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EX-32.1 - SECTION 906 CERTIFICATION - VERITEQex32-1.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________
 
Form 10-Q

(Mark One)
 
R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the quarterly period ended September 30, 2010
   
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the transition period from______________to______________

Commission file number: 000-26020
________________
 
DIGITAL ANGEL CORPORATION
(Exact Name of Registrant as Specified in Its Charter)

Delaware
43-1641533
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification Number)
   
490 Villaume Avenue, South St. Paul, Minnesota
55075
(Address of Principal Executive Offices)
(Zip Code)

(651) 455-1621
Registrant’s Telephone Number, Including Area Code
__________________

 (Former Name, Former Address and Formal Fiscal Year, if Changed Since Last Report)

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 R No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).      Yes £ No £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one).
 
Large accelerated filer  £ Accelerated filer  £
   
Non-accelerated filer  £ Smaller reporting company  R
(Do not check if smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No R

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
Class
 
Outstanding at November 12, 2010
Common Stock, $.01 par value per share
 
29,152,126 shares
 
 


 
 

 
 
DIGITAL ANGEL CORPORATION

TABLE OF CONTENTS

 
 
Page
     
PART I – Financial Information
     
Item 1.
Financial Statements (unaudited):
3
     
 
Condensed Consolidated Balance Sheets – As of September 30, 2010 and December 31, 2009
3
     
 
Condensed Consolidated Statements of Operations – Three and nine-months ended September 30, 2010 and 2009
4
     
 
Condensed Consolidated Statement of Changes in Stockholders’ Equity – Nine-months ended September 30, 2010
6
     
 
Condensed Consolidated Statements of Cash Flows – Nine-months ended September 30, 2010 and 2009
7
     
 
Notes to Condensed Consolidated Financial Statements
8
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
21
     
Item 4T.
Controls and Procedures
32
     
PART II – Other Information
     
Item 1.
Legal Proceedings
33
     
Item 6.
Exhibits
33
     
 
Signatures
34
     
 
Certifications
 

 
2

 

PART I – FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS

DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands, except par values)
 
   
September 30,
2010
   
December 31,
2009
 
Assets
 
(unaudited)
       
Current Assets
           
Cash and cash equivalents
  $ 1,641     $ 1,895  
Restricted cash
          202  
Accounts receivable, net of allowance for doubtful accounts of $841 and $906 at September 30, 2010 and December 31, 2009, respectively
    5,258       6,370  
Inventories
    8,799       8,980  
Other current assets
    3,309       2,514  
Current assets of discontinued operations
    1,499       3,735  
Total Current Assets
    20,506       23,696  
                 
Property and equipment, net
    5,539       6,998  
Goodwill
    3,339       3,343  
Intangible assets, net
    10,144       11,447  
Other assets, net
    1,100       1,195  
Other assets of discontinued operations
          365  
Total Assets
  $ 40,628     $ 47,044  
                 
Liabilities and Stockholders’ Equity
               
Current Liabilities
               
Notes payable and current maturities of long-term debt
  $ 3,616     $ 7,263  
Mortgage note payable
    1,977       2,034  
Accounts payable
    8,095       7,905  
Advances from factors
    1,133       1,240  
Accrued expenses
    7,645       6,580  
Deferred gain on sale
    1,678       960  
Deferred revenue
    516       548  
Current liabilities of discontinued operations
    2,109       2,734  
Total Current Liabilities
    26,769       29,264  
                 
Long-term debt and notes payable
    161       392  
Other liabilities                                                                                                     
    961       1,445  
Total Liabilities
    27,891       31,101  
                 
Commitments and ontingencies:
               
                 
Stockholders’ Equity:
               
Digital Angel Corporation stockholders’ equity:
               
Preferred shares ($10 par value; shares authorized, 5,000; shares issued, nil)
           
Common shares ($0.01 par value; shares authorized, 50,000; shares issued and outstanding, 28,319 and 23,479)
    283       235  
Additional paid-in capital
    590,679       588,652  
Accumulated deficit
    (576,535 )     (571,203 )
Accumulated other comprehensive income (loss) – foreign currency translation
    (1,653 )     (1,737 )
Total Digital Angel Corporation stockholders’ equity
    12,774       15,947  
Noncontrolling interest
    (37 )     (4 )
Total Stockholders’ Equity
    12,737       15,943  
Total Liabilities and Stockholders’ Equity
  $ 40,628     $ 47,044  

See Notes to Condensed Consolidated Financial Statements.

 
3

 

DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
 (in thousands, except per share data)
 
   
For the Three-Months Ended
September 30, 2010
   
For the Three-Months Ended
September 30, 2009
 
             
Revenue
  $ 9,111     $ 9,919  
                 
Cost of sales
    6,534       6,084  
                 
Gross profit
    2,577       3,835  
                 
Selling, general and administrative expenses
    4,274       5,343  
Research and development expenses
    257       285  
Restructuring, severance and separation expenses
    14       142  
Total operating expenses
    4,545       5,770  
                 
Operating loss
    (1,968 )     (1,935 )
                 
Interest and other income (expense), net
    30       34  
Interest expense
    (283 )     (619 )
                 
Loss from continuing operations before income tax (provision) benefit
    (2,221 )     (2,520 )
                 
(Provision) benefit for income taxes
    (8 )     60  
                 
Loss from continuing operations
    (2,229 )     (2,460 )
                 
(Loss) income from discontinued operations, net of income tax provision of nil and $7
    (245 )     785  
                 
Net loss
    (2,474 )     (1,675 )
                 
Loss attributable to the noncontrolling interest, continuing operations
    20       14  
Loss (income) attributable to the noncontrolling interest, discontinued operations
    4       (12  
                 
Net loss attributable to Digital Angel Corporation
  $ (2,450 )   $ (1,673 )
                 
(Loss) income per common share attributable to Digital Angel Corporation common stockholders – basic and diluted:
               
Loss from continuing operations, net of noncontrolling interest
  $ (0.08 )   $ (0.13 )
(Loss) income from discontinued operations, net of noncontrolling interest
    (0.01 )     0.04  
Net loss
  $ (0.09 )   $ (0.09 )
                 
Weighted average number of common shares outstanding – basic and diluted
    28,215       18,271  

See Notes to Condensed Consolidated Financial Statements.

 
4

 

DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
 (in thousands, except per share data)
 
   
For the Nine-
Months Ended
September 30, 2010
   
For the Nine-
Months Ended
September 30, 2009
 
             
Revenue
  $ 28,703     $ 32,645  
                 
Cost of sales
    18,339       20,151  
                 
Gross profit
    10,364       12,494  
                 
Selling, general and administrative expenses
    14,042       17,024  
Research and development expenses
    766       853  
Restructuring, severance and separation expenses
    1,229       455  
Total operating expenses
    16,037       18,332  
                 
Operating loss
    (5,673 )     (5,838 )
                 
Interest and other income (expense), net
    (325 )     169  
Interest expense
    (954 )     (1,687 )
                 
Loss from continuing operations before income tax (provision) benefit
    (6,952 )     (7,356 )
                 
(Provision) benefit for income taxes
    (23 )     4  
                 
Loss from continuing operations
    (6,975 )     (7,352 )
                 
Income from discontinued operations, net of income tax provision of nil and $22
    1,615       3,578  
                 
Net loss
    (5,360 )     (3,774 )
                 
Loss attributable to the noncontrolling interest, continuing operations
    49       27  
Income attributable to the noncontrolling interest, discontinued operations
    (21 )     (54 )
                 
Net loss attributable to Digital Angel Corporation
  $ (5,332 )   $ (3,801 )
                 
(Loss) income per common share attributable to Digital Angel Corporation common stockholders – basic and diluted:
               
Loss from continuing operations, net of noncontrolling interest
  $ (0.25 )   $ (0.41 )
Income from discontinued operations, net of noncontrolling interest
    0.06       0.20  
Net loss
  $ (0.19 )   $ (0.21 )
                 
Weighted average number of common shares outstanding – basic and diluted
    27,366       17,798  

See Notes to Condensed Consolidated Financial Statements.

