As filed with the Securities and Exchange Commission on August 14, 2000
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
______________________________
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended June 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) 366-4800
(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 August 10, 2000:
Class Number of Shares
Common Stock; $.001 Par Value 60,053,396
APPLIED DIGITAL SOLUTIONS, INC.
TABLE OF CONTENTS
Item Description Page
PART I - FINANCIAL INFORMATION
1. Financial Statements
Consolidated Balance Sheets -
June 30, 2000 (unaudited) and December 31, 1999 3
Consolidated Statements of Operations -
Three and Six Months ended June 30, 2000 and 1999 (unaudited) 4
Consolidated Statement of Stockholders' Equity -
Six Months ended June 30, 2000 (unaudited) 5
Consolidated Statements of Cash Flows -
Six Months ended June 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 16
3. Quantitative and Qualitative Disclosures About Market Risk 36
PART II - OTHER INFORMATION
1. Legal Proceedings 37
2. Changes In Securities 38
3. Defaults Upon Senior Securities 38
4. Submission of Matters to a Vote of Security Holders 38
5. Other Information 39
6. Exhibits and Reports on Form 8-K 39
SIGNATURE 40
EXHIBITS 41
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
- ------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
ASSETS
JUNE 30,
2000 December 31,
(UNAUDITED) 1999
-------------------------------
CURRENT ASSETS
Cash and cash equivalents $ 12,688 $ 5,138
Due from buyer of divested subsidiary -- 31,302
Accounts receivable (net of allowance for doubtful
accounts of $4,493 in 2000 and $1,698 in 1999) 50,122 52,170
Inventories 39,009 40,448
Notes receivable 4,463 3,822
Prepaid expenses and other current assets 9,912 6,001
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 116,194 138,881
PROPERTY AND EQUIPMENT, NET 17,410 13,886
NOTES RECEIVABLE 3,345 3,297
GOODWILL, NET 97,359 62,000
OTHER ASSETS 17,782 10,912
- ------------------------------------------------------------------------------------------------------------------------------
$ 252,090 $ 228,976
==============================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable $ 31,627 $ 25,211
Current maturities of long-term debt 8,953 8,038
Due to shareholders of acquired subsidiaries 18,864 15,000
Accounts payable 23,683 29,499
Accrued expenses 16,353 17,672
Other current liabilities -- 2,745
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 99,480 98,165
LONG-TERM DEBT 35,050 35,317
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 134,530 133,482
- ------------------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES
- ------------------------------------------------------------------------------------------------------------------------------
MINORITY INTEREST 2,272 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 80,000 shares in 2000 and 1999 of $.001 par value;
62,078 shares issued and 59,222 shares outstanding in 2000
and 51,116 shares issued and 48,260 shares outstanding in 1999 59 48
Common and preferred additional paid-in capital 129,211 87,470
Retained earnings (6,236) 12,664
Treasury stock (carried at cost, 2,856 shares) (7,310) (7,310)
Accumulated other comprehensive income (loss) (436) 64
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 115,288 92,936
- ------------------------------------------------------------------------------------------------------------------------------
$ 252,090 $ 228,976
==============================================================================================================================
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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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------------------------------------------------
2000 1999 2000 1999
---------------------------------------------------------
NET OPERATING REVENUE $ 63,863 $ 72,955 $ 149,016 $ 124,528
COST OF GOODS SOLD 44,660 46,672 108,570 79,782
- -------------------------------------------------------------------------------------------------------------------------------
GROSS PROFIT 19,203 26,283 40,446 44,746
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (24,169) (21,724) (44,524) (37,816)
DEPRECIATION AND AMORTIZATION (2,309) (2,275) (4,399) (3,761)
UNUSUAL AND RESTRUCTURING CHARGES (17,000) -- (17,000) (2,550)
INTEREST INCOME 369 144 566 278
INTEREST EXPENSE (1,349) (690) (2,467) (1,135)
- -------------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE PROVISION (BENEFIT) FOR INCOME TAXES,
MINORITY INTEREST AND EXTRAORDINARY LOSS (25,255) 1,738 (27,378) (238)
PROVISION (BENEFIT) FOR INCOME TAXES (8,123) 1,017 (8,721) 442
- -------------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE MINORITY INTEREST AND
EXTRAORDINARY LOSS (17,132) 721 (18,657) (680)
MINORITY INTEREST 596 220 243 464
- -------------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE EXTRAORDINARY LOSS (17,728) 501 (18,900) (1,144)
EXTRAORDINARY LOSS (NET OF TAXES OF $89) -- 160 -- 160
- -------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS $(17,728) $ 341 $ (18,900) $ (1,304)
===============================================================================================================================
INCOME (LOSS) BEFORE EXTRAORDINARY LOSS $ (.35) $ .01 $ (.38) $ (.03)
EXTRAORDINARY LOSS -- -- -- --
- -------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) PER COMMON SHARE - BASIC $ (.35) $ .01 $ (.38) $ (.03)
===============================================================================================================================
INCOME (LOSS) BEFORE EXTRAORDINARY LOSS $ (.35) $ .01 $ (.38) $ (.03)
EXTRAORDINARY LOSS -- -- -- --
- -------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) PER COMMON SHARE - DILUTED $ (.35) $ .01 $ (.38) $ (.03)
===============================================================================================================================
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING - BASIC 50,995 46,325 50,003 45,347
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING - DILUTED 50,995 46,829 50,003 45,347
- -------------------------------------------------------------------------------
See the accompanying notes to consolidated financial statements. Page 4
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
- ------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE SIX MONTH PERIOD ENDED JUNE 30, 2000
(In thousands)
(UNAUDITED)
ACCUMULATED
OTHER
COMPRE- TOTAL
PREFERRED SHARES COMMON SHARES ADDITIONAL HENSIVE STOCK-
------------------ --------------- PAID-IN RETAINED TREASURY INCOME HOLDERS'
NUMBER AMOUNT NUMBER AMOUNT CAPITAL EARNINGS STOCK (LOSS) EQUITY
- ----------------------------------------------------------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 1999 -- $ -- 48,260 $ 48 $ 87,470 $ 12,664 $(7,310) $ 64 $ 92,936
Net loss -- -- -- -- -- (18,900) -- --
Comprehensive loss -
foreign currency translation -- -- -- -- -- -- -- (500)
Total comprehensive loss -- -- -- -- -- (18,900) -- (500) (19,400)
Issuance of common shares -- -- 1,478 2 4,574 -- -- -- 4,576
Issuance of common shares for
acquisition -- -- 9,166 9 36,215 -- -- -- 36,224
Warrants redeemed for common
shares -- -- 318 -- 952 -- -- -- 952
- ----------------------------------------------------------------------------------------------------------------------------------
BALANCE - JUNE 30, 2000 -- $ -- 59,222 $ 59 $129,211 $ (6,236) $(7,310) $(436) $115,288
==================================================================================================================================
