As filed with the Securities and Exchange Commission on May 20, 2002
- -------------------------------------------------------------------------------
UNITED STATES
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 March 31, 2002
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: 0-26020
APPLIED DIGITAL SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
MISSOURI 43-1641533
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
400 ROYAL PALM WAY, SUITE 410
PALM BEACH, FLORIDA 33480
(561) 805-8000
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Exchange Act
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes |X| No | |
The number of shares outstanding of each of the issuer's classes of
common stock as of the close of business on May 10, 2002:
Class Number of Shares
Common Stock; $.001 Par Value 269,879,106
APPLIED DIGITAL SOLUTIONS, INC.
TABLE OF CONTENTS
Item Description Page
PART I - FINANCIAL INFORMATION
1. Financial Statements (unaudited)
Consolidated Balance Sheets
March 31, 2002 and December 31, 2001 3
Consolidated Statements of Operations -
Three Months ended March 31, 2002 and 2001 4
Consolidated Statement of Stockholders' Equity -
Three Months ended March 31, 2002 5
Consolidated Statements of Cash Flows -
Three Months ended March 31, 2002 and 2001 6
Notes to Consolidated Financial Statements 7
2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 19
3. Quantitative and Qualitative Disclosures About Market Risk 37
PART II - OTHER INFORMATION
1. Legal Proceedings 38
2. Changes In Securities 40
3. Defaults Upon Senior Securities 41
4. Submission of Matters to a Vote of Security Holders 41
5. Other Information 42
6. Exhibits and Reports on Form 8-K 42
SIGNATURE 43
EXHIBITS 44
2
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
(Unaudited)
MARCH 31, December 31,
2002 2001
------------------------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 7,026 $ 3,696
Due from buyers of divested subsidiaries - 2,625
Accounts receivable and unbilled receivables (net of allowance
for doubtful accounts of $1,622 in 2002 and $2,581 in 2001) 13,487 21,871
Inventories 1,601 6,174
Notes receivable 1,848 2,256
Other current assets 4,539 4,786
- --------------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 28,501 41,408
PROPERTY AND EQUIPMENT, NET 3,031 20,185
NOTES RECEIVABLE, NET 5,170 4,004
GOODWILL, NET 17,356 90,831
INVESTMENT IN DIGITAL ANGEL CORPORATION 80,767 -
INVESTMENT IN AFFILIATE - 6,779
OTHER ASSETS, NET 3,678 4,282
- --------------------------------------------------------------------------------------------------------------------------------
$ 138,503 $ 167,489
================================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable and current maturities of long-term debt $ 82,296 $ 83,836
Accounts payable 8,946 15,441
Accrued expenses 12,966 18,207
Earnout and put accruals 200 200
Net liabilities of Discontinued Operations 9,529 9,460
- --------------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 113,937 127,144
LONG-TERM DEBT AND NOTES PAYABLE 38 2,586
- --------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 113,975 129,730
- --------------------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES - -
- --------------------------------------------------------------------------------------------------------------------------------
MINORITY INTEREST 3,980 4,460
- --------------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------------
REDEEMABLE PREFERRED STOCK OPTIONS - SERIES C - 5,180
- --------------------------------------------------------------------------------------------------------------------------------
PREFERRED STOCK, COMMON STOCK AND OTHER STOCKHOLDERS' EQUITY
Preferred shares: Authorized 5,000 shares in 2002 and 2001 of $10 par value;
special voting, no shares issued or outstanding in 2002 and 2001,
Class B voting, no shares issued or outstanding in 2002 and 2001 - -
Common shares: Authorized 345,000 shares in 2002 and 2001, of $.001 par
value; 269,540 shares issued and 267,619 shares outstanding in 2002
and 252,449 shares issued and 251,514 shares outstanding in 2001 270 252
Common and preferred additional paid-in capital 350,601 342,189
Accumulated deficit (321,612) (304,581)
Net loss arising from sale of Advanced Wireless Group (3,533) -
Common stock warrants 4,337 3,293
Treasury stock (carried at cost, 1,921 in 2002 and 935 shares in 2001) (3,655) (1,777)
Accumulated other comprehensive income (loss) 226 (747)
Notes received from shares issued (6,086) (10,510)
- --------------------------------------------------------------------------------------------------------------------------------
Total Preferred Stock, Common Stock, and Other Stockholders' Equity 20,548 28,119
- --------------------------------------------------------------------------------------------------------------------------------
$ 138,503 $ 167,489
================================================================================================================================
See the accompanying notes to consolidated financial statements.
3
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
FOR THE THREE MONTHS
ENDED MARCH 31,
--------------------------------
2002 2001
--------------------------------
Product revenue $ 23,795 $ 34,383
Service revenue 5,356 13,026
- -------------------------------------------------------------------------------------------------------------------------
Total revenue 29,151 47,409
Cost of products sold 17,419 23,844
Cost of services sold 2,313 6,217
- -------------------------------------------------------------------------------------------------------------------------
Gross profit 9,419 17,348
Selling, general and administrative expenses 8,536 17,673
Research and development 1,448 1,385
Non-cash compensation expense 282 -
Depreciation and amortization 1,002 6,458
Interest income (86) (487)
Interest expense 2,059 2,126
- -------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before taxes,
minority interest and equity in net loss of affiliate (3,822) (9,807)
Provision for income taxes 108 1,548
- -------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before minority interest,
and equity in net loss of affiliate (3,930) (11,355)
Minority interest (14) (93)
Equity in net loss of affiliate 14,394 131
- -------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations (18,310) (11,393)
Income from discontinued operations, net of income
taxes of $0 in 2001 - 213
Change in estimate on loss on disposal and operating
losses during the phase out period 1,279 -
- -------------------------------------------------------------------------------------------------------------------------
Net income (loss) (17,031) (11,180)
Preferred stock dividends and other - 238
Accretion of beneficial conversion feature of
redeemable preferred stock - series C - 2,451
- -------------------------------------------------------------------------------------------------------------------------
Net income (loss) available to common stockholders $ (17,031) $ (13,869)
=========================================================================================================================
Income (loss) per common share - basic
Income (loss) from continuing operations $ (0.07) $ (0.13)
Income from discontinued operations - -
- -------------------------------------------------------------------------------------------------------------------------
Net income (loss) per common share - basic $ (0.07) $ (0.13)
=========================================================================================================================
Income (loss) per common share - diluted
Income (loss) from continuing operations $ (0.07) $ (0.13)
Income from discontinued operations - -
- -------------------------------------------------------------------------------------------------------------------------
Net income (loss) per common share - diluted $ (0.07) $ (0.13)
=========================================================================================================================
Weighted average number of common shares outstanding - basic 253,938 103,602
Weighted average number of common shares outstanding - diluted 253,938 103,602
See the accompanying notes to consolidated financial statements.
4
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF PREFERRED STOCK,
COMMON STOCK AND OTHER STOCKHOLDERS' EQUITY
For The Three Months Ended March 31, 2002
(In thousands)
(Unaudited)
ADDITIONAL
PREFERRED STOCK COMMON STOCK PAID-IN ACCUMULATED
NUMBER AMOUNT NUMBER AMOUNT CAPITAL DEFICIT
--------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2001 - $ - 252,449 $ 252 $ 342,189 $ (304,581)
Net income - - - - - (17,031)
Comprehensive income -
Foreign currency translation - - - - - -
-----------
Total comprehensive loss - - - - - (17,031)
Net loss arising from sale of
Advanced Wireless Group - - - - - -
Expiration of redeemable preferred
stock options - Series C - - - - 5,180 -
Adjustment to notes received
for shares issued - - - (4,424) -
Repurchase of common stock - - - - 1,878 -
Stock option repricing - - - - 282 -
Stock warrant repricing - - - - - -
Issuance of common shares - - 5,585 6 683 -
Issuance of common shares for
services, compensation and other - - 11,506 12 4,813 -
- --------------------------------------------------------------------------------------------------------------------------------
BALANCE - MARCH 31, 2002 - $ - 269,540 $ 270 $ 350,601 $ (321,612)
================================================================================================================================
ACCUMULATED
NET LOSS ARISING COMMON OTHER NOTES TOTAL
FROM SALE OF ADVANCED STOCK TREASURY COMPREHENSIVE RECEIVED FOR STOCKHOLDERS'
WIRELESS GROUP WARRANTS STOCK INCOME (LOSS) SHARES ISSUED EQUITY
------------------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2001 $ - $ 3,293 $ (1,777) $ (747) $ (10,510) $ 28,119
Net income - - - - - (17,031)
Comprehensive income -
Foreign currency translation - - - 973 - 973
--------- -----------
Total comprehensive loss - - - 973 - (16,058)
Net loss arising from sale of
Advanced Wireless Group (3,533) - - - - (3,533)
Expiration of redeemable preferred
stock options - Series C - - - - - 5,180
Adjustment to notes received
for shares issued - - - - 4,424 -
Repurchase of common stock - - (1,878) - - -
Stock option repricing - - - - - 282
Stock warrant repricing - 1,044 - - - 1,044
Issuance of common shares - - - - - 689
Issuance of common shares for
services, compensation and other - - - - - 4,825
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE - MARCH 31, 2002 $ (3,533) $ 4,337 $ (3,655) $ 226 $ (6,086) $ 20,548
====================================================================================================================================
See the accompanying notes to consolidated financial statements.
5
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
FOR THE THREE MONTHS
ENDED MARCH 31,
------------------------------
2002 2001
------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (17,031) $ (11,180)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Income from discontinued operations (1,279) (213)
Deferred income taxes 403 2,299
Depreciation and amortization 1,002 6,458
Minority interest (14) (93)
Equity in net loss of affiliate 14,394 131
Gain on sale of subsidiaries and business assets (194) -
Loss on sale of equipment 87 85
Issuance of stock for services 2,451 -
Non-cash compensation expense 282 -
Change in assets and liabilities:
Decrease in accounts receivable 2,949 2,531
(Increase) decrease in inventories (1,322) 125
Decrease in other current assets 290 578
Decrease in other assets 407 281
Decrease in accounts payable and
accrued expenses (607) (720)
Net cash provided by (used in) discontinued operations 415 (520)
- -----------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 2,233 (238)
- -----------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Decrease in notes receivable 92 1,854
Due from buyers of divested subsidiaries 2,625 -
Decrease (increase) in other assets 111 (485)
Proceeds from sale of property and equipment 2,469 -
Proceeds from sale of subsidiaries and business assets 707 -
Payments for property and equipment (210) (1,879)
Net cash used in discontinued operations (658) (1,359)
- -----------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 5,136 (1,869)
- -----------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net amounts (paid) borrowed on notes payable (3,583) 1,600
Payments on long-term debt (1,119) (1,089)
Other financing costs (39) (25)
Issuance of common shares 866 78
Stock issuance costs (177) (63)
Proceeds from subsidiary issuance of common stock - 126
Net cash provided by (used in) discontinued operations 13 (166)
- -----------------------------------------------------------------------------------------------------------------------------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (4,039) 461
- -----------------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 3,330 (1,646)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 3,696 8,039
- -----------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 7,026 $ 6,393
=============================================================================================================================
See the accompanying notes to consolidated financial statements.
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 March 31, 2002 and
December 31, 2001 (the December 31, 2001 financial information included
herein has been extracted from the Company's audited financial statements
included in the Company's 2001 Annual Report on Form 10-K) and for the three
months ended March 31, 2002 and 2001 have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X under the Securities Exchange Act of 1934,
except as set forth below. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally
accepted in the United States of America 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.
On May 16, 2002, the Company filed a Notification of Late Filing on
Form 12b-25 indicating that it had a disagreement with its former outside
auditing firm, Grant Thornton LLP, concerning the proper accounting
treatment with respect to certain options and, as a result of this
disagreement, Grant Thornton LLP communicated its resignation in a letter to
the Company dated May 14, 2002. Grant Thornton LLP has advised the Company
that it has not completed its review of the Company's Quarterly Report on
Form 10-Q for the quarter ended March 31, 2002 and should not be associated
with that report in any way. Due to the timing of the resignation, the
Company has not engaged an outside auditing firm to replace Grant Thornton
LLP. As a result of the foregoing, the interim financial statements
contained in the Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 2002 have not been reviewed by an independent public
accountant as required pursuant to Rule 10-01(d) of Regulation S-X. When the
Company appoints its new auditors, they will complete the SAS 71 review of
its first quarter financial statements and the Company will file an amended
Form 10-Q/A.
The consolidated statements of operations for the three months
ended March 31, 2002 are not necessarily indicative of the results that may
be expected for the entire year. These statements should be read in
conjunction with the consolidated financial statements and related notes
thereto included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2001.
Certain items in the consolidated financial statements for the 2001
period have been reclassified for comparative purposes.
Accounting Policy
- -----------------
Gains and losses on issuance of unissued shares of stock by a
subsidiary are reflected as equity transactions. In accordance with
Statement of Financial Accounting Standard No. 109, Accounting for Income
Taxes, income taxes are not provided on the gains and losses.
