepting the new position, Mr. Geissler
voluntarily agreed to terminate his existing employment agreement with
Digital Angel Corporation, which included a change-of-control triggering
event provision that would have required a minimum cash payment of $4.0
million to Mr. Geissler. In his new position, Mr. Geissler has been granted
a stock option of 1.0 million shares of Digital Angel Corporation common
stock at the current market price. Kevin McLaughlin, our President and Chief
Operating Officer, was named Interim Chief Executive Officer of Digital
Angel Corporation. Mr. Geissler resigned from Digital Angel Corporation
effective November 6, 2003. In addition, on September 12, 2003, Michael
Zarriello, a member of our Board of Directors, was appointed to the Board
of Directors of Digital Angel Corporation.
On November 2, 2003, Digital Angel Corporation signed an agreement
and plan of merger pursuant to which it will acquire OuterLink Corporation
("OuterLink") of Concord, Massachusetts, subject to certain conditions.
OuterLink manufactures and markets a suite of satellite tracking systems,
operates a mobile satellite data communications service, and supplies
tracking software systems for mapping and messaging. The OuterLink "CP-2
system" provides real-time automated tracking, wireless data transfer, and
two-way messaging with large fleets of vehicles -- including utility trucks,
helicopters and fixed-wing aircraft, long haul trucks, service vehicles,
short haul trucks, and ships. OuterLink's current customer base includes
various branches of the Department of Homeland Security (for example, U.S.
Border Patrol and U.S. Customs Service). The transaction consideration is
the issuance of a zero coupon preferred stock instrument that is convertible
into 4.0 million shares of Digital Angel Corporation's common stock as
such time as Digital Angel Corporation's common shares close at or above
$4.00 per share for ten consecutive trading days. OuterLink's Chief
Executive Officer, Mr. Van
29
Chu, was appointed Chief Executive Officer of Digital Angel Corporation,
replacing Kevin McLaughlin, Digital Angel Corporation's interim Chief
Executive Officer. Mr. Chu also joined Digital Angel Corporation's Board of
Directors.
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,
which increase became effective on August 26, 2003.
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. On August 28, 2003, Digital Angel Corporation
entered into a Security Agreement with Laurus under which it may borrow from
Laurus the lesser of $5.0 million or an amount that is determined based on
percentages of Digital Angel Corporation's eligible accounts receivable and
inventory as prescribed by the terms of the Security Agreement. Digital
Angel Corporation used proceeds from the loans to satisfy in full its credit
facility with Wells Fargo Business Credit, Inc., which was cancelled
effective August 28, 2003. The loans are more fully described in Note 4 to
the condensed consolidated financial statements.
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. It 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 purchase price will be paid in shares of our
common stock. The Stock Purchase Agreement is more fully described in Note
7 to the condensed consolidated financial statements.
On October 29, 2003, we announced that we had submitted a 510(k)
application to the FDA seeking the FDA's permission to market VeriChip's
healthcare information applications in the United States. The FDA's ruling
in October 2002, that VeriChip is a regulated medical devise when marketed
to provide information to assist in the diagnosis or treatment of injury or
illness, necessitated the 510(k) submission. The timetable for the FDA
review process is not defined and we understand that the entire process
could take several months or more to run its course. Assuming clearance is
obtained from the FDA, we plan to market VeriChip's family of healthcare
information applications in the United States using the VeriMed(TM) product
name.
During October 2003, we began marketing samples of our Thermo Life
product to potential customers.
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 two years 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.
30
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 this segment.
Digital Angel Corporation
Our Digital Angel Corporation segment consists of the business
operations of Digital Angel Corporation, our approximately 71.4% 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 this 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 2001 and 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-months ended September 30, 2003, is a
reversal of approximately $3.9 million of severance expense associated with
the termination of a former officer and director and included in the
nine-months ended September 30, 2003, is a gain on the forgiveness of debt
obligations to IBM Credit of $70.0 million, $4.3 million of bonuses awarded
for the successful repayment of all obligations to IBM Credit and a
severance charge of approximately $18.1 million associated with the
termination of certain former officers and director. Included in
"Corporate/Eliminations" for the nine-months ended September 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.
31
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.
32
RESULTS OF CONTINUING OPERATIONS
The following table summarizes our results of operations as a
percentage of net operating revenue for the three and nine-month periods
ended September 30, 2003 and 2002, and is derived from the unaudited
condensed consolidated statements of operations in Part I, Item 1 of this
report.
---------------------- ----------------------
RELATIONSHIP TO RELATIONSHIP TO
REVENUE REVENUE
THREE-MONTHS ENDED NINE-MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2003 2002 2003 2002
---- ---- ---- ----
% % % %
- - - -
Product revenue 78.8 81.4 81.9 81.4
Service revenue 21.2 18.6 18.1 18.6
---------------------- ----------------------
Total revenue 100.0 100.0 100.0 100.0
Cost of products sold 62.9 54.7 60.5 56.9
Cost of services sold 6.5 8.1 7.3 8.3
---------------------- ----------------------
Total cost of products and services sold 69.4 62.8 67.8 65.2
---------------------- ----------------------
Gross profit 30.6 37.2 32.2 34.8
Selling, general and administrative expenses 21.3 30.7 67.3 69.7
Research and development 7.7 3.6 6.4 3.2
Depreciation and amortization 2.5 5.2 2.6 4.8
Asset impairment -- -- -- 1.0
Interest and other income (1.0) (3.0) (1.0) (1.8)
Loss (gain) on forgiveness of debt 1.9 -- (100.2) --
Interest expense 7.8 23.9 15.9 16.0
---------------------- ----------------------
(Loss) income from continuing operations before taxes,
minority interest, net (gain) loss on subsidiary stock
issuances and merger transaction and equity in net loss
of affiliate (9.6) (23.2) 41.2 (58.1)
(Benefit) provision for income taxes (0.1) 0.4 1.1 0.2
---------------------- ----------------------
(Loss) income from continuing operations before minority
interest, net (gain) loss on subsidiary stock issuances and
merger transaction and equity in net loss of affiliate (9.5) (23.6) 40.1 (58.3)
Minority interest (3.1) (1.3) (2.4) (1.0)
Net (gain) loss on subsidiary stock issuances and merger
transaction (1.1) 1.5 1.3 5.9
Equity in net loss of affiliate -- -- -- 0.4
---------------------- ----------------------
(Loss) income from continuing operations (5.3) (23.8) 41.2 (63.6)
Change in estimate on loss on disposal and operating losses
during the phase out period 0.4 (0.5) (0.7) 0.1
---------------------- ----------------------
Net (loss) income (4.9) (24.3) 40.5 (63.5)
====================== ======================
33
REVENUE
Revenue from continuing operations for the three-months ended
September 30, 2003 and 2002, remained constant at $23.8 million and $24.2
million, respectively. Revenue from continuing operations for the
nine-months ended September 30, 2003, decreased $8.6 million, or 11.0%, to
$69.8 million from $78.4 million for the nine-months ended September 30,
2002.
