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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

(Mark One)
 
R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the quarterly period ended June 30, 2012
   
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the transition period from______________to______________

Commission file number: 000-26020

DIGITAL ANGEL CORPORATION
(Exact Name of Registrant as Specified in Its Charter)

Delaware
43-1641533
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification Number)
   
300 State Street, Suite 214, New London, Connecticut
06320
(Address of Principal Executive Offices)
(Zip Code)

(651) 900-0776
Registrant’s Telephone Number, Including Area Code


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

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.      Yes R No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).      Yes RNo £

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
Class
 
Outstanding at August 10, 2012
Common Stock, $.01 par value per share
 
30,874,685 shares
 


 
 
 
 
 
DIGITAL ANGEL CORPORATION

TABLE OF CONTENTS

 
 
Page
     
PART I – Financial Information
Item 1.
Financial Statements (unaudited):
 
 
Condensed Consolidated Balance Sheets – As of June 30, 2012 and December 31, 2011
3
 
Condensed Consolidated Statements of Operations – Three-months ended June 30, 2012 and 2011
4
 
Condensed Consolidated Statements of Operations – Six-months ended June 30, 2012 and 2011
5
 
Condensed Consolidated Statements of Comprehensive Loss – Three-months and Six-Months ended June 30, 2012 and 2011
6
 
Condensed Consolidated Statement of Changes in Stockholders’ (Deficit) Equity – Six-months ended March 31, 2012
7
 
Condensed Consolidated Statements of Cash Flows – Six-months ended March 31, 2012 and 2011
8
 
Notes to Condensed Consolidated Financial Statements
9
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
15
Item 4.
Controls and Procedures
20
     
PART II – Other Information
Item 1A.
Risk Factors
21
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
21
Item 6.
Exhibits
21
 
Signatures
22
 
Certifications
 
 
 
2

 
 
PART I – FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS

DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands, except par values)
 
    June 30,
2012
    December 31,
2011
 
Assets
 
(unaudited)
       
Current Assets
           
Cash
  $ 2,898     $ 6,302  
Restricted cash
    972        
Accounts receivable assigned to factor, net of allowance for doubtful accounts of $57 and $56 at June 30, 2012 and December 31, 2011, respectively
    589       434  
Inventories, consisting of finished goods
    169       130  
Other current assets
    262       671  
Funds held in escrow from sales of businesses
    1,325       309  
Current assets of discontinued operations
    187       4,514  
Total Current Assets
    6,402       12,360  
                 
Property and equipment, net
    144       195  
Funds held in escrow from sale of business
    1,175       2,500  
Other assets, net
    157       203  
Other assets of discontinued operations, net
          179  
Total Assets
  $ 7,878     $ 15,437  
                 
Liabilities and Stockholders’ (Deficit) Equity
               
Current Liabilities
               
Notes payable
  $     $ 40  
Accounts payable
    669       844  
Advances from factor
    134       39  
Accrued expenses
    2,430       2,723  
Deferred gain on sale of businesses
    1,456       439  
Current liabilities of discontinued operations
    2,242       4,422  
Total Current Liabilities
    6,931       8,507  
                 
Deferred gain on sale of business
    1,175       2,500  
Other liabilities
    419       419  
Total Liabilities
    8,525       11,426  
                 
Commitments and Contingencies:
               
                 
Stockholders’ (Deficit) Equity:
               
Digital Angel Corporation stockholders’ equity:
               
Preferred shares ($10 par value; shares authorized, 5,000; shares issued, nil)
           
Common shares ($0.01 par value; shares authorized, 50,000; shares issued and outstanding, 30,875 and 29,875, respectively)
    309       299  
Additional paid-in capital
    591,321       591,287  
Accumulated deficit
    (591,914 )     (587,275
)
Accumulated other comprehensive loss – foreign currency translation, net of tax
    (198 )     (183
)
Total Digital Angel Corporation stockholders’ (deficit) equity
    (482 )     4,128  
Noncontrolling interest
    (165 )     (117
)
Total Stockholders’ (Deficit) Equity
    (647 )     4,011  
Total Liabilities and Stockholders’ (Deficit) Equity
  $ 7,878     $ 15,437  
 
See Notes to Condensed Consolidated Financial Statements.
 
 
3

 
 
DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
 (in thousands, except per share data)
 
    For the Three-Months Ended
June 30, 2012
    For the Three-Months Ended
June 30, 2011
 
             
Revenue (including short-term equipment rentals of $263 and $285)
  $ 835     $ 1,060  
                 
Cost of sales
    476       601  
                 
Gross profit
    359       459  
                 
Selling, general and administrative expenses
    1,065       1,509  
Severance and separation expenses
    96        
Total operating expenses
    1,161       1,509  
                 
Operating loss
    (802 )     (1,050 )
                 
Other income (expense), net
    30       1,414  
Interest expense
    (2 )     (411 )
                 
Loss from continuing operations before provision for income taxes
    (774 )     (47 )
                 
Provision for income taxes
           
                 
Loss from continuing operations
    (774 )     (47 )
                 
Loss from discontinued operations
    (72 )     (1,535 )
                 
Net loss
    (846 )     (1,582 )
                 
Loss attributable to the noncontrolling interest, continuing operations
    3       6  
Loss attributable to the noncontrolling interest, discontinued operations
    1       9  
                 
Net loss attributable to Digital Angel Corporation
  $ (842 )   $ (1,567 )
                 
Loss per common share attributable to Digital Angel Corporation common stockholders – basic and diluted:
               
Loss from continuing operations, net of noncontrolling interest
  $ (0.03 )   $ (0.00 )
Loss from discontinued operations, net of noncontrolling interest
    (0.00 )     (0.05 )
Net loss per common share
  $ (0.03 )   $ (0.05 )
                 
Weighted average number of common shares outstanding – basic and diluted
    30,501       29,950  
 
See Notes to Condensed Consolidated Financial Statements.

