As filed with the Securities and Exchange Commission on August 3, 2004
UNITED
STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
ý QUARTERLY REPORT PURSUANT TO SECTION
13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2004
or
o 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: 1-15177
DIGITAL ANGEL CORPORATION
(Exact name of registrant as specified in its charter)
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DELAWARE |
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52-1233960 |
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(State or other jurisdiction of |
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(IRS Employer |
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490 Villaume Avenue, South Saint Paul, Minnesota, 55075 |
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(Address of registrant’s principal executive offices) |
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(651) 455-1621 |
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(Registrant’s telephone number, including area code) |
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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 ý No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule12b-2 of the Exchange Act).
Yes o No ý
As of the close of business on July 30, 2004, there were 32,820,511 shares outstanding of the issuer’s $0.005 per share par value common stock.
DIGITAL ANGEL CORPORATION
TABLE OF CONTENTS
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Description |
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Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities |
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Item 1. Financial Statements.
DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
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June 30, |
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December 31, |
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(Unaudited) |
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Assets |
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Current Assets |
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Cash |
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$ |
670 |
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$ |
894 |
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Restricted cash |
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777 |
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765 |
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Applied Digital common stock |
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2,621 |
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— |
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Accounts receivable and unbilled receivables (net of allowance for doubtful accounts of $236 in 2004 and $212 in 2003) |
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5,144 |
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3,400 |
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Inventories |
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6,269 |
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6,543 |
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Deferred costs |
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132 |
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— |
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Other current assets |
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1,165 |
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785 |
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Net assets from discontinued operations |
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26 |
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1,251 |
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Total Current Assets |
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16,804 |
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13,638 |
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Property And Equipment, net |
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6,198 |
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6,528 |
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Goodwill and Other Intangible Assets, net |
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53,297 |
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45,119 |
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Other Assets, net |
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1,097 |
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942 |
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$ |
77,396 |
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$ |
66,227 |
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Liabilities and Stockholders’ Equity |
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Current Liabilities |
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Line of credit and current maturities of long-term debt and notes payable |
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$ |
4,363 |
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$ |
5,008 |
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Accounts payable |
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4,465 |
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5,226 |
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Accrued expenses and other current liabilities |
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3,799 |
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3,201 |
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Deferred revenue |
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1,505 |
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1,144 |
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Due to Applied Digital |
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96 |
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347 |
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Total Current Liabilities |
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14,228 |
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14,926 |
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Long-Term Debt And Notes Payable |
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1,975 |
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2,818 |
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Deferred Revenue |
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599 |
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— |
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Total Liabilities |
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16,802 |
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17,744 |
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Commitments And Contingencies |
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Minority Interest |
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3 |
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— |
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Stockholders’ Equity (See Note 1) |
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Preferred stock: Authorized 1,000 in 2002, of $1.75 par value, 100 shares issued and outstanding in 2004 and 0 issued and outstanding in 2003 |
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175 |
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— |
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Common stock: Authorized 95,000 shares, of $.005 par value; 32,871 shares issued and 32,821 shares outstanding in 2004 and 28,891 shares issued and 28,841 outstanding in 2003 |
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164 |
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144 |
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Additional paid-in capital |
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189,543 |
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171,909 |
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Accumulated deficit |
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(129,250 |
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(123,517 |
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Treasury stock (carried at cost, 50 shares) |
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(43 |
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(43 |
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Accumulated other comprehensive loss |
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2 |
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(10 |
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Total Stockholders’ Equity |
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60,591 |
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48,483 |
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$ |
77,396 |
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$ |
66,227 |
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See the accompanying notes to condensed consolidated financial statements.