Revenue from continuing operations during the three and
nine-months ended September 30, 2003 and 2002, by segment was as follows:
THREE-MONTHS ENDED SEPTEMBER 30,
(IN THOUSANDS)
------------------------------------------------------------------------------------
2003 2002
---- ----
------------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
Advanced Technology $ 8,514 $2,737 $11,251 $ 7,019 $2,970 $ 9,989
Digital Angel Corporation 6,814 1,512 8,326 8,796 826 9,622
InfoTech USA, Inc. 3,419 806 4,225 3,850 691 4,541
All Other -- -- -- -- -- --
Corporate / Eliminations -- -- -- -- 18 18
------------------------------------------------------------------------------------
Total $18,747 $5,055 $23,802 $19,665 $4,505 $24,170
========================================== ========================================
NINE-MONTHS ENDED SEPTEMBER 30,
(IN THOUSANDS)
------------------------------------------------------------------------------------
2003 2002
---- ----
------------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
Advanced Technology $22,768 $ 8,303 $31,071 $20,451 $ 9,954 $30,405
Digital Angel Corporation 25,710 2,287 27,997 24,676 2,035 26,711
InfoTech USA, Inc. 8,686 2,043 10,729 17,670 2,171 19,841
All Other -- -- -- 1,014 375 1,389
Corporate / Eliminations -- -- -- -- 54 54
------------------------------------------------------------------------------------
Total $57,164 $12,633 $69,797 $63,811 $14,589 $78,400
========================================== ========================================
Advanced Technology segment's revenue increased $1.3 million and
$0.7 million in the three and nine-month periods ended September 30, 2003,
respectively, when compared to the three and nine-month periods ended
September 30, 2002. When compared to the amounts for the three-months ended
September 30, 2002, product revenue increased by $1.5 million, or 21.3%, and
service revenue decreased by $0.2 million, or 7.8%. When compared to the
amounts for the nine-months ended September 30, 2002, product revenue
increased by $2.3 million, or 11.3%, and service revenue decreased by $1.7
million, or 16.6%. We attribute the increase in product revenue during the
three and nine-months ended September 30, 2003, primarily to government
contract projects. We attribute the decrease in service revenue during the
three and nine-months ended September 30, 2003, to the sale of one of the
businesses in this group during the fourth quarter of 2002, and to reduced
sales of website and software support and other technology services.
Digital Angel Corporation segment's revenue decreased $1.3 million
and increased $1.3 million in the three and nine-month periods ended
September 30, 2003, respectively, when compared to the three and nine-month
periods ended September 30, 2002. When compared to the amounts for the
three-months ended September 30, 2002, product revenue decreased by $2.0
million, or 22.5%, and service revenue increased by $0.7 million. When
compared to the amounts for the nine-months ended September 30, 2002,
product revenue increased by $1.0 million, or 4.2%, and service revenue
increased by $0.3 million, or 12.4%. We attribute the decrease in product
revenue for the three months ended September 30, 2003, primarily to fewer
sales to fish and wildlife industry customers. We attribute the
increase in product sales for the nine-months ended September 30, 2003,
primarily to an increase in sales to fish and wildlife industry and
companion animal microchip customers in North America and Europe. We
attribute the
34
increases in service revenue for the three and nine-months ended
September 30, 2003, primarily to Animal Application's engineering service
revenue.
InfoTech USA, Inc. segment's revenue decreased $0.3 million and
$9.1 million in the three and nine-months ended September 30, 2003,
respectively, when compared to the amounts for the three and nine-month
periods ended September 30, 2002. When compared to the amounts for the
three-months ended September 30, 2002, product revenue decreased by
$0.4 million, or 11.2%, and service revenue increased by $0.1 million, or
16.6%. When compared to the amounts for the nine-months ended September 30,
2002, product revenue decreased by $9.0 million, or 50.8%, and service
revenue decreased by $0.1 million, or 5.9%. We attribute the decreases in
product revenue for both periods and the decrease in service revenue during
the nine-months ended September 30, 2003, to a continued soft market for
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 selling higher-margin products and related technical services. We
attribute the increase in services revenue for the three-months ended
September 30, 2003, to an increase in sales requiring technical services.
All Other had no revenue for the three-months ended September 30,
2003 and 2002, and for the nine-months ended September 30, 2003, as compared
to revenue of $1.4 million during the nine-months ended September 30, 2002.
The decreases in revenue were due to the sale or closure of all of the
business units comprising this group during the last half of 2001 and the
first half of 2002.
GROSS PROFIT AND GROSS PROFIT MARGIN
Gross profit from continuing operations for the three-months ended
September 30, 2003, decreased $1.7 million, or 19.2%, to $7.3 million from
$9.0 million for the three-months ended September 30, 2002. Gross profit
from continuing operations for the nine-months ended September 30, 2003,
decreased $4.8 million, or 17.7%, to $22.5 million from $27.3 million for
the nine-months ended September 30, 2002. Our gross profit margin was 30.6%
and 32.2% of revenue, respectively, for the three and nine-months ended
September 30, 2003, and 37.2% and 34.8% of revenue, respectively, for the
three and nine-months ended September 30, 2002.
Gross profit from continuing operations during the three and
nine-months ended September 30, 2003 and 2002, by segment was as follows:
THREE-MONTHS ENDED SEPTEMBER 30,
(IN THOUSANDS)
---------------------------------------------------------------------------------
2003 2002
---- ----
---------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
Advanced Technology $ 794 $1,931 $2,725 $1,169 $1,765 $2,934
Digital Angel Corporation 2,454 1,326 3,780 4,418 456 4,874
InfoTech USA, Inc. 531 236 767 845 331 1,176
All Other -- -- -- -- -- --
Corporate / Eliminations -- -- -- -- 18 18
---------------------------------------------------------------------------------
Total $3,779 $3,493 $7,272 $6,432 $2,570 $9,002
======================================= ========================================
35
NINE-MONTHS ENDED SEPTEMBER 30,
(IN THOUSANDS)
---------------------------------------------------------------------------------
2003 2002
---- ----
---------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
Advanced Technology $ 2,858 $5,321 $ 8,179 $ 4,677 $5,551 $10,228
Digital Angel Corporation 10,974 1,490 12,464 11,231 1,099 12,330
InfoTech USA, Inc. 1,120 690 1,810 2,496 1,010 3,506
All Other -- -- -- 826 339 1,165
Corporate / Eliminations -- -- -- -- 54 54
---------------------------------------------------------------------------------
Total $14,952 $7,501 $22,453 $19,230 $8,053 $27,283
======================================= ========================================
Gross profit margin from continuing operations during the three and
nine-months ended September 30, 2003 and 2002, by segment was as follows:
THREE-MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------------------------------------
2003 2002
---- ----
---------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
% % % % % %
- - - - - -
Advanced Technology 9.3 70.6 24.2 16.7 59.4 29.4
Digital Angel Corporation 36.0 87.7 45.4 50.2 55.2 50.7
InfoTech USA, Inc. 15.5 29.3 18.2 21.9 47.9 25.9
All Other -- -- -- -- -- --
Corporate / Eliminations -- -- -- -- 100.0 100.0
---------------------------------------------------------------------------------
Total 20.2 69.1 30.6 32.7 57.0 37.2
======================================= ========================================
NINE-MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------------------------------------
2003 2002
---- ----
---------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
% % % % % %
- - - - - -
Advanced Technology 12.6 64.1 26.3 22.9 55.8 33.6
Digital Angel Corporation 42.7 65.2 44.5 45.5 54.0 46.2
InfoTech USA, Inc. 12.9 33.8 16.9 14.1 46.5 17.7
All Other -- -- -- 81.5 90.4 83.9
Corporate / Eliminations -- -- -- -- 100.0 100.0
---------------------------------------------------------------------------------
Total 26.2 59.4 32.2 30.1 55.2 34.8
======================================= ========================================
Advanced Technology segment's gross profit decreased $0.2 million
in the three-months ended September 30, 2003, and margin decreased to 24.2%
from 29.4% when compared to the three-months ended September 30 2002. Gross
profit decreased $2.0 million in the nine-months ended September 30, 2003,
and margin decreased to 26.3% from 33.6% when compared to the nine-months
ended September 30, 2002. We attribute the decrease in gross profit in the
three and nine-months ended September 30, 2003, primarily to lower profit
margins on government contract sales, as well as to a reduction in sales of
software and website support, and the sale of one of the businesses in this
group during the fourth quarter of 2002. We attribute the decrease in
margins in the three and nine-months ended September 30, 2003, primarily to
the increase in lower-margin government contract sales, as well as to the
reduction in sales of higher-margin services such as website and software
support.
