Selling, general and administrative expense as a percentage of revenue for each of the operating segments was:
InfoTech USA, Inc.’s selling, general and administrative expense remained relatively constant at approximately $0.8 million and approximately $0.8 million in the three-months ended September 30, 2004 and 2003, respectively. Selling, general and administrative expense remained relatively constant at$2.3 million in the nine-months ended September 30, 2004, as compared to$2.4 million and in the nine-months ended September 30, 2003. Increases and decreases in selling, general and admini strative expense as a percentage of revenue are the result of the decrease/increase in revenue during the comparable periods. We expect selling, general and administrative expense to remain relatively constant during the remainder of 2004.
Research and development expense from continuing operations during the three and nine-months ended September 30, 2004 and 2003, by segment was as follows:
Depreciation and amortization expense from continuing operations during the three and nine-months ended September 30, 2004 and 2003, by segment was as follows:
Advanced Technology’s depreciation and amortization expense remained relatively constant in the three-months ended September 30, 2004, as compared to the three-months ended September 30, 2003. Its depreciation and amortization expense decreased in the nine-months ended September 30, 2004, as compared to the nine-months ended September 30, 2003, due primarily to the sale of our website design and Internet access business during the fourth quarter of 2003.
Digital Angel Corporation’s depreciation and amortization expense increased $0.2 million, or182.4%, to$0.3 million in the three-months ended September 30, 2004, from$0.1 million in the three-months ended September 30, 2003, and increased$0.6 million, or128.0%, to$1.0 million in the nine-months ended September 30, 2004, from$0.4 million in the nine-months ended September 30, 2003. We attribute the increase primarily to depreciation and amortization expense related to the satellite and tracking systems business that we acquired on January 22, 2004.
InfoTech USA, Inc.’s depreciation and amortization expense decreased in the three and nine-months ended September 30, 2004, as compared to the three and nine-months ended September 30, 2003, due to fully depreciating certain assets during 2003.
“Corporate/Eliminations” depreciation expense increased in the three-months ended September 30, 2004, as compared to the three-months ended September 30, 2003, primarily as a result of depreciation expense associated with furniture and leasehold improvements for our new corporate headquarters. We moved our corporate headquarters to Delray Beach, Florida in June 2004. The decrease in the nine-months ended September 30, 2004, as compared to the nine-months ended September 30, 2003, was due primarily to fully depreciating certain assets during 2003.
Interest and Other Income and Interest Expense (Reduction)
Interest and other income was $0.2 million and $0.2 million, for the three-months ended September 30, 2004 and 2003, respectively, and $0.8 million and $0.7 million for the nine-months ended September 30, 2004 and 2003, respectively. Interest income is earned primarily from short-term investments and notes receivable.
Interest expense (reduction) was $0.1 million and $1.8 million for the three-months ended September 30, 2004 and 2003, respectively, and $(0.4) million and $11.0 million for the nine-months ended September 30, 2004 and 2003, respectively. Included in interest expense for the three and nine-months ended September 30, 2004, was a credit of approximately $0.3 million and $1.3 million, respectively, related to the value of certain of our warrants, which are settleable in shares of the Digital Angel Corporation common stock that we own. Increases and decreases in the fair market value of Digital Angel Corporation’s common stock result in increases and reductions of our interest expense until the warrants are exercised, forfeited or expired. The interest expense incurred during the nine-months ended September 30, 2003, related primarily to our obligations to IBM credit, which were repaid-in-full on June 30, 2003.
Income Taxes
We had an effective (benefit) income tax rate of (0.5%) and (0.9%) for the three-months ended September 30, 2004 and 2003, respectively, and 1.7% and 2.6% for the nine-months ended September 30, 2004 and 2003, respectively. Differences in the effective (benefit) income tax rate from the statutory federal income tax rate arise primarily from the net operating loss carry-forwards generated in 2004, for which no benefit has been recognized and state taxes net of federal benefits. In addition, during the nine-months ended September 30, 2003, we recorded approximately $0.9 million of alternative minimum tax.