- -------------------------------------------------------------------------------
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 SIX MONTHS
ENDED JUNE 30,
---------------------------
2000 1999
---------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(18,900) $ (1,304)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 4,399 3,761
Minority interest 243 464
(Gain) loss on sale of equipment (4) 59
Non-cash unusual and restructuring charges 17,000 251
Change in assets and liabilities, excluding unusual charges:
(Increase) decrease in accounts receivable 3,969 (4,781)
Increase in inventories (6,712) (5,809)
Increase in prepaid expenses and other current assets (3,754) (277)
Increase in deferred tax asset (6,571) --
Increase (decrease) in accounts payable and accrued
expenses (18,309) 4,776
- -------------------------------------------------------------------------------------------------------------------------------
NET CASH USED IN OPERATING ACTIVITIES (28,639) (2,860)
- -------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Decrease in due from buyer of divested subsidiary 31,302 --
Increase in notes receivable (689) (34)
Increase in other assets (182) (1,081)
Proceeds from sale of property and equipment 32 90
Payments for property and equipment (4,328) (2,586)
Payments for asset and business
acquisitions (net of cash balances acquired) (1,709) (15,838)
- -------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 24,426 (19,449)
- -------------------------------------------------------------------------------------------------------------------------------
Cash Flows From Financing Activities
Net amounts borrowed (paid) on notes payable 6,188 (11,119)
Proceeds from long-term debt 4,866 44,765
Payments on long-term debt (4,650) (7,252)
Issuance of common shares 5,359 --
Other financing costs -- (3,065)
- -------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 11,763 23,329
- -------------------------------------------------------------------------------------------------------------------------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 7,550 1,020
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 5,138 4,555
- -------------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 12,688 $ 5,575
===============================================================================================================================
- -------------------------------------------------------------------------------
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 June 30, 2000 and
December 31, 1999 and for the three and six months ended June 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 six
months ended June 30, 2000 is 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.
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
June 30, December 31,
2000 1999
----------- ---------------
Raw materials $ 3,930 $ 4,648
Work in process 1,600 1,195
Finished goods 34,100 35,602
----------- ---------------
39,630 41,445
Allowance for excess and obsolescence (621) (997)
----------- ---------------
$39,009 $40,448
=========== ===============
As discussed in Note 5, the $8.5 million unusual charge has been
recognized as a write-off of specific inventory items.
4. FINANCING AGREEMENTS
In August 1998, the Company entered into a $20 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 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. The IBM Agreement, as amended,
provides for:
7
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
(a) a revolving credit line of up to $33.855 million, designated
as follows: (i) a USA revolving credit line of up to $30
million, and (ii) a Canadian revolving credit line of up to
$3.855 million,
(b) a term loan A of up $22 million,
(c) a term loan B of up to $36.405 million and
(d) 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 1.75% to 1.90% depending on
the Company's leverage ratio; the Canadian revolving credit line bears
interest at the base rate as announced by the Toronto-Dominion Bank of
Canada each month plus 0.1707% to .3207%, depending on the Company's
leverage ratio. As of June 30, 2000, the LIBOR rate was approximately
6.5% and approximately $30.6 million was outstanding on the revolving
credit line, which is included in notes payable.
Term loan A, which was used to pay off State Street Bank and Trust
Company, bears interest at the 30-day LIBOR rate plus 1.75% to 1.90%, is
amortized in quarterly installments over six years and is repayable in
full on May 25, 2002. As of June 30, 2000, approximately $18.3 million
was outstanding on this loan.
Term loan B, which may be used for acquisitions, bears interest at
the 30-day LIBOR rate plus 1.75% to 1.90%, is amortized in quarterly
installments over six years and is repayable in full on May 25, 2002.
As of June 30, 2000, approximately $22.3 million was outstanding on this
loan.
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 0.1707%, to 0.3207%, is
amortized in quarterly installments over six years and is repayable in
full on May 25, 2002. As of June 30, 2000, Toronto-Dominion's rate was
approximately 7.5% and approximately $2.7 million was outstanding on
this loan.
The agreement contains standard debt covenants relating to the
financial position and performance as well as restrictions on the
declarations and payment of dividends. As of June 30, 2000, the Company
was not in compliance with three of its four debt covenants and is
negotiating waivers with IBM Credit Corporation. The Company believes
it will be successful in negotiating waivers and therefore, has
classified the term loans as noncurrent.
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 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 which may exceed the second quarter unusual
charge.
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 June 30, 2000:
Balance, Balance Balance
January 1, December 31, June 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
===================================================================================
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.
9
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
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 SIX MONTHS ENDED
ENDED JUNE 30,
JUNE 30,
--------------------------------------------------------
2000 1999 2000 1999
---- ---- ---- ----
NUMERATOR:
Net income (loss) available to common stockholders $(17,728) $ 341 $(18,900) $(1,304)
========================================================
DENOMINATOR:
Denominator for basic income (loss) per share -
Weighted-average shares<F1> 50,995 46,325 50,003 45,347
Effect of dilutive securities -
Warrants -- 155 -- --
Employee stock options -- 349 -- --
--------------------------------------------------------
Denominator for diluted income (loss) per share<F2> 50,995 46,829 50,003 45,347
========================================================
Basic income (loss) per share $(0.35) $ 0.01 $(0.38) $ (0.03)
========================================================
Diluted income (loss) per share $(0.35) $ 0.01 $(0.38) $ (0.03)
========================================================
<FN>
<F1> Includes, for the three and six month periods ended June 30, 2000
and 1999, 0.5 and 1,353 shares of common stock, respectively,
reserved for issuance to the holders of ACT-GFX, Inc.'s
exchangeable shares and for the three and six month periods ended
June 30, 1999, 1,393 shares of common stock reserved for issuance
to the holders of TigerTel Services Limited's (formerly Commstar
Ltd.) exchangeable shares.