Accounting Changes
- ------------------
Effective January 1, 2002, the Company adopted Statement of
Financial Accounting Standard No. 142 Goodwill and Other Intangible Assets
(FAS 142). FAS 142 requires that goodwill and certain intangibles no longer
be amortized, but instead tested for impairment at least annually. There was
no impairment of goodwill upon adoption of FAS 142. However, there can be no
assurance that future goodwill impairment tests will not result in
impairment charges.
The following table presents the impact of FAS 142 on net loss and net loss
per share had the standard been in effect for the three months ended March
31, 2001:
Three
Months Ended
March 31, 2001
----------------------
(amounts in thousands)
Net loss available to common stockholders:
Net loss available to common stockholders as reported $ (13,869)
Goodwill amortization 5,391
Equity method investment amortization 113
----------------------
Adjusted net loss $ (8,365)
======================
Basic and diluted loss per share:
Net loss per share, basic and diluted, as reported $ (0.13)
Goodwill amortization 0.05
Equity method investment amortization --
----------------------
Adjusted net loss per share, basic and diluted $ (0.08)
======================
7
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
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. Effective March 27, 2002, the Company's 93% owned subsidiary,
Digital Angel Corporation (Digital Angel), merged with Medical Advisory
Systems, Inc. (AMEX: DOC) (MAS). MAS's name was changed to Digital Angel
Corporation. Pursuant to the merger agreement, the Company contributed all
of its stock in Timely Technology Corp. and Signature Industries, Limited to
MAS. Digital Angel, Timely Technology Corp. and Signature Industries,
Limited are collectively referred to as the Advanced Wireless Group. As a
result of the merger, the Company beneficially owns approximately 77.46% of
the newly combined company, after giving effect to the exercise of options
to acquire shares of Digital Angel Corporation common stock exercised prior
to the merger. Prior to the merger, the Company owned 16.6% of MAS. In
satisfaction of a condition to the consent of the merger by IBM Credit
Corporation, the Company's lender, the Company transferred to a Delaware
business trust controlled by an advisory board all of the shares of MAS
common stock owned by it and, as a result, the trust has legal title to
approximately 77.46% of the MAS common stock. The trust has voting rights
with respect to the MAS common stock until the Company's obligations to IBM
Credit are repaid in full. The trust may be obligated to liquidate the
shares of MAS common stock owned by it for the benefit of IBM Credit
Corporation in the event the Company fails to make payments, or otherwise
defaults, under its new credit agreement with IBM Credit, which became
effective on the date of the merger. The Company has retained beneficial
ownership of the shares.
Until the effective date of the merger, the Company included the
accounts of Digital Angel Corporation, Timely Technology Corp. and Signature
Industries, Limited on a consolidated basis and it accounted for its
investment in MAS under the equity method of accounting. The Company's
investment in the newly-merged entity is being accounted for in a manner
similar to the equity method of accounting post merger, except if and until
such time the shares of MAS common stock revert back to the Company, equity
in losses will be recognized, but not equity in income.
3. INVENTORY
March 31, December 31,
2002 2001
------------------ ------------------
Raw materials $-- $1,474
Work in process 668 176
Finished goods 1,340 6,226
------------------ ------------------
2,008 7,876
Allowance for excess and obsolescence (407) (1,702)
------------------ ------------------
Net inventory for continuing operations $1,601 $6,174
================== ==================
8
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
4. FINANCING AGREEMENTS
On January 31, 2002 and again on February 27, 2002, the Company
entered into amendments to its credit agreement with IBM Credit. These
amendments extended the principal and interest payments, which were due to
April 2, 2002, including principal payments that were initially due on July
1, 2001.
On March 1, 2002, the Company, Digital Angel Share Trust, a newly
created Delaware business trust and IBM Credit entered into a Third Amended
and Restated Term Credit Agreement. The new credit agreement became
effective on March 27, 2002 the effective date of the merger between Digital
Angel and MAS. Amounts outstanding under the new credit agreement bear
interest at an annual rate of 17% and mature on February 28, 2003. No
principal or interest payments are due until the maturity date. However, the
maturity date will be extended for consecutive one-year periods if the
Company repays at least 40% of the original principal amount outstanding
plus accrued interest and expenses prior to February 28, 2003 and an
additional 40% of the original principal amount outstanding plus accrued
interest and expenses prior to February 28, 2004. In any event, all amounts
outstanding will be required to be repaid by August 15, 2005. If all amounts
are not repaid by February 28, 2003, the unpaid amount will accrue interest
at an annual rate of 25%. If not repaid by February 28, 2004, the interest
rate increases to 35%.
On March 31, 2002, the total amounts outstanding under the new
credit agreement were $82.1 million. As part of the amendments to the
agreement with IBM Credit, the Company paid bank fees of $0.3 million in
March 2002 and agreed to re-price warrants that were previously issued to
IBM Credit in April 2001. The re-priced warrants were valued at $1.0
million. The bank fees and fair value of the warrants are recorded as
deferred financing fees and are being amortized over the life of the debt as
interest expense.
The Company's covenants under the new credit agreement are as
follows:
COVENANT COVENANT REQUIREMENT
- --------------------------------------------------------------------------------------
As of the following date not less than:
Current Assets to Current Liabilities 31-Mar-02 .17:1
30-Jun-02 .14:1
30-Sep-02 .11:1
31-Dec-02 .11:1
- --------------------------------------------------------------------------------------
Minimum Cumulative EBITDA 31-Mar-02 ($1,528,000)
30-Jun-02 121,000
30-Sep-02 817,000
9
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
In addition, the new credit agreement contains covenants for
Digital Angel Corporation, as follows:
COVENANT COVENANT REQUIREMENT
- --------------------------------------------------------------------------------------
As of the following date not less than:
Current Assets to Current Liabilities 30-Jun-02 1.8:1
30-Sep-02 1.8:1
31-Dec-02 2.0:1
- --------------------------------------------------------------------------------------
Minimum Cumulative EBITDA 30-Jun-02 $577,000
30-Sep-02 1,547,000
31-Dec-02 3,329,000
- --------------------------------------------------------------------------------------
If these Digital Angel Corporation covenants are not met the
Company will be in default under the credit agreement.
The credit agreement also contains restrictions on the declaration
and payment of dividends.
At March 31, 2002, the Company was in compliance with its debt
covenants. Based on 2002 projections, the Company currently expects to meet
and be in compliance throughout 2002 with the covenants in its new credit
agreement. However, if business conditions are other than as anticipated or
other unforeseen events or circumstances occur, these may impact the
Company's ability to remain in compliance with the covenants. In the absence
of waiver or amendment to such financial covenants, such noncompliance would
constitute an event of default under the new credit agreement, and IBM
Credit would be entitled to accelerate the maturity of all amounts the
Company owes them. In the event that such noncompliance appears likely, or
occurs, the Company will seek to renegotiate the covenants and/or obtain
waivers, as required. There can be no assurance, however, that the Company
would be successful in negotiating such amendments or obtaining such
waivers.
Amounts outstanding under the credit agreement are secured by a
security interest in substantially all of the Company's assets, excluding
the assets of Digital Angel Corporation. The shares of the Company's
subsidiaries, including the Digital Angel Corporation common stock held in
the Digital Angel Share Trust, also secure the amounts outstanding under the
credit agreement.
10
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
5. EARNINGS (LOSS) PER SHARE
The following is a reconciliation of the numerator and denominator
of basic and diluted earnings (loss) per share:
------------------------------------------
THREE MONTHS ENDED MARCH 31,
------------------------------------------
2002 2001
---- ----
NUMERATOR:
Loss from continuing operations $(18,310) $(11,393)
Preferred stock dividends -- (238)
Accretion of beneficial conversion feature of redeemable preferred stock -- (2,451)
-----------------------------------------
NUMERATOR FOR BASIC EARNINGS (LOSS) PER SHARE -
Net loss from continuing operations available to common shareholders $(18,310) $(14,082)
Net income from discontinued operations available to common shareholders 1,279 213
-----------------------------------------
Net loss available to common shareholders $(17,031) $(13,869)
=========================================
DENOMINATOR:
DENOMINATOR FOR BASIC EARNING (LOSS) PER SHARE -
Weighted-average shares 253,938 103,602
-----------------------------------------
Denominator for diluted earnings (loss) per share(1) 253,938 103,602
-----------------------------------------
BASIC EARNINGS (LOSS) PER SHARE:
CONTINUING OPERATIONS $(0.07) $(0.13)
DISCONTINUED OPERATIONS -- --
-----------------------------------------
TOTAL - BASIC $(0.07) $(0.13)
=========================================
DILUTED EARNINGS (LOSS) PER SHARE:
CONTINUING OPERATIONS $(0.07) $(0.13)
DISCONTINUED OPERATIONS -- --
-----------------------------------------
TOTAL - DILUTED $(0.07) $(0.13)
=========================================
<FN>
(1) 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 ENDED MARCH 31,
2002 2001
---- ----
Redeemable preferred stock -- 16,064
Employee stock options 16,020 3,444
Warrants 2,103 --
----------------------------------------
18,123 19,508
========================================
11
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
6. SEGMENT INFORMATION
As a result of the merger of Digital Angel and MAS, the significant
restructuring of the Company's business during the past several months and
the Company's emergence as an advanced technology development company, the
Company has re-evaluated and realigned its reporting segments. The Company
currently operates in one business segment - Advanced Technology. The
business units comprising the Advanced Technology segment represent those
business that management believes will provide the necessary synergies,
support and infrastructure to allow the Company to develop, promote and
fully integrate its life-enhancing technology products and services.
Business units that were closed or sold during the 2001 and 2002 are
reported as "All Other." Prior to January 1, 2002, the Company's business
units were organized into three segments: Applications, Services and
Advanced Wireless. Prior period information has been restated to present the
Company's reportable segments on a comparative basis.
Additionally, the Company's previously reported Intellesale and all
other non-core business segments are reported as discontinued operations.
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 in the 2001
period, goodwill amortization. The accounting policies of the 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, 2001, except that intersegment sales and transfers are
generally accounted for as if the sales or transfers were to third parties
at current market prices. It is on this basis that management utilizes the
financial information to assist in making internal operating decisions. The
Company evaluates performance based on segment operating income.
Following is the selected segment data as of and for the three
months ended March 31, 2002:
SEGMENTS
--------
Advanced Technology All Other Eliminations Consolidated
----------------------------------------------------------------------
Net revenue from external customers:
Product $22,782 $1,013 $-- $23,795
Service 4,981 375 -- 5,356
Inter-segment revenue -- -- -- --
----------------------------------------------------------------------
Total revenue $27,763 $1,388 $-- $29,151
======================================================================
Income (loss) from continuing operations before
income taxes, minority interest and equity in net
loss of affiliate $(3,956) $134 $-- $(3,822)
======================================================================
Total assets $321,130 $2,909 $(185,536) $138,503
======================================================================
12
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 March 31, 2001:
SEGMENTS
--------
Advanced Technology All Other Eliminations Consolidated
----------------------------------------------------------------------
Net revenue from external customers:
Product $27,109 $7,274 $-- $34,383
Service 5,933 7,260 (167) 13,025
Inter-segment revenue (167) -- 167 --
----------------------------------------------------------------------
Total revenue $32,875 $14,534 $-- $47,409
======================================================================
Loss from continuing operations before income taxes,
minority interest and equity in loss of affiliate $(2,258) $(882) $(6,667) $(9,807)
======================================================================
Total assets, exclusive of net assets of
discontinued operations $500,576 $34,452 $(223,576) $311,452
======================================================================
7. ACQUISITIONS AND DISPOSITIONS
On February 27, 2001, the Company acquired 16.6% of the capital
stock of MAS, a provider of medical assistance and technical products and
services, in a transaction valued at approximately $8.3 million in
consideration for 3.3 million shares of its common stock. The Company became
the single largest shareholder and controlled two of the seven board seats.
The Company accounted for this investment under the equity method of
accounting. The excess of the purchase price over the net book value
acquired was approximately $6.8 million and was being amortized on a
straight-line basis over five years. Under Financial Accounting Standards
No. 142, which the Company adopted on January 1, 2002, the goodwill embedded
in the Company's equity investment in MAS is no longer amortized. As a
result of no longer amortizing this goodwill, the Company' net income
increased by $0.3 million for the three months ended March 31, 2002.
Effective March 27, 2002, the Company's 93% owned subsidiary,
Digital Angel, merged with MAS. As a result of the merger, the Company now
owns approximately 77.46% of Digital Angel Corporation. During the three
months ended March 31, 2002, the Company recorded a net loss of $3.5 million
arising from the transaction. The net loss is comprised of a loss of
approximately $6.9 million resulting from the exercise of 1.5 million
Digital Angel options, partially offset by a gain of approximately $3.4
million from the sale of 22.54% of the Advanced Wireless Group as a result
of the merger with MAS. The net loss is reflected in the equity section of
the balance sheet at March 31, 2002.
In satisfaction of a condition to the consent to the merger by IBM
Credit Corporation, the Company's lender, the Company transferred to a
Delaware business trust controlled by an advisory board all of the shares of
MAS common stock owned by it and, as a result, the trust has legal title to
approximately 77.46% of the MAS common stock. The trust has voting rights
with respect to the MAS common stock until the Company's obligations to IBM
Credit are repaid in full. The trust may be obligated to liquidate the
shares of MAS common stock owned by it for the benefit of IBM Credit
Corporation in the event the Company fails to make payments, or otherwise
defaults, under its new credit agreement with IBM Credit, which became
effective on the date of the merger. The Company has retained beneficial
ownership of the shares.