Digital Angel Corporation segment's gross profit decreased $1.1 million
in the three-months ended September 30, 2003, and margin decreased to 45.4%
in the three-months ended September 30, 2003, from 50.7% in the three-months
ended September 30, 2002. Gross profit increased $0.1 million in the
nine-months ended September 30, 2003, while margin decreased to 44.5% in the
nine-months ended September 30, 2003, from 46.2% in the nine-months ended
September 30, 2002. We attribute the
36
decrease in gross profit for the three months ended September 30, 2003,
primarily to the reduced sales during the period. We attribute the increase
in gross profit for the nine months ended September 30, 2003, primarily to
the previously mentioned sales increase. We attribute the decreases in gross
profit margin primarily to lower margin sales, increased overhead expenses
and increased scrap expense.
InfoTech USA, Inc. segment's gross profit decreased $0.4 million in
the three-months ended September 30, 2003, and margin decreased to 18.2% in the
three-months ended September 30, 2003, from 25.9% in the three-months ended
September 30, 2002. Gross profit decreased $1.7 million in the nine-months
ended September 30, 2003, and margin decreased to 16.9% in the nine-months
ended September 30, 2003, from 17.7% in the nine-months ended September 30,
2002. The decreases in gross profit and gross profit margin during the three
and nine-months ended September 30, 2003, were primarily due to reduced
incentives from manufacturers.
All Other had no gross margin for the three-months ended
September 30, 2003 and 2002, and the nine-months ended September 30, 2003,
compared to gross margin of $1.2 million during the nine-months ended
September 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 expense from continuing operations
was $5.1 million in the three-months ended September 30, 2003, a
decrease of $2.4 million, or 31.7%, from $7.4 million in the three-
months ended September 30, 2002. Selling, general and administrative expense
from continuing operations was $47.0 million in the nine-months ended
September 30, 2003, a decrease of $7.6 million, or 14.0%, from $54.6
million in the nine-months ended September 30, 2002. As a percentage of
total revenue, selling, general and administrative expense from continuing
operations decreased to 21.3% in the three-months ended September 30,
2003, from 30.7% in the three-months ended September 30, 2002, and decreased
to 67.3% in the nine-months ended September 30, 2003, from 69.7% in the
nine-months ended September 30, 2002.
Selling, general and administrative expense from continuing operations
during the three and nine-months ended September 30, 2003 and 2002, by
segment was as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(In thousands) (In thousands)
----------------------------- --------------------------
2003 2002 2003 2002
---- ---- ---- ----
Advanced Technology $ 1,857 $3,106 $ 5,937 $ 9,508
Digital Angel Corporation 4,215 4,051 12,115 11,322
InfoTech USA, Inc. 849 1,125 2,411 3,224
All Other (44) 11 (373) 1,067
Corporate / Eliminations (1,802) (863) 26,915 29,514
----------------------------- --------------------------
Total $ 5,075 $7,430 $47,005 $54,635
============================= ==========================
37
Selling, general and administrative expense as a percentage of revenue
for each of the operating segments was:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- -------------------------
2003 2002 2003 2002
---- ---- ---- ----
% % % %
- - - -
Advanced Technology 16.5 31.1 19.1 31.3
Digital Angel Corporation 50.6 42.1 43.3 42.4
InfoTech USA, Inc. 20.1 24.8 22.5 16.2
All Other -- -- -- --
Corporate / Eliminations (1) (7.6) (3.6) 38.6 38.1
--------------------------- -------------------------
Total 21.3 30.7 67.3 69.7
=========================== =========================
(1) Corporate's percentage has been calculated as a percentage of total
revenue.
Advanced Technology segment's selling, general and administrative
expense decreased $1.2 million, or 40.2%, to $1.9 million in
the three-months ended September 30, 2003 from $3.1 million in the
three-months ended September 30, 2002. Selling, general and administrative
expense decreased $3.6 million, or 37.6%, to $5.9 million in the
nine-months ended September 30, 2003, from $9.5 million in the nine-months
ended September 30, 2002. As a percentage of revenue, selling, general and
administrative expense decreased in the three and nine-months ended
September 30, 2003. We attribute the decrease for the three-months ended
September 30, 2003, primarily to introductory marketing and promotional
costs associated with our VeriChip product, which were incurred during the
three-months ended September 30, 2002, and to the sale of one of the
businesses in this group during the fourth quarter of 2002. We attribute the
decrease for the nine-months ended September 30, 2003, primarily to
decreased legal and 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 segment's selling, general and administrative
expense increased $0.2 million, or 4.0%, to $4.2 million in the three-
months ended September 30, 2003, from $4.1 million in the three-months ended
September 30, 2002. Selling, general and administrative expense increased
$0.8 million, or 7.0%, to $12.1 million in the nine-months ended September
30, 2003, from $11.3 million in the nine-months ended September 30, 2002. We
attribute the increases for the three and nine-months ended September 30,
2003, primarily to additional consulting expenses associated with the
VeriChip product distribution and licensing agreement and the payment of a
$0.2 million credit termination fee to Wells Fargo. Digital Angel
Corporation also incurred additional Board of Director related expenses
during the nine-months ended September 30, 2003. As a percentage of revenue,
selling, general and administrative expense increased during the
three-months ended September 30, 2003, due primarily to the reduction in
sales during the period and the additional expenses noted above. As a
percentage of revenue, selling, general and administrative expense remained
relatively constant during the nine-months ended September 30, 2003, as
compared to the nine-months ended September 30, 2002.