 
5

 

DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statement of Changes in Stockholders’ Equity (Unaudited)
For the Nine-Months Ended September 30, 2010
(in thousands)
 
 
Digital Angel Corporation Shareholders
             
 
Common Stock
   
Additional
Paid-In
   
Accumulated
   
Accumulated
Other
Comprehensive
   
Noncontrolling
   
Total Stockholders’
 
 
Number
   
Amount
   
Capital
   
Deficit
   
Income (Loss)
   
Interest
   
Equity
 
                                         
Balance, December 31, 2009
  23,479     $ 235     $ 588,652     $ (571,203 )   $ (1,737 )   $ (4 )   $ 15,943  
                                                       
Net loss
                    (5,332 )           (28 )     (5,360 )
Comprehensive loss:
                                                     
Foreign currency translation
                          84       (5 )     79  
Total comprehensive loss
                          (5,332 )     84       (33 )     (5,281 )
                                                       
Issuance of common stock in settlement for payables and for services
  786       8       350                         358  
Issuance of common stock and cash for price protection under the terms of a legal settlement
  314       3       (43 )                       (40 )
Sale of common stock
  3,385       34       1,659                         1,693  
Sale of common stock under the Standby Equity Distribution Agreement
  94       1       60                         61  
Financing fees
              (165 )                       (165 )
Share-based compensation
  261       2       766                         768  
Stock issuance costs
              (74 )                       (74 )
Issuance of warrants
              (526 )                       (526 )
                                                       
Balance, September 30, 2010
  28,319     $ 283     $ 590,679     $ (576,535 )   $ (1,653 )   $ (37 )   $ 12,737  

 
See Notes to Condensed Consolidated Financial Statements.

 
6

 

DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
(in thousands)

   
For the Nine-
Months Ended
September 30, 2010
   
For the Nine-
Months Ended
September 30, 2009
 
Cash Flows From Operating Activities            
Net loss
  $ (5,360 )   $ (3,774 )
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
               
Income from discontinued operations
    (1,615 )     (3,578 )
Equity compensation and administrative expenses
    780       428  
Depreciation and amortization
    2,436       2,898  
Loss on sale of equipment
    243        
Amortization of debt discount and financing costs
    417       446  
Allowance for doubtful accounts
    (65 )     123  
Inventory excess and obsolescence adjustments
    978        
Change in fair value of warrant liability
    8       (39 )
Changes in assets and liabilities:
               
Decrease (increase) in restricted cash
    192       (196 )
Decrease in accounts receivable
    1,330       1,367  
Increase in inventories
    (865 )     (2,249 )
(Increase) decrease in other current assets
    (404 )     332  
Increase in accounts payable, accrued expenses and other liabilities
    580       2,374  
Net cash provided by discontinued operations
    3,377       4,635  
Net Cash Provided by Operating Activities
    2,032       2,767  
                 
Cash Flows From Investing Activities
               
Collections of notes receivable
    617       314  
Increase in other assets
    (266 )     (125 )
Payments for property and equipment
    (57 )     (404 )
Net cash used in discontinued operations
    (38 )     (225 )
Net Cash Provided by (Used in) Investing Activities
    256       (440 )
                 
Cash Flows From Financing Activities
               
Amounts paid on notes payable
    (1,884 )     (1,718 )
Net payments of debt
    (2,144 )     (3,435 )
Sale of common stock in private placement
    1,693       127  
Sale of common stock under the Standby Equity Distribution Agreement
    61       1,590  
Stock issuance costs
    (74 )     (108 )
Financing costs
    (165 )      
Net cash provided by discontinued operations
          1,641  
Net Cash Used in Financing Activities
    (2,513 )     (1,903 )
                 
Net (Decrease) Increase In Cash and Cash Equivalents
    (225 )     13  
                 
Effect of Exchange Rate Changes on Cash and Cash Equivalents
    (29 )     437  
                 
Cash and Cash Equivalents – Beginning of Period
    1,895       1,414  
                 
Cash and Cash Equivalents – End of Period
  $ 1,641     $ 1,851  

See Notes to Condensed Consolidated Financial Statements.
 
 
7

 
DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
 
 
1.  Basis of Presentation

Digital Angel Corporation, a Delaware corporation, and its subsidiaries, (referred to together as, “Digital Angel,” “the Company,” “we,” “our,” and “us”) develops innovative identification and security products for consumer, commercial and government sectors worldwide. Our unique and often proprietary products provide identification and security for people, animals, food chains, government/military assets, and commercial assets. Included in this diverse product line are applications for radio frequency identification systems (“RFID”), global positioning systems (“GPS”) and satellite communications.

The accompanying condensed consolidated financial statements of the Company have been prepared in accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”) and with the instructions to Form 10-Q and Article 8 of Regulation S-X under the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The interim financial information in this report has not been audited. In the opinion of the Company’s management, all adjustments (consisting of normal recurring adjustments) considered necessary for fair financial statement presentation have been made. Results of operations reported for interim periods may not be indicative of the results for the entire year. These condensed consolidated financial statements and notes should be read in conjunction with the consolidated financial statements and notes included in our Form 10-K for the year ended December 31, 2009, filed with the Securities and Exchange Commission (“SEC”) on April 1, 2010.

The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Although these estimates are based on the knowledge of current events and actions that we may undertake in the future, they may ultimately differ from actual results. Included in these estimates are assumptions about allowances for inventory obsolescence, bad debt reserves, lives of long-lived assets and intangible assets, assumptions used in Black-Scholes valuation models and the determination of whether any impairment is to be recognized on long-lived and intangible assets, among others.

Currently, we operate in two business segments: Animal Identification, which comprises the operations of our wholly-owned subsidiary, Destron Fearing Corporation (“Destron”), and Emergency Identification, which comprises the operations of our 98.5%-owned subsidiary, Signature Industries Limited (“Signature”). Our segments are discussed in Note 6.

Discontinued Operations

In 2008, our board of directors decided to sell our wholly-owned subsidiary Thermo Life Energy Corp. (“Thermo Life”) and in 2009, decided to sell our ownership in Signature’s business unit, McMurdo Limited (“McMurdo”). During the first and second quarter of 2010, we sold our Control Products business unit (“Control Products Group”) and Clifford and Snell business unit (“Clifford & Snell”), respectively, both of which were divisions of Signature. The decisions to sell these businesses were made as part of management’s strategy to streamline operations to focus our efforts on the Animal Identification segment. As a result, these sold businesses are presented in discontinued operations for all periods presented. Discontinued operations are more fully discussed in Note 9.

Related Parties

We have in the past entered into various related party transactions. Each of these transactions is described in Note 20 to our Annual Report on Form 10-K for the year ended December 31, 2009. During the nine months ended September 30, 2010, we had the following related party transactions:

 
·
On January 21, 2010, we sold the assets of Thermo Life to Ingo Stark, an employee and scientist at Thermo Life.
 
·
On January 25, 2010, we sold our Control Products Group to Gary Lawrence, the former manager of the Control Products Group for the past several years, and another former employee.

Both sales are more fully discussed in Note 9.
 
 
8

 
DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)(continued)
 
 
1.  Basis of Presentation (continued)

Liquidity

The Company is technically currently in default on our mortgage loan which matured on November 1, 2010 but has received a forbearance from the current mortgage lender stating that there would be no default remedies taken through November 30, 2010 to enable the parties to discuss a resolution to the default. We are having discussions to extend our existing mortgage loan with the current lender while we are pursing loan refinancing with another lender, which discussions are already underway. If we are unable to extend the loan or refinance with another lender and the current lender withdraws the forbearance, they could pursue the default remedies under the loan. This could trigger a cross default under our TCI Revolving Credit Facility which could result in an increase in annual interest rate to the floating rate plus 4%. In addition, TCI could, at any time, refuse to make any requested advance, demand payment of the advances or terminate the facility. All indebtedness under both the mortgage and the TCI Revolving Credit Facility are classified as current liabilities at September 30, 2010.
 
Our goal is to achieve profitability and to generate positive cash flows from operations. During 2008, we restructured our Animal Identification segment which eliminated redundancies, improved gross margins and decreased expenses. In the second quarter of 2010, we restructured our Corporate activities. Our capital requirements depend on a variety of factors, including but not limited to, the rate of increase or decrease in our existing business base; the success, timing, and amount of investment required to bring new products on-line and complete existing contract deliveries; revenue growth or decline; and potential acquisitions or divestitures. We established a management plan to guide us in our goal of achieving profitability and improving positive cash flows from operations although no assurance can be given that we will be successful in implementing the plan. Failure to generate positive cash flow from operations will have a material adverse effect on our business, financial condition and results of operations.

