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EX-31.2 - CERTIFICATION CFO - VERITEQex31-2.htm
EX-31.1 - CERTIFICATION CEO - VERITEQex31-1.htm
EX-23.1 - CONSENT OF ACCOUNTING FIRM - VERITEQex23-1.htm
EX-21.1 - SUBSIDIARIES - VERITEQex21-1.htm
EX-32.2 - CERTIFICATION CFO - VERITEQex32-2.htm
EX-32.1 - CERTIFICATION CEO - VERITEQex32-1.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
(Mark One)
     
þ
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2010
     
o
 
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
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)

490 Villaume Avenue
South Saint Paul, Minnesota 55075
(Address of principal executive offices, including zip code)

(651) 455-1621
Registrant’s telephone number, including area code
 
Securities registered pursuant to Section 12(b) of the Act:
     
(Title of each class)
 
(Name of each exchange on which registered)
Common Stock, $0.01 par value
 
OTC Bulletin Board

Securities registered pursuant to Section 12(g) of the Act: Not applicable

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

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.
             
Large accelerated filer o
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company þ
 
     
(Do not check if a 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 o No þ
 
 
 

 

At June 30, 2010, the aggregate market value of the voting and non-voting common stock held by non-affiliates was approximately $13.6 million, computed by reference to the price at which the stock was last sold on that date of $0.50 per share reported on the National Association of Securities Dealers Automated Quotation System. On October 5, 2010, Digital Angel Corporation began trading on the OTC Bulletin Board.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date:
     
Class
 
Outstanding at March 30, 2011
Common Stock, $.01 par value per share
 
29,697,225 shares

Documents Incorporated by Reference: Parts of the definitive Proxy Statement for the 2011 Annual Meeting of Stockholders which the Registrant intends to file with the Securities and Exchange Commission within 120 days after the end of the Registrant’s fiscal year ended December 31, 2010, are incorporated by reference in Part III of this Annual Report on Form 10-K to the extent described herein. If the Registrant does not file its Proxy Statement with the Commission on or before 120 days after the end of its 2010 fiscal year, the Registrant will file the required information in an amendment to this Annual Report on Form 10-K.
 
 
 

 
 
DIGITAL ANGEL CORPORATION
TABLE OF CONTENTS
             
Item
 
Description
 
Page
 
             
   
PART I
       
             
1.
 
Business
   
1
 
1A.
 
Risk Factors
   
9
 
2.
 
Properties
   
15
 
3.
 
Legal Proceedings
   
15
 
             
   
PART II
       
             
5.
 
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
   
16
 
7.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
   
17
 
8.
 
Financial Statements
   
27
 
9.
 
Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
   
27
 
9A
 
Controls and Procedures
   
28
 
             
   
PART III
       
             
10
 
Directors, Executive Officers and Corporate Governance
   
28
 
11
 
Executive Compensation
   
28
 
12
 
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
   
28
 
13
 
Certain Relationships and Related Transactions, and Director Independence
   
28
 
14
 
Principal Accountant Fees and Services
   
28
 
             
   
PART IV
       
             
15.
 
Exhibits and Financial Statements and Supplementary Data
   
29
 
   
Signatures
   
30
 
             
Exhibit 21.1
List of Subsidiaries
       
Exhibit 23.1
Consent of Independent Registered Public Accounting Firm
       
Exhibit 31.1
302 Certificate of Chief Executive Officer
       
Exhibit 31.2
302 Certificate of Chief Financial Officer
       
Exhibit 32.1
906 Certificate of Chief Executive Officer
       
Exhibit 32.2
906 Certificate of Chief Financial Officer
       

 
2

 
 
PART 1

ITEM 1. BUSINESS

Unless the context otherwise provides, when we refer to the “Company,” “we,” “Digital Angel,” or “us,” we are referring to Digital Angel Corporation and its subsidiaries (either wholly- or majority-owned).

Overview

As of December 31, 2010, our business operations consisted primarily of the operations of our wholly-owned subsidiary, Destron Fearing Corporation and its wholly-owned subsidiaries, which collectively we refer to in this Annual Report as Destron Fearing, and our 98.5% owned subsidiary, Signature Industries Limited (“Signature”). Currently we operate in two business segments: Animal Identification, which comprises the operations of Destron Fearing; and Emergency Identification, which comprises the operations of Signature.

We currently engage in the following principal business activities:

 
 
Our Animal Identification segment develops, manufactures and markets visual and electronic identification tags and implantable radio frequency identification (“RFID”) microchips, primarily for identification, tracking and location of companion pets, livestock (e.g., cattle and hogs), horses, fish and wildlife worldwide, and, more recently, for animal bio-sensing applications, such as temperature reading for companion pet applications; and
 
 
Our Emergency Identification segment develops, manufactures and markets global position systems (“GPS”) and GPS-enabled products used for emergency location and tracking of pilots, aircraft and maritime vehicles in remote locations.

Discontinued Operations

During the years ended December 31, 2010 and 2009, we sold several non-core businesses. On November 20, 2009, we sold the assets of one of Signature’s business units, McMurdo Limited (“McMurdo”). On January 21, 2010, we sold Thermo Life Energy Corp. (“Thermo Life”), on January 25, 2010, we sold substantially all of the assets of a division known as the Control Products Group within the Clifford & Snell business unit of Signature, and on April 30, 2010, we sold the assets of Clifford & Snell. Accordingly, the financial results of these businesses are now classified as discontinued operations for all periods presented in this Annual Report. Our decision to sell these businesses was a result of management’s strategy to streamline operations. Going forward, our strategy is to focus our efforts on the business operations of our Animal Identification segment. Discontinued operations are more fully discussed in Note 13 to our consolidated financial statements.

Internet Website

Our Internet website address is www.digitalangel.com. Our segments’ internet website addresses are: www.destronfearing.com and www.signatureindustries.com. The information on these websites is not incorporated by reference into this Annual Report on Form 10-K. We make available free of charge through our website annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Forms 3, 4 and 5 filings, and all amendments to those reports and filings as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”).

**************

Effective April 20, 2007, we became a Delaware corporation. We initially incorporated in the state of Missouri on May 11, 1993. Our principal executive offices are located at 490 Villaume Avenue, South Saint Paul, Minnesota 55075 (651-455-1621).

Recent Events

16% Senior Secured Debenture and Warrants

On February 24, 2011, we entered into a Securities Purchase Agreement (the “Agreement”) with certain investors, including Hillair Capital Investments LLC (the "Investors") whereby we issued and sold (the “Offering”) to the Investors (i) $2.0 million of senior secured Debentures (the “Debentures”), (ii) Series A warrants (the “Series A Warrants”) to purchase up to 4,000,000 shares of our common stock and (iii) Series B warrants (the “Series B Warrants” and collectively with the Series A Warrants, the “Warrants”) to purchase up to 4,000,000 shares of our common stock.  
 
We will be obligated to redeem the Debentures on a quarterly basis beginning on October 1, 2011, in an amount equal to $0.5 million each quarter, until the Debentures maturity date of July 1, 2012. The Debentures accrue interest at a rate of 16% per annum which is due on a quarterly basis beginning on April 1, 2011. Upon any event of default, 125% of the then outstanding principal amount of the Debentures and any accrued interest would become immediately due and payable at the Investors’ election and the annual interest rate would increase to 18%. During the first six months after closing, we may not prepay any portion of the principal amount of the Debentures without the consent of the Investors. After the six month anniversary, we may elect to redeem some or all of the then principal amount outstanding with notice to the Investors at an amount equal to 120% of the then outstanding principal amount. We are subject to certain non-financial covenants under the Agreement.

 
3

 
 
The 4,000,000 Series A Warrants may be exercised at any time through the maturity date of the Debentures at an exercise price of $0.45 per share and the 4,000,000 Series B Warrants may be exercised at any time for a period of five years at an exercise price of $0.45 per share. If at any time after six months subsequent to the date of the Agreement there is no effective registration statement registering the resale of the shares of common stock underlying the Warrants, the holder of the Warrants may elect to exercise using a net exercise (i.e., cashless exercise) mechanism. If we sell or grant any option to purchase, or sell or grant any right to reprice, or otherwise dispose of or issue any common stock or common stock equivalents at an effective price per share less than $0.45, then simultaneously with the consummation of each dilutive issuance, the Warrant exercise price for both of the Warrants shall be reduced to the lower price. In addition, the number of shares of common stock underlying the Series B Warrants will be increased such that the aggregate value of the Series B Warrants, after taking into account the decrease in the exercise price, shall be equal to the value prior to such adjustment. If we enter into a fundamental transaction that (i) is an all cash transaction, (ii) is a Rule 13e-3 transaction as defined in Rule 13e-3 under the Exchange Act, or (iii) involves a person or entity not traded on a national securities exchange, we or any successor entity must, at the holder’s request within thirty days after each fundamental transaction (“Holder Option Period”), purchase the Warrants from the holder for an amount of cash 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 (“the Black Scholes Value”). The maximum amount payable under the Black Scholes Value shall be (i) $0.5 million if the fundamental transaction is consummated prior to the six month anniversary of the issuance date or (ii) $1.0 million if the fundamental transaction is consummated subsequent to the six month anniversary but prior to the first anniversary of the issuance date. 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. We have estimated the initial value of the warrants to be approximately $2.3 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%; expected life of sixteen months for the Series A Warrants and five years for the Series B warrants; volatility of 77.58% and 98.09%, respectively; and a risk free rate of 0.26% and 2.19%, respectively.

To secure our obligations under the Debentures, we and Destron Fearing have pledged our ownership interests in Signature. In addition, Signature, Destron Fearing and its wholly-owned subsidiaries Digital Angel Technology Corporation and Digital Angel International, collectively and individually have guaranteed the Debentures.

Mortgage Loan Modification Agreement

On February 25, 2011, we entered into a Loan Modification Agreement (the “Mortgage Agreement”) with the mortgage lender extending the mortgage loan’s term to November 1, 2011, with the option to extend the maturity date for an additional six months. If we elect to extend the maturity date, we must notify the current mortgage lender by September 30, 2011 and pay a fee of $25 thousand which would be applied to the outstanding principal. Under the Mortgage Agreement, the interest rate and monthly payments will remain the same as prior to the mortgage loan maturity. Upon closing, we were required to pay an additional principal payment of $25 thousand plus certain other closing fees. We are also required to make an extension payment of approximately $25 thousand which will be paid ratably over four months beginning March 1, 2011.

Industry Overview

Our principal activities encompass the development and marketing of RFID and GPS-enabled identification and location products.

RFID technology continues to grow in its importance to the animal identification industry. RFID systems identify objects using radio frequency transmissions, typically achieved with communication between a microchip or tag and a scanner or reader. Historically, RFID has been used to identify objects in security, retail, transportation and logistics industries, as well as to identify, track and locate livestock and companion pets. Prior to the adoption of RFID, users identified and tracked objects manually as well as through the use of bar code technology. These solutions were limited because of the need for ongoing human intervention and the lack of instantaneous location capabilities. RFID technology possesses greater range, accuracy, speed and lower line-of-sight requirements than bar code technology.

Our RFID businesses focus on companion pet identification and retrieval, equine identification, livestock food safety and traceability, and fish tracking through the network of dams in the Columbia River Basin.

The basic components of an RFID system consist of:

 
 
a “tag,” containing a microchip-equipped transponder, an antenna and a capacitor, attached to the item to be identified, located or tracked, which wirelessly transmits stored information to a receiver;
 
 
one or more receivers, also referred to as “readers” or “scanners”, which are devices that read the tag by sending out an RF signal to which a tag, in the range of the signal, responds; and
 
 
the equipment, cabling, computer network and software applications to use the processed data for one or more applications.

Most RFID systems use either “active” or “passive” tags, with the choice reflecting the different characteristics of the tags and the nature of the RFID system application. The key difference in the technology is that active RFID systems deploy tags with battery-powered microchips that emit a signal at regular intervals or continuously and do not rely on power from the reader to operate, while passive RFID systems deploy tags with microchips that have no attached power supply and receive an activating charge from the reader’s signal. Applications that require receipt of signals between the tag and the reader beyond approximately 10 meters in range usually require a battery in the tags. Currently, we sell passive RFID tags, with active tags under development.
 
 
4

 

Pet Identification and Retrieval

Pet identification and retrieval systems involve the insertion of a microchip with identifying information in the animal. Readers at animal shelters, veterinary clinics and other locations can determine the animal’s owner and other information with the use of RFID scanners and a registry database. The pet identification and retrieval market is expanding at accelerated levels. In the U.S., more and more shelters promote the use of microchipping as a way to insure that a lost pet can be reunited with its owner. With only an estimated 10% of pets chipped, the U.S. pet market has significant growth potential. As a result of the recent expansion of the capabilities of the electronic chips (e.g., providing feedback on the health of the animal, such as a temperature reading), we believe the market will expand even further. In Europe, microchips are required for any pets traveling across borders.  These “pet passports” allow the animal to travel freely throughout Europe without quarantine, and in some European countries, as many as 40% of the pets have electronic identification.

Livestock Identification and Tracking and Food Safety and Traceability

The use of RFID technology in the tracking of livestock in the U.S. is currently limited to utilization for herd management (breeding, performance, etc), United States Department of Agriculture (“USDA”) disease control programs (Brucellosis, Tuberculosis, etc.) and Marketing programs (Non-Hormone Treated Cattle and limited use for the Beef Export Verification Program). Recently the US federal government announced that it would discontinue the USDA’s National Animal Identification System (“NAIS”), moving traceability responsibilities to the state and tribal levels. The USDA will work with the states to establish a common system for animals transported across state lines. While NAIS at the federal level has been discontinued, 48-hour trace-back, and age and source verification will remain a central part of the livestock industry’s processes. Destron Fearing products have been widely adopted for these requirements, and we continue to see more opportunities from growth in these segments. At Destron Fearing, our business model has always been to develop and sell innovative herd management products to producers that add value to their businesses. We have developed programs that make it easier for producers to do business with us, and to provide them with products that enhance their productivity and business success. Our RFID products are focused on gaining information, such as monitored animal behavior, and yielding data that can achieve early detection of potential illnesses in their herds.

Internationally, the market place for electronic identification tags continues to grow. The need to combat animal disease has the European Union (“EU”) focusing on improved traceability of livestock. Beginning on December 31, 2009, the EU has mandated the use of electronic tags for all sheep and goats, which is believed to be a forerunner to eventually requiring all large animal livestock to have electronic tags in the future. It is planned to be implemented in the entire European herd over the next few years. In South America, Brazil, with approximately 200 million cattle, implemented mandatory electronic identification of all feed lot cattle in 2010. Soon all new born cattle in Brazil will be required to have electronic tags, with the objective to move the entire herd to electronic tags over the next two years. Similar implementations are occurring in other South American countries, such as Colombia and Chile. These are all favorable signs for our Animal Identification segment, and the outlook shows signs of growth. 