Net (Gain) Loss on Capital Transactions of Subsidiary and (Gain) Loss Attributable to Changes in Minority Interest as a Result of Capital Transactions of Subsidiary
During the three-months ended September 30, 2004 and 2003, we recorded a loss of $38 thousand and $0.1 million, respectively, on the issuances of 0.1 million and 0.1 million shares of Digital Angel Corporation’s common stock, respectively. During the nine-months ended September 30, 2004 and 2003, we recorded a loss of $1.8 million and $0.3 million, respectively, on the issuances of 4.0 million and 0.5 million shares of Digital Angel Corporation’s common stock, respectively. Included in the issuances for the nine-months ended September 30, 2004, were 3.0 million shares of common stock issued by Digital Angel Corporation to us in connection with the Share Exchange Agreement, which is more fully discussed in Note 7 to our Condensed Consolidated Financial Statements. The loss represents the difference between the carrying amount of the pro-rata share of our investment in Digital Angel Corporation and the net proceeds from the issuances of the stock, as well as the portion of the minority owners’ interest in the capital contributed to Digital Angel Corporation by us in connection with the Share Exchange Agreement. In addition, we recorded a loss (gain) of $0.3 million and $(0.4) million during the three-months ended September 30, 2004 and 2003, respectively, and a (gain) loss of $(1.6) million and $0.6 million during the nine-months ended September 30, 2004 and 2003, respectively, attributable to changes in the minority interest ownership as a result of the capital transactions of Digital Angel Corporation. The business operations of Digital Angel Corporation and its capital transactions are described in Notes 6 and 7, respectively, to our Condensed Consolidated Financial Statements.
RESULTS OF DISCONTINUED OPERATIONS
During the second quarter of 2004, Digital Angel Corporation’s Board of Directors approved a plan to sell our Medical Systems operations, which we acquired on March 27, 2002. Medical Systems represented the business operations of MAS. On March 27, 2002, our 93% owned subsidiary pre-merger Digital Angel, merged with MAS and MAS changed its named to Digital Angel Corporation. Medical Systems was one of our reporting units in accordance with FAS 142. Accordingly, the financial condition, results of operations and cash flows of Medical Systems have been reported as Discontinued Operations for all periods presented. The following discloses the operating losses from Discontinued Operations for the three and nine-months ended September 30, 2004 and 2003, consisting of income (loss) attributable to Medical Systems:
| | | Three-Months Ended September 30, | | | Three-Months Ended September 30, | | | Nine-Months Ended September 30, | | | Nine-Months Ended September 30, | |
| | | 2004 | | | 2003 | | | 2004 | | | 2003 | |
| Product revenue | | $ | | | $ | 139 | | $ | 204 | | $ | 726 | |
| Service revenue | | | | | | 195 | | | 223 | | | 811 | |
| Total revenue | | | | | | 334 | | | 427 | | | 1,537 | |
| Cost of products sold | | | | | | 63 | | | 87 | | | 321 | |
| Cost of services sold | | | | | | 239 | | | 317 | | | 832 | |
| Total cost of products and services sold | | | | | | 302 | | | 404 | | | 1,153 | |
| Gross profit | | | | | | 32 | | | 23 | | | 384 | |
| Selling, general and administrative expense | | | 35 | | | 134 | | | 974 | | | 573 | |
| Depreciation and amortization | | | | | | 169 | | | 107 | | | 386 | |
| Gain on sale of property and equipment | | | (290 | ) | | | | | (290 | ) | | | |
| Other income and expense | | | | | | 35 | | | 105 | | | 104 | |
| Minority interest | | | 53 | | | (84 | ) | | (285 | ) | | (183 | ) |
| Income (loss) from Discontinued Operations | | $ | 202 | | $ | (222 | ) | $ | (588 | ) | $ | (496 | ) |
The above results do not include any allocated or common overhead expenses. We have not provided a benefit for income taxes on the losses attributable to Medical Systems. We do not anticipate that Medical Systems will incur additional losses in the future. However, in accordance with FAS 144, any additional operating losses or changes in the values of assets and liabilities will be reflected in our financial condition and results of operations as incurred.