InfoTech USA, Inc. segment's selling, general and administrative
expense decreased $0.3 million, or 24.5%, to $0.8 million in the
three-months ended September 30, 2003, from $1.1 million in the three-months
ended September 30, 2002. Selling, general and administrative expense
decreased $0.8 million, or 25.2%, to $2.4 million in the nine-months ended
September 30, 2003, from $3.2 million in the nine-months ended September 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, costs related to the aborted VeriChip merger which were
expensed during the three-months ended September 30, 2002, and other cost
control programs. As a percentage of revenue, selling, general and
administrative expense decreased in the three-months ended September 30,
2003, due to the VeriChip merger expenses and cost control programs, and
increased in the nine-months ended September 30, 2003, due to the decrease
in sales.
38
All Other's selling, general and administrative expense was a credit
of $44 thousand in the three-months ended September 30, 2003, compared to an
expense of $11 thousand in the three-months ended September 30, 2002.
Selling, general and administrative expense decreased $1.4 million, or
135.0%, to a credit of $0.4 million in the nine-months ended September 30,
2003, from $1.1 million in the nine-months ended September 30, 2002. The
decreases resulted primarily from the settlement of certain litigation for
less than anticipated during the three and nine-months ended September 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 expense
decreased $0.9 million, or 108.8%, resulting in a credit of $1.8
million for the three-months ended September 30, 2003, compared to a credit
of $0.9 million in the three-months ended September 30, 2002. We attribute
this decrease primarily to the reduction of severance expense of $3.9
million. On July 25, 2003, our shareholders approved the terms of Richard
Sullivan's (our former Chairman and Chief Executive Officer) severance
agreement. Since our obligation to Richard Sullivan under his severance
agreement was less than our obligation to him under his employment
agreement, we reversed approximately $3.9 million of severance expense
during the three-months ending September 30, 2003. Partially offsetting this
decrease was a fluctuation of non-cash compensation expense associated with
the re-pricing of 19.3 million stock options during 2001. During the
three-months ended September 30, 2003, we reversed approximately $0.5
million in non-cash compensation expense associated with the re-priced
options compared to a reversal of $2.9 million during the three-months ended
September 2002. 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 result in increases and decreases of non-cash compensation
expense until the options are exercised, forfeited or expired. Also
partially offsetting the decrease was a reversal during the three-months
ended September 30, 2002, of the valuation allowance associated with a note
receivable of approximately $0.9 million.
Selling, general and administrative expense decreased $2.6 million, or
8.8%, to $26.9 million in the nine-months ended September 30, 2003, from
$29.5 million in the nine-months ended September 30, 2002. We attribute the
majority of the decrease to the following factors: 1) we incurred a charge
of approximately $3.9 million during the nine-months ended September 30,
2002, for valuation reserves associated with notes receivable for stock
issuances from certain current and former officers and directors. The
officers and directors received no cash proceeds from these loans. In
September 2000, when the notes were originated, we notified these officers
and directors that we intended to pay their annual interest as part of their
compensation expense/directors remuneration and to provide a gross-up for
the associated income taxes. Annual interest payments were due on September
27, 2001 and September 27, 2002. We chose not to pay the interest and
related tax gross-up. In addition, the principal amount of the notes and a
final annual interest payment became due on September 27, 2003. We,
therefore, consider such notes to be in default and have begun steps to
foreclose on the underlying collateral (all of the stock) in satisfaction of
the notes. Our decision to take this action relates in part to the passage
of the corporate reform legislation under the Sarbanes-Oxley Act of 2002,
which, among other things, prohibits further extension of credit to officers
and directors; 2) we reduced approximately $1.5 million and incurred
approximately $0.5 million in non-cash compensation expense during the
nine-months ended September 30, 2003 and 2002, respectively, due primarily
to re-pricing 19.3 million stock options during 2001; and 3) we recorded
non-cash compensation expense associated with pre-merger Digital Angel
options of approximately $18.7 million during the nine-months ended
September 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
39
intrinsic value of the options converted. Partially offsetting these
decreases were the following: 1) we incurred approximately $17.9 million in
severance expense during the nine-months ended September 30, 2003, which
resulted from the termination of executive officers and director during the
nine-months ended September 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 nine-months
ended September 30, 2003); and 2) we incurred $4.3 million in bonus expense
during the nine-months ended September 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 approvals for our VeriChip product's
heathcare information applications, capital equipment needs, the
requirements of our customers, and opportunities discovered or presented
to us.
RESEARCH AND DEVELOPMENT
Research and development expense from continuing operations was
$1.8 million and $0.9 million for the three months ended September 30, 2003,
and 2002, respectively. Research and development expense from continuing
operations was $4.5 million and $2.5 million for the nine-months ended
September 30, 2003 and 2002, respectively. Research and development expense
increased to 7.7% of revenue in the three-months ended September 30, 2003,
from 3.6% of revenue in the three-months ended September 30, 2002, and
increased to 6.4% of revenue in the nine-months ended September 30, 2003,
from 3.2% of revenue in the nine-months ended September 30, 2002. Research
and development expense relates primarily to the development of our
products, Digital Angel, VeriChip, Thermo Life, Bio-Thermo and PLD, and
Digital Angel Corporation's Sarbe (locator beacon) project.
Research and development expense from continuing operations during the
three and nine-months ended September 30, 2003 and 2002, by segment was as
follows:
THREE-MONTHS ENDED NINE-MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(In thousands) (In thousands)
---------------------------- ------------------------
2003 2002 2003 2002
---- ---- ---- ----
Advanced Technology $ 46 $ 32 $ 147 $ 148
Digital Angel Corporation 1,551 747 3,634 2,228
InfoTech USA, Inc. -- -- -- --
All Other -- -- -- --
Corporate / Eliminations 242 97 683 98
---------------------------- ------------------------
Total $1,839 $876 $4,464 $2,474
============================ ========================
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense from continuing operations
was $0.6 million and $1.3 million for the three-months ended September 30,
2003 and 2002, respectively. Depreciation and amortization expense from
continuing operations was $1.8 million and $3.7 million for the nine-months
ended September 30, 2003 and 2002, respectively. Depreciation and
amortization expense decreased to 2.5% of revenue in the three-months ended
September 30, 2003, from 5.2% of revenue in the three-months ended
September 30, 2002, and decreased to 2.6% of revenue in the nine-months
ended September 30, 2003, from 4.8% of revenue in the nine months ended
September 30, 2002.
40
Depreciation and amortization expense from continuing operations
during the three and nine-months ended September 30, 2003 and 2002, by
segment was as follows:
THREE-MONTHS ENDED NINE-MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(In thousands) (In thousands)
---------------------------- ------------------------
2003 2002 2003 2002
---- ---- ---- ----
Advanced Technology $ 57 $ 158 $ 191 $ 407
Digital Angel Corporation 437 968 1,305 2,900
InfoTech USA, Inc. 56 62 167 205
All Other -- -- -- 9
Corporate / Eliminations 38 69 161 226
----------------------------- --------------------------
Total $588 $1,257 $1,824 $3,747
============================= ==========================
Advanced Technology segment's depreciation and amortization expense
decreased by $0.1 million, or 63.9%, to $0.1 million in the three-months
ended September 30, 2003, from $0.2 million in the three-months ended
September 30, 2002. Depreciation and amortization expense decreased by
$0.2 million, or 53.1%, to $0.2 million in the nine-months ended September 30,
2003, from $0.4 million in the nine-months ended September 30, 2002. We
attribute the decrease to fully depreciating certain assets during 2002 and
2003, our decision to limit our expenditures for property and equipment and
the sale of one of the business units within this group during the fourth
quarter of 2002.