13
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
The Company's investment in the newly merged entity will be
accounted for in a manner similar to the equity method of accounting post
merger, except if and until such time the shares of MAS common stock revert
back to the Company, equity in losses will be recognized, but not equity in
income.
Unaudited pro forma results of operations for the three months
ended March 31, 2002 are included below. Such pro forma information assumes
that the merger of Digital Angel and MAS had occurred as of January 1, 2002.
-----------------
THREE MONTHS
ENDED
MARCH 31,
-----------------
2002
----
Net operating revenue from continuing operations $30,037
Loss from continuing operations (18,595)
Loss available to common stockholders from continuing operations (18,595)
Loss per common share from continuing operations - basic $(0.07)
Loss per common share from continuing operations - diluted $(0.07)
Earnout and Put Agreements
--------------------------
Certain acquisition agreements the Company entered into during 2000
include additional consideration contingent on profits of the acquired
subsidiary. Upon earning this additional consideration, the value will be
recorded as additional goodwill. The financial statements include the value
of shares earned upon attainment of certain profits by subsidiaries through
March 31, 2002. At March 31, 2002, under these agreements, assuming all
earnout profits are achieved, the Company is contingently liable for
additional consideration of approximately $15.9 million in 2002, all of
which would be payable in shares of the Company's common stock.
8. REDEEMABLE PREFERRED STOCK
The Preferred Stock. On October 26, 2000, the Company issued 26,000
shares of Series C convertible preferred stock to a select group of
institutional investors in a private placement. The stated value of the
preferred stock was $1,000 per share, or an aggregate of $26.0 million, and
the purchase price of the preferred stock and the related warrants was an
aggregate of $20.0 million. The preferred stock was convertible into shares
of the Company's common stock. The holders of the preferred stock were
entitled to receive annual dividends of 4% of the stated value (or 5.2% of
the purchase price) payable in either cash or additional shares of preferred
stock. As of December 31, 2001, all of the preferred shares have been
converted into shares of the Company's common stock.
For the quarter ended March 31, 2001, the beneficial conversion
feature (BCF) associated with the Company's preferred stock charged to
earnings per share was $2.5 million. As of June 30, 2001, the BCF was fully
accreted. The BCF was recorded as a reduction in the value assigned to the
preferred stock and an increase in additional paid-in capital. The Company
recorded the accretion of the BCF over the period from the date of issuance
to the earliest beneficial conversion date available through equity,
reducing the income available to common stockholders and earnings per share.
14
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Option to Acquire Additional Preferred Stock. The investors had the
option to purchase up to an additional $26.0 million in stated value of
Series C convertible preferred stock and warrants with an initial conversion
price of $5.00 per share, for an aggregate purchase price of $20.0 million,
at any time up to ten months following the effective date of the Company's
registration statement relating to the common stock issuable on conversion
of the initial series of the preferred stock. The additional preferred stock
would have had the same preferences, qualifications and rights as the
initial preferred stock. The fair value of the option was estimated using
the Black-Scholes option pricing model with the following assumptions:
dividend yield of 0%, expected volatility of .40% and a risk free interest
rate of 5.5%. The investors elected not to exercise the option and it
expired on February 24, 2002, and accordingly, the fair value of the option
was recorded as an increase in additional-paid-in-capital.
9. DISCONTINUED OPERATIONS
On March 1, 2001, the Company's board of directors approved a plan
to offer for sale its Intellesale business segment and all of its other
"non-core businesses". Accordingly, the operating results of these entities
have been reclassified and reported as discontinued operations for all
periods presented. As of March 1, 2002, the Company had sold or closed
substantially all of the businesses comprising Discontinued Operations.
There are two insignificant companies remaining, which had combined revenues
and net losses for the year ended March 31, 2002 of $0.3 million and $0.1
million, respectively. The Company anticipates selling these two remaining
companies within the next several months. Proceeds from the sales of
Discontinued Operations companies were used to repay amounts outstanding
under the IBM Agreement. Any additional proceeds on the sales of the
remaining two businesses will also be used to repay the IBM debt.
The following discloses the results of Intellesale and all other
non-core businesses comprising discontinued operations for the period from
January 1, 2001 through March 1, 2001:
January 1, through
March 1,
-----------------------------
2001
----
Product revenue $13,039
Service revenue 846
-----------------------------
Total revenue 13,885
Cost of products sold 10,499
Cost of services sold 259
-----------------------------
Total cost of products and services sold 10,758
-----------------------------
Gross profit 3,127
Selling, general and administrative expenses 2,534
Depreciation and amortization 264
Interest, net 29
Provision for income taxes 34
Minority interest 53
-----------------------------
Income from discontinued operations $213
=============================
15
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
The above results do not include any allocated or common overhead
expenses. Included in Interest, net, above are interest charges based on the
debt of one of these businesses. A purchaser assumed this debt when the
business was sold on January 31, 2002.
Assets and liabilities of discontinued operations are as follows at
March 31, 2002 and December 31, 2001.
March 31, 2002 December 31, 2001
-------------------------------------------------
(In thousands)
Current Assets
Cash and cash equivalents $ 328 $ --
Accounts receivable and unbilled receivables, net 452 5,745
Inventories 173 4,430
Prepaid expenses and other current assets -- 291
-------------------------------------------------
Total Current Assets 953 10,466
Property and equipment, net 246 3,553
Other assets 15 242
-------------------------------------------------
$ 1,214 $14,261
=================================================
Current Liabilities
Notes payable and current maturities of long-term debt $ 4 $ 5,040
Accounts payable 4,157 8,670
Accrued expenses 6,347 9,610
-------------------------------------------------
Total Current Liabilities 10,508 23,320
Long-term debt 36 --
Minority interest 199 401
-------------------------------------------------
10,743 23,721
=================================================
Net Liabilities of Discontinued Operations $(9,529) $(9,460)
=================================================
16
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
The Company recorded a provision for operating losses, estimated
loss on sale and carrying costs during the phase-out period including
operating and other disposal costs to be incurred in selling the businesses.
Carrying costs primarily include the cancellation of facility leases,
employment contract buyouts and litigation reserves. During the quarter
ended March 31, 2002, the Company increased by $0.2 million its estimated
loss on sale of its 85% ownership in its Canadian subsidiary, Ground
Effects, Ltd, which was sold on January 31, 2002. Proceeds on the sale of
Ground Effects, Ltd. approximated $1.6 million plus the assumption of the
Canadian portion of the IBM debt. Offsetting the increase in the estimated
loss on sale was net operating income for the first quarter of 2002. This
net income was primarily due to a change in estimated carrying costs
associated with the discontinued businesses during the first quarter of
2002.
The following table sets forth the roll forward of the liabilities
for estimated loss on sale and operating losses and carrying costs from
December 31, 2001 through March 31, 2002. The additions represent operating
income during the quarter.
Balance
Balance March 31,
Type of Cost December 31, 2001 Additions Deductions 2002
- --------------------------------------------------------------------------------------------------------------------
Estimated loss on sale, net of change in
estimated operating losses $1,173 $(1,279) $106 $--
Carrying costs 7,218 -- (1,295) 5,923
--------------------------------------------------------------
Total $8,391 $(1,279) $1,189 $5,923
==============================================================
10. NON-CASH COMPENSATION EXPENSE
The Company incurred approximately $0.3 million in non-cash
compensation expense from re-pricing 19.3 million stock options during 2001.
The options had original exercise prices ranging from $0.69 to $6.34 per
share and were modified to change the exercise price to $0.15 per share. Due
to the modification, these options are being accounted for as variable
options under APB Opinion No. 25 and fluctuations in the Company's common
stock price will result in increases and decreases of non-cash compensation
expense until the options are exercised, forfeited or expired.
11. EQUITY IN NET LOSS OF AFFILIATE
Equity in net loss of affiliate was $14.4 million and $0.1 million
for three months ended March 31, 2002 and 2001, respectively. Included in
the equity in net loss of affiliate for the three months ended March 31,
2002 is non-cash compensation expense. Pursuant to the terms of the Digital
Angel and MAS merger agreement effective March 27, 2002, options to acquire
shares of Digital Angel common stock were converted into options to acquire
shares of MAS common stock. The conversion resulted in a new measurement
date for the options and, as a result, the Company recorded its equity
percentage of the one-time, non-recurring, non-cash compensation expense,
which was approximately $14.3 million during the three months ended March
31, 2002. For current employees of Digital Angel, these options are
considered fixed awards under APB Opinion No. 25 and expense was recorded
for the intrinsic value of the options converted. For all others, expense
was recorded for the fair value of the options converted in accordance with
FAS 123. Fair value was determined by using the Black-Scholes option pricing
model.
17
APPLIED DIGITAL SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
12. NASDAQ LISTING REQUIREMENTS
On May 2, 2002, the Company received a letter from Nasdaq
containing a staff determination that it had regained compliance with
Nasdaq's minimum bid price requirement of $1.00 per share. The Company had
previously been given until May 15, 2002 to regain compliance with the
minimum bid price requirement.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with the accompanying
financial statements and related notes included in Item 1 of this report as
well as our 2001 Annual Report on Form 10-K.
We are an advanced technology development company. We focus on
developing advanced life-enhancing technology products and services. To
date, we have developed three such products: (i) Digital Angel, for
monitoring and tracking people and objects; (ii) VeriChip, an implantable
radio frequency verification device that can be used for security, emergency
and healthcare applications; and (iii) Thermo Life, a thermoelectric
generator.
Approximately two years ago, we developed a patent for what we believe
is the world's first combination of advanced biosensor technology and
web-enabled wireless telecommunications linked to GPS in a watch/pager
device that communicates through proprietary software to a secure 24/7
operations center in California. This technology provides "where-you-are"
and "how-you-are" information about loved ones (particularly elderly
relatives and children), their location and their vital signs via the
subscriber's computer, PDA or wireless phone. We branded this technology
Digital Angel and merged the technology with a company formerly known as
Destron Fearing Corporation. Our goal was to create a new corporation
underpinned by the patented technology and complemented by the products and
services and revenues of our existing business segments. We united our
existing GPS, application service provider and animal tracking business
units to form Digital Angel Corporation. Effective March 27, 2002, Digital
Angel Corporation became its own public company through the merger of
Medical Advisory Systems, Inc. (AMEX:DOC). We are the beneficial owner of
approximately 77.46% of this new company. We launched Digital Angel, the
product, on November 26, 2001.
In October 2001, we announced our new wholly-owned subsidiary, Thermo
Life Energy Corp, formerly Advanced Power Solutions, Inc., which will
develop, market and license our new product, Thermo Life, the world's
smallest thermoelectric generator powered by body heat. Thermo Life is
intended to provide a miniaturized power source for a wide range of consumer
electronic devices including attachable or implantable medical devices and
wristwatches.
In December 2001, we announced the development of a miniaturized,
implantable verification chip, called VeriChip that can be used in a variety
of security, emergency and healthcare applications. On February 7, 2002, we
created a new wholly-owned subsidiary, VeriChip Corporation, which will
develop, market and license VeriChip. About the size of the point of a
typical ballpoint pen, each VeriChip will contain a unique verification
number. Utilizing an external scanner, radio frequency energy passes through
the skin energizing the dormant VeriChip, which then emits a radio frequency
signal transmitting the verification number contained in the VeriChip.
As a result of the merger of Digital Angel and MAS, which occurred on
March 27, 2002, the significant restructuring of our business during the
past year and our emergence as an advanced technology development company,
we have re-evaluated and realigned our reporting segments. Effective January
1, 2002, we currently operate in one business segment - Advanced Technology.
The business units comprising the Advanced Technology segment represent
those business units that we believe will provide the necessary synergies,
support and infrastructure to allow us to develop, promote and fully
integrate our life-enhancing technology products and services. Business
units that were part of our Continuing Operations and that were closed or
sold during the 2001 and 2002 are reported as All Other. Prior to January 1,
2002, our business was organized into three segments: Applications, Services
and Advanced Wireless. Prior period information has been restated to present
the our reportable segment on a comparative basis.
19
Additionally, our previously reported Intellesale and all other
non-core business segments are reported as Discontinued Operations.
RECENT DEVELOPMENTS
On March 27, 2002, Digital Angel merged with MAS. Also, pursuant to the
merger agreement, we contributed all of our stock in Timely Technology
Corp., our wholly owned subsidiary, and Signature Industries, Limited, an
85% owned subsidiary. Digital Angel, Timely Technology Corp. and Signature
Industries, Limited are collectively referred to as the Advanced Wireless
Group. In satisfaction of a condition to the consent to the merger by IBM
Credit, we transferred to a Delaware business trust controlled by an
advisory board all shares of MAS common stock owned by us and, as a result,
the trust has legal title to approximately 77.46% of the MAS common stock.