Emergency Identification

Global Navigation Satellite System (“GNSS”) is the standard generic term for satellite navigation systems that provide autonomous geospatial positioning with global coverage. The Navigation Satellite Timing and Ranging Global Position System (“NAVSTAR GPS”), which was developed by the U.S. Department of Defense, is the only fully operational GNSS. The satellite constellation is managed by the U.S. Air Force 50th Space Wing. Although the cost of maintaining the system is approximately $400 million per year, including the replacement of aging satellites, GPS is free for civilian use as a public good. In addition to NAVSTAR GPS, there is some indication that other nations may begin deploying GNSS. The Russian GLONASS is a GNSS in the process of being restored to full operation. The European Union Galileo positioning system is a next generation GNSS in the initial deployment phase, scheduled to be operational in a few years, and China has indicated it may expand its regional Beidou navigation system into a global system.

A GPS receiver calculates its position by measuring the distance between itself and three or more GPS satellites. Measuring the time delay between transmission and reception of each GPS radio signal gives the distance to each satellite, since the signal travels at a known speed. The signals also carry information about the satellites’ location. By determining the position of, and distance to, at least three satellites, the receiver can compute its position using trilateration. Receivers typically do not have perfectly accurate clocks and, therefore, track one or more additional satellites to correct the receiver’s clock error.

The original motivation for satellite navigation was for military applications. Today, GNSS systems have a wide variety of civilian uses such as:

 
 
navigation, ranging from personal hand-held devices for trekking, to devices fitted to cars, trucks, ships and aircraft;
 
 
synchronization;
 
 
location-based services such as enhanced 911;
 
 
surveying;
 
 
entering data into a geographic information system;
 
 
search and rescue;
 
 
geophysical sciences; and
 
 
tracking devices used in wildlife management.

 
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Our focus is in the areas of search and rescue and locator beacons and tracking systems which include mobile satellite data communications service and software for messaging for a variety of markets including the military, law enforcement and energy market. We believe that there is excellent growth potential in each of our markets and particularly, for us, in sales of our military personal location beacons due to recent technology improvements. However, each market in which we compete is highly competitive.

Operating Segments

Financial Information About Our Segments

Revenues from our two segments over the past two years were as follows:
 
   
For the years ended December 31,
 
   
2010
   
2009
 
   
(in thousands)
 
Animal Identification
 
$
30,830
   
$
30,774
 
Emergency Identification
   
6,890
     
11,791
 
Total
 
$
37,720
   
$
42,565
 

Refer to the segment information in Note 18 to our consolidated financial statements.

Animal Identification Segment

Principal Products and Services

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, and, for animal bio-sensing applications, such as temperature reading for companion pet applications. Our Animal Identification segment’s proprietary products focus on pet identification and safeguarding, as well as the positive identification and tracking of livestock and fish, which is crucial for asset management, disease control, food safety, and environmental impact analysis. 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.

The Animal Identification segment consists of Destron Fearing’s operations located in Minnesota and its wholly-owned subsidiaries: DSD Holding A/S and Destron Fearing A/S and its subsidiaries, which have operations in Denmark and Poland (collectively referred to as “Destron Fearing A/S”); and Digital Angel International, Inc. and its subsidiaries located in Argentina, Brazil, Chile, Paraguay and Uruguay.

We hold patents on our syringe-injectable microchip for use in animals. Each microchip is individually inscribed and programmed to store a unique, permanent 10 to 16-digit alphanumeric identification code. These microchips are tiny, passive electronic devices ranging in size from 8 to 28 millimeters in length and 2.1 to 3.5 millimeters in diameter. The smallest microchip is about the size of a grain of rice. The microchip is coupled with an antenna and placed either in a two-piece plastic button RFID tag or in a glass-like injectable capsule. The button RFID tag is typically affixed to the ear of the animal. The implantable microchip is injected under the skin using a hypodermic syringe, without requiring surgery. Each capsule is coated with a polymer, BioBondTM, to form adherence to tissue, thereby preventing migration in the host’s body. An associated scanner device uses radio frequency to interrogate the microchips and read the code. Our patented Bio-Thermo® implantable microchip product provides temperature readings of animals by simply passing an RFID handheld scanner over the animal.

Our pet identification and location system involves the insertion of a microchip, with identifying information, in the animal. Scanners located at animal shelters, veterinary clinics and other locations can read the RFID tag ID which is then queried in a database to determine the animal’s owner. Presently, there is an established infrastructure with RFID scanners placed in approximately 70,000 global animal shelters and veterinary clinics. We believe that approximately 4.0 million companion animals in the U.S. have been enrolled in our distributor’s database, and a pet is recovered in the U.S. by that system approximately every six minutes.

Our miniature RFID microchips are also used for the tagging of fish, especially salmon, for identification by biologists and governments in environmental programs and studies, migratory studies and other purposes. These microchips are accepted as a safe, reliable alternative to traditional identification methods because once the fish are implanted with the microchips, they can be identified without recapturing or sacrificing the fish. In 2006, we installed what is believed to be the world’s largest RFID ready system, a 17-foot by 17-foot RFID antenna designed to electronically track indigenous salmon populations. In addition, we launched our next generation transponders. These updated transponders are designed to provide greater reader reliability while increasing reader range.

In addition to pursuing the market for permanent identification of companion animals and tracking microchips for fish, we also produce visual and RFID identification products, for livestock producers. The tracking of cattle and hogs is crucial in order to provide security both for asset management and for disease control and food safety. Destron Fearing has marketed visual identification products for livestock since the 1940s. Visual identification products typically include numbered ear tags. Electronic identification products for livestock are currently being utilized for herd management (breeding, performance, etc), United States Department of Agriculture (“USDA”) disease control programs (Brucellosis, Tuberculosis, etc.) and Marketing programs (Non-Hormone Treated Cattle and limited use for the Beef Export Verification Program). Currently, sales of visual products represent a substantial percentage of our sales to livestock producers.
 
 
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Growth Strategy

The principal components of our Animal Identification segment’s growth strategy are to:

 
 
focus on animal identification products in the growing livestock, fish and wildlife industries;
 
 
become a major support player in the food source traceability and safety tracking systems arena;
 
 
increase our market share in the pet identification and equine markets with enhanced products such as our temperature-sensing Bio-Thermo® product, and
 
 
the development of high frequency tags both passive and active for longer read range - rTAG product development.

Through our Animal Identification segment, we are one of the leading suppliers in the U.S. of RFID-enabled implantable microchip products for companion animals, laboratory animals, wildlife, and visual identification tags for livestock. The “chipping” of companion pets has increased in Europe, in part, because in 2004, several European countries began requiring that all pets crossing their borders be identified with a either a tattoo or a microchip. In addition, world-wide standardization of the frequency on which the microchips operate will most likely lead to higher world-wide chipping rates. Our chips can be read by the world standard, which is 134.2 kilohertz.

During 2010, we continued our national initiative to target the use of our microchips to address the more than $100 million estimated U.S. equine market for identification products. There are approximately 9.2 million horses in the U.S. We believe that approximately 6.0 million are competition horses requiring identification by local and state equine animal health rules and regulations. In addition, USDA’s NAIS business plan categorizes equines as medium priority for permanent identification. Since late 2005, the California Horseracing Board, a division of the California Department of Agriculture, has been implanting all new, in-coming young horses entering their racing career with our microchips, which we call LifeChips®. The State of Louisiana has also been utilizing our LifeChips® to identify horses that have been Coggins tested which checks for Equine Infectious Anemia. The New York State Horse Health Assurance Program implemented a comprehensive health campaign that utilizes our microchips, and other state agencies are expected to launch similar programs. In addition, in March 2008, we entered into a non-exclusive distribution agreement with The Jockey Club, the official registry for North American Thoroughbred horses. Additional growth in LifeChip sales is expected to come from the recent requirement in Mexico, where all horses entering their country must have microchips.

New Products

In the second quarter of 2010, we launched a family of HDX (Half Duplex) products. This launch positions us to globally compete in markets that require this specialized technology. We have seen good growth in the US throughout 2010 and have developed beachheads in other key countries that will develop over the next one to three years.

Throughout 2010 we made progress on a number of new fishery antennas and readers:

 
 
FishTracker IS1001TM is a standalone RFID Antenna Control Node (ACN) designed to be a low cost, highly adaptable system for a variety of Passive Integrated Transponder (PIT) tag interrogation sites. The IS1001TM is capable of operating antennas sized up to 4 feet by 20 feet, with low coil inductance and advance auto-tuning circuitry that is tolerant of changing environmental conditions.
 
 
FishTracker FS2020 is a powerful, high speed ISO compliant stationary transceiver designed as a direct replacement for existing single channel transceivers currently installed throughout the Columbia River Basin.
 
 
FishTracker FS3001 will be the most advanced PIT tag detection system yet to be deployed in the Columbia River Basin. This interrogation system will be integrated into the spillway of the hydroelectric dams, and will be capable of tracking and identifying fish moving at over 60 miles per hour.
 
 
FishTracker IS1001-MTS is a distributed Multiplexing Transceiver System (MTS). It is a high performance RFID detection system that is specifically designed for adaptability to environmental changes.

In addition, in the fourth quarter of 2010, we completed development of the next generation Destron Fearing PIT tag providing a 15% performance improvement over the previous standard SST-1 PIT tag.

In 2010 we announced our long range, active RFID system called rTAG. Active tags have applications for livestock in cow/calf, feed lot, and dairy applications. We anticipate rTAG will be developed for market availability in late 2011.
 
 
7

 
 
Sales, Marketing and Distribution

Our companion pet identification and location system is marketed in the U.S. by Intervet/Schering-Plough Animal Health Corporation (“Intervet/Schering-Plough”) under the brand name Home Again® Pet Recovery Service. In February 2007, we signed an exclusive product supply and distribution agreement with Intervet/Schering-Plough Home Again LLC, a wholly owned subsidiary of Intervet/Schering-Plough, to provide electronic identification microchips and scanners as part of the Home Again® Proactive Pet Recovery Network. Intervet/Schering-Plough’s network, which markets the complete electronic pet identification system under the brand name HomeAgain®, is the nation’s first comprehensive system to assist in the search for lost pets. We helped Intervet/Schering-Plough develop this system in the late 90’s. In December, 2010, we entered into an amendment to the February 2007 agreement, which extends our agreement to provide Intervet/Schering-Plough electronic identification microchips and scanners as part of the Home Again® Proactive Pet Recovery Network through December 2011. During the term of the amended agreement, we will exclusively manufacture, supply and sell to Intervet/Schering-Plough and Intervet/Schering-Plough will exclusively purchase from us certain products (as defined in the amended agreement). The amended agreement contains, among other things, minimum purchase requirements by Intervet/Schering-Plough. The amended agreement also prohibits us from manufacturing, supplying or selling the products to any other person, governmental authority or entity in the territory (as defined in the amended agreement). The amended agreement also grants to Intervet/Schering-Plough exclusive distribution, marketing and sale rights to our RFID products in the companion animal market in the U.S. and non-exclusive distribution, marketing and sale rights to our RFID Bio Thermo product in the designated animal markets and territories, subject to a maximum amount of units of such RFID Bio Thermo products.

Currently our companion pet/equine product is also marketed by various other companies, including, but not limited to, (i) in some countries in Europe by Merial Pharmaceutical under the Indexel® brand; (ii) in the United Kingdom (U.K.) and Ireland by Animalcare under the idENTICHIP® brand; and (iii) in other European countries and in Australia, New Zealand and Japan by various distributors under the LifeChip® brand.

BioMark, Inc. is our primary U.S. distributor for our fish and wildlife RFID microchip products. Electronic identification products for livestock are sold directly to our customers under the Destron brand. Our principal customers for electronic identification devices for fish are Pacific States Marine and the U.S. Army Corps of Engineers. The loss of, or a significant reduction in, orders from either of these customers could have a material adverse effect on our financial condition and results of operations.

Competition

The animal identification market is highly competitive. The principal competitors in the U.S. visual identification market are Allflex USA, Inc. and Y-Tex Corporation, and the principal competitors in the U.S. RFID identification market are Allflex USA, Inc., Datamars SA and Avid Identification Systems, Inc. We believe that our intellectual property position and our reputation for high quality products are our competitive advantages.

Our principal competitor in other global markets is Allflex, with the remainder of the market quite fragmented with regional players. We believe that our efficient low cost production, reputation for high quality ear tags and our clear focus on the market are our competitive advantages. We expect our competitors to continue to improve the performance of and support for their current products. We also expect that, like us, they will introduce new products, technologies or services. Our competitors’ new or upgraded products could adversely affect sales of our current and future products.

Manufacturing; Supply Arrangements

Our Animal Identification segment has not been materially or adversely affected by the inability to obtain raw materials or products during the past three years. We rely on a production arrangement with Raytheon Microelectronics Espana (“RME”), a subsidiary of Raytheon Company, for the assembly of certain of our patented syringe-injectable transponders. The term of that agreement ends in December 2013, subject to earlier termination by either party if, among other things, the other party breaches the agreement and does not remedy the breach within 30 days of receiving notice. Under the agreement, RME is our preferred supplier of the glass encapsulated, syringe-implantable transponders, provided that RME’s pricing remains market competitive. Certain of the automated equipment and tooling used in the production of the transponders are owned by us; other automated equipment and tooling is owned by RME.

Besides RME, our Animal Identification segment’s other principal suppliers are TSI Molding, Inc., Feature Products and Creation Technologies. We generally do not enter into contracts with these suppliers.

Emergency Identification Segment

Principal Products and Services

Our Emergency Identification segment’s proprietary products provide 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 mobile data and radio communications applications, including our SARBETM brand which serves commercial and military markets.
 
 
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GPS Enabled Search and Rescue Equipment and Intelligent Communications Products

Our personal locator beacons (“PLBs”) are sold under the SARBE™ brand name. SARBE products are primarily used by military air crew in the event of an ejection or other event requiring emergency evacuation of an aircraft in a remote, possibly hostile location. SARBE equipment is also used by land and naval forces. Signature is based in the U.K. and has been developing and manufacturing PLBs for five decades. Reports of Second World War airmen and sailors at sea awaiting rescue with little more than the faint hope that a passing ship would find them was the catalyst that inspired Signature to develop a new way of saving lives by making the search part of search and rescue more effective. Today, we believe that we are a world-leading supplier of PLBs and our SARBE trademark is a common term for these devices, which are now found on ships, aircraft and submarines in the armed forces of over 40 countries. U.K. airmen were among the first to carry these lifesaving devices. Today every U.K. Royal Air Force, Royal Navy and Army airman carries a SARBE. PLBs are also packed in the survival packs of life rafts on military ships. Our latest generation SARBE for military personnel is the software programmable SARBE G2R, which provides true global reach and recovery. This flexible radio features peacetime and combat modes. As with previous PLBs, G2R can be configured to operate with any fast jet ejection seat and incorporates a specially designed system that automatically activates the beacon and deploys the antenna to the optimum position. This ensures that even if aircrew are unconscious or injured, the SARBE transmission will be initiated immediately as no human intervention is required, reducing the time it takes to initiate a search. Our SARBE G2R has been approved to operate on the Cospas-Sarsat Satellite System. Cospas-Sarsat is the internationally funded satellite system operator that detects activated search and rescue beacons and is responsible for approving all rescue beacons. Beginning February 1, 2009, Cospas-Sarsat ceased monitoring beacons using 121.5 MHz and 243 MHz satellite frequencies. The outdated beacons were replaced by the new generation of 406 MHz beacons, such as our SARBE G2R.