<F2> 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:
----------------------------------------------
THREE MONTHS SIX MONTHS ENDED
ENDED JUNE 30, JUNE 30,
----------------------------------------------
2000 2000 1999
---- ---- ----
Employee stock options 2,993 3,999 413
Warrants 245 389 229
Contingent stock - acquisitions -- 58 --
----------------------------------------------
3,238 4,445 642
==============================================
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 June 30, 2000:
-------------------------------------------------------------------------------------------------------------
Appli- Intelle- Corporate Elimi- Consol-
Telephony Network Internet cations Sale.com Non-Core Overhead nations idated
-------------------------------------------------------------------------------------------------------------
External
revenue $10,436 $11,022 $2,797 $9,498 $21,081 $9,019 $10 $ -- $63,863
Intersegment
revenue -- -- -- -- 1,500 -- -- (1,500) --
-------------------------------------------------------------------------------------------------------------
Total revenue $10,436 $11,022 $2,797 $9,498 $22,581 $9,019 $10 $(1,500) $63,863
=============================================================================================================
Income (loss)
before benefit
for income
taxes and
minority
interest $1,614 $591 $(52) $(626) $(21,724) $(789) $(3,114) $(1,155) $(25,255)
=============================================================================================================
Total assets $29,449 $10,333 $4,364 $24,279 $53,206 $24,607 $247,689 $(140,008) $253,919
=============================================================================================================
Following is the selected segment data as of and for the six months
ended June 30, 2000:
-------------------------------------------------------------------------------------------------------------
Appli- Intelle- Corporate Elimi- Consol-
Telephony Network Internet cations Sale.com Non-Core Overhead nations idated
-------------------------------------------------------------------------------------------------------------
External
revenue $14,934 $18,267 $4,823 $18,432 $69,418 $23,035 $107 $ -- $149,016
Intersegment
revenue -- -- -- -- 4,000 -- -- (4,000) --
-------------------------------------------------------------------------------------------------------------
Total revenue $14,934 $18,267 $4,823 $18,432 $73,418 $23,035 $107 $(4,000) $149,016
=============================================================================================================
Income (loss)
before benefit
for income
taxes and
minority
interest $1,152 $843 $(46) $(654) $(21,212) $212 $(5,717) $(1,956) $(27,378)
=============================================================================================================
Total assets $29,449 $10,333 $4,364 $24,279 $53,206 $24,607 $247,689 $(140,008) $253,919
=============================================================================================================
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 June 30, 1999:
-------------------------------------------------------------------------------------------------------------
Appli- Intelle- Corporate Elimi- Consol-
Telephony Network Internet cations Sale.com Non-Core Overhead nations idated
-------------------------------------------------------------------------------------------------------------
External
revenue $13,523 $8,501 $2,121 $7,943 $23,499 $17,349 $19 $ -- $72,955
Intersegment
revenue -- -- -- -- 655 -- -- (655) --
-------------------------------------------------------------------------------------------------------------
Total revenue $13,523 $8,501 $2,121 $7,943 $24,154 $17,349 $19 $(655) $72,955
=============================================================================================================
Income (loss)
before
provision
(benefit) for
income taxes,
minority
interest and
extraordinary
loss $191 $781 $260 $331 $1,367 $747 $(1,501) $(438) $1,738
=============================================================================================================
Total assets $27,382 $8,250 $2,128 $26,368 $49,664 $32,109 $202,623 $(140,903) $207,621
=============================================================================================================
Following is the selected segment data as of and for the six months
ended June 30, 1999:
-------------------------------------------------------------------------------------------------------------
Appli- Intelle- Corporate Elimi- Consol-
Telephony Network Internet cations Sale.com Non-Core Overhead nations idated
-------------------------------------------------------------------------------------------------------------
External
revenue $23,532 $12,507 $2,121 $14,698 $39,072 $32,559 $39 $ -- $124,528
Intersegment
revenue -- -- -- -- 2,188 -- -- (2,188) --
-------------------------------------------------------------------------------------------------------------
Total revenue $23,532 $12,507 $2,121 $14,698 $41,260 $32,559 $39 $(2,188) $124,528
=============================================================================================================
Income (loss)
before
provision
(benefit) for
income taxes,
minority
interest and
extraordinary
loss $557 $968 $257 $(120) $3,656 $944 $(5,675) $(825) $(238)
=============================================================================================================
Total assets $27,382 $8,250 $2,128 $26,367 $49,664 $32,108 $202,623 $(140,903) $207,621
=============================================================================================================
12
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
9. MERGERS AND ACQUISITIONS
The following represents acquisitions which occurred in the first
six months of 2000 and 1999:
Acquisi- Common
Date of Percent tion Shares
Acquisition Acquired Price Issued Business Description
- ----------------------------------------------------------------------------------------------------------------------
2000 Acquisitions:
- ------------------
Independent Business Consultants 04/01/00 100% $5,547 958 Network integration company
P-Tech, Inc. 04/01/00 100% 4,825 1,182 Software development company
Timely Technology Corp. 04/01/00 100% 1,164 209 Software developer and application
service provider
Computer Equity Corporation 06/01/00 100% 24,630 4,804 Communications integration company
1999 Acquisitions:
- ------------------
Port Consulting, Inc. 04/01/99 100% 1,292 303 Integrator of information technology
application systems
Hornbuckle Engineering, Inc. 04/01/99 100% 5,103 631 Integrated voice and data solutions
provider
Lynch Marks & Associates, Inc. 04/01/99 100% 2,571 773 Network integration company
STR, Inc. 04/01/99 100% 6,822 1,332 Software solutions provider for
retailers
Contour Telecom Management, Inc.
(Divested effective 12/31/99) 05/01/99 75% 5,627 --- Provider of outsourced
telecommunications management services
Bostek, Inc. & affiliate 06/01/99 100% 27,466 --- Seller of computer systems and
peripherals
All acquisitions have been accounted for using the purchase method
of accounting and, accordingly, the consolidated financial statements
reflect the results of operations of each company from the date of
acquisition. The costs of acquisitions include all payments according
to the acquisition agreements plus costs for investment banking
services, legal and accounting services that were direct costs of
acquiring these assets. Goodwill resulting from these acquisitions is
being amortized on a straight-line basis over twenty years.
Major Acquisitions
- ------------------
Effective June 1, 2000, the Company acquired all of the
outstanding common stock of Computer Equity Corporation. The aggregate
purchase price was approximately $24.6 million, $15.7 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. 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. Pro forma financial information related to this acquisition will
be included in the Company's Current Report on Form 8K/A, which will be
filed on or before September 12, 2000.
13
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
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.
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 June 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, 1.1 million of which have been issued through
June 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.
There were 1.9 million and 6.0 million shares of common stock
issued during the first six months of 2000 and 1999, respectively,
related to agreements with the Company's subsidiaries for 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
14
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
treasury stock in the amount of $7 million. No gain was recorded on
this transaction, because the shareholders of the purchaser of the
divested assets 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. RECENT DEVELOPMENTS
On March 3, 2000, we announced, and on April 24, 2000, we signed a
definitive merger agreement to acquire Destron Fearing Corporation, a
Nasdaq listed company trading under the stock symbol "DFCO". Destron
Fearing is a leading developer, manufacturer and marketer of a broad
line of electronic and visual identification devices for companion
animals, livestock, laboratory animals and wildlife. In this proposed
transaction, we will issue 1.5 shares of our common stock in exchange
for each share of common stock of Destron Fearing. The transaction is
expected to close in August, 2000, subject to the approval of both our
and Destron Fearing's shareholders. Under the agreement, Destron
Fearing would be merged into Digital Angel.net Inc., our wholly owned
subsidiary. This transaction will be accounted for under the purchase
method of accounting.