The trust has voting rights with respect to the MAS common shares until we
repay our obligations to IBM Credit in full. We have retained beneficial
ownership of the shares. The trust may be obligated to liquidate the shares
of MAS common stock owned by it for the benefit of IBM Credit in the event
we fail to make payments, or otherwise default, under our new credit
agreement with IBM Credit, as discussed below. Such liquidation of the
shares of MAS common stock will be in accordance with the Securities and
Exchange Commission's rules and regulations governing affiliates.
During the three months ended March 31, 2002, we recorded a net loss of
$3.5 million arising from the transaction. The net loss is comprised of a
loss of approximately $6.9 million resulting from the exercise of 1.5
million Digital Angel options, partially offset by a gain of approximately
$3.4 million from the sale of approximately 22.54% of Digital Angel and the
other subsidiaries comprising the Advanced Wireless Group as a result of the
merger with MAS. The net loss is reflected in the equity section of the
balance sheet at March 31, 2002.
Our investment in the newly merged entity will not be consolidated and
will be accounted for in a manner similar to the equity method post merger,
except if and until such time the shares of MAS revert back to us, equity in
losses will be recognized but not equity in income.
Credit Agreement
On January 31, 2002 and again on February 27, 2002, we entered into
amendments to our credit agreement with IBM Credit. These amendments
extended the principal and interest payments, which were due to April 2,
2002, including principal payments that were initially due on July 1, 2001.
Effective March 27, 2002, we entered into a new credit agreement with
IBM Credit. Amounts outstanding under the new credit agreement of $82.1
million at March 31, 2002 bear interest at an annual rate of 17% and mature
on February 28, 2003. No principal or interest payments are due until the
maturity date. However, the maturity date will be extended for consecutive
one-year periods if we repay at least $32.8 million, or 40% of the principal
amount outstanding plus accrued interest and expenses prior to February 28,
2003 and an additional 40% of the principal amount outstanding plus accrued
interest and expenses prior to February 28, 2004. In any event, all amounts
outstanding will be required to be repaid by August 15, 2005. If all amounts
are not repaid by February 28, 2003, the unpaid amount will accrue interest
at an annual rate of 25%. If not repaid by February 28, 2004, the interest
rate increases to 35%.
Our new credit agreement with IBM Credit also contains debt covenants
relating to our financial position and performance, as well as the financial
position and performance of Digital Angel Corporation. The new credit
agreement also prohibits us from borrowing funds from other lenders, and
does not provide for any additional advances.
20
RESULTS OF CONTINUING OPERATIONS
The following table summarizes our results of operations as a
percentage of net operating revenue for the three month periods ended March
31, 2002 and 2001 and is derived from the unaudited consolidated statements
of operations in Part I, Item 1 of this report.
RELATIONSHIP TO
REVENUE
----------------------------------------
THREE MONTHS ENDED MARCH 31,
----------------------------------------
2002 2001
---- ----
% %
- -
Product revenue 81.6 72.5
Service revenue 18.4 27.5
----------------------------------------
Total revenue 100.0 100.0
Cost of goods sold 73.2 69.3
Cost of services sold 43.2 47.7
----------------------------------------
Total cost of goods and services sold 67.3 63.4
----------------------------------------
Gross profit 32.3 36.6
Selling, general and administrative expense 29.3 37.3
Research and development 5.0 2.9
Non-cash compensation expense 1.0 --
Depreciation and amortization 3.4 13.6
Interest income (0.3) (1.0)
Interest expense 7.0 4.5
----------------------------------------
Income (loss) from continuing operations before income taxes, minority
interest and equity in net loss of affiliate (13.1) (20.7)
Provision for income taxes (0.4) (3.3)
----------------------------------------
Income (loss) from continuing operations before minority interest and
equity in net loss of affiliate (13.5) (24.0)
Minority interest -- (0.2)
Equity in net loss of affiliate (49.3) 0.2
----------------------------------------
Income (loss) from continuing operations (62.8) (24.0)
Income from discontinued operations, net of income taxes 4.4 0.4
----------------------------------------
Net income (loss) (58.4) (23.6)
Preferred stock dividends -- 0.5
Accretion of beneficial conversion feature of redeemable preferred stock -
series C -- 5.2
----------------------------------------
Net loss available to common shareholders (58.4) (29.3)
========================================
21
REVENUE
Revenue from continuing operations for the first quarter of 2002
decreased $18.2 million, or 38.4%, to $29.2 million from $47.4 million in
the first quarter of 2001.
Revenue from continuing operations during the three months ended March
31, 2002 and 2001 by segment was as follows:
THREE MONTHS ENDED MARCH 31,
(IN THOUSANDS)
------------------------------------------------------------------------------------
2002 2001
---- ----
------------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
Advanced Technology $22,782 $4,981 $27,763 $27,109 $5,933 $33,042
All other 1,013 375 1,388 7,274 7,093 14,367
-------------------------------------------------------- --------------------------
Total $23,795 $5,356 $29,151 $34,383 $13,026 $47,409
======================================================== ==========================
Advanced Technology's revenue decreased $5.3 million in the first
quarter of 2002 compared to the first quarter of 2001. When compared to the
amounts for the quarter ended March 31, 2001, product revenue decreased by
$4.3 million, or 16.0%, and service revenue decreased by $1.0 million, or
16.0%. These decreases were due to several factors including:
o Reduced sales in the animal tracking business primarily as a
result of orders to replenish inventory and billings for the
infrastructure associated with a customer's launch of our
products in France during the first quarter of 2001, which
were not repeated during the first quarter of 2002;
o Government contract projects which we expected to complete in
the first quarter of 2002 that will not be realized until the
second quarter of 2002; and
o A reduction in demand for certain of our software products and
networking services during the first quarter of 2002.
All Other's revenue decreased $13.0 million, or 90.3%, in the first
quarter of 2002 compared to the first quarter of 2001. The decrease was due
to the sale or closure of the majority of the business units comprising this
group during the last half of 2001 and the first quarter of 2002.
22
GROSS PROFIT AND GROSS PROFIT MARGIN
Gross profit from continuing operations for the first quarter of 2002
decreased $7.9 million, or 45.7%, to $9.4 million from $17.3 million in
2001. Our gross profit margin was 32.3% and 36.6% of revenue for the three
months ended March 31, 2002 and 2001, respectively.
Gross profit from continuing operations during the three months ended
March 31, 2002 and 2001 by segment was as follows:
THREE MONTHS ENDED MARCH 31,
(IN THOUSANDS)
---------------------------------------------------------------------------------
2002 2001
---- ----
---------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
Advanced Technology $5,551 $2,703 $8,254 $7,480 $3,121 $10,601
All other 825 340 1,165 3,059 3,688 6,747
------------------------------------------- -------------------------------------
Total $6,376 $3,043 $9,419 $10,539 $6,809 $17,348
=========================================== =====================================
Gross profit margin from continuing operations during the three months
ended March 31, 2002 and 2001 by segment was as follows:
THREE MONTHS ENDED MARCH 31,
(IN THOUSANDS)
---------------------------------------------------------------------------------
2002 2001
---- ----
---------------------------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
% % % % % %
Advanced Technology 24.4 54.3 29.7 27.6 52.6 32.1
All other 81.4 90.7 91.6 42.1 52.0 47.0
------------------------------------------ --------------------------------------
========================================== ======================================
Total 26.8 56.8 32.3 30.7 52.3 36.6
========================================== ======================================
Advanced Technology's gross profit decreased $2.3 million in the first
quarter of 2002, and margins decreased to 29.7% from 32.1% in the first
quarter of 2001. We attribute the decrease in gross profit primarily to the
reduction in sales during the first quarter of 2002 and the decrease in
margin primarily to a one-time order for networking products during the
first quarter of 2002 that yielded lower margins than we typically realize
for our products.
All Other's gross profit decreased $5.6 million, or 82.7%, during the
first quarter of 2002. Gross margin percentage increased to 91.6% in the
first quarter of 2002 from 47.0% in 2001. The decreased in gross profit
resulted from the sale or closure of the majority of the business units
comprising this group during the last half of 2001 and the first quarter of
2002. We attribute the increase in gross margin percentage to the sale and
closure of business units within this group. The majority of the business
units that were sold or closed earned lower gross margins on average than
the remaining business unit comprising the group during the first quarter of
2002.
23
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expenses from continuing operations
approximated $8.5 million in the first quarter of 2002, a decrease of $9.2
million, or 52.0%, from the $17.7 million reported in the first quarter of
2001. As a percentage of total revenue, selling, general and administrative
expenses from continuing operations decreased to 29.3% in the first quarter
2002, from 37.3% in the first quarter of 2001.
Selling, general and administrative expense from continuing operations
during the three months ended March 31, 2002 and 2001 by segments was as
follows:
THREE MONTHS ENDED MARCH 31,
(IN THOUSANDS)
---------------------------------------
2002 2001
---- ----
Advanced Technology $7,622 $10,843
All Other 914 6,830
---------------------------------------
Total $8,536 $17,673
=======================================
Selling, general and administrative expense from continuing operations
as a percentage of revenue during the three months ended March 31, 2002 and
2001 by segments was as follows:
THREE MONTHS ENDED MARCH 31,
2001 2000
---- ----
---------------------------------------
% %
- -
Advanced Technology 27.5 32.8
All Other 65.9 47.5
---------------------------------------
Total 29.3 37.3
=======================================
Advanced Technology's selling general and administrative expense
decreased $3.2 million, or 29.6%, to $7.6 million in the first quarter of
2002 from $10.8 million in the first quarter of 2001. We attribute the
reduction primarily to the cost saving initiatives and staff reductions that
we began during the last nine months of 2001.
All Other's general and administrative expenses decreased $5.9 million,
or 86.8%, to $0.9 million in the first quarter of 2002 from the $6.8 million
reported in the first quarter of 2001. The decrease resulted from the sale
or closure of all but one of the business units comprising this group during
the last half of 2001 and the first quarter of 2002.
24
RESEARCH AND DEVELOPMENT
Research and development expense from continuing operations was $1.4
million and $1.4 million for the three months ended March 31, 2002 and 2001,
respectively. Research and development expense increased to 5.0% of revenue
in the first quarter of 2002 from 2.9% of revenue in the first quarter of
2001. Research and development expense relates primarily to the development
of Digital Angel and VeriChip.
Research and expense from continuing operations during the three months
ended March 31, 2002 and 2001 by segments was as follows:
THREE MONTHS ENDED MARCH 31,
(IN THOUSANDS)
---------------------------------------
2002 2001
---- ----
Advanced Technology $1,448 $1,385
All Other -- --
---------------------------------------
Total $1,448 $1,385
=======================================
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense from continuing operations for
the first quarter of 2002 decreased $5.5 million, or 84.6%, to $1.0 million
from $6.5 million in the first quarter of 2001. As a percentage of revenue,
depreciation and amortization expense decreased to 3.4% in the first quarter
of 2002 from 13.6% in the first quarter of 2001.
Depreciation and amortization expense from continuing operations during
the three months ended March 31, 2002 and 2001 by segments was as follows:
THREE MONTHS ENDED MARCH 31,
(IN THOUSANDS)
---------------------------------------
2002 2001
---- ----
Advanced Technology $993 $854
All Other 9 404
Eliminations (1) -- 5,200
=======================================
Total $1,002 $6,458
=======================================
<FN>
(1) Includes consolidation adjustments for goodwill amortization of $0
million and $5.2 million in 2002 and 2001, respectively. Under FAS 142,
which we adopted on January 1, 2002, goodwill and certain other intangible
assets are no longer amortized.
Advanced Technology's depreciation and amortization expense increased
by $0.1 million, or 11.1%, to $1.0 million in the first quarter of 2002 from
$0.9 million in the first quarter of 2001. We attribute the increase to
capital expenditures during the last nine months of 2002, offset by a
reduction in goodwill amortization.
All Other's depreciation and amortization expense decreased due to the
sale or closure of the majority of the business units comprising this group
during the last half of 2001 and the first quarter of 2002.
25
NON-CASH COMPENSATION EXPENSE
Non-cash compensation expense was approximately $0.3 million for the
three months ended March 31, 2002. The non-cash compensation expense
resulted from re-pricing 19.3 million stock options during 2001. The options
had original exercise prices ranging from $0.69 to $6.34 per share and were
modified to change the exercise price to $0.15 per share. Due to the
modification, these options are being accounted for as variable options
under APB Opinion No. 25 and fluctuations in our common stock price will
result in increases and decreases of non-cash compensation expense until the
options are exercised, forfeited or expire.
INTEREST INCOME AND EXPENSE
Interest income was $0.1 million and $0.5 million, for the first
quarter of 2002 and 2001, respectively. Interest income is earned primarily
from short-term investments and notes receivable.
Interest expense was $2.1 million and $2.1 million for the first
quarter of 2002 and 2001, respectively. Interest expense is primarily a
function of the level of outstanding debt and is principally associated with
notes payable and term loans.
INCOME TAXES
We had a negative effective income tax rate of 2.8% and 15.8% in the
first quarter of 2002 and 2001, respectively. Differences in the effective
income tax rate from the statutory federal income tax rate arise primarily
from the recognition of net operating loss carryforwards, non-deductible
goodwill amortization associated with acquisitions and state taxes net of
federal benefits. In addition, the rate for the first quarter of 2001 was
impacted by our projection of taxable income with a book loss from
continuing operations for the year ended December 31, 2001.
