As filed with the Securities and Exchange Commission on April 23, 2001
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
-------------------------------------
Amendment No. 1 on
FORM 10-Q/A
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 2000
or
[ ] 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
APPLIED DIGITAL SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
MISSOURI 43-1641533
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
400 ROYAL PALM WAY, SUITE 410
PALM BEACH, FLORIDA 33480
(561) 805-8000
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes [X] No [ ]
The number of shares outstanding of each of the issuer's classes of
common stock as of the close of business on November 13, 2000:
Class Number of Shares
Common Stock; $.001 Par Value 102,101,653
EXPLANATORY NOTE
This Amendment No. 1 to Quarterly Report on Form 10-Q/A amends and
restates the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter
ended September 30, 2000, filed by the Registrant on November 15, 2000.
APPLIED DIGITAL SOLUTIONS, INC.
TABLE OF CONTENTS
Item Description Page
PART I - FINANCIAL INFORMATION
1. Financial Statements
Consolidated Balance Sheets
September 30, 2000 (unaudited) and December 31, 1999 3
Consolidated Statements of Operations -
Three and Nine Months ended September 30, 2000 and 1999
(unaudited) 4 Consolidated Statement of Stockholders' Equity -
Nine Months ended September 30, 2000 (unaudited) 5
Consolidated Statements of Cash Flows -
Nine Months ended September 30, 2000 and 1999 (unaudited) 6
Notes to Consolidated Financial Statements (unaudited) 7
2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 19
3. Quantitative and Qualitative Disclosures About Market Risk 44
PART II - OTHER INFORMATION
1. Legal Proceedings 45
2. Changes In Securities 45
3. Defaults Upon Senior Securities 46
4. Submission of Matters to a Vote of Security Holders 46
5. Other Information 47
6. Exhibits and Reports on Form 8-K 48
SIGNATURE 50
EXHIBITS 51
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
- ----------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
ASSETS
September 30, December 31,
2000 1999
(Unaudited)
---------------------------------
CURRENT ASSETS
Cash and cash equivalents $ 9,508 $ 5,138
Due from buyer of divested subsidiary -- 31,302
Accounts receivable and unbilled receivables (net of allowance
for doubtful accounts of $4,433 in 2000 and $1,698 in 1999) 55,646 52,170
Inventories 42,577 40,448
Notes receivable 4,477 3,822
Prepaid expenses and other current assets 10,796 6,001
- ----------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 123,004 138,881
PROPERTY AND EQUIPMENT, NET 19,387 13,886
NOTES RECEIVABLE 3,260 3,297
GOODWILL, NET 175,642 62,000
OTHER ASSETS 20,333 10,912
- ----------------------------------------------------------------------------------------------------------------
$ 341,626 $ 228,976
================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable $ 632 $ 818
Current maturities of long-term debt 5,694 8,038
Due to shareholders of acquired subsidiary 10,000 15,000
Accounts payable 24,917 29,499
Accrued expenses 16,692 17,672
Other current liabilities -- 2,745
- ----------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 57,935 73,772
LONG-TERM DEBT 81,673 59,710
- ----------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 139,608 133,482
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COMMITMENTS AND CONTINGENCIES
- ----------------------------------------------------------------------------------------------------------------
MINORITY INTEREST 2,247 2,558
- ----------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY Preferred shares:
Authorized 5,000 shares in 2000 and 1999 of $10 par value; special voting,
issued and outstanding 1 share in 2000 and 1999, Class B voting, issued
and outstanding 1 share in 2000 and 1999 -- --
Common shares:
Authorized 245,000 shares in 2000 and 80,000 in 1999 of $.001 par value;
84,077 shares issued and 82,861 shares outstanding in 2000
and 51,116 shares issued and 48,260 shares outstanding in 1999 83 48
Common and preferred additional paid-in capital 209,598 87,470
Retained earnings (7,976) 12,664
Common stock warrants 1,656 --
Treasury stock (carried at cost, 1,216 shares in 2000 and 2,856 in 1999) (2,802) (7,310)
Accumulated other comprehensive income (loss) (788) 64
- ----------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 199,771 92,936
- ----------------------------------------------------------------------------------------------------------------
$ 341,626 $ 228,976
================================================================================================================
- ----------------------------------------------------------------------------------------------------------------
See the accompanying notes to consolidated financial statements. Page 3
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
- ----------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(UNAUDITED)
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------------------------------------------
2000 1999 2000 1999
--------------------------------------------------------
NET OPERATING REVENUE $ 73,846 $ 107,262 $ 222,862 $ 231,790
COST OF GOODS SOLD 50,814 78,596 159,384 158,378
UNUSUAL INVENTORY CHARGE -- -- 8,500 --
- ----------------------------------------------------------------------------------------------------------------------------
GROSS PROFIT 23,032 28,666 54,978 73,412
- ----------------------------------------------------------------------------------------------------------------------------
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (21,227) (24,022) (65,751) (61,838)
DEPRECIATION AND AMORTIZATION (3,136) (2,612) (7,535) (6,373)
UNUSUAL AND RESTRUCTURING CHARGES -- -- (8,500) (2,550)
INTEREST INCOME 110 155 676 433
INTEREST EXPENSE (1,636) (1,160) (4,103) (2,295)
- ----------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE PROVISION (BENEFIT) FOR INCOME TAXES,
MINORITY INTEREST AND EXTRAORDINARY LOSS (2,857) 1,027 (30,235) 789
PROVISION (BENEFIT) FOR INCOME TAXES (1,219) 644 (9,940) 1,086
- ----------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE MINORITY INTEREST AND
EXTRAORDINARY LOSS (1,638) 383 (20,295) (297)
MINORITY INTEREST 102 (64) 345 400
- ----------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE EXTRAORDINARY LOSS (1,740) 447 (20,640) (697)
EXTRAORDINARY LOSS (NET OF TAXES OF $89) -- -- -- 160
- ----------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS $ (1,740) $ 447 $ (20,640) $ (857)
============================================================================================================================
INCOME (LOSS) BEFORE EXTRAORDINARY LOSS $ (.03) $ .01 $ (.38) $ (.02)
EXTRAORDINARY LOSS -- -- -- --
- ----------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) PER COMMON SHARE - BASIC $ (.03) $ .01 $ (.38) $ (.02)
============================================================================================================================
INCOME (LOSS) BEFORE EXTRAORDINARY LOSS $ (.03) $ .01 $ (.38) $ (.02)
EXTRAORDINARY LOSS -- -- -- --
- ----------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) PER COMMON SHARE - DILUTED $ (.03) $ .01 $ (.38) $ (.02)
============================================================================================================================
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING - BASIC 63,862 47,087 54,623 46,102
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING - DILUTED 63,862 47,424 54,623 46,102
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
See the accompanying notes to consolidated financial statements. Page 4
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
- ------------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2000
(In thousands)
(UNAUDITED)
ADDIT- ACCUMULATED
PREFERRED SHARES COMMON SHARES IONAL COMMON OTHER TOTAL
---------------- ------------- PAID-IN RETAINED STOCK TREASURY COMPREHENSIVE STOCKHOLDERS'
NUMBER AMOUNT NUMBER AMOUNT CAPITAL EARNINGS WARRANTS STOCK INCOME (LOSS) EQUITY
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 1999 -- $ -- 48,260 $48 $ 87,470 $ 12,664 $ -- $(7,310) $ 64 $ 92,936
Net loss -- -- -- -- -- (20,640) -- - --
Comprehensive loss -
foreign currency translation -- -- -- -- -- -- -- -- (852)
Total comprehensive loss -- -- -- -- -- (20,640) -- -- (852) (21,492)
Issuance of common shares -- -- 1,635 2 4,849 -- -- -- -- 4,851
Issuance of common shares for
acquisition -- -- 31,006 31 120,822 -- -- -- -- 120,853
Assumption of common stock
warrants for acquisition -- -- -- -- -- -- 1,672 -- -- 1,672
Warrants redeemed for common
shares -- -- 320 -- 967 -- (16) -- -- 951
Reissue of treasury shares -- -- 1,640 2 (4,510) -- -- 4,508 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE - SEPTEMBER 30, 2000 -- $ -- 82,861 $83 $209,598 $ (7,976) $1,656 $(2,802) $(788) $199,771
====================================================================================================================================
- ------------------------------------------------------------------------------------------------------------------------------------
See the accompanying notes to consolidated financial statements. Page 5
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
- ---------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(UNAUDITED)
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
-------------------------------
2000 1999
-------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (20,640) $ (857)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 7,535 6,373
Minority interest 345 400
(Gain) loss on sale of equipment and other assets (449) 62
Non-cash unusual and restructuring charges 17,000 251
Change in assets and liabilities, excluding unusual charges:
Increase (decrease) in accounts receivable 741 (22,767)
Increase in inventories (5,809) (15,121)
Increase in prepaid expenses and other current assets (4,311) (2,603)
Increase in deferred tax asset (8,475) --
Increase (decrease) in accounts payable and accrued
expenses (19,531) 19,966
- ---------------------------------------------------------------------------------------------------------
NET CASH USED IN OPERATING ACTIVITIES (33,594) (14,296)
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Decrease in due from buyer of divested subsidiary 31,302 --
Increase in notes receivable (617) (857)
Increase in other assets (680) (1,304)
Proceeds from sale of equipment and other assets 829 360
Payments for property and equipment (5,476) (3,771)
Payments for asset and business
acquisitions (net of cash balances acquired) (10,490) (15,852)
- ---------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 14,868 (21,424)
- ---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net amounts borrowed (paid) on notes payable 8,935 (70)
Proceeds from long-term debt 16,271 51,942
Payments on long-term debt (7,212) (8,334)
Issuance of common shares 5,487 --
Other financing costs (385) (3,340)
- ---------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 23,096 40,198
- ---------------------------------------------------------------------------------------------------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 4,370 4,478
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 5,138 4,555
- ---------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 9,508 $ 9,033
=========================================================================================================
- ---------------------------------------------------------------------------------------------------------
See the accompanying notes to consolidated financial statements. Page 6
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Applied
Digital Solutions, Inc. (the "Company") as of September 30, 2000 and December
31, 1999 (the December 31, 1999 financial information included herein has been
extracted from the Company's audited financial statements included in the
Company's 1999 Annual Report on Form 10-K) and for the three and nine months
ended September 30, 2000 and 1999 have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X of the
Securities Exchange Act of 1934. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of the Company's management,
all adjustments (consisting of only normal recurring adjustments) considered
necessary to present fairly the consolidated financial statements have been
made.
The consolidated statements of operations for the three and nine months
ended September 30, 2000 are not necessarily indicative of the results that may
be expected for the entire year. These statements should be read in conjunction
with the consolidated financial statements and related notes thereto included in
our Annual Report on Form 10-K for the year ended December 31, 1999.
Certain items in the consolidated financial statements for the 1999
periods have been reclassified for comparative purposes.
2. PRINCIPLES OF CONSOLIDATION
The financial statements include the accounts of the Company and its
wholly owned and majority owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
3. INVENTORY
September 30, December 31,
2000 1999
------------------ ------------------
Raw materials $ 4,402 $ 4,648
Work in process 1,859 1,195
Finished goods 37,195 35,602
------------------ ------------------
43,456 41,445
Allowance for excess and obsolescence (879) (997)
------------------ ------------------
$ 42,577 $ 40,448
================== ==================
As discussed in Note 5, the $8.5 million unusual charge to gross profit
recorded in the second quarter of 2000 has been recognized as a write-down of
specific inventory items.
4. FINANCING AGREEMENTS
In August 1998, the Company entered into a $20.0 million line of
credit with State Street Bank Trust Company secured by all of our domestic
7
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
assets at the prime lending rate or at the London Interbank Offered Rate, at our
discretion. In February 1999, the amount of the credit available under the
facility was increased to $23.0 million. On May 25, 1999, the Company entered
into a Term and Revolving Credit Agreement with IBM Credit Corporation (the "IBM
Agreement"). On May 26, 1999, the Company repaid the amount due to State Street
Bank and Trust Company. On July 30, 1999 the IBM Agreement was amended and
restated, and it was again amended on January 27, 2000. In a letter to the
Company dated September 29, 2000, IBM Credit agreed to extend the deadline for
amending the IBM Agreement from September 30, 2000 to October 17, 2000. On
October 17, 2000, the Company entered into a Second Amended and Restated Term
and Revolving Credit Agreement with IBM Credit Corporation ("the Second IBM
Agreement").
The Second IBM Agreement provides for:
(a) a revolving credit line of up to $67.260 million, subject
to availability under a borrowing base formula, designated
as follows: (i) a USA revolving credit line of up to
$63.405 million, and (ii) a Canadian revolving credit line
of up to $3.855 million,
(b) a term loan A of up $25.0 million, and
(c) a term loan C of up to $2.740 million.
The revolving credit line may be used for general working capital
requirements, capital expenditures and certain other permitted purposes and is
repayable in full on May 25, 2002. The USA revolving credit line bears interest
at the 30-day LIBOR rate plus 2.75%; the Canadian revolving credit line bears
interest at the base rate as announced by the Toronto-Dominion Bank of Canada
each month plus 1.17%. As of September 30, 2000, the LIBOR rate was
approximately 6.6% and approximately $33.7 million was outstanding on the
revolving credit line, which is included in long-term debt.
Term loan A bears interest at the 30-day LIBOR rate plus 3.50%, is
amortized in quarterly installments over six years and is repayable in full on
May 25, 2002. As of September 30, 2000, approximately $17.4 million was
outstanding on this loan.
Term loan B bears interest at the 30-day LIBOR rate plus 1.75% to
1.90%. As of September 30, 2000, approximately $32.6 million was outstanding on
this loan. On October 17, 2000, Term loan B was terminated and the balance was
transferred into the revolving credit line.
Term loan C, which was used by our Canadian subsidiary to pay off their
bank debt, bears interest at the base rate as announced by the Toronto-Dominion
Bank of Canada each month plus 1.17%, is amortized in quarterly installments
over six years and is repayable in full on May 25, 2002. As of September 30,
2000, Toronto-Dominion's rate was approximately 7.5% and approximately $2.1
million was outstanding on this loan.
The agreement contains standard debt covenants relating to the
financial position and performance of the Company as well as restrictions on the
declarations and payment of dividends. As of September 30, 2000, the Company was
in compliance with all debt covenants.
8
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
5. UNUSUAL AND RESTRUCTURING CHARGES
Unusual Charges
- ---------------
In the second quarter of 2000 the Company's subsidiary,
IntelleSale.com, Inc. ("IntelleSale"), recorded a pre-tax charge of $17.0
million, $14.0 million of which related to reserves established in association
with the discovery of potential impropriety and possible fraud and
misrepresentations in connection with the purchase of Bostek, Inc. and affiliate
("Bostek"), which was acquired by IntelleSale in June 1999, and $3.0 million of
which related to fees and expenses incurred in connection with IntelleSale's
cancelled Initial Public Offering ("IPO") and certain other intangible assets.
The $14.0 million charge is composed of an inventory reserve of $8.5 million for
products IntelleSale expects to sell below cost (included as a component of cost
of goods sold in the accompanying Consolidated Statements of Operations for the
nine months ended September 30, 2000) and $5.5 million related to specific
accounts and other receivables.
The former Bostek owners filed a lawsuit against the Company and
IntelleSale claiming that their earnout payment was inadequate. The Company and
IntelleSale believe that the claim is without merit and intend to defend it
vigorously, and have filed counterclaims alleging, among other things, fraud on
the part of the former Bostek owners. IntelleSale has also filed a lawsuit in
Massachusetts seeking to recover the damages it has sustained.
Restructuring Charge
- --------------------
In the first quarter of 1999, a pre-tax charge of $2.5 million was
recorded to cover restructuring costs of $2.2 million and unusual charges of
$0.3 million.
As part of the Company's reorganization of its core business into four
reportable business groups, the Company has implemented a restructuring plan.