We are also a distributor of two-way communications equipment in the U.K. Our products range from conventional radio systems for the majority of radio users, for example, safety and security, construction, manufacturing, to trunked radio systems for large scale users, such as local authorities and public utilities. We also offer marine radios, air band radios and satellite communication equipment for use on a global basis.

Growth Strategy

We believe that our SARBE PLBs offer the greatest source of growth for our Emergency Identification segment. Cospas-Sarsat forecasts that the global population of the new generation of digital beacons will grow to 900,000 by 2012, providing us with opportunities to upgrade existing customers’ equipment and sell into new markets. We expect to see an increase in the demand for our beacons as air forces upgrade their PLBs to new digital standards. Air forces in the U.K. and the U.S. will be required to replace their existing beacons with the new generation 406 MHz beacons in the future. SARBE has developed a specific new product, the AAPLB, which we believe is a superior next generation search and rescue beacon that addresses this market well. The UK MoD selected our AAPLB for tri-service use in 2008, and we expect to begin shipping our AAPLBs to the MoD in 2011. We have also shipped this new, next generation product to a second customer, Spain, during the first quarter of 2011.

Sales and Distribution

We sell our PLBs directly to our customers worldwide through a direct sales force of approximately four personnel and through supply and distribution agreements, which have varying expiration dates. The remaining terms of such agreements are between one and three years. We are also a distributor of two-way communication equipment in the U.K. Our agreements with these distributors have varying expiration dates.

Competition

Principal methods of competition in our Emergency Identification segment include geographic coverage, service and product performance. The principal competitors for our PLBs are Boeing North American Inc., General Dynamics Decision Systems, Tadiran, Spectralink Ltd., and Becker Avionic Systems. We believe that introducing new leading edge products in the search and rescue beacon market and the use of our search and rescue beacons in over forty countries are competitive advantages. In addition, the barriers to entry in this market are high due to the technical demands of the market.

Manufacturing; Supply Arrangements

Our Emergency Identification segment has not been materially or adversely affected by the inability to obtain raw materials or products during the past three years. This segment’s principal suppliers are C.I.L. Ltd., Motorola Ltd., and Base Ltd. We generally do not enter into contracts with these suppliers.

Government Regulation

Animal Identification Laws and Regulations

Our passive RFID systems rely on low-power, localized use of the radio frequency spectrum to operate. As a result, we must comply with U.S. Federal Communications Commission (“FCC”) and Industry Canada (“IC”) regulations, as well as the laws and regulations of other jurisdictions in which we sell our products, governing the design, testing, marketing, operation and sale of RFID devices. Accordingly, all of our products and systems have the FCC equipment authorization, the IC equipment authorization, or other jurisdictions’ authorizations, as appropriate.
 
 
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U.S. Federal Communications Commission Regulations

Under FCC rules and regulations and Section 302 of the Communications Act, RFID devices, including those we market and sell, must be authorized and comply with all applicable technical standards and labeling requirements prior to being marketed in the U.S. The FCC’s rules prescribe technical, operational and design requirements for devices that operate on the electromagnetic spectrum at very low power levels. The rules ensure that such devices do not cause interference to licensed spectrum services, mislead consumers regarding their operational capabilities or produce emissions that are harmful to human health. Our RFID devices are intentional radiators, as defined in the FCC’s rules. As such, our devices may not cause harmful interference to licensed services and must accept any interference received. Additionally, we must construct all equipment in accordance with good engineering design and manufacturers’ practices. The FCC rules also establish standards for labeling, user manuals, recordkeeping and testing. We believe that we are in substantial compliance with all FCC requirements applicable to our products and systems.
 
Industry Canada Regulations

Industry Canada regulates the design, sale and use of radio communications devices in accordance with its Radio Standards Specifications (“RSS”) and Radio Standards Procedures (“RSP”). As intentional emitters, our RFID devices are subject to Industry Canada’s RSP-100, which establishes the procedures by which RFID communications equipment receives certification by Industry Canada. The RSP-100 certification procedure and RSS standards ensure that RFID radio devices do not cause interference to licensed spectrum services and that the devices do not produce emissions that are harmful to human health.
 
Manufacturers of RFID devices must demonstrate compliance with RSP-100 and RSS-210, which establish standards for obtaining certification of services, obtaining unique certification/registration numbers, display and label requirements on the equipment, user manuals, recordkeeping and testing. We believe we are in substantial compliance with all Industry Canada requirements applicable to our products and systems.

Emergency Identification Laws and Regulations

The manufacture and distribution of our emergency identification products are subject to compliance with applicable regulatory requirements in both the country of manufacture and in those countries where these products are sold. We must comply with local, state, federal/national, and international laws and regulations in the countries in which we do business, including environmental, technical, communications, and other laws and regulations governing the manufacture of our products, their technical specifications, their labeling and communications protocols, user manuals, and recordkeeping and testing. We believe that we are in substantial compliance with all FCC requirements applicable to our emergency identification products and systems.

Intellectual Property
 
In both our Animal Identification and Emergency Identification segments, we rely on a combination of patents, copyrights, trademarks, trade secrets (including know-how), employee intellectual property agreements, and third-party agreements to establish and protect proprietary rights in our products and technologies. It is our practice to seek protections in all jurisdictions where such protections are deemed useful and desirable to our business and competitive interests.
 
We believe our global patent portfolio will continue to provide a competitive advantage in protecting innovation, although our competitors in each business are actively seeking patent protection as well.
 
In the Animal Identification segment, some of our more important patents and intellectual property rights include those relating to the design and manufacture of RFID tags and readers, including their communications protocols, reader scanning algorithms, reader self testing methods, manufacturing methods for unitary antenna cores, improved antenna designs, injection molding techniques, and temperature sensing and communication capabilities. No one patent is considered material to this business segment.
 
In the Emergency Identification segment, some of our more important patents and intellectual property rights include those relating to the design and manufacture of locator beacons and their communications protocols. No one patent is considered material to this business segment.
 
Our trademarks include the following: Digital Angel, Destron Fearing, Bio-Thermo and SARBE.

Seasonality

No significant portion of our business is considered to be seasonal; however, our Animal Identification and Emergency Identification segments’ revenue, while not considered to be seasonal, may vary significantly based on government procurement cycles and technological development, and our Animal Identification segment’s revenues and operating income can be affected by the timing of animal reproduction cycles.

Employees

At March 23, 2011, we and our subsidiaries employed approximately 167 employees, of which 162 are full-time. Our Animal Identification segment’s production workforce located in South Saint Paul, Minnesota is party to a collective bargaining agreement covering wage rates and benefits to certain union employees, which expires on April 30, 2011. Our Emergency Identification segment has employees who are members of the G.M.B. and Amicus trade unions. Upon termination there are no future obligations other than payments of accrued wages. We believe we have positive relationships with our employees.

 
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Geographic Areas

We have operations and sales in various regions of the world. Additionally, we 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. Sales and expenses are denominated in local currencies and may be affected as currency fluctuations affect our product prices and operating costs or those of our competitors.

Currently, we operate in three geographic areas: the U.S. and Europe (both of which comprise the majority of our operations) and South America. The majority of our revenues and expenses in each geographic area were generated in the same currencies during the two-years ended December 31, 2010, and accordingly, we did not incur any significant foreign currency gains or losses during those years.

Revenues from continuing operations are attributed to geographic areas based on the location of the assets producing the revenue. Information concerning revenues by principal geographic areas as of and for the years ended December 31, 2010 and 2009 was as follows (in thousands):

   
United
States
   
Europe
 
South
America
 
Total
 
2010
                           
Net revenue
 
$
23,118
   
$
13,963
 
$
639
 
$
37,720
 
Property and equipment, net
   
4,078
     
1,160
   
   
5,238
 
2009
                           
Net revenue
 
$
21,694
   
$
20,176
 
$
695
 
$
42,565
 
Property and equipment, net
   
4,854
     
2,025
   
119
   
6,998
 

For a discussion of risks associated with our foreign operations, please see Item 1A. Risk Factors.

Each of our segment’s operating income (loss) is presented below in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and each of their assets is presented in Note 18 to our consolidated financial statements.

ITEM 1A. RISK FACTORS

We have a history of operating losses and we may not become profitable in the future, which could ultimately result in our inability to continue operations in the normal course of business.

We incurred a consolidated loss from continuing operations of $7.3 million and $17.0 million in the years ended December 31, 2010 and 2009, respectively. Our consolidated operating activities used cash of $(0.5) million and $(3.9) million during the years ended December 31, 2010 and 2009, respectively. As of December 31, 2010, we had an accumulated deficit of approximately $577.5 million. There is no assurance that our operating activities will be able to fund our cash requirements in the future if our investing and/or financing activities cannot.

Our independent registered public accounting firm, in their audit report related to our financial statements for the year ended December 31, 2010, expressed substantial doubt about our ability to continue as a going concern.

Our consolidated financial statements as of December 31, 2010 and 2009 and for the two years in the period ended December 31, 2010 were prepared on a “going concern” basis; however, as a result of our continued losses, negative working capital and significant cash flow commitments, our independent auditors have included an explanatory paragraph in their report on our financial statements for the fiscal year ended December 31, 2010, expressing substantial doubt as to our ability to continue as a going concern. Our consolidated financial statements do not include any adjustments to reflect the possible future effects on the recovery and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
 
 
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Historical losses and maturity of debt have raised concerns about our ability to continue operations at the current level.

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 stock options and 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 especially if we continue to incur losses. We will be required to generate funds to repay certain of our debt obligations during 2011. As of December 31, 2010, we had a working capital deficiency, which is partially due to a number of our debt obligations becoming due or potentially due within the next twelve months. Our credit facility with Danske Bank, which is more fully discussed in Note 8 to our consolidated financial statements, is due on demand in addition to our requirement to make monthly principal payments of approximately $0.1 million. Our factoring lines may be amended or terminated at any time by the lenders, and our mortgage loan of approximately $2.0 million is due on November 1, 2011, although we have the option to extend the loan an additional six months. In February, 2011 we issued $2.0 million Debentures which we are obligated to redeem in an amount equal to $0.5 million each quarter beginning October 1, 2011 as well as make quarterly interest payments beginning April 1, 2011 (see recent events for further discussion). These conditions indicate that substantial doubt exists about our ability 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 uncertainty. Our ability to continue operations at the current level is also discussed below in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Our ability in the future to achieve or sustain profitability is based on a number of factors, many of which are beyond our control, including the future demand for our RFID and GPS satellite-based systems and the technical requirements associated with the manufacture of our GPS products. If demand for such systems does not reach anticipated levels, or if we fail to manage our cost structure or to develop technologically viable products, we may not achieve profitability.

Our capital requirements depend on a variety of factors, including but not limited to, the rate of increase or decrease in our existing business base; the success, timing, and amount of investment required to bring new products on-line; revenue growth or decline; and potential acquisitions or divestitures. We have established a management plan to guide us in achieving profitability and positive cash flows from operations during 2011. 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.

We have substantial debt and debt service.

As of December 31, 2010, our indebtedness totaled approximately $5.7 million, in addition to advances on our factoring lines of approximately $0.5 million. As a result, we incur significant interest expense. We are obligated on our factoring lines, our revolving lines of credit, which had an aggregate outstanding balance of approximately $3.3 million at December 31, 2010, and our outstanding mortgage debt of approximately $2.0 million which matures on November 1, 2011, although we have the option to extend the loan for six additional months. We are also obligated to make monthly principal payments of approximately $0.1 million on our outstanding credit line with Danske Bank. In February, 2011 we issued $2.0 million Debentures which we are obligated to redeem in an amount equal to $0.5 million each quarter beginning October 1, 2011 as well as make quarterly interest payments beginning April 1, 2011 (see recent events for further discussion). For further discussion on our debt, see Note 8 to the consolidated financial statements.

Our debt agreements contain certain events of default, including, among other things, failure to pay, violation of covenants, and certain other expressly enumerated events. Additionally, we guaranteed Destron Fearing’s debt with TCI Corporation (approximately $1.7 million at December 31, 2010) as well as granted TCI Corporation a security interest in certain of our intellectual property to secure such debt.

The degree to which we are leveraged could have important consequences, including the following:
 
 
 
our ability to obtain additional or replacement financing in the future for operations, capital expenditures, potential acquisitions, and other purposes may be limited, or financing may not be available on terms favorable to us or at all;
 
 
a substantial portion of our cash flows from operations must be used to pay our interest expense and repay our debt, which reduces the funds that would otherwise be available to us for our operations and future business opportunities; and
 
 
our ability to continue operations at the current level could be negatively affected if we cannot refinance our obligations before their due date.

A default under any of our debt agreements could result in acceleration of debt payments and it could permit the lender to foreclose on our assets and the stock we have pledged in our subsidiaries. We cannot assure you that we will be able to maintain compliance with these covenants. Failure to maintain compliance could have a material adverse impact on our financial position, results of operations and cash flow.
 
 
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We have effected or entered into (and will likely continue to effect or enter into) capital raising transactions, acquisitions, legal settlements and contracts for services that involve the issuance of shares of our common stock (or securities convertible into or exchangeable for such shares) and, if such transactions occur, investments in our common stock will be further diluted.

We currently have a legal settlement of approximately $0.3 million which we currently intend to settle in unregistered shares of our common stock. On February 24, 2011, we issued 8,000,000 warrants to purchase our common stock at an exercise price of $0.45, as more fully discussed in Note 22 to our consolidated financial statements. Such share issuances have in the past been and we expect will in the future be dilutive to the value of our common stock. As a result, your investment in our common stock will be further diluted if such transactions occur.

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 shares of our common stock. We may issue additional shares of common stock:

 
 
to raise additional capital;
 
 
upon the exercise of outstanding options and stock purchase warrants or additional options and warrants issued in the future;
 
 
in connection with severance agreements;
 
 
in connection with loans or other capital raising transactions; and
 
 
in connection with acquisitions of other businesses or assets.

Each of these transactions would result in further dilution or result in ratchet of existing warrants.