On March 1, 2001, our Board of Directors approved a plan to offer for sale our Intellesale segment and all of our other non-core businesses, and accordingly, these entities are presented in Discontinued Operations for all periods presented. We accounted for the Intellesale segment and our other non-core businesses as Discontinued Operations in accordance with Accounting Principles Board 30,Reporting the Results of Operations- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions (“APB 30”). APB 30, of which portions related to the accounting for discontinued opera tions have been superceded by the provisions of FAS 144, required that we accrue estimates for future operating loses, gains/losses on sale, costs to dispose and carry costs of these businesses at the time the businesses were discontinued. Accordingly, at December 31, 2000, we recorded a provision for operating losses and carrying costs during the phase-out period for our Intellesale and other non-core businesses including estimated disposal costs to be incurred in selling the businesses. Carrying costs consisted primarily of cancellation of facility and equipment leases, legal settlements, employment contract buyouts and sales tax liabilities. The following table sets forth the roll forward of the liabilities for operating losses and carrying costs for
the periods December 31, 2002 to September 30, 2003, and December 31, 2003 through September 30, 2004. The additions/reductions represent a change in the estimated carrying costs during the phase out period, as certain of these costs were settled for more/less than anticipated, as well as to operating costs associated with one remaining business within this group, which was sold in July 2003.
Type of Cost (in thousands) | | Balance December 31, 2002 | | Additions | | Deductions | | Balance September 30, 2003 | |
| | | | | | | | | | |
| Change in estimated operating losses | | $ | | | $ | 176 | | $ | 176 | | $ | | |
| Carrying costs | | | 4,908 | | | 316 | | | 111 | | | 5,113 | |
| Total | | $ | 4,908 | | $ | 492 | | $ | 287 | | $ | 5,113 | |
Type of Cost (in thousands) | | | Balance December 31, 2003 | | | Additions (Reductions) | | | Deductions | | | Balance September 30, 2004 | |
| | | | | | | | | | | | | | |
| Carrying costs | | $ | 4,913 | | $ | (2,184 | ) | $ | 1,853 | | $ | 876 | |
LIQUIDITY AND CAPITAL RESOURCES FROM CONTINUING OPERATIONS
As of September 30, 2004, cash and cash equivalents totaled$8.1 million, a decrease of $2.1 million, or 20.6%, from$10.2 million at December 31, 2003.
Operating activities used cash of $9.6 million and $5.0 million during the nine-months ended September 30, 2004 and 2003, respectively. During the nine-months ended September 30, 2004, cash was used primarily to fund losses, for purchases of inventory, to fund discontinued operations, and also as a result of an increase in accounts receivable. During the nine-months ended September 30, 2003, cash was used primarily to purchase inventory.
Accounts and unbilled receivables, net of allowance for doubtful accounts increased by $1.5 million, or 10.6%, to $15.6 million at September 30, 2004, from $14.1 million at December 31, 2003. We attribute the increase primarily to accounts receivable associated with our Digital Angel segment as a result of increased sales during the three-months ended September 30, 2004, as compared to the three-months ended December 31, 2003.
Inventory levels increased by $3.4 million, or 36.2%, to $12.8 million at September 30, 2004, from $9.4 million at December 31, 2003. We attribute the increase primarily to an increase in work-in-process related to government contract projects.
Accounts payable increased by $1.9 million, or 14.0%, to $15.5 million at September 30, 2004, from $13.6 million at December 31, 2003, primarily as a result of vendor invoices associated with the increase in work-in-process related to government contract projects.