 
4

 
 
DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
 (in thousands, except per share data)
 
    For the Six-Months Ended
June 30, 2012
    For the Six-Months Ended
June 30, 2011
 
             
Revenue (including short-term equipment rentals of $526 and $555)
  $ 1,658     $ 1,874  
                 
Cost of sales
    936       1,065  
                 
Gross profit
    722       809  
                 
Selling, general and administrative expenses
    1,996       3,438  
Severance and separation expenses
    442        
Total operating expenses
    2,438       3,438  
                 
Operating loss
    (1,716 )     (2,629 )
                 
Other income (expense), net
          2,127  
Interest expense
    (3 )     (1,953 )
                 
Loss from continuing operations before provision for income taxes
    (1,719 )     (2,455 )
                 
Provision for income taxes
           
                 
Loss from continuing operations
    (1,719 )     (2,455 )
                 
Loss from discontinued operations
    (2,968 )     (746 )
                 
Net loss
    (4,687 )     (3,201 )
                 
Loss attributable to the noncontrolling interest, continuing operations
    5       19  
Loss (income) attributable to the noncontrolling interest, discontinued operations
    43       (1 )
                 
Net loss attributable to Digital Angel Corporation
  $ (4,639 )   $ (3,183 )
                 
Loss per common share attributable to Digital Angel Corporation common stockholders – basic and diluted:
               
Loss from continuing operations, net of noncontrolling interest
  $ (0.06 )   $ (0.08 )
Loss from discontinued operations, net of noncontrolling interest
    (0.09 )     (0.03 )
Net loss per common share
  $ (0.15 )   $ (0.11 )
                 
Weighted average number of common shares outstanding – basic and diluted
    30,188       29,801  
 
See Notes to Condensed Consolidated Financial Statements.
 
 
5

 

DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Loss (Unaudited)
 (in thousands)
 
   
Three-Months Ended
June 30,
   
Six-Months Ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
Net loss
  $ (846 )   $ (1,582 )   $ (4,687 )   $ (3,201 )
Other comprehensive income (loss), net of tax:
                               
Foreign currency translation adjustments
    260       (107 )     (15 )     (110 )
Comprehensive loss
    (586 )     (1,689 )     (4,702 )     (3,311 )
Comprehensive loss attributable to noncontrolling interest
          15       48       18  
Comprehensive loss attributable to Digital Angel Corporation
  $ (586 )   $ (1,674 )   $ (4,654 )   $ (3,293 )
 
See Notes to Condensed Consolidated Financial Statements.
 
 
6

 
 
DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statement of Changes in Stockholders’ (Deficit) Equity (Unaudited)
For the Six-Months Ended June 30, 2012
(in thousands)
 
   
Digital Angel Corporation Stockholders
             
   
Common Stock
   
Additional
Paid-In
   
Accumulated
   
Accumulated
Other
Comprehensive Income
   
Noncontrolling
   
Total
Stockholders’
(Deficit)
 
   
Number
   
Amount
   
Capital
   
Deficit
   
(Loss)
   
Interest
   
Equity
 
                                           
Balance, December 31, 2011
    29,875     $ 299     $ 591,287     $ (587,275 )   $ (183 )   $ (117 )   $ 4,011  
                                                         
Net loss
                      (4,639 )           (48 )     (4,687 )
Accumulated other comprehensive loss:
                                                       
Foreign currency translation adjustments
                            (15 )           (15 )
Total comprehensive loss
                            (4,639 )     (15 )     (48 )     (4,702 )
                                                         
Issuance of common stock for services
    1,000       10       30                         40  
Share based compensation
                4                         4  
                                                         
Balance, June 30, 2012
    30,875     $ 309     $ 591,321     $ (591,914 )   $ (198 )   $ (165 )   $ (647 )

See Notes to Condensed Consolidated Financial Statements.

 
7

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

   
For the Six-
Months Ended
June 30, 2012
    For the Six-
Months Ended
June 30, 2011
 
Cash Flows From Operating Activities
           
Net loss
  $ (4,687 )   $ (3,201 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Loss from discontinued operations
    2,968       746  
Equity compensation and administrative expenses
    4       78  
Depreciation and amortization
    73       9  
Loss on disposal of equipment
    3        
Amortization of debt discount and financing costs
          1,821  
Allowance for doubtful accounts
          3  
Inventory excess and obsolescence adjustments
          2  
Foreign currency translation loss
    21        
Change in fair value of warrant liabilities
          (1,946 )
Common stock issued for services
     40        
Changes in assets and liabilities:
               
Increase in restricted cash
    (972 )      
Increase in accounts receivable
    (152 )     (98 )
Increase in inventories
    (38 )     (8 )
Decrease (increase) in other current assets
    411       (116 )
Decrease in accounts payable, accrued expenses and other liabilities
    (486 )     (993 )
Net cash (used in) provided by discontinued operations
    (617 )     3,024  
Net Cash Used In Operating Activities
    (3,432 )     (679 )
                 
Cash Flows From Investing Activities
               
Collections of notes receivable
    48       184  
Decrease in other assets
          162  
Payments for property and equipment
    (23 )      
Net cash used in discontinued operations
          (13 )
Net Cash Provided by Investing Activities
    25       333  
                 
Cash Flows From Financing Activities
               
Amounts borrowed (repaid) on advances from factors
    96       (75 )
Net (payments) borrowings of debt
    (40 )     7  
Proceeds from sale of debentures
          2,000  
Stock issuance costs
          (10 )
Financing costs
          (242 )
Net cash used in discontinued operations
          (1,099 )
Net Cash Provided by Financing Activities
    56       581  
                 
Net (Decrease) increase In Cash
    (3,351 )     235  
                 
Effect of Exchange Rate Changes on Cash
    (53 )     (9 )
                 
Cash – Beginning of Period
    6,302       268  
                 
Cash – End of Period
  $ 2,898     $ 494  

See Notes to Condensed Consolidated Financial Statements.
 
 
8

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

Digital Angel Corporation, a Delaware corporation, and its subsidiary, (referred to together as, “Digital Angel,” “the Company,” “we,” “our,” and “us”) operates in one business segment, which we refer to as Signature Communications, or SigComm. SigComm comprises the operations of Signature Industries Limited, or Signature, our 98.5% owned subsidiary located in the United Kingdom (“U.K.”).  Signature’s functional currency is British Pounds.  Our reporting currency is U.S. Dollars.

The accompanying condensed consolidated financial statements of the Company have been prepared in accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”) and with the instructions to Form 10-Q and Article 8 of Regulation S-X under the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The interim financial information in this report has not been audited. In the opinion of the Company’s management, all adjustments (consisting of normal recurring adjustments) considered necessary for fair financial statement presentation have been made. Results of operations reported for interim periods may not be indicative of the results for the entire year. These condensed consolidated financial statements and notes should be read in conjunction with the consolidated financial statements and notes included in our Form 10-K for the year ended December 31, 2011, filed with the Securities and Exchange Commission (“SEC”) on March 29, 2012.