15
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 Annual Report on Form 10-K for the year
ended December 31, 1999. 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.
OUTLOOK
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
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.
16
ACQUISITIONS AND RECENT DEVELOPMENTS
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. We
had concluded that the business units within this segment were no longer
core to our operations and we anticipate that we will dispose of the
remaining three business units that were within this segment during 2000
or 2001. 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,
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. The treasury stock was recorded at $2.54 per share.
On March 3, 2000, we announced, and on April 24, 2000, we signed a
definitive merger agreement to acquire Destron Fearing Corporation, a
Nasdaq listed company trading under the stock symbol "DFCO". Destron
Fearing is a leading developer, manufacturer and marketer of a broad
line of electronic and visual identification devices for companion
animals, livestock, laboratory animals and wildlife. In this proposed
transaction, we will issue 1.5 shares of our common stock in exchange
for each share of common stock of Destron Fearing. The transaction is
expected to close in August 2000, subject to the approval of both our
and Destron Fearing's shareholders. Under the agreement, Destron
Fearing would be merged into Digital Angel.net Inc., our wholly owned
subsidiary. This transaction will be accounted for under the purchase
method of accounting.
On March 22, 2000, we filed a shelf registration statement to
sell, from time to time, up to 3 million shares of our common stock.
Proceeds from the sale will be used for general corporate purposes,
17
including the funding of future acquisitions. On April 5, 2000 we
announced that we were postponing this offering because of adverse
market conditions.
During the second quarter of 2000 we acquired, in transactions
accounted for under the purchase method of accounting:
* 100% of the capital stock of Independent Business
Consultants, a network integration company based in Valley
Village, California, effective as of April 1, 2000;
* 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;
* 100% of the capital stock of P-Tech, Inc., a software
development company based in Manchester, New Hampshire,
effective as of April 1, 2000; and
* 100% of the capital stock of Computer Equity Corporation, a
communications integration company based in Chantilly,
Virginia, effective as of June 1, 2000.
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.com, the Non-Core
Business Group, and Digital Angel, are now organized into four business
divisions:
* 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 interest in our Canadian subsidiary, TigerTel, Inc. to
concentrate our efforts on our domestic CTI solutions.
* 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.
* 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.
18
* 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.COM
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 sales force.
THE NON-CORE BUSINESS GROUP
This group is comprised of seven individually managed companies
whose businesses are as follows:
* 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.
* 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.
* Hopper Manufacturing Co., Inc. remanufactures and distributes
automotive parts. This primarily includes alternators,
starters, water pumps, distributors and smog pumps.
* Innovative Vacuum Solutions, Inc. designs, installs and re-
manufactures vacuum systems used in industry.
* Americom, STC Netcom and ACT Leasing are all involved in the
fabrication, installation and maintenance of microwave,
cellular and digital personal communication services towers.
We have previously announced our intention to divest, in the
ordinary course of business, these non-core businesses at such time and
on such terms as our Board of Directors determines advisable. There can
be no assurance that we will divest of any or all of these businesses or
as to the terms of any divestiture transaction.
19
RESULTS OF OPERATIONS
The following table summarizes the Company's results of operations
as a percentage of net operating revenue for the three and six month
periods ended June 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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-----------------------------------------------------
2000 1999 2000 1999
---- ---- ---- ----
% % % %
- - - -
Net operating revenue 100.0 100.0 100.00 100.0
Cost of goods sold 69.9 64.0 72.9 64.1
-----------------------------------------------------
Gross profit 30.1 36.0 27.1 35.9
Selling, general and administrative expenses 37.9 29.8 29.9 30.4
Depreciation and amortization 3.6 3.1 3.0 3.0
Unusual and restructuring charges 26.6 0.0 11.4 2.0
Interest income 0.6 0.2 0.4 0.2
Interest expense (2.1) (0.9) (1.7) (0.9)
-----------------------------------------------------
Income (loss) before provision (benefit) for
income taxes, minority interest and
extraordinary loss (39.5) 2.4 (18.4) (0.2)
Provision (benefit) for income taxes (12.7) 1.4 (5.9) 0.3
-----------------------------------------------------
Income (loss) before minority interest and
extraordinary loss (26.8) 1.0 (12.5) (0.5)
Minority interest (0.9) 0.3 0.2 0.4
-----------------------------------------------------
Income (loss) before extraordinary loss (27.7) 0.7 (12.7) (0.9)
Extraordinary loss 0.0 0.2 0.0 0.1
-----------------------------------------------------
Net income (loss) available to common stockholders (27.7) 0.5 (12.7) (1.0)
=====================================================
COMPANY OVERVIEW
Revenue
- -------
Revenue for the three months ended June 30, 2000 was $63.9
million, a decrease of $9.1 million, or 12.5%, from $73.0 million for
the three months ended June 30, 1999. Revenue for the six months ended
June 30, 2000 was $149.0 million, an increase of $24.5 million, or
19.7%, from $124.5 million for the six months ended June 30, 1999. The
decrease for the three months is due primarily to the dispositions
during 1999. The significant increase for the six months is attributable
to the growth of existing businesses as well as to growth through
acquisitions.
20
Revenue for each of the operating segments was:
(In thousands)
-------------------------------------------------------
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------------------------------------------
2000 1999 2000 1999
---- ---- ---- ----
Telephony<F1> $ 10,436 $ 13,523 $ 14,934 $ 23,532
Network 11,022 8,501 18,267 12,507
Internet 2,797 2,121 4,823 2,121
Applications 9,498 7,943 18,432 14,698
IntelleSale.com 22,581 24,154 73,418 41,260
Non-Core<F2> 9,019 17,349 23,035 32,559
Corporate Consolidating Eliminations (1,490) (636) (3,893) (2,149)
-------------------------------------------------------
Consolidated $ 63,863 $ 72,955 $ 149,016 $ 124,528
=======================================================
<FN>
- ----------
<F1> Includes TigerTel's revenue of $8.4 million and $13.4 million for
the three and six months ending June 30, 1999.
<F2> 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
$9.2 million and $16.9 million during the three and six months
ended June 30, 1999.
Changes during the quarter were:
* Telephony revenue decreased 22.8% for the quarter and 36.5% for
the six months primarily as a result of the sale of TigerTel in
December 1999. Revenue from the remaining entities increased by
$5.4 million in the quarter and $4.8 million for the six months
primarily as a result of the acquisition, in the second quarter of
2000, of Computer Equity Corporation.