Accrued expenses decreased by $1.8 million, or 7.9%, to $20.9 million at September 30, 2004, from $22.7 million at December 31, 2003, due primarily to the payment of certain bonuses during January 2004, which were accrued in 2003.
Investing activities provided cash of $0.1 million and $0.3 million during the nine-months ended September 30, 2004 and 2003, respectively. During the nine-months ended September 30, 2004, cash of $0.7 million was provided primarily from the collection of notes receivable and cash of $1.7 million was provided from the sale of certain assets related to our Discontinued Operations, offset by cash of $1.1 million
used to purchase property and equipment, and cash of $0.7 million used to purchase other assets. During the nine-months ended September 30, 2003, cash was provided primarily by collections on notes receivable of $1.5 million, and used primarily to purchase property and equipment of $1.0 million.
Financing activities provided cash of $7.5 million and $4.1 million during the nine-months ended September 30, 2004 and 2003, respectively. During the nine-months ended September 30, 2004, cash of $5.7 million was provided from the issuances of common shares, and $3.8 million of cash was provided by subsidiary issuances of common stock. During the nine-months ended September 30, 2003, cash of $20.8 million was provided primarily from the issuances of common stock, $10.0 million was provided from the issuance of debentures, and cash of $27.6 million was used primarily to repay notes payable.
Liquidity and Debt Covenants
As of September 30, 2004, our consolidated cash and cash equivalents totaled $8.8 million, including restricted cash of $0.7 million. During October 2004, we generated cash of approximately $11.8 million from the sale of 2.5 million shares of our common stock to SSFA, and the exercise of SSFA’s Series A Warrants. These transactions are more fully described in Note 4 to our Condensed Consolidated Financial Statements. In addition, on October 13, 2004, Digital Angel Corporation realized net proceeds of $4.0 million from the sale of 1.1 million shares of our common stock that we issued to them in March 2004 under the terms of the Share Exchange Agreement, which is more fully described in Note 7 to our Condensed Consolidated Financial Statements.
We believe that we have sufficient funds to operate our business over the next twelve months. However, our goal is to achieve profitability and to generate positive cash flows from operations. We have established a management plan to guide us in achieving profitability and positive cash flows from operations during the remainder of 2004 and 2005. The major components of the plan are discussed below. No assurance can be given that we will be successful in implementing the plan. Our profitability and cash flows from operations depend on many factors including the success of our marketing programs, the maintenance and reduction of expenses and our ability to successfully develop and bring to market our new products and technologies. On October 12, 2004, we obtained the FDA’s clearance to market VeriChipTM for medical applications, which had previously been one of the major components of our plan.
Laurus Master Fund Ltd. Credit Agreements
On July 31, 2003, Digital Angel Corporation entered into a Securities Purchase Agreement, referred to as the Purchase Agreement, to sell to Laurus Master Fund Ltd., referred to as Laurus, the Secured Convertible Note, referred to as the Convertible Note, in the original principal amount of $2.0 million and a five-year warrant to purchase up to approximately $0.1 million new shares of Digital Angel Corporation’s common stock. The Convertible Note is convertible, at Laurus’s option, into shares of Digital Angel Corporation’s common stock at a per share price of $2.33. The Convertible Note accrues interest at an annual rate equal to the higher of the prime rate plus 1.75% or 6% per annum, and matures on July 31, 2005. On September 30, 2004, $0.7 million was outstanding under the Convertible Note. In connection with the Convertible Note, Digital Angel Corporation entered into a Security Agreement with Laurus granting to Laurus a lien and security interest in its assets. Additionally, the Purchase Agreement includes default provisions should an event of default (as defined in the agreement) occur. On August 28, 2003, Digital Angel Corporation entered into a second security agreement, referred to as the Second Security Agreement, with Laurus under which we may borrow from Laurus the lesser of $5.0 million or an amount that is determined based on percentages of certain eligible accounts receivable and inventory as prescribed by the terms of the Second Security Agreement. Borrowings under the Second Security Agreement accrue interest at an annual rate equal to the prime rate plus 2.5%. We had availability under the Second Security
Agreement of $2.1 million as of September 30, 2004.