Digital Angel Corporation segment's depreciation and amortization
expense decreased by $0.5 million, or 54.9%, to $0.4 million in the
three-months ended September 30, 2003, from $1.0 million in the three-
months ended September 30, 2002. Depreciation and amortization expense
decreased by $1.6 million, or 55.0%, to $1.3 million in the nine-months
ended September 30, 2003, from $2.9 million in the nine-months ended
September 30, 2002. We attribute the decreases 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. segment's depreciation and amortization expense
decreased slightly during the three and nine-months ended September 30,
2003, as compared to the three and nine-months ended September 30, 2002. We
attribute the decreases primarily to the sale of the Shirley, New York
facility during the three-months ended March 31, 2002, and to fully
depreciating certain assets during 2002 and 2003.
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
decreased in the three and nine-months ended September 30, 2003, as compared
to the three and nine-months ended September 30, 2002. We attribute the
decreases primarily to our decision to limit our expenditures for property
and equipment and to fully depreciating certain assets during 2002 and 2003.
ASSET IMPAIRMENT
During the economic slowdown of 2001 and 2002, and partially
resulting from the terrorist attacks on September 11, 2001, we experienced
deteriorating sales for certain of our businesses. This resulted in the shut
down of several of our businesses during 2001. Also, letters of intent that
we received during the third quarter of 2001 related to the sales of certain
of our businesses had indicated a decline in their fair market values. The
sales of these businesses were due to our financial condition and did not
comprise an entire business segment. Based upon these developments, we
reassessed our future expected operating cash flows and business valuations.
This reassessment resulted in Corporate/Eliminations incurring asset
impairments of $0.8 million for the nine-months ended September 30, 2002.
41
INTEREST AND OTHER INCOME AND INTEREST EXPENSE
Interest income was $0.2 million and $0.7 million, for the three-
months ended September 30, 2003 and 2002, respectively, and $0.7 million and
$1.4 million for the nine-months ended September 30, 2003 and 2002,
respectively. Interest income is earned primarily from short-term
investments and notes receivable.
Interest expense was $1.9 million and $5.8 million, for the
three-months ended September 30, 2003 and 2002, respectively, and $11.1
million and $12.6 million for the nine-months ended September 30, 2003 and
2002, respectively. Interest expense is primarily a function of the level of
outstanding debt and the associated interest rate. The decrease in interest
expense during the three and nine-months ended September 30, 2003, is due
primarily to the repayment of all of our obligations to IBM Credit on
June 30. 2003.
INCOME TAXES
Our effective (benefit) income tax rates were (1.1)% and 1.9% in the
three-months ended September 30, 2003 and 2002, respectively, and 2.6% and
0.0% in the nine-months ended September 30, 2003 and 2002, respectively.
Differences in the effective income tax rate from the statutory federal
income tax rate arise primarily from the timing of the recognition of net
operating loss carryforwards and state taxes net of federal benefits. In
addition, during the nine-months ended September 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 our Intellesale business segment and all of our other "non-core
businesses." Accordingly, the operating results of these entities have been
reclassified and reported as discontinued operations for all periods
presented. As of March 1, 2002, we had sold or closed substantially all of
the businesses comprising Discontinued Operations and there were two
insignificant companies remaining. One of the remaining businesses was sold
effective May 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 September 30, 2003 and 2002,
Discontinued Operations incurred a (decrease) increase in the estimated loss
on disposal and operating losses during the phase out period of $(0.1)
million and $0.1 million, respectively, and during the nine-months ended
September 30, 2003 and 2002, Discontinued Operations incurred an increase
(decrease) in the estimated operating loss on disposal and operating losses
during the phase out period of $0.5 million and $(0.1) million,
respectively. The primary reason for the reduction in estimated losses
during the three-months ended September 30, 2003, and the nine-months ended
September 30, 2002, was a reduction in carrying costs as certain of these
items were settled during the periods for amounts less than previously
anticipated. Carrying costs include the cancellation of facility leases,
employment contract buyouts, sales tax liabilities and litigation reserves.
The primary reasons for the increase in estimated losses during the
nine-months ended September 30, 2003, were an increase in carrying costs and
the loss of $0.1 million on the sale of the one remaining business unit in
this group, which was sold in July 2003, as well as the operations of the
remaining business, and the primary reason for the increase in the
three-months ended September 30, 2002, was the operations of the one
remaining business unit.
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 September 30, 2003:
Balance Balance
Type of Cost December 31, 2002 Additions Deductions September 30, 2003
- ----------------------------------------------------------------------------------------------------------------------------
Estimated loss on sale, net of change in
estimated operating losses $ -- $176 $176 $ --
Carrying costs 4,908 316 111 5,113
----------------------------------------------------------------------
Total $4,908 $492 $287 $5,113
======================================================================
LIQUIDITY AND CAPITAL RESOURCES FROM CONTINUING OPERATIONS
As of September 30, 2003, cash and cash equivalents totaled
$5.3 million, a decrease of $0.5 million, or 8.6%, from $5.8 million at
December 31, 2002.
Cash of $5.0 million was used by operations and cash of $0.7 million
was provided by operations during the nine-months ended September 30, 2003,
and 2002, respectively. In the nine-months ended September 30, 2003, cash
was used primarily to purchase inventory. In the nine-months ended September
30, 2002, cash was provided primarily by collections on accounts receivable
and a decrease in current assets.
Accounts and unbilled receivables, net of allowance for doubtful
accounts, decreased by $1.4 million, or 8.5%, to $15.1 million at September
30, 2003, from $16.5 million at December 31, 2002. We attribute the decrease
primarily to increased collections during the current period.
Inventory levels increased by $3.4 million, or 53.1%, to $9.8 million
at September 30, 2003, from $6.4 million at December 31, 2002. We attribute
the increase primarily to an increase in work-in process related to
government contract projects and the accumulation of inventory by Digital
Angel Corporation in anticipation of future sales.
Accounts payable increased by $2.8 million, or 28.6%, to $12.6 million
at September 30, 2003, from $9.8 million at December 31, 2002, due primarily
to the increase in inventory.
Accrued interest decreased by $10.0 million, or 99.0%, from
$10.1 million at December 31, 2002, due primarily to the payment in full of
all obligations to IBM Credit on June 30, 2003.
Investing activities provided cash of $0.3 million and $5.0 million
in the nine-months ended September 30, 2003 and 2002, respectively. In the
nine-months ended September 30, 2003, cash was provided primarily by
collections on notes receivable of $1.5 million and used primarily to
purchase property and equipment of $1.0 million. In the nine-months ended
September 30, 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, proceeds from the sale of
subsidiaries and business assets of $1.1 million and collection on notes
receivable of $1.0 million. Partially offsetting the amounts provided were
cash used to purchase property and equipment of $1.4 million and cash used
by Discontinued Operations of $0.5 million.