Our historical sources of liquidity have included proceeds from the sale of common stock and preferred shares, proceeds from the issuance of debt, proceeds from the sale of businesses, and proceeds from the exercise of warrants. In addition to these sources, other sources of liquidity may include the raising of capital through additional private placements or public offerings of debt or equity securities. However, going forward some of these sources may not be available, or if available, they may not be on favorable terms. We will be required to generate funds to repay certain of our debt obligations during 2010. As of September 30, 2010, we had a working capital deficiency, which is primarily due to a number of our debt obligations becoming due or potentially due within the next twelve months. Specifically, these obligations include: (i) our mortgage note which matured November 1, 2010; (ii) our factoring lines; and (iii) our credit facility with Danske Bank, which are more fully discussed in Note 9 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2009. In addition, our debt obligation to Danske Bank is due on demand and we are required to make monthly principal payments as more fully discussed in Note 9 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2009. Our factoring lines may also be amended or terminated at any time by the lenders. These conditions indicate that we may not be able to continue operations as a going concern, as we may be unable to generate the funds necessary to pay our obligations in the ordinary course of business. The accompanying financial statements do not include any adjustments related to the recoverability and classification of asset carrying amounts or the amounts and classification of liabilities that may result from the outcome of this uncertainity.
 
2.  Impact of Recently Issued Accounting Standards
 
In February 2010, the Financial Accounting Standards Board (“FASB”) issued an amendment to the guidance on subsequent events that removed the requirement for an SEC registrant to disclose the date through which subsequent events are evaluated. It did not change the accounting for or disclosure of events that occur after the balance sheet date but before the financial statements are issued. This amendment was effective upon issuance.

 
9

 
DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)(continued)
 
 
3.  Inventories

Inventories, net of writedowns for excess and obsolescence, consist of the following:

   
September 30,
   
December 31,
 
   
2010
   
2009
 
   
(in thousands)
 
Raw materials
  $ 7,559     $ 7,446  
Work in process
    128       738  
Finished goods
    1,112       796  
Total inventory
  $ 8,799     $ 8,980  

We had $6.7 million and $7.1 million of our inventory at foreign locations at September 30, 2010 and December 31, 2009, respectively.

4.  Loss Per Share

A reconciliation of the numerator and denominator of basic and diluted (loss) income per share is provided as follows, in thousands, except per share amounts:

   
Three-Months Ended
September 30,
 
Nine-Months Ended
September 30,
 
   
2010
   
2009
 
2010
 
2009
 
Numerator for basic and diluted (loss) income per share attributable to Digital Angel Corporation:
                       
Loss from continuing operations, net of noncontrolling interest
  $ (2,209 )   $ (2,446 )   $ (6,926 )   $ (7,325 )
(Loss) income from discontinued operations, net of noncontrolling interest
    (241 )     773       1,594       3,524  
Net loss attributable to common stockholders
  $ (2,450 )   $ (1,673 )   $ (5,332 )   $ (3,801 )
                                 
Denominator for basic and diluted (loss) income per share attributable to Digital Angel Corporation:
                               
Basic and diluted weighted-average shares outstanding (1)
    28,215       18,271       27,366       17,798  
                                 
(Loss) income per share attributable to Digital Angel Corporation — basic and diluted:
                               
Continuing operations, net of noncontrolling interest
  $ (0.08 )   $ (0.13 )   $ (0.25 )   $ (0.41 )
Discontinued operations, net of noncontrolling interest
    (0.01 )     0.04       0.06       0.20  
Total — basic and diluted
  $ (0.09 )   $ (0.09 )   $ (0.19 )   $ (0.21 )

(1)
The following stock options and warrants outstanding as of September 30, 2010 and 2009 were not included in the computation of dilutive (loss) income per share because the net effect would have been anti-dilutive: 

   
September 30,
 
   
2010
   
2009
 
   
(in thousands)
 
Stock options
   
3,020
     
2,701
 
Warrants
   
1,521
     
314
 
Restricted stock
   
373
     
20
 
   Total
   
4,914
     
3,035
 
 
 
10

 
DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)(continued)
 
 
5.  Financings
 
We have entered into various financing agreements as more fully described in Note 9 to our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2009. The following are descriptions of our financing agreements that have been entered into, modified or terminated during 2010:
 
Senior Secured Term Notes

In August 2006, we entered into a term note (“2006 Note”) with Laurus Master Fund, Ltd. (“Laurus”) in the original principal amount of $13.5 million. The 2006 Note, as amended, accrued interest at a rate of 12% per annum, was payable monthly and had a maturity date of February 1, 2010. In August 2007, we entered into a $7.0 million term note (“2007 Note”) with Kallina Corporation (“Kallina”) pursuant to the terms of a Securities Purchase Agreement between us and Kallina. The 2007 Note, as amended, accrued interest at a rate of 12% per annum, was payable monthly and had a maturity date of February 1, 2010. In October 2008, we entered into a letter agreement with Laurus, Kallina, Valens U.S. SPV I, LLC, Valens Offshore SPV I Ltd., Valens Offshore SPV II Corp and PSource Structured Debt Limited (collectively referred to as the “Lenders”) and issued a $2.0 million senior secured, non-convertible term note (the “2008 Note”) to the Lenders which accrued interest at a rate equal to 12% and was due in full on February 1, 2010. The 2006 Note, the 2007 Note and the 2008 Note (collectively the “Debt Obligations”) allowed for optional redemption without a prepayment penalty.

At December 31, 2009, the remaining amount owed under our Debt Obligations was approximately $1.4 million. On February 1, 2010, the maturity date, we paid the final balance of approximately $1.4 million on the Debt Obligations.

Registered Direct Offering

On February 9, 2010, we sold, in a registered direct offering, 3,385,000 shares of our common stock and warrants to purchase 1,354,000 shares of common stock to two institutional investors pursuant to the terms of a securities purchase agreement we entered into on February 3, 2010. The purchase price of the securities was $1.7 million in the aggregate. We entered into a placement agent agreement with Chardan Capital Markets, LLC (“Chardan”) relating to our registered direct offering where we agreed to pay Chardan a placement agent fee of 6.0% of the gross proceeds from the sale. The net proceeds from the sale, after deducting the placement agent fee and other offering expenses, were approximately $1.6 million and were used primarily to cover the repayment of the Debt Obligations discussed above.

The exercise price of the warrants is $0.50 per share, and the warrants may be immediately exercised and expire seven years from the date of issuance. The warrants are not exercisable by a holder to the extent that such holder or any of its affiliates would beneficially own in excess of 4.9% of our common stock. If at the time of exercise, the registration statement relating to the shares underlying the warrants is not effective, or if the related prospectus is not available for use, then a holder of warrants may elect to exercise warrants using a net exercise (i.e., cashless exercise) mechanism. The warrants are entitled to “full-ratchet” anti-dilution protection. If we grant, issue or sell any options, convertible securities or rights to purchase stock, warrants, other securities or other property pro rata to the record holders of any class of the shares of common stock (the “Purchase Rights”), the holders of warrants are entitled to acquire such Purchase Rights which the holders could have acquired if the holders had held the number of shares of Common Stock acquirable upon the complete exercise of the holder’s warrants. We may not enter into certain fundamental transactions, such as a merger, consolidation, sale of substantially all assets, tender offer or exchange offer with respect to our common stock or reclassification of our common stock, unless the successor entity assumes in writing all of our obligations under the warrants. If certain fundamental transactions occur with respect to us or our “significant subsidiaries” as defined by Rule 1-02 of Regulation S-X, at the holder’s request within fifteen days after each fundamental transaction (“Holder Option Period”), we or the successor entity shall purchase the warrants from the holder for an amount equal to the value of the unexercised portion of the warrants that remain as of the time of such fundamental transaction based on the Black Scholes Option Pricing Model obtained from the “OV” function on Bloomberg, L.P. If such redemption option is not exercised by the holder during the Holding Option Period, we have an option to repurchase the unexercised portion of the warrants for the same amount within ten days after the expiration of the Holder Option Period. We have estimated the initial value of the warrants to be approximately $0.5 million based on a valuation model considering a sensitivity analysis performed to evaluate the impact on value of a potential down round, and using the following assumptions: dividend yield of 0.0%; volatility of 124.14%; expected life of seven years; and a risk-free rate of 3.08%.