As of March 23, 2011, there were 9,504,444 outstanding warrants, with exercise prices per share of $0.45, and 2,581,225 options to acquire additional shares of our common stock, with exercise prices per share ranging from $0.52 to $42.48. If exercised, these securities could dilute the value of shares of our common stock. In addition, we have the authority to issue up to a total of 50,000,000 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 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 our common stock.

Volatility in economic conditions and the financial markets may adversely affect our industry, business and financial performance.

We have witnessed unprecedented disruptions in financial markets, including volatility in asset values and constraints on the availability of credit. In response to these developments, the U.S. government has taken, and may take further, steps designed to stabilize markets generally and strengthen financial institutions in particular. The impact, if any, that these financial market events or these governmental actions might have on us and our business is uncertain and cannot be estimated at this time. If current economic conditions deteriorate or legislation or regulatory action adversely affects the U.S. economy, there could be an adverse impact on our access to capital and to our results of operations.

Our stock price has reflected a great deal of volatility, including a significant decrease over the past few years. The volatility may mean that, at times, our stockholders may be unable to resell their shares at or above the price at which they acquired them.

From January 1, 2007 to March 23, 2011, the price per share of our common stock has ranged from a high of $18.00 to a low of $0.32. The price of our common stock has been, and may continue to be, highly volatile and subject to wide fluctuations. The market value of our common stock has declined in the past, in part, due to our operating performance. In the future, broad market and industry factors may decrease the market price of our common stock, regardless of our actual operating performance. Recent declines in the market price of our common stock could affect our access to capital, and may, if continuing, impact our ability to continue operations at the current level. In addition, any continuation of the recent declines in the price of our common stock may harm employee morale and retention, curtail investment opportunities presented to us, and negatively impact other aspects of our business. As a result of any such declines, many stockholders have been or may become unable to resell their shares at or above the price at which they acquired them.

We rely heavily on revenues derived from sales to various governmental agencies, and the loss of, or a significant reduction in, orders from government agencies could result in significant losses and negative changes to cash flows from operations.

Our principal customers for electronic identification devices for fish are Pacific States Marine, a government contractor that relies on funding from the U.S. government, and the U.S. Army Corps of Engineers. Our Emergency Identification segment is heavily dependent on contracts with domestic government agencies and foreign governments, including the U.K., primarily relating to military applications. Because we rely on revenues and cash flows generated from contracts, directly or indirectly, with governmental agencies, the loss of any such contract would result in a decrease in revenues and cash flows, and such a decrease may be significant and thereby have a material adverse effect on our financial condition and results of operations.
 
 
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Our Animal Identification segment relies heavily on revenue from a principal distributor and two customers and the loss of the principal distributor and customers could negatively affect our revenue, cash flows and results of operations.

Our pet identification and location system is marketed in the U.S. by Intervet/Schering-Plough. For the years ended December 31, 2010 and 2009, Intervet/Schering-Plough accounted for approximately 12% and 8%, respectively, of our Animal Identification segment’s revenues. It may be difficult and time-consuming for us to arrange for distribution of the implantable microchip by a third party. The loss of Intervet/Schering-Plough as our exclusive distributor could negatively affect future sales. In December 2010, we amended our exclusive product supply and distribution agreement with Intervet/Schering-Plough to extend the agreement through December 31, 2011. There is no assurance that Intervet/Schering-Plough and Destron Fearing will extend the contract beyond December 31, 2011. Our principal customers for electronic identification devices for fish are Pacific States Marine and the U.S. Army Corps of Engineers. The loss of, or a significant reduction in, orders from these customers could have a material adverse effect on our financial condition and results of operations.

We depend on a small team of senior management and key employees, and we may have difficulty attracting and retaining additional personnel.

Our future success will depend in large part upon the continued services and performance of key senior management and other key personnel. If we lose the services of any key member of our senior management team, our overall operations could be materially and adversely affected. In addition, our future success will depend on our ability to identify, attract, hire, train, retain and motivate other highly skilled technical, managerial, marketing, purchasing and customer service personnel when they are needed. Competition for qualified individuals to fill these positions is intense. We cannot ensure that we will be able to successfully attract, integrate or retain sufficiently qualified personnel when the need arises. Any failure to attract and retain the necessary technical, managerial, marketing, purchasing and customer service personnel could have a material adverse effect on our financial condition and results of operations.

The loss of any key senior executive could materially adversely affect our financial results. Our senior executives, in many cases, have strong relationships with our customers, suppliers and lenders. Therefore, the loss of the services of such senior executives or any general instability in the composition of our senior management could have a negative impact on our relationship with these customers and suppliers.

Over the past few years, we have made significant changes in the nature and scope of our businesses.

If we are not successful in implementing our business model and developing and marketing our products or if these products do not gain sufficient market acceptance, we may not be able to achieve or sustain profitable operations. In that case, the market price of our stock would likely decrease.

Management continues to review strategic alternatives to increase shareholder value, which may result in a further decrease in consolidated revenue and the overall size of our operations.

Management is focusing on various strategic alternatives, which include the possibility of selling additional business units in our Emergency Identification segment. If we are successful in further streamlining our business to focus our attention solely on our Animal Identification business segment, it would, at least in the short term, result in a further decrease in our revenue and the size of our operations. Such a decrease could negatively impact the price of our common stock.

Technological change could cause our products and technology to become obsolete or require the redesign of our products, which could have a material adverse effect on our businesses.

Technological changes within the industries in which we conduct business may require us to expend substantial resources in an effort to develop new products and technology. We may not be able to anticipate or respond to technological changes in a timely manner, and our response may not result in successful product development and timely product introductions. If we are unable to anticipate or respond to technological changes, our businesses could be adversely affected.

We may be subject to costly product liability claims from the use of our systems, which could damage our reputation, impair the marketability of our systems and force us to pay costs and damages that may not be covered by adequate insurance.

Manufacturing, marketing, selling, testing and operation of our systems entail a risk of product liability. We could be subject to product liability claims in the event our systems fail to perform as intended. Even unsuccessful claims against us could result in the expenditure of funds in litigation, the diversion of management time and resources, damage to our reputation and impairment in the marketability of our systems. While we maintain liability insurance, it is possible that a successful claim could be made against us, that the amount of our insurance coverage would not be adequate to cover the costs of defending against or paying such a claim, or that damages payable by us would harm our business.

If others assert that our products infringe their intellectual property rights, we may be drawn into costly disputes and risk paying substantial damages or losing the right to sell our products.

We face the risk of adverse claims and litigation alleging infringement of the intellectual property rights of others. If infringement claims are brought against us or our suppliers, these assertions could distract management and necessitate our expending potentially significant funds and resources to defend or settle such claims. We cannot be certain that we will have the financial resources to defend ourselves against any patent or other intellectual property litigation. If we or our suppliers are unsuccessful in any challenge to our rights to market and sell our products, we may, among other things, be required to:
 
 
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pay actual damages, royalties, lost profits and/or increased damages and the third party’s attorneys’ fees, which may be substantial;
 
 
cease the development, manufacture, use and/or sale of products that use the intellectual property in question through a court-imposed sanction called an injunction;
 
 
expend significant resources to modify or redesign our products, manufacturing processes or other technology so that it does not infringe others’ intellectual property rights or to develop or acquire non-infringing technology, which may not be possible; or
 
 
obtain licenses to the disputed rights, which could require us to pay substantial upfront fees and future royalty payments and may not be available to us on acceptable terms, if at all, or to cease marketing the challenged products.

Ultimately, we could be prevented from selling a product or otherwise be forced to cease some aspect of our business operations as a result of any intellectual property litigation. Even if we or our suppliers are successful in defending an infringement claim, the expense, time delay, and burden on management of litigation and negative publicity could have a material adverse effect on our business.

We obtain the implantable microchip used in certain of our Animal Identification segment’s products from a single supplier, making us vulnerable to supply disruptions that could constrain our sales of such systems and/or increase the per-unit cost of production of the microchip.

At present, we source the microchip for certain of our products from Raytheon Microelectronics España S.A. (“RME”), the actual manufacturer, under a supply agreement between us and RME for use in our Animal Identification segment’s products. We and RME each own certain of the automated equipment and tooling used in the manufacture of the microchip. Accordingly, it would be difficult for us to arrange for a third party other than RME to manufacture the implantable microchip to satisfy our requirements. Even if we were able to arrange to have the implantable microchip manufactured in another facility, we believe that making such arrangements and commencement of production could take at least three to six months. A supply disruption of this length could cause customers to cancel orders, negatively affect future sales and damage our business reputation. In addition, the per-unit cost of production at another facility could be more than the price per unit that we currently pay.

The expiration or invalidation of patents covering products and technologies in our Animal Identification segment could expose us to potential competition that may have a material adverse effect on our sales and results of operations.

We rely on various patents covering microchip and reader products used in our Animal Identification segment. Without patent protection, our competitors may be able to independently develop similar technology or duplicate our systems, or the value of our products could be diminished which could have a material adverse effect on our sales and results of operations.

Our inability to safeguard our intellectual property may adversely affect our business by causing us to lose a competitive advantage or by forcing us to engage in costly and time-consuming litigation to defend or enforce our rights.

We rely on copyrights, trademarks, trade secret protections, know-how and contractual safeguards to protect our non-patented intellectual property, including our software technologies. Our employees, consultants and advisors are required to enter into confidentiality agreements that prohibit the disclosure or use of our confidential information. We also have entered into confidentiality agreements to protect our confidential information delivered to third parties for research and other purposes. There can be no assurance that we will be able to effectively enforce these agreements, the confidential information will not be disclosed, others will not independently develop substantially equivalent confidential information and techniques or otherwise gain access to our confidential information, or that we can meaningfully protect our confidential information. Costly and time-consuming litigation could be necessary for enforcement and failure to maintain the confidentiality of our confidential information could adversely affect our business by causing us to lose a competitive advantage maintained through such confidential information.

Disputes may arise in the future with respect to the ownership of rights to any technology developed with third parties. These and other possible disagreements could lead to delays in the collaborative research, development or commercialization of our systems, or could require or result in costly and time-consuming litigation that may not be decided in our favor. Any such event could have a material adverse effect on our business, financial condition and results of operations by delaying our ability to commercialize innovations or by diverting our resources away from revenue-generating projects.

We compete with other companies in the visual and electronic identification and locator markets, and the products sold by our competitors could become more popular than our products or render our products obsolete.

The markets for visual and electronic identification and beacon products are highly competitive. We believe that our principal competitors in the visual identification market for livestock are AllFlex USA and Y-Tex Corporation, that our principal competitors in the electronic identification market are AllFlex USA, Datamars SA and Avid Identification Systems, Inc., and that our principal competitors in the beacon market are Boeing North American Inc., General Dynamics Decision Systems, Tadiran Spectralink Ltd., and Becker Avionic Systems.

In addition, other companies could enter these lines of business in the future. Many of our competitors have substantially greater financial and other resources than us. We may not be able to compete successfully with our competitors, and our competitors may develop or market technologies and products that are more widely accepted than our products or that would render our products obsolete or noncompetitive.
 
 
15

 
 
Infringement by third parties on our intellectual property or development of substantially equivalent proprietary technology by our competitors could negatively affect our businesses.

Our success depends significantly on our ability to:

 
 
maintain patent and trade secret protection;
 
 
obtain future patents and licenses; and
 
 
operate without infringing on the proprietary rights of third parties.

There can be no assurance that the measures we have taken to protect our intellectual property will prevent the misappropriation or circumvention of our intellectual property. In addition, there can be no assurance that any patent application, when filed, will result in an issued patent, or that our existing patents, or any patents that may be issued in the future, will provide us with significant protection against competitors. Moreover, there can be no assurance that any patents issued to or licensed by us will not be infringed upon or circumvented by others. Litigation to establish the validity of patents and to assert infringement claims against others can be expensive and time-consuming, even if the outcome, which is often uncertain, is in our favor. Infringement of our intellectual property or the development of substantially equivalent technology by competitors could have a material adverse effect on our business.

Our efforts to protect our intellectual property may be less effective in some foreign countries where intellectual property rights are not as well protected as in the U.S.

The laws of some foreign countries do not protect intellectual property to as great an extent as do the laws of the U.S. Policing unauthorized use of the intellectual property utilized in our systems and system components is difficult, and there is a risk that our means of protecting our intellectual property may prove inadequate in these countries. Our competitors in these countries may independently develop similar technology or duplicate our systems, which would likely reduce our sales in these countries. Furthermore, some of our patent rights may be limited in enforceability to the U.S. or certain other select countries, which may limit our intellectual property protection abroad.

Domestic and foreign government regulation and other factors could impair our ability to develop and sell our products in certain markets.

The electronic animal identification market can be negatively affected by such factors as food safety concerns, price, consumer perceptions regarding cost and efficacy, international technology standards, government regulation and slaughterhouse removal of microchips.

We are also subject to federal, state and local regulation in the U.S., including regulation by the FDA, the FCC and the USDA, and similar regulatory bodies in other countries. We cannot predict the extent to which we may be affected by further legislative and regulatory developments concerning our products and markets. We are required to obtain regulatory approval before marketing most of our products. The regulatory process can be very time-consuming and costly, and there is no assurance that we will receive the regulatory approvals necessary to sell our products under development. Regulatory authorities 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 such regulatory action, including the failure to obtain such approval, could prevent us from selling, or materially impair our ability to sell, our products in certain markets and could negatively affect our businesses.

Our results of operations may be adversely affected if we write-off additional goodwill and other intangible assets.

During the fourth quarter of 2009, we recorded an impairment charge of $7.1 million for goodwill and intangible assets associated with our Emergency Identification reporting unit. As of December 31, 2010, we had approximately $13.1 million of goodwill and intangible assets, all related to the Animal Identification segment. We assess the fair value of our goodwill and other intangible assets annually or earlier if events occur or circumstances change that would more likely than not reduce the fair value of these assets below their carrying value. If we determine that significant additional impairment has occurred, we will be required to write off the impaired portion of goodwill and our other intangible assets. Additional impairment charges could have a material adverse effect on our operating results and financial condition.

We face the risk that the value of our inventory may decline before it is sold or that our inventory may not be able to be sold at anticipated prices.

On December 31, 2010, the book value of our inventory was $8.9 million. Our inventory could decline in value as a result of technological obsolescence or a change in the product. Our success depends in part on our ability to minimize the cost to purchase/produce inventory and turn that inventory rapidly through sales. The failure to turn such inventory may require us to sell such inventory at a discount or at a loss or write down its value, which could result in significant losses and decreases in our cash flows.

Our foreign operations pose additional risks.

We operate our businesses and market our products internationally. During the years ended December 31, 2010 and 2009, approximately 39% and 53% of our sales were to private and public businesses in non U.S. countries. Our foreign operations are subject to the risks described herein, as well as risks related to compliance with foreign laws and other economic or political uncertainties. International sales are subject to risks related to general economic conditions, currency exchange rate fluctuations, imposition of tariffs, quotas, trade barriers and other restrictions, enforcement of remedies in foreign jurisdictions and compliance with applicable foreign laws and foreign corrupt practices act, and other economic and political uncertainties. All of these risks could result in increased costs or decreased revenues, which could have an adverse effect on our financial results.
 