1
DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
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For the Three Months |
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For the Six Months |
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2004 |
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2003 |
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2004 |
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2003 |
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Product revenue |
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$ |
9,403 |
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$ |
7,554 |
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$ |
19,914 |
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$ |
17,729 |
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Service revenue |
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667 |
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347 |
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927 |
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826 |
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Total net revenue |
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10,070 |
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7,901 |
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20,841 |
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18,555 |
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Cost of products sold |
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5,479 |
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4,969 |
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11,608 |
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10,445 |
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Cost of services sold |
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435 |
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1 |
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548 |
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56 |
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Gross profit |
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4,156 |
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2,931 |
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8,685 |
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8,054 |
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Selling, general and administrative expenses |
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4,303 |
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3,850 |
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8,727 |
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7,799 |
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Research and development expenses |
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850 |
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1,172 |
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1,519 |
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2,083 |
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Operating loss |
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(997 |
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(2,091 |
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(1,561 |
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(1,828 |
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Interest income |
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8 |
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— |
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16 |
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— |
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Interest expense |
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(247 |
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(154 |
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(503 |
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(254 |
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Realized and unrealized losses on Applied Digital common stock |
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(26 |
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— |
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(2,612 |
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— |
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Other income |
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20 |
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39 |
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58 |
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78 |
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Loss before minority interest share of losses (income) and discontinued operations |
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(1,242 |
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(2,206 |
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(4,602 |
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(2,004 |
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Minority interest share of losses (income) |
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3 |
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77 |
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(3 |
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110 |
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Net loss from continuing operations |
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(1,239 |
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(2,129 |
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(4,605 |
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(1,894 |
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Loss from discontinued operations |
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(750 |
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(248 |
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(1,128 |
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(373 |
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Net loss |
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$ |
(1,989 |
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$ |
(2,377 |
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$ |
(5,733 |
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$ |
(2,267 |
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Loss per common share-basic and diluted: |
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Loss from continuing operations |
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(0.04 |
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(0.08 |
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(0.15 |
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(0.07 |
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Loss from discontinued operations |
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(0.02 |
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(0.01 |
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(0.03 |
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(0.01 |
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Net loss per common share –basic and diluted |
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$ |
(0.06 |
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$ |
(0.09 |
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$ |
(0.18 |
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$ |
(0.08 |
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Weighted average number of common shares outstanding - basic and diluted |
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32,691 |
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26,856 |
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31,604 |
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26,760 |
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See the accompanying notes to condensed consolidated financial statements.
2
DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
For The Six Months Ended June 30, 2004
(In Thousands)
(Unaudited)
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Accumulated |
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Additional |
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Other |
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Total |
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Preferred Stock |
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Common Stock |
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Paid-In |
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Accumulated |
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Treasury |
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Comprehensive |
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Stockholders’ |
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Number |
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Amount |
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Number |
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Amount |
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Capital |
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Deficit |
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Stock |
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Loss |
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Equity |
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Balance — December 31, 2003 |
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— |
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$ |
— |
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28,891 |
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$ |
144 |
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$ |
171,909 |
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$ |
(123,517 |
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$ |
(43 |
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$ |
(10 |
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$ |
48,483 |
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Net loss |
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— |
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— |
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— |
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— |
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— |
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(5,733 |
) |
— |
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— |
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(5,733 |
) |
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Comprehensive loss —Foreign currency translation |
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— |
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— |
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— |
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— |
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— |
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12 |
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12 |
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Total comprehensive income (loss) |
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— |
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— |
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— |
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— |
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— |
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(5,733 |
) |
— |
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12 |
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(5,721 |
) |
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Merger consideration-OuterLink Corporation |
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100 |
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175 |
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— |
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— |
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8,125 |
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— |
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— |
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— |
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8,300 |
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Issuance of common stock to Applied Digital |
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— |
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— |
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3,000 |
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15 |
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7,905 |
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— |
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— |
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— |
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7,920 |
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Conversion of debt into stock |
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— |
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250 |
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1 |
|
582 |
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— |
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— |
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— |
|
583 |
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Shares cancelled on settlement with vendor |
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— |
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— |
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(23 |
) |
— |
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— |
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— |
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— |
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— |
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— |
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Issuance of stock for services |
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— |
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— |
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10 |
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— |
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31 |
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— |
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— |
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— |
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31 |
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Exercise of stock options |
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— |
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— |
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743 |
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4 |
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991 |
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— |
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— |
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— |
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995 |
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Balance — June 30, 2004 |
|
100 |
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$ |
175 |
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32,871 |
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$ |
164 |
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$ |
189,543 |
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$ |
(129,250 |
) |
$ |
(43 |
) |
$ |
2 |
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$ |
60,591 |
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See the accompanying notes to condensed consolidated financial statements.