Financing activities provided cash of $4.1 million in the nine-months
ended September 30, 2003, and used cash of $2.3 million in the nine-months
ended September 30, 2002. In the nine-months ended September 30, 2003, cash
of $20.8 million was provided from the issuances of common stock, $10.0
million was provided from the issuance of the Debentures and $2.0 million
was provided from the issuance of long-term debt. During the nine-months
ended September 30, 2003, $27.6 million of cash was
43
used to repay notes payable. In the nine-months ended September 30, 2002,
cash was used primarily to repay $6.4 million against long-term debt and
notes payable. Partially offsetting the use of cash during the nine-months
September 30, 2002, was cash of $1.7 million provided from the issuance of
common shares, cash of $1.3 million provided by long-term debt and cash of
$1.2 million from the collection of notes receivable for shares 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
failed to maintain compliance with certain financial covenants under its
credit agreement with its prior lender, Wells Fargo. Well Fargo provided
Digital Angel Corporation with waivers of such non-compliance. IBM did not
provide a waiver. Digital Angel Corporation terminated its lending
arrangement with Well Fargo on August 28, 2003, as more fully discussed in
Note 4 to the condensed consolidated financial statements.
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 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 $100.0 million (including accrued interest), if we paid IBM
Credit $30 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, we
recorded a gain on the forgiveness of debt of approximately $70.0 million in
the nine-months ended September 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.
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
or exchangeable for shares of Digital Angel Corporation common stock owned
by us, or a combination thereof at any time at the option of the Purchasers,
through the maturity date of November 1, 2005.
On November 12, 2003, we announced that we had entered in a
letter agreement with the Purchasers. Under the letter agreement, the
Purchasers were required to convert a minimum of 50% of the outstanding
principal amount of the Debentures plus all accrued and unpaid interest
into shares of our common stock on November 12, 2003, the First Conversion
Date. The conversion price was $0.35 per share. In addition, per the
terms of the letter agreement, the Purchasers are required to convert
any remaining outstanding principal amount of the Debentures plus accrued
interest on or before November 19, 2003, the Second Conversion Date.
The conversion price for the Second Conversion Date is 84% of the volume-
weighted average trading price of
44
our common stock for the five trading days prior to November 17, 2003 (the
"Discounted VWAP"). If the Discounted VWAP is less than $0.35 per share, the
conversion price shall be $0.35 per share and not the Discounted VWAP and
the Purchasers shall not be obligated to purchase the remaining principal
amount. As of the First Conversion Date, the Purchasers have converted
approximately 93% of the original principal amount of the Debentures. We
have issued 23.8 million shares of our common stock in connection with the
conversions taking place on the First Conversion Date. In addition,
as of November 12, 2003, the Debenture holders have exchanged $0.7 million
of principal amount of the Debentures into 0.3 million shares of the Digital
Angel Corporation common stock owned by us. Following these exchanges, we
currently own 19.3 million shares of Digital Angel Corporation's common
stock, or approximately 71.4% of the shares of Digital Angel Corporation's
common stock outstanding as of November 12, 2003. Any Debenture that is
not converted under the terms of the letter agreement will continue in
accordance with the terms of the Debentures and related agreements, except
that a Debenture holder electing not to convert its Debenture under the
offer may not deem the participation in the offer by the other Debenture
holders to change the price or cause other adjustments to the Debentures.
The Debentures are more fully described in Note 4 to our condensed
consolidated financial statements.
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, and a change in
control of us as defined, among others, constitute events of default. A
principal market is defined as the SmallCap, the Nasdaq National Market, the
New York Stock Exchange, and the American Stock Exchange. We cannot assure
you that we will be able to maintain compliance with these covenants. See
the risk factor, "We cannot provide assurances that we will be able to
maintain our listing on the SmallCap." Failure to maintain compliance could
have a material adverse impact on our financial position, results of
operations and cash flow.
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;
o Attract, motivate and/or retain key executives and employees;
and
o Maintain compliance with the covenants under the Debentures
and related agreements.
Sources of Liquidity
Our operating activities did not provide positive cash flow during
the nine-months ended September 30, 2003, or during 2002 and 2001. In
addition, during the nine-months ended September 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.
45
We are offering up to 30.0 million shares of our common stock in a
public offering registered under the Securities Act of 1933. To date, we
have sold an aggregate of 22.0 million shares of our common stock under the
offering, pursuant to the terms of three separate securities purchase
agreements entered into on September 19, 2003. J.P. Carey Securities, Inc.
acted as our placement agent. The sales resulted in gross proceeds to us of
$8.0 million before deduction of a 2.0% placement agency fee.
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. 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.
Contractual Obligations
The following table shows the aggregate of our contractual cash
obligations as of September 30, 2003:
Less Than 1-3 4-5 After
Contractual Cash Obligations Total 1 Year Years Years 5 Years
- -------------------------------------------------------------------------------------------------------------------------
(amounts in thousands)
- -------------------------------------------------------------------------------------------------------------------------
Notes payable, long-term debt and other(1) $15,824 $5,413 $ 8,170 $ 120 $ 2,121
Operating leases 17,084 1,656 1,778 1,160 12,490
Employment related contracts 4,028 1,573 1,604 276 575
-------------------------------------------------------------------------
Total contractual cash obligations $36,936 $8,642 $11,552 $1,556 $15,186
=========================================================================
(1) Subsequent to September 30, 2003, $9.0 million of the cash obligations
reflected in notes payable long-term and other were settled in shares of our
common stock as a result of the conversion of a significant portion of the
Debentures as more fully discussed in Note 4 to the condensed consolidated
financial statements.
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
On January 28, 2003, the Securities and Exchange Commission issued
FIN 45, Disclosure in Management's Discussion and Analysis about Off-Balance
Sheet Arrangements and Aggregate Contractual Obligations (FIN 45). FIN 45
requires a registrant to provide an explanation of its off-balance sheet
arrangements in a separately captioned subsection of the "Management's
Discussion and Analysis" section of a registrant's disclosure documents. It
also requires registrants to provide an
46
overview of certain known contractual obligations in a tabular format. We
must adopt the disclosure provisions of FIN 45 in our registration
statements, annual reports, proxy statements or information statements that
are required to include our financial statements for the year ended December
31, 2003.
On January 17, 2003, the Securities and Exchange Commission issued
FIN 46, Consolidation of Variable Interest Entities (FIN 46). The primary
objectives of FIN 46 are to provide guidance on the identification of
entities for which control is achieved through means other than through
voting rights ("variable interest entities" or VIEs") and how to determine
when and which business enterprise should consolidate the VIE (the "primary
beneficiary"). This new model for consolidation applies to an entity which
either (1) the equity investors (if any) do not have a controlling financial
interest or (2) the equity investment at risk is insufficient to finance
that entity's activities without receiving addition subordinated financial
support from other parties. In addition, FIN 46 requires that both the
primary beneficiary and all other enterprises with a significant variable
interest in a VIE make addition disclosures. FIN 46 is effective immediately
for VIEs created after January 31, 2003. A company with a variable interest
in a VIE created before February 1, 2003, must apply the provisions of FIN
46 no later than the beginning of the first fiscal year or interim period
beginning after June 15, 2003. The adoption of FIN 46 did not have an impact
on our financial position or results of operations.