The restructuring plan includes the exiting of selected lines of business within
the Company's Telephony and Applications business groups, and the associated
write-off of assets. The restructuring charge of $2.2 million included asset
impairments, primarily software and other intangible assets, of $1.5 million,
lease terminations of $0.5 million, and employee separations of $0.2 million.
The total charge reduced net income by $1.6 million.
The following table sets forth the rollforward of the liabilities for
business restructuring from January 1, 1999 through September 30, 2000:
Balance, Balance Balance
January 1, December 31, September 30,
Type of Cost 1999 Additions Deductions 1999 Deductions 2000
- -----------------------------------------------------------------------------------------------------------------
Asset impairment $ -- $ 1,522 $ 1,522 $ -- $ -- $ --
Lease terminations -- 541 342 199 199 --
Employee separations -- 173 123 50 -- 50
--------------------------------------------------------------------------------------
Total $ -- $ 2,236 $ 1,987 $ 249 $ 199 $ 50
======================================================================================
9
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
6. EXTRAORDINARY LOSS
In connection with the early retirement of the Company's line of credit
with State Street Bank and Trust Company and its simultaneous refinancing with
IBM Credit Corporation, deferred financing fees associated with the State Street
Bank and Trust agreement were written off during the second quarter of 1999. The
total amount of the write off classified as an extraordinary loss was $0.2
million, net of income taxes.
7. EARNINGS (LOSS) PER SHARE
The following is a reconciliation of the numerator and denominator
of basic and diluted earnings (loss) per share
--------------------------------------------------
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------------------------
2000 1999 2000 1999
---- ---- ---- ----
NUMERATOR:
Net income (loss) available to common stockholders $(1,740) $447 $(20,640) $(857)
==================================================
DENOMINATOR:
Denominator for basic income (loss) per share -
Weighted-average shares(1) 63,862 47,087 54,623 46,102
Effect of dilutive securities -
Warrants -- 85 -- --
Employee stock options -- 252 -- --
--------------------------------------------------
Denominator for diluted income (loss) per share(2) 63,862 47,424 54,623 46,102
==================================================
Basic income (loss) per share $(0.03) $ 0.01 $(0.38) $ (0.02)
==================================================
Diluted income (loss) per share $(0.03) $ 0.01 $(0.38) $ (0.02)
==================================================
<FN>
(1) Includes, for the three and nine month periods ended September 30, 2000 and
1999, 5 hundred and 0.8 million shares of common stock, respectively,
reserved for issuance to the holders of ACT-GFX, Inc.'s exchangeable
shares.
(2) The weighted average shares listed below were not included in the
computation of diluted loss per share because to do so would have been
anti-dilutive for the periods presented:
</FN>
------------------------------------------
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------
2000 2000 1999
---- ---- ----
Employee stock options 1,960 3,319 448
Warrants 184 321 186
Contingent stock - acquisitions -- 39 --
------------------------------------------
2,144 3,679 634
==========================================
10
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
8. SEGMENT INFORMATION
The Company is organized into six operating segments. The
"eliminations" category includes all amounts recognized upon consolidation of
the Company's subsidiaries such as the elimination of intersegment revenues,
expenses, assets and liabilities and goodwill amortization expense. The
accounting policies of the operating segments are the same as those described in
the summary of significant accounting policies in the Company's Annual Report on
Form 10-K filed for the year ended December 31, 1999, except that intersegment
sales and transfers are generally accounted for as if the sales or transfers
were to third parties at current market prices and segment data includes an
allocated charge for the corporate headquarters costs. It is on this basis that
management utilizes the financial information to assist in making internal
operating decisions. The Company evaluates performance based on stand-alone
segment operating income. Certain prior period information has been reclassified
for comparative purposes.
Following is the selected segment data as of and for the three months
ended September 30, 2000:
-------------------------------------------------------------------------------------------------------------
Corporate
Telephony Network Internet Applications IntelleSale Non-Core Overhead Eliminations Consolidated
-------------------------------------------------------------------------------------------------------------
External
revenue $ 12,276 $ 12,758 $ 4,248 $ 11,638 $ 20,342 $ 12,532 $ 52 $ -- $ 73,846
Intersegment
revenue -- -- -- -- 1,105 -- -- (1,105) --
-------------------------------------------------------------------------------------------------------------
Total revenue $ 12,276 $ 12,758 $ 4,248 $ 11,638 $ 21,447 $ 12,532 $ 52 $ (1,105) $ 73,846
=============================================================================================================
Income (loss)
before benefit
for income
taxes and
minority
interest $ 648 $ 607 $ 221 $ 519 $ (1,076) $ 725 $ (2,896) $ (1,605) $ (2,857)
=============================================================================================================
Total assets $ 30,253 $ 11,481 $ 4,567 $ 35,625 $ 48,057 $ 27,670 $341,111 $(157,138) $ 341,626
=============================================================================================================
Following is the selected segment data as of and for the nine months
ended September 30, 2000:
-------------------------------------------------------------------------------------------------------------
Corporate
Telephony Network Internet Applications IntelleSale Non-Core Overhead Eliminations Consolidated
-------------------------------------------------------------------------------------------------------------
External
revenue $ 27,210 $ 31,026 $ 9,071 $ 30,069 $ 89,753 $ 35,566 $ 167 $ -- $ 222,862
Intersegment
revenue -- -- -- -- 5,112 -- -- (5,112) --
-------------------------------------------------------------------------------------------------------------
Total revenue $ 27,210 $ 31,026 $ 9,071 $ 30,069 $ 94,865 $ 35,566 $ 167 $ (5,112) $ 222,862
=============================================================================================================
Income (loss)
before benefit
for income
taxes and
minority
interest $ 1,799 $ 1,450 $ 175 $ (135) $(22,288) $ 937 $ (8,607) $ (3,566) $ (30,235)
=============================================================================================================
Total assets $ 30,253 $ 11,481 $ 4,567 $ 35,625 $ 48,057 $ 27,670 $341,111 $(157,138) $ 341,626
=============================================================================================================
11
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Following is the selected segment data as of and for the three months
ended September 30, 1999:
-------------------------------------------------------------------------------------------------------------
Corporate
Telephony Network Internet Applications IntelleSale Non-Core Overhead Eliminations Consolidated
-------------------------------------------------------------------------------------------------------------
External revenue $ 17,265 $ 7,399 $ 2,285 $ 11,800 $ 48,663 $ 19,820 $ 30 $ -- $ 107,262
Intersegment
revenue -- -- -- -- 2,818 -- -- (2,818) --
-------------------------------------------------------------------------------------------------------------
Total revenue $ 17,265 $ 7,399 $ 2,285 $ 11,800 $ 51,481 $ 19,820 $ 30 $ (2,818) $ 107,262
=============================================================================================================
Income (loss)
before provision
(benefit) for
income taxes,
minority
interest and
extraordinary
loss $ 402 $ 569 $ 261 $ 164 $ 1,606 $ 560 $ (1,678) $ (857) $ 1,027
=============================================================================================================
Total assets $ 39,211 $ 7,242 $ 2,166 $ 26,874 $ 72,166 $ 35,272 $213,012 $(155,468) $ 240,475
=============================================================================================================
Following is the selected segment data as of and for the nine months
ended September 30, 1999:
-------------------------------------------------------------------------------------------------------------
Corporate
Telephony Network Internet Applications IntelleSale Non-Core Overhead Eliminations Consolidated
-------------------------------------------------------------------------------------------------------------
External revenue $ 40,797 $ 19,905 $ 4,405 $ 26,498 $ 87,735 $ 52,379 $ 71 $ -- $ 231,790
Intersegment
revenue -- -- -- -- 5,007 -- -- (5,007) --
-------------------------------------------------------------------------------------------------------------
Total revenue $ 40,797 $ 19,905 $ 4,405 $ 26,498 $ 92,742 $ 52,379 $ 71 $ (5,007) $ 231,790
=============================================================================================================
Income (loss)
before provision
(benefit) for
income taxes,
minority
interest and
extraordinary
loss $ 958 $ 1,495 $ 526 $ 26 $ 5,262 $ 1,504 $ (7,300) $ (1,682) $ 789
=============================================================================================================
Total assets $ 39,211 $ 7,242 $ 2,166 $ 26,874 $ 72,166 $ 35,272 $213,012 $(155,468) $ 240,475
=============================================================================================================
12
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
9. MERGERS, ACQUISITIONS AND DISPOSITIONS
The following represents acquisitions which occurred in the first nine
months of 2000 and during 1999:
Value of
Cash Share Common
Date of Percent Acquisition Consid- Issued or Shares Goodwill Business
Acquisition Acquired Price eration Issuable Issued Acquired Description
- --------------------------- ----------- -------- ----------- ------- --------- ------ -------- -----------------------
2000
Acquisitions:
- ------------
Independent 04/01/00 100% $5,547 $ 75 $ 5,472 958 5,109 Network
Business integration
Consultants company
P-Tech, Inc. 04/01/00 100% 4,830 80 4,750 1,182 4,690 Software
development
company
Timely 04/01/00 100% 1,315 450 865 215 988 Software
Technology Corp. developer
and
application
service
provider
Computer Equity 06/01/00 100% 24,712 8,968 15,744 4,829 15,935 Communications
Corporation integration
company
WebNet Services, Inc. 07/01/01 100% 958 58 900 268 827 Network integrator
and website
developer
Destron Fearing 09/08/00 100% 84,642 1,373 83,269 20,821 76,852 Animal identification
and microchip
technology
company
1999
Acquisitions:
Port 04/01/99 100% 1,292 1,292 621 303 800 Integrator
Consulting, Inc. of
information
technology
application
systems
Hornbuckle 04/01/99 100% 5,103 180 4,923 631 4,912 Integrated
Engineering, voice and
Inc. data
solutions
provider
Lynch Marks & 04/01/99 100% 2,571 0 2,526 773 1,404 Network
Associates, Inc. integration
company
STR, Inc. 04/01/99 100% 6,822 50 6,772 1,332 7,507 Software
solutions
provider for
retailers
Contour Telecom 05/01/99 75% 5,627 5,627 --- --- 4,752 Provider of
Management, outsourced
Inc. telecommunications
(Divested management
effective services
12/31/99)
Bostek, Inc. & 06/01/99 100% 27,466 26,966 --- --- 24,876 Seller of
affiliate computer
systems and
peripherals
In each of the above transactions, the value of the consideration paid
by the Company was in accordance with the acquisition agreement. Based on the
contractually agreed to amounts, the Company calculated the number of shares to
be issued to the sellers as of the closing date. The price of the Company's
common stock used to determine the number of shares issued was either the
closing price set on a fixed date or based on a formula as specified in the
agreements.
13
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Major Acquisitions
------------------
On September 8, 2000, the Company completed the acquisition of Destron
Fearing Corporation through a merger of its wholly-owned subsidiary, Digital
Angel.net Inc., into Destron Fearing Corporation. As a result of the merger,
Destron Fearing is now a wholly-owned subsidiary of the Company and has been
renamed "Digital Angel.net Inc."
In connection with the merger, each outstanding share of Destron
Fearing common stock was exchanged for 1.5 shares of the Company's common stock,
with fractional shares settled in cash. In addition, outstanding options and
warrants to purchase shares of Destron Fearing common stock were converted into
a right to purchase that number of shares of the Company's common stock as the
holders would have been entitled to receive had they exercised such options and
warrants prior to September 8, 2000 and participated in the merger. The Company
issued 20.5 million shares if its common stock in exchange for all the
outstanding common stock of Destron Fearing and 0.3 million shares of its common
stock as a transaction fee. The Company will issue up to 2.7 million shares of
its common stock upon the exercise of the Destron Fearing options and warrants.
The aggregate purchase price of approximately $84.6 million, including the
liabilities, was allocated to the identifiable assets with the remainder of
$75.1 million recorded as goodwill, which is being amortized over 20 years.
Effective June 1, 2000, the Company acquired all of the outstanding
common stock of Computer Equity Corporation. The aggregate purchase price was
approximately $24.7 million, $15.8 million of which was paid in shares of the
Company's common stock and $8.9 million of which was payable in cash and paid in
August, 2000. An additional $10.3 million is contingent upon achievement of
certain earnings targets during the two years ended June 30, 2002. The total
purchase price of Computer Equity Corporation, including the liabilities, was
allocated to the identifiable assets with the remainder of $15.9 million
recorded as goodwill, which is being amortized over 20 years.
Effective June 1, 1999, IntelleSale acquired all of the outstanding
common stock of Bostek. The aggregate purchase price was approximately $27.0
million, of which $10.2 million was paid in cash at closing, $5 million was paid
in cash in January 2000 and $1.8 million for the 1999 earnout was paid in cash
in February 2000. The earnout accrual was included in the other current
liabilities at December 31, 1999. An additional $3.2 million is contingent upon
achievement of certain additional earnings targets. The total purchase price of
Bostek, including the liabilities, was allocated to the identifiable assets with
the remainder of $24.4 million recorded as goodwill, which is being amortized
over 20 years. Under the terms of the agreement, the former owners of Bostek
were entitled to be paid $10.0 million in cash on June 30, 2000. As previously
discussed, due to the litigation between the Company, IntelleSale and the former
Bostek owners, the $10.0 million payment was not paid on June 30, 2000 because
the Company and IntelleSale believe it is not owed. The Company and IntelleSale
intend to vigorously assert their position set forth in their counterclaims and
lawsuits that such payments are not owed, but continue to carry this amount as a
liability pending the outcome of the litigation.
14
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Unaudited pro forma results of operations for the nine months ended
September 30, 2000 and 1999 are included below. Such pro forma information
assumes that the above transactions had occurred as of January 1, 2000 and 1999,
respectively.
-------------------------------
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------------
2000 1999
---- ----
Revenues $ 249,113 $ 335,618
Income (loss) before extraordinary loss (22,545) 368
Net income (loss) (22,545) 208
Earnings per common shares - basic (0.41) 0.01
Earnings per common share - diluted (0.41) 0.01
Earnout and Put Agreements
- --------------------------
Certain acquisition agreements include additional consideration
contingent on profits of the acquired subsidiary. Upon earning this additional
consideration, the value will be recorded as additional goodwill. The
acquisitions above include contingent shares earned upon attainment of certain
profits by subsidiaries through September 30, 2000. Under these agreements,
assuming all earnout profits are achieved, the Company is contingently liable
for additional consideration of approximately $19.6 million in 2001, $9.1
million in 2002 and $2.0 million in 2004, of which $1.0 million would be payable
in cash and $29.7 million would be payable in stock.
The Company has entered into put options with the sellers of those
companies in which the Company acquired less than a 100% interest. These options
require the Company to purchase the remaining portion it does not own after
periods ranging from four to five years from the dates of acquisition at amounts
per share generally equal to 10% to 20% of the average annual earnings per share
of the acquired company before income taxes for, generally, a two year period
ending on the effective date of the put multiplied by a multiple ranging from
four to five. The purchases under these put options are recorded as changes in
minority interest based upon current operating results.
In June 2000, the Company entered into agreements to issue, in the
aggregate, 2.3 million shares of its common stock, 1.6 million of which have
been issued, to acquire $10.0 million in put options and to settle earnout
payments in certain companies owned by IntelleSale. These agreements superseded
agreements entered into during the second quarter of 1999.
During the first nine months of 2000 and 1999, 2.4 million and 6.0
million shares of common stock, respectively, were issued to satisfy earnouts
and to purchase minority interests.
Dispositions
- ------------
Effective October 1, 1999, the Company entered into a Stock Purchase
Agreement for the sale of all outstanding shares of common stock of four
non-core subsidiaries. In consideration, the Company received a note for $2.5
million, and 2.8 million shares of the Company's common stock, recorded as
treasury stock in the amount of $7.0 million. No gain was recorded on this
transaction, because the shareholders of the purchaser of the divested assets
15
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
were deemed to be significant shareholders of the Company. The operating results
of these companies are properly included in the Company's financial statements
through the date of disposition.