The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Although these estimates are based on the knowledge of current events and actions that we may undertake in the future, they may ultimately differ from actual results. Included in these estimates are assumptions about allowances for inventory obsolescence, bad debt reserves, assumptions used in Black-Scholes valuation models, estimated contract losses, lease termination obligations and other contingent liabilities, among others.

Discontinued Operations

In July 2011, we sold all of our outstanding capital stock of our then wholly-owned subsidiary, Destron Fearing, (“Destron”) to Allflex USA, Inc. (the “Destron Transaction”).  In June 2011, we sold certain assets of our SARBE business excluding one contract for the sale of personal emergency location beacons (“PELS”) to the U.K. Ministry of Defence, or MOD.  In April 2012, the MOD notified Signature of its exercise of the termination provision of the PELS contract effective April 24, 2012. The final settlement agreement resulted in a reimbursement of approximately £0.4 million (approximately $0.7 million at the June 30, 2012 exchange rate) plus value added tax (“VAT”) to the MOD in July 2012.  The Destron transaction, SARBE sale and settlement agreement with the MOD are more fully discussed in Note 6.

Related Parties

We have in the past entered into various related party transactions. Each of these transactions is described in Note 13 to our Annual Report on Form 10-K for the year ended December 31, 2011.

Liquidity

As of June 30, 2012, the Company had unrestricted cash of approximately $2.9 million, and a working capital deficiency of approximately $0.5 million.  However, included in current liabilities are approximately $0.7 million of liabilities associated with subsidiaries we closed in 2001 and 2002 that were not guaranteed by us and that we believe we will not be required to pay.  We believe that we have sufficient funds to operate the business and meet our commitments and obligations over the next twelve months ending June 30, 2013.

Over the next twelve months ending June 30, 2013, the Company expects to achieve positive operating cash flows from its SigComm business.  In addition, the Company expects to realize cash inflows from the release of funds held in escrow from the sale of Destron, although the amount that will be realized is uncertain at this time.  The Company expects that with the funds on hand and this expected cash inflow, it will have sufficient funds to cover its corporate and U.K. overhead for the next twelve months, to pay any obligations that the Company may be required to pay under the Thamesmead lease, and to pay down the accounts payable and accrued liabilities.

 
9

 

DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 
2.  Recently Issued Accounting Standards
 
In June 2011, the Financial Accounting Standards Board, or FASB, issued guidance regarding the presentation of comprehensive income (loss). The new standard requires the presentation of comprehensive loss, the components of net loss and the components of other comprehensive loss either in a single continuous statement of comprehensive income (loss) or in two separate but consecutive statements. The updated guidance is effective on a retrospective basis for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. We adopted the provisions of this guidance effective January 1, 2012, as reflected in the unaudited condensed consolidated statements of comprehensive loss herein.

3. Accrued Expenses

The following table summarizes the significant components of accrued expenses.

   
June 30,
2012
   
December 31,
2011
 
   
(in thousands)
 
Accrued severance and separation expenses
    1,013       1,106  
Liabilities of companies whose assets we have sold
    667       667  
Other accruals
    750       950  
Total accrued expenses
  $ 2,430     $ 2,723  

4.  Loss Per Share

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

   
Three-Months Ended
June 30,
   
Six-Months Ended
June 30,
   
2012
   
2011
   
2012
   
2011
 
Numerator for basic and diluted loss per share attributable to Digital Angel Corporation:
                               
Loss from continuing operations
  $ (771 )   $ (41 )   $ (1,714 )   $ (2,436 )
Loss from discontinued operations
    (71 )     (1,526 )     (2,925 )     (747 )
Net loss attributable to common stockholders
  $ (842 )   $ (1,567 )   $ (4,639 )   $ (3,183 )
                                 
Denominator for basic and diluted loss per share attributable to Digital Angel Corporation:
                               
Basic and diluted weighted-average shares outstanding (1)
    30,501       29,950       30,188       29,801  
                                 
Loss per share attributable to Digital Angel Corporation — basic and diluted:
                               
Continuing operations
  $ (0. 03 )   $ (0.00 )   $ (0.06 )   $ (0.08 )
Discontinued operations
    (0.00 )     (0.05 )     (0.09 )     (0.03 )
Total — basic and diluted
  $ (0. 03 )   $ (0. 05 )   $ (0.15 )   $ (0.11 )

(1)   The following stock options, warrants and restricted stock outstanding as of June 30, 2012 and 2011 were not included in the computation of dilutive loss per share because the net effect would have been anti-dilutive.  (The warrants outstanding at June 30, 2011 were repurchased during 2011 as more fully discussed in Note 4 to our Annual Report on Form 10-K for the year ended December 31, 2011): 
 
   
June 30,
 
   
2012
   
2011
 
   
(in thousands)
 
Stock options
   
2,266
     
2,564
 
Warrants
   
     
9,504
 
Restricted stock
   
11
     
188
 
Total
   
2,277
     
12,256
 

 
10

 

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

5.  Stockholders’ Equity

Common Stock

In May 2012, we issued 500,000 shares of our common stock to each of two consultants (for a total of 1,000,000 shares) for strategic advisory services rendered for an aggregate value of $40,000.  The shares were valued at the fair market value of the stock on the date of issuance which was $0.04 per share. Under the terms of the non-exclusive advisory services agreement, we paid a non-refundable up front fee of $20 thousand and we agreed to pay $3.5 thousand per month during the 12 month term of the engagement. In the event of a transaction, as defined in the agreement, the monthly fee will increase to $20 thousand and will be capped at $180 thousand in the aggregate.
 
Stock Option Plans

We have stock-based employee plans, which were outstanding as of June 30, 2012, and are more fully described in Note 6 to our Annual Report on Form 10-K for the year ended December 31, 2011.   During the three-months ended June 30, 2012 and 2011, we recorded approximately $0 and $20 thousand, respectively, in compensation expense related to stock options granted to our employees.  During the six-months ended June 30, 2012 and 2011, we recorded approximately $1 thousand and $40 thousand, respectively, in compensation expense related to stock options granted to our employees.

Stock Option Activity

There were no stock options granted during the six-months ended June 30, 2012 and 2011. A summary of our stock option activity as of June 30, 2012, and changes during the six-months then ended, is presented below (in thousands, except per share amounts):

   
Stock
Options
   
Weighted
Average
Exercise Price
   
Weighted Average
Contractual Term
(years)
   
Aggregate
Intrinsic 
Value
 
Outstanding at January 1, 2012
    2,471     $ 16.05              
Granted
                       
Exercised
                       
Forfeited or expired
    (205 )     20.85              
Outstanding at June 30, 2012
    2,266       15.61       3.5     $ *
Vested or expected to vest at June 30, 2012
    2,266       15.61       3.5       *
Exercisable at June 30, 2012
    2,257       15.66       3.5       *
The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the exercise price of the option. The market value of our common stock was $0.04 per share at June 30, 2012.
 