16

 
 
Currency exchange rate fluctuations could have an adverse effect on our sales and financial results.

During the years ended December 31, 2010 and 2009, we generated approximately 38% and 56%, respectively, of our sales and incurred a portion of our expenses in currencies other than U.S. dollars. We incurred approximately $0.1 million and $0.6 million of other comprehensive income due to fluctuations in foreign currency exchange rates. To the extent that going forward we are unable to match revenues received in foreign currencies with costs paid in the same currency, exchange rate fluctuations in any such currency could have an adverse effect on our financial results.

If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements could be impaired, which could adversely affect our operating results, our ability to operate our business and our stock price.

During the course of our testing of our internal controls, we may identify, and have to disclose, material weaknesses or significant deficiencies in our internal controls that will have to be remediated. Implementing any appropriate changes to our internal controls may require specific compliance training of our directors, officers and employees, entail substantial costs in order to modify our existing accounting systems, and take a significant period of time to complete. Such changes may not, however, be effective in maintaining the adequacy of our internal controls, and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. In addition, investors’ perceptions that our internal controls are inadequate or that we are unable to produce accurate financial statements may negatively affect our stock price.

ITEM 2. PROPERTIES

At December 31, 2010, we were obligated under leases for approximately 77,824 square feet of facilities, of which 25,035 square feet was for office facilities and 52,789 square feet was for factory and warehouse space. These leases expire at various dates through 2042. In addition, we own 31,892 square feet of office space and 47,800 square feet of factory and warehouse facilities at the locations below. Our owned property is subject to a mortgage as discussed in Note 8 to our consolidated financial statements.

The following table sets forth our owned and leased properties by business segment (amounts in square feet):
 
                   
Factory /
       
   
Office
   
Warehouse
   
Total
 
   
Owned
   
Leased
   
Owned
   
Leased
   
Owned
   
Leased
 
Animal Identification
   
31,892
     
4,534
     
47,800
     
8,005
     
79,692
     
12,539
 
Emergency Identification
   
     
20,501
     
     
44,784
     
     
65,285
 
Total
   
31,892
     
25,035
     
47,800
     
52,789
     
79,692
     
77,824
 
 
The following table sets forth the principal locations of our properties (amounts in square feet):
 
                   
Factory /
       
   
Office
   
Warehouse
   
Total
 
   
Owned
   
Leased
   
Owned
   
Leased
   
Owned
   
Leased
 
Europe
   
     
4,416
     
     
8,005
     
     
12,421
 
Minnesota
   
31,892
     
     
47,800
     
     
79,692
     
 
South America
   
     
118
     
     
     
     
118
 
United Kingdom
   
     
20,501
     
     
44,784
     
     
65,285
 
Total
   
31,892
     
25,035
     
47,800
     
52,789
     
79,692
     
77,824
 

ITEM 3. LEGAL PROCEEDINGS

We are involved in legal proceedings from time to time. We have accrued to the extent practicable our estimate of the probable costs for the resolution of these claims. Our estimate has been developed in consultation with outside counsel handling our defense in these matters and is based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. It is possible, however, that future results of operations or cash flows for any particular quarterly or annual period could be materially affected by changes in our estimates. See Note 17 to our consolidated financial statements for a description of certain legal proceedings.
 
 
17

 

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is traded on the OTC Bulletin Board under the symbol “DIGA.” The following table lists the high and low price for our common stock as quoted, in U.S. dollars, on the internet tracking services during each quarter within the last two fiscal years: 

   
High
   
Low
 
2010
               
First Quarter
 
$
0.73
   
$
0.43
 
Second Quarter
   
0.69
     
0.46
 
Third Quarter
   
0.52
     
0.35
 
Fourth Quarter
   
0.47
     
0.32
 
2009
               
First Quarter
 
$
0.68
   
$
0.40
 
Second Quarter
   
1.70
     
0.69
 
Third Quarter
   
1.49
     
1.03
 
Fourth Quarter
   
1.25
     
0.62
 

The quotations set forth above reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions. On March 23, 2011, the closing sale price of our common stock on the OTC Bulletin Board was $0.39 per share.

On June 9, 2010, we received a Staff Determination Letter from Nasdaq indicating that we failed to comply with the $1.00 bid price requirement for continued listing set forth in Nasdaq Listing Rule 5550(a)(2). Our common stock was therefore subject to delisting from The Nasdaq Capital Market, unless we requested a hearing before a Nasdaq Listing Qualifications Panel (the “Panel”). Accordingly, we requested a hearing before the Panel and presented our plan for regaining compliance with the Nasdaq bid price requirement. Following a hearing held on July 22, 2010, the Panel granted our request for continued listing. However, we did not comply with the terms of the Panel's decision, which was conditioned upon the Company filing a proxy for a special meeting of shareholders to approve implementation of a reverse stock split if bid price compliance had not been regained. On October 1, 2010, we announced that trading in our common stock on the Nasdaq Capital Market was suspended prior to the opening of trading on October 5, 2010. Beginning with the opening of trading October 5, 2010, our common stock began to trade under the symbol "DIGA" on the OTC Bulletin Board.
 
Holders

According to the records of our transfer agent, as of March 23, 2011, there were approximately 1,487 holders of record of our common stock.

Dividends

We have never paid cash dividends on our common stock and do not anticipate paying any cash dividends on our common stock in the foreseeable future.

Securities Authorized for Issuance Under Equity Compensation Plans

During 2010, we did not grant any shares of restricted common stock or stock options for executive compensation As of December 31, 2010, the following shares of our common stock were authorized for issuance under our equity compensation plans:
 
    Equity Compensation Plan Information  
              (c)   
             
Number of securities
 
   
(a)
   
(b)
 
remaining available for
 
   
Number of
   
Weighted-average
 
future issuance under
 
   
securities to be
   
exercise price per
 
equity compensation
 
   
issued upon exercise
   
share of outstanding
 
plans(excluding
 
   
of outstanding options,
   
options, warrants
 
securities reflected
 
Plan Category (1)
 
warrants and rights
   
and rights
 
in column (a))
 
Equity compensation plans approved by security holders
   
3,889,932
   
$
11.23
 
1,742,307
(2)
Equity compensation plans not approved by security holders (3)
   
221,874
     
13.39
 
 
Total
   
4,111,806
     
11.34
 
1,742,307
 

(1)
 
A narrative description of the material terms of our equity compensation plans is set forth in Note 10 to our consolidated financial statements.
(2)
 
Includes 24,787 shares available for future issuance under our 1999 Employees Stock Purchase Plan.
(3)
 
We have made grants outside of our equity plans and have outstanding options exercisable for shares of our common stock. These options were granted as an inducement for employment or for the rendering of consulting services.

 
18

 
 
Recent Sales of Unregistered Securities / Recent Purchases of Securities

We did not repurchase any shares of our common stock during the year ended December 31, 2010.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Annual Report on Form 10-K contains forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that reflect our current estimates, expectations and projections about our future results, performance, prospects and opportunities. Forward-looking statements include, without limitation, statements about our market opportunities, our business and growth strategies, our projected revenue and expense levels, possible future consolidated results of operations, the adequacy of our available cash resources, our financing plans, our competitive position and the effects of competition and the projected growth of the industries in which we operate. This Annual Report on Form 10-K also contains forward-looking statements attributed to third parties relating to their estimates regarding the size of the future market for products and systems such as our products and systems, and the assumptions underlying such estimates. Forward-looking statements are only predictions based on our current expectations and projections, or those of third parties, about future events and involve risks and uncertainties.

Although we believe that the expectations reflected in the forward-looking statements contained in this Annual Report on Form 10-K are based upon reasonable assumptions, no assurance can be given that such expectations will be attained or that any deviations will not be material. In light of these risks, uncertainties and assumptions, the forward-looking statements, events and circumstances discussed in this Annual Report on Form 10-K may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. Important factors that could cause our actual results, level of performance or achievements to differ materially from those expressed or forecasted in, or implied by, the forward-looking statements we make in this Annual Report on Form 10-K are discussed under “Item 1A. Risk Factors” and elsewhere in this Annual Report on Form 10-K and include:

 
 
our ability to fund our operations;
 
 
our growth strategies including, without limitation, our ability to deploy our products and services including Bio-Thermo™ and rTAG™;
 
 
anticipated trends in our business and demographics;
 
 
the ability to hire and retain skilled personnel;
 
 
relationships with and dependence on technological partners;
 
 
our reliance on government contractors;
 
 
uncertainties relating to customer plans and commitments;
 
 
our future profitability and liquidity;
 
 
our ability to continue operations at the current level;
 
 
our ability to maintain compliance with covenants under our credit facilities and Debentures, including our ability to make principal and interest payments when due;
 
 
our ability to obtain patents, enforce those patents, preserve trade secrets and operate without infringing on the proprietary rights of third parties;
 
 
governmental export and import policies, global trade policies, worldwide political stability and economic growth;
 
 
expectations about the outcome of litigation and asserted claims;
 
 
regulatory, competitive or other economic influences;
 
 
our ability to successfully mitigate the risks associated with foreign operations;
 
 
our ability to successfully implement our business strategy;
 
 
our ability to perform on MoD contract;
 
 
our expectation that we can achieve profitability in the future;
 
 
borrowings under Destron Fearing’s and Destron Fearing A/S’s existing bank and credit facilities as well as Signature’s invoice discounting facility are payable on demand and/or the facilities could be terminated at any time without notice;
 
 
our reliance on third-party dealers to successfully market and sell our products;
 
 
our reliance on a single source of supply for our implantable microchip;
 
 
we may become subject to costly product liability claims and claims that our products infringe the intellectual property rights of others;
 
 
our ability to comply with current and future regulations relating to our businesses;
 
 
the potential for patent infringement claims to be brought against us asserting that we hold no rights for the use of the implantable microchip technology and that we are violating another party’s intellectual property rights. If any such a claim is successful, we could be enjoined from engaging in activities to market the systems that utilize the implantable microchip and be required to pay substantial damages;
 
 
our ability to comply with the obligations in our various registration rights agreements;
 
 
the impact of new accounting pronouncements;
 
 
our ability to establish and maintain proper and effective internal accounting and financial controls; and
 
 
our actual results may differ materially from those reflected in forward-looking statements as a result of (i) the risk factors described under the heading “Risk Factors” beginning on page 12 of this Annual Report and in our other public filings, (ii) general economic, market or business conditions, (iii) the opportunities (or lack thereof) that may be presented to and pursued by us, (iv) competitive actions by other companies, (v) changes in laws, and (vi) other factors, many of which are beyond our control.
 
 
19

 
 
Forward-looking statements include all statements that are not historical facts and can be identified by forward-looking words such as “will likely result,” “are expected to,” “will continue,” “is anticipated,” “projects,” “target,” “goal,” “plans,” “objective,” “may,” “should,” “could,” “would,” “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “hopes,” 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 (including those described under “Risk Factors” in this Annual Report) that could cause actual results to differ materially from estimates or forecasts contained in the forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this Annual Report. Other than as required by law, we do not undertake any obligation to publicly update or correct any forward-looking statements to reflect events or circumstances that subsequently occur or of which we hereafter become aware.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying consolidated financial statements and related notes included in this Annual Report.

Overview

We currently engage in the following principal business activities:

 
 
developing, manufacturing and marketing of 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, and, for animal bio-sensing applications, such as temperature reading for companion pet applications; and
 
 
developing, manufacturing and marketing global position systems (“GPS”) and GPS-enabled products used for emergency location and tracking of pilots, aircraft and maritime vehicles in remote locations.

Discontinued Operations

During the years ended December 31, 2010 and 2009, we sold several non-core businesses. On November 20, 2009, we sold the assets of one of Signature’s business units, McMurdo Limited (“McMurdo”). On January 21, 2010, we sold Thermo Life Energy Corp. (“Thermo Life”), on January 25, 2010, we sold substantially all of the assets of a division known as the Control Products Group within the Clifford & Snell business unit of Signature, and on April 30, 2010, we sold the assets of Clifford & Snell. Accordingly, the financial results of these businesses are now classified as discontinued operations for all periods presented in this Annual Report. Our decision to sell these businesses was a result of management’s strategy to streamline operations. Going forward, our strategy is to focus our efforts on the business operations of our Animal Identification segment. Discontinued operations are more fully discussed in Note 13 to our consolidated financial statements.

Recent Events

16% Senior Secured Debenture and Warrants

On February 24, 2011, we entered into a Securities Purchase Agreement (the “Agreement”) with certain investors, including Hillair Capital Investments LLC (the "Investors") whereby we issued and sold (the “Offering”) to the Investors (i) $2.0 million of senior secured Debentures (the “Debentures”), (ii) Series A warrants (the “Series A Warrants”) to purchase up to 4,000,000 shares of our common stock and (iii) Series B warrants (the “Series B Warrants” and collectively with the Series A Warrants, the “Warrants”) to purchase up to 4,000,000 shares of our common stock.  

We will be obligated to redeem the Debentures on a quarterly basis beginning on October 1, 2011, in an amount equal to $0.5 million each quarter, until the Debentures maturity date of July 1, 2012. The Debentures accrue interest at a rate of 16% per annum which is due on a quarterly basis beginning on April 1, 2011. Upon any event of default, 125% of the then outstanding principal amount of the Debentures and any accrued interest would become immediately due and payable at the Investors’ election and the annual interest rate would increase to 18%. During the first six months after closing, we may not prepay any portion of the principal amount of the Debentures without the consent of the Investors. After the six month anniversary, we may elect to redeem some or all of the then principal amount outstanding with notice to the Investors at an amount equal to 120% of the then outstanding principal amount. We are subject to certain non-financial covenants under the Agreement.
 
 
20

 
 
The 4,000,000 Series A Warrants may be exercised at any time through the maturity date at an exercise price of $0.45 per share and the 4,000,000 Series B Warrants may be exercised at any time for a period of five years at an exercise price of $0.45 per share. If at any time after six months subsequent to the date of the Agreement there is no effective registration statement registering the resale of the shares of common stock underlying the Warrants, the holder of the Warrants may elect to exercise using a net exercise (i.e., cashless exercise) mechanism. If we sell or grant any option to purchase, or sell or grant any right to reprice, or otherwise dispose of or issue any common stock or common stock equivalents at an effective price per share less than $0.45, then simultaneously with the consummation of each dilutive issuance, the Warrant exercise price for both of the Warrants shall be reduced to the lower price. In addition, the number of shares of common stock underlying the Series B Warrants will be increased such that the aggregate value of the Series B Warrants, after taking into account the decrease in the exercise price, shall be equal to the value prior to such adjustment. If we enter into a fundamental transaction that (i) is an all cash transaction, (ii) is a Rule 13e-3 transaction as defined in Rule 13e-3 under the Exchange Act, or (iii) involves a person or entity not traded on a national securities exchange, we or any successor entity shall, at the holder’s request within thirty days after each fundamental transaction (“Holder Option Period”), purchase the Warrants from the holder for an amount of cash 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 (“the Black Scholes Value”). The maximum amount payable under the Black Scholes Value shall be (i) $0.5 million if the fundamental transaction is consummated prior to the six month anniversary of the issuance date or (ii) $1.0 million if the fundamental transaction is consummated subsequent to the six month anniversary but prior to the first anniversary of the issuance date. 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. We have estimated the initial value of the warrants to be approximately $2.3 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%; expected life of sixteen months for the Series A Warrants and five years for the Series B warrants; volatility of 77.58% and 98.09%, respectively; and a risk free rate of 0.26% and 2.19%, respectively.