EQUITY IN NET LOSS OF AFFILIATE
Equity in net loss of affiliate was $14.4 million and $0.1 million
for three months ended March 31, 2002 and 2001, respectively. Included in
the equity in net loss of affiliate for the three months ended March 31,
2002 is non-cash compensation expense. Pursuant to the terms of the Digital
Angel and MAS merger agreement effective March 27, 2002, options to acquire
shares of Digital Angel common stock were converted into options to acquire
shares of MAS common stock. The conversion resulted in a new measurement
date for the options and, as a result, we recorded our equity percentage of
the one-time, non-recurring, non-cash compensation expense, which was
approximately $14.3 million during the three months ended March 31, 2002.
For current employees of Digital Angel, these options are considered fixed
awards under APB Opinion No. 25 and expense was recorded for the intrinsic
value of the options converted. For all others, expense was recorded for the
fair value of the options converted in accordance with FAS 123. Fair value
was determined by using the Black-Scholes option pricing model.
26
RESULTS OF DISCONTINUED OPERATIONS
On March 1, 2001, our board of directors approved a plan to offer for
sale our Intellesale business segment and all of our other "non-core
businesses". Accordingly, the operating results of these entities have been
reclassified and reported as discontinued operations for all periods
presented. As of March 1, 2002, we had sold or closed substantially all of
the businesses classified as Discontinued Operations. There are two
insignificant companies remaining, which had combined revenues and net
losses for the quarter ended March 31, 2002 of $0.3 million and $0.1
million, respectively. We anticipate selling these two remaining companies
within the next several months. We use proceeds from the sales of companies
classified as Discontinued Operations to repay amounts outstanding under the
IBM Agreement.
The following discloses the results of Intellesale and all other
non-core businesses comprising discontinued operations for the period from
January 1, 2001 through March 1, 2001, the measurement date:
January 1, through
March 1,
-----------------------------
(amounts in thousands)
2001
----
Product revenue $13,039
Service revenue 846
-----------------------------
Total revenue 13,885
Cost of products sold 10,499
Cost of services sold 259
-----------------------------
Total cost of products and services sold 10,758
-----------------------------
Gross profit 3,127
Selling, general and administrative expenses 2,534
Depreciation and amortization 264
Interest, net 29
Provision for income taxes 34
Minority interest 53
-----------------------------
Income from discontinued operations $213
=============================
The above results do not include any allocated or common overhead
expenses. Included in Interest, net, above are interest charges based on the
debt of one of these businesses. A purchaser assumed this debt when the
business was sold on January 31, 2002.
We recorded a provision for operating losses, estimated loss on sale
and carrying costs during the phase-out period including operating and other
disposal costs to be incurred in selling the businesses. Carrying costs
primarily include the cancellation of facility leases, employment contract
buyouts and litigation reserves. During the quarter ended March 31, 2002, we
increased by $0.2 million the estimated loss on sale of our 85% ownership in
our Canadian subsidiary, Ground Effects, Ltd, which we sold on January 31,
2002. Proceeds from the sale of Ground Effects, Ltd. approximated $1.6
million plus the assumption of the Canadian portion of the IBM debt.
Offsetting the increase in the estimated loss on sale was net operating
income for the first quarter of 2002. This net income was primarily due to a
change in estimated carrying costs associated with these discontinued
businesses during the first quarter of 2002.
27
The following table sets forth the roll forward of the liabilities for
estimated loss on sale and operating losses and carrying costs from December
31, 2001 through March 31, 2002.
Balance
Balance March 31,
Type of Cost December 31, 2001 Additions Deductions 2002
(amounts in thousands)
Estimated loss on sale, net of change in
estimated operating losses $1,173 ($1,279) $106 $--
Carrying costs 7,218 -- (1,295) 5,923
-------------------------------------------------------------
Total $8,391 $(1,279) $1,189 $5,923
==============================================================
LIQUIDITY AND CAPITAL RESOURCES FROM CONTINUING OPERATIONS
As of March 31, 2002, cash and cash equivalents totaled $7.0 million,
an increase of $3.3 million, or 89.2%, from $3.7 million at December 31,
2001.
Cash of $2.2 million was provided by operations and cash of $0.2
million was used by operations during the first three months of 2002 and
2001, respectively. In the three months ended March 31, 2002, cash was
provided primarily by collections on accounts receivable and cash was used
primarily to decrease accounts payable and accrued expenses and to purchase
inventory. In the first three months of 2001, cash was used primarily to
decrease accounts payable and accrued expenses and to fund discontinued
operations, after adjusting for the net loss, the income from discontinued
operations and for non-cash charges. Partially offsetting the uses of cash
were increases in cash from the collection of accounts receivable, decreases
in inventory and other current assets.
Due from buyers of divested subsidiaries represented the deferred
purchase price due on the sale of several businesses during the fourth
quarter of 2001. We collected these proceeds during the first quarter of
2002.
Accounts and unbilled receivables, net of allowance for doubtful
accounts, decreased by $8.4 million, or 38.4%, to $13.5 million at March 31,
2002 from $21.9 million at December 31, 2001. We attribute the decrease
primarily to our investment in the new Digital Angel Corporation, which we
are accounting for under a modified equity method. At December 31, 2001,
Digital Angel's, Timely Technology Corp.'s and Signature Industries,
Limited's (the Advanced Wireless Group's) balance sheets were presented on a
consolidated basis.
Inventory levels decreased by $4.6 million, or 74.2%, to $1.6 million
at March 31, 2002 from $6.2 million at December 31, 2001. We attribute the
decrease primarily to the fact that we no longer consolidate the Advanced
Wireless Group at March 31, 2002.
Other current assets were $4.5 million at March 31, 2002 compared to
$4.8 million at December 31, 2001. We attribute the decrease primarily to
the fact that we no longer consolidate the Advanced Wireless Group at March
31, 2002.
Accounts payable decreased by $6.5 million, or 42.2%, to $8.9 million
at March 31, 2002 from $15.4 million at December 31, 2001. We attribute the
decrease primarily to the fact that we no longer consolidate the Advanced
Wireless Group at March 31, 2002. Also, a reduction in accounts payable for
various business units classified as All Other contributed to the decrease,
since all but one of these business units had ceased operations as of March
31, 2002.
28
Accrued expenses decreased by $5.2 million, or 28.6%, to $13.0 million
at March 31, 2002 from $18.2 million at December 31, 2001. We attribute the
decrease to the fact that we no longer consolidate the Advanced Wireless
Group at March 31, 2002 and because accrued interest at December 31, 2001
related to the IBM debt has been converted into principal under the terms of
our new credit agreement.
Investing activities provided cash of $5.1 million in the first quarter
of 2002, and used cash of $1.9 million in the first quarter of 2001. In the
first quarter of 2002, cash was provided primarily by collections of amounts
due from buyers of divested subsidiaries of $2.6 million, proceeds from the
sale of property and equipment of $2.5 million and proceeds from the sale of
subsidiaries and business assets of $0.7 million. Partially offsetting the
amounts provided were cash used by discontinued operations of $0.7 million
and cash used to purchase property and equipment of $0.2 million. In the
first quarter of 2001, $1.9 million was used to acquire property and
equipment, $1.4 million was used by discontinued operations and $0.5 million
was used to increase other assets. Partially offsetting these uses was cash
of $1.9 million advanced against notes receivable.
Financing activities in the first quarter of 2002 used cash of $4.0
million and financing activities in the first quarter of 2001 provided cash
of $0.5 million. In the first quarter of 2002, cash was used primarily to
repay $4.7 million against long-term debt and notes payable. Partially
offsetting the use of cash during the first quarter of 2002 was cash of $0.9
million provided from the issuance of common shares. The primary source of
cash in the first quarter of 2001 was borrowings of $1.6 million against
notes payable. The primary use of cash during the first quarter of 2001 was
payments on long-term debt of $1.1 million.
Debt, Covenant Compliance and Liquidity
On March 1, 2002, we and Digital Angel Share Trust, a newly created
Delaware business trust, entered into a new credit agreement with IBM
Credit, which became effective on March 27, 2002, the effective date of the
merger between Digital Angel and MAS. Amounts outstanding under the new
credit agreement of $82.1 million at May 10, 2002, bear interest at an
annual rate of 17% and mature on February 28, 2003. No principal or interest
payments are due until the maturity date. However, the maturity date will be
extended for consecutive one-year periods if we repay at least $32.8
million, or 40% of the original principal amount outstanding plus accrued
interest and expenses prior to February 28, 2003 and an additional 40% of
the original principal amount outstanding plus accrued interest and expenses
prior to February 28, 2004. In any event, all amounts outstanding will be
required to be repaid by August 15, 2005. If all amounts are not repaid by
February 28, 2003, the unpaid amount will accrue interest at an annual rate
of 25%. If not repaid by February 28, 2004, the interest rate increases to
35%.
29
The new credit agreement with IBM Credit contains debt covenants
relating to our financial position and performance, as well as the financial
condition and performance of the Digital Angel Corporation as follows:
For Applied Digital Solutions, Inc.:
COVENANT COVENANT REQUIREMENT
-----------------------------------------------------------------------------------------------------------
As of the following date not less than:
Current Assets to Current
Liabilities March 31, 2002 .17:1
June 30, 2002 .14:1
September 30, 2002 .11:1
December 31, 2002 .11:1
-----------------------------------------------------------------------------------------------------------
Minimum Cumulative EBITDA March 31, 2002 $ (1,528,000)
June 30, 2002 121,000
September 30, 2002 817,000
December 31, 2002 1,286,000
-----------------------------------------------------------------------------------------------------------
For the new Digital Angel/MAS:
COVENANT COVENANT REQUIREMENT
-----------------------------------------------------------------------------------------------------------
As of the following date not less than:
Current Assets to Current
Liabilities June 30, 2002 1.8:1
September 30, 2002 1.8:1
December 31, 2002 2.0:1
-----------------------------------------------------------------------------------------------------------
Minimum Cumulative EBITDA June 30, 2002 $577,000
September 30, 2002 1,547,000
December 31, 2002 3,329,000
-----------------------------------------------------------------------------------------------------------
In satisfaction of a condition to the consent to the merger by IBM
Credit, we transferred to the Digital Angel Share Trust, which is controlled
by an advisory board, all shares of Digital Angel common stock owned by us
and, as a result, the trust has legal title to approximately 77.46% of the
Digital Angel common stock. The trust has voting rights with respect to the
Digital Angel Corporation common stock until we repay our obligations to IBM
Credit in full. We retained beneficial ownership of the shares. The trust
may be obligated to liquidate the shares of Digital Angel Corporation common
stock owned by it for the benefit of IBM Credit in the event we fail to make
payments, or otherwise default, under the new credit agreement with IBM
Credit. Such liquidation of the shares of Digital Angel Corporation common
stock will be in accordance with the SEC rules and regulations governing
affiliates.
At March 31, 2002, we were in compliance with our debt covenants. We
currently expect to meet and be in compliance throughout 2002 with the
covenants in our new credit agreement. However, if business conditions are
other than as anticipated or other unforeseen events or circumstances occur,
our ability to remain in compliance with the covenants may be adversely
affected. On several occasions during 2001, we failed to comply with the
covenants contained in our previous credit agreement with IBM Credit, and,
as a result, at times we were in default under that agreement. In the
absence of a waiver or amendment to the financial covenants, such
noncompliance would constitute an event of default under the new credit
agreement, and IBM Credit would be entitled to accelerate the maturity of
all amounts we owe them. In the event that such noncompliance appears
likely, or occurs, we will seek to renegotiate the covenants
30
and/or obtain waivers, as required. There can be no assurance however that
we would be successful in negotiating such amendments or obtaining such
waivers.
The new credit agreement prohibits us from borrowing funds from other
lenders without the approval of IBM Credit, and does not provide for any
further advances by IBM Credit. The new credit agreement also limits the
amount we may pay our Chief Executive Officer, Richard Sullivan in cash, and
prevents us from making certain cash incentive and perquisite payments,
including cash payment arising upon a change in control, to various other
executive officers.
Amounts outstanding under the new credit agreement are secured by a
security interest in substantially all of our assets, excluding the assets
of Digital Angel Corporation. The shares of our subsidiaries, including the
Digital Angel Corporation common stock held in the Digital Angel Share
Trust, also secure the amounts outstanding under the credit agreement.
Sources of Liquidity
If we are unable to generate the funds that will be required for the
payments under our new credit agreement, as discussed above, shares of
Digital Angel Corporation common stock initially owned by us upon completion
of the merger between Digital Angel and Digital Angel Corporation and
transferred to the Digital Angel Share Trust may be liquidated, if so
directed by IBM Credit, to provide funds necessary to make these payments.