There were no stock option exercises during the six-months ended June 30, 2012 and 2011. At June 30, 2012, we had approximately 1.6 million shares available to be granted under our plans. As of June 30, 2012, there was approximately $1 thousand of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under our plans. That cost is expected to be recognized over a weighted-average period of approximately 0.3 years. The total fair value of shares vested during the three months ended June 30, 2012 and 2011, was approximately $42 thousand and $0.1 million, respectively.  The total fair value of shares vested during the six-months ended June 30, 2012 and 2011, was approximately $42 thousand and $0.1 million, respectively.

Restricted Stock Grants

A summary of the status of our nonvested restricted stock awards as of June 30, 2012 is presented below (shares in thousands):

   
Stock Options
   
Weighted  
Average
Grant-Date
Fair Value
 
Nonvested at January 1, 2012
    52     $ 1.46  
Granted
           
Vested
    (41 )     1.32  
Forfeited or expired
           
Nonvested at June 30, 2012
    11     $ 1.99  

 
11

 
 
DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 
We recorded compensation expense of approximately $1 thousand and $19 thousand in the three-months ended June 30, 2012 and 2011, respectively, associated with restricted stock grants. During the six-months ended June 30, 2012 and 2011, we recorded compensation expense of $3 thousand and $38 thousand, respectively.  As of June 30, 2012, approximately 11 thousand shares of our restricted stock were unvested.

6.  Discontinued Operations

On July 22, 2011, we sold Destron and on June 15, 2011, we sold certain of the assets of our SARBE business unit, excluding the PELS contract.  Destron manufactured radio frequency identification and visual tags primarily for livestock, fisheries and companion pets and SARBE manufactured search and rescue beacons primarily for military applications.  As a result of the sales of Destron and SARBE, the financial condition, results of operations and cash flows of each of these businesses through the date of sale have been reported as discontinued operations in our financial statements, and prior period information has been reclassified accordingly.  The PELs contract, which was terminated by the MOD in the second quarter of 2012, is also included in discontinued operations for all periods presented.

PELS Contract

As of December 31, 2011, we had recorded our estimate of the loss on the PELS contract of approximately $3.7 million.  On April 10, 2012, the MOD notified Signature of its exercise of the termination provision of the contract for failure to complete certain milestones for product approvals by the established deadline.  Under the terms of the termination notice, such termination became effective as of April 24, 2012.  As stated in the notice, termination triggered the requirement that Signature reimburse to the MOD all monies paid by the MOD to Signature in respect of this contract for product or inventory previously delivered.  No early termination or other penalties were claimed by the MOD in the termination notice and in the final settlement agreement dated July 6, 2012.  The total amount of reimbursement claimed by the MOD was £0.4 million (approximately $0.7 million at the June 30, 2012 exchange rate), plus VAT.  As a result of the payment of this amount in full in July 2012, and the elimination of revenue from the production phase of the contract, we realized a reduction in expected net cash flow and an increase in the projected loss from the PELS contract of approximately $2.9 million, primarily for the writedown of inventory to estimated realizable value. Accordingly, we accrued an additional loss of $0 in the second quarter of 2012, and approximately $2.9 million on the PELS contract during the six-months ended June 30, 2012. In the aggregate, the loss recognized on the PELS contract in 2011 and the first half of 2012 totaled approximately $6.6 million.

The following table, in thousands, presents the results of operations of our discontinued operations, excluding any allocated or common overhead expenses, for the three and six-months ended June 30, 2012 and 2011. (The losses on the PELS contract are included in cost of sales):

   
Three-Months Ended
June 30,
   
Six-Months Ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(in thousands)
 
Revenue
  $     $ 6,661     $     $ 15,670  
Cost of sales
          4,799       2,901       10,299  
Gross profit (loss)
          1,862       (2,901 )     5,371  
                                 
Selling, general and administrative expenses
    72       2,796       72       5,365  
Research and development expenses
          207             436  
Operating loss
    (72 )     (1,141 )     (2,973 )     (430 )
                                 
Interest and other income (expense), net
          73       5       117  
Interest expense
          (138 )           (310 )
Loss on sale
          (316 )           (92 )
Provision for income taxes
          (13 )           (31 )
Loss from discontinued operations
    (72 )     (1,535 )     (2,968 )     (746 )
Loss (income) attributable to noncontrolling interest
    1       9       43       (1 )
Net loss from discontinued operations attributable to Digital Angel Corporation
  $ (71 )   $ (1,526 )   $ (2,925 )   $ (747 )
                                 
Loss from discontinued operations per common share – basic and diluted   $ (0.00 )   $ (0.05 )   $ (0.09 )   $ (0.03 )
Weighted average number of common shares outstanding – basic and diluted
    30,501       29,950       30,188       29,801  
 
 
12

 
 
DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 
The net assets of discontinued operations as of June 30, 2012 and December 31, 2011, were as follows (in thousands):
 
   
June 30,
2012
   
December 31,
2011
 
    (in thousands)  
Cash
  $     $ 17  
Accounts receivable
          563  
Inventory
    156       3,103  
Other current assets
    31       831  
Total current assets
    187       4,514  
Fixed assets
          179  
Total assets
  $ 187     $ 4,693  
                 
Accounts payable, accrued expenses and other current liabilities
    2,242       4,422  
Total current liabilities
  $ 2,242     $ 4,422  
Long-term debt and other long-term liabilities
           
Net (liabilities) assets of discontinued operations
  $ (2,055 )   $ 271  

7.  Supplemental Cash Flow Information

In the six-months ended June 30, 2012 and 2011, we had the following non-cash activities:

 
Six-Months Ended June 30,
 
 
2012
 
2011
 
 
(in thousands)
 
Non-cash operating activities:
           
Issuance of shares of common stock to settle accounts payable
  $     $ 224  
Cash paid for:
               
Interest
  $ 3     $ 55  

8.  Severance and Separation Expenses
 
We are subject to indemnification, confidentiality, and three-year non-competition and non-solicitation provisions in connection with the July 2011 Destron Transaction. The terms of the Destron Transaction also required Joseph J. Grillo, our former chief executive officer, to enter into a three-year non-competition agreement with Allflex. Under the terms of Mr. Grillo’s then existing employment agreement with us, if a change of control occurred and Mr. Grillo resigned within six months of the change of control and provided us a four-month notice of such resignation, Mr. Grillo was entitled to a change of control payment equal to one and a half times both his base salary and bonus, or approximately $1.0 million. The Destron Transaction represented a change of control as defined in the agreement. In addition, due to Allflex’s requirement that Mr. Grillo sign a three year non-competition agreement, we agreed to amend Mr. Grillo’s employment agreement to include an additional payment of one year base salary, or $338 thousand, and make other changes to the terms of payment. The additional one year base salary is payable on the earlier of the second anniversary of the closing date of the Destron Transaction or our winding down if, and only if, Mr. Grillo has not found employment by that time. In addition, if Mr. Grillo secures alternative employment during the third year after the closing of the Destron Transaction, he will be obligated to repay the amount earned during the third year up to the amount he received from us.