 
11

 
DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)(continued)

 
5.  Financings (continued)

The value of the warrants is reflected in our consolidated balance sheet as a liability and the warrants are required to be revalued at each reporting period. Based on the valuation at September 30, 2010, we recorded other income (expense) of approximately $0.1 million and $8 thousand during the three and nine-months ended September 30, 2010, respectively. We determined the value at September 30, 2010 to be approximately $0.5 million, based on a valuation model considering a sensitivity analysis performed to evaluate the impact on value of a potential down round, and using the following assumptions: dividend yield of 0.0%; volatility of 93.2%; expected life of 6.3 years and a risk-free rate of 1.9%. Going forward, changes in the value of the warrants will result in additional increases or decreases in other income (expense) in our consolidated statement of operations.

Termination of Standby Equity Distribution Agreement

On July 10, 2009, we entered into a Standby Equity Distribution Agreement (the “SEDA”) with YA Global Master SPV Ltd. (“YA SPV”), an affiliate of Yorkville Advisors, for the sale of up to $5.0 million of shares of our common stock over a two-year commitment period. Under the terms of the SEDA, we could from time to time, at our discretion, sell newly-issued shares of our common stock to YA SPV. We issued shares of our common stock under the SEDA pursuant to a Registration Statement on Form S-3 (Registration No. 333-159880), declared effective by the SEC on July 9, 2009 wherein we registered 3.0 million shares of our common stock.

The SEDA required payment of a commitment fee to YA SPV in an amount equal to $125,000. We delivered approximately 88 thousand shares of common stock under the Registration Statement to pay the commitment fee. The price of the shares delivered was the average of the daily volume weighted average price for the three trading days after the date of the Agreement. We issued an aggregate of approximately 3.0 million shares of our common stock and received an aggregate of approximately $2.9 million in cash under the SEDA, of which 0.1 million shares of our common stock were issued and approximately $0.1 million in cash was received during the first quarter of 2010. In connection with the registered direct offering discussed above, we terminated the SEDA effective February 4, 2010.

TCI Revolving Credit Facility

On August 31, 2010, Destron Fearing entered into a $4.0 million revolving credit facility with TCI Business Capital, Inc. (“TCI”) pursuant to the Credit and Security Agreement dated August 31, 2010 (the “TCI Agreement”). Under the terms of the TCI Agreement, Destron Fearing may borrow, from time to time, up to an aggregate of the lesser of: (i) 90% of eligible account receivables, based on dilution of less than 4%, plus 25% of eligible inventory capped at $500,000, as may be adjusted for reserves, or (ii) $4.0 million (the “TCI Revolving Facility”). The TCI Revolving Facility accrues interest at an annual rate equal to the prime rate as announced by Bank of America plus 8.0% (“Floating Rate”) which was 11.25% as of September 30, 2010. Upon default or early termination, the annual interest rate increases to the Floating Rate plus 4%. The TCI Revolving Facility matures on August 31, 2012, but can be terminated early by Destron Fearing upon payment of a termination fee or by TCI in accordance with the terms of the TCI Agreement. Destron Fearing is subject to certain financial and non-financial covenants under the TCI Agreement. As of September 30, 2010, we were in compliance with all convenants.

To secure Destron Fearing’s obligations under the TCI Revolving Facility, (a) Destron Fearing and its wholly-owned subsidiaries GT Acquisition Sub, Inc. and Digital Angel Technology Corporation have granted TCI security interests in their ownership interests (including stock and membership interests) of their subsidiaries, excluding the stock of all foreign subsidiaries; and (b) the Company, Destron Fearing and its wholly-owned subsidiaries Digital Angel Technology Corporation, Fearing Manufacturing Co., Inc. and GT Acquisition Sub, Inc. have granted TCI security interests in certain intellectual property. In addition, (i) the Company, (ii) Destron Fearing’s wholly-owned subsidiaries Digital Angel Technology Corporation, Fearing Manufacturing Co., Inc., Digital Angel International, Inc., Timely Technology Corp., and GT Acquisition Sub, Inc., and (iii) C-Scan, LLC, a wholly-owned subsidiary of GT Acquisitions Sub, Inc., collectively and individually have guaranteed the TCI Revolving Facility.

The TCI Revolving Facility replaced the $6.0 million revolving facility with Kallina Corporation which matured on August 31, 2010.

AL Finans A/S Factoring Agreement

On September 1, 2010, Destron Fearing A/S entered into a factoring agreement (the “AL Finans Factoring Agreement”) with AL Finans A/S (“AL Finans”) which replaced the Nordisk Factoring Agreement. Under the AL Finans Factoring Agreement, AL Finans advances 80% of Destron Fearing A/S’s eligible receivables, not to exceed a balance of DKK 6.0 million (approximately $1.1 million) at any given time. As security, Destron Fearing A/S assigns all invoice balances to AL Finans, regardless of whether advances were made on them, and warrant payments by its customers. Destron Fearing A/S pays a factoring commission charge to AL Finans of 0.15% of the gross volume of receivables factored with a minimum of DKK 40 per invoice. The AL Finans Factoring Agreement requires a minimum commission charge of DKK 36,000 (approximately $7 thousand) per year, and AL Finans reserves the right to have recourse against Destron Fearing A/S for any losses sustained on the factored invoices. As of September 30, 2010, we had approximately DKK 0.6 million (approximately $0.1 million) outstanding and no availability for borrowing under the AL Finans Factoring Agreement.
 
 
12

 
DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)(continued)
 
 
5.  Financings (continued)
 
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Liquidity and Capital Resources from Continuing Operations,” which are presented below, for a discussion of the availability under our credit facilities.

6.  Segment Information

Currently, we operate in two business segments: Animal Identification and Emergency Identification.

Animal Identification

Our Animal Identification segment develops, manufactures and markets visual and electronic identification tags and implantable RFID microchips, primarily for identification, tracking and location of companion pets, livestock (e.g., cattle and hogs), horses, fish and wildlife worldwide, as well as for animal bio-sensing applications, such as temperature reading for companion pet and equine applications. Our Animal Identification segment’s proprietary products focus on pet identification and safeguarding and the positive identification and tracking of livestock and fish, which we believe are crucial for asset management and for disease control and food safety. This segment’s principal products are visual and electronic ear tags for livestock and implantable microchips and RFID scanners for the companion pet, livestock, horses, fish and wildlife industries.

Emergency Identification

Our Emergency Identification segment develops, manufactures and markets GPS and GPS-enabled products used for emergency location and tracking of pilots, aircraft and maritime vehicles in remote locations. This segment’s principal products are GPS-enabled search and rescue equipment and intelligent communications products and services for telemetry, mobile data and radio communications applications, including our SARBETM brand, which serve military and commercial markets.

Corporate

Our Corporate activities include all amounts recognized upon consolidation of our subsidiaries, such as the elimination of inter-segment expenses, assets and liabilities. This category also includes certain selling, general and administrative expenses associated with corporate activities and interest expense and interest and other income associated with corporate activities and functions. Included in the Corporate activities as of September 30, 2010 are approximately $0.8 million of liabilities related to companies that we sold or closed in 2001 and 2002. It is expected that these liabilities will be reversed during 2011 to 2016, as they will no longer be considered our legal obligations.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies in our Annual Report on Form 10-K for the year ended December 31, 2009, except that inter-segment 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. We evaluate performance based on segment results as presented below.