Effective December 30, 1999, the Company sold its approximately 4.9
million shares in TigerTel, Inc., its Toronto-based telecommunications
subsidiary. The total proceeds were $31.3 million in cash, resulting in a
pre-tax gain of $20.1 million. Payment of the proceeds was received on January
10, 2000. The operating results of TigerTel are properly included in the
Company's financial statements through the date of disposition.
10. SUBSEQUENT EVENTS
SERIES C PREFERRED STOCK TRANSACTION
The Preferred Stock. On October 26, 2000, the Company issued 26
thousand shares of Series C convertible preferred stock to a select group of
institutional investors in a private placement. The stated value of the
preferred stock is $1,000 per share, or an aggregate of $26.0 million, and the
purchase price of the preferred stock and the related warrants was an aggregate
of $20.0 million. The preferred stock is convertible into shares of the
Company's common stock initially at a rate of $7.56 in stated value per share,
which is reduced to $5.672 in stated value per share 91 days after issuance of
the preferred stock. At the earlier of 90 days after the issuance of the
preferred stock or upon the effective date of the Company's registration
statement relating to the common stock issuable on the conversion of the initial
series of preferred stock, the holders also have the option to convert the
stated value of the preferred stock to common stock at an alternative conversion
rate starting at 140% and declining to 110% of the average closing price for the
10 trading days preceding the date of the notice of conversion. The conversion
price and the alternative conversion price are subject to adjustment based on
certain events, including the Company's issuance of shares of common stock, or
options or other rights to acquire common stock, at an issuance price lower than
the conversion price of the preferred stock, or issuance of convertible
securities that have a more favorable price adjustment provision than the
preferred stock. The Company will be required to accrete the discount on the
preferred stock through equity. However, the accretion will reduce the income
available to common stockholders and earnings per shares. The value assigned to
the warrants will increase the discount on the preferred stock. The holders of
the preferred stock are entitled to receive annual dividends of 4% of the stated
value (or 5.2% of the purchase price) payable in either cash or additional
shares of preferred stock.
If certain triggering events occur in respect of the preferred stock,
the holders may require the Company to redeem the preferred stock at a price per
share equal to 130% of the stated value (or an aggregate of $33.8 million) plus
accrued dividends, as long as such redemption is not prohibited under the
Company's credit agreement. In addition, under certain circumstances during the
occurrence of a triggering event, the conversion price per share of the
preferred stock would be reduced to 50% of the lowest closing price of the
Company's common stock during such period. The triggering events include (i)
failure to have the registration statement relating to the common stock issuable
on the conversion of the preferred stock declared effective on or prior to 180
days after issuance of the preferred stock or the suspension of the
effectiveness of such registration statement, (ii) suspensions in trading of or
failure to list the common stock issuable on conversion of the preferred stock,
(iii) failure to obtain shareholder approval at least by June 30, 2001 for the
issuance of the common stock upon the conversion of the preferred stock and upon
16
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
the exercise of the warrants, and (iv) certain defaults in payment of or
acceleration of our payment obligations under our credit agreement.
Warrants. The holders of the preferred stock have also received 0.8
million warrants to purchase up to 0.8 million shares of our common stock over
the next five years. The exercise price is $4.73 per share, subject to
adjustment for various events, including the issuance of shares of common stock,
or options or other rights to acquire common stock, at an issuance price lower
than the exercise price under the warrants. The exercise price may be paid in
cash, in shares of common stock or by surrendering warrants.
Option to Acquire Additional Preferred Stock. The investors may
purchase up to an additional $26.0 million in stated value of Series C
convertible preferred stock and warrants with an initial conversion price of
$5.00 per share, for an aggregate purchase price of $20.0 million, at any time
up to ten months following the effective date of the Company's registration
statement relating to the common stock issuable on conversion of the initial
series of the preferred stock. The additional preferred stock will have the same
preferences, qualifications and rights as the initial preferred stock.
ACQUISITIONS AND DISPOSITIONS
Effective as of October 19, 2000, the Company entered into transactions
with MCY.com, Inc. (OTC-BB:MCYC) ("MCY") under which it sold to MCY a
non-exclusive perpetual worldwide license to use its recently-acquired Net-Vu
product, an Internet-based Automatic Contact Distributor, for $9.0 million in
cash plus $1.0 million in shares of MCY. In addition, MCY granted to the Company
an exclusive perpetual license to MCY's digital encryption and distribution
systems, including its NETrax(TM) software for use in various non-entertainment
business-to-business applications, in consideration for 11.8 million shares of
our common stock valued at $40.0 million. These transactions with MCY are
subject to governmental clearance under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended.
On October 25, 2000, the Company acquired Pacific Decision Sciences
Corporation, a California corporation ("PDSC"). The aggregate purchase price was
approximately $28 million which the Company paid by issuing approximately 8.6
million shares of its common stock. In addition, for each of the twelve-month
periods ending September 30, 2001 and September 30, 2002, the former
stockholders of PDSC will be entitled to receive earnout payments, payable in
cash or in shares of our common stock, of $9.7 million plus 4.0 times EBITDA (as
defined in the merger agreement) in excess of $3.7 million, subject to reduction
by 4.0 times the shortfall from the Projected EBITDA Amount (as defined in the
merger agreement). Goodwill associated with the acquisition amounted to
approximately $23.5 million and will be amortized over 20 years at the rate of
approximately $1.2 million per year. Pro forma financial information related to
this acquisition will be included in the Company's Current Report on Form 8-K/A,
which will be filed on or before December 30, 2000. PDSC, based in Santa Ana,
California, is a provider of proprietary web-based customer relationship
management software. It develops, sells and implements software systems that
enable automated, single point of contact delivery of customer service.
17
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
On October 27, 2000, the Company acquired 16% of the capital stock of
ATEC Group, Inc. (AMEX:TEC), in consideration for shares of its common stock
valued at approximately $9.1 million. Goodwill associated with the acquisition
amounted to approximately $7.8 million and will be amortized over 20 years at
the rate of approximately $0.4 million per year. Based in Commack, New York,
ATEC is a leading system integrator and provider of a full line of information
technology products and services. The Company intends to account for the
acquisition using the equity method. Based on the Company's board
representation, the fact that the Company will be providing direct day to day
management of ATEC's operations and that no other shareholder or group of
related shareholders owns more than 10.4% of ATEC's outstanding voting common
stock, the Company believes it effectively controls ATEC. The Company is
evaluating whether or not it has legal control of ATEC. If it is determined that
the Company has legal control of ATEC, the Company will be required to
consolidate ATEC.
On October 31, 2000, under an agreement dated November 3, 2000, the
Company sold its wholly-owned subsidiary STC Netcom, Inc.
On November 2, 2000 the Company acquired 80% of the capital stock of
Connect Intelligence Limited, in consideration for shares of its common stock
valued at approximately $10.0 million. Goodwill associated with the acquisition
amounted to approximately $7.1 million and will be amortized over 20 years at
the rate of approximately $0.4 million per year. Based in Ireland, Connect
Intelligence has successfully completed a vetting procedure and has now been
formally offered up to 70 high-speed fiber optic circuits from the Irish
government's Department of Enterprise and Employment. The offering, part of the
Irish government's e-commerce infrastructure initiative, grants Connect
Intelligence and its partners exclusive rights to nearly one half of all
circuits to and from the Republic of Ireland.
On November 13, 2000 the Company entered into an agreement to acquire
approximately 54% of the outstanding capital stock of SysComm International
Corporation (NASDAQ:SYCM) in consideration for a combination of cash and shares
of its common stock valued at $4.5 million. No goodwill was associated with the
acquisition. Concurrently, the Company agreed to sell its interest in
Information Products Corporation to SysComm. Based in Shirley, New York, SysComm
is a network and systems integrator and reseller of computer hardware.
As stated above, the Company separately determined the purchase price
for the PDSC, Connect, ATEC and Syscom transactions through its valuation
techniques and related valuation models and analysis of the acquired companies.
In each of these transactions, the value of the consideration to be paid to the
Company was contractually agreed to. Based on the contractually agreed to
amounts, the Company calculated the number of shares to be issued to the sellers
as of the closing date. In certain cases, the price of the Company's common
stock to be used to determine the number of shares to be issued to the sellers
to provide the contractually agreed-upon purchase price was based on a formula.
The formula generally averages the closing price of the Company's common stock
for a certain number of days prior to and subsequent to the closing date of the
transaction. EITF 95-19 specifically addresses when to value securities issued
in a purchase business combination. In the previous situations, the Company
believes it has already agreed to a value to be paid to the sellers based on its
valuation methodologies and that the Company is contractually obligated to
provide this value to the sellers. When the acquisition closes, the number of
shares is adjusted to ensure the agreed-upon value is provided to the sellers.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This discussion should be read in conjunction with the accompanying
consolidated financial statements and related notes in Item 1 of this report as
well as our 1999 Annual Report on Form 10-K. Certain statements made in this
report may contain forward-looking statements. For a description of risks and
uncertainties relating to such forward-looking statements, see the Risk Factors
sections later in this Item.
Applied Digital Solutions, Inc. is a leading edge, single-source
provider of e-business solutions. We differentiate ourselves in the marketplace
by enabling e-business through Computer Telephony Internet Integration
(CTII(TM)). Beginning in the fourth quarter of 1998 and continuing into 1999 and
2000, we reorganized to refocus our strategic direction, organizing into four
core business groups: Telephony, Network, Internet and Applications. With CTII
we provide the full range of services and skills companies need to conduct
business online.
Our objective is to continue to grow each of our core operating
segments internally and through acquisitions, both domestically and abroad. Our
strategy has been, and continues to be, to invest in and acquire businesses that
complement and add to our existing business base. We have expanded significantly
through acquisitions in the past and continue to do so. Our financial results
and cash flows are substantially dependent on not only our ability to sustain
and grow existing businesses, but to continue to grow through acquisition. We
expect to continue to pursue our acquisition strategy in 2000 and future years,
but there can be no assurance that management will be able to continue to find,
acquire, finance and integrate high quality companies at attractive prices.
As part of the reorganization of our core business into four reportable
business groups, we implemented a restructuring plan in the first quarter of
1999. The restructuring plan included the exiting of selected lines of business
within our Telephony and Applications business groups, and the associated
write-off of assets. In the first quarter of 1999, we incurred a restructuring
charge of $2.2 million that included asset impairments, primarily software and
other intangible assets, of $1.5 million, lease terminations of $0.5 million,
and employee separations of $0.2 million. In addition, during the first quarter
of 1999, as part of our core business reorganization, we realigned certain
operations within our Telephony division and recognized impairment charges and
other related costs of $0.3 million.
In the second quarter of 2000, IntelleSale recorded a pre-tax charge of
$17.0 million. Included in this charge is an inventory reserve of $8.5 million
for products IntelleSale expects to sell below cost, $5.5 million related to
specific accounts and other receivables, and $3.0 million related to fees and
expenses incurred in connection with IntelleSale's cancelled IPO and certain
other intangible assets. The Company believes this charge was a result of the
segment's decreasing revenue trend, lower quarterly gross profits and the
expansion of IntelleSale's infrastructure into a major warehouse facility. In
addition, a more competitive business environment resulting from an overall
slowdown in Intellesale's business segment, and management's attention to the
Bostek operational and legal issues, discussed below, contributed to the
negative results. The impact of the loss has resulted in Intellesale
restructuring its overhead and refocusing its business model away from the
Internet segment and back to its traditional business lines. While IntelleSale
has historically been able to rely on its parent for liquidity, if there are
continued losses, that may result in a further restructuring to ensure that
Intellesale will be able to maintain adequate liquidity. The former Bostek
owners filed a lawsuit against the Company and IntelleSale claiming that their
earnout payment was inadequate. The Company and IntelleSale believe that the
claim is without merit and intend to defend it vigorously, and have filed
counterclaims alleging, among other things, fraud on the part of the former
19
Bostek owners. IntelleSale has also filed a lawsuit in Massachusetts seeking to
recover the damages it has sustained.
RECENT DEVELOPMENTS
SERIES C PREFERRED STOCK TRANSACTION
The Preferred Stock. On October 26, 2000, we issued 26 thousand shares
of Series C convertible preferred stock to a select group of institutional
investors in a private placement. The stated value of the preferred stock is
$1,000 per share, or an aggregate of $26.0 million, and the purchase price of
the preferred stock and the related warrants was an aggregate of $20.0 million.
The preferred stock is convertible into shares of our common stock initially at
a rate of $7.56 in stated value per share, which is reduced to $5.672 in stated
value per share 91 days after issuance of the preferred stock. At the earlier of
90 days after the issuance of the preferred stock or upon the effective date of
our registration statement relating to the common stock issuable on the
conversion of the initial series of preferred stock, the holders also have the
option to convert the stated value of the preferred stock to common stock at an
alternative conversion rate starting at 140% and declining to 110% of the
average closing price for the 10 trading days preceding the date of the notice
of conversion. The conversion price and the alternative conversion price are
subject to adjustment based on certain events, including our issuance of shares
of common stock, or options or other rights to acquire common stock, at an
issuance price lower than the conversion price of the preferred stock, or
issuance of convertible securities that have a more favorable price adjustment
provision than the preferred stock. We will be required to accrete the discount
on the preferred stock through equity. However, the accretion will reduce the
income available to common stockholders and earnings per shares. The value
assigned to the warrants will increase the discount on the preferred stock. The
holders of the preferred stock are entitled to receive annual dividends of 4% of
the stated value (or 5.2% of the purchase price) payable in either cash or
additional shares of preferred stock.
If certain triggering events occur in respect of the preferred stock,
the holders may require us to redeem the preferred stock at a price per share
equal to 130% of the stated value (or an aggregate of $33.8 million) plus
accrued dividends, as long as such redemption is not prohibited under our credit
agreement. In addition, under certain circumstances during the occurrence of a
triggering event, the conversion price per share of the preferred stock would be
reduced to 50% of the lowest closing price of our common stock during such
period. The triggering events include (i) failure to have the registration
statement relating to the common stock issuable on the conversion of the
preferred stock declared effective on or prior to 180 days after issuance of the
preferred stock or the suspension of the effectiveness of such registration
statement, (ii) suspensions in trading of or failure to list the common stock
issuable on conversion of the preferred stock, (iii) failure to obtain
shareholder approval at least by June 30, 2001 for the issuance of the common
stock upon the conversion of the preferred stock and upon the exercise of the
warrants, and (iv) certain defaults in payment of or acceleration of our payment
obligations under our credit agreement.
Warrants. The holders of the preferred stock have also received 0.8
million warrants to purchase up to 0.8 million shares of our common stock over
the next five years. The exercise price is $4.73 per share, subject to
adjustment for various events, including the issuance of shares of common stock,
or options or other rights to acquire common stock, at an issuance price lower
than the exercise price under the warrants. The exercise price may be paid in
cash, in shares of common stock or by surrendering warrants.
20
Option to Acquire Additional Preferred Stock. The investors may
purchase up to an additional $26.0 million in stated value of Series C
convertible preferred stock and warrants with an initial conversion price of
$5.00 per share, for an aggregate purchase price of $20.0 million, at any time
up to ten months following the effective date of the Company's registration
statement relating to the common stock issuable on conversion of the initial
series of the preferred stock. The additional preferred stock will have the same
preferences, qualifications and rights as the initial preferred stock.
ACQUISITIONS AND DISPOSITIONS
In April 1999, we acquired:
(a) 100% of Port Consulting, Inc., an integrator of information
technology application systems and custom application development services based
in Jacksonville, Florida;
(b) 100% of Hornbuckle Engineering, Inc., an integrated voice and
data solutions provider based in Monterey, California;
(c) 100% of Lynch Marks & Associates, Inc., a network integration
company based in Berkley, California; and
(d) 100% of STR, Inc., a software solutions company based in
Cleveland, Ohio.