In February 2012, approximately $1.0 million was placed in the Grillo Rabbi Trust and such funds were distributed to Mr. Grillo in August 2012.  This amount is reflected on the balance sheet at June 30, 2012, as restricted cash and accrued expenses.  Of the remaining balance at June 30, 2012, $338 thousand, which is included in other long-term liabilities, is due to Mr. Grillo as more fully discussed above.

Included on the balance sheet at June 30, 2012 and December 31, 2011 are accrued severance expenses of approximately $1.4 million and $1.4 million, respectively, which include the severance and related payments due to Mr. Grillo under the terms of his employment agreement, as amended.  Mr. Grillo’s severance expense was amortized over the four months ending January 31, 2012 and accordingly, we recorded one month, or approximately $0.3 million of severance expense in the first half of 2012.   In addition, we incurred approximately $0.1 million of severance and separation expenses during the second quarter of 2012 related to U.K. statutory redundancy payments made as a result of headcount reductions.
 
 
13

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

As of June 30, 2012, our severance and separation accrual, including amounts reflected in other long-term liabilities, was as follows (in thousands):

   
Total
 
         
Balance – January 1, 2012
 
$
1,444
 
         
Cash payments
   
(94
)
         
Balance – June 30, 2012
 
$
1,350
 

9. Commitments and Contingencies

Lease Termination

During the third quarter of 2011, we made the decision to outsource the manufacturing of the PELS beacons.  As a result, on December 24, 2011, we vacated the Thamesmead U.K. factory/office facility. Keyswitch Varley, a wholly-owned subsidiary of Signature, is obligated on the lease.  Neither Signature nor the Company guaranteed the lease.  We have assessed the liability for the lease termination in accordance with ASC 420, “Exit or Disposal Cost Obligations”, and ASC 450, “Loss Contingencies”, and accordingly, we have accrued an estimated lease termination liability at December 31, 2011 and June 30, 2012.  The estimated amount was included in the results of discontinued operations for the year ended December 31, 2011, and in the current liabilities of discontinued operations at June 30, 2012 and December 31, 2011. This estimate is subject to change and any increases or decreases will be reflected in the results of our discontinued operations in future periods.

Destron Transaction Claim of Recovery

On February 3, 2012, we received formal notice of a claim from Allflex, alleging that certain implantable chips supplied to an overseas customer were defective.  The formal notice states that the loss estimate and claim against the funds held in escrow from the sale of Destron is $1.2 million and that there may be additional alleged losses.  We have disputed this claim and notified Allflex that we intend to further investigate this matter, vigorously defend any claim of impropriety and aggressively pursue responsible parties.  Historically, we have never experienced the type of defect claimed. This $1.2 million part of the escrow is included in other long-term assets and long-term deferred gain, and the remainder of the escrow of $1.3 million is included in other current assets and current deferred gain at June 30, 2012.  Income will be recognized only upon receipt, if any, of the escrow funds.

SARBE Sale Escrow

Included in funds held in escrow from sales of businesses at December 31, 2011 was an outstanding escrow of £0.2 million (or approximately $0.3 million) from the sale of our SARBE business. The funds were placed in escrow to cover certain indemnifications. During the quarter ended June 30, 2012, we were notified that claims had been made against the escrow, which are still pending.  Therefore, as of June 30, 2012, our unaudited condensed consolidated balance sheet no longer reflects these funds as being held in escrow nor does it reflect the associated deferred gain on the sale of the SARBE business.
 
 
14

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying financial statements and related notes included in Item 1 of this report as well as our Annual Report on Form 10-K for the year ended December 31, 2011.

Overview

We operate in one business segment, which we refer to as Signature Communications, or SigComm.  SigComm is a distributor of two-way communications equipment in the U.K.  Products offered range from conventional radio systems used by the majority of SigComm’s customers, for example, for safety and security uses and construction and manufacturing site monitoring, to trunked radio systems for large scale users, such as local authorities and public utilities.

Critical Accounting Policies

Our Annual Report on Form 10-K, for the year ended December 31, 2011 contains further information regarding our critical accounting policies.

Impact of Recently Issued Accounting Standards

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

Consolidated Results of Operations

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

   
For the Three-Months Ended
June 30,
   
For the Six-Months Ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
Revenue
    100 %     100 %     100 %     100 %
Cost of sales
    57       57       56       57  
Gross profit
    43       43       44       43  
                                 
Selling, general and administrative expenses
    128       142       121       183  
Severance and separation expenses
    11    
      27    
 
Operating loss
    (96 )     (99 )     (104 )     (140 )
                                 
Other (expense) income, net
    3       133    
      113  
Interest expense
 
      (39 )  
      (104 )
Loss from continuing operations before income tax provision
    (93 )     (5 )     (104 )     (131 )
                                 
Provision for income taxes
 
   
   
   
 
Loss from continuing operations
    (93 )     (5 )     (104 )     (131 )
                                 
Loss from discontinued operations
    (8 )     (145 )     (179 )     (40 )
Net loss
    (101 )     (150 )     (283 )     (171 )
                                 
Loss attributable to the noncontrolling interest, continuing operations
 
      1    
      1  
(Loss) income attributable to the noncontrolling interest, discontinued operations
 
      1       3    
 
                                 
Net loss attributable to Digital Angel Corporation
    (101 )%     (148 )%     (280 )%     (170 )%

 
15

 
 
Results of Continuing Operations

Outlook and Trends

Going forward, we will continue to try to maximize the cash flow from SigComm, our remaining business.  During this process, our board of directors is continuing to evaluate strategic alternatives for SigComm, including a possible sale of SigComm. New revenue opportunities that could benefit shareholder value continue to be explored.  We have been working with investment firms who have been assisting us in identifying and evaluating companies that might be interested in merging with us as well as opportunities that would allow us to enter into new markets. We believe that such opportunities may enhance shareholder value by allowing us to capitalize on our public company listing and existing stockholder base.