 
13

 
DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)(continued)
 
 
6.  Segment Information (continued)

The following is selected segment data as of and for the periods ended (in thousands):
 
   
Animal Identification
   
Emergency Identification
   
Corporate
   
Total From Continuing Operations
 
As of and For the Three-Months Ended September 30, 2010
                       
Revenue
  $ 7,197     $ 1,914     $     $ 9,111  
Operating loss
    (29 )     (1,119 )     (820 )     (1,968 )
Loss from continuing operations before income tax provision
    (90 )     (1,357 )     (774 )     (2,221 )
                                 
Total assets of continuing operations
  $ 22,883     $ 11,432     $ 4,814     $ 39,129  
                                 
As of and For the Three-Months Ended September 30, 2009
                               
Revenue
  $ 6,815     $ 3,104     $     $ 9,919  
Operating loss
    (278 )     (863 )     (794 )     (1,935 )
Loss from continuing operations before income tax (provision) benefit
    (821 )     (992 )     (707 )     (2,520 )
                                 
Total assets of continuing operations
  $ 25,775     $ 18,112     $ 8,179     $ 52,066  

   
Animal Identification
   
Emergency Identification
   
Corporate
   
Total From Continuing Operations
 
As of and For the Nine-Months Ended September 30, 2010
                       
Revenue
  $ 23,572     $ 5,131     $     $ 28,703  
Operating income (loss)
    1,399       (3,119 )     (3,953 )     (5,673 )
Income (loss) from continuing operations before income tax provision
    699       (3,379 )     (4,272 )     (6,952 )
                                 
Total assets of continuing operations
  $ 22,883     $ 11,432     $ 4,814     $ 39,129  
                                 
As of and For the Nine-Months Ended September 30, 2009
                               
Revenue
  $ 23,074     $ 9,571     $     $ 32,645  
Operating loss
    (944 )     (1,682 )     (3,212 )     (5,838 )
Loss from continuing operations before income tax (provision) benefit
    (2,530 )     (1,845 )     (2,981 )     (7,356 )
                                 
Total assets of continuing operations
  $ 25,775     $ 18,112     $ 8,179     $ 52,066  

7.  Stock Options and Restricted Stock
 
Stock Option Plans

We and our subsidiaries have stock-based employee plans, which were outstanding as of December 31, 2009, and are more fully described in Note 11 to our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2009.

During the second quarter of 2010, our shareholders approved an amendment to our 2003 Flexible Stock Plan to increase the number of authorized shares of common stock issuable under the plan from 2,875,000 to 4,000,000. No other changes were made.

During the three-months ended September 30, 2010 and 2009, we recorded approximately $0.1 million and $0.1 million, respectively, in compensation expense related to stock options granted to our employees. During the nine-months ended September 30, 2010 and 2009, we recorded approximately $0.3 million and $0.3 million, respectively, in compensation expense related to stock options granted to our employees.
 
 
14

 
DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)(continued)

 
7.  Stock Options and Restricted Stock (continued)
 
Stock Option Activity

There were no options granted during the nine-months ended September 30, 2010 and 2009. A summary of our stock option activity as of September 30, 2010, and changes during the nine-months then ended, is presented below (in thousands, except per share amounts):
 
   
Stock
Options
   
Weighted
Average
Exercise Price
 
Weighted Average
Contractual Term
 
Aggregate
Intrinsic 
Value
 
Outstanding at January 1, 2010
    3,189     $ 15.05            
Granted
                     
Exercised
                     
Forfeited or expired
    169       16.15            
Outstanding at September 30, 2010
    3,020       14.99    5.0 
years
  $ 12 *
                             
Vested or expected to vest at September 30, 2010
    2,900       13.99   4.3 
years 
    12 *
Exercisable at September 30, 2010
    2,298       19.28   3.9 
years
    12 *
 
* The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the exercise price of the option. The market value of our common stock was $0.51 per share at September 30, 2010.

There were no option exercises during the nine-months ended September 30, 2010 and 2009. At September 30, 2010, we had approximately 1.6 million options available for issuance under our plans. The total cash value of potential option exercises at September 30, 2010 was approximately $20 thousand and would have a de minimus dilution impact to our stockholders’ ownership.

As of September 30, 2010, there was approximately $0.2 million of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under our plans. That cost is expected to be recognized over a weighted-average period of approximately 1.1 years. The total fair value of shares vested during the three-months ended September 30, 2010 and 2009, was approximately $30 thousand and $39 thousand, respectively. The total fair value of shares vested during the nine-months ended September 30, 2010 and 2009 was approximately $0.2 million and $0.2 million, respectively.
 
A summary of the status of our nonvested stock options as of September 30, 2010 and changes during the nine-months ended September 30, 2010 is presented below (in thousands, except per share amounts):
 
   
Stock Options
   
Weighted  Average
Grant-Date
Fair Value
 
Nonvested at January 1, 2010
    889     $ 1.14  
Granted
           
Vested
    (86 )     2.64  
Forfeited or expired
    (81 )     0.72  
Nonvested at September 30, 2010
    722     $ 1.01  

In addition to the stock options presented above, Thermo Life has approximately 4.4 million fully vested stock options outstanding. These stock options have no intrinsic value as of September 30, 2010 and Thermo Life’s two options plans have been discontinued with respect to future grants. On January 21, 2010, we sold the assets of Thermo Life as more fully discussed in Note 9.

Restricted Stock

In October 2009, we issued approximately 0.5 million shares of our restricted common stock to our directors and executive and senior management. We determined the value of the stock to be approximately $0.5 million based on the closing price of our stock on the date of the grant. The value of the restricted stock is being amortized as compensation expense over the vesting period which is three years. In January 2008, we issued approximately 31 thousand shares of our restricted common stock to our directors. We determined the value of the stock to be approximately $0.2 million based on the closing price of our stock on the date of the grant. The value of the restricted stock is being amortized as compensation expense over the vesting period which is five years. As a result, we recorded compensation expense of approximately $0.1 million and $22 thousand in the three-months ended September 30, 2010 and 2009, respectively, associated with such restricted stock grants. We recorded compensation expense of approximately $0.2 million and $44 thousand in the nine-months ended September 30, 2010 and 2009, respectively, associated with such restricted stock grants. As of September 30, 2010, approximately 0.4 million shares of our restricted stock was unvested.
 
 
15

 
DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)(continued)
 
 
8.  Income Taxes

Differences in the effective income tax rates from the statutory federal income tax rate arise from state and foreign income taxes (benefits), net of federal tax effects, and the increase or reduction of valuation allowances related to net operating loss carryforwards, non-deductible intangible amortization associated with acquisitions and other deferred tax assets. At September 30, 2010, we had aggregate net operating loss carryforwards of approximately $280.3 million for income tax purposes that expire in various amounts from 2013 through 2029. Through December 28, 2007, Destron Fea
 
ring filed a separate federal income tax return. Of the aggregate U.S. net operating loss carryforwards of $270.4 million, $69.2 million relates to Destron Fearing and approximately $9.9 million relates to foreign loss carryforwards. These foreign net operating loss carryforwards are available to only offset future taxable income earned in the home country of the foreign entity. As of September 30, 2010, we have provided a valuation allowance to fully reserve our U.S. net operating loss carryforwards and our other existing U.S. net deferred tax assets, primarily as a result of our recent losses and our current projections of future taxable U.S. income. As a result of fully reserving our U.S. deferred tax assets, we did not record a benefit related to our net U.S. losses during the nine-months ended September 30, 2010 and 2009.

The amount of any benefit from our US net operating losses is dependent on: (1) our ability to generate future taxable income and (2) the unexpired amount of net operating loss carryforwards available to offset amounts payable on such taxable income. Any greater than fifty percent change in ownership under Internal Revenue Code (“IRC”) section 382 would place significant annual limitations on the use of such net operating losses to offset any future taxable income we may generate. Such limitations, in conjunction with the net operating loss expiration provisions, could effectively eliminate our ability to use a substantial portion of our net operating loss carryforwards to offset future taxable income. Based on our current cumulative three-year change in ownership, we exceeded the fifty percent threshold during 2009, thus approximately $192.7 million is limited under IRC section 382. As a result of this limitation, we estimate that approximately $18.7 million of these losses will be available to offset future taxable income, with the remainder being available to offset certain built-in gains, with both amounts subject to expiration provisions. Certain transactions could cause an additional ownership change in the future, including (a) additional issuances of shares of common stock by us or our subsidiaries or (b) acquisitions or sales of shares by certain holders of our shares, including persons who have held, currently hold, or accumulate in the future five percent or more of our outstanding stock.

We, in combination with our subsidiary, Destron Fearing, file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions in which we operate. In general, we and Destron Fearing are no longer subject to U.S. federal, state or local income tax examinations for years before 2005, Danish tax examinations for years before 2005 and U.K. tax examinations for years before 2001. At September 30, 2010, we had a liability for unrecognized tax benefits of $0.2 million primarily related to state income tax positions.
 
9.  Discontinued Operations

We sold our ownership of McMurdo during the three-months ended December 31, 2009, our Control Products Group and Thermo Life during the three-months ended March 31, 2010 and Clifford & Snell during the three-months ended June 30, 2010. McMurdo is a manufacturer of emergency locator beacons; Thermo Life is a development stage company with patented rights to a thin-film thermoelectric generator; Control Products Group manufactures and distributes electronic relay switches for nuclear power applications; and Clifford & Snell manufactures electronic alarm sounders which are used to provide audible and or visual signals which alert personnel in hazardous areas, including the oil and petrochemical industry and in the fire and security market. The decisions to sell these businesses were made as part of management’s strategy to streamline our operations to focus our efforts on the Animal Identification segment.