To secure our obligations under the Debentures, we and Destron Fearing have pledged our ownership interests in Signature. In addition, Signature, Destron Fearing and its wholly-owned subsidiaries Digital Angel Technology Corporation and Digital Angel International, collectively and individually have guaranteed the Debentures.

Rodman & Renshaw, LLC, a subsidiary of Rodman & Renshaw Capital Group, Inc. (NASDAQ:RODM) acted as the exclusive placement agent in connection with the Offering.

Mortgage Loan Modification Agreement

On February 25, 2011, we entered into a Loan Modification Agreement (the “Mortgage Agreement”) with the mortgage lender extending the mortgage loan’s term to November 1, 2011, with the option to extend the maturity date for an additional six months. If we elect to extend the maturity date, we must notify the current mortgage lender by September 30, 2011 and pay a fee of $25 thousand which would be applied to the outstanding principal. Under the Mortgage Agreement, the interest rate and monthly payments will remain the same as prior to the mortgage loan maturity. Upon closing, we were required to pay an additional principal payment of $25 thousand plus certain other closing fees. We are also required to make an extension payment of approximately $25 thousand which will be paid ratably over four months beginning March 1, 2011.

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 1 to our consolidated financial statements.

Business Segment Overview

We operate in two business segments: Animal Identification and Emergency Identification. Our Animal Identification segment’s revenue remained relatively constant at $30.8 million for both years ended December 31, 2010 and 2009. Our Animal Identification segment experienced operating income of $1.4 million in the year ended December 31, 2010 compared to an operating loss of $(0.8) million in the year ended December 31, 2009. Our Emergency Identification segment’s revenue decreased to $6.9 million for the year ended December 31, 2010 compared to $11.8 million for the year ended December 31, 2009 and experienced operating losses for the years ended December 31, 2010 and 2009. See pages 23 and 24 for discussions on the results of our Animal Identification and Emergency Identification segments, respectively.

The tables below provide a percentage breakdown of the significant sources of our consolidated revenues and gross profits over the past two fiscal years and reflect certain trends in the composition of such revenues and gross profits:

Sources of Revenue:   2010     2009  
Animal Identification segment
   
81.7
%
   
72.3
%
Emergency Identification segment
   
18.3
     
27.7
 
Total
   
100.0
%
   
100.0
%

Sources of Gross Profit:   2010     2009  
Animal Identification segment
   
79.8
%
   
64.1
%
Emergency Identification segment
   
20.2
     
35.9
 
Total    
100.0
%    
100.0
%
 
 
 
21

 
 
The table below sets forth data from our consolidated statements of operations for the past two fiscal years, expressed as a percentage of total revenues from continuing operations:
 
   
2010
   
2009
 
Revenue
   
100.0
 %
   
100.0
 %
Cost of sales
   
65.1
     
61.1
 
Gross profit
   
34.9
     
38.9
 
                 
Selling, general and administrative expenses
   
46.8
     
52.9
 
Research and development expenses
   
2.7
     
2.8
 
Restructuring, severance and separation expenses
   
3.6
     
1.6
 
Goodwill and asset impairment charges
   
     
17.2
 
Total operating expenses
   
53.1
     
74.5
 
             
Operating loss
   
(18.2
)
   
(35.6
)
                 
Interest and other income (expense), net
   
(0.5
   
0.7
 
Interest expense
   
(3.1
)
   
(5.1
)
             
Loss from continuing operations before income tax benefit
   
(21.8
)
   
(40.0
)
                 
Benefit from income taxes
   
2.5
 
   
0.1
 
             
Loss from continuing operations
   
(19.3
)
   
(39.9
)
                 
Income from discontinued operations, net of income taxes
   
3.8
     
10.7
 
             
Net loss
   
(15.5
)
   
(29.2
)
                 
Loss (income) attributable to the noncontrolling interest, continuing operations
   
0.1
     
(0.3
)
(Income) loss attributable to the noncontrolling interest, discontinued operations
   
 
   
0.2
 
                 
Net loss attributable to Digital Angel Corporation
   
(15.4
)%
   
(29.1
)%

Our consolidated operating activities used cash of $0.5 million and $3.9 million during the years ended December 31, 2010 and 2009, respectively. As of December 31, 2010, our cash and cash equivalents totaled $0.9 million compared to $1.9 million as of December 31, 2009. As of December 31, 2010, our stockholders’ equity was $12.5 million, as compared to $15.9 million as of December 31, 2009, and as of December 31, 2010, we had an accumulated deficit of $577.5 million. Our consolidated operating loss was approximately $6.9 million and $15.2 million for the years ending December 31, 2010 and 2009, respectively. The decrease in our 2010 operating loss was due, in large part, to our Animal Identification segment as discussed on page 23.

Our profitability and liquidity depend on many factors, including the success of our marketing programs, the maintenance and reduction of expenses, our ability to successfully complete existing contracts, develop and bring to market our new products and technologies and the protection of our intellectual property rights. We have established a management plan intended to guide us in achieving profitability in future periods. The major components of our plan are as follows:

 
 
To streamline our segments’ operations and improve our supply chain management;
 
 
To streamline and consolidate our corporate structure and minimize overhead costs;
 
 
To divest of non-core assets and businesses;
 
 
To attempt to produce additional cash flow and revenue from our technology products;
 
 
To transition portions of our in-house manufacturing to lower-cost countries;
 
 
To instill a pay for performance culture; and
 
 
To seek growth through strategic acquisitions or partnerships.

Our management believes that the above plan can be effectively implemented.

Critical Accounting Policies and Estimates

Listed below are descriptions of the accounting policies that our management believes involve a high degree of judgment and complexity, and that, in turn, could materially affect our consolidated financial statements if various estimates and assumptions were changed significantly. The preparation of our consolidated financial statements requires that we make certain estimates and judgments that affect the amounts reported and disclosed in our consolidated financial statements and related notes. We base our estimates on historical experience and on other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. For more detailed information on our significant accounting policies, see Note 1 to our consolidated financial statements.
 
 
22

 

Revenue Recognition

Our revenue recognition policies, which are listed in Note 1 to our consolidated financial statements, determine the timing and recognition of certain expenses, such as sales commissions. We follow specific and detailed guidelines in measuring revenue; however, certain judgments affect the application of our revenue policy. The complexity of the estimation process and all issues related to the assumptions, risks and uncertainties inherent with our revenue recognition policies affect the amounts reported in our financial statements. A number of internal and external factors affect the timing of our revenue recognition, including estimates of customer service/warranty periods, estimates of customer returns and the timing of customer acceptance. Our revenue results are difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter and year to year.

Goodwill and Other Intangible Assets

As of December 31, 2010, our consolidated goodwill was $3.3 million and our intangible assets were $9.7 million. We had no intangible assets with indefinite lives. We test our goodwill and intangible assets for impairment annually as a part of our annual business planning cycle during the fourth quarter of each fiscal year or earlier depending on specific changes in conditions surrounding our business units. The determination of the value of our intangible assets requires management to make estimates and assumptions about the future operating results of our operating units. In the fourth quarter of 2009, we recorded an impairment charge of approximately $7.1 million related to our Emergency Identification reporting unit; $3.8 million relating to goodwill and $3.3 million (net of approximately $(1.4) million of related deferred tax liabilities) related to intangible assets. Future events, such as market conditions or operational performance of our businesses, could cause us to conclude that additional impairment exists, which could have a material impact on our financial condition and results of operations.

Principles of Consolidation

We consolidate all subsidiaries in which we hold a greater than 50% voting interest, which requires that we include the revenue, expenses, assets and liabilities of such subsidiaries in our financial statements. Currently, we own a majority of each of our subsidiaries. However, if in the future we were to own less than 50% but equal to or more than 20% of the voting interest of any investee, we will account for such investment under the equity method. All significant intercompany transactions and balances between or among us and our subsidiaries have been eliminated in consolidation.

Stock-Based Compensation

In accordance with the Compensation – Stock Compensation Topic of the FASB Accounting Standards Codification (“ASC” or “Codification”), stock-based awards granted are valued at fair value and compensation cost is recognized on a straight line basis over the service period of each award. See Note 10 for further information concerning our stock option plans.

In the years ended December 31, 2010 and 2009, we incurred stock-based compensation expense of approximately $0.4 million and $0.5 million, respectively. This stock-based compensation expense is reflected in our consolidated statements of operations in selling, general and administrative expense.

Inventory Obsolescence

Estimates are used in determining the likelihood that inventory on hand can be sold. Historical inventory usage and current revenue trends are considered in estimating both obsolescence and slow-moving inventory. Inventory is stated at lower of cost (determined by the first-in, first-out method) or market, net of writedowns for obsolete or slow-moving inventory. The estimated market value of our inventory is based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required, which could have a material adverse affect on our financial condition and results of operations.

Accounting for Income Taxes

As part of the process of preparing our consolidated financial statements, we are required to estimate our income tax liability in each of the jurisdictions in which we do business. This process involves estimating our actual current tax expense together with assessing temporary differences resulting from differing treatment of items, such as deferred revenues, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. We must then assess the likelihood that our net deferred tax assets in each tax jurisdiction will be recovered from future taxable income in the applicable jurisdiction and, to the extent we believe that recovery is not more likely than not or is unknown, we must establish a valuation allowance.

Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against the deferred tax assets. As of December 31, 2010 and 2009, we had recorded a full valuation allowance against our U.S. net deferred tax assets due to uncertainties related to our ability to utilize these deferred tax assets, primarily consisting of net operating losses carried forward. The valuation allowance is based on our historical operating performance and estimates of taxable income in the U.S. and the period over which our deferred tax assets will be recoverable. As of December 31, 2010, we have not provided a valuation allowance against certain of our United Kingdom deferred tax assets as we have deemed it more likely than not that these assets will be realized.
 
 
23

 
 
If we continue to operate at a loss or are unable to generate sufficient future taxable income, or if there is a material change in the actual effective tax rates or time period within which the underlying temporary differences become taxable or deductible, we may be required to increase our valuation allowance against previously recognized deferred tax assets, which could result in a material adverse impact on our operating results. Conversely, if we become profitable in the future or if we realize certain built-in-gains, we may reduce a significant portion of our valuation allowance, which could result in a significant tax benefit and a favorable impact on our financial condition and operating results. As of December 31, 2010, we had an aggregate valuation allowance against our net deferred tax assets of approximately $116.6 million.

The amount of any benefit from our US tax 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 a fifty percent change in ownership under IRC section 382 places 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, 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 the year ended December 31, 2010. As a result, approximately $196.7 million of the U.S. net operating loss carryforwards is limited under IRC section 382. 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. See Note 12 for further information concerning our income taxes.

Results of Operations from Continuing Operations

We evaluate the performance of our two operating segments based on stand-alone segment operating income (loss), as presented below. Operating income (loss) from each of our segments during 2010 and 2009 was as follows:
 
   
For the years ended December 31,
 
   
2010
   
2009
 
   
(in thousands)
 
Animal Identification
 
$
1,415
   
$
(757
)
Emergency Identification
   
(3,820
)
   
(10,780
)
Corporate (1)
   
(4,468
)
   
(3,626
)
Total
 
$
(6,873
)
 
$
(15,163
)
 
(1)
 
Our Corporate segment includes all amounts given effect to in the consolidation of our subsidiaries, such as the elimination of inter-segment revenues, expenses, assets and liabilities. Corporate also includes certain selling, general and administrative expense and interest expense and other expenses associated with corporate activities and functions.

Animal Identification Segment

Year Ended December 31, 2010 Compared to the Year Ended December 31, 2009
 
           
% of
           
% of
   
Change
 
   
2010
   
Revenue
   
2009
   
Revenue
   
Increase (Decrease)
 
   
(dollar amounts in thousands)
 
Revenue
 
$
30,830
     
100.0
%
 
$
30,774
     
100.0
%
 
$
56
   
0.2
%
Cost of sales 
   
20,336
     
66.0
     
20,139
     
65.5
     
197
   
1.0
 
Gross profit
   
10,494
     
34.0
     
10,635
     
34.5
     
(141
)
 
(1.3
)
                                               
Selling, general and administrative expenses
   
7,902
     
25.3
     
9,492
     
30.8
     
(1,590
)
 
(16.7
)
Research and development expenses
   
1,031
     
3.3
     
1,206
     
3.9
     
(175
)
 
(14.5
)
Restructuring, severance and separation expenses
   
146
     
0.5
     
497
     
1.6
     
(351
)
 
(70.6
)
Goodwill and asset impairment charges
   
     
     
197
     
0.6
     
(197
)
 
(100.0
)
                                     
Operating income (loss)
 
$
1,415
     
4.6
%
 
$
(757
)
   
(2.4
)%
 
$
2,172
   
NM
 
 NNM – Not meaningful
                                   
 
Revenue — Our Animal Identification segment’s revenue remained constant at approximately $30.8 million for the years ended December 31, 2010 and 2009. There was an increase in sales related to electronic livestock products as a result of market share gains and higher sales of our LifeChip product. These increases were slightly offset by a decrease in our companion pet product sales in Europe and decreased livestock sales in Europe primarily due to a lower volume of sales to Austria.
 
 
24

 
 
Gross Profit and Gross Profit Margin — Our Animal Identification segment’s gross profit decreased approximately $0.1 million, or 1.0%, in the year ended December 31, 2010 compared to the year ended December 31, 2009. The decrease primarily relates to slightly higher labor costs associated with certain electronic livestock products as well as higher health insurance premiums. The gross profit margin remained relatively constant at 34.0% in the year ended December 31, 2010 compared to 34.5% in the year ended December 31, 2009. 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 $1.6 million, or 16.7% in the year ended December 31, 2010 compared to the year ended December 31, 2009. This was primarily attributable to decreased salaries and bonus compensation, legal and accounting costs, depreciation and amortization and travel expenses. Selling, general and administrative expenses as a percentage of revenue decreased to 26.0% in the year ended December 31, 2010 compared to 30.8% in the year ended December 31, 2009 due to the decrease in the aforementioned expenses.