3
DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
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For the Six Months |
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2004 |
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2003 |
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Cash Flows From Operating Activities |
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Net loss from continuing operations |
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$ |
(4,605 |
) |
$ |
(1,894 |
) |
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Adjustments to reconcile net loss to net cash used in operating activities: |
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Loss from discontinued operations |
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(1,128 |
) |
(373 |
) |
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Equity-based compensation |
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31 |
|
25 |
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Amortization of debt discount and deferred financing costs |
|
124 |
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19 |
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Depreciation and amortization |
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1,157 |
|
869 |
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Minority interest |
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3 |
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(110 |
) |
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Loss on Applied Digital common stock |
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2,612 |
|
— |
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Loss on disposal of equipment |
|
39 |
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16 |
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Change in assets and liabilities: |
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Increase in restricted cash |
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(74 |
) |
— |
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Increase in accounts receivable |
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(1,169 |
) |
(1,348 |
) |
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Decrease (increase) in inventories |
|
542 |
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(1,728 |
) |
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Increase in deferred costs |
|
(296 |
) |
— |
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Increase in other current assets |
|
(259 |
) |
(859 |
) |
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Decrease in due to Applied Digital |
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(250 |
) |
(47 |
) |
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(Decrease) increase in accounts payable, accrued expenses and deferred revenue |
|
(113 |
) |
3,017 |
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Net cash provided by discontinued operations |
|
379 |
|
120 |
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Net Cash Used In Operating Activities |
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(3,007 |
) |
(2,293 |
) |
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Cash Flows From Investing Activities |
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Proceeds from sale of Applied Digital common stock |
|
2,687 |
|
— |
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Decrease in other assets |
|
18 |
|
— |
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Payments for property and equipment |
|
(235 |
) |
(507 |
) |
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Cash acquired through acquisition, net of acquisition costs |
|
(20 |
) |
— |
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Net cash provided by (used in) discontinued operations |
|
383 |
|
(16 |
) |
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Net Cash Provided By (Used In) Investing Activities |
|
2,833 |
|
(523 |
) |
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|
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Cash Flows From Financing Activities |
|
|
|
|
|
||
|
Amounts borrowed on line of credit |
|
18,837 |
|
17,285 |
|
||
|
Amounts paid on line of credit |
|
(19,510 |
) |
(14,876 |
) |
||
|
Payments on notes payable and long-term debt |
|
(355 |
) |
(20 |
) |
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|
Exercise of stock options |
|
995 |
|
231 |
|
||
|
Payments for financing costs |
|
(20 |
) |
— |
|
||
|
Net cash used in discontinued operations |
|
— |
|
(18 |
) |
||
|
Net Cash (Used In) Provided By Financing Activities |
|
(53 |
) |
2,602 |
|
||
|
|
|
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|
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|
Effect of Exchange Rate Changes on Cash |
|
3 |
|
— |
|
||
|
|
|
|
|
|
|
||
|
Net Decrease In Cash |
|
(224 |
) |
(214 |
) |
||
|
|
|
|
|
|
|
||
|
Cash - Beginning Of Period |
|
894 |
|
214 |
|
||
|
|
|
|
|
|
|
||
|
Cash - End Of Period |
|
$ |
670 |
|
$ |
— |
|
See the accompanying notes to condensed consolidated financial statements.
4
DIGITAL ANGEL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands)
(Unaudited)
1. Basis of Presentation
On March 27, 2002, Digital Angel Acquisition Co. (“Acquisition”), then a wholly-owned subsidiary of Medical Advisory Systems, Inc. (“MAS”), merged with and into Digital Angel Corporation, which was then a 93% owned subsidiary of Applied Digital. In the merger, the corporate existence of Acquisition ceased, Digital Angel Corporation became a wholly-owned subsidiary of MAS and was renamed Digital Angel Technology Corporation (“DATC”), and MAS was renamed “Digital Angel Corporation.” In connection with the merger transaction, Applied Digital contributed to MAS all of its stock in Timely Technology Corp., a wholly-owned subsidiary, and Signature Industries, Limited, an 85% owned subsidiary. These two subsidiaries, along with DATC, comprised the Advanced Wireless Group (“AWG”). As a result of this contribution by Applied Digital, Timely Technology Corp. became a wholly-owned subsidiary of the Company and Signature Industries, Limited became an 85% subsidiary. Prior to the merger with DATC, Applied Digital owned 850,000 shares of MAS stock, representing approximately 16.3% of the outstanding stock of MAS. (Unless the context otherwise requires, the term “Company” means Digital Angel Corporation and its subsidiaries). In the merger, the shares of DATC owned by Applied Digital were converted into a total of 18,750,000 shares of MAS common stock. As a result of the merger, Applied Digital owned 19,600,000 shares or 77.15% of the Company’s common stock. The merger was treated as a reverse acquisition for accounting purposes, with AWG treated as the accounting acquirer.
The accompanying unaudited condensed consolidated financial statements of Digital Angel Corporation and subsidiaries as of June 30, 2004 and for the three and six month periods ended June 30, 2004 and 2003 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. 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 (including normal recurring adjustments) considered necessary to present fairly the financial statements have been made.
The consolidated statements of operations for the three and six months ended June 30, 2004 and 2003 are not necessarily indicative of the results that may be expected for the entire year. These statements should be read in conjunction with the Digital Angel Corporation’s audited consolidated financial statements and related notes thereto for the year ended December 31, 2003 which are included in the Company’s Annual Report on Form 10-K.