* Network revenue increased 29.7% for the quarter and 46.1% for the
six months. The acquisition of Independent Business Consultants
in the second quarter of 2000 contributed $2.5 million,
representing 100.0% and 43.1% of the increase for the quarter and
six months, respectively. Growth of existing business contributed
the additional increase in the six months.
* Internet revenue increased by 31.9% in the quarter and 127.4% for
the six months. The increases were the result of the growth of
Port Consulting, Inc., which was acquired on April 1, 1999, and
the acquisition of Timely Technology Corp. on April 1, 2000.
* Applications revenue increased by 19.6% in the quarter and 25.4%
for the six months. P-Tech, Inc., an acquisition completed during
the second quarter of 2000 contributed $1.1 million or 73.3% of
the increase in the quarter and 29.7% of the increase for the six
months. The remaining increase is primarily as a result of revenue
of STR, Inc., an acquisition completed during the second quarter
of 1999. STR, Inc.'s revenue grew 49.6% and 223.5% for the three
and six months, respectively.
* IntelleSale's revenue decreased 6.5% in the quarter, while revenue
for the six months increased 78.0%. Bostek, which was acquired in
June 1999, contributed $24.3 million in the six months or 58.8% of
the increase, while existing businesses contributed the
difference. 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. The
revenues in the first quarter of 2000 for IntelleSale were
particularly high in relation to the second quarter in large part
because sales of Bostek's low-margin products are included in the
first quarter's results.
21
* Non-core revenue, which includes revenue from the former
Communications Infrastructure group, decreased $8.3 million, or
48%, in the second quarter and $9.5, or 29.3%, for the six 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 June 30, 2000 was $19.2
million, a decrease of $7.1 million, or 27.0%, from $26.3 million for
the three months ended June 30, 1999. Gross profit for the six months
ended June 30, 2000 was $40.4 million, a decrease of $4.3 million, or
9.6% from $44.7 million for the six months ended June 30, 1999. As a
percentage of revenue, the gross margin was 30.1% and 36.0% for the
three months ended June 30, 2000 and 1999, and was 27.1% and 35.9% for
the six months ended June 30, 2000 and 1999 respectively.
Gross profit for the three and six months ended June 30, 2000 and
1999 by each of the operating segments was:
(In thousands)
-----------------------------------------------------
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-----------------------------------------------------
2000 1999 2000 1999
---- ---- ---- ----
Telephony<F1> $4,673 $5,606 $6,640 $11,017
Network 2,854 2,833 5,149 3,654
Internet 2,120 1,618 3,979 1,618
Applications 5,063 5,538 9,602 9,169
IntelleSale.com 2,834 6,514 9,871 11,643
Non-Core<F2> 1,651 4,156 5,098 7,606
Corporate 8 18 107 39
-----------------------------------------------------
Consolidated $19,203 $26,283 $40,446 $44,746
=====================================================
<FN>
- ---------
<F1> Includes TigerTel's gross profit of $3.7 million and $7.2 million
for the three and six months ended June 30, 1999.
<F2> 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 $2.1 million and $3.8 million during the three and six months
ended June 30, 1999.
22
Gross margin percentage for the three and six months ended June
30, 2000 and 1999 by operating segments was:
----------------------------------------------------
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------------------------------------
2000 1999 2000 1999
---- ---- ---- ----
% % % %
- - - -
Telephony<F1> 44.8 41.5 44.5 46.8
Network 25.9 33.3 28.2 29.2
Internet 75.8 76.3 82.5 76.3
Applications 53.3 69.7 52.1 62.4
IntelleSale.com 12.6 27.0 13.4 28.2
Non-Core<F2> 18.3 24.0 22.1 23.4
----------------------------------------------------
Consolidated 30.1 36.0 27.1 35.9
====================================================
<FN>
- ---------
<F1> Includes TigerTel's gross profit margin of 44.0% and 53.7% and for
the three and six months ended June 30, 1999.
<F2> 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 22.8% and 22.3% during the
three and six months ended June 30, 1999.
Changes during the quarters were:
* Telephony gross profit decreased by 16.6% for the quarter and
39.7% for the six months primarily as a result of the sale of
TigerTel in December 1999. This was partially offset by the
acquisition, in the second quarter of 2000, of Computer Equity
Corporation, which contributed $1.3 million in gross profit.
Margins increased to 44.8% from 41.5% for the quarter primarily
due to higher margins from existing businesses and decreased to
44.5% from 46.8% for the six months primarily as a result of the
sale of TigerTel.
* Network gross profit remained stable for the quarter and margins
decreased to 25.9% from 33.3% due to a reduction in gross profit
from existing businesses partially offset by the acquisition of
Independent Business Consultants during the second quarter of
2000. Gross profit increased 40.9% for the six months and margins
remained relatively stable as a result of higher gross profit from
one of our existing businesses and the second quarter acquisition
of Independent Business Consultants.
* Internet gross profit increased for the three and six 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.
Timely Technology earns lower margin than Port Consulting, which
resulted in the slight decrease in the quarter. Margins increased
for the six months due to improvements by Port Consulting. 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.
* Applications gross profit decreased $0.5 million or 8.6% in the
quarter and increased $0.4 million or 4.7% for the six months.
Margins decreased 23.5% and 16.5% for the three and six month
periods, respectively. We are continuing to implement our planned
exit from a once highly profitable but declining modem and
communications market in the United Kingdom. The increase in
gross profit for the six months is due to the inclusion of P-Tech,
Inc., acquired in the second quarter of 2000.
23
* 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, inventory was liquidated at below cost
resulting in a loss of approximately $3.4 million which affected
IntelleSale's gross profit in the current quarter. Gross margin
has declined from 1999 to 2000 primarily as a result of the sales
of the low margin products discussed above and, in the second
quarter of 2000, because of the sale of inventory at a loss.
* 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 six months.
Selling, General and Administrative Expense
- -------------------------------------------
Selling, general and administrative expense for the three months
ended June 30, 2000 was $24.2 million, an increase of $2.5 million, or
11.5%, from $21.7 million for the three months ended June 30, 1999.
Selling, general and administrative expense for the six months ended
June 30, 2000 was $44.5 million, an increase of $6.7 million, or 17.7%
from $37.8 million for the six months ended June 30, 1999. As a
percentage of revenue, selling, general and administrative expense was
37.9% and 29.8% for the three months ended June 30, 2000 and 1999, and
was 29.9% and 30.4% for the six months ended June 30, 2000 and 1999,
respectively.