We expect 2012 sales and gross profits for SigComm to be comparable with the 2011 results and we expect SigComm’s and corporate’s selling, general and administrative expenses to continue to decrease in 2012 as compared to 2011.  We presently operate with one U.S.-based corporate employee, three outsourced, part-time consultants, one outsourced, full-time consultant and three board members in a “virtual” office environment, in order to minimize costs and conserve cash.  We expect to continue to execute all required filings, tax returns, and maintain insurance and perform other required activities to maintain our standing as an Over-the-Counter Bulletin Board, or OTC Bulletin Board, publicly-traded company.  Also see the discussion below under the heading Liquidity and Capital Resources, which discusses our expectations regarding liquidity.

Three-Months Ended June 30, 2012 Compared to Three-Months Ended June 30, 2011

Revenue

Our revenue was approximately $0.8 million and $1.1 million for the three-months ended June 30, 2012 and 2011, respectively. Sales decreased in the second quarter of 2012, primarily due to depressed sales and unfavorable market trading conditions within the oil and gas sector of SigComm’s business.  We expect revenue for the remainder of 2012 to remain relatively constant.  Revenue from short-term equipment rentals was similar for each period.

Gross Profit and Gross Profit Margin
 
Our gross profit was approximately $0.4 million and $0.5 million for the three-months ended June 30, 2012 and 2011, respectively.  Gross profit margin was 43% in the three-months ended June 30, 2012 as compared to 43% in the three-months ended June 30, 2011.  The decrease in the gross profit amount related to the reduction in sales.
 
Selling, General and Administrative Expenses

Selling, general and administrative expenses were $1.1 million and $1.5 million for the three-months ended June 30, 2012 and 2011, respectively, and were 128% and 142% of revenue for the same respective periods.  The $0.4 million decrease in selling, general and administrative expenses was due primarily to the scale down of our corporate and U.K.-based operations, including vacating the Thamesmead facility in December 2011, reduction in corporate and U.K. personnel costs and other cost containment measures.  For the three months ended June 30, 2012 and 2011, selling, general and administrative expenses consisted of $0.6 million and $0.7 million, respectively, of expenses associated with Signature’s U.K. operations and $0.5 million and $0.8 million, respectively, of corporate related expenses.  We expect Signature’s expenses to decrease somewhat as we continue to reduce headcount and consolidate operations in our Scotland, U.K. facility.  We expect corporate expenses to remain relatively constant for the remainder of the year.

Severance and Separation Expenses

We incurred approximately $0.1 million of severance and separation expenses during the second quarter of 2012. The severance expense related to U.K. statutory redundancy payments made as a result of headcount reductions.

Other Income (Expense), Net

Other income (expense) was approximately $30 thousand in the quarter ended June 30, 2012 compared to $1.4 million in the quarter ended June 30, 2011.  The $1.4 million decrease in other income in 2012, as compared to 2011, is primarily related to the revaluation of the outstanding warrants to fair value during the three-months ended June 30, 2011. The warrants outstanding at June 30, 2011 were repurchased in July 2011 in connection with the Destron Transaction.  Therefore, no warrants were outstanding during the three months ended June 30, 2012.
 
 
16

 

Interest Expense

Interest expense was $2 thousand and $0.4 million for the second quarters ended June 30, 2012 and 2011, respectively. The decrease was primarily due to interest expense associated with debentures that we issued in February 2011 and redeemed on July 22, 2011. Approximately $0.3 million of the interest expense in the three-months ended June 30, 2011 related to the value of warrants that we issued in connection with the debentures.

Income Taxes

We did not have an income tax provision or benefit for the three-months ended June 30, 2012 and 2011.  Differences in the effective income tax rate from the statutory federal income tax rate arise from state taxes (benefits) net of federal tax effects, and the increase or reduction of valuation allowances related to net operating loss carry forwards and other deferred tax assets. As of June 30, 2012, we have provided a valuation allowance to fully reserve our net operating loss carryforwards and our other existing net deferred tax assets, primarily as a result of our continuing losses and our current projections of future results. As a result of fully reserving our deferred tax assets, we did not record a benefit related to our net losses during the three-months ended June 30, 2012 and 2011.

Loss from Continuing Operations

During the three months ended June 30, 2012 and 2011, we reported a loss from continuing operations of approximately $0.8 million and $47 thousand, respectively. The increase in the loss for 2012 compared to 2011 relates primarily to the $1.4 million decrease in other income related primarily to the revaluation of previously outstanding warrants to fair value, $0.1 million of severance and separation expenses during the second quarter of 2012 compared to the second quarter of 2011, and lower gross profit of $0.1 million.  This increase in the loss was partially offset by the reduced interest expense of $0.4 million and reduced selling, general and administrative expenses of approximately $0.4 million.  We expect our loss from continuing operations to decrease during the remainder of 2012 due to anticipated lower selling, general and administrative expenses and lower severance and separation expenses.

Six-Months Ended June 30, 2012 Compared to Six-Months Ended June 30, 2011

Revenue

Our revenue was approximately $1.7 million and $1.9 million for the six-months ended June 30, 2012 and 2011, respectively. We expect revenues for the remainder of 2012 to remain relatively constant. Revenue from short-term equipment rentals was similar for each period.

Gross Profit and Gross Profit Margin
 
Our gross profit was approximately $0.7 million and $0.7 million for the six-months ended June 30, 2012 and 2011, respectively.  Gross profit margin increased slightly to 44% in the six-months ended June 30, 2012 as compared to 43% in the three-months ended June 30, 2011, primarily due to product mix.
 
Selling, General and Administrative Expenses

Selling, general and administrative expenses were $2.0 million and $3.4 million for the six-months ended June 30, 2012 and 2011, respectively, and were 121% and 183% of revenue for the same respective periods.  The $1.4 million decrease in selling, general and administrative expenses was due primarily to the scale down of our U.K. operations, including vacating the Thamesmead facility in December 2011, reduction in corporate and U.K.-based personnel costs and other cost containment measures.  For the six months ended June 30, 2012 and 2011, selling, general and administrative expenses consisted of $1.0 million and $2.1 million, respectively, of expenses associated with Signature’s U.K. operations and $1.0 million and $1.3 million, respectively, of corporate related expenses.  We expect Signature’s expenses to decrease as we continue to reduce headcount and consolidate operations in our Scotland, U.K. facility.  We expect corporate expenses to remain relatively constant for the remainder of the year.