Wells Fargo Credit Facility and IBM Credit Wholesale Agreement
On June 30, 2004, InfoTech USA, Inc. entered into the Credit Facility with Wells Fargo providing for up to $4.0 million in borrowings. Amounts borrowed under the Credit Facility bear interest at Wells Fargo’s prime rate plus 3%. The Credit Facility matures on June 29, 2007, and automatically renews for successive one-year periods thereafter unless terminated by either party. In connection with the execution of the Credit Facility, InfoTech USA, Inc. and IBM Credit entered into a new Wholesale Agreement. Under the terms of the Credit Facility, Wells Fargo may, at its election, make advances as requested from time to time in amounts up to an amount equal to the difference between the borrowing base and the sum of (i) the amount outstanding under the Credit Facility, and (ii) the $0.6 million letter of credit agreeme nt outstanding under the Credit Facility which secures the obligations to IBM Credit under the Wholesale Agreement. The borrowing base is equal to the lesser of $4.0 million or the amount equal to 85% of (i) eligible accounts receivable, plus (ii) the amount of available funds on deposit at Wells Fargo, and minus (iii) certain specified reserves. As of September 30, 2004, the borrowing base was approximately $1.8 million and approximately $0.4 million was available under the Credit Facility. The Credit Facility requires InfoTech USA, Inc. to maintain certain financial covenants, limits its capital expenditures, and contains other standard covenants including prohibitions on its incurrence of additional debt, sales of its assets and other corporate transactions of InfoTech USA, Inc. without Wells Fargo’s consent.
Under the terms of the Wholesale Agreement, IBM Credit may, at its election, advance InfoTech USA, Inc. up to $0.6 million to be used for the purchase of certain computer hardware and software products approved in advance by IBM Credit. Amounts outstanding under the Wholesale Agreement are required to be secured by a $0.6 million irrevocable letter of credit and bear finance charges in an amount to be agreed upon with IBM Credit from time to time. The Wholesale Agreement will remain in effect until terminated by either party upon at least 90 days written notice. As of September 30, 2004, $0.3 million was outstanding under the Wholesale Agreement and $0.3 million was available for future advances.
As of September 30, 2004, InfoTech USA, Inc. may not be in compliance with certain of its financial covenants under its Credit Facility with Wells Fargo. In the event of any such noncompliance, InfoTech USA, Inc. will seek to obtain a waiver. No assurance can be given that such waiver will be granted. If such a waiver is not granted, it could have an adverse effect on InfoTech USA, Inc. and us.