In May 1999, we entered into an agreement to merge our wholly owned
Canadian subsidiary, TigerTel Services Limited, with Contour Telecom Management,
Inc., a Canadian company. We received, in a reverse merger transaction, 19,769
shares of Contour's common stock, representing approximately 75% of the total
outstanding shares. In November 1999, TigerTel received an all cash bid for all
of its outstanding common shares from AT&T Canada, Inc. We entered into a
lock-up agreement with AT&T to tender the approximately 65% of the outstanding
shares we owned and, on December 30, 1999, AT&T purchased all of the shares
tendered. We recorded a pre-tax gain in the fourth quarter of 1999 of
approximately $20.1 million, and received gross proceeds of approximately $31.3
million in January 2000, which we applied against the outstanding balance on our
domestic revolving credit line.
In June 1999, IntelleSale purchased all of the shares of Bostek. Bostek
is engaged in the business of acquiring open-box and off-specification computer
equipment and selling such equipment, using the Internet and other selling
channels.
In October 1999, we disposed of the main business units comprising our
Communications Infrastructure division and dissolved this group. As
consideration for the sale, we received approximately 2.8 million shares of our
common stock and a note for $2.5 million. The treasury shares were recorded at
the book value of the divested assets ($2.54 per share), which resulted in no
gain being recognized. The transaction was reflected at book value because the
shareholders of the purchaser of the divested assets were collectively deemed to
be significant shareholders of the Company.
Since April 1, 2000, we acquired, in transactions accounted for under
the purchase method of accounting:
o 100% of the capital stock of Independent Business Consultants, a
network integration company based in Valley Village, California,
effective as of April 1, 2000;
21
o 100% of the capital stock of Timely Technology Corp., a software
developer and application service provider based in Riverside,
California, effective as of April 1, 2000;
o 100% of the capital stock of P-Tech, Inc., a software development
company based in Manchester, New Hampshire, effective as of April
1, 2000;
o 100% of the capital stock of Computer Equity Corporation, a
communications integration company based in Chantilly, Virginia,
effective as of June 1, 2000;
o 100% of the capital stock of WebNet Services, Inc., an internet
service provider, network integrator and website developer,
effective July 1, 2000; and
On September 8, 2000, we completed our acquisition of Destron Fearing
Corporation, through a merger of our wholly-owned subsidiary, Digital Angel.net
Inc., into Destron Fearing. As a result of the merger, Destron Fearing is now
our wholly-owned subsidiary and has been renamed "Digital Angel.net Inc." The
transaction was accounted for under the purchase method of accounting.
In connection with the merger, each outstanding share of Destron
Fearing common stock was exchanged for 1.5 shares of the Company's common stock,
with fractional shares settled in cash. In addition, outstanding options and
warrants to purchase shares of Destron Fearing common stock were converted into
a right to purchase that number of shares of the Company's common stock as the
holders would have been entitled to receive had they exercised such options an
warrants prior to September 8, 2000 and participated in the merger. The Company
issued 20.5 million shares if its common stock in exchange for all the
outstanding common stock of Destron Fearing and 0.3 million shares of its common
stock as a transaction fee. The Company will issue up to 2.7 million shares of
its common stock upon the exercise of the Destron Fearing options and warrants.
Destron Fearing has been in the animal identification business since
1945. For over 50 years, Destron Fearing has developed, manufactured and
marketed a broad range of individual animal identification products. Destron
Fearing owns patents worldwide in microchip technology and is a leader in the
world evolution of radio frequency animal identification.
Effective as of October 19, 2000, we entered into transactions with
MCY.com, Inc. (OTC-BB:MCYC) ("MCY") under which we sold to MCY a non-exclusive
worldwide license to use our recently-acquired Net-Vu product, an Internet-based
Automatic Contact Distributor, for $9.0 million in cash plus $1.0 million in
shares of MCY. In addition, MCY granted to us an exclusive license to MCY's
digital encryption and distribution systems, including its NETrax(TM) software
for use in various non-entertainment business-to-business applications, in
consideration for 11.8 million shares of our common stock valued of $40.0
million. These transactions with MCY are subject to governmental clearance under
the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended.
On October 25, 2000, we acquired Pacific Decision Sciences Corporation,
a California corporation ("PDSC"). In the merger transaction, we issued
approximately 8.6 million shares of our common stock. In addition, for each of
the twelve-month periods ending September 30, 2001 and September 30, 2002, the
former stockholders of PDSC will be entitled to receive earnout payments,
payable in cash or in shares of our common stock, of $9.7 million plus 4.0 times
EBITDA (as defined in the merger agreement) in excess of $3.7 million, subject
to reduction by 4.0 times the shortfall from the Projected EBITDA Amount (as
defined in the merger agreement). Goodwill associated with the acquisition
amounted to approximately $23.5 million and will be amortized over 20 years at
the rate of approximately $1.2 million per year. PDSC, based in Santa Ana,
California, is a provider of proprietary web-based customer relationship
management software. It develops, sells and implements software systems that
enable automated, single point of contact delivery of customer service.
22
On October 27, 2000, we acquired 16% of the capital stock of ATEC
Group, Inc. (AMEX:TEC), in consideration for shares of our common stock valued
at approximately $9.1 million. Goodwill associated with the acquisition amounted
to approximately $7.8 million and will be amortized over 20 years at the rate of
approximately $0.4 million per year. Based in Commack, New York, ATEC is a
leading system integrator and provider of a full line of information technology
products and services.
On October 31, 2000, under an agreement dated November 3, 2000, we sold
our wholly-owned subsidiary STC Netcom, Inc.
On November 2, 2000 we acquired 80% of the capital stock of Connect
Intelligence Limited, in consideration for shares of our common stock valued at
approximately $10.0 million. Goodwill associated with the acquisition amounted
to approximately $7.1 million and will be amortized over 20 years at the rate of
approximately $0.4 million per year. Based in Ireland, Connect Intelligence has
successfully completed a vetting procedure and has now been formally offered up
to 70 high-speed fiber optic circuits from the Irish government's Department of
Enterprise and Employment. The offering, part of the Irish government's
e-commerce infrastructure initiative, grants Connect Intelligence and its
partners exclusive rights to nearly one half of all circuits to and from the
Republic of Ireland.
On November 13, 2000 we entered into an agreement to acquire
approximately 54% of the outstanding capital stock of SysComm International
Corporation (NASDAQ:SYCM) in consideration for a combination of cash and shares
of our common stock valued at $4.5 million. No goodwill was associated with the
acquisition. Concurrently, we agreed to sell our interest in Information
Products Corporation to SysComm. Based in Shirley, New York, SysComm is a
network and systems integrator and reseller of computer hardware.
OUR BUSINESS
Beginning in the fourth quarter of 1998 and continuing into 1999 and
2000, we reorganized into six operating segments to more effectively and
efficiently provide integrated communications products and services to a broad
base of customers. During the second quarter of 1999, several adjustments were
made to the composition of the Telephony, Internet and Non-core divisions to
better align the strengths of the respective divisions with the objectives of
those divisions. In October 1999, we disposed of the main business units
comprising our Communication Infrastructure division and dissolved this group.
Prior period information has been restated to present our reportable segments.
CORE BUSINESS
Our primary businesses, other than IntelleSale, the Non-Core Business
Group, and Digital Angel, are now organized into four business divisions:
o TELEPHONY -- implements telecommunications and Computer Technology
Integration (CTI) solutions for e-business. We integrate a wide range
of voice and data solutions from communications systems to voice over
Internet Protocol and Virtual Private Networking (VPN). We provide
complete design, project management, cable/fiber infrastructure,
installation and ongoing support for the customers we support. On
December 30, 1999, as discussed above, we sold our
23
interest in our Canadian subsidiary, TigerTel, Inc. to concentrate
our efforts on our domestic CTI solutions.
o NETWORK -- is a professional services organization dedicated to
delivering quality e-business services and support to our client
partners, providing e-business infrastructure design and deployment,
personal computer network infrastructure for the development of local
and wide area networks as well as site analysis, configuration
proposals, training and customer support services.
o INTERNET -- equips our customers with the necessary tools and support
services to enable them to make a successful transition to implementing
e-business practices, Enterprise Resource Planning (ERP) and Customer
Relationship Management (CRM) solutions, website design, and
application and internet access services to customers of our other
divisions.
o APPLICATIONS -- provides software applications for large retail
application environments, including point of sale, data acquisition,
asset management and decision support systems and develops programs for
portable data collection equipment, including wireless hand-held
devices. It is also involved in the design, manufacture and support of
satellite communication technology including satellite modems, data
broadcast receivers and wireless global positioning systems for
commercial and military applications.
INTELLESALE
IntelleSale sells refurbished and new computer equipment and related
components online, through its website at www.IntelleSale.com, and through other
Internet companies, as well as through traditional channels, which includes
sales made by IntelleSale's sales force.
THE NON-CORE BUSINESS GROUP
This group is comprised of six individually managed companies whose
businesses are as follows:
o Gavin-Graham Electronic Products is a custom manufacturer of electrical
products, specializing in digital and analog panelboards, switchboards,
motor controls and general control panels. The company also provides
custom manufacturing processes such as shearing, punching, forming,
welding, grinding, painting and assembly of various component
structures.
o Ground Effects, Ltd., based in Windsor, Canada, is a certified
manufacturer and tier one supplier of standard and specialized vehicle
accessory products to the automotive industry. The company exports over
80% of the products it produces to the United States, Mexico, South
America, the Far East and the Middle East.
o Hopper Manufacturing Co., Inc. remanufactures and distributes
automotive parts. This primarily includes alternators, starters,
water pumps, distributors and smog pumps.
o Innovative Vacuum Solutions, Inc. designs, installs and
re-manufactures vacuum systems used in industry.
o Americom and STC Netcom are each involved in the fabrication,
installation and maintenance of microwave, cellular and digital
personal communication services towers.
24
We previously announced our intention to divest, in the ordinary course
of business, our non-core businesses at such time and on such terms as our Board
of Directors determines advisable. During the third quarter of 2000, we sold ACT
Leasing for no gain or loss, and effective October 31, 2000, we sold STC Netcom,
Inc. There can be no assurance that we will divest of any or all of these
remaining businesses or as to the terms of any divestiture transaction.
RESULTS OF OPERATIONS
The following table summarizes the Company's results of operations as a
percentage of net operating revenue for the three and nine month periods ended
September 30, 2000 and 1999 and is derived from the unaudited consolidated
statements of operations in Part I, Item 1 of this report.
RELATIONSHIP TO REVENUE
-------------------------------------
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------
2000 1999 2000 1999
---- ---- ---- ----
% % % %
- - - -
Net operating revenue 100.0 100.0 100.00 100.0
Cost of goods sold 68.8 73.3 71.5 68.3
Unusual inventory charge 0.0 0.0 3.8 0.0
-------------------------------------
Gross profit 31.2 26.7 24.7 31.7
Selling, general and administrative expenses 28.8 22.4 29.5 26.7
Depreciation and amortization 4.2 2.4 3.4 2.8
Unusual and restructuring charges 0.0 0.0 3.8 1.1
Interest income (0.1) (0.2) (0.3) (0.2)
Interest expense 2.2 1.1 1.9 1.0
-------------------------------------
Income (loss) before provision (benefit) for income taxes, minority
interest and extraordinary loss (3.9) 1.0 (13.6) 0.3
Provision (benefit) for income taxes (1.7) 0.6 (4.5) 0.4
-------------------------------------
Income (loss) before minority interest and extraordinary loss (2.2) 0.4 (9.1) (0.1)
Minority interest 0.2 0.0 0.2 0.2
-------------------------------------
Income (loss) before extraordinary loss (2.4) 0.4 (9.3) (0.3)
Extraordinary loss 0.0 0.0 0.0 0.1
-------------------------------------
Net income (loss) available to common stockholders (2.4) 0.4 (9.3) (0.4)
=====================================
COMPANY OVERVIEW
Revenue
- -------
Revenue for the three months ended September 30, 2000 was $73.8
million, a decrease of $33.5 million, or 31.2%, from $107.3 million for the
three months ended September 30, 1999. Revenue for the nine months ended
September 30, 2000 was $222.9 million, a decrease of $8.9 million, or 3.8%, from
$231.8 million for the nine months ended September 30, 1999. The decrease for
the three and nine month periods is due primarily to the dispositions during
1999. Also, revenue for the third quarter has decreased because we ceased
selling certain low-margin Bostek products during the second quarter of 2000, as
more fully discussed below. Partially offsetting these decreases were revenues
from acquisition during the nine months ended September 30, 2000.
25
Revenue for each of the operating segments was:
(In thousands)
----------------------------------------------------
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------------------------------------
2000 1999 2000 1999
---- ---- ---- ----
Telephony(1) $12,276 $ 17,265 $ 27,210 $ 40,797
Network 12,758 7,399 31,026 19,905
Internet 4,248 2,285 9,071 4,405
Applications 11,638 11,800 30,069 26,498
IntelleSale 21,447 51,481 94,865 92,742
Non-Core(2) 12,532 19,820 35,566 52,379
Corporate Consolidating Eliminations (1,053) (2,788) (4,945) (4,936)
----------------------------------------------------
Consolidated $73,846 $107,262 $222,862 $231,790
====================================================
<FN>
- ---------
(1) Includes TigerTel's revenue of $12.4 million and $25.8 million for the
three and nine months ending September 30, 1999.
(2) Includes revenue from the Communications Infrastructure group of
companies, the majority of which were disposed of in 1999. Revenue for
these disposed entities included above amounted to $10.5 million and
$26.4 million during the three and nine months ended September 30,
1999.
</FN>
Changes during the quarter were:
o Telephony revenue decreased 28.9% for the quarter and 33.3% for the
nine months primarily as a result of the sale of TigerTel in December
1999. Revenue from the remaining entities increased by $7.4 million in
the quarter and $12.2 million for the nine months primarily as a result
of the acquisition, in the second quarter of 2000, of Computer Equity
Corporation.
o Network revenue increased 72.4% for the quarter and 55.9% for the nine
months. The acquisition of Independent Business Consultants in the
second quarter of 2000 contributed $2.9 million and $5.3 million,
representing 54.1% and 47.6% of the increase for the quarter and nine
months, respectively. Growth of existing business contributed the
additional increase in the three and nine month periods.
o Internet revenue increased by 85.9% in the quarter and 105.9% for the
nine months. The increases were due to the result of the growth of Port
Consulting, Inc., which was acquired on April 1, 1999 and to the
acquisitions of Timely Technology Corp. on April 1, 2000 and WebNet
Services, Inc. on July 1, 2000.
o Applications revenue decreased by 1.4% in the quarter and increased by
13.5% for the nine months. The decline in the quarter is due to a delay
in implementations of retail application software and a shift into new
geographic markets for existing businesses. Partially offsetting the
decrease in revenue for the quarter and the primary contributors to the
increase in revenue for the nine months are the acquisitions of Destron
Fearing Corporation, which
26
was acquired on September 8, 2000, and P-Tech, Inc., which was acquired
during the second quarter of 2000. During the nine months of 2000,
Destron Fearing Corporation and P-Tech, Inc. contributed revenue of
$2.7 million and $2.4 million, respectively.
o IntelleSale's revenue decreased 58.3% in the quarter, while revenue for
the nine months increased 2.3%. As previously discussed, the Company
and IntelleSale are in a dispute with the former owners of Bostek and
have ceased selling certain high-volume, low-margin Bostek products in
the second quarter of 2000. Revenue remained relatively stable for the
nine months periods despite the loss of revenue from Bostek products
due to increased business in several of IntelleSale's subsidiaries.
o Non-core revenue, which includes revenue from the former Communications
Infrastructure group, decreased $7.3 million, or 36.8%, in the third
quarter and $16.8 million, or 32.1%, for the nine months. Four entities
in this segment were sold during 1999 and their revenue is no longer
included, and certain lines of business within this segment continue to
suffer from competition and lost market share. Partially offsetting the
decrease was an increase in Ground Effect's revenue due to increased
business.