The new credit agreement prohibits us from borrowing funds from other
lenders, and does not provide for any further advances by IBM Credit. In
addition, our prior accountants have expressed doubt about our ability to
continue as a going concern. Accordingly, there can be no assurance that we
will have access to funds necessary to repay IBM Credit or to provide for
our ongoing operating expenses to the extent not provided from our ongoing
operating revenue. In addition we may be able to use proceeds from the sale
of 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
to fund ongoing operations. 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 amount of investment required to bring new products on-line;
revenue growth or decline; and potential acquisitions.
Outlook
We are constantly looking for ways to maximize shareholder value. As
such, we are continually seeking operational efficiencies and synergies
within our operating segment as well as evaluating acquisitions of
businesses and customer bases which complement our operations. These
strategic initiatives may include acquisitions, raising additional funds
through debt or equity offerings, or the divestiture of non-core business
units that are not critical to our long-term strategy or other restructuring
or rationalization of existing operations. We will continue to review all
alternatives to ensure maximum appreciation of our shareholders'
investments. There can be no assurance however, that any initiatives will be
found, or if found, that they will be on terms favorable to us.
31
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2001, the FASB issued FAS No. 141 Business Combinations and FAS
No. 142 Goodwill and Other Intangible Assets. FAS 141 requires business
combinations initiated after June 30, 2001 to be accounted for using the
purchase method of accounting, and broadens the criteria for recording
intangible assets separate from goodwill. Recorded goodwill and intangibles
will be evaluated against these new criteria and may result in certain
intangibles being included in goodwill, or alternatively, amounts initially
recorded as goodwill may be separately identified and recognized apart from
goodwill. FAS 142 requires the use of a non-amortization approach to account
for purchased goodwill and certain intangibles. Under a non-amortization
approach, goodwill and certain intangibles will not be amortized into
results of operations, but instead would be reviewed for impairment and
written down and charged to results of operations only in the periods in
which the recorded value of goodwill and certain intangibles is more than
its fair value. We adopted the provisions of each statement, which apply to
goodwill and certain intangibles acquired prior to June 30, 2001, on January
1, 2002. The adoption of these standards had the impact of reducing our
amortization of goodwill commencing January 1, 2002. There was no impairment
of goodwill upon adoption of FAS 142. However, future impairment reviews may
result in periodic write-downs.
In August 2001, the FASB issued FAS 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. This standard supersedes FAS 121,
Accounting for the Impairment of Long-Lived Assets to Be Disposed Of, and
provides a single accounting model for long-lived assets to be disposed of.
This standard significantly changes the criteria that would have to be met
to classify an asset as held-for-sale. This distinction is important because
assets to be disposed of are stated at the lower of their fair values or
carrying amounts and depreciation is no longer recognized. The new rules
will also supercede the provisions of APB Opinion 30, Reporting the Results
of Operations-Reporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions, with regard to reporting the effects of a disposal of a
segment of a business and will require expected future operating losses from
Discontinued Operations to be displayed in Discontinued Operations in the
period in which the losses are incurred, rather than as of the measurement
date as presently required by APB 30. This statement is effective for fiscal
years beginning after December 15, 2001. We adopted this statement on
January 1, 2002. The adoption of FAS 144 did not have a material impact on
our operations or financial position.
In May 2002, the FASB issued SFAS 145, Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS 145 eliminates Statement 4 (and Statement 64, as it amends
Statement 4), which requires gains and losses from extinguishments of debt
to be aggregated and, if material, classified as an extraordinary item, and
thus, also the exception to applying Opinion 30 is eliminated as well. This
statement is effective for years beginning after May 2002 for the provisions
related to the rescission of Statements 4 and 64, and for all transactions
entered into beginning May 2002 for the provision related to the amendment
of Statement 13. We have not yet determined what impact the adoption of FAS
145 will have on our operations and financial position.
32
FORWARD LOOKING STATEMENTS AND ASSOCIATED RISKS
RISK FACTORS
You should carefully consider the risk factors listed below. These risk
factors may cause our future earnings to be less or our financial condition
to be less favorable than we expect. You should read this section together
with the other information contained herein.
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISK.
This Form 10-Q contains forward-looking statements within the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995
with respect to our financial condition, results of operations and business,
and include statements relating to:
o our growth strategies including, without limitation, our ability
to deploy the Advanced Wireless segments new Digital Angel
divisions products and services;
o anticipated trends in our business and demographics;
o our ability to successfully integrate the business operations of
recently acquired companies and successfully complete the
divestitures of our discontinued operations;
o our future profitability and liquidity; and
o regulatory, competitive or other economic influences.
Words such as "anticipates," "expects," "intends," "plans," "believes,"
"seeks," "estimates" and similar expressions also identify forward-looking
statements. These forward-looking statements are not guarantees of future
performance and are subject to risks and uncertainties that could cause
actual results to differ materially from estimates or forecasts contained in
the forward-looking statements. Some of these risks and uncertainties are
beyond our control.
WE CANNOT BE CERTAIN OF FUTURE FINANCIAL RESULTS.
We reported a net loss from continuing operations of $18.3 million for
the first quarter of 2002. We incurred losses of $198.1 million and $29.2
million from continuing operations for the years ended December 31, 2001 and
2000, respectively. We reported income from continuing operations of $2.6
million for the year ended December 31, 1999 which included a loss from
continuing operations of $17.4 million, offset by a gain of $20.0 million
from the sale of our Canadian subsidiary, TigerTel, Inc. Our business plan
depends on our attaining and maintaining profitability; however, while we
cannot predict whether we will remain profitable in the future. Our
profitability depends on many factors, including the success of our
marketing programs, the maintenance and reduction of expenses and our
ability to successfully develop and bring to market new products and
technologies. We may not be able to sustain or increase profitability on a
quarterly or annual basis. In addition, if we fail to sustain or grow our
profits within the time frame expected by investors, the market price of our
common stock may fall.
OUR STOCK PRICE MAY CONTINUE TO BE VOLATILE, AND YOU MAY BE UNABLE TO
RESELL YOUR SHARES AT OR ABOVE THE PRICE AT WHICH YOU ACQUIRE THEM.
Since January 1, 2000, the price per share of our common stock has
ranged from a high of $18.00 to a low of $0.11. The price of our common
stock has been, and may continue to be, highly volatile and subject to wide
fluctuations in response to factors, including the following:
(i) Significant changes to our business resulting from
acquisitions and/or expansions into different product
lines;
33
(ii) quarterly fluctuations in our financial results or cash
flows;
(iii) changes in investor perception of us or the market for our
products and services;
(iv) changes in economic and capital market conditions for other
companies in our market sector; and
(v) changes in general economic and market conditions.
In addition, the stock market in general, and the Nasdaq National
Market and stocks of technology companies in particular, have often
experienced extreme price and volume fluctuations. This volatility is often
unrelated or disproportionate to the operating performance of these
companies. Broad market and industry factors may decrease the market price
of our common stock, regardless of our actual operating performance.
Declines in the market price of our common stock could also harm employee
morale and retention, our access to capital and other aspects of our
business. If our share price is volatile, we may be the target of securities
litigation, which is costly and time-consuming to defend. Historically,
following periods of volatility in the market price of a company's
securities, securities class action litigation has often been initiated
against that company. Litigation of this type could result in substantial
costs and a diversion of management's attention and resources, which would
harm our business.
WE MAY ISSUE PREFERRED STOCK, WHICH WILL RANK SENIOR TO THE SHARES OF
COMMON STOCK OFFERED BY THIS PROSPECTUS AND WHICH MAY DELAY OR PREVENT A
CHANGE IN CONTROL OF US.
Our board of directors has the right to issue additional preferred
stock without further shareholder approval, and the holders of such
preferred stock may have preferences over the holders of our common stock as
to payments of dividends, liquidation and other matters. These provisions
could delay or prevent a change in control of us or limit the price that
investors might be willing to pay in the future for shares of our common
stock.
IF WE ARE REQUIRED TO DELIST OUR COMMON STOCK, TRADING IN OUR SHARES
COULD DECREASE AND THE MARKET PRICE OF OUR SHARES COULD DECLINE.
Our ability to remain listed on the Nasdaq National Market depends on
our ability to satisfy applicable Nasdaq criteria including our ability to
maintain a minimum bid price of $1.00 per share. We recently received a
letter from Nasdaq containing a staff determination that we had failed to
comply with the minimum bid price requirement. On May 2, 2002 we receive a
letter from the Nasdaq stating that we had regained compliance. However, if
we are unable to maintain compliance with the minimum bid price requirement,
Nasdaq may begin procedures to remove our common stock from the Nasdaq
National Market.
If we were to be delisted from the Nasdaq National Market, an active
trading market for our common stock may no longer exist. As a result,
trading in our shares of common stock could decrease substantially, and the
price of our shares of common stock may decline.
IF WE ARE REQUIRED TO ISSUE ADDITIONAL SHARES OF COMMON STOCK IN
CONNECTION WITH PRIOR ACQUISITIONS, OUR STOCK MAY BE FURTHER DILUTED.
As of March 31, 2002, there were 267,619,643 shares of our common stock
outstanding. Since January 1, 2001, we have issued a net aggregate of
168,807,876 shares of common stock, of which 83,759,195 shares were issued
in connection with acquisitions of businesses and assets and 64,810,635
shares were issued upon conversion of our Series C preferred stock. We have
effected, and will likely continue to effect, acquisitions or contract for
services through the issuance of common stock or our other equity
securities. In addition, we have agreed to "price protection" provisions in
prior acquisition and other agreements which may result in additional shares
of common stock being issued. Such issuances of additional securities may be
dilutive to the value of our common stock and may have an adverse impact on
the market price of our common stock.
34
COMPETITION COULD REDUCE OUR MARKET SHARE AND DECREASE OUR REVENUE.
Each of our business units is highly competitive, and we expect that
competitive pressures will continue in the future. 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 and Europe. In
response to competitive pressures, we may be required to reduce prices or
increase spending in order to retain or attract customers or to pursue new
market opportunities. As a result, our revenue, gross profit and market
share may decrease, each of which could significantly harm our results of
operations. In addition, increased competition could prevent us from
increasing our market share, or cause us to lose our existing market share,
either of which would harm our revenues and profitability. We cannot assure
you that we will have the financial, technical, marketing and other
resources required to successfully compete against current and future
competitors or that competitive pressures faced by us will not harm our
business, financial condition or results of operations.
WE HAVE ENTERED INTO EARNOUT AGREEMENTS FOR COMPANIES WHICH WE HAVE
ACQUIRED, WHICH COULD REQUIRE US TO PAY ADDITIONAL CASH OR STOCK
CONSIDERATION TO THE SELLERS OF THESE BUSINESSES.
We have entered into earnout arrangements under which sellers of some
of the businesses we acquired are entitled to additional consideration for
their interests in the companies they sold to us. Under these agreements,
assuming that all earnout profits are achieved, at March 31, 2002, we are
contingently liable for additional consideration of approximately $15.9
million in 2002 which would be payable in shares of our common stock. If we
are required to issue additional shares pursuant to these earnout
arrangements, it could cause further dilution and adversely affect the
market price of our common stock.
WE MAY BE UNABLE TO COMPLY WITH THE REQUIREMENTS OF OUR CREDIT
FACILITY, WHICH COULD RESULT IN A DEFAULT UNDER THAT AGREEMENT ENABLING IBM
CREDIT TO DECLARE AMOUNTS BORROWED DUE AND PAYABLE IMMEDIATELY.
On several occasions during 2001, we failed to comply with the
covenants contained in our previous credit agreement with IBM Credit, and,
as a result, at times we were in default under that agreement. We entered
into a new credit agreement with IBM Credit, which became effective on March
27, 2002, upon the completion of the merger between Digital Angel and MAS.
The new credit agreement contains various financial and other restrictive
covenants that, among other things, limit our ability to borrow additional
funds and declare and pay dividends, and requires us to, among other things,
maintain various financial ratios and comply with various other financial
covenants.
Our failure to comply with the restrictions imposed by our credit
agreement would constitute a default under the credit agreement, allowing
IBM Credit to accelerate the maturity of all amounts owed it. We do not
currently have available funds to repay the amounts owed to IBM Credit if
the maturity of the obligation is accelerated. If IBM Credit were to
accelerate these obligations and enforce its rights against the collateral
securing these obligations, without additional financing resources, there
would be substantial doubt we would be able to continue operations in the
normal course of business.
IF WE NEED ADDITIONAL CAPITAL FOR OUR ONGOING OPERATIONS OR TO REPAY
IBM CREDIT, WE MAY NOT BE ABLE TO CONTINUE OPERATIONS IN THE NORMAL COURSE
OF BUSINESS.
We may require additional capital for our ongoing operations or to
repay IBM Credit the amounts owed it. Under the terms of the new credit
agreement with IBM Credit Corporation, which became effective on March 27,
2002, the effective date of the merger between Digital Angel and MAS,
amounts outstanding bear interest at an annual rate of 17% and mature on
February 28, 2003. No principal or
35
interest payments are due until the maturity date. However, the maturity
date will be extended for consecutive one-year periods if we repay at least
$32.8 million, or 40% of the original principal amount outstanding, plus
accrued interest and expenses, prior to February 28, 2003 and an additional
40% of the original principal amount outstanding, plus accrued interest and
expenses, prior to February 28, 2004. In any event, all amounts outstanding
will be required to be repaid by August 15, 2005. If all amounts are not
repaid by February 28, 2003, the unpaid amount will accrue interest at an
annual rate of 25%. If not repaid by February 28, 2004, the interest rate
increases to 35%. We do not currently have the funds that will be required
for such payments, and there is no likelihood that the funds will be
available when required for these payments. Shares of MAS common stock,
which we transferred to a Delaware business trust may be liquidated, if so
directed by IBM Credit, to provide funds necessary to make these payments.