Management Plan to Achieve Profitability and Positive Cash Flow from Operations
Our ability to achieve profitability and/or generate positive cash flows from operations in the future is predicated upon numerous factors with varying levels of importance as follows:
| · | First, we will attempt to successfully implement our business plans, manage expenditures according to our budget, and generate positive cash flow from operations; |
| · | Second, we will attempt to develop an effective marketing and sales strategy in order to grow our business and compete successfully in our markets; |
| · | Third, we will attempt to expand the market for our VeriChipTM product, particularly for its medical, security and financial applications; |
| · | Fourth, we will attempt to realize positive cash flow with respect to our investment in Digital Angel Corporation in order to provide us with an appropriate return on our investment; and |
| · | Finally, we will attempt to complete the development of the Digital AngelTM technology. |
We have established a management plan to assist us in achieving profitability and positive cash flows over the twelve-months ending September 30, 2005. The major components of our plan are as follows:
| · | To attempt to establish a sustainable positive cash flow business model; |
| · | To attempt to produce additional cash flow and revenue from our advanced technology products -VeriChipTM, Bio-ThermoTM, Digital AngelTM and Thermo LifeTM; |
| · | To attempt to capitalize on the FDA’s recent approval of VeriChipTM for medical applications through strategic partnerships and alliances with healthcare providers; |
| · | To generate additional liquidity through divestiture of business units and assets that are not critical to us; |
| · | To position Digital Angel Corporation for growth under the leadership of its management team and through strategic acquisitions such as the OuterLink acquisition made in January 2004; |
| · | To generate additional liquidity through transactions such as the Share Exchange Agreement described in Note 7 to our Condensed Consolidated Financial Statements; and |
| · | To attempt to pair VeriChip Corporation with a complementary company that will bring experienced management, revenue and a synergistic customer base. |
Our management believes that the above plan can be effectively implemented. As of September 30, 2004, we had a working capital deficiency. However, a significant portion of the past due liabilities associated with the Discontinued Operations and All Other business units have not been guaranteed by us and/or we do not intend to repay such liabilities in cash during the next twelve months. Therefore, notwithstanding our working capital deficiency, we believe that with our current cash position, our expectations about the achievement of our management plan, and the reliance on our various other sources of liquidity as discussed below, we should have sufficient working capital to satisfy our needs over the next twelve months.
We believe that with the cash we have on hand and the revenue and related cash flows we expect to generate during the next twelve months from our Advanced Technology segment, we will have sufficient funds available to cover the operating expenses of this segment as well as our corporate overhead (exclusive of the corporate overhead of Digital Angel Corporation and InfoTech USA, Inc.). We believe that our Digital Angel Corporation segment will have sufficient funds to cover its operating expenses over the next twelve months as a result of cash flow from operations, the availability under the credit facilities with Laurus and the proceeds from the sale of our common stock issued under the Share Exchange Agreement. We believe that our InfoTech USA, Inc. segment will have sufficient funds to cover its operating expenses ov er the next twelve months as a result of cash flow from operations and availability under the Credit Facility with Wells Fargo and the Wholesale Agreement with IBM Credit.
The primary source of revenue for the Advanced Technology segment is the sale of voice, data and video telecommunications networks to various branches of the U.S. government. The future revenue outlook for such sales is expected to be positive. During the last quarter of 2004 and beyond, our focus will be to generate significant revenue and cash flow from our advanced technology products. We hope to realize
positive cash flow in the next twelve months and beyond as these products gain customer acceptance and awareness throughout the world.
The specific components and the approximate amount of funds we anticipate we will need to continue operating for the next twelve months are as follows:
| · | To fund operations (excluding research and development) - none, as we are hopeful that we will be able to achieve cash flow from operations, exclusive of research and development expense; |
| · | To fund research and development - approximately $4.0 million; |
| · | To fund capital expenditures - approximately $1.5 million; and |
| · | To fund current maturities of principal debt payments - approximately $4.9 million. |
The nature of our business is such that it does not require a material cash outlay for capital expenditures, and we have no plans to make significant investments in capital expenditures for the next twelve months.
Sources of Liquidity
Our sources of liquidity include proceeds from the sale of common stock and preferred shares, availability under our credit agreements with Laurus and Wells Fargo, proceeds from the sale of businesses, proceeds from the sale of the Digital Angel Corporation common stock owned by us, proceeds from the exercise of stock options and warrants, proceeds from InfoTech USA, Inc.’s Wholesale Agreement with IBM Credit, and the raising of capital through the private placement or public offering of our debt or equity securities. However, some of these options may not be available, or if available, they may not be on favorable terms. 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 investmen t required to bring new products on-line, revenue growth or decline, and potential acquisitions. Failure to generate positive cash flow from operations will have a material adverse effect on our business, financial condition and results of operations.