Gross Profit and Gross Margin Percentage
- ----------------------------------------
Gross profit for the three months ended September 30, 2000 was $23.0
million, a decrease of $5.7 million, or 19.9%, from $28.7 million for the three
months ended September 30, 1999. Gross profit for the nine months ended
September 30, 2000 was $55.0 million, a decrease of $18.4 million, or 25.1% from
$73.4 million for the nine months ended September 30, 1999. As a percentage of
revenue, the gross margin was 31.2% and 26.7% for the three months ended
September 30, 2000 and 1999, and was 24.7% and 31.7% for the nine months ended
September 30, 2000 and 1999 respectively.
27
Gross profit for the three and nine months ended September 30, 2000 and
1999 by each of the operating segments was:
(In thousands)
------------------------------------------------------
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------------------------------
2000 1999 2000 1999
---- ---- ---- ----
Telephony(1) $ 4,214 $ 5,837 $10,853 $16,853
Network 2,899 2,574 8,048 6,226
Internet 2,845 1,696 6,824 3,314
Applications 5,747 5,367 15,350 14,537
IntelleSale 4,253 7,943 5,623 19,588
Non-Core(2) 3,015 5,219 8,113 12,825
Corporate 59 30 167 69
------------------------------------------------------
Consolidated $23,032 $28,666 $54,978 $73,412
- --------- ======================================================
<FN>
(1) Includes TigerTel's gross profit of $3.8 million and $11.1 million for
the three and nine months ended September 30, 1999.
(2) Includes gross profit from the Communications Infrastructure group of
companies, the majority of which were disposed of in 1999. Gross profit
for these disposed entities included above amounted to $2.4 million and
$5.7 million during the three and nine months ended September 30, 1999.
</FN>
Gross margin percentage for the three and nine months ended September
30, 2000 and 1999 by operating segments was:
-----------------------------------------------------
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-----------------------------------------------------
2000 1999 2000 1999
---- ---- ---- ----
% % % %
- - - -
Telephony(1) 34.3 33.8 39.9 41.3
Network 22.7 34.8 25.9 31.3
Internet 67.0 74.2 75.2 75.2
Applications 49.4 45.5 51.0 54.9
IntelleSale 19.8 15.4 5.9 21.1
Non-Core(2) 24.1 26.3 22.8 24.5
-----------------------------------------------------
Consolidated 31.2 26.7 24.7 31.7
=====================================================
- ---------
<FN>
(1) Includes TigerTel's gross profit margin of 30.6% and 43.0% and for the
three and nine months ended September 30, 1999.
(2) Includes gross profit margin from the Communications Infrastructure
group of companies, the majority of which were disposed of in 1999.
Gross profit margin for these disposed entities included above amounted
to 22.9% and 21.6% during the three and nine months ended September 30,
1999.
</FN>
Changes during the quarters were:
o Telephony gross profit decreased by 27.8% for the quarter and 35.6% for
the nine months primarily as a result of the sale of TigerTel
28
in December 1999. This was partially offset by the acquisition, in the
second quarter of 2000, of Computer Equity Corporation, which
contributed $1.7 million and $3.0 million in gross profit for the three
and nine months periods, respectively. Margins increased to 34.3% from
33.8% for the quarter primarily due to higher margins from existing
businesses and decreased to 39.9% from 41.3% for the nine months
primarily as a result of the sale of TigerTel.
o Network gross profit increased in the quarter and nine months due to
the acquisition of Independent Business Consultants during the second
quarter of 2000 and increased profits from our existing businesses.
Gross margins decreased for the quarter and nine months primarily
because Independent Business Consultants earns lower margins than our
existing businesses.
o Internet gross profit increased for the three and nine month periods as
a result of increased business from Port Consulting, Inc., acquired in
the second quarter of 1999 and the inclusion of Timely Technology
Corp., acquired in the second quarter of 2000 and WebNet Services,
Inc., acquired July 1, 2000. Timely Technology and WebNet Services,
Inc. earn lower margins than Port Consulting, which resulted in the
slight decrease in the quarter. Margins remained stable for the nine
months. Generally, gross profit and margins are higher in this division
as it is service oriented and most of its operating costs are recorded
in selling, general and administrative expense.
o Applications gross profit increased $0.4 million or 7.1% in the quarter
and increased $0.8 million or 5.6% for the nine months. Margins
increased 3.9% and decreased 3.9% for the three and nine month periods,
respectively. The increase in margins for the quarter is due primarily
to the acquisitions of Destron Fearing Corporation and P-Tech, Inc. The
decrease in margins for the nine months is due primarily to a delay in
implementations of applications for one our existing businesses. Also,
we are continuing to implement our planned exit from a once highly
profitable but declining modem and communications market in the United
Kingdom.
o IntelleSale's gross profit decreased in the quarter and nine months. As
previously discussed, the Company and IntelleSale are in a dispute with
the former owners of Bostek and have ceased selling certain
high-volume, low-margin Bostek products. During the second quarter of
2000, the Company set up an inventory reserve of $8.5 million and, in
addition, inventory was liquidated at below cost resulting in a loss of
approximately $3.4 million, both of which affected IntelleSale's gross
profit and margins in the nine months. Gross margin increased in the
quarter primarily as a result of ceasing the sales of the low margin
products discussed above.
o Non-core gross profit and margins decreased primarily as a result of
the sale of four businesses during 1999. Improved business conditions
at Ground Effects partially offset the decrease in gross profit for the
nine months.
Selling, General and Administrative Expense
- -------------------------------------------
Selling, general and administrative expense for the three months ended
September 30, 2000 was $21.2 million, a decrease of $2.8 million, or 11.7%, from
$24.0 million for the three months ended September 30, 1999. Selling, general
and administrative expense for the nine months ended September 30, 2000 was
$65.8 million, an increase of $4.0 million, or 6.5% from $61.8 million for the
nine months ended September 30, 1999. As a percentage of revenue, selling,
general and administrative expense was 28.8% and 22.4% for the three months
ended September 30, 2000 and 1999, and was 29.5% and 26.7% for the nine months
ended September 30, 2000 and 1999, respectively.
29
Selling, general and administrative expense for the three and nine
months ended September 30, 2000 and 1999 by each of the operating segments was:
(In thousands)
------------------------------------------
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------
2000 1999 2000 1999
---- ---- ---- ----
Telephony(1) $ 3,400 $ 4,829 $ 8,424 $14,459
Network 1,616 1,913 5,808 4,566
Internet 2,505 1,397 6,386 2,716
Applications 4,697 4,616 14,111 12,617
IntelleSale 3,850 5,737 15,560 13,259
Non-Core(2) 1,932 4,196 5,934 10,083
Corporate 3,227 1,334 9,528 4,138
------------------------------------------
Consolidated $21,227 $24,022 $65,751 $61,838
==========================================
- ---------
<FN>
(1) Includes TigerTel's SG&A of $2.8 million and $8.2 million for the three
and nine months ended September 30, 1999.
(2) Includes SG&A from the Communications Infrastructure group of
companies, the majority of which were disposed of in 1999. SG&A for
these disposed entities included above amounted to $1.8 million and
$4.6 million in the three and nine months ended September 30, 1999.
</FN>
30
Selling, general and administrative expense as a percentage of revenue for the
three and nine months ended September 30, 2000 and 1999 by each of the operating
segments was:
--------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------------------
2000 1999 2000 1999
---- ---- ---- ----
% % % %
- - - -
Telephony(1) 27.7 28.0 31.0 35.4
Network 12.7 25.9 18.7 22.9
Internet 59.0 61.1 70.4 61.7
Applications 40.4 39.1 46.9 47.6
IntelleSale 18.0 11.1 16.4 14.3
Non-Core(2) 15.4 21.2 16.7 19.3
--------------------------------------------
Consolidated 28.8 22.4 29.5 26.7
============================================
- ---------
<FN>
(1) Includes TigerTel's SG&A of 22.6% and 31.8% for the three and nine
months ended September 30, 1999.
(2) Includes SG&A from the Communications Infrastructure group of
companies, the majority of which were disposed of in 1999. SG&A for
these disposed entities included above amounted to 17.1% and 17.4% for
the three and nine months ended September 30, 1999.
</FN>
Changes during the quarter were:
o Telephony decreased $1.4 million or 29.2% in the quarter and $6.0
million or 41.4% in the nine months primarily due to the sale of
TigerTel in December 1999. As a percentage of revenue, SG&A expense in
this division decreased for both periods as a result of lower SG&A
costs excluding TigerTel, which had a historically higher percentage of
SG&A to revenue.
o Network remained relatively stable in dollar terms for the third
quarter of 2000. The increase of $1.2 million or 26.3% for the nine
months is due to increases in salaries and related benefits, rent and
additional sales and marketing expenses, some of which is attributable
to the acquisition of Creative Computers in April 2000. As a percentage
of revenue, SG&A expense in this division decreased 13.2% in the
quarter and 4.2% for the nine months primarily because Creative
Computers incurs lower SG&A expense as a percentage of revenue than our
existing businesses.
o Internet increased in dollar terms for the three and nine month periods
as a result of increased business by Port Consulting, acquired in the
second quarter of 1999 and the inclusion of Timely Technology Corp.,
acquired in the second quarter of 2000 and the acquisition of WebNet
Services, Inc. on July 1, 2000. As a percentage of revenue, SG&A
decreased for the quarter primarily due the acquisitions of Timely
Technology Corp. and WebNet Services, Inc. which have lower SG&A costs
and increased for the nine months due to higher expenses associated
with our expansion of Port Consulting. As a rule, entities comprising
this group are service oriented companies with lower cost of goods sold
but higher SG&A expenses.
o Applications increased $0.1 million or 2.2% for the quarter and $1.5
million or 11.9% for the nine months due to the acquisition of P-Tech,
Inc. in the second quarter of 2000 and Destron Fearing Corporation on
31
September 8, 2000. Partially offsetting these increases was a decrease
in SG&A expenses of existing businesses. As a percentage of revenue,
SG&A expense in this division has remained relatively stable over the
comparable 1999 periods.
o IntelleSale's SG&A expenses decreased in dollar terms in the quarter
primarily as a result of a reduction in personnel related costs as we
consolidated the businesses and ceased certain operations related to
Bostek. SG&A expenses increased in the nine months as a result of the
acquisition of Bostek in June 1999 and the expansion of that company's
infrastructure to handle increases in both its traditional and internet
related business and the consolidation of operations into one facility.
As a percentage of revenue, SG&A expense in this division has increased
6.9% and 2.1% in the quarter and nine months, respectively, primarily
due to lower sales from Bostek.
o Non-core SG&A decreased in dollar terms and as a percentage of revenue
primarily as a result of the sale of four entities during 1999.
o Corporate SG&A increased $1.9 million or 142.4% in the quarter and $5.4
million or 130.5% for the nine months as a result of the establishment
of a corporate office in June of 1999, and the corresponding costs
associated therewith, including increases in personnel and the
associated costs therewith, facilities costs, increases in the
remuneration of outside directors, insurance and legal and other
professional fees.
Depreciation and Amortization
- -----------------------------
Depreciation and amortization expense for the three months ended
September 30, 2000 was $3.1 million, an increase of $0.5 million or 19.2%, from
$2.6 million for the three months ended September 30, 1999. Depreciation from
companies disposed was offset by depreciation from companies acquired and fixed
asset additions. Depreciation and amortization expense for the nine months ended
September 30, 2000 was $7.5 million, an increase of $1.1 million, or 17.2%, from
$6.4 million for the nine months ended September 30, 1999.
32
Depreciation and amortization expense for the three and nine months
ended September 30, 2000 and 1999 by operating segments was:
------------------------------------------------
(In thousands) THREE MONTHS ENDED NINE MONTHS
SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------------------------
2000 1999 2000 1999
---- ---- ---- ----
Telephony(1) $ 201 $ 465 $ 428 $1,127
Network 32 51 117 86
Internet 72 23 150 46
Applications 332 461 841 1,208
IntelleSale 232 132 575 317
Non-Core(2) 245 364 852 949
Corporate(3) 2,022 1,116 4,572 2,640
------------------------------------------------
Consolidated $3,136 $2,612 $7,535 $6,373
================================================
- ---------
<FN>
(1) Includes TigerTel's depreciation and amortization of $0.4 million and
$0.9 million in the three and nine months ended September 30, 1999.
(2) Includes depreciation and amortization from the Communications
Infrastructure group of companies, the majority of which were disposed
of in 1999. Depreciation and amortization for these disposed entities
included above amounted to $0.1 million and $0.3 million in the three
and nine months ended September 30, of 1999.
(3) Includes consolidation adjustments of $1.6 million and $0.9 million in
the third quarters ended September 30, 2000 and 1999, respectively, and
$3.6 million and $1.9 million in the first nine months ended September
30, 2000 and 1999, respectively.
</FN>
Changes during the quarter were
o Telephony decreased primarily as a result of the sale of TigerTel in
December 1999.
o Network decrease in the quarter as a result of assets retired in
previous quarters and increased in the nine month period due to an
increase in depreciable assets in this group during 1999 and 2000.
o Internet increased due to the increase in depreciable assets associated
with the expansion of this division during 1999 and 2000 and the
acquisitions of Timely Technology Corp. in the second quarter of 2000
and WebNet Services, Inc. on July 1, 2000.
o Applications decreased due primarily to the reduction of depreciable
assets in this division during 2000.
o IntelleSale increased as a result of the increase in depreciable assets
during 1999 and the first half of 2000 associated with the
consolidation of the businesses into one facility.
o Non-core decreased in 2000 due primarily to the sale of assets
associated with the Communications Infrastructure group of companies in
1999.
o On an annual basis, goodwill amortization will be approximately $8.8
million for goodwill recorded as of September 30, 2000.
33
Interest Income and Expense
- ---------------------------
Interest income was $0.1 million and $0.2 million for the three months
ended September 30, 2000 and 1999, respectively, and was $0.7 million and $0.4
million for the nine months ended September 30, 2000 and 1999, respectively.
Interest income is earned primarily from short-term investments and notes
receivable.
Interest expense was $1.6 million and $1.2 million for the three months
ended September 30, 2000 and 1999, respectively, and was $4.1 million and $2.3
million for the nine months ended September 30, 2000 and 1999, respectively.
Interest expense is principally associated with revolving credit lines, notes
payable and term loans.
Income Taxes
- ------------
The effective tax rates were 42.7% and 62.7% for the three months ended
September 30, 2000 and 1999, respectively and 32.9% and 137.6% for the nine
months ended September 30, 2000 and 1999, respectively. The income tax benefits
are the result of losses arising in the periods. The effective tax rates
differed from the statutory federal income tax rate of 34% primarily as a result
of non-deductible goodwill amortization associated with acquisitions and state
taxes net of federal benefits.
Extraordinary Loss
- ------------------
In connection with the early retirement of the Company's line of credit
with State Street Bank and Trust Company and its simultaneous refinancing with
IBM Credit Corporation, deferred financing fees associated with the State Street
Bank and Trust agreement were written off during the second quarter of 1999. The
total amount of the write off classified as an extraordinary loss was $0.2
million, net of income taxes.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2000, cash and cash equivalents totaled $9.5
million, an increase of $4.4 million, or 86.3% from $5.1 million at December 31,
1999. We utilize a cash management system to apply excess cash on hand against
our revolving credit facility for which we had availability of $0.2 million at
September 30, 2000, down from $11.8 million at December 31, 1999. Working
capital was $65.1 million at both September 30, 2000 and December 31, 1999. Cash
used by operating activities totaled $33.6 million in the first nine months of
2000 as compared to cash used by operating activities of $14.3 million in the
first nine months of 1999. The significant increase in cash used by operating
activities in 2000 was primarily due to the reduced profitability of IntelleSale
and a reduction in cash provided by TigerTel, which was sold in December 1999,
and the Communications Infrastructure group of companies, the majority of which
were disposed of in 1999. Excluding assets and liabilities acquired or assumed
in connection with acquisitions, cash used in the first nine months of 2000 was
due to the net loss, after adjusting for non-cash expenses, and increases in
inventories, prepaid expenses and other current assets, deferred taxes and
decreases in accounts payable and accrued expenses. Partially offsetting these
uses was cash received on the collection of accounts receivable. Excluding
assets and liabilities acquired or assumed in connection with acquisitions, cash
used in the first nine months of 1999 was due to the net loss, after adjusting
for non-cash expenses, and increases in receivables, inventories and prepaid
expenses and other current assets. An increase in accounts payable and accrued
expenses partially offset these uses.