Such liquidation of the shares of MAS common stock will be made in
accordance with the SEC rules and regulations governing affiliates.
The new credit agreement prohibits us from borrowing funds from other
lenders, and will not provide for any further advances by IBM Credit.
Accordingly, there can be no assurance that we will have access to funds
necessary to provide for our ongoing operating expenses to the extent not
provided from our ongoing operating revenue.
WE DEPEND ON OUR SMALL TEAM OF SENIOR MANAGEMENT, AND WE MAY HAVE
DIFFICULTY ATTRACTING AND RETAINING ADDITIONAL PERSONNEL.
We depend on the continued service of our executive officers and other
key personnel. We have entered into employment contracts ranging for periods
of one to five years through February 2006 with our key officers and
employees. Some of these employment contracts call for bonus arrangements
based on earnings. There can be no assurance that we will be successful in
retaining our key employees or that we can attract and retain additional
skilled personnel as required. The loss of the services of any of our
central management team could harm our business, financial condition and
results of operations. In addition, the operations of any of our individual
facilities could be adversely affected if the services of the local managers
should be unavailable.
WE FACE THE RISKS THAT THE VALUE OF OUR INVENTORY MAY DECLINE BEFORE WE
SELL IT OR THAT WE MAY NOT BE ABLE TO SELL THE INVENTORY AT THE PRICES WE
ANTICIPATE.
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. Because we will not pay dividends on our common stock for the
foreseeable future, shareholders must rely on stock appreciation for any
return on their investment in the common stock.
WE DO NOT HAVE A HISTORY OF PAYING DIVIDENDS ON OUR COMMON STOCK, AND
WE CANNOT ASSURE YOU THAT ANY DIVIDENDS WILL BE PAID IN THE FORESEEABLE
FUTURE.
Our current credit agreement with IBM Credit places restrictions on the
declaration and payment of dividends. We intend to use any earnings which we
generate to finance our operations and to repay the amounts outstanding
under our credit agreement with IBM Credit, and, therefore, we do not
anticipate paying cash dividends in the future. As a result, only
appreciation of the price of our common stock will provide a return to our
shareholders.
PROVISIONS IN OUR EMPLOYMENT AGREEMENTS MAY MAKE IT DIFFICULT FOR A
THIRD PARTY TO ACQUIRE US, DESPITE THE POSSIBLE BENEFITS TO OUR
SHAREHOLDERS.
Our employment or other agreements with Richard Sullivan and Jerome
Artigliere include change of control provisions under which the employees
may terminate their employment within one year after a change of control and
are entitled to receive specified severance payments and/or continued
36
compensation payments for sixty months. The employment agreement for Richard
Sullivan also provides for supplemental compensation payments for sixty
months upon termination of employment, even if there is no change in
control, unless his employment is terminated due to a material breach of the
terms of the employment agreement. executive officers if any payments upon a
change of control are subject to such taxes as excess parachute payments.
Under the terms of the new amended and restated credit agreement with
IBM Credit, we are prevented from making cash payments to various executive
officers, including the payments described above in cash to Richard
Sullivan, Garrett Sullivan and Jerome Artigliere until our obligations to
IBM Credit are repaid in full. Nevertheless, our obligation to make the
payments described in this section could adversely affect our financial
condition or could discourage other parties from entering into transactions
with us which might be treated as a change in control or triggering event
for purposes of these agreements.
WE MAY NOT PREVAIL IN ONGOING LITIGATION AND MAY BE REQUIRED TO PAY
SUBSTANTIAL DAMAGES.
We are party to various legal actions as either plaintiff or defendant
in the ordinary course of business. While we believe that the final outcome
of these proceedings will not have a material adverse effect on our
financial position, cash flows or results of operations, we cannot assure
the ultimate outcome of these actions and the estimates of the potential
future impact on our financial position, cash flows or results of operations
for these proceedings could change in the future. In addition, we will
continue to incur additional legal costs in connection with pursuing and
defending such actions.
WE HAVE BEEN, AND MAY CONTINUE TO BE, ADVERSELY AFFECTED BY RECENT
EVENTS.
The events of September 11, 2001 in New York City and Washington, D.C.
have, and are likely to continue to have, a negative effect on the economic
condition of the U.S. financial markets in general and on the technology
sector in particular. As a result of the current economic slowdown, which
was exacerbated by the events of September 11, 2001, we have experienced
deteriorating sales for certain of our businesses. This resulted in the shut
down of several of our businesses during the third and fourth quarters of
2001. Also, letters of intent that we had received during the last half of
2001 and the first quarter of 2002 related to the sales of certain of our
businesses indicated a decline in their fair values. As a result, we
recorded asset impairment charges and increased inventory reserves during
the third and fourth quarters of 2001. If the economic condition of the U.S.
financial markets in general and of the technology sector in particular do
not improve in the near term, and if the current economic slowdown
continues, we may be forced to shut down additional businesses, causing us
to incur additional charges, which could have a material adverse effect on
our business, operating results and financial condition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
With the sale and closure of our Canadian and United Kingdom
subsidiaries, we no longer have operations and foreign of the world.
However, our United States companies 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.
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 existing
credit agreement with IBM Credit bear interest at a fixed rate. 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.
37
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We, and certain of our subsidiaries, are parties to various legal
actions as either plaintiff or defendant and accordingly, have recorded
certain reserves in its financial statements at December 31, 2001. In our
opinion, these proceedings are not likely to have a material adverse affect
on our financial position, our cash flows or our overall trends in results.
The estimate of the potential impact on our financial position, our overall
results of operations or our cash flows for these proceedings could change
in the future.
On April 7, 2000, we and Intellesale filed a counterclaim against
David Romano and Eric Limont, the former owners of Bostek, Inc. and Micro
Components International Incorporated, two companies acquired by Intellesale
in June 1999, in the U.S. District Court for the District of Delaware for,
generally, breach of contract, breach of fiduciary duty and fraud. Messrs.
Romano and Limont had filed their claim generally alleging that their
earnout payment from Intellesale was inadequate. In July 2000, we and
Intellesale amended our counterclaim in the U.S. District Court for the
District of Delaware to seek damages for, among other things, securities law
violations. In addition, on May 19, 2000, Intellesale and two of its
subsidiaries, Bostek, Inc. and Micro Components International Incorporated,
filed suits against Messrs. Romano and Limont in Superior Court of
Massachusetts to recover damages. 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. As of January 16, 2001, we, Intellesale, Bostek, Inc. and Micro
Components International Incorporated settled all claims with Messrs. Romano
and Limont. As part of the settlement agreement, Messrs. Romano and Limont
agreed to acquire shares of our common stock and to indemnify us against
various other litigation filed against Bostek, Inc. The settlement
agreement, which was consummated on April 12, 2002, provides for Messrs.
Romano and Limont to purchase approximately 2.0 million shares of our common
stock for a note receivable of $1.6 million due on October 12, 2003.
On June 8, 2001, three individuals filed suit against us and four
of our officers in the United States District Court for Delaware seeking
equitable relief and damages. The plaintiffs had acquired our stock when the
company in which they were shareholders, Computer Equity Corporation, was
merged into one of our subsidiaries in 2000. The suit alleged, inter alia,
that, because of asserted violations of federal and state securities laws
and breach of a contract by us, the merger transaction should be rescinded.
The suit was not served until August 6, by which time, a First Amended
Complaint had been filed. As amended, the suit now has eight plaintiffs, all
of whom had formerly owned stock in Computer Equity Corporation, and no
longer seeks rescission. The various counts of the complaint assert
violations of federal and state securities laws for our alleged failure to
register timely the shares issued in connection with the merger; breach of
contract by us for allegedly failing to comply with a registration rights
agreement regarding the shares; and breach of a covenant of good faith and
fair dealing arising from the same matters. In addition, in two counts the
plaintiffs seek a declaratory judgment that any future payments due to them
under the merger agreement, so called "earnout" payments, due on or before
September 30, 2001 and 2002, must be made in cash instead of through
issuance of stock, as is permitted in the agreement, because of our alleged
failures with regard to registration of shares in the past. The damages
sought are those which allegedly arose because of the claimed delay in the
registration of the stock issued in connection with the merger in 2000 and
are described in the First Amended Complaint as being "not less than $1
million." On October 18, 2001, the eight plaintiffs filed a motion for leave
to file a second amended complaint. The proposed second amended complaint
adds Computer Equity Corporation as a defendant. It continues to assert
claims for violation of federal securities law, breach of contract for
failure to comply with a registration rights agreement, and breach of the
covenant of good faith and fair dealing. The proposed second amended
complaint adds a breach of contract claim for
38
failure to make the September 30, 2001 "earnout" payment. All other claims
were eliminated. Plaintiffs seek over $10 million in damages and rescission,
as they ask the Court to return the shares of Computer Equity Corporation.
In January 2002, the Delaware court dismissed the action without prejudice.
Certain of the plaintiffs filed a new law suit in Delaware Chancery Court,
claiming amounts in connection with the earnout and claiming damages
relating to the registration of the shares previously issued to them. We
believe the claims made by these plaintiffs are without merit and intend to
vigorously defend them.
On August 3, 2001, Prodigy Communications, successor to FlashNet
Communications, filed suit against Intellesale in connection with a
settlement and computer purchase agreement. Prodigy alleges that Intellesale
has not performed under the agreement and seeks damages of $3.0 million. We
are vigorously defending these claims.
On January 31, 2002, Treeline, Inc., filed a Complaint in the
Common Pleas Court of Cuyahoga County, Ohio against us, one of our
subsidiaries, STR, Inc, nka ARJANG, Inc. ("STR") and another defendant who
was formerly an executive of STR, alleging that STR breached its lease
agreement with Treeline, Inc. in connection with a facility no longer being
used by us. The Complaint alleges that we, and the former executive, are
liable as Guarantors of the lease for damages sustained by Treeline as a
result of the alleged breach. We have retained counsel in Cuyahoga County
who will soon be filing on our behalf an Answer to the Complaint. We intend
to vigorously defend this action.
During the quarter ended March 31, 2002, 510 Ryerson Road Inc.
filed a lawsuit against us and one of our subsidiaries in connection with a
lease for a facility that is no longer in use. We are vigorously defending
this action.
In the fourth quarter of 2000, the Company entered into an
agreement to acquire an interest in Connect Intelligence Limited, an Irish
company. A dispute between the Connect Intelligence sellers and us ensued
and the sellers filed several litigations in Ireland and the United States.
The litigations have been settled under the terms of a settlement agreement
dated March 21, 2002. The settlement resulted in approximately 3.2 million
shares of our common stock being issued to the sellers and resulted in a
charge to us of approximately $1.0 million, which was accrued at December
31, 2001 and a payment to us of approximately $1.4 million, which we
received in May 2002. At the time of the settlement agreement, the closing
price of our common stock was $0.45 per share.
39
ITEM 2. CHANGES IN SECURITIES
Recent Sales of Unregistered Securities
The following table lists all unregistered securities sold by the
Company between January 1, 2002 and March 31, 2002. These shares were issued
in (a) acquisition transactions to the selling shareholders in connection
with the acquisition of a subsidiary in transactions directly negotiated by
the stockholders in connection with the sale of their business or interest
to the Company and pursuant to the "price protection" or "earnout"
provisions of the agreement of sale, (b) for settlement of legal disputes,
(c) for employment or consulting services, or (d) for purchases of
equipment. These shares were issued without registration in reliance upon
the exemption provided by Section 4(2) of the Securities Act of 1933, as
amended, or Rule 506 of Regulation D promulgated thereunder.
Aggregate Number of
Amount of Number of Common
Name/Entity/Nature Date of Sale Consideration Persons Note Issued For Shares
- ----------------------------------------------------------------------------------------------------------------------
Amro Albanna January 2002 $8,550 1 1 Acquisition 13,746
Arthur F. Noterman February 2002 $21,000 1 2 Services 140,000
Angela Sullivan February 2002 $15,000 1 2 Services 100,000
Constance Weaver February 2002 $21,000 1 2 Services 140,000
Daniel Penni February 2002 $21,000 1 2 Services 140,000
Garrett Sullivan February 2002 $1,250,192 1 3 Services 2,500,000
South Seas Data, Inc. February 2002 (a) 5 4 Settlement 590,760
Scott Lines February 2002 $50,000 1 5 Settlement 131,579
Kevin Barker February 2002 $28,537 1 6 Settlement 73,171
Douglas Marlin February 2002 $218,781 1 7 Settlement 487,805
Steve R. Matulich February 2002 $32,250 1 8 Settlement 75,000
John McCarthy February 2002 $20,000 1 9 Acquisition 46,512
Avnet, Inc. February 2002 $167,000 1 10 Equipment 368,421
Pinacor, Inc. February 2002 $50,000 1 11 Equipment 147,058
Richard Sullivan March 2002 $435,821 1 3 Services 2,912,141
Garrett Sullivan March 2002 $27,687 1 3 Services 184,580
Fahnestock March 2002 $100,000 1 12 Services 250,000
------------
Total 8,300,773
============
<FN>
(a) Shares were issued in connection with price protection provisions
of purchase and sale agreements and, accordingly, no consideration was
exchanged at the time of sale.