Certain items in the condensed consolidated financial statements for the 2003 periods have been reclassified for comparative purposes.
The Company develops and deploys sensor and communications technologies that enable rapid and accurate identification, location tracking, and condition monitoring of high-value assets. Prior to January 22, 2004, the Company operated in four segments: Animal Applications, Wireless and Monitoring, GPS and Radio Communications and Medical Systems. With the acquisition of OuterLink Corporation in January 2004, the Company reorganized into three segments: Animal Applications, GPS and Radio Communications and Medical Systems. The GPS and Radio Communications segment, the Wireless and Monitoring segment and the OuterLink Corporation business, which was acquired on January 22, 2004, were combined to form the new GPS and Radio Communications segment. On April 19, 2004, Digital Angel Corporation sold certain assets of its Medical Systems segment’s medical services business. Assets sold include all of the tangible and intangible intellectual property developed for the operation of the Medical Systems segment’s medical services business, pharmaceutical supplies and other inventory items, customer and supplier contracts, computer software licenses, internet website and domain name and mailing lists and did not include the land and building used by this operation. The Company sold the Medical Systems segment’s land and buildings in a separate transaction on July 30, 2004 for $1.5 million. Net cash received on the sale, after paying off the related building mortgage, was approximately $0.4 million.
Animal Applications—develops, manufactures, and markets a broad line of electronic and visual identification devices for the companion animal, livestock, laboratory animal, fish and wildlife markets worldwide. The tracking of cattle and hogs are crucial both for asset management and for disease control and food safety. The principal technologies employed by Animal Applications are electronic ear tags and implantable microchips that use radio frequency transmission.
GPS and Radio Communications-consists of the design, manufacture and support of GPS enabled equipment. Applications for the segment’s products include location tracking and message monitoring of vehicles, aircraft and people in remote locations through systems that integrate GPS and geosynchronous satellite communications and GPS enabled equipment and intelligent communications products and services for telemetry, mobile data and radio communications applications serving commercial and military markets. Technology development in this segment includes the integration and miniaturization into marketable products of
5
three technologies: wireless communications (such as cellular), sensors (including bio-sensors) and position location technology (including global positioning systems (GPS) and other systems).
2. Principles of Consolidation
The June 30, 2004 and 2003 condensed consolidated financial statements include the accounts of the Company and its wholly-owned and majority-owned subsidiaries (OuterLink Corporation from the date of acquisition on January 22, 2004). All significant intercompany accounts and transactions have been eliminated in consolidation.
3. Revenue Recognition
The Company, except for its subsidiary OuterLink Corporation, recognizes product revenue at the time product is shipped and title has transferred, provided that a purchase order has been received or a contract has been executed, there are no uncertainties regarding customer acceptance, the sales price is fixed and determinable and collectibility is deemed probable. If uncertainties regarding customer acceptance exists, revenue is recognized when such uncertainties are resolved. There are no significant post-contract support obligations at the time of revenue recognition. Digital Angel Corporation’s accounting policy regarding vendor and post contract support obligations is based on the terms of the customers’ contracts, billable upon occurrence of the post-sale support. Costs of products sold and services provided are recorded as the related revenue is recognized. Digital Angel Corporation offers a warranty on its products. For non-fixed fee jobs, revenue is recognized based on the actual direct labor hours in the job multiplied by the standard billing rate and adjusted to net realizable value, if necessary. Revenues from contracts that provide services are recognized ratably over the term of the contract. Fixed fee revenues from contracts for services are recorded when earned and exclude reimbursable costs. Reimbursable costs incurred in performing such services are presented on a net basis and include transportation medical and communication costs. Other revenue is recognized at the time service or goods are provided. It is the Company’s policy to record contract losses in their entirety in the period in which such losses are foreseeable.
The Company’s subsidiary, OuterLink Corporation, earns revenue from messaging services, which generally provide for service on a month-to month basis and from the sale of related products to customers (communication terminals and software). OuterLink Corporation’s messaging service is only available through use of its products, such products have no alternative use. Accordingly, service revenue is recognized as the services are performed. OuterLink Corporation’s product revenue, for which title and risk of loss transfers to the customer on shipment, is deferred upon shipment and is recognized ratable over the estimated customer service period, currently 30 months.