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 adopted the provisions of FAS No.
150 effective July 1, 2003. The adoption of FAS No. 150 did not have an
impact on our financial position.
FORWARD LOOKING STATEMENTS AND ASSOCIATED RISKS AND UNCERTAINTIES
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. 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 includes
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;
47
o our ability to successfully integrate the business operations
of acquired companies;
o our future profitability and liquidity;
o our ability to maintain our SmallCap listing;
o governmental export and import policies, global trade
policies, worldwide political stability and economic growth;
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 GENERATE POSITIVE CASH FLOW FROM OPERATIONS 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 nine months of 2003 and during 2002 and 2001. 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. In the future, if we fail to generate
positive cash flow from operations, it will have a materially adverse effect
on our business, financial condition and results of operations.
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;
48
o Attract, motivate and/or retain key executives and
employees; and
o Maintain compliance with the covenants under the Debentures
and related agreements.
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.
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. Since November 12, 2003, our common
stock has traded on the SmallCap under the symbol "ADSX." Since being traded
on the SmallCap, the minimum bid price of our common stock has been less
than the SmallCap's minimum bid price requirement. To maintain our SmallCap
listing, we were required by October 27, 2003, to regain the minimum bid
requirement of at least $1.00 per share for a minimum of ten (10)
consecutive trading days. Our common stock did not regain the minimum bid
price requirement and on October 28, 2003, the Nasdaq Stock Market informed
us by letter that our securities would be delisted from the SmallCap. We
have filed an appeal and an oral hearing request. The hearing request will
stay the delisting of our securities pending a decision by the Nasdaq's
Listing Qualifications Panel ("Panel"). Since we comply with all of the
SmallCap's listing requirements with the exception of the minimum bid
price requirement, and since our Board of Directors has the authority to
effect a reverse stock split which may enable us to meet the minimum bid
price requirement as more fully discussed below, we do not expect to be
delisted from the SmallCap. However, we cannot provide assurances that the
decision of the Panel will result in the continued listing of our common
stock on the SmallCap. If our stock is delisted from the SmallCap, it may
trade on the OTC Bulletin Board or another market or quotation system.
On September 10, 2003, our shareholders approved the granting of
discretionary authority to our Board of Directors for a period of twelve
months to effect a reverse stock split not to exceed a ratio of 1-for-25, or
to determine not to proceed with a 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 Board of
Directors effects a reverse stock split that it will facilitate the
continued listing of our common stock on the SmallCap. See the risk factor,
"We may not be able to maintain compliance with the covenants under the
Debentures and related agreements, including the requirement that our common
stock be eligible for quotation on or quoted for trading on a principal
market, as defined."
49
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-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, all of which have been exercised. 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 required us to issue to him 7.5 million shares of our common stock. We
issued the shares to Garrett Sullivan on August 19, 2003. In September 2003,
Garrett Sullivan surrendered the shares to us. We will reissue the shares to
him upon the effectiveness of the registration statement registering the
shares, which was filed with the SEC on October 6, 2003. The issuance of
these shares to our former executive officers and directors, which have been
approved by our shareholders, will result in an increase in the total number
of our shares outstanding and, as a result, your investment in our common
stock will be further diluted.
WE CANNOT BE CERTAIN OF FUTURE FINANCIAL RESULTS.
We incurred income from continuing operations of $28.8 million
during the nine-months ended September 30, 2003, which included a loss from
continuing operations of $41.2 million, offset by a gain on the forgiveness
of debt of $70.0 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 September
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;
50
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 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 MAY NOT BE ABLE TO MAINTAIN COMPLIANCE WITH THE COVENANTS UNDER
THE DEBENTURES AND RELATED AGREEMENTS, INCLUDING THE REQUIREMENT THAT OUR
COMMON STOCK BE ELIGIBLE FOR QUOTATION ON OR QUOTED FOR TRADING ON A
PRINCIPAL MARKET, AS DEFINED.
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, and a change in
control of us as defined, among others, constitute events of default. A
principal market is defined as the SmallCap, the Nasdaq National Market, the
New York Stock Exchange, and the American Stock Exchange. We cannot assure
you that we will be able to maintain compliance with these covenants. See
the risk factor, "We cannot provide assurances that we will be able to
maintain our listing on the SmallCap." Failure to maintain compliance could
have a material adverse impact on our financial position, results of
operations and cash flow.
WE MAY ISSUE ADDITIONAL SECURITIES, WHICH WOULD ALSO DILUTE THE
VALUE OF YOUR INVESTMENTS IN OUR COMMON STOCK.
As of November 12, 2003, there were 406,491,500 shares of our
common stock outstanding.
51
Since January 1, 2001, we have issued a net aggregate of 305,004,799 shares
of common stock, of which 97,261,634 shares were issued in connection with
acquisitions of businesses and assets, 64,810,635 shares were issued upon
conversion of our Series C preferred stock, 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, an aggregate of 21,965,584 shares
were issued in connection with our current offering up to 30,000,000 shares
of our common stock on a best efforts basis through the efforts of our
placement agent, J.P. Carey Securities, Inc. and 23,765,779 shares have been
issued to date upon conversion of the Debentures. In addition, our
shareholders have approved the issuance of 68.3 million shares of our common
stock in connection with three severance agreements with our former officers
and directors (7.5 million of which are reflected as outstanding at November
12, 2003), the remaining principal amount of 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
Debenture holders, and on August 14, 2003, we entered into a Stock Purchase
Agreement with Digital Angel Corporation whereby we have agreed to issue up
to 19,800,000 shares of our common stock, subject to closing conditions.
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 November 12, 2003, there were outstanding warrants and
options to acquire up to 30,448,083 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
52
continued growth and expansion are also target market segments for some of
the largest and most strongly capitalized companies in the United States and
Europe. In response to competitive pressures, we may be required to reduce
prices or increase spending in order to retain or attract customers or to
pursue new market opportunities. As a result, our revenue, gross profit and
market share may decrease, each of which could significantly harm our
results of operations. In addition, increased competition could prevent us
from increasing our market share, or cause us to lose our existing market
share, either of which would harm our revenues and profitability. We cannot
assure you that we will have the financial, technical, marketing and other
resources required to successfully compete against current and future
competitors or that competitive pressures faced by us will not 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. 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.
53
WE HAVE GRANTED A SECURITY INTEREST IN OUR ACCOUNTS RECEIVABLE AND
THE ACCOUNTS RECEIVABLE OF OUR WHOLLY-OWNED SUBSIDIARY, COMPUTER EQUITY
CORPORATION, AS COLLATERAL FOR THE DEBENTURES AND IF THE DEBENTURE HOLDERS
WERE TO ENFORCE THEIR RIGHTS AGAINST THESE ASSETS, IT COULD HAVE AN
ADVERSE EFFECT ON OUR BUSINESS.
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 Debenture holders a security interest in all of our
accounts receivable. If we are not successful in satisfying the payment
obligations under the Debentures or we do not comply with the terms of the
Debentures and the Debenture holders were to enforce their rights against
our accounts receivable and the accounts receivable of Computer Equity
Corporation, there could be no assurance that we would have liquidity and
access to funds necessary to provide for our ongoing operations; at that
time, there would be substantial doubt that we would be able to continue
operations in the normal course of business.