Research and Development Expenses — Our Animal Identification segment’s research and development expenses decreased approximately $0.2 million in the year ended December 31, 2010 compared to the year ended December 31, 2009. The decrease was primarily due to a decrease in salaries and travel expenses slightly offset by an increase in quality testing. 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 were approximately $0.1 million and $0.5 million in the years ended December 31, 2010 and 2009, respectively. The costs in 2010 relate to severance costs and the costs in 2009 primarily related to severance and contract termination costs for the St. Paul, Denmark and South American locations.

Goodwill and Asset Impairment Charges — Our Animal Identification segment recorded goodwill and asset impairment charges of $0.2 million for the year ended December 31, 2009. The goodwill and asset impairment charges in 2009 related to fixed asset impairments at the St. Paul location. In the future, if we fail to perform as expected, we could face additional goodwill and intangible asset impairment charges.

Outlook and Trends

We anticipate our Animal Identification segment’s sales and gross profits to increase in 2011 and our operating expenses to remain relatively constant in 2011. 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 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.

Emergency Identification Segment

Year Ended December 31, 2010 Compared to the Year Ended December 31, 2009
 
           
% of
           
% of
   
Change
 
   
2010
   
Revenue
   
2009
   
Revenue
   
Increase (Decrease)
 
   
(dollar amounts in thousands)
 
Revenue
 
$
6,890
     
100.0
 %
 
$
11,791
     
100.0
%
 
$
(4,901
)
 
(41.6
)%
Cost of sales 
   
4,234
     
61.4
     
5,846
     
49.6
     
(1,612
)
 
(27.6
)
Gross profit
   
2,656
     
38.6
     
5,945
     
50.4
     
(3,289
)
 
(55.3
)
                                               
Selling, general and administrative expenses
   
6,476
     
94.0
     
9,402
     
79.7
     
(2,926
)
 
(31.1
)
Restructuring, severance and separation expenses
   
     
     
181
     
1.5
     
(181
)
 
(100.0
 
)
Goodwill and asset impairment
   
     
     
7,142
     
60.6
     
(7,142
)
 
(100.0
)
                                     
Operating loss
 
$
(3,820
)
   
(55.4
)%
 
$
(10,780
   
(91.4
)%
 
$
6,960
   
(64.6
)

Revenue — Our Emergency Identification segment’s revenue decreased approximately $4.9 million, or 41.6%, in the year ended December 31, 2010 compared to the year ended December 31, 2009. The decrease in revenue was primarily due to decreased sales of approximately $5.4 million at our Sarbe division as a result of lower PELS and G2R sales as well as decreased sales to the U.S. Air Force. The Sarbe product sales decrease was primarily related to the mandatory transition to higher satellite frequency beacons in the prior year. In addition, we experienced lower sales at our Communications division due to market conditions. We anticipate our revenues to increase provided we commence shipping on a large PELS contract, which have been delayed as a result of extended testing and customer certification requirements.

Gross Profit and Gross Profit Margin — Our Emergency Identification segment’s gross profit decreased approximately $3.3 million, or 55.3%, in the year ended December 31, 2010 as compared to the year ended December 31, 2009. The decrease was primarily attributable to the overall decrease in sales and gross profit margin. Gross profit margin was 38.6% in the year ended December 31, 2010 as compared to 50.4% during the year ended December 31, 2009. The decrease in gross profit margin relates primarily to an inventory provision of approximately $1.1 million of Sarbe inventory. The decrease was slightly offset by higher margins at our Sarbe division. We expect gross margins to return to previous levels when sales return which may vary period-to-period because of the changes in the product mix and in the ratio of fixed and variable costs.
 
 
25

 
 
Selling, General and Administrative Expenses — Our Emergency Identification segment’s selling, general and administrative expenses decreased approximately $2.9 million, or 31.1%, in the year ended December 31, 2010 compared to the year ended December 31, 2009. This decrease in selling, general and administrative expenses is primarily due to a decrease in personnel costs as a result of the restructuring implemented in the prior year. In addition, there were decreases in engineering consumables, advertising costs, audit and legal fees as well as corporate salaries allocated to Signature. As a percentage of revenue, selling, general and administrative expenses increased to 94.0% in the year ended December 31, 2010 from 79.7% in the year ended December 31, 2009. The increase in selling, general and administrative expenses as a percentage of revenue resulted primarily from the decrease in sales discussed above.

Restructuring, Severance and Separation Expenses Our Emergency Identification segment’s restructuring, severance and separation expenses were approximately $0.2 million in the year ended December 31, 2009 and primarily related to severance at our U.K. locations as we continue our efforts to reduce expenses and streamline operations.

Goodwill and Asset Impairment – Our Emergency Identification segment’s goodwill and asset impairment expense of approximately $7.1 million during the year ended December 31, 2009 related to impairments of approximately $3.8 million of goodwill and approximately $3.3 million (net of approximately $(1.4) million of related deferred tax liabilities) related to intangible assets. The impairments were recorded as a result of our annual testing during the fourth quarter of 2009.

Outlook and Trends

We anticipate our Emergency Identification segment’s sales and gross profits to increase provided we commence shipping on the PELS contract, which has been delayed as a result of extended testing and certification requirements, and our operating expenses to remain relatively constant in 2011. We believe that the future will bring market opportunities due to increasing demand for recreational PLBs, expansion into the North American market and our belief that PLBs will become a highly desired product during peacetime for many of our current, and potentially new, worldwide armed forces customers. However, going forward we intend to focus on growing our Animal Identification business.

Corporate Segment

Year Ended December 31, 2010 Compared to the Year Ended December 31, 2009
 
                   
Change
 
   
2010
   
2009
   
Increase (Decrease)
 
   
(dollar amounts in thousands)
 
Revenue
 
$
   
$
   
$
     
%
Cost of sales
   
     
     
     
 
Gross profit
   
     
     
     
 
                           
Selling, general and administrative expenses
   
3,267
     
3,626
     
(359
)
   
(9.9
)
Restructuring, severance and separation expenses
   
1,201
     
     
1,201
     
NM
 
                           
Operating loss
 
$
(4,468
)
 
$
(3,626
)
 
$
842
     
(23.2
)
NM – Not meaningful
                         
 
Selling, General and Administrative Expenses — Our Corporate segment’s selling, general and administrative expenses decreased approximately $0.4 million in 2010 as compared to 2009. The decrease primarily relates to lower salary expense, a decrease in bonus compensation, lower insurance expense and accounting fees. Slightly offsetting the decrease were higher Nasdaq fees, investor relations fees, legal expenses and non-cash compensation expense resulting from the granting of options and restricted stock to certain executives and management in October 2009.

Restructuring Expenses Our Corporate segment’s restructuring expense in 2010 related to the accrual of costs associated with certain headcount reductions.

Consolidated

Interest and Other Income (Expense), net

Interest and other income (expense), net decreased approximately $0.5 million to $(0.2) million in the year ended December 31, 2010 compared to $0.3 million in the year ended December 31, 2009. The decrease was primarily the result of the write off of the discounted portion of a note receivable, approximately $0.3 million, during the first quarter of 2010 and a decrease in royalty payments at our Animal Identification segment.

Interest Expense

Interest expense was $1.2 million and $2.2 million for the years ended December 31, 2010 and 2009, respectively. The decrease in interest expense from 2009 is primarily due to a final payment of $1.4 million of our Term Debt Obligations with Laurus Master Fund and affiliates on February 1, 2010. Based on our current level of debt we estimate that our interest expense will decrease slightly for the year ended December 31, 2011.
 
 
26

 
 
Total cash paid for interest was approximately $0.8 million and $1.5 million, or 64% and 68% of total interest expense, for the years ended December 31, 2010 and 2009, respectively.

Income Taxes

Differences in the effective income tax rates from the statutory federal income tax rate arise from state taxes net of federal benefits, and the increase or reduction of valuation allowances related to net operating loss carry forwards and other deferred tax assets. As of December 31, 2010, we have provided a valuation allowance to fully reserve our U.S. net operating losses carried forward and our other U.S. existing net deferred tax assets, primarily as a result of our recent losses. Our tax provisions for 2010 and 2009 were primarily related to our foreign operations.

Net Loss from Continuing Operations

During the years ended December 31, 2010 and 2009, we reported a loss from continuing operations of approximately $7.3 million and $17.0 million, respectively. The decrease in the loss for the year ended December 31, 2010 compared to December 31, 2009 principally relates to the company-wide reduction in selling, general and administrative expenses, interest expense and asset impairment expenses. Slightly offsetting these changes was an increase in restructuring, severance and separation expenses at Corporate as well as a decrease in gross margin at our Emergency Identification segment. Each of these items is more fully discussed above in the context of the appropriate segment.

LIQUIDITY AND CAPITAL RESOURCES FROM CONTINUING OPERATIONS

As of December 31, 2010, cash and cash equivalents totaled $0.9 million, a decrease of $1.0 million, or 47.4%, from $1.9 million at December 31, 2009.

Net cash used in operating activities totaled $0.5 million and $3.9 million in 2010 and 2009, respectively. In 2010, cash was used primarily by the net loss slightly offset by discontinued operations and the net change in operating assets and liabilities. In 2009, cash used by operating activities was primarily the net loss and the net change in operating assets and liabilities.

Adjustments to reconcile operating losses to net cash used in operating activities included the following:

 
 
Accounts and unbilled receivables, net of allowance for doubtful accounts, were $5.2 million and $6.4 million at December 31, 2010 and 2009, respectively. The decrease is primarily due to our Emergency Identification segment’s decrease in sales from the prior year as well as the collection on the U.S. Air Force contract in the first quarter of 2010. We anticipate accounts receivable to increase slightly going forward provided we begin shipping on a large PELS contract.
 
 
Inventories decreased to $8.9 million at December 31, 2010, compared to $9.0 million at December 31, 2009. The decrease was primarily due to $1.1 million of inventory write-offs recorded at our Emergency Identification segment, slightly offset by increased inventory at our Animal Identification segment due to general inventory level fluctuations. We expect inventory levels to decrease in 2011 provided we commence shipments under the PELS contract.
 
 
Accounts payable remained constant at $7.9 million at both December 31, 2010 and December 31, 2009. Our accounts payable balance fluctuates due to the general timing of billings and payments. We anticipate accounts payable levels to decrease throughout 2011.
 
 
Accrued expenses increased $0.2 million to $6.8 million at December 31, 2010, from $6.6 million at December 31, 2009. The increase was primarily related to accrued severance expenses recorded during 2010 at our Corporate segment which was slightly offset by a decrease at our Emergency Identification segment due to payments of accrued legal and professional fees and a decrease at our Animal Identification segment due to payments of certain compensation expenses. We expect accrued expenses to decrease slightly in 2011 as we make payments for accrued bonuses, severance and other accrued liabilities.

Investing activities provided cash of $2.6 million and $8.1 million in 2010 and 2009, respectively. In 2010, cash provided by investing activities was primarily related to the proceeds from the sale of Clifford & Snell, the collection of the McMurdo funds held in escrow and certain notes receivable and in 2009, cash provided by investing activities was primarily related to the sale of McMurdo.

Financing activities used cash of $(3.1) million and $(3.8) million in 2010 and 2009, respectively. In 2010, cash was primarily used for payments on debt which was partially offset by the sale of common stock to two investors for approximately $1.7 million. In 2009, we paid a total of approximately $6.6 million on our debt which was partially offset by the cash received from the issuance of shares of our common stock under the SEDA.

Financial Condition

Financing Agreements and Debt Obligations

We are party to certain financing agreements and debt obligations, which total approximately $5.7 million as of December 31, 2010, and are discussed in detail in Note 8 to our consolidated financial statements. The following is a discussion of our liquidity, and therefore, focuses on our revolving debt and advances from factors which represent approximately $3.3 million and $0.5, respectively. For discussion of our financial and non-financial covenants and outstanding debt, see Note 8 to our consolidated financial statements.
 
 
27

 
 
Destron Fearing’s 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%, as defined, plus 25% of eligible inventory capped at $0.5 million, as may be adjusted for writedowns, 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 December 31, 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 December 31, 2010, we were in compliance with all covenants.

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 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. 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 guaranteed the TCI Revolving Facility.

The TCI Revolving Facility replaced the $6.0 million revolving facility with Kallina.

Destron Fearing A/S’s Line of Credit

Destron Fearing A/S is party to a credit agreement with Danske Bank (the “Credit Facility”). On June 1, 2006, Destron Fearing A/S amended the borrowing availability from DKK 12.0 million to DKK 18.0 million. In connection with the amendment, Destron Fearing executed a Letter of Support which confirms that it will maintain its holding of 100% of the share capital of Destron Fearing A/S, and will neither sell, nor pledge, nor in any way dispose of any part of Destron Fearing A/S or otherwise reduce Destron Fearing’s influence on Destron Fearing A/S without the prior consent of Danske Bank. Interest is determined quarterly and is based on the international rates Danske Bank can establish on a loan in the same currency on the international market plus 2.0%. At December 31, 2010, the annual interest rate on the Credit Facility was 7.65%. Borrowing availability under the Credit Facility considers guarantees outstanding. The Credit Facility will remain effective until further notice. Destron Fearing A/S can terminate the Credit Facility and pay the outstanding balance, or Danske Bank may demand the credit line be settled immediately at any given time, without prior notice. Beginning in July 2009, Destron Fearing A/S and Danske Bank agreed to reduce the borrowing availability on the Credit Facility each month by DKK 0.5 thousand (approximately $0.1 million). As of December 31, 2010, total availability had been reduced from DKK 18.0 million (approximately $3.2 million) to DKK 9.0 million (approximately $1.6 million). DKK 9.0 million (approximately $1.6 million) was outstanding at December 31, 2010 and there was no additional availability under the credit line.

Signature’s Invoice Discounting Factoring Agreement

In July 2009, Signature entered into an invoice discounting factoring agreement (the “Bibby Invoice Discounting Agreement”) with Bibby Financial Services (“Bibby”), which replaced a similar arrangement with the Royal Bank of Scotland. The Bibby Invoice Discounting Agreement provides for Signature to sell, with full title guarantee, certain of its receivables as defined in the Bibby Invoice Discounting Agreement. Bibby prepays 80% of the receivables sold in the U.K. and 70% of receivables sold in the rest of the world, not to exceed a balance of £2.5 million (approximately $3.9 million at December 31, 2010). Bibby repays Signature the remainder of the receivable upon collection.