Outlook
We are constantly looking for ways to maximize shareholder value. As such, we are continually seeking operational efficiencies and synergies within our operating segments as well as evaluating acquisitions of businesses and customer bases which complement our operations. These strategic initiatives may include acquisitions, raising additional funds through debt or equity offerings, or the divestiture of business units that are not critical to our long-term strategy or other restructuring or rationalization of existing operations. We will continue to review all alternatives to ensure maximum appreciation of our shareholders’ investments. However, initiatives may not be found, or if found, they may not be on terms favorable to us.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In January 2003, the FASB issued Interpretation No. 46,Consolidation of Variable Interest Entities—an Interpretation of ARB No. 51 (“FIN 46”), which addresses consolidation of variable interest entities. FIN 46 expands the criteria for consideration in determining whether a variable interest entity should be consolidated by a business entity, and requires existing unconsolidated variable interest entities (which include, but are not limited to, Special Purpose Entities, or SPEs) to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among parties involved. On October 9, 2003, the FASB issued Staff Position No. 46-6 which deferred the effective date for applying the provisions of FIN 46 for interests held by public entities in variable interest entities or potential variable interest entities created before February 1, 2003. On December 24, 2003, the FASB issued a revision to FIN 46. Under the revised interpretation, the effective date was delayed to periods ending after March 15, 2004, for all variable interest entities, other than SPEs. The adoption of FIN 46 did not have any impact on our financial condition, results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (“FAS No. 150”). FAS 150 establishes standards for how companies classify and measure certain financial instruments with characteristics of both liabilities and equity. It requires companies to classify a financial instrument that is within its scope as a liability, or an asset, in some circumstances. FAS No. 150 is effective beginning with the second quarter of fiscal 2004. We do not currently have financial instruments with characteristics of both liabilities and equity, and therefore, the adoption of FAS No. 150 did not presently have an impact on our financial condition, results of operations or cash flows.
Forward-Looking Statements
This Form 10-Q contains forward-looking statements within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 with respect to our financial condition, results of operations and business, and includes statements relating to:
| · | our growth strategies including, without limitation, our ability to deploy our products and services including VeriChipTM, Bio-ThermoTM, Digital AngelTM and Thermo LifeTM; |
| · | anticipated trends in our business and demographics; |
| · | the ability to hire and retain skilled personnel; |
| · | relationships with and dependence on technological partners; |
| · | uncertainties relating to customer plans and commitments; |
| · | our ability to successfully integrate the business operations of acquired companies; |
| · | our future profitability and liquidity; |
| · | governmental export and import policies, global trade policies, worldwide political stability and economic growth; |
| · | regulatory, competitive or other economic influences; and |
| · | all statements referring to the future or future events. |
In some cases, you can identify forward-looking statements by terms such as “may,” “should,” “could,” “would,” “anticipates,” “expects,” “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 Form 10-Q is as of September 30, 2004, 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 Report 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 Securities and Exchange Commission. Please also note that we provide a cautionary discussion of risks and uncertainties under the section entitled “Risk Factors” in our Annual Report on Form 10-K, as amended, for the year ended December 31, 2003. These are factors that we think could cause our actual results to differ materially from expected results. Other factors b esides those listed could also adversely affect us.
As with our United Kingdom subsidiary, 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.
We presently do not use any derivative financial instruments to hedge our exposure to adverse fluctuations in interest rates, foreign exchange rates, fluctuations in commodity prices or other market risks, nor do we invest in speculative financial instruments. As of September 30, 2004, our debt consisted of borrowings under our loan agreements with Laurus and Wells Fargo, mortgage notes with fixed interest rates and capitalized leases with fixed implicit interest rates. Our borrowings under our loan agreements with Laurus bear interest at prime plus 1.75% to prime plus 2.5%, and our borrowings under our Credit Facility with Wells Fargo bear interest at prime plus 3%. Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our investments are short-term .
Due to the nature of our short-term investments, and the de minimus amounts of our foreign currency gains and losses, we have concluded that there is no material market risk exposure and, therefore, no quantitative tabular disclosure is required.