4. Stock-Based Compensation
The Company applies APB Opinion No. 25 and related Interpretations in accounting for all its stock option plans. Accordingly, no compensation cost has been recognized under these stock option plans. The Company has adopted the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” which was released in December 2002 as an amendment to SFAS No. 123. The following table illustrates the effect on net loss and loss per share if the fair value based method had been applied to all awards (in thousands, except per share data):
|
|
|
Three Months Ended June 30, |
|
Six Months Ended June 30, |
|
||||||||
|
|
|
2004 |
|
2003 |
|
2004 |
|
2003 |
|
||||
|
Reported net loss |
|
$ |
(1,989 |
) |
$ |
(2,377 |
) |
(5,733 |
) |
$ |
(2,267 |
) |
|
|
Stock-based employee compensation expense in reported net loss, net of related tax effects |
|
31 |
|
(61 |
) |
31 |
|
25 |
|
||||
|
Stock-based employee compensation expense determined under the fair value based method, net of related tax effects |
|
(2,111 |
) |
(1,695 |
) |
(3,611 |
) |
(3,358 |
) |
||||
|
Pro forma net loss |
|
$ |
(4,069 |
) |
$ |
(4,133 |
) |
$ |
(9,313 |
) |
$ |
(5,600 |
) |
|
|
|
|
|
|
|
|
|
|
|
||||
|
Loss per share -basic and diluted |
|
|
|
|
|
|
|
|
|
||||
|
As reported |
|
$ |
(0.06 |
) |
$ |
(0.09 |
) |
$ |
(0.18 |
) |
$ |
(0.08 |
) |
|
Pro forma |
|
$ |
(0.12 |
) |
$ |
(0.15 |
) |
$ |
(0.30 |
) |
$ |
(0.21 |
) |
6
5. Inventory (in thousands)
|
|
|
June 30, |
|
December 31, |
|
||
|
Raw materials |
|
$ |
2,899 |
|
$ |
1,976 |
|
|
Work in process |
|
143 |
|
94 |
|
||
|
Finished goods |
|
5,342 |
|
6,294 |
|
||
|
|
|
8,384 |
|
8,364 |
|
||
|
Allowance for excess and obsolescence |
|
(2,115 |
) |
(1,821 |
) |
||
|
Net inventory |
|
$ |
6,269 |
|
$ |
6,543 |
|
6. Stock Exchange with Applied Digital
On March 1, 2004, the Company issued 3,000,000 shares of its common stock to Applied Digital pursuant to the Stock Purchase Agreement (“Stock Purchase Agreement”) with Applied Digital dated August 14, 2003. The Stock Purchase Agreement provided for Applied Digital to purchase 3,000,000 shares of the Company’s common stock at a price of $2.64 per share and a warrant (the “Applied Digital Warrant”) to purchase up to 1,000,000 shares of the Company’s common stock, which is exercisable for five years beginning February 1, 2004, at a price per share of $3.74 payable in cash or shares of common stock of Applied Digital. The consideration for the sale of the Company’s 3,000,000 shares and the warrant was 1,980,000 shares of Applied Digital common stock. The Company expects to sell the stock of Applied Digital to generate additional funds. As of June 30, 2004, the Company has sold 910,000 shares of Applied Digital common stock. The Company has accounted for the Applied Digital stock as a trading security under SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities”. In the six months ended June 30, 2004 the Company recorded realized losses of $955,000 on the 910,000 shares of Applied Digital common stock sold and an unrealized loss of $1,657,000 on the remaining 1,070,000 shares held by the Company. Fair value of the Applied Digital common stock is determined by quoted values reported on NASDAQ.
7. Discontinued Operations
In April 2004, our Board of Directors approved a plan to sell our Medical Systems segment. The Medical Systems segment represented the business operations of Medical Advisory Systems, Inc, which we acquired on March 27, 2002. The Medical Systems segment was one of our reporting units in accordance with SFAS 142, “Goodwill and Other Intangible Assets”. Accordingly, the financial condition, results of operations and cash flows of our Medical Systems segment have been reported as discontinued operations for all periods presented. The following discloses the operating losses from discontinued operations for the three and six-months ended June 30, 2004 and 2003, consisting of losses attributable to the Medical Systems segment:
|
|
|
Three-Months |
|
Six-Months |
|
||||||||
|
|
|
2004 |
|
2003 |
|
2004 |
|
2003 |
|
||||
|
Product revenue |
|
$ |
40 |
|
$ |
222 |
|
$ |
204 |
|
$ |
587 |
|
|
Service revenue |
|
32 |
|
237 |
|
223 |
|
616 |
|
||||
|
Total revenue |
|
72 |
|
459 |
|
427 |
|
1,203 |
|
||||
|
Cost of products sold |
|
20 |
|
95 |
|
87 |
|
258 |
|
||||
|
Cost of services sold |
|
82 |
|
252 |
|
317 |
|
593 |
|
||||
|
Total cost of products and services sold |
|
102 |
|
347 |
|
404 |
|
851 |
|
||||
|
Gross profit |
|
(30 |
) |
112 |
|
23 |
|
352 |
|
||||
|
Selling, general and administrative expenses |
|
648 |
|
325 |
|
1,046 |
|
656 |
|
||||
|
Other income and expense |
|
72 |
|
35 |
|
105 |
|
69 |
|
||||
|
Loss from discontinued operations |
|
$ |
(750 |
) |
$ |
(248 |
) |
$ |
(1,128 |
) |
$ |
(373 |
) |
The above results do not include any allocated or common overhead expenses. We have not provided a benefit for income taxes on the losses attributable to the Medical Systems division. We do not anticipate the Medical Systems division incurring additional losses in the future. However, in accordance with SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, any additional operating losses or changes in the values of assets or liabilities will be reflected in our financial condition and results of operations as incurred.