Receivables which remain outstanding 90 days from the invoice date become ineligible and Signature is required to repurchase the receivable. The Bibby Invoice Discounting Agreement requires a fee of 0.25% for each U.K. receivable sold and 0.3% for each receivable sold in the rest of the world. If the total of the yearly fee is less than £60,000, Signature is required to pay Bibby the amount of such deficit. Signature is also required to pay a discounting charge of 2.0% above the higher of Barclays Bank Plc base rate or 3 month LIBOR subject to a minimum of 3.5% (5.0% at December 31, 2010). Discounting charges of approximately $41 thousand and $0.1 million are included in interest expense for the years ended December 31, 2010 and 2009, respectively. Either Signature or Bibby can terminate the Bibby Invoice Discounting Agreement by providing written notice to the other party six months prior to the intended termination date but neither party can terminate for eighteen months following the commencement date. As of December 31, 2010, we had approximately £0.3 million outstanding (approximately $0.4 million) and approximately £0.3 million available (approximately $0.5 million) for borrowing under the Bibby Invoice Discounting Agreement.

Destron Fearing A/S’s Factoring Agreements

In March 2008, our wholly-owned European subsidiary, Destron Fearing A/S, entered into a factoring agreement (the “Nordisk Factoring Agreement”) with Nordisk Factoring A/S (“Nordisk”). Under the Nordisk Factoring Agreement, Nordisk advanced 80% of Destron Fearing A/S’s eligible receivables, not to exceed a balance of DKK 6.0 million at any given time. As security, Destron Fearing A/S assigned all invoice balances to Nordisk, regardless of whether advances were made on them, and warranted payments by its customers. Destron Fearing A/S paid a factoring commission charge to Nordisk of 0.15% of the gross volume of receivables factored. The Nordisk Factoring Agreement required a minimum commission charge of DKK 36,000 per year. Discounting charges of approximately $4 thousand and $34 thousand are included in interest expense for the years ended December 31, 2010 and 2009, respectively. On September 1, 2010 we replaced the Nordisk Factoring Agreement with the AL Finans Factoring Agreement as discussed below.
 
 
28

 

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 warrants 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 thousand (approximately $6 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. Discounting charges of approximately $13 thousand are included in interest expense for the year ended December 31, 2010. As of December 31, 2010, we had approximately DKK 0.6 million (approximately $0.1 million) outstanding and no availability for borrowing under the AL Finans Factoring Agreement.

Liquidity

As of March 23, 2011, our consolidated cash and cash equivalents totaled approximately $1.9 million. In addition, we had an aggregate of $0.2 million available under our credit facilities.

We had negative working capital at December 31, 2010. During 2008 we restructured our Animal Identification business which eliminated redundancies, improved gross margins and decreased expenses. In 2010, we initiated the next stage of restructuring of our corporate group which will result in the elimination of our corporate structure and the associated costs of a separate headquarters and several management positions. 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 perform existing contracts, revenue growth or decline, and potential acquisitions or divestitures. We have established a management plan to guide us in achieving profitability and positive cash flows from operations during 2011. Failure to generate positive cash flow from operations might require us to substantially reduce our level of operations and 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 stock options and 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/refinance/extend our mortgage loan obligation, and to pay principal and interest payments on our Debentures during 2011. As of December 31, 2010, we had a working capital deficiency, which is partially due to having to classify our revolving line of credit, our factoring lines and our credit facility with Danske Bank, which are more fully discussed in Note 8, as current liabilities on our consolidated balance sheet. In addition, our debt obligation to Danske Bank is due on demand and we are required to make $0.1 million a month in principal payments to reduce the credit facility. Our factoring lines may also be amended or terminated by the lenders. These conditions indicate that substantial doubt exists about our ability 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 uncertainty.

Outlook

We are constantly looking for ways to maximize stockholder value. As such, we are continually seeking operational efficiencies and synergies within 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, refinancing existing debt obligations or the divestiture of business units or other restructuring or rationalization of existing operations. We will continue to review all alternatives to ensure maximum appreciation of our stockholders’ investments. However, initiatives may not be found, or if found, they may not be on terms favorable to us.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Our consolidated financial statements included in this Annual Report are listed in Item 15 and begin immediately after the signature pages.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.
 
 
29

 
 
ITEM 9A. CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures.
 
 
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 as of the end of the period covered by this report (the “Evaluation Date”). Based upon the evaluation, our principal executive officer and principal financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective. Disclosure controls are controls and procedures designed to reasonably ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls include controls and procedures designed to reasonably ensure that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. Our quarterly evaluation of disclosure controls and procedures includes an evaluation of some components of our internal control over financial reporting, and internal control over financial reporting is also separately evaluated on an annual basis for purposes of providing the management report which is set forth below.
 
Report of Management on Internal Control Over Financial Reporting.

Our management is responsible for establishing and maintaining a comprehensive system of internal control over financial reporting to provide reasonable assurance of the proper authorization of transactions, the safeguarding of assets and the reliability of the financial records. Our internal control system was designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of published financial statements. The system of internal control over financial reporting provides for appropriate division of responsibility and is documented by written policies and procedures that are communicated to employees. The framework upon which management relied in evaluating the effectiveness of our internal control over financial reporting was set forth in Internal Controls — Integrated Framework published by the Committee of Sponsoring Organizations of the Treadway Commission.
Our internal control system was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the U.S. Our internal control over financial reporting includes those policies and procedures that:

 
(i)
 
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
 
(ii)
 
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the U.S., and that our receipts and expenditures are being made only in accordance with authorization of our management and directors; and
 
(iii)
 
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the consolidated financial statements.

Based on the results of our evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2010. However, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in our business or other conditions, or that the degree of compliance with our policies or procedures may deteriorate.

Inherent Limitations of Disclosure Controls and Procedures and Internal Control over Financial Reporting

There are inherent limitations to the effectiveness of any control system. A control system, no matter how well conceived and operated, can provide only reasonable assurance that its objectives are met. No evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or because the degree of compliance with the policies and procedures may deteriorate.

Changes in Internal Control over Financial Reporting.

There were no changes in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during the quarter ended December 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. There were no significant deficiencies or material weaknesses, and therefore no corrective actions were taken.

PART III

The information required in Item 10 (Directors, Executive Officers and Corporate Governance), Item 11 (Executive Compensation), Item 12 (Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters), Item 13 (Certain Relationships and Related Transactions, and Director Independence), and Item 14 (Principal Accountant Fees and Services) will be filed by amendment to this Annual Report on or before April 30, 2011 or incorporated by reference to our definitive proxy statement for the 2011 Annual Meeting of Stockholders to be filed with the SEC.
 
 
30

 
 
PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENTS
     
(a)(1)
 
The financial statements listed below are included in this report
     
   
Report of Independent Registered Public Accounting Firm
     
   
Financial Statements
     
   
Consolidated Balance Sheets
     
   
Consolidated Statements of Operations
     
   
Consolidated Statements of Stockholders’ Equity
     
   
Consolidated Statements of Cash Flows
     
   
Notes to Consolidated Financial Statements
     
(a)(3)
 
Exhibits
     
   
See the Exhibit Index filed as part of this Annual Report on Form 10-K.
 
 
31

 
 
 SIGNATURES
 

Pursuant to the requirements of Section 13 or 15(d) 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.
         
 
DIGITAL ANGEL CORPORATION
 
 
 
By:
/s/ Joseph J. Grillo
 
Date: March 31, 2011
 
Joseph J. Grillo 
 
   
President and Chief Executive Officer 
 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
         
Signature
 
Title
 
Date
         
 
/s/ Joseph J. Grillo
 
President, Chief Executive Officer and
 
March 31, 2011
(Joseph J. Grillo)
 
Director (Principal Executive Officer)
   
         
/s/ Jason G. Prescott
 
Chief Financial Officer
 
March 31, 2011
(Jason G. Prescott)
       
         
/s/ Daniel E. Penni
 
Chairman of the Board of Directors
 
March 31, 2011
(Daniel E. Penni)
       
         
/s/ John R. Block
 
Director
 
March 31, 2011
(John R. Block)
       
         
/s/ Dennis G. Rawan
 
Director
 
March 31, 2011
(Dennis G. Rawan)
       
         
/s/ Michael S. Zarriello
 
Director
 
March 31, 2011
(Michael S. Zarriello)
       

 
32

 

DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS


CONTENTS
         
   
Page
 
         
Report of Independent Registered Public Accounting Firm
 
F-2
 
         
Consolidated Balance Sheets as of December 31, 2010 and 2009
 
F-3
 
         
Consolidated Statements of Operations for each of the years in the two-year period ended December 31, 2010
 
F-4
 
         
Consolidated Statements of Stockholders’ Equity for each of the years in the two-year period ended December 31, 2010
 
F-5
 
         
Consolidated Statements of Cash Flows for each of the years in the two-year period ended December 31, 2010
 
F-7
 
         
Notes to Consolidated Financial Statements
 
F-8
 
 
 
F-1

 
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
Board of Directors and Stockholders
Digital Angel Corporation
 
We have audited the accompanying consolidated balance sheets of Digital Angel Corporation and subsidiaries (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting as of December 31, 2010. Our audits include consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the financial statements enumerated above present fairly, in all material respects, the consolidated financial position of Digital Angel Corporation and subsidiaries as of December 31, 2010 and 2009, and the consolidated results of their operations and their consolidated cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States.
 
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has incurred recurring net losses, and at December 31, 2010 had negative working capital, and significant cash flow commitments. These circumstances raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plan in regard to these matters are also described in Note 1. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
 
/s/ EisnerAmper LLP
 
New York, New York
March 31, 2011
 
 
F-2

 
 
Digital Angel Corporation and Subsidiaries
Consolidated Balance Sheets
(in thousands, except par value)
 
   
December 31,
 
   
2010
   
2009
 
ASSETS
             
Current assets:
               
Cash and cash equivalents
 
$
903
   
$
1,895
 
Restricted cash
   
     
202
 
Accounts receivable, net of allowance for doubtful accounts of $835 in 2010 and $906 in 2009
   
5,155
     
6,370
 
Inventories
   
8,859
     
8,980
 
Other current assets
   
1,665
     
2,514
 
Current assets of discontinued operations
   
339
     
3,735
 
Total current assets
   
16,921
     
23,696
 
                 
Property and equipment, net
   
5,238
     
6,998
 
Goodwill, net
   
3,338
     
3,343
 
Intangibles, net
   
9,716
     
11,447
 
Other assets, net
   
716
     
1,195
 
Other assets of discontinued operations
   
     
365
 
Total assets
 
$
35,929
   
$
47,044
 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Notes payable and current maturities of long-term debt
 
$
3,794
   
$
9,297
 
Accounts payable
   
7,924
     
7,905
 
Advances from factors
   
523
     
1,019
 
Accrued expenses
   
6,810
     
6,580
 
Deferred gain on sale
   
584
     
960
 
Deferred revenue
   
529
     
548
 
Current liabilities of discontinued operations
   
732
     
2,955
 
Total current liabilities
   
20,896
     
29,264
 
                 
Commitments and contingencies:
               
Long-term debt and notes payable
   
1,919
     
392
 
Other liabilities
   
606
     
1,445
 
Total liabilities
   
23,421
     
31,101
 
             
Stockholders’ equity:
               
Digital Angel Corporation stockholders’ equity:
               
Preferred shares ($10 par value; shares authorized, 5,000; shares issued, nil)
   
     
 
Common shares ($.01 par value; shares authorized 50,000; shares issued and outstanding, 29,273 and 23,479)
   
293
     
235
 
Additional paid-in-capital
   
590,945
     
588,652
 
Accumulated deficit
   
(577,021
)
   
(571,203
)
Accumulated other comprehensive loss - foreign currency translation
   
(1,674
   
(1,737
Total Digital Angel Corporation stockholders’ equity
   
12,543
     
15,947
 
Non-controlling interest
   
(35
)
   
(4
)
Total stockholders’ equity
   
12,508
     
15,943
 
Total liabilities and stockholders’ equity
 
$
35,929
   
$
47,044
 

See the accompanying notes to consolidated financial statements.
 
 
F-3

 

Digital Angel Corporation and Subsidiaries
Consolidated Statements of Operations
(in thousands, except per share data)
 
   
For the years ended
 
   
December 31,
 
   
2010
   
2009
 
                 
Revenue
 
$
37,720
   
$
42,565
 
                 
Cost of sales
   
24,570
     
25,985
 
             
Gross profit
   
13,150
     
16,580
 
                 
Selling, general and administrative expenses
   
17,645
     
22,520
 
Research and development expenses
   
1,031
     
1,206
 
Restructuring, severance and separation expenses
   
1,347
     
678
 
Goodwill and asset impairments
   
     
7,339
 
             
Operating loss
   
(6,873
)
   
(15,163
)
                 
Interest and other income (expense), net
   
(189
)
   
319
 
Interest expense
   
(1,185
)
   
(2,176
)
             
Loss from continuing operations before income tax benefit
   
(8,247
)
   
(17,020
)
                 
Benefit from income taxes
   
967
 
   
24
 
             
Loss from continuing operations
   
(7,280
)
   
(16,996
)
                 
Income from discontinued operations, net of income taxes of $501 and $608
   
1,436
     
4,566
 
             
Net loss
   
(5,844
)
   
(12,430
)
                 
Loss attributable to the noncontrolling interest, continuing operations
   
45
     
135
 
Income attributable to the noncontrolling interest, discontinued operations
   
(19
)
   
(69
)
                 
Net loss attributable to Digital Angel Corporation
 
$
(5,818
)
 
$
(12,364
)
                 
             
(Loss) income per common share attributable to Digital Angel Corporation
    common stockholders – basic and diluted:
           
Loss from continuing operations, net of noncontrolling interest
 
$
(0.26
)
 
$
(0.90
)
Income from discontinued operations, net of noncontrolling interest
   
0.05
     
0.24
 
Net loss
 
$
(0.21
)
 
$
(0.66
)
             
Weighted average number of common shares outstanding — basic and diluted
   
27,794
     
18,768
 
 
See the accompanying notes to consolidated financial statements.
 
 
F-4

 
 
Digital Angel Corporation and Subsidiaries
Consolidated Statements of Stockholders’ Equity
For the Year Ended December 31, 2009
(in thousands)

 
Digital Angel Corporation Stockholders
             
 
Common Stock
   
Additional
Paid-In
   
Accumulated
   
Accumulated
Other
Comprehensive
   
Treasury
   
Noncontrolling
   
Total Stockholders’
 
 
Number
   
Amount
   
Capital
   
Deficit
   
Income (Loss)
   
Stock
   
Interest
   
Equity
 
                                               
Balance, December 31, 2008
  16,080     $ 161     $ 584,466     $ (558,839 )   $ (2,308 )   $ (820 )   $ 45     $ 22,705  
                                                               
Net loss
                    (12,364 )                 (66 )     (12,430 )
Comprehensive loss:
                                                             
Foreign currency translation
                          571             17       588  
Total comprehensive loss
                          (12,364 )     571               (49 )     (11,842 )
                                                               
Issuance of common stock under the Standby
     Equity Distribution Agreement (“SEDA”)
  2,880       29       2,776                               2,805  
Issuance of common stock for equipment purchase
  296       3       183                               186