Selling, general and administrative expense for the three and six
months ended June 30, 2000 and 1999 by each of the operating segments
was:
(In thousands)
-----------------------------------------------------
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-----------------------------------------------------
2000 1999 2000 1999
---- ---- ---- ----
Telephony<F1> $2,813 $ 4,928 $5,024 $ 9,630
Network 2,194 2,007 4,192 2,612
Internet 2,087 1,321 3,881 1,327
Applications 5,289 4,696 9,414 8,035
IntelleSale.com 6,277 4,860 11,709 7,522
Non-Core<F2> 2,050 3,007 4,002 5,887
Corporate
3,459 905 6,302 2,803
-----------------------------------------------------
Consolidated $24,169 $21,724 $44,524 $37,816
=====================================================
<FN>
- ---------
<F1> Includes TigerTel's SG&A of $2.8 million and $5.4 million for the
three and six months ended June 30, 1999.
<F2> 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 $1.5
million and $3.1 million in the three and six months ended June
30, 1999.
24
Selling, general and administrative expense as a percentage of revenue
for the three and six months ended June 30, 2000 and 1999 by each of the
operating segments was:
-----------------------------------------------------
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-----------------------------------------------------
2000 1999 2000 1999
---- ---- ---- ----
% % % %
- - - -
Telephony<F1> 27.0 36.4 33.6 40.9
Network 19.9 23.6 22.9 20.9
Internet 74.6 62.3 80.5 62.6
Applications 55.7 59.1 51.1 54.7
IntelleSale.com 27.8 20.1 15.9 18.2
Non-Core<F2> 22.7 17.3 17.4 18.1
-----------------------------------------------------
Consolidated 37.9 29.8 29.9 30.4
=====================================================
<FN>
- ---------
<F1> Includes TigerTel's SG&A of 32.6% and 40.0% for the three and six
months ended June 30, 1999.
<F2> 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 16.3% and
18.1% for the three and six months ended June 30, 1999.
Changes during the quarter were:
* Telephony decreased $2.1 million or 42.8% in the second quarter of
2000 and $4.6 million or 47.7% in the six 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.
* Network remained relatively stable for the second quarter of 2000.
The significant increase of $1.6 million or 60.5% for the six
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 3.7% in the quarter due to SG&A being relatively the
same as the prior years quarter while sales increased, and
increased 2.0% for the six months due to increases in salaries and
related benefits, rent, and additional sales and marketing
expenses, offset by the additional revenue contributed by Creative
Computers.
* Internet increased both in dollar terms and as a percentage of
revenue for the quarter and six months 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. Entities comprising this group are service
oriented companies with lower cost of goods sold but higher SG&A
expenses.
* Applications increased $0.6 million or 12.6% for the quarter and
$1.4 million or 17.2% for the six months due to the acquisition of
P-Tech, Inc. in the second quarter of 2000 and increased costs
associated with the expansion of existing businesses. As a
percentage of revenue, SG&A expense in this division has decreased
slightly over the comparable 1999 periods.
* IntelleSale's SG&A expenses increased in dollar terms as a result
of the acquisition of Bostek in June 1999 and the increase of that
company's infrastructure to handle increases in both it's
traditional and Internet related business and the consolidation of
operations into one facility. As a
25
percentage of revenue, SG&A expense in this division has increased
7.7% in the quarter due to increased salaries and related
benefits, rent and advertising, but declined 2.3% in the six
months due to increased sales levels, particularly in the first
quarter of 2000. As previously discussed, the Company and
IntelleSale are in a dispute with the former owners of Bostek and
have ceased selling high-volume, low-margin Bostek products. The
revenues in the first quarter of 2000 for IntelleSale were
particularly high in relation to the second quarter in large part
because sales of Bostek's low-margin products are included in the
first quarter's results.
* Non-core SG&A decreased in dollar terms as a result of the sale of
four entities during 1999. The increase in SG&A as a percentage of
revenue in the quarter is due to significantly lower revenue at
two entities within this group in the second quarter without a
corresponding reduction in fixed SG&A.
* Corporate SG&A increased $2.6 million or 282.2% in the quarter and
$3.5 million or 124.8% for the six 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.
26
Depreciation and Amortization
- -----------------------------
Depreciation and amortization expense for the three months ended
June 30, 2000 and 1999 was $2.3 million. Depreciation from companies
disposed was offset by depreciation from companies acquired and fixed
asset additions. Depreciation and amortization expense for the six
months ended June 30, 2000 was $4.4 million, an increase of $0.6
million, or 15.8%, from $3.8 million for the six months ended June 30,
1999.
Depreciation and amortization expense for the three and six months
ended June 30, 2000 and 1999 by operating segments was:
(In thousands)
-----------------------------------------------------
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-----------------------------------------------------
2000 1999 2000 1999
---- ---- ---- ----
Telephony<F1> $133 $ 393 $227 $ 662
Network 46 30 84 35
Internet 46 23 78 23
Applications 231 399 509 746
IntelleSale.com 174 89 343 185
Non-Core<F2> 247 319 607 585
Corporate<F3> 1,432 1,022 2,551 1,525
-----------------------------------------------------
Consolidated $2,309 $ 2,275 $4,399 $ 3,761
=====================================================
<FN>
- ---------
<F1> Includes TigerTel's depreciation and amortization of $0.3 million
and $0.5 million in the three and six months ended June 30, 1999.
<F2> 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 $0.2
million in the three and six months ended June 30, of 1999.
<F3> Includes consolidation adjustments of $1.2 million and $0.7
million in the second quarters ended June 30, 2000 and 1999,
respectively, and $2.0 million and $1.1 million in the first six
months ended June 30, 2000 and 1999, respectively.
Changes during the quarter were
* Telephony decreased primarily as a result of the sale of TigerTel
in December 1999.
* Network increased due to an increase in depreciable assets in this
group during 2000.
* Internet increased due to the increase in depreciable assets
associated with the expansion of this division during 1999 and
2000 and the acquisition of Timely Technology Corp. in the second
quarter of 2000.
* Applications decreased due primarily to the reduction of
depreciable assets in this division during 2000.
* IntelleSale increased as a result of the increase in
depreciable assets during 1999 and the first six months of 2000
associated with the consolidation of the businesses into one
facility.
* Non-core decreased in the second quarter of 2000 due primarily to
the sale of assets associated with the Communications
Infrastructure group of companies in 1999. Non-core increased in
the six
27
months of 2000 primarily as a result of assets purchased by Ground
Effects during 1999 and in the first six months of 2000.
On an annual basis, goodwill amortization will be approximately $4.9
million for goodwill recorded as of June 30, 2000.
Interest Income and Expense
- ---------------------------
Interest income was $0.4 million and $0.1 million for the three
months ended June 30, 2000 and 1999, respectively, and was $0.6 million
and $0.3 million for the six months ended June 30, 2000 and 1999,
respectively. Interest income is earned primarily from short-term
investments and notes receivable.