34
"Due from buyer of divested subsidiary" at December 31, 1999
represents the net proceeds due from AT&T Canada, Inc. on the sale of TigerTel,
Inc. This amount was paid in January 2000, and we applied the proceeds against
our domestic line of credit.
Accounts and unbilled receivables, net of allowance for doubtful
accounts, increased by $3.4 million, or 6.5%, to $55.6 million at September 30,
2000 from $52.2 million at December 31, 1999. This increase was primarily
attributable to the receivables associated with companies acquired during 2000,
partially offset by the unusual charge against receivables in the second quarter
of 2000.
Inventories increased by $2.2 million, or 5.4%, to $42.6 million at
September 30, 2000 from $40.4 million at December 31, 1999. This increase was
primarily attributable to inventories associated with companies acquired during
2000, partially offset by write-downs of inventories associated with the second
quarter unusual charges.
Prepaid expenses and other current assets increased by 80.0%, or $4.8
million to $10.8 million at September 30, 2000 from $6.0 million at December 31,
1999. This increase was primarily attributable to prepaid expenses and other
current assets associated with companies acquired during 2000 and income tax
receivable associated with the carryback of net operating losses.
Other assets increased by $9.4 million, or 86%, to $20.3 million at
September 30, 2000 from $10.9 million at December 31, 1999. The increase was
primarily attributable to other assets associated with the companies acquired
during 2000 and deferred income taxes associated with net operating losses.
"Due to shareholders of acquired subsidiary" decreased by $5.0 million,
or 33.3%, to $10.0 million at September 30, 2000 from $15.0 million at December
31, 1999. At September 30, 2000, the balance consisted of $10.0 million due to
the former owners of Bostek. As previously discussed, due to the litigation
between the Company, IntelleSale and the former Bostek owners, the $10.0 million
payment due to the former Bostek owners on June 30, 2000 was not paid. The
Company and IntelleSale intend to vigorously assert their position set forth in
their counterclaims and lawsuits that such payments are not owed, but continue
to carry this amount as a liability pending the outcome of the litigation.
Accounts payable decreased by $4.6 million, or 15.6%, to $24.9 million
at September 30, 2000 from $29.5 million at December 31, 1999. This decrease was
primarily attributable to a reduction of higher payables incurred in the fourth
quarter of 1999 to support year end sales, partially offset by accounts payable
associated with companies acquired in 2000.
Accrued expenses decreased by $1.0 million, or 5.6%, to $16.7 million
at September 30, 2000 from $17.7 million at December 31, 1999 due primarily to a
reduction in accrued personnel related costs.
Other current liabilities represent accrued earnout payments of $2.7
million at December 31, 1999.
Investing activities provided cash of $14.9 million and used cash of
$21.4 million in the first nine months of 2000 and 1999, respectively. In the
first nine months of 2000, cash proceeds of $31.3 million was collected on the
sale of TigerTel, while cash of $10.5 million was used in connection with
acquired businesses, $5.5 million was spent to acquire property and equipment,
$0.6 million was advanced against notes receivable and $0.7 million was used to
increase other assets. In the first nine months of 1999, cash of $15.8 million
was used to acquire businesses, $3.8 million was used to acquire property and
equipment and $1.3 million was used to increase other assets. Partially
offsetting these uses was $0.8 million and $0.4 million in proceeds from the
35
sales of property, equipment and other assets in the first nine months of 2000
and 1999, respectively.
Cash of $23.1 million and $40.2 million was provided by financing
activities in the first nine months of 2000 and 1999, respectively. In the nine
months of 2000, $8.9 million was borrowed under notes payable, $7.2 million was
repaid and $16.3 million was borrowed on long-term debt, while $5.5 million was
obtained through the issuance of common shares and $0.4 million was used for
other financing costs. In the nine months of 1999, $51.9 million was borrowed
and $8.3 million was repaid on long-term debt, while $0.1 million was used to
repay borrowings under notes payable and $3.3 million was used for other
financing costs.
One of our stated objectives is to maximize cash flow, as management
believes positive cash flow is an indication of financial strength. However, due
to our significant growth rate, our investment needs have increased.
Consequently we will continue, in the future, to use cash from operations and
will continue to finance this use of cash through financing activities such as
the sale of common and preferred stock and/or bank borrowing, if available.
In August 1998, we entered into a $20.0 million line of credit with
State Street Bank and Trust Company secured by all of our domestic assets at the
prime lending rate or at the London Interbank Offered Rate, at our discretion.
In February 1999, the amount of the credit available under the facility was
increased to $23.0 million. On May 25, 1999, we entered into a Term and
Revolving Credit Agreement with IBM Credit Corporation (the "IBM Agreement")
and, on May 26, 1999, we repaid the amount due to State Street Bank and Trust
Company. On July 30, 1999 the IBM Agreement was amended and restated, and it was
again amended on January 27, 2000. On October 17, 2000, we entered into a Second
Amended and Restated Term and Revolving Credit Agreement with IBM Credit
Corporation. The Second IBM Agreement provides for: (a) a revolving credit line
of up to $67.260 million, subject to availability under a borrowing base
formula, designated as follows: (i) a U.S. revolving credit line of up to
$63.405 million, (ii) a Canadian revolving credit line of up to $3.855 million,
and (b) a term loan A of up to $25.0 million, and (c) a Canadian term loan C of
up to $2.740 million.
The revolving credit line may be used for general working capital
requirements, capital expenditures and certain other permitted purposes and is
payable in full on May 25, 2002. The U.S. revolving credit line bears interest
at the 30-day LIBOR rate plus 2.75% and the Canadian revolving credit line bears
interest at the base rate as announced by the Toronto-Dominion Bank of Canada
each month plus 1.17%. As of September 30, 2000, the LIBOR rate was
approximately 6.6% and approximately $33.7 million was outstanding on the
revolving credit line, which is included in long-term debt.
Term loan A, which was used to pay off State Street Bank and Trust
Company, bears interest at the 30-day LIBOR rate plus 3.5%, is amortized in
quarterly installments over six years and is repayable in full on May 25, 2002.
As of September 30, 2000 approximately $17.4 million was outstanding on this
loan.
Term loan B bears interest at the 30-day LIBOR rate plus 1.75% to
1.90%. As of September 30, 2000, approximately $32.6 million was outstanding on
this loan. On October 17, 2000, Term loan B was terminated and the balance was
transferred into the revolving credit line.
36
Term loan C, which was used by our Canadian subsidiary to pay off its
bank debt, bears interest at the base rate as announced by the Toronto-Dominion
Bank of Canada each month plus 1.17%, is amortized in quarterly installments
over six years and is repayable in full on May 25, 2002. As of September 30,
2000, Toronto-Dominion's rate was approximately 7.5% and approximately $2.1
million was outstanding on this loan.
The agreement contains standard debt covenants relating to the
financial position and performance of the Company as well as restrictions on the
declarations and payment of dividends. As of September 30, 2000, the Company was
in compliance with all debt covenants under the IBM Agreement.
As of September 30, 2000, there were 82.9 million shares of Common
Stock outstanding. In addition, five hundred shares of Common Stock are reserved
for issuance in exchange for certain exchangeable shares issued by our Canadian
subsidiary. Since January 1, 2000, we have issued an aggregate of 34.6 million
shares of Common Stock, of which 2.4 million shares of Common Stock were issued
as earnout payments and puts in acquisitions, 46 thousand shares were issued in
exchange for the exchangeable shares of our Canadian subsidiary and the
exchangeable shares of our former Canadian subsidiary, TigerTel Services
Limited, 28.5 million shares of Common Stock were issued for acquisitions, 3.1
million shares were issued upon the exercise of options, 0.3 million shares were
issued upon the exercise of warrants, and 0.2 million shares were issued under
our Employee Stock Purchase Program.
Certain acquisition agreements include additional consideration
contingent on profits of the acquired subsidiary. Upon earning this additional
consideration, the value will be recorded as additional purchase price. On
September 30, 2000, under these agreements, assuming all earnout profits are
achieved, we were contingently liable for additional consideration of
approximately $19.6 million in 2001, $9.1 million in 2002 and $2.0 million in
2004, of which $1.0 million would be payable in cash and $29.7 million would be
payable in stock.
We have entered into put options with the sellers of those companies in
which we acquired less than a 100% interest. These options require us to
purchase the remaining portion we do not own after periods ranging from four to
five years from the dates of acquisition at amounts per share generally equal to
10% to 20% of the average annual earnings per share of the acquired company
before income taxes for, generally, a two year period ending on the effective
date of the put multiplied by a multiple ranging from four to five. The
purchases under these put options are recorded as changes in minority interest
based upon current operating results.
In June 2000, we entered into agreements to issue, in the aggregate,
2.3 million shares of our common stock, 1.6 million of which have been issued
through September 30, 2000, to acquire $10.0 million in put options and to
settle earnout payments in certain companies owned by IntelleSale. These
agreements superseded agreements entered into during the second quarter of 1999.
Our sources of liquidity include, but are not limited to, funds from
operations and funds available under the Second IBM Agreement. We may be able to
use additional bank borrowings, proceeds from the sale of non-core businesses,
proceeds from the sale of common and preferred shares, proceeds from the
exercise of stock options and warrants, and the raising of other forms of debt
or equity through private placement or public offerings. There can be no
assurance however, that these options will be available, or if available, on
favorable terms. Our capital requirements depend on a variety of factors,
including but not limited to, the rate of increase or decrease in our existing
business base; the success, timing, and amounts of investment required to bring
new products on-line; revenue growth or decline; and potential acquisitions. We
37
believe that we have the financial resources to meet our future business
requirements for at least the next twelve months.
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
Certain statements in this Form 10-Q, and the documents incorporated by
reference herein, constitute "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, Section 21E of the Securities
Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995.
We intend that such forward-looking statements be subject to the safe harbors
created thereby. Such forward-looking statements involve known and unknown
risks, uncertainties and other factors which may cause our actual results,
performance or achievements to be materially different from any future results,
performance or achievement expressed or implied by such forward-looking
statements. Such factors include, among others, the following: our continued
ability to sustain our growth through product development and business
acquisitions; the successful completion and integration of future acquisitions;
the ability to hire and retain key personnel; the continued development of
technical, manufacturing, sales, marketing and management capabilities,
relationships with and dependence on third-party suppliers; anticipated
competition; uncertainties relating to economic conditions where we operate;
uncertainties relating to government and regulatory policies; uncertainties
relating to customer plans and commitments; rapid technological developments and
obsolescence in the industries in which we operate and complete; potential
performance issues with suppliers and customers; governmental export and import
policies; global trade policies; worldwide political stability and economic
growth; the highly competitive environment in which we operate; potential entry
of new, well-capitalized competitors into our markets; changes in our capital
structure and cost of capital; and uncertainties inherent in international
operations and foreign currency fluctuations. The words "believe", "expect",
"anticipate", "intend" and "plan" and similar expressions identify
forward-looking statements. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date the statement
was made.
RISK FACTORS
You should carefully consider the risk factors listed below. These risk
factors may cause our future earnings to be less or our financial condition to
be less favorable than we expect. You should read this section together with the
other information contained herein.
Forward Looking Statements and Associated Risk. This Form 10-Q contains
"forward-looking statements" as defined in the Private Securities Litigation
Reform Act of 1995. All such forward-looking information involves risks and
uncertainties and may be affected by many factors, some of which are beyond our
control. These factors include:
o our growth strategies,
o anticipated trends in our business and demographics,
o our ability to successfully integrate the business operations of
recently acquired companies, and
o regulatory, competitive or other economic influences.
We Cannot Be Certain of Future Financial Results. While we have been
profitable for the last three fiscal years, future financial results are
39
uncertain. During both the three and nine month periods ended September 30,
2000, we incurred net losses. There can be no assurance that we will return to
profitability which depends upon many factors, including the success of our
various marketing programs, the maintenance or reduction of expense levels and
our ability to successfully coordinate the efforts of the different segments of
our business.
Future Sales of Shares of our Common Stock Could Adversely Affect the
Market Price of Our Common Stock. As of September 30, 2000, there were 82.9
million shares of our common stock outstanding. In addition, five hundred shares
of Common Stock are reserved for issuance in exchange for certain exchangeable
shares issued by our Canadian subsidiary. Since January 1, 2000, we have issued
an aggregate of 34.6 million shares of common stock, of which 2.4 million shares
of common stock were issued as earnout payments and puts in acquisitions, 46
thousand shares were issued in exchange for the exchangeable shares of our
Canadian subsidiary and the exchangeable shares of our former Canadian
subsidiary, TigerTel Services Limited, 28.5 million shares of common stock were
issued for acquisitions, 3.1 million shares were issued upon the exercise of
options, 0.3 million shares were issued upon the exercise of warrants, and 0.2
million shares were issued under our Employee Stock Purchase Program. In
addition, we have entered into additional acquisition agreements which, when
completed, will result in the issuance of approximately 11.8 million additional
shares of our common stock.
We have effected, and will continue to effect, acquisitions or contract
for certain services through the issuance of common stock or our other equity
securities, as we have typically done in the past. In addition, we have agreed
to certain "price protection" provisions in prior acquisition agreements which
may result in additional shares of common stock being issued. Such issuances of
additional securities may be dilutive of the value of our common stock in
certain circumstances and may have an adverse impact on the market price of our
common stock.
Our Series C Convertible Preferred Stock. You should be aware of the
following matters relating to our Series C Convertible Preferred Stock which is
described under "Recent Developments":
o The conversion of the Series C Preferred Stock and the exercise of the
related warrants could result in a substantial number of additional
shares being issued if the market price of our common stock declines.
At the earlier of 90 days after the issuance of the Series C Preferred
Stock or upon the effective date of our registration statement relating
to the common stock issuable on the conversion of preferred stock, the
holders of the Series C Preferred Stock have the option to convert the
Series C Preferred at a floating rate based on the market price of our
common stock, but the conversion price may not exceed $7.56 per share,
subject to adjustment. As a result, the lower the price of our common
stock at the time of conversion, the greater the number of shares the
holders of the Series C Preferred Stock will receive.
o To the extent that shares of the Series C Preferred Stock are
converted, a significant number of shares of common stock may be sold
into the market, which could decrease the price of our common stock. In
that case, we could be required to issue an increasingly greater number
of shares of our common stock upon future conversions of the Series C
Preferred Stock, sales of which could further depress the price of our
common stock.
o Upon the occurrence of certain triggering events set forth in the
certificate of designation relating to our Series C Preferred Stock, we
may be required to redeem the preferred stock at a redemption price
equal to 130% of the stated value (or $33.8 million) plus accrued
dividends, if such redemption is not prohibited by our credit
40
agreement. In addition, under certain circumstances during the
occurrence of a triggering event, the conversion price of the
preferred stock may be reduced to 50% of the lowest closing price of
our common stock during such period. We may also be required to redeem
the preferred stock at a redemption price equal to 130% of the stated
value upon a change of control or other major transactions. If we
become obligated to effect such redemption, it could adversely affect
our financial condition. If such reduction in the conversion price
occurs, it would double the number of shares of common stock issuable
on conversion.
o We may be required to delist our shares of common stock from the Nasdaq
National Market if specific events occur. In accordance with Nasdaq
Rule 4460, which generally requires shareholder approval for the
issuance of securities representing 20% or more of an issuer's
outstanding listed securities, and under the terms of the agreement
pursuant to which we sold the Series C Preferred Stock and related
warrants, we must solicit shareholder approval of the issuance of the
common stock issuable upon the conversion of the Series C Preferred
Stock and the exercise of the related warrants, at a meeting of our
shareholders which shall occur on or before June 30, 2001. If we obtain
shareholder approval, the number of shares that could be issued upon
the conversion of the Series C Preferred Stock would not be limited by
the Nasdaq 20% limitation. If we do not obtain shareholder approval and
are not obligated to issue shares because of restrictions relating to
Nasdaq Rule 4460, we may be required to pay a substantial penalty and
may be required to voluntarily delist our shares of common stock from
the Nasdaq National Market. In that event, trading in our shares of
common stock could decrease substantially, and the price of our shares
of common stock may decline.
o We will be required to accrete the discount on the preferred stock
through equity. However, the accretion will reduce the income available
to common stockholders and earnings per shares. The value assigned to
the warrants will increase the discount on the preferred stock.
o We may not pay dividends on our common stock without the consent of the
holders of a majority of the shares of preferred stock.
o The holders of the preferred stock have the right to require us to
issue up to an additional $26 million in stated value of the preferred
stock for an aggregate purchase price of $20 million, at any time until
ten months from the effective date of the registration statement
relating to the common stock issuable on conversion of the initial
series of the preferred stock. The additional preferred stock will have
the same preferences, qualifications and rights as the initial
preferred stock. The additional preferred stock would be accompanied by
warrants to purchase up to 0.8 million shares of our common stock.