Severance and Separation Expenses

We incurred approximately $0.4 million of severance and separation expenses during the first half of 2012. Approximately $0.3 million of the severance expense related to a change of control provision in our former CEO’s employment agreement, which was triggered by the sale of Destron, and approximately $0.1 million related to  U.K. statutory redundancy payments made as a result of headcount reductions.
 
 
17

 

Other Income (Expense), Net

Other income (expense) was nil in the six-months ended June 30, 2012 compared to $2.1 million in the six-months ended June 30, 2011.  The $2.1 million decrease in other income in 2012, as compared to 2011, is primarily related to the revaluation of the outstanding warrants to fair value during the six-months ended June 30, 2011. The warrants outstanding at June 30, 2011 were repurchased in July 2011 in connection with the Destron Transaction.  Therefore, no warrants were outstanding during 2012.

Interest Expense

Interest expense was $3 thousand and $2.0 million for the six months ended June 30, 2012 and 2011, respectively. The decrease was primarily due to interest expense associated with debentures that we issued in February 2011 and redeemed on July 22, 2011. Approximately $1.5 million of the interest expense in the six-months ended June 30, 2011 related to the value of warrants that we issued in connection with the debentures.

Income Taxes

We did not have an income tax provision or benefit for the six-months ended June 30, 2012 and 2011.  Differences in the effective income tax rate from the statutory federal income tax rate arise from state taxes (benefits) net of federal tax effects, and the increase or reduction of valuation allowances related to net operating loss carry forwards and other deferred tax assets. As of June 30, 2012, we have provided a valuation allowance to fully reserve our net operating loss carryforwards and our other existing net deferred tax assets, primarily as a result of our continuing losses and our current projections of future results. As a result of fully reserving our deferred tax assets, we did not record a benefit related to our net losses during the six-months ended June 30, 2012 and 2011.

Loss from Continuing Operations

During the six months ended June 30, 2012 and 2011, we reported a loss from continuing operations of approximately $1.7 million and $2.5 million, respectively. The decrease in the loss for 2012 compared to 2011 relates primarily to the $2.0 million decrease in interest expense, as well as the $1.4 million decrease in selling, general and administrative expenses, partially offset by the $2.1 million decrease in other income related primarily to the revaluation of previously outstanding warrants to fair value, and $0.4 million of severance and separation expenses during the first half of 2012 compared to the first half of 2011.  We expect our loss from continuing operations to decrease during the remainder of 2012 due to anticipated lower selling, general and administrative expenses and severance and separation expenses.

Liquidity and Capital Resources

As of June 30, 2012, cash totaled $2.9 million, a decrease of $3.4 million, from $6.3 million at December 31, 2011.

Net cash used in operating activities totaled $3.4 million in the first six months of 2012 and $0.7 million in the first half of 2011.  In 2012, cash was used primarily by the net loss, payments of accounts payable and accrued obligations and discontinued operations.  In 2011, cash was used primarily by the net loss, partially offset by discontinued operations.

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 $0.6 million and $0.4 million, at June 30, 2012 and December 31, 2011, respectively. We anticipate accounts receivable to remain at a similar level to the June 30th balance going forward.
 
 
Accounts payable decreased to $0.7 million at June 30, 2012 from $0.8 million at December 31, 2011. We anticipate accounts payable to decrease during the remainder of 2012 with cash payments.
 
 
Accrued expenses decreased to $2.4 million at June 30, 2012, from $2.7 million at December 31, 2011.  We expect accrued expenses to decrease during the year, primarily due to the distribution of approximately $1.0 million of restricted cash funds placed in February 2012 in the Grillo Rabbi Trust for the change in control payment.  Such funds were distributed to Mr. Grillo in August 2012.

 
18

 
 
Investing activities provided cash of $25 thousand and $0.3 million in the first six months of 2012 and 2011, respectively. In 2012, cash was provided by collections on notes receivables offset by purchases of fixed assets, and in 2011, cash was primarily provided by collection on notes receivables and a decrease in other assets.

Financing activities provided cash of $0.1 million and $0.6 million during the first six months of 2012 and 2011, respectively.  In 2012, cash was provided by advances under note payable from our U.K. factor, slightly offset by other notes payable payments. In 2011, cash was primarily provided by the proceeds from issuance of debentures, partially offset by discontinued operations.

Financial Condition

As of June 30, 2012, we had a working capital deficiency of approximately $0.5 million. However, included in current liabilities are approximately $0.7 million of liabilities associated with subsidiaries we closed in 2001 and 2002 that were not guaranteed by us and that we believe we will not be required to pay.  In addition, under the terms of the Destron Transaction $2.5 million of the purchase price has been placed in an escrow fund. On February 3, 2012, we received formal notice of a claim under the purchase agreement from Allflex alleging that certain implantable chips supplied to an overseas customer were defective.  The formal notice states that the loss estimate and claim against the funds held in escrow from the sale of Destron is $1.2 million and that there may be additional alleged losses.  We have disputed this claim and notified Allflex that we intend to further investigate this matter, vigorously defend any claim of impropriety and aggressively pursue responsible parties.  Historically, we have never experienced the type of defect claimed. This $1.2 million part of the escrow is included in other long-term assets and long-term deferred gain, and the remainder of the escrow of $1.3 million is included in other current assets and current deferred gain at June 30, 2012.  Income will be recognized only upon receipt, if any, of the escrow funds.  The escrow agreement provides for a January 2013 release.

We used a portion of the net proceeds from the Destron Transaction to satisfy certain of our outstanding notes payable, accounts payable, accrued expenses and other outstanding liabilities, including severance related liabilities, to fund working capital and to fund obligations under the PELS contract, including the termination payment to the MOD that we made in July 2012. With the remaining net proceeds and the expected release of some or all of the funds held in escrow, we believe that we have sufficient funds to operate the business and meet our commitments and obligations over the next twelve months ending June 30, 2013.  See further discussion in Note 1 to our accompanying unaudited condensed consolidated financial statements.
 