1. Represents shares issued in connection with the "earnout" provision of
the agreement of sale relating to a prior private transaction directly
negotiated by the shareholders in connection with the sale of their
business to us, which transactions were exempt from registration
pursuant to Section 4 (2) of the Securities Act. The transaction
document included an acknowledgment that the sale was not registered,
that the shareholder was acquiring the shares for investment and not
for resale, and that the shareholder acknowledged that he must hold the
shares until and unless registered or transferred in another
transaction exempt from registration. In addition, certificates
representing the shares were legended to indicate that they were
restricted.
2. Represents shares issued in lieu of cash payments for director's fees
for the second, third and fourth quarters of 2001. The certificates
representing the shares were legended to indicate that they were
restricted.
3. Represents shares issued in lieu of cash compensation. The certificates
representing the shares were legended to indicate that they were
restricted.
4. Represents shares issued in connection with price protection provisions
of the settlement agreement pertaining to certain litigation between us
and the shareholders of South Seas Data, Inc. pertaining to our
termination of an agreement and plan of merger with South Seas Data,
Inc., which transaction was exempt from registration pursuant to
Section 4(2) of the Securities Act. The transaction document included
an acknowledgment that the sale was not registered, that the purchaser
was acquiring the shares for investment and not for resale, and that
the purchaser acknowledged that he must hold the shares until and
unless registered or transferred in another transaction exempt from
registration. In addition, certificates representing the shares were
legended to indicate that they were restricted.
40
5. Represents shares issued in connection with the settlement of a dispute
between Mr. Lines and us, which transaction was exempt from
registration pursuant to Section 4(2) of the Securities Act. The
transaction document included an acknowledgment that the sale was not
registered, that the purchaser was acquiring the shares for investment
and not for resale, and that the purchaser acknowledged that he must
hold the shares until and unless registered or transferred in another
transaction exempt from registration. In addition, certificates
representing the shares were legended to indicate that they were
restricted.
6. Represents shares issued in connection with the settlement of
compensation and other disputes with Mr. Barker pertaining to his
employment agreement, which transaction was exempt from registration
pursuant to Section 4(2) of the Securities Act. The transaction
document included an acknowledgment that the sale was not registered,
that the purchaser was acquiring the shares for investment and not for
resale, and that the purchaser acknowledged that he must hold the
shares until and unless registered or transferred in another
transaction exempt from registration. In addition, certificates
representing the shares were legended to indicate that they were
restricted.
7. Represents shares issued in connection with the settlement of
compensation and other disputes with Mr. Marlin pertaining to his
employment agreement, which transaction was exempt from registration
pursuant to Section 4(2) of the Securities Act. The transaction
document included an acknowledgment that the sale was not registered,
that the purchaser was acquiring the shares for investment and not for
resale, and that the purchaser acknowledged that he must hold the
shares until and unless registered or transferred in another
transaction exempt from registration. In addition, certificates
representing the shares were legended to indicate that they were
restricted.
8. Represents shares issued in connection with the settlement of certain
litigation between us and the plaintiffs, Sophis Luna, William Bumby
and Kerry Dennis, which transaction was exempt from registration
pursuant to Section 4(2) of the Securities Act. The transaction
document included an acknowledgment that the sale was not registered,
that the purchaser was acquiring the shares for investment and not for
resale, and that the purchaser acknowledged that he must hold the
shares until and unless registered or transferred in another
transaction exempt from registration. In addition, certificates
representing the shares were legended to indicate that they were
restricted.
9. Represents shares issued as partial compensation for Mr. McCarthy's
minority interest in Atlantic Systems, Inc., which we acquired
immediately prior to, and in connection with, selling 100% of the stock
of Atlantic Systems, Inc.
10. Represents shares issued for amounts owed to Avnet, Inc. for purchases
of computer equipment, which transaction was exempt from registration
pursuant to Section 4(2) of the Securities Act. The transaction
document included an acknowledgment that the sale was not registered,
that shares were acquired for investment and not for resale, and that
the shares must be held until and unless registered or transferred in
another transaction exempt from registration. In addition, certificates
representing the shares were legended to indicate that they were
restricted. Nasim Kahn, an officer of Avenet, Inc., has sole voting and
dispositive power with respect to the shares held by Avnet, Inc.
11. Represents shares issued to Pinacor, Inc. in connection with and in
settlement of amounts owing to Pinacor for purchases of equipment and
related fees, which transaction was exempt from registration pursuant
to Section 4(2) of the Securities Act. The transaction document
included an acknowledgment that the sale was not registered, that
shares were acquired for investment and not for resale, and that the
shares must be held until and unless registered or transferred in
another transaction exempt from registration. In addition, certificates
representing the shares were legended to indicate that they were
restricted. Raymond Stork, an officer of Pinacor, Inc., has sole voting
and dispositive power with respect to the shares held by Pinacor, Inc.
12. Represents shares issued in connection with investment banking services
provided in connection with the restructure of our credit facility with
IBM Credit Corporation, which transaction was exempt from registration
pursuant to Section 4(2) of the Securities Act. The transaction
document included an acknowledgment that the sale was not registered,
that shares were acquiring for investment and not for resale, and that
the shares much be held until and unless registered or transferred in
another transaction exempt from registration. In addition, certificates
representing the shares were legended to indicate that they were
restricted. Albert G. Lowenthal, Chairman, has sole voting and
dispositive power with respect to the shares held by Fahnestock & Co.
Inc.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
41
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
We have listed the exhibits by numbers corresponding to the Exhibit
Table of Item 601 in Regulation S-K on the Exhibit list attached to
this report.
(b) REPORTS ON FORM 8-K
(i) On March 8, 2002, we filed a Current Report on Form
8-K which included a copy of the Third Amended and
Restated Credit Agreement dated March 1, 2002 between
IBM Credit Corporation, the Company and Digital Angel
Share Trust.
(ii) On March 27, 2002, we filed a Current Report on Form
8-K announcing the completion of the merger of our
subsidiary, Digital Angel Corporation and Medical
Advisory Systems, Inc.
(iii) On April 18, 2002, we filed a Current Report on Form
8-K, which announced the termination of
PricewaterhouseCoopers LLP as our independent
accountants and our engagement of Grant Thornton LLP
as our new independent accountants. On April 22, 2002,
we filed a Form 8-K/A amending our Current Report on
Form 8-K filed on April 18, 2002 which included a
letter from PricewaterhouseCoopers LLP addressed to
the SEC.
42
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: May 20, 2002 By: /S/ EVAN C. MCKEOWN
-----------------------------------
Evan C. McKeown
Vice President, Chief Financial
Officer
43
EXHIBITS
Exhibit
Number Description
- ------ -----------
2.1 Agreement and Plan of Merger by and between Applied Digital
Solutions, Digital Angel Corporation, Medical Advisory Systems,
Inc. and Acquisition Subsidiary, Inc. dated as of November 1,
2001.
3.1 Second Restated Articles of Incorporation of the Company
(incorporated herein by reference to Exhibit 4.1 to the
Company's Registration Statement on Form S-1 (Form S-3 File No.
333-64605) filed with the Commission on June 23, 1999).
3.2 Amendment of Articles of Incorporation of the Company filed with
the Secretary of State of the State of Missouri on September 5,
2000 (incorporated herein by reference to Exhibit 4.3 to the
Company's Post-Effective Amendment No. 3 on Form S-3 to
Registration Statement on Form S-4 (File No. 333-38420-02) filed
with the Commission on September 29, 2000).
3.3 Certificate of Designation of Preferences of Series C
Convertible Preferred Stock (incorporated herein by reference to
Exhibit 3.1 to the Company's Current Report on Form 8-K filed
with the Commission on October 26, 2000).
3.4 Amended and Restated Bylaws of the Company dated March 31, 1998
(incorporated herein by reference to Exhibit 4.1 to the
Company's Registration Statement on Form S-3 (File No.
333-51067) filed with the Commission on April 27, 1998).
10.1* 1996 Non-Qualified Stock Option Plan of Applied Cellular
Technology, Inc., as amended through June 13, 1998 (incorporated
herein by reference to Exhibit 4.1 to the Company's Registration
Statement on Form S-8 filed with the Commission on December 2,
1999 (Commission File Number 333-91999)).
10.2* Applied Digital Solutions, Inc. 1999 Employees Stock Purchase
Plan, as amended through September 23, 1999 (incorporated herein
by reference to Exhibit 10.1 to the Company's Registration
Statement on Form S-8 (File No. 333-88421) filed with the
Commission on October 4, 1999).
10.3* Applied Digital Solutions, Inc. 1999 Flexible Stock Plan
(incorporated herein by reference to Exhibit 4.1 to the
Company's Registration Statement on Form S-8 (File No. 333-
92327) filed with the Commission on December 8, 1999).
10.4 Second Amended and Restated Term and Revolving Credit Agreement,
dated October 17, 2000, between the Company and IBM Credit
Corporation, and others (incorporated by reference to Exhibit
99.1 to the Company's Current Report on Form 8-K filed with the
Commission on October 24, 2000).
10.5 Acknowledgement, Waiver and Amendment No. 1 to the Second
Amended and Restated Term and Revolving Credit Agreement dated
March 30, 2001 between Applied Digital Solutions, Inc. and IBM
Credit Corporation, and others (incorporated by reference to
Exhibit 10.7 to the registrant's Annual Report on Form 10-K
filed with the Commission on April 10, 2001).
10.6 Letter dated July 1, 2001 from IBM Credit Corporation amending
the Second Amended and Restated and Revolving Credit Agreement,
as amended (incorporated by reference to Exhibit 10.5 to the
registrant's Quarterly Report on Form 10-Q filed with the
Commission on October 14, 2001).
44
Exhibit
Number Description
- ------ -----------
10.7 Letter dated December 31, 2001 from IBM Credit Corporation
amending the Second Amended and Restated Term and Revolving
Credit Agreement, as amended (incorporated by reference to
Exhibit 10.9 to the Company's Registration Statement on Form S-1
(File No. 333-75928) filed with the Commission on February 8,
2002.
10.8 Letter dated January 31, 2002 from IBM Credit Corporation
amending the Second Amended and Restated Term and Revolving
Credit Agreement, as amended (incorporated by reference to
Exhibit 10.10 to the Company's Registration Statement on Form
S-1 (File No. 333-75928) filed with the Commission on February
2, 2002.
10.9 Letter dated February 27, 2002 from IBM Credit Corporation
amending the Second Amended and Restated Term and Revolving
Credit Agreement, as amended (incorporated by reference to
Exhibit 10.1 to the Company's Current Report on Form 8-K filed
with the Commission on March 8, 2002.
10.10 Third Amended and Restated Term Credit Agreement dated March 1,
2002 between Applied Digital Solutions, Inc., Digital Angel
Share Trust and IBM Credit Corporation (incorporated by
reference to Exhibit 10.2 to the Company's Current Report on
Form 8-K filed with the Commission on March 8, 2002.
10.11 Trust Agreement dated March 1, 2002 between Applied Digital
Solutions, Inc. and Digital Angel Share Trust incorporated by
reference to Exhibit 10.3 to the Company's Current Report on
Form 8-K filed with the Commission on March 8, 2002.
10.12* Richard J. Sullivan Employment Agreement.
10.13* Garrett A. Sullivan Employment Agreement.
10.14* Dr. Peter Zhou Employment Agreement incorporated by reference to
the Exhibit 10.19 to the Company's Registration Statement on
Form S-1 (File No. 333-75928) filed with the Commission on
February 8, 2002.
10.15* Jerome C. Artigliere Employment Agreement (incorporated by
reference to the corresponding Exhibit to the Company's Annual
Report on Form 10-K filed with the Commission on April 10,
2001).
10.16* Michael E. Krawitz Employment Agreement (incorporated by
reference to the corresponding Exhibit to the Company's Annual
Report on Form 10-K filed with the Commission on April 10,
2001).
10.17 Securities Purchase Agreement, dated as of October 24, 2000,
relating to the Company's Series C Convertible Preferred Stock
(incorporated by reference to Exhibit 10.1 to the Company's
Current Report on Form 8-K filed with the Commission on October
26, 2000).
10.18 Form of warrant to purchase common stock of the Company issued
to the holders of the Series C Convertible Preferred Stock
(incorporated by reference to Exhibit 4.1 to the Company's
Current Report on Form 8-K filed with the Commission on October
26, 2000).
10.19 Registration Rights Agreement between the Company and the
holders of the Series C Convertible Preferred Stock
(incorporated by reference to Exhibit 10.2 to the Company's
Current Report on Form 8-K filed with the Commission on October
26, 2000).
<FN>
- ---------
* Management contract or compensatory plan.
45