We Face Significant Competition. Each segment of our business is highly
competitive, and we expect that competitive pressures will continue. Many of our
competitors have far greater financial, technological, marketing, personnel and
other resources than us. The areas which we have identified for continued growth
and expansion are also target market segments for some of the largest and most
strongly capitalized companies in the United States, Canada and Europe. There
can be no assurance that we will have the financial, technical, marketing and
other resources required to compete successfully in this environment in the
future.
We Face Risks Associated with Acquisitions and Expansion. We have
engaged in a continuing program of acquisitions of other businesses which are
considered to be complementary to our lines of business, and we anticipate that
41
such acquisitions will continue to occur. Since January 1, 1995 we have made 49
acquisitions and since January 1, 2000 we have made seven acquisitions. Our
total assets were approximately $341.6 million as of September 30, 2000 and $229
million, $124 million, $61 million, $33 million and $4 million as of December
31, 1999, 1998, 1997, 1996 and 1995, respectively. Net operating revenue was
approximately $73.8 million and $107.3 million for the three months ended
September 30, 2000 and 1999, respectively, $222.9 million and $231.8 million for
the nine months ended September 30, 2000 and 1999, respectively, and $337
million, $207 million, $103 million, $20 million and $2 million for the years
ended December 31, 1999, 1998, 1997, 1996 and 1995, respectively. Managing these
dramatic changes in the scope of our business will present ongoing challenges to
management, and there can be no assurance that our operations as currently
structured, or as affected by future acquisitions, will be successful.
It is our policy to retain existing management of acquired companies,
under the overall supervision of our senior management. The success of the
operations of these subsidiaries will depend, to a great extent, on the
continued efforts of the management of the acquired companies.
We have entered into earnout arrangements with certain sellers under
which they are entitled to additional consideration for their interests in the
companies they sold to us. At September 30, 2000, under these agreements,
assuming that all earnout profits are achieved, we are contingently liable for
additional consideration of approximately $19.6 million in 2001, $9.1 million in
2002 and $2.0 million in 2004, of which $1.0 million would be payable in cash
and $29.7 million would be payable in stock.
We have entered into put options with the sellers of those companies in
which we acquired less than a 100% interest. These options require us to
purchase the remaining portion we do not own after periods ranging from four to
five years from the dates of acquisition at amounts per share generally equal to
10% to 20% of the average annual earnings per share of the acquired company
before income taxes for, generally, a two year period ending on the effective
date of the put multiplied by a multiple ranging from four to five. The
purchases under these put options are recorded as changes in minority interest
based upon current operating results.
In June 2000, we entered into agreements to issue, in the aggregate,
2.3 million shares of our common stock, 1.6 million of which have been issued,
to acquire $10.0 million in put options and to settle earnout payments in
certain companies owned by our subsidiary, IntelleSale. These agreements
superseded agreements entered into during the second quarter of 1999.
Goodwill Amortization will Reduce Our Earnings. As a result of the
acquisitions we have completed through September 30, 2000, we have approximately
$175.6 million of goodwill, approximately $23.3 million of which is deductible
for tax purposes, which is currently being amortized over 20 years at the rate
of approximately $8.8 million per year, which reduces our net income and
earnings per share. In addition, future acquisitions may also increase the
existing goodwill and the amount of annual amortization, further reducing net
income and earnings per share. Goodwill associated with the Pacific Decision
Sciences Corporation, ATEC and Connect Intelligence acquisitions recently
completed amounted to approximately $38.4 million and will be amortized over 20
years at the rate of approximately $2.0 million per year. As required by
Statement of Financial Accounting Standards No. 121, we will periodically review
our goodwill for impairment, based on expected discounted cash flows. If we
determine that there is such impairment, we would be required to write down the
amount of goodwill accordingly, which would also reduce our earnings.
Our Need for Additional Capital Could Adversely Affect Earnings and
Shareholder Rights. We may require additional capital to fund growth of our
42
current business as well as to make future acquisitions. However, we may not be
able to obtain capital from outside sources. Even if we do obtain capital from
outside sources, it may not be on terms favorable to us. Our current credit
agreement with IBM Credit Corporation may hinder our ability to raise additional
debt capital. In addition, the terms of the Series C Preferred Stock and the
sale of substantial amounts of our common stock upon the conversion of the
Series C Preferred may make it more difficult for us to raise capital through
the sale of equity or equity-related securities. If we raise additional capital
by issuing equity securities, these securities may have rights, preferences or
privileges senior to those of our common shareholders.
Covenants Under Credit Agreement. We entered into an amended and
restated credit agreement with IBM Credit Corporation on October 17, 2000, which
contains various covenants relating to our financial position and performance as
well as restrictions on declaration and payment of dividends. As of June 30,
2000, we were out of compliance with three of four financial debt covenants in
our prior agreement with IBM Credit, and we received waivers of compliance from
IBM. As of September 30, 2000 we were in compliance with the terms of the new
agreement, but we cannot assure you that we will be able to maintain compliance
with our covenants in the future. If we fail to comply with such covenants, IBM
Credit would have the right to accelerate the maturity of our loans.
We Depend on Key Individuals. Our future success is highly dependent
upon our ability to attract and retain qualified key employees. We are organized
with a small senior management team, with each of our separate operations under
the day-to-day control of local managers. If we were to lose the services of any
members of our central management team, our overall operations could be
adversely affected, and the operations of any of our individual facilities could
be adversely affected if the services of the local managers should be
unavailable. We have entered into employment contracts with our key officers and
employees and certain subsidiaries. The agreements are for periods of one to ten
years through June 2009. Some of the employment contracts also call for bonus
arrangements based on earnings.
We Face Risks that the Value of our Inventory May Decline. We purchase
and warehouse inventory, much of which is refurbished or excess inventory of
personal computer equipment. As a result, we assume inventory risks and price
erosion risks for these products. These risks are especially significant because
personal computer equipment generally is characterized by rapid technological
change and obsolescence. These changes affect the market for refurbished or
excess inventory equipment. Our success will depend on our ability to purchase
inventory at attractive prices relative to its resale value and our ability to
turn our inventory rapidly through sales. If we pay too much or hold inventory
too long, we may be forced to sell our inventory at a discount or at a loss or
write down its value, and our business could be materially adversely affected.
We Do Not Pay Dividends on Our Common Stock. We do not have a history
of paying dividends on our common stock, and we cannot assure you that any
dividends will be paid in the foreseeable future. The Second IBM Agreement
places restrictions on the declaration and payment of dividends. In addition, we
may not pay dividends on our common stock without the consent of the holders of
a majority of the shares of the preferred stock. We intend to use any earnings
which may be generated to finance the growth of our businesses.
We May Issue Preferred Stock. Our Board of Directors has the right to
authorize the issuance of preferred stock, without further shareholder approval,
the holders of which may have preferences over the holders of our common stock
as to payments of dividends, liquidation and other matters. As described under
"Recent Developments," we issued a series of convertible preferred stock in
43
October 2000, and have granted the purchasers the right to require us to issue
additional shares of convertible preferred stock in the future.
Our Stock Price May Continue to be Volatile. Our common stock is listed
on The Nasdaq National Market, which has experienced and is likely to experience
in the future significant price and volume fluctuations which could adversely
affect the market price of our common stock without regard to our operating
performance. In addition, we believe that factors such as the significant
changes to our business resulting from continued acquisitions and expansions,
quarterly fluctuations in our financial results or cash flows, shortfalls in
earnings or sales below expectations, changes in the performance of other
companies in our same market sectors and the performance of the overall economy
and the financial markets could cause the price of our common stock to fluctuate
substantially. During the 12 month period prior to September 30, 2000, the price
per share of our common stock has ranged from a high of $18.00 to a low of
$1.63.
We are Obligated to Make Termination Payments Upon a Change of Control.
Our employment agreements with Richard Sullivan, Garrett Sullivan and David
Loppert include change of control provisions under which the employees may
terminate their employment within one year after a change of control and are
entitled to receive specified severance payments and/or continued compensation
payments for sixty months. The employment agreements also provide that these
executive officers are entitled to supplemental compensation payments for sixty
months upon termination of employment, even if there is no change in control,
unless their employment is terminated due to a material breach of the terms of
the employment agreement. Also, the agreements for both Richard Sullivan and
Garrett Sullivan provide for certain "triggering events," which include a change
in control, the termination of Richard Sullivan's employment other than for
cause, or if Richard Sullivan ceases to hold his current positions with us for
any reason other than a material breach of the terms of his employment
agreement. In that case, we would be obligated to pay, in cash and/or in stock,
$12.1 million and $3.5 million, respectively, to Richard Sullivan and to Garrett
Sullivan, in addition to certain other compensation. Finally, the employment
agreements provide for a gross up for excise taxes which are payable by these
executive officers if any payments upon a change of control are subject to such
taxes as excess parachute payments.
Our obligation to make the payments described in this section could
adversely affect our financial condition or could discourage other parties from
entering into transactions with us which might be treated as a change in control
or triggering event for purposes of these agreements.
We are Involved in Litigation. We, and certain of our subsidiaries, are
parties to various legal actions as either plaintiff or defendant in the
ordinary course of business.
On April 7, 2000, we and IntelleSale filed a counterclaim against David
Romano and Eric Limont, the former owners of Bostek, Inc. and Micro Components
International Incorporated, two companies acquired by IntelleSale in June 1999,
in the U.S. District Court for the District of Delaware for, generally, breach
of contract, breach of fiduciary duty and fraud. Messrs. Romano and Limont had
filed their claim generally alleging that their earnout payment from IntelleSale
was inadequate. In July 2000, we and IntelleSale amended our counterclaim in the
U.S. District Court for the District of Delaware to seek damages for, among
other things, securities law violations. In addition, on May 19, 2000,
IntelleSale and two of its subsidiaries, Bostek, Inc. and Micro Components
International Incorporated, filed suits against Messrs. Romano and Limont in
Superior Court of Massachusetts to recover damages as a result of fraud,
misrepresentations, and breach of fiduciary duties. In July 2000, Messrs. Romano
and Limont amended their complaint in the U.S. District Court for the District
of Delaware to add a claim for $10 million for the $10 million payment not made
44
to them. We believe that the claims filed by Messrs. Romano and Limont are
without merit and we intend to vigorously defend against the claims. In
addition, we intend to vigorously pursue our claims against Messrs. Romano and
Limont.
While we believe that the final outcome of these proceedings will not
have a material adverse effect on our financial position, cash flows or results
of operations, we cannot assure the ultimate outcome of these actions and the
estimates of the potential future impact on our financial position, cash flows
or results of operations for these proceedings could change in the future. In
addition, we will continue to incur additional legal costs in connection with
pursuing and defending such actions.
Digital Angel may Not be Able to Develop Products From its Unproven
Technology. In December 1999, Digital Angel acquired the patent rights to a
miniature digital receiver named "Digital Angel(TM)." This technology is still
in the development stage. Digital Angel's ability to develop and commercialize
products based on its proprietary technology will depend on its ability to
develop its products internally on a timely basis or to enter into arrangements
with third parties to provide these functions. If Digital Angel fails to develop
and commercialize products successfully and on a timely basis, it could have a
material adverse effect on Digital Angel's business, operating results and
financial condition.
Digital Angel is Subject to Restrictions Imposed by Government
Regulation. Digital Angel is subject to federal, state and local regulation in
the United States and other countries, and it cannot predict the extent to which
it may be affected by future legislative and other regulatory developments
concerning its products and markets. Digital Angel is required to obtain
regulatory approval before marketing most of its products. Digital Angel's
readers must and do comply with the FCC Part 15 Regulations for Electromagnetic
Emissions, and its insecticide products have been approved by the U.S.
Environmental Protection Agency and are produced under EPA regulations. Sales of
insecticide products are incidental to Digital Angel's primary business and do
not represent a material part of its operations. Digital Angel's products also
are subject to compliance with foreign government agency requirements. Digital
Angel's contracts with its distributors generally require the distributor to
obtain all necessary regulatory approvals from the governments of the countries
into which they sell Digital Angel's products. However, any such approval may be
subject to significant delays. Some regulators also have the authority to revoke
approval of previously approved products for cause, to request recalls of
products and to close manufacturing plants in response to violations. Any
actions by these regulators could materially adversely affect Digital Angel's
business.
Year 2000 Compliance. We have not experienced any significant internal
Year 2000 related problems. During 1998 and 1999, we implemented a company wide
program to ensure that our internal systems would be compliant prior to the Year
2000 failure dates. We have not experienced any Year 2000 compliance problems.
However, we cannot make any assurances that unforeseen problems may not arise in
the future.
Software Sold to Customers. During 1998 and 1999, we identified what we
believe to be all potential Year 2000 problems with any of the software products
we develop and market. However, our management believes that it is not possible
to determine with complete certainty that all Year 2000 problems affecting our
software products have been identified or corrected due to the complexity of
these products. In addition, these products interact with other third party
vendor products and operate on computer systems which are not under our control.
For non-compliant products, we have provided and are continuing to provide
recommendations as to how an organization may address possible Year 2000 issues
regarding that product. Software updates are available for most, but not all,
known issues. Such information is the most currently available concerning the
behavior of our products and is provided "as is" without warranty of any kind.
45
However, variability of definitions of "compliance" with the Year 2000 and of
different combinations of software, firmware and hardware has led to, and could
lead to further lawsuits against us. The outcome of any such lawsuits and the
impact on us is not estimable at this time.
We do not believe that the Year 2000 problem has had or will continue
to have a material adverse effect on our business, results of operations or cash
flows. The estimate of the potential impact on our financial position, overall
results of operations or cash flows for the Year 2000 problem could change in
the future. Our ability to achieve Year 2000 compliance and the level of
incremental costs associated therewith, could be adversely impacted by, among
other things, the availability and cost of programming and testing resources, a
vendor's ability to modify proprietary software, and unanticipated problems
identified in the ongoing compliance review. The discussion of our efforts, and
management's expectations, relating to Year 2000 compliance are forward-looking
statements.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board (FASB) issued
FAS 133, Accounting for Derivative Instruments and Hedging Activities, which
provides a comprehensive and consistent standard for the recognition and
measurement of derivatives and hedging activities. The statement is effective
for fiscal years commencing after June 15, 2000. In June 2000, the FASB issued
FAS 138, Accounting for Certain Derivative Instruments and Certain Hedging
Activities - an Amendment of FAS statement 133, which addresses implementation
issues experienced by those companies that adopted FAS 133 early. We will adopt
FAS 133, as well as its amendments and interpretations, in fiscal year 2001. We
do not believe that FAS 133 will have a material impact on our results of
operations, cash flows and financial condition.