Interest expense was $1.3 million and $0.7 million for the three
months ended June 30, 2000 and 1999, respectively, and was $2.5 million
and $1.1 million for the six months ended June 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 32.2% and 58.5% for the three months
ended June 30, 2000 and 1999, respectively and 31.9% and 185.7% for the
six months ended June 30, 2000 and June 30, 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 June 30, 2000, cash and cash equivalents totaled $12.7
million, an increase of $7.6 million, or 59.8% 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 $3.2 million at June 30, 2000, down from $11.8 million
at December 31, 1999. Cash used by operating activities totaled $28.6
million in the first six months of 2000 as compared to cash used by
operating activities of $2.9 million in the first six months of 1999.
Excluding assets and liabilities acquired or assumed in connection with
acquisitions, cash used in the first six 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 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 six 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 is accounts payable and accrued expenses partially offset
these uses.
28
"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, decreased by $2.1 million, or 4.0%, to $50.1 million at June
30, 2000 from $52.2 million at December 31, 1999. This decrease was
primarily attributable to the unusual charge against receivables in the
second quarter, partially offset by receivables associated with
companies acquired in the second quarter of 2000.
Inventories decreased by $1.4 million, or 3.5%, to $39.0 million
at June 30, 2000 from $40.4 million at December 31, 1999. This decrease
was primarily attributable to write-downs of inventories associated with
the second quarter unusual charges, partially offset by the inventories
associated with companies acquired in the second quarter of 2000.
Prepaid expenses and other current assets increased by 65.0%, or
$3.9 million to $9.9 million at June 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 in
the second quarter of 2000 and income tax receivable associated with the
carryback of net operating losses.
"Due to shareholders of acquired subsidiary" increased by $3.9
million, or 26.0%, to $18.9 million at June 30, 2000 from $15.0 million
at December 31, 1999. At June 30, 2000, the balance consisted of $10.0
million due to the former owners of Bostek, discussed below, and $8.9
million due to the sellers of Computer Equity Corporation, which was
paid in August 2000. 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 was not paid on June 30,
2000. 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 $5.8 million, or 19.7%, to $23.7
million at June 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 the second quarter of 2000.
Accrued expenses decreased by $1.3 million, or 7.3%, to $16.4
million at June 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 $24.4 million and used cash
of $19.4 million in the first six months of 2000 and 1999, respectively.
In the first six months of 2000, cash proceeds of $31.3 million was
collected on the sale of TigerTel, while cash of $1.7 million was used
in connection with acquired businesses, $4.3 million was spent to
acquire property and equipment, $0.7 million was advanced against notes
receivable and $0.2 million was used to increase other assets. In the
first six months of 1999, cash of $15.8 million was used to acquire
businesses, $2.6 million was used to acquire property and equipment and
$1.1 million was used to increase other assets.
Cash of $11.8 million and $23.3 million was provided by financing
activities in the first six months of 2000 and 1999, respectively. In
the six months of 2000, $6.2 million was borrowed under notes payable,
$4.6 million was repaid and $4.8 million was borrowed on long-term debt,
while $5.4 million was obtained through the issuance of common shares.
In the six months of 1999, $44.8 million was borrowed
29
and $7.3 million was repaid on long-term debt, while $11.2 million was
used to repay borrowings under notes payable and $3.1 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 stock and/or
bank borrowing, if available.
In August 1998, we entered into a $20 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 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. The IBM
Agreement, as amended and restated on July 30, 1999, and further
amended on January 27, 2000, provides for: (a) a revolving credit line
of up to $33.855 million, designated as follows: (i) a U.S. revolving
credit line of up to $30 million, (ii) a Canadian revolving credit line
of up to $3.855 million, and (b) a term loan A of up to $22 million,
(c) a term loan B of up to $36.405 million and (d) 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 1.75% to 1.90% depending on
our leverage ratio and the Canadian revolving credit line bears interest
at the base rate as announced by the Toronto-Dominion Bank of Canada
each month plus 0.1707% to 0.3207%, depending on our leverage ratio. As
of June 30, 2000, the LIBOR rate was approximately 6.5% and
approximately $30.6 million was outstanding on the revolving credit
line, which is included in notes payable.
Term loan A, which was used to pay off State Street Bank and Trust
Company, bears interest at the 30-day LIBOR rate plus 1.75% to 1.90%, is
amortized in quarterly installments over six years and is repayable in
full on May 25, 2002. As of June 30, 2000 approximately $18.3 million
was outstanding on this loan.
Term loan B, which may be used for acquisitions, bears interest at
the 30-day LIBOR rate plus 1.75% to 1.90%, is amortized in quarterly
installments over six years and is repayable in full on May 25, 2002.
As of June 30, 2000, approximately $22.3 million was outstanding on this
loan.
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 0.1707%, to 0.3207%, is
amortized in quarterly installments over six years and is repayable in
full on May 25, 2002. As of June 30, 2000, Toronto-Dominion's rate was
approximately 7.5% and approximately $2.7 million was outstanding on
this loan.
The agreement contains standard debt covenants relating to the
financial position and performance as well as restrictions on the
declarations and payment of dividends. As of June 30, 2000, the Company
was not in compliance with three of its four debt covenants and is
negotiating waivers with IBM Credit Corporation.
As of June 30, 2000, there were 59.2 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 10.9
30
million shares of Common Stock, of which 1.9 million shares of Common
Stock were issued as earnout payments 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, 7.2 million shares of Common
Stock were issued for acquisitions, 1.3 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. Under these agreements, assuming 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, 1.1 million of
which have been issued through June 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 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 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. Applied Digital Solutions
intends 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
31
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
In addition to the other information contained herein, the
following factors should be considered carefully in evaluating our
company and its business.
Uncertainty of Future Financial Results
- ---------------------------------------
While we have been profitable for the last three fiscal years,
future financial results are uncertain. There can be no assurance that
we will continue to be operated in a profitable manner. Profitability
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 and Market for our Shares of 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
acquisition agreements which may result in additional shares of common
stock being issued to selling shareholders as of the effective date of
the registration of the shares such selling shareholder previously
received as consideration from us. Such issuance of additional
securities may be dilutive of the value of the Common Stock in certain
circumstances and may have an adverse impact on the market price of the
Common Stock.
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 complete
successfully in this environment in the future.
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 such acquisitions will continue to
occur. Our total assets were approximately $252 million as of June 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 $63.9 million and
$73.0 million for the three months ended June 30, 2000 and 1999,
respectively, $149.0 million and $124.5 million for the six months ended
June 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
32
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.