As a result of the board of directors’ decision to sell, and the subsequent sale of, the operations of Thermo Life, McMurdo, Control Products Group and Clifford & Snell, the financial condition, results of operations and cash flows of each of these businesses have been reported as discontinued operations in our financial statements, and prior period information has been reclassified accordingly.

Sale of McMurdo

On November 2, 2009, we, together with Signature and McMurdo, entered into a definitive agreement to sell substantially all of the assets of Signature’s U.K.-based McMurdo business unit for $10.0 million in cash (“the McMurdo Purchase Agreement”). The purchaser was France-based Orolia Group (“Orolia”), a high-technology firm specializing in positioning, navigation and timing solutions for critical operations.
 
 
16

 
DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)(continued)
 
 
9.  Discontinued Operations (continued)

On November 20, 2009, pursuant to the terms of the McMurdo Purchase Agreement, we completed the sale of McMurdo. At closing, the parties amended the McMurdo Purchase Agreement to reduce the amount to be held in escrow to $1.0 million, to assign to the buyer the obligation for certain trade and vendor payables in existence at the time of closing, and to exclude certain product lines and related assets from the transaction (which product lines and assets were retained by Signature in exchange for a $250,000 credit against the purchase price). As a result of these amendments and the adjustment for actual inventory levels at the time of closing, the consideration paid at closing totaled approximately $9.6 million, of which approximately $8.8 million was paid to Signature in cash and approximately $0.8 million was retained by the buyer to pay the retained trade and vendor payables. The remaining $1.0 million of the proceeds, less claims, will be held in escrow for 12 months. We expect to receive approximately $0.7 million of this amount in November 2010. The proceeds were used to pay debt obligations and to fund working capital. Both the Company and Orolia guaranteed performance to the other, thus we have guaranteed Signature’s obligations under the McMurdo Purchase Agreement on a fully subordinated basis. The Company’s guarantee will continue until all liabilities have been paid, discharged or satisfied in full.

In the fourth quarter of 2009, we recorded a gain on the sale of McMurdo of approximately $2.1 million, net of U.K. income taxes of $0.5 million. Upon the receipt of the funds held in escrow in connection with the McMurdo sale, if any, such proceeds will be recorded as additional gain on sale.
 
Sale of Thermo Life

On January 21, 2010, we entered into agreements with Ingo Stark, the employee and scientist who was chiefly responsible for the development of Thermo Life’s patented technology, to sell him the remaining assets of Thermo Life for nil and granting him a license on the patents in exchange for any future royalty payments on any products that become commercialized using the patents. Thermo Life has never generated any revenue and has been included in our discontinued operations since 2008. The loss on this transaction was not significant.

Sale of Control Products Group

On January 25, 2010, we entered into an agreement to sell substantially all of the assets of a small division known as the Control Products Group, a group within the Clifford & Snell business unit of Signature. The buyer, C&S Controls Limited, is a U.K. entity controlled by Gary Lawrence, the former manager of the Control Products Group for the past several years, and another former employee. The purchase price of £0.4 million (approximately $0.6 million) was represented, in part, by a non-interest bearing promissory note in the original principal amount of £0.4 million (approximately $0.6 million) issued from the buyer to Signature, which calls for monthly cash payments for approximately 5 years. As of September 30, 2010, approximately $33 thousand has been collected on the promissory note. The promissory note is collateralized but subordinated to a £30 thousand (approximately $45 thousand) working capital loan issued by a third party to the buyers. We have imputed interest at a rate of 8.0% per annum which represents a discount of £67 thousand (approximately $0.1 million) which will be amortized as additional interest income as cash is collected over the life of the promissory note. Based on the small scale of this entity, we believe that our treatment of this transaction as a sale for accounting purposes is not materially different from treatment that does not recognize the legal transfer of the ownership of the business. The gain on sale of approximately $0.1 million was deferred and will be recognized in the future when circumstances have changed sufficiently to so warrant.

Sale of Clifford & Snell

On April 30, 2010, we entered into a definitive agreement to sell the assets of Clifford & Snell for £2.3 million in cash (approximately $3.5 million) (“the Clifford & Snell Purchase Agreement”). The purchaser was R.Stahl Ltd., a subsidiary of R.Stahl AG, a public company based in Waldenburg, Germany (“R.Stahl”). R.Stahl develops, manufactures and markets explosion-protection products worldwide for industrial customers. During the three-months ended March 31, 2010 and 2009, Clifford & Snell’s revenues were approximately £0.5 million (approximately $0.8 million) and approximately £1.0 million (approximately $1.4 million), respectively, and did not represent a significant disposition in accordance with Article 1 of Regulation S-X.
 
 
17

 
DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)(continued)
 
 
9.  Discontinued Operations (continued)

Clifford & Snell’s assets were sold for a cash consideration of £2.3 million (approximately $3.5 million). The purchase price was structured into two payments; £2.1 million (approximately $3.1 million) upon closing of the Clifford & Snell Purchase Agreement and £0.2 million (approximately $0.4 million) on October 30, 2010 following a six-month supply agreement during which R.Stahl purchased products from Signature. On April 30, 2010, we received approximately £1.2 million (approximately $1.7 million) in net cash proceeds, which represented the first payment of £2.1 million less £0.3 million (approximately $0.5 million) of repayment on our Bibby invoice discounting line, £0.2 million (approximately $0.3 million) in closing and transaction costs and £0.4 million (approximately $0.6 million) which is to be held in escrow and paid out in two equal installments, net of any claims, on January 30, 2011 and October 31, 2011. On September 30, 2010, we received approximately £0.1m (approximately $0.2 million) of the second purchase price and on November 1, 2010, we received the remaining £0.1m (approximately $0.2 million). Both the Company and R.Stahl AG issued guarantees of subsidiary performance to the other. The Company’s guarantee will continue until all liabilities have been paid, discharged or satisfied in full.

In the second quarter of 2010, we recorded a gain on the sale of Clifford & Snell of approximately £0.7 million (approximately $1.0 million). Upon the receipt of the funds held in escrow in connection with the Clifford & Snell sale, if any, such proceeds will be recorded as additional gain on sale.

The following table, in thousands, presents the results of operations of our discontinued operations, excluding any allocated or common overhead expenses, for the three and nine-months ended September 30, 2010 and 2009:

   
Three-Months Ended
September 30,
   
Nine-Months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Revenue
  $ 754     $ 5,745     $ 3,525     $ 18,047  
Cost of sales
    794       3,075       2,395       9,712  
Gross (loss) profit
    (40 )     2,670       1,130       8,335  
                                 
Selling, general and administrative expenses
    4       1,690       484       4,777  
Research and development expenses
          183             527  
Operating (loss) income
    (44 )     797       646       3,031  
                                 
Interest and other income (expense), net
    (197 )     (19 )     (46 )     525  
(Loss) gain on sale
    (4 )           1,015        
Benefit for income taxes
          7             22  
(Loss) income from discontinued operations
  $ (245 )   $ 785     $ 1,615     $ 3,578  
                                 
(Loss) income from discontinued operations per common share – basic and diluted
  $ (0.01 )   $ 0.04     $ 0.06     $ 0.20  
Weighted average number of common shares outstanding – basic and diluted
    28,215       18,271       27,366       17,798  

The net (liabilities) assets of discontinued operations as of September 30, 2010 and December 31, 2009, which represented the net (liabilities) assets of McMurdo, Thermo Life, Control Products Group and Clifford & Snell, were comprised of the following (in thousands):
 
   
September 30,
2010
   
December 31,
2009
 
Cash
  $     $ 66  
Accounts receivable
    935       2,813  
Inventory
    564       856  
Total current assets
    1,499       3,735  
Fixed assets
          365  
Total assets
  $ 1,499     $ 4,100  
                 
Accounts payable
  $ 386     $ 478  
Accrued expenses and other current liabilities
    1,723       2,256  
Total liabilities
  $ 2,109     $ 2,734  
                 
Net (liabilities) assets of discontinued operations
  $ (610 )   $ 1,366  
 
 
18

 
DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)(continued)
 
 
10.  Comprehensive Loss

Comprehensive loss represents all non-owner changes in preferred stock, common stock and other stockholders’ equity and consists of the following:

   
Three-Months Ended
September 30,
   
Nine-Months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
   
(in thousands)
 
Net loss
  $ (2,474 )   $ (1,675 )   $ (5,360 )   $ (3,774 )
Other comprehensive income, net of tax:
                               
Foreign currency translation adjustments
    18       (527 )     84       584  
Total comprehensive loss
  $ (2,456 )   $ (2,202 )   $ (5,276 )   $ (3,190 )

The other comprehensive loss during the three and nine-months ended September 30, 2010 related to the change in the foreign currency exchange rates of the British Pound, which is Signature’s functional currency, and the Danish Krone, which is Destron Fearing A/S’s functional currency. Approximately nil and $(18) thousand of the foreign currency translation adjustments related to the noncontrolling interest during the three-months ended September 30, 2010 and 2009, respectively. Approximately $(5) thousand and $(72) thousand of the foreign currency translation adjustments related to the noncontrolling interest during the nine-months ended September 30, 2010 and 2009, respectively.