The net assets of discontinued operations as of June 30, 2004 and December 31, 2003, were comprised of the following:
7
|
|
|
June 30, 2004 |
|
December 31, 2003 |
|
||
|
|
|
(in thousands) |
|
||||
|
Assets |
|
|
|
|
|
||
|
Cash |
|
$ |
— |
|
$ |
— |
|
|
Accounts receivable, net |
|
66 |
|
453 |
|
||
|
Inventory |
|
— |
|
46 |
|
||
|
Other current assets |
|
1 |
|
43 |
|
||
|
Property and equipment, net |
|
1,050 |
|
1,137 |
|
||
|
Goodwill and other intangible assets, net |
|
— |
|
489 |
|
||
|
Other assets |
|
144 |
|
163 |
|
||
|
Total Assets |
|
$ |
1,261 |
|
$ |
2,331 |
|
|
|
|
|
|
|
|
||
|
Current Liabilities: |
|
|
|
|
|
||
|
Notes payable and current maturities of long-term debt |
|
$ |
(910 |
) |
$ |
(910 |
) |
|
Accounts payable |
|
(27 |
) |
(71 |
) |
||
|
Accrued expenses and deferred revenue |
|
(298 |
) |
(99 |
) |
||
|
Total Liabilities |
|
$ |
(1,235 |
) |
$ |
(1,080 |
) |
|
|
|
|
|
|
|
||
|
Net Assets |
|
$ |
26 |
|
$ |
1,251 |
|
8. Loss Per Share
The following is a reconciliation of the numerator and denominator of basic and diluted loss per share (in thousands, except per share data):
|
|
|
Three Months |
|
Six Months |
|
||||||||
|
|
|
2004 |
|
2003 |
|
2004 |
|
2003 |
|
||||
|
Numerator: |
|
|
|
|
|
|
|
|
|
||||
|
Net loss |
|
$ |
(1,989 |
) |
$ |
(2,377 |
) |
$ |
(5,733 |
) |
$ |
(2,267 |
) |
|
Denominator: |
|
|
|
|
|
|
|
|
|
||||
|
Denominator for basic loss per share - |
|
|
|
|
|
|
|
|
|
||||
|
Weighted-average shares |
|
32,691 |
|
26,856 |
|
31,604 |
|
26,760 |
|
||||
|
Denominator for diluted loss per share (1)- |
|
32,691 |
|
26,856 |
|
31,604 |
|
26,760 |
|
||||
|
Basic and diluted loss per share |
|
$ |
(0.06 |
) |
$ |
(0.09 |
) |
$ |
(0.18 |
) |
$ |
(0.08 |
) |
(1) Potentially dilutive securities are excluded from the computation of diluted loss per share because to do so would have been anti-dilutive.
9. Segment Information
The Company is an advanced technology company in the field of rapid and accurate identification, location tracking, and condition monitoring of high-value assets. Prior to January 22, 2004, the Company operated in four segments: Animal Applications, Wireless and Monitoring, GPS and Radio Communications and Medical Systems. With the acquisition of OuterLink Corporation in January 2004, the Company reorganized into three segments: Animal Application, GPS and Radio Communications and Medical Systems. The GPS and Radio Communications segment, the Wireless and Monitoring segment and the OuterLink Corporation business, which was acquired on January 22, 2004, were combined to form the new GPS and Radio Communications segment. Prior period segment information has been restated to reflect the Company’s current segment structure. On April 19, 2004, Digital Angel Corporation sold certain assets of its Medical Systems segment’s medical services business. Assets sold include all of the tangible and intangible intellectual property developed for the operation of the Medical Systems segment’s medical services business, pharmaceutical supplies and other inventory items, customer and supplier contracts, computer software licenses, internet website and domain name and mailing lists and did not include the land and building used by this operation. The Company sold the Medical Systems segment’s land and buildings in a separate transaction on July 30, 2004 for $1.5 million. Net cash received on the sale, after paying off the related building mortgage, was approximately $0.4 million.