The table below presents the principal amount and weighted-average interest rate for our debt portfolio:
| | | Carrying Value at September 30, 2004 | |
Dollars in Thousands | | | | |
| Total notes payable and long-term debt (including current portion) | | | $7,177 | |
Notes payable bearing interest at fixed interest rates (including current portion) | | | $2,342 | |
Weighted-average interest rate on notes payable and long-term debt during the nine-months ended September 30, 2004 | | | 14.4% | |
(a) Evaluation of Disclosure Controls and Procedures
The Company’s Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 240.13a - 15(e) and 240.15d - 15(e)) as of the end of the quarterly period ended September 30, 2004. Based on that evaluation, they have concluded that the Company’s 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 the Company required to be disclosed in the reports the Company files or submits under the Exchange Act. The Company’s disclosure controls and procedures are designed to provide reasonable assurances of achieving their objectives and the Company’s Chief Executive Officer and Ch ief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective in reaching that level of reasonable assurance.
(b) Changes in Internal Control Over Financial Reporting
There have not been any changes in the Company’s internal controls over financial reporting identified in connection with an evaluation thereof that occurred during the Company’s third fiscal quarter that have materially affected, or are reasonable likely to materially affect the Company’s internal control over financial reporting. There were no significant deficiencies or material weaknesses, and therefore no corrective actions were taken.
We, and certain of our subsidiaries, are parties to various legal actions as either plaintiff or defendant and accordingly, have recorded certain reserves in our financial statements as of September 30, 2004. In our opinion, these proceedings are not likely to have a material adverse affect on our financial position, our cash flows or our overall trends in results. The estimate of the potential impact on our financial position, our overall results of operations or our cash flows for these proceedings could change in the future. See Note 13 to our Condensed Consolidated Financial Statements for a description of certain of these proceedings.
None.
ITEM 3.DEFAULTS UPON SENIOR SECURITIES
None.
An annual meeting of our shareholders was held on July 24, 2004. The results of the matters voted on by our shareholders at the meeting are presented in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2004.
ITEM 5.OTHER INFORMATION
Website Access to Information and Disclosure of Web Access to Company Reports
Our website address is:http://www.adsx.com. We make available free of charge through our website our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K, Forms 3, 4 and 5, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission.
i. 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
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.
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| | Applied Digital Solutions, Inc. (Registrant) |
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| Date: November 3, 2004 | By: | /s/ EVAN C. MCKEOWN |
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| | Evan C. McKeown |
| Senior Vice President, Chief |
| Financial Officer |
| | Description |
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| 3.1 | | Amended and Restated Bylaws of the Registrant dated March 31, 1998 (incorporated by reference to Exhibit 4.7 to the registrant’s Post-Effective Amendment No. 1 to Registration Statement on Form S-1 (File No. 333-102165) filed with the Commission on April 14, 2003) |
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| 3.2 | | Fourth Restated Articles of Incorporation of the Registrant filed with the Secretary of State of Missouri on August 26, 2003 (incorporated by reference to Exhibit 4.8 to the registrant’s Registration Statement on Form S-1 (File No. 333-108338) filed with the Commission on August 28, 2003) |
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| 3.3 | | Amendment of Fourth Restated Articles of Incorporation of the Registrant filed with the Secretary of State of Missouri on March 19, 2004 (incorporated by reference to Exhibit 3.14 to the registrant’s Quarterly Report on Form 10-Q filed with the Commission on May 5, 2004) |
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| 10.1 | | International Distribution Agreement dated September 22, 2004, by and between VeriChip Corporation and Surge IT Solutions for the territory of England* |
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| 31.1 | | Certification by Scott R. Silverman, Chief Executive Officer, pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a)* |
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| 31.2 | | Certification by Evan C. McKeown, Chief Financial Officer, pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a)* |
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| 32.1 | | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002* |
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| 32.2 | | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002* |
* Filed herewith
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