11.  Supplemental Cash Flow Information

In the nine-months ended September 30, 2010 and 2009, we had the following non-cash activities:

   
Nine-Months Ended September,
 
   
2010
   
2009
 
   
(in thousands)
 
Non-cash operating activities:
           
Issuance of shares of common stock for settlement of payables
  $ 362     $  
Non-cash investing activities:
               
Issuance of shares of common stock for purchase of equipment
  $     $ 186  
Non-cash investing activities:
               
Issuance of shares of common stock for SEDA commitment fee
  $     $ 125  
Cash paid for:
               
Interest
  $ 563     $ 1,153  
Taxes
    23       58  

12.  Restructuring Accrual

During the second quarter of 2008, we initiated restructuring efforts to develop a strategic long-range plan focusing on restoring growth and profitability. With our restructuring, we sought to generate annual costs savings by exiting some costly facilities, outsourcing some manufacturing to lower cost suppliers, moving some operations to lower cost countries and reducing headcount. Our purpose in taking these actions was to increase profitability at the gross margin level, which management believes is necessary to competitively price products and achieve positive earnings. Our restructuring plan has been substantially implemented. Restructuring activities were recorded in accordance with the Exit or Disposal Cost Obligation Topic and the Compensation — Nonretirement Postemployment Benefit Topic of the Codification. During the three and nine-months ended September 30, 2010, we recorded approximately $14 thousand and $1.2 million, respectively, of severance expenses. During the three-months ended September 30, 2009, we recorded approximately $0.1 million of severance expenses and during the ning-months ended September 30, 2009, we recorded approximately $0.3 million of severance expenses and $0.2 million of contract termination costs.
 
 
19

 
DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)(continued)
 
 
12.  Restructuring Accrual (continued)

As of September 30, 2010, our restructuring accrual was as follows (in thousands):
 
   
Severance
   
Lease and Building Costs
   
Total
 
                   
Balance, January 1, 2010
  $ 303     $ 232     $ 535  
                         
Additional expense
    1,229             1,229  
Payments
    (573 )     (222 )     (795 )
                         
Balance, September 30, 2010
  $ 959     $ 10     $ 969  

We anticipate that the accrued amounts covering the remaining restructuring costs will be paid over the next eighteen months.

13.  Legal Proceedings

Former Officer

On June 19, 2009, Michael Krawitz, a former executive officer of ours, filed a lawsuit (Michael Krawitz v. Digital Angel Corporation Case No. 09-80910-CIV-RYSKAMP/VITUNAC in the U.S. District Court for the Southern District of Florida) against us and several members of our board of directors. The lawsuit alleged a variety of claims relating to the amounts owed to him under his employment agreement. We filed a Motion to Dismiss all claims except the breach of contract claim, which we are prepared to defend on the merits. In December 2009, the federal court granted our Motion to Dismiss in its entirety and granted Mr. Krawitz leave to re-file his lawsuit in light of the court’s decision. In January 2010, Mr. Krawitz amended his Complaint to re-file the breach of contract claim against us and filed notice that he voluntarily dismissed all other claims against us and the members of our board of directors. On the remaining breach of contract claim, we intend to vigorously defend against his claims. Presently, we are scheduled for trial in late November or early December 2010.

Additionally, we are party to various legal actions, as either plaintiff or defendant, arising in the ordinary course of business, none of which is expected to have a material adverse effect on our business, financial condition or results of operations.

14.  Subsequent Events

Issuance of Common Stock to Hark M. Vasa

On October 15, 2010, we issued 800,000 shares of our common stock to Hark M. Vasa in connection with a settlement agreement entered into November 8, 2007. The securities were issued in a transaction exempt from registration under Section 4(2) of the Securities Act of 1933, as amended.

 
20

 

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 Annual Report on Form 10-K for the year ended December 31, 2009.

Overview

We currently operate in two business segments and engage in the following principal business activities:

Animal Identification - We develop, manufacture and market visual and radio frequency identification (“RFID”) products under the brand name Destron Fearing to customers worldwide. Destron Fearing products include visual and electronic tags and implantable RFID microchips that identify, track and locate animals, including bio-sensing chips that measure an animal’s temperature. These products promote recovery of lost pets, livestock herd management, environmental protection, and animal health while fulfilling the requirements of certain government regulations aimed at insuring the safety of food supplies throughout the world. Our Animal Identification business is headquartered in Minnesota, with direct and indirect, wholly and majority-owned subsidiaries located in Europe and South America.

Emergency Identification - We develop, manufacture and market emergency identification products that are enabled through global positioning system (“GPS”) technology, and sold worldwide under the brand name SARBE™. This segment’s principal products are search and rescue beacons that safeguard people and high-value assets utilizing intelligent communications and emergency messaging services for telemetry, mobile data and satellite radio communications. SARBE safety products are sold to government and military customers worldwide. The Emergency Identification segment includes our 98.5% owned subsidiary, Signature Industries Limited (“Signature”), which is headquartered in the United Kingdom.

Our business segments are more fully discussed in Note 6 to our accompanying condensed consolidated financial statements.

Summary of our Results of Continuing Operations

During the three-months ended September 30, 2010, as compared to the three-months ended September 30, 2009, our consolidated revenue decreased approximately $0.8 million, or 8.9%, to $9.1 million. The decrease is due to the results of our Emergency Identification segment discussed further below. Our consolidated operating loss was $2.0 million in the three-months ended September 30, 2010 as compared to $1.9 million in the three-months ended September 30, 2009. Excluding approximately $0.1 million of restructuring, severance and separation expenses, our consolidated operating loss was $1.8 million for the three-months ended September 30, 2009. We primarily attribute the increase in our consolidated operating loss to our Emergency Identification segment discussed further below, slightly offset by a decrease in selling, general and administrative expenses company wide. During the nine-months ended September 30, 2010, as compared to the nine-months ended September 30, 2009, our consolidated revenue decreased approximately $3.9 million, or 13.7%, to $28.7 million. The decrease in consolidated revenue is due to the results of our Emergency Identification segment discussed further below. Our consolidated operating loss was $5.7 million in the nine-months ended September 30, 2010 as compared to $5.8 million in the nine-months ended September 30, 2009. Excluding approximately $1.2 million of restructuring, severance and separation expenses, our consolidated operating loss was $4.5 million for the nine-months ended September 30, 2010. Excluding approximately $0.5 million of restructuring, severance and separation expenses, our consolidated operating loss was $5.3 million for the nine-months ended September 30, 2009. We primarily attribute the improvement to the decrease in selling, general and administrative expenses company wide.

Critical Accounting Policies

Our Annual Report on Form 10-K for the year ended December 31, 2009 contains further information regarding our critical accounting policies.

Impact of Recently Issued Accounting Standards

For information regarding recent accounting pronouncements and their expected impact on our future consolidated results of operations or financial condition, see Note 2 to our accompanying condensed consolidated financial statements.

 
21

 

Consolidated Results of Operations

The following table summarizes our results of operations as a percentage of net operating revenues and is derived from the accompanying unaudited condensed consolidated statements of operations in Part I, Item 1 of this quarterly report (in thousands except percentages).