In December 1999, the SEC issued Staff Accounting Bulletin (SAB) No.
101, Revenue Recognition in Financial Statements. This Staff Accounting Bulletin
summarizes certain of the staff's views on applying Generally Accepted
Accounting Principles to revenue recognition in financial statements. On June
26, 2000, the SEC staff issued SAB No. 101B, which delays the implementation
date of SAB 101 until no later than the fourth fiscal quarter of fiscal years
beginning after December 15, 1999. Therefore, we will adopt this statement no
later than the fourth quarter of 2000. We do not believe that SAB 101 will have
a material impact on our results of operations, cash flows and financial
condition.
In September 2000, the EITF reached a consensus in EITF Issues 00-10,
"Accounting for Shipping and Handling Fees and Costs," agreeing that shipping
and handling fees must be classified as revenues and comparable prior periods
should be restated. Further, they agreed that shipping and handling costs can be
classified anywhere in the statement of earnings, except they cannot be netted
against sales. If shipping and handling costs are not included in costs of goods
sold, the amount and classification of these expenses must be disclosed in the
footnotes to the financial statements. This consensus must be adopted no later
than the fourth quarter of fiscal years beginning after December 15, 1999.
Therefore, we will adopt EITF Issue 00-10 in the fourth quarter of 2000. We do
not anticipate that the adoption of EITF Issue 00-10 will have a material impact
on our results of operations, cash flows and financial condition.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
With our Canadian and United Kingdom subsidiaries, we have operations
and sales in various regions of the world. Additionally, we may export and
46
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 may be
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. Borrowings under the Second IBM Agreement are
at the London Interbank Offered Rate which is adjusted monthly. Our interest
income is sensitive to changes in the general level of U.S. interest rates,
particularly since the majority of our investments are in short-term
investments.
Due to the nature of our borrowings and our short-term investments, we
have concluded that there is no material market risk exposure and, therefore, no
quantitative tabular disclosures are required.
47
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On April 7, 2000, the Company and Intellesale filed a counterclaim
against David Romano and Eric Limont, the former owners of Bostek, in the U.S.
District Court for the District of Delaware for, generally, breach of contract,
breach of fiduciary duty and fraud. Messrs. Romano and Limont, the former owners
of Bostek, had filed their claim generally alleging that their earnout payment
from Intellesale was inadequate. In July 2000, the Company and Intellesale
amended their counterclaim in the U.S. District Court for the District of
Delaware to seek damages for, among other things, securities law violations. In
addition, on May 19, 2000, Intellesale and two of its subsidiaries, Bostek and
Micro Components, filed suit against Messrs. Romano and Limont in Superior Court
of Massachusetts to recover damages as a result of fraud, misrepresentations,
and breach of fiduciary duties. In July 2000, Messrs. Romano and Limont amended
their complaint in the U.S. District Court for the District of Delaware to add a
claim for $10 million for the $10 million payment not made to them. The Company
believes that the claims filed by Messrs. Romano and Limont are without merit
and intends to vigorously defend against the claims. In addition, the Company
intends to vigorously pursue its claims against Messrs. Romano and Limont.
We, and certain of our subsidiaries, are parties to various other legal
actions as either plaintiff or defendant in the ordinary course of business.
In the opinion of management, these proceedings will not have a
material adverse effect on the financial position, cash flows or overall trends
in our results. The estimate of the potential impact on our financial position,
overall results of operations or cash flows for these proceedings could change
in the future.
48
ITEM 2. CHANGES IN SECURITIES
Recent Sales of Unregistered Securities
The following table lists all unregistered securities sold by us from
July 1, 2000 through September 30, 2000. These acquisition shares were issued to
the selling shareholders in connection with the acquisition of the indicated
subsidiary or the shareholder's minority interest in transactions directly
negotiated by the shareholders in connection with the sale of their business or
interests to the Company and pursuant to the "price protection" or "earnout"
provisions of the agreement of sale. These shares were issued without
registration in reliance upon the exemption provided by Section 4(2) of the
Securities Act of 1933, as amended, and Regulation D promulgated thereunder.
Number
of Issued Number of Common
Name/Entity/Nature Persons Note For Shares
------------------ ------- ---- --- ------
Computer Equity Corporation 1 1 Acquisition 25,000
GDB Software Services, Inc. 2 2 Acquisition 337,838
Norcom Resources, Inc. 3 3 Acquisition 162,162
WebNet Services 3 1 Acquisition 267,857
--------
Total 792,857
========
<FN>
1. Represents shares issued in connection with a prior acquistion exempt from
registration pursuant to Section 4(2) of the Securities Act. The
transaction document related to the acquisition included an acknowledgment
that the sale was not registered, that the shareholder was acquiring the
shares for investment and not for resale, and that the shareholder
acknowledged that he must hold the shares until and unless registered or
unless transferred in another transaction exempt from registration. In
addition, the certificates representing the shares were legended to
indicate that they were restricted.
2. Represents shares issued in connection with the "earnout" provision of the
agreement of sale relating to a prior private transaction directly
negotiated by the shareholder(s) in connection with the sale of their
business(es) to the Company, which transactions were exempt from
registration pursuant to Section 4(2) of the Act.
3. Represents shares issued to a selling shareholder to acquire such
shareholder's minority interest in a transaction directly negotiated by
representatives for the shareholders in connection with the sale of their
interests to the Company and exempt from registration pursuant to Section
4(2) of the Act. The transaction document included an acknowledgement that
the sale was not registered, that the shareholder was acquiring the shares
for investment and not for resale, and that the shareholder acknowledged
that he must hold the shares until and unless registered or unless
transferred in another transaction exempt from registration. In addition,
certificates representing the shares were legended to indicate that they
were restricted.
</FN>
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A Special Meeting of Shareholders was held on September 2, 2000, at
which the Company's shareholders were asked to (i) ratify the approval and
adoption of a transaction whereby the Company will issue 23,264,916 shares of
the Company's common stock in exchange for all of the issued and outstanding
49
shares of common stock of Destron Fearing Corporation, a Delaware corporation
("Destron"), including shares of Company common stock to be issued upon exercise
of outstanding options and warrants to purchase Destron common stock pursuant to
the Agreement and Plan of Merger dated as of April 24, 2000, as amended, (the
"Merger Agreement") among the Company, Digital Angel.net Inc. and Destron (the
"Merger Proposal"), and (ii) ratify the approval of the proposed amendment to
the Company's Second Restated Articles of Incorporation to increase the number
of authorized shares of Company common stock from 85,000,000 to 250,000,000,
with 245,000,000 of such shares designated as common stock (the "Amendment
Proposal"). The appropriate motions were made and seconded and the voting was
held.
The results of the shareholders' vote showed that the holders of (i) a
majority of the total votes cast on the Merger Proposal had approved and adopted
the Merger Proposal, and (ii) a majority of the outstanding shares of Company
stock entitled to vote had approved and adopted the Amendment Proposal as
follows:
For Against Abstain
----------------------------------------------------------
Merger Proposal 26,126,477 2,882,809 360,949
Amendment Proposal 44,282,213 4,839,830 453,033
ITEM 5. OTHER INFORMATION
On July 1, 2000 we acquired 100% of the capital stock of WebNet
Services, Inc., an internet service provider, network integrator and website
developer.
On September 8, 2000, we completed our acquisition of Destron Fearing
Corporation, an animal identification and microchip technology company, through
a merger of our wholly-owned subsidiary, Digital Angel.net Inc., with and into
Destron Fearing pursuant to a Agreement and Plan of Merger dated as of April 24,
2000, as amended. As a result of the merger, Destron Fearing is now our
wholly-owned subsidiary and has been renamed "Digital Angel.net Inc.
Effective as of October 19, 2000, we entered into transactions with
MCY.com, Inc. (OTC-BB:MCYC) ("MCY") under which we sold to MCY a non-exclusive
perpetual worldwide license to use our recently-acquired Net-Vu product, an
Internet-based Automatic Contact Distributor, for $9.0 million in cash plus $1.0
million in shares of MCY. In addition, MCY granted to us an exclusive perpetual
license to MCY's digital encryption and distribution systems, including its
NETrax(TM) software for use in various non-entertainment business-to-business
applications, in consideration for 11.8 million shares of our common stock
valued of $40.0 million. These transactions with MCY are subject to governmental
clearance under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as
amended.
On October 25, 2000, we acquired Pacific Decision Sciences Corporation,
a California corporation ("PDSC"). In the merger transaction, we issued
approximately 8.6 million shares of our common stock. In addition, for each of
the twelve-month periods ending September 30, 2001 and September 30, 2002, the
former stockholders of PDSC will be entitled to receive earnout payments,
payable in cash or in shares of our common stock, of $9.7 million plus 4.0 times
EBITDA (as defined in the merger agreement) in excess of $3.7 million, subject
to reduction by 4.0 times the shortfall from the Projected EBITDA Amount (as
defined in the merger agreement). Goodwill associated with the acquisition
amounted to approximately $23.5 million and will be amortized over 20 years at
the rate of approximately $1.2 million per year. Pro forma financial information
50
related to this acquisition will be included in our Current Report on Form
8-K/A, which will be filed on or before December 30, 2000. PDSC, based in Santa
Ana, California, is a provider of proprietary web-based customer relationship
management software. It develops, sells and implements software systems that
enable automated, single point of contact delivery of customer service.
On October 27, 2000, we acquired 16% of the capital stock of ATEC
Group, Inc. (AMEX:TEC), in consideration for shares of our common stock valued
at approximately $9.1 million. Goodwill associated with the acquisition amounted
to approximately $7.8 million and will be amortized over 20 years at the rate of
approximately $0.4 million per year. Based in Commack, New York, ATEC is a
leading system integrator and provider of a full line of information technology
products and services.
On October 31, 2000, under an agreement dated November 3, 2000, we sold
our wholly-owned subsidiary STC Netcom, Inc.
On November 2, 2000 we acquired 80% of the capital stock of Connect
Intelligence Limited, in consideration for shares of our common stock valued at
approximately $10.0 million. Goodwill associated with the acquisition amounted
to approximately $7.1 million and will be amortized over 20 years at the rate of
approximately $0.4 million per year. Based in Ireland, Connect Intelligence has
successfully completed a vetting procedure and has now been formally offered up
to 70 high-speed fiber optic circuits from the Irish government's Department of
Enterprise and Employment. The offering, part of the Irish government's
e-commerce infrastructure initiative, grants Connect Intelligence and its
partners exclusive rights to nearly one half of all circuits to and from the
Republic of Ireland.
On November 13, 2000 we entered into an agreement to acquire
approximately 54% of the outstanding capital stock of SysComm International
Corporation (NASDAQ:SYCM) in consideration for a combination of cash and shares
of our common stock valued at $4.5 million. No goodwill was associated with the
acquisition. Concurrently, we agreed to sell our interest in Information
Products Corporation to SysComm. Based in Shirley, New York, SysComm is a
network and systems integrator and reseller of computer hardware.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
4.1 Second Restated Articles of Incorporation of the Registrant
(incorporated herein by reference to Exhibit 4.1 to the Registrant's
Post-Effective Amendment No. 1 on Form S-1 to Registration Statement
(Form S-3 File No. 333-64605) filed with the Commission on June 24,
1999)
51
4.2 Amendment of Articles of Incorporation of the Registrant filed with the
Secretary of State of the State of Missouri on September 5, 2000
(incorporated herein by reference to Exhibit 4.3 to the Registrant's
Post-Effective Amendment No. 3 on Form S-3 to Registration Statement on
Form S-4 (File No. 333-38420-02) filed with the Commission on September
29, 2000)
4.3 Certificate of Designation of Preferences of Series C Convertible
Preferred Stock (incorporated herein by reference to Exhibit 3.1 to the
Registrant's Current Report on Form 8-K filed with the Commission on
October 26, 2000)
4.4 Amended and Restated Bylaws of the Registrant dated March 31, 1998
(incorporated herein by reference to Exhibit 3.1 to the Registrant's
Registration Statement on Form S-3 (File No. 333-51067) filed with the
Commission on April 27, 1998)
10.1 Securities Purchase Agreement, dated as of October 24, 2000, relating
to the Registrant's Series C Convertible Preferred Stock (incorporated
by reference to Exhibit 10.1 to the Registrant's Current Report on Form
8-K filed with the Commission on October 26, 2000)
10.2 Form of warrant to purchase common stock of the Registrant issued to
the holders of the Series C Convertible Preferred Stock (incorporated
by reference to Exhibit 4.1 to the Registrant's Current Report on Form
8-K filed with the Commission on October 26, 2000)
10.3 Registration Rights Agreement between the Registrant and the holders of
the Series C Convertible Preferred Stock (incorporated by reference to
Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with
the Commission on October 26, 2000)
10.4 Agreement and Plan of Merger dated as of October 18, 2000 among the
Registrant, PDS Acquisition Corp., Pacific Decision Sciences
Corporation, H&K Vasa Family 1999 Limited Partnership, H&K Vasa Family
2000 Limited Partnership, David Dorret and David Englund (incorporated
by reference to Exhibit 2 to the Registrant's Current Report on Form
8-K filed with the Commission on November 1, 2000)
(b) REPORTS ON FORM 8-K
The following Current Reports on Form 8-K were filed by the Company
between July 1, 2000 and the date of this report:
(1) On July 14, 2000, we filed a Current Report on Form 8-K which included
a copy of the Agreement and Plan of Merger, dated as of June 30, 2000,
between the Company and Computer Equity Corporation.
(2) On September 11, 2000, we filed a Current Report on Form 8-K/A which
included the financial statements and pro forma financial information
in connection with the acquisition of Computer Equity Corporation.
(3) On September 21, 2000, we filed a Current Report on Form 8-K which
included the financial statements and pro forma financial information
in connection with the acquisition of Destron Fearing Corporation on
September 8, 2000.
52
(4) On October 24, 2000, we filed a Current Report on Form 8-K which
included a copy of the Second Amended and Restated Term and Revolving
Credit Agreement dated October 17, 2000 between IBM Credit Corporation,
the Company, and others.
(5) On October 26, 2000, we filed a Current Report on Form 8-K which
included a copy of the Certificate of Designation of Preferences, Form
of Warrant, Registration Rights Agreement and the Securities Purchase
Agreement in connection with the issuance of 26,000 shares of our
Series C Convertible Preferred Stock and related Warrants to
institutional investors in a private placement.
(6) On November 1, 2000, we filed a Current Report on Form 8-K which
included a copy of the Agreement and Plan of Merger, dated as of
October 18, 2000, between the Company and Pacific Decision Sciences
Corporation.
(7) On December 5, 2000, we filed a Current Report on Form 8-K which
included a copy of the MCY Agreement executed in connection with our
acquisition of license rights to use certain systems developed by
MCY.com.
(8) On December 29, 2000, we filed a Current Report on Form 8-K/A which
included the financial statements and pro forma financial information
in connection with the acquisition of Pacific Decision Sciences
Corporation.
(9) On April 23, 2001, we filed a Current Report on Form 8-K/A which
amended our Current Report on Form 8-K/A filed on September 11, 2000.
(10) On April 23, 2001, we filed a Current Report on Form 8-K/A which
amended our Current Report on Form 8-K filed on September 21, 2000.
(11) On April 23, 2001, we filed a Current Report on Form 8-K/A which
amended our Current Report on Form 8-K/A filed on December 29, 2000.
53
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
APPLIED DIGITAL SOLUTIONS, INC.
(Registrant)
Dated: April 23 , 2001 By: /S/ JEROME C. ARTIGLIERE
----------------------------------------
Jerome C. Artigliere
Chief Financial Officer
54