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 through March 2013. 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.
54
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.
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 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 have
recently submitted a 510-K application to the FDA to obtain permission to
market VeriChip for certain healthcare information applications. 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.
The Digital Angel Corporation product line is subject to federal,
state and local regulation in the United States and other countries, and we
cannot predict the extent to which Digital Angel Corporation's business 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.
55
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 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 PLD TECHNOLOGY HAS NOT YET BEEN DEVELOPED FOR COMMERCIAL
DEPLOYMENT.
The PLD technology has been successfully tested in the laboratory.
Our ability to develop and commercialize products based on this proprietary
technology 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 PLD
technology 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.
56
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. Our borrowings under the
Debentures bear interest at a fixed rate. Digital Angel Corporation's
borrowings under its loan agreements with Laurus bear interest at prime plus
1.75%, to prime plus 2.50%, subject to certain minimums. 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 quarterly period ended September 30,
2003. 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 November 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 September 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.
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
57
lease and which is no longer in use. The trial date has been set for
November 2003.
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 arose from a vacation guarantee
insurance policy (the "Insurance Contract") allegedly purchased by
Plaintiffs from the Defendants on March 6, 2000. The complaint alleged,
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. and the intentional infliction of emotional distress on
Plaintiffs. Effective September 9, 2003, this lawsuit was settled and the
Plaintiffs executed a Full Release and Covenant Not to Sue in which the
Plaintiffs agreed to forgo any action against Digital Angel Corporation in
consideration for a payment within Digital Angel Corporation's insurance
limits.
ITEM 2. CHANGES IN SECURITIES
Recent Sales of Unregistered Securities
The following table lists all unregistered securities sold by us
between July 1, 2003, and September 30, 2003. 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 NUMBER OF
AMOUNT OF NUMBER OF ISSUED COMMON
NAME/ENTITY/NATURE DATE OF SALE CONSIDERATION PERSONS NOTE FOR SHARES
================================================================================================================
Severance
Garrett Sullivan August 2003 $3,525,000 1 (1) Agreement 7,500,000
---------------
Total 7,500,000
===============
(1) Represents shares issued to Mr. Garrett Sullivan in connection with a
severance agreement, 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. In September 2003, Garrett Sullivan surrendered the shares
to us. We will reissue the shares to him upon the effectiveness of a
registration statement registering the shares.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
58
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A special meeting of our shareholders was held on September 10,
2003 to:
(1) Approve the potential issuance of up to approximately
26,200,000 shares of our common stock upon the conversion or redemption of
our $10,500,000 aggregate principal amount of 8.5% Convertible Exchangeable
Debentures and 5,352,773 shares of our common stock upon the exercise of
related stock purchase warrants. The proposal received 37,401,447 votes for,
22,642,283 votes against, and 2,834,249 abstentions;
(2) Approval of the issuance of up to 30,000,000 shares of our
common stock after effectiveness of our registration statement on Form S-1
(File No. 333-106300), which was filed with the Securities and Exchange
Commission on June 20, 2003. The proposal received 36,033,932 votes for,
23,986,478 votes against, and 2,857,568 abstentions; and
(3) Approval of an amendment to our Third Restated Articles of
Incorporation, as amended, effecting a reverse stock split of our common
stock and granting of discretionary authority to the Board of Directors for
a period of twelve months after the date our shareholders approve this
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 proposal received
293,145,335 votes for, 28,791,946 votes against and 2,624,660 abstentions.
Broker non-votes were not counted with respect to matters submitted
for a vote at the meeting.
All of the proposals were approved.
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) Form 8-K dated July 9, 2003, under Item 5.
"Other Events" 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.
(ii) Form 8-K dated August 15, 2003, under Item 5.
"Other Events" containing our earning release dated
August 14, 2003.
(iii) Form 8-K dated August 22, 2003, under Item 5.
"Other Events" announcing the terms of a Stock Sale
Plan dated August 11, 2003, between Daniel E. Penni,
a member of our Board of Directors, and his broker.
(iv) Form 8-K dated September 22, 2003, under
Item 5. "Other Events" announcing
59
that we had entered into three separate securities
purchase agreements to sell an aggregate of up to
22,857,143 shares of our common stock.
(v) Form 8-K dated November 3, 2003, under Item 5.
"Other Events" containing our press release dated
October 31, 2003, announcing that we had received
notification from the Nasdaq that our common stock
did not meet the $1.00 minimum bid closing price
requirement of Nasdaq Marketplace Rule 4310 (c)(4).
(vi) Form 8-K dated November 14, 2003, under Item
5. "Other Events" announcing the terms of an
agreement to satisfy our aggregate principal
amount of $10.5 million 8.5% Convertible
Exchangeable Debentures, which were originally
issued on June 30, 2003.
(vii) Form 8-K dated November 14, 2003, under Item
9. "Regulation FD" containing our earnings release
dated November 14, 2003.
60
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: November 14, 2003 By: /S/ EVAN C. MCKEOWN
---------------------------
Evan C. McKeown
Senior Vice President,
Chief Financial Officer
61
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
62
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 Fourth Restated Articles of Incorporation of the Registrant filed
with the Secretary of State of Missouri on August 26, 2003
(incorporated by reference to Exhibit 4.5 to the registrant's
Registration Statement on Form S-1 (File No. 333-108338) filed with
the Commission on August 28, 2003)
4.6 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)
4.7 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)
4.8 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)
63
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)
64
10.24 Warrant Agreement between VeriChip Corporation and IBM Credit
Corporation dated August 21, 2002 (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)
65
10.36 Security Agreement among Applied Digital Solutions, Inc., Computer
Equity Corporation and the Secured 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)
10.39 Stock Purchase Agreement between Applied Digital Solutions, Inc.
and Digital Angel Corporation dated August 14, 2003 (incorporated
herein by reference to Exhibit 10.39 to the registrant's
Registration Statement on Form S-1 (File No. 333-109512) filed with
the Commission on October 6, 2003)
10.40 Securities Purchase Agreement between Applied Digital Solutions, Inc.
and First Investors Holding Co., Inc. dated September 19, 2003,
(incorporated herein by reference to Exhibit 10.1 to the registrant's
Current Report on Form 8-K filed with the Commission on September 22,
2003)
10.41 Securities Purchase Agreement between Applied Digital Solutions,
Inc. and Magellan International LTD dated September 19, 2003,
(incorporated herein by reference to Exhibit 10.2 to the registrant's
Current Report on Form 8-K filed with the Commission on September
22, 2003)
10.42 Securities Purchase Agreement between Applied Digital Solutions,
Inc. and Cranshire Capital, LP dated September 19, 2003,
(incorporated herein by reference to Exhibit 10.3 to the registrant's
Current Report on Form 8-K filed with the Commission on September
22, 2003)
10.43 Form of letter agreement between Applied Digital Solution, Inc. and
each of the Purchasers (incorporated herein by reference to
Exhibit 99.1 to the registrant's Current Report on Form 8-K filed
with the Commission on November 14, 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)*
99.1 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*
99.2 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*
* Filed herewith
66