   
For the Three-Months Ended
September 30,
   
For the Nine-Months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Revenue
    100.0 %     100.0 %     100.0 %     100.0 %
Cost of sales
    71.7       61.3       63.9       61.7  
Gross profit
    28.3       38.7       36.1       38.3  
                                 
Selling, general and administrative expenses
    46.9       53.9       49.0       52.1  
Research and development expenses
    2.8       2.9       2.6       2.6  
Restructuring, severance and separation expenses
    0.2       1.4       4.3       1.4  
Operating loss
    (21.6 )     (19.5 )     (19.8 )     (17.8 )
                                 
Interest and other (expense) income, net
    0.3       0.3       (1.2 )     0.5  
Interest expense
    (3.0 )     (6.2 )     (3.3 )     (5.2 )
Loss from continuing operations before income tax provision
    (24.3 )     (25.4 )     (24.3 )     (22.5 )
                                 
(Provision) benefit for income taxes
    (0.1 )     0.6    
   
 
Loss from continuing operations
    (24.4 )     (24.8 )     (24.3 )     (22.5 )
                                 
(Loss) income from discontinued operations
    (2.7 )     7.9       5.6       11.0  
Net loss
    (27.1 )     (16.9 )     (18.7 )     (11.5 )
                                 
Loss attributable to the noncontrolling interest, continuing operations
    0.2       0.1       0.2       0.1  
(Loss) income attributable to the noncontrolling interest, discontinued operations
 
      (0.1 )     (0.1 )     (0.2 )
                                 
Net loss attributable to Digital Angel Corporation
    (26.9 )%     (16.9 )%     (18.6 )%     (11.6 )%

Results of Operations by Segment
 
Three-Months Ended September 30, 2010 Compared to Three-Months Ended September 30, 2009

Animal Identification

   
Three-Months Ended September 30,
 
   
2010
   
% of Revenue
   
2009
   
% of Revenue
   
Change
 
   
(in thousands, except percentages)
 
                                     
Revenue
  $ 7,197       100.0 %   $ 6,815       100.0 %   $ 382       5.6 %
Cost of sales
    4,992       69.4       4,515       66.2       477       10.6  
Gross profit
    2,205       30.6       2,300       33.8       (95 )     (4.1 )
                                                 
Selling, general and administrative expenses
    1,963       27.3       2,151       31.6       (188 )     (8.7 )
Research and development expenses
    257       3.6       285       4.2       (28 )     (9.8 )
Restructuring, severance and separation expenses
    14       0.2       142       2.1       (128 )     (90.1 )
                                                 
Operating loss
  $ (29 )     (0.5 )%   $ (278 )     (4.1 )%   $ 249       (89.6 )

 
22

 

Revenues

Our Animal Identification segment’s revenue increased approximately $0.4 million for the three-months ended September 30, 2010 compared to the three-months ended September 30, 2009. The increase was primarily due to increased sales of our fish chip resulting from the timing of demand from the government and increased sales of our electronic livestock tags to existing and new customers. The increase was slightly offset by a decrease in our companion pet product sales during the third quarter of 2010 compared to the third quarter of 2009.

Gross Profit and Gross Profit Margin

Our Animal Identification segment’s gross profit decreased approximately $0.1 million in the three-months ended September 30, 2010 compared to the three-months ended September 30, 2009. The slight decrease in gross profit was primarily due to higher material cost associated with sales of our electronic livestock tags accompanied by an increase in inbound freight costs. The gross profit margin decreased to 30.6% in the three-months ended September 30, 2010 as compared to 33.8% in the three-months ended September 30, 2009. The decrease in gross profit margin is primarily due to the increase in costs discussed above. Gross profit margin may vary period-to-period because of changes in the product mix and in the ratio of fixed and variable costs.

Selling, General and Administrative Expenses

Our Animal Identification segment’s selling, general and administrative expenses decreased approximately $0.2 million in the three-months ended September 30, 2010 compared to the three-months ended September 30, 2009. The decrease in selling, general and administrative expenses was primarily the result of decreased salaries, travel and sales and marketing expenses. Selling, general and administrative expenses as a percentage of revenue decreased from 31.6% to 27.3% primarily due to the items discussed above.

Research and Development Expenses

Our Animal Identification segment’s research and development expenses remained relatively constant during the three-months ended September 30, 2010 as compared to the three-months ended September 30, 2009. Research and development expenses relate to new product development associated with RFID microchips and related scanners.

Restructuring, Severance and Separation Expenses

Our Animal Identification segment’s restructuring, severance and separation expenses recorded in the third quarter of 2010 and 2009 related to severance expenses.

Outlook and Trends

As anticipated, our Animal Identification segment’s sales and profits have increased in 2010 as compared to 2009. We continue to expect to achieve higher gross profits and to reduce selling, general and administrative expenses as we continue to control costs and implement cost savings measures. However, we are unable to quantify such possible operating efficiencies at this time.

We believe our investment in technology and product development, such as the rTag™ and BioThermo®, will enable future growth for our Animal Identification segment. We also believe that we face favorable long-term market trends, such as the technology migration from visual to electronic identification and increased government regulation in the area of food safety and traceability.

 
23

 

Emergency Identification

   
Three-Months Ended September 30,
 
   
2010
   
% of Revenue
   
2009
   
% of Revenue
   
Change
 
   
(in thousands, except percentages)
 
                                     
Revenue
  $ 1,914       100.0 %   $ 3,104       100.0 %   $ (1,190 )     (38.3 )%
Cost of sales
    1,542       80.6       1,569       50.5       (27 )     (1.7 )
Gross profit
    372       19.4       1,535       49.5       (1,163 )     (75.8 )
                                                 
Selling, general and administrative expenses
    1,491       77.9       2,398       77.3       (907 )     (37.8 )
                                                 
Operating loss
  $ (1,119 )     (58.5 )%   $ (863 )     (27.8 )%   $ (256 )     29.7  
 
Revenues

Our Emergency Identification segment’s revenue decreased approximately $1.2 million in the three-months ended September 30, 2010 compared to the three-months ended September 30, 2009. The decrease in revenue was primarily due to a decrease in sales at our Sarbe division of approximately $1.2 million due to lower PELS and G2R sales resulting from the mandatory transition to higher satellite frequency beacons in the prior year.  In addition, we experienced lower sales at our Communciations division. We expect our revenues to increase as we commence shipping on a large PELS contract.

Gross Profit and Gross Profit Margin

Our Emergency Identification segment’s gross profit decreased approximately $1.2 million in the three-months ended September 30, 2010 compared to the three-months ended September 30, 2009. The decrease was primarily due to the decrease in sales discussed above accompanied by an inventory provision at our Sarbe division of approximately $0.9 million that was recorded in the third quarter of 2010. Third quarter gross profit margin was 19.4% in the three-months ended September 30, 2010 as compared to 49.5% in the third quarter of 2009. Gross profit margin decreased due to lower margins at our Sarbe division in addition to the inventory provision discussed above. We expect gross profit margins to return to previous levels which may vary period-to-period because of the changes in the product mix and in the ratio of fixed and variable costs.

Selling, General and Administrative Expenses

Our Emergency Identification segment’s selling, general and administrative expenses decreased approximately $0.9 million in the three-months ended September 30, 2010 compared to the three-months ended September 30, 2009. This decrease in selling, general and administrative expenses relates primarily to a decrease in personnel costs as a result of the restructuring implemented in the prior year, lower audit and legal fees, decreased engineering consumables and lower marketing expenses. As a percentage of revenue, selling, general and administrative expenses remained relatively constant at 77.9% in the three-months ended September 30, 2010 compared to 77.3% in the three-months ended September 30, 2009.

Outlook and Trends

As anticipated, our Emergency Identification segment’s sales have decreased in 2010 as compared to 2009 primarily due to a reduction in sales of Sarbe products. Prior year’s sales were positively impacted by the required transition to higher satellite frequency beacons. We expect sales and operating profits to improve as we commence shipping on the PELS contract, which have been delayed as a result of extended testing and certification requirements, and as a result of reduced asset impairments and selling, general and administrative expenses. However, we are unable to quantify such possible operating efficiencies at this time.

We believe that the future will bring both military and commercial market opportunities. However, going forward, we intend to focus on growing our Animal Identification business.
 
 
24

 
 
Corporate

   
Three-Months Ended September 30,
 
   
2010
   
2009
   
Change
 
   
(in thousands, except percentages)
 
                         
Revenue
  $
    $
    $
    %
Cost of sales
 
   
   
   
 
Gross profit
 
   
   
   
 
                               
Selling, general and administrative expenses
    820       794       26       3.3  
                                 
Operating loss
  $ (820