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. Under these agreements, assuming 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, 1.1 million of
which have been issued through June 30, 2000, 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 write-offs will reduce our earnings
- --------------------------------------------
As a result of the acquisitions we have done to date, we have
approximately $97.4 million of goodwill, approximately $23.6 million of
which is deductible for tax purposes, which is currently being amortized
over 20 years at the rate of approximately $4.9 million per year, which
reduces our net income and our earnings per share. In addition, future
acquisitions may also increase our existing goodwill and the amount of
annual amortization, further reducing net income and earnings per share.
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.
Need for Additional Capital
- ---------------------------
We may require additional capital to fund growth of our current
business as well as to make future acquisitions. However, we may not be
able to obtain capital from outside sources. Even if we 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. If we raise additional
capital by issuing equity securities, there securities may have rights,
preferences or privileges senior to those of our common stockholders.
The IBM Agreement contains standard debt covenants relating to the
financial position and performance as well as restrictions on the
declarations and payment of dividends. As of June 30, 2000, the Company
was not in compliance with three of its four debt covenants and is
negotiating waivers with IBM
33
Credit Corporation. There can be no assurance that our negotiations
with IBM will be successful and that they will not exercise their rights
under the Agreement.
Dependence 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.
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.
Lack of Dividends on Common Stock; Issuance of Preferred Stock
- --------------------------------------------------------------
We do not have a history of paying dividends on our Common Stock,
and there can be no assurance that such dividends will be paid in the
foreseeable future. Pursuant to certain restrictions under our Amended
and Restated Term of Revolving Credit Agreement dated as of July 30,
1999 with IBM Credit Corporation, as amended, there are restrictions on
the declaration and payment of dividends. We intend to use any earnings
which may be generated to finance the growth of our businesses. 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 the Common Stock as to payment of
dividends.
Possible Volatility of Stock Price
- ----------------------------------
Our Common Stock is quoted on the Nasdaq Stock 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 June 30, 2000, the price per share of our Common Stock has
ranged from a high of $18.00 to a low of $1.63.
34
Termination Payments
- --------------------
Our employment agreements with three of our executive officers
include "change of control" provisions, under which the employees may
terminate their employment within one year after a change of control,
and be 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 obligations 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.
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
function. 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, results of operations or cash flows.
Year 2000 Compliance
- --------------------
We have not experienced any significant Year 2000 related
problems. During 1998 and 1999, we implemented a company wide program
to ensure that we would be compliant prior to the Year 2000 failure
dates. We did not experience problems on either January 1, 2000 or
February 29, 2000. However we cannot make any assurances that
unforeseen problems many not arise in the future.
Software Sold to Consumers. 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, management believes
that it is not possible to determine with complete certainty that all
Year 2000 problems affecting our software products will be 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 or other solutions 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. However, variability of
definitions of "compliance" with the Year 2000 and of different
combinations of software, firmware and hardware has led to law suits
against us and could possibly lead to additional lawsuits in the future.
The outcome of any such lawsuits and the impact on us are not estimable
at this time.
We do not believe that the Year 2000 problem has had or will have
a material adverse effect on our business, results of operations or cash
flows. The estimate of the potential impact on our financial
35
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, vendors' 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 FAS 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.
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 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 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.
36
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. We are not subject to any
environmental or governmental proceedings.
37
ITEM 2. CHANGES IN SECURITIES
Recent Sales of Unregistered Securities
The following table lists all unregistered securities sold by us
from January 1, 2000 through June 30, 2000. 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 Common
Name/Entity/Nature Note For Shares
------------------ ---- --- ------
Various <F1> Stock Options Exercised 1,291,090
Various <F2> Employee Stock Purchase Plan 187,041
Various <F3> Warrants Exercised 317,500
The Americom Group <F4> Acquisition 48,333
Computer Equity Corporation <F5> Acquisition 4,804,294
Hornbuckle Engineering, Inc. <F4> Acquisition 76,104
Independent Business Consultants <F5> Acquisition 957,912
Innovative Vacuum Solutions, Inc. <F6> Acquisition 25,881
Pizarro Remarketing, Inc. <F7> Acquisition 112,612
Port Consulting, Inc. <F4> Acquisition 302,981
PPL, Ltd. <F8> Acquisition 900,900
P-Tech, Inc. <F5> Acquisition 1,181,592
Service Transport Company <F7> Acquisition 101,351
STR, Inc. <F4> Acquisition 400,267
Timely Technology Corp. <F5> Acquisition 208,706
- -------------------------------------------------------------------------------------------------
Total 10,916,564
=================================================================================================
<FN>
<F1> Represents shares issued in connection with the exercise of
employee stock options.
<F2> Represents shares issued in connection with the Company's employee
stock purchase plan.
<F3> Represents shares issued in connection with the exercise of
warrants.
<F4> Represents shares issued in connection with the "earnout"
provision of the Agreement of Sale.
<F5> Represents shares issued to the selling shareholders to acquire
such shareholder's 100% interest in the company.
<F6> Represents additional consideration per the Merger Agreement
between IVS and MVAK Technologies, Inc.
<F7> Represents shares issued to a selling shareholder to acquire such
shareholder's minority interest.
<F8> Represents shares issued to the selling shareholders in
consideration for their minority interest and in settlement or
future earnout payments.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Information required by this item has been included in the
Amendment No. 1 to Form S-4 Registration Statement filed with the
Commission on June 27, 2000 (Registration No. 333-38068).
38
ITEM 5. OTHER INFORMATION
Mergers and Acquisitions
- ------------------------
During the second quarter of 2000 we acquired, in transactions
accounted for under the purchase method of accounting:
* 100% of the capital stock of Independent Business Consultants, a
network integration company based in Valley Village, California,
effective as of April 1, 2000;
* 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;
* 100% of the capital stock of P-Tech, Inc., a software development
company based in Manchester, New Hampshire, effective as of April
1, 2000; and
* 100% of the capital stock of Computer Equity Corporation, a
communications integration company based in Chantilly, Virginia,
effective as of June 1, 2000.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
27 Financial Data Schedule.
(b) Reports on Form 8-K.
The following Current Reports on Form 8-K were filed by the Company
between April 1, 2000 and the date of this report:
(1) On May 1, 2000, we filed a Current Report on Form 8-K which
included a copy of the Agreement and Plan of Merger, dated April
24, 2000, between Digital Angel.net Inc., a Delaware corporation
and wholly-owned subsidiary of the Registrant, and Destron
Fearing Corporation, a Delaware corporation.
(2) 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 Registrant and Computer Equity
Corporation.
39
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: August 14, 2000 By: /S/ DAVID A. LOPPERT
---------------------------------------
David A. Loppert
Vice President, Chief Financial Officer
40
EXHIBIT INDEX
Number Description of Exhibits
27 Financial Data Schedule
41