During the next several months, our board of directors will continue to evaluate strategic alternatives for our SigComm business and for us as a whole. To this end, in May 2012, we engaged a financial advisor on a non-exclusive basis to assist our board in identifying and evaluating potential strategic options.  One strategic alternative is to sell our SigComm business however we have not yet located a buyer for SigComm despite several attempts and many inquiries.  While the settlement of the PELS contract with the MOD resolved a major ongoing potential liability, several additional legal issues and outstanding liabilities must be resolved before we can act on our previously-discussed strategy of liquidating and distributing a dividend. These include claims against the escrow from the sale of Signature’s SARBE division in June of 2011 and claims against the escrow from the sale of Destron Fearing and a potential payment that may be due under a lease related to Signature’s former U.K. manufacturing facility in Thamesmead. It is possible that no dividend payment will be made or be permissible under Delaware corporate law requirements.

With the ongoing legal claims and the difficulty finding a buyer for SigComm, and the uncertainty surrounding our working capital requirements over the next several months, our board of directors is taking a closer look at other strategic alternatives. Many possibilities have been reviewed by management, the board and their advisors. Several of those alternatives could provide greater value for shareholders than the distribution of dividend, especially since the timing of such a payout is uncertain. We have been working with investment firms who have been assisting us in identifying and evaluating companies that might be interested in merging with us as well as opportunities that would allow us to enter into new markets. We believe that such opportunities may enhance shareholder value by allowing us to capitalize on our public company listing and existing stockholder base.
 
 
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Cautionary Note Regarding Forward-Looking Statements

This quarterly report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements concern expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. Specifically, this quarterly report contains forward-looking statements including, but not limited to:

 
 
our ability to fund our operations;
 
 
our ability to identify favorable strategic alternatives;
 
 
our ability to have excess cash available for future actions;
 
 
anticipated trends in our business and demographics;
 
 
expectations about the outcome of adverse developments, and outcomes and expenses in legal proceedings, litigation and asserted claims;
 
 
relationships with and dependence on technological partners;
 
 
our future profitability and liquidity;
 
 
our ability to enforce our patents, preserve trade secrets and operate without infringing on the proprietary rights of third parties;
 
 
worldwide political stability and economic growth;
 
 
regulatory, competitive or other economic influences;
 
 
our ability to successfully mitigate the risks associated with foreign operations;
 
 
our operational strategies including, without limitation, our ability to deploy our products;
 
 
our expectation that we will not suffer costly or material 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;
 
 
uncertainty regarding the payment of any special cash dividend, including the timing and amount;
 
 
our estimate of the liability associated with the termination of the Thamesmead U.K. facility lease;
 
 
our ability to realize the funds held in escrow from the sale of Destron;
 
 
our ability to successfully sell our remaining Signature business, if we decide to do so and such opportunities are present;
 
 
the impact of foreign currency exchange rate fluctuations and additional risks of foreign operations;
 
 
the impact of new accounting pronouncements;
 
 
our ability to establish and maintain proper and effective internal accounting and financial controls;
 
 
the potential of further dilution to our common stock based on transactions effected involving issuance of shares;
 
 
the impact of our inability to compete with Destron’s business for three years;
 
 
volatility in our stock price, including a significant decrease over the past few years; 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 5 of our Annual Report on Form 10-K filed with the SEC  on March 29, 2012, 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.

In some cases, you can identify forward-looking statements by terms such as “may,” “should,” “could,” “would,” “anticipates,” “expects,” “attempt,” “intends,” “plans,” “hopes,” “believes,” “seeks,” “estimates” and similar expressions intended to identify forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from estimates or forecasts contained in the forward-looking statements. Some of these risks and uncertainties are beyond our control. Also, these forward-looking statements represent our estimates and assumptions only as of the date the statement was made.

The information in this quarterly report is as of June 30, 2012, or, where clearly indicated, as of the date of this filing. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. We also may make additional disclosures in our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K that we may file from time to time with the SEC. Please also note that we provided a cautionary discussion of risks and uncertainties under the section below in Part II, Item 1A entitled “Risk Factors” and in our Annual Report on Form 10-K for the year ended December 31, 2011. These are factors that could cause our actual results to differ materially from expected results and they should be reviewed carefully. Other factors besides those listed could also adversely affect us.

 
ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our Interim Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 240.13a - 15(e) and 240.15d — 15(e)) as of the end of the quarter ended June 30, 2012. Based on that evaluation, they have concluded that our disclosure controls and procedures as of the end of the period covered by this report are effective in timely providing them with material information relating to us required to be disclosed in the reports we file or submit under the Exchange Act. Our disclosure controls and procedures are designed to provide reasonable assurances of achieving our objectives, and our Interim Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective in reaching that level of reasonable assurance.
 
 
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Change in Internal Control Over Financial Reporting

There have not been any changes in our internal controls over financial reporting identified in connection with an evaluation thereof that occurred during our second fiscal quarter of 2012 that have materially affected, or are reasonable 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 II – OTHER INFORMATION

ITEM 1A.  RISK FACTORS

Termination of the PELS contract has had a negative impact on our projected cash flows and funds available for future plans.

The MOD’s termination of the PELS contract caused a reduction in expected net cash flow from this contract of approximately $2.9 million.  This reduction resulted from the resolution of the claim made by the MOD for product or inventory previously delivered, as well as the elimination of expected future revenue that would have come from the production phase of the contract. The termination of this PELS contract has created significant uncertainties regarding our future plans and the cash available for (and timing of) any dividend payment to stockholders.  It is possible that no dividend payment will be made or be permissible.


ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

On May 4, 2012, the Company issued 500,000 shares of our common stock, $0.01 par value, to each of two consultants (total of 1 million shares) for services rendered for an aggregate value of $40,000.  The shares of common stock were issued to the consultants without registration in reliance upon the exemption provided by Section 4(2) of the Securities Act of 1933, as amended, as a transaction by the Company not involving any public offering, and Rule 506 promulgated thereunder.


ITEM 6.  EXHIBITS

We have listed the exhibits by numbers corresponding to the Exhibit Table of Item 601 in Regulation S-K on the Exhibit list attached to this report.
 
 
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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
DIGITAL ANGEL CORPORATION
(Registrant)
 
       
Date:  August 14, 2012
By:
/s/ Lorraine M. Breece  
    Name: Lorraine M. Breece  
    Title: Chief Financial Officer  
      (Duly Authorized Officer)  
 

 
 
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INDEX TO EXHIBITS

Exhibit No.
 
Description of Exhibit
     
31.1
 
Certification by Daniel E. Penni, Interim Chief Executive Officer and President, pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a)*
     
31.2
 
Certification by Lorraine M. Breece, Chief Financial Officer, pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a)*
     
32.1
 
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

* Filed herewith



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