8
It is on this basis that management utilizes the financial information to assist in making internal operating decisions. The Company evaluates performance based on stand-alone segment operating income.
Following is the selected segment data as of and for the three months ended June 30, 2004 (in thousands):
|
|
|
Animal |
|
GPS and Radio |
|
Corporate / |
|
Consolidated |
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Net revenue from external customers: |
|
|
|
|
|
|
|
|
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Product |
|
$ |
5,779 |
|
$ |
3,624 |
|
$ |
— |
|
$ |
9,403 |
|
|
Service |
|
334 |
|
333 |
|
— |
|
667 |
|
||||
|
Total revenue |
|
$ |
6,113 |
|
$ |
3,957 |
|
$ |
— |
|
$ |
10,070 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Income (loss) before minority interest share of losses (income) and discontinued operations |
|
$ |
(439 |
) |
$ |
(803 |
) |
$ |
— |
|
$ |
(1,242 |
) |
|
|
|
|
|
|
|
|
|
|
|
||||
|
Total assets |
|
$ |
60,303 |
|
$ |
17,067 |
|
$ |
26 |
|
$ |
77,396 |
|
In the three month period ended June 30, 2004, two customers accounted for approximately 22.9%, and 11.1% of our Animal Applications revenue.
Following is the selected segment data as of and for the six months ended June 30, 2004 (in thousands):
|
|
|
Animal |
|
GPS and Radio |
|
Corporate / |
|
Consolidated |
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Net revenue from external customers: |
|
|
|
|
|
|
|
|
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Product |
|
$ |
12,788 |
|
$ |
7,126 |
|
$ |
— |
|
$ |
19,914 |
|
|
Service |
|
397 |
|
530 |
|
— |
|
927 |
|
||||
|
Total revenue |
|
$ |
13,185 |
|
$ |
7,656 |
|
$ |
— |
|
$ |
20,841 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Income (loss) before minority interest share of losses (income) and discontinued operations |
|
$ |
(3,082 |
) |
$ |
(1,520 |
) |
$ |
— |
|
$ |
(4,602 |
) |
|
|
|
|
|
|
|
|
|
|
|
||||
|
Total assets |
|
$ |
60,303 |
|
$ |
17,067 |
|
$ |
26 |
|
$ |
77,396 |
|
In the six month period ended June 30, 2004, two customers accounted for approximately 18.2%, and 12.0% of our Animal Applications revenue.
Following is the selected segment data as of and for the three months ended June 30, 2003 (in thousands):
|
|
|
Animal |
|
GPS and Radio |
|
Corporate / |
|
Consolidated |
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Net revenue from external customers: |
|
|
|
|
|
|
|
|
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Product |
|
$ |
4,846 |
|
$ |
2,708 |
|
$ |
— |
|
$ |
7,554 |
|
|
Service |
|
342 |
|
5 |
|
— |
|
347 |
|
||||
|
Total revenue |
|
$ |
5,188 |
|
$ |
2,713 |
|
$ |
— |
|
$ |
7,901 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Income (loss) before minority interest share of losses (income) and discontinued operations |
|
$ |
(938 |
) |
$ |
(1,268 |
) |
$ |
— |
|
$ |
(2,206 |
) |
|
|
|
|
|
|
|
|
|
|
|
||||
|
Total assets |
|
$ |
57,872 |
|
$ |
7,574 |
|
$ |
4,199 |
|
$ |
69,645 |
|
9
In the three month period ended June 30, 2003, two customers accounted for approximately 21.8% and 16.7% of our Animal Applications revenue.
Following is the selected segment data as of and for the six months ended June 30, 2003 (in thousands):
|
|
|
Animal |
|
GPS and Radio |
|
Corporate / |
|
Consolidated |
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Net revenue from external customers: |
|
|
|
|
|
|
|
|
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Product |
|
$ |
12,322 |
|
$ |
5,407 |
|
$ |
— |
|
$ |
17,729 |
|
|
Service |
|
667 |
|
159 |
|
— |
|
826 |
|
||||
|
Total revenue |
|
$ |
12,989 |
|
$ |
5,566 |
|
$ |
— |
|
$ |
18,555 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Income (loss) before minority interest share of losses (income) and discontinued operations |
|
$ |
521 |
|
$ |
(2,525 |
) |
$ |
— |
|
$ |
(2,004 |
) |
|
|
|
|
|
|
|
|
|
|
|
||||
|
Total assets |
|
$ |
57,872 |
|
$ |
7,574 |
|
$ |
4,199 |
|
$ |
69,645 |
|
In the six month period ended June 30, 2003, four customers accounted for approximately 17.1%, 11.6%, 10.9%, and 10.3% of our Animal Applications revenue.
10. Acquisition
The following describes the acquisition by the Company (in thousands):
|
Company |
|
Date |
|
Acquisition |
|
Value of |
|
Series A |
|
Goodwill |
|
Other Net |
|
Business |
|
||||
|
OuterLink Corporation |
|
1/22/04 |
|
$ |
8,501 |
|
$ |
8,300 |
|
100 |
|
$ |
8,522 |
|
$ |
(21 |
) |
Provider of real-time, satellite-based automated tracking, wireless data transfer and two-way messaging with large fleets of vehicles. |
|
On January 22, 2004, the Company acquired OuterLink Corporation. OuterLink Corporation became a wholly-owned subsidiary of Digital Angel Corporation. The acquisition was accounted for under the purchase method of accounting. The excess of purchase price over the fair value of the assets and liabilities of OuterLink Corporation was recorded as goodwill of $3.8 million and intangible assets of $4.7 million.
The cost of the acquisition consisted of 100,000 shares of Series A preferred stock valued at $8.3 million and acquisition costs of $0.2 million. The Series A preferred stock is convertible into four million shares of the Company’s common stock when the volume weighted average price of the Company’s common stock equals or exceeds $4.00 per share for ten consecutive trading days.
10
The valuation of the stock is primarily based on historical trading history and stock prices of the Company’s common stock and a marketability discount of 30%. The cost of the acquisition consists of legal and accounting related services that were direct costs of acquiring these assets.
In considering the benefits the OuterLink Corporation acquisition, the management of Digital Angel Corporation recognized the strategic complement of OuterLink Corporation’s technologies and customer base with Digital Angel Corporation’s existing animal applications and military GPS business lines. This complement provides for a strong platform for further development of Digital Angel Corporation’s capabilities in the area of high-value asset identification, tracking and condition monitoring.
The results of OuterLink Corporation have been included in the consolidated financial statements since the date of acquisition of January 22, 2004. Unaudited pro forma results of operations for the three months ended June 30, 2003 and the six months ended June 30, 2004 and 2003 are included below. Such pro forma information assumes that the above acquisition had occurred as of January 1, 2004 and 2003, and revenue is presented in accordance with the Company’s accounting policies. This summary is not necessarily indicative of what the result of operations of the Company would have been had it been a combined entity during such periods, nor does it purport to represent results of operations for any future periods.
|
|
|
|
|
For the
three-months |
|
|
|
(In thousands) |
|
|
|
2003 |
|
|
|
Net revenue |
|
|
|
$ |
8,235 |
|
|
Net loss |
|
|
|
$ |
(3,300 |
) |
|
Net loss per common share - basic and diluted |
|
|
|
$ |
(0.12 |
) |
|
|
|
For the six-months ended June 30, |
|
||||
|
(In thousands) |
|
2004 |
|
2003 |
|
||
|
Net revenue |
|
$ |
20,928 |
|
$ |
19,149 |
|
|
Net loss |
|
$ |
(6,436 |
) |
$ |
(4,281 |
) |
|
Net loss per common share - basic and diluted |
|
$ |
(0.20 |
) |
$ |
(0.16 |
) |
11. Contingencies
Wurts Litigation
In February 2003, an action was filed in the Middlesex County Superior Court in the Commonwealth of Massachusetts. The Company’s subsidiary, OuterLink Corporation, as well as a significant stockholder of OuterLink and a principal of the significant stockholder were named as defendants. The complaint alleged breach of an August 25, 1999 employment contract. The plaintiff was President and CEO of OuterLink Corporation from July 1999 through August 2002. The Complaint sought damages based principally on a contractual severance provision that allegedly provided for four months of compensation for every year or fraction thereof served prior to termination. This matter was settled in July 2004 in consideration for a cash payment of $250,000.
E-Research Litigation
In June, 2002, eResearch Technology, Inc. f/k/a Premier Research Worldwide, Ltd. (“ERT”) commenced a proceeding against U.S. Bank National Association (“US Bank”), subsequently intervened in by the Company in the New Jersey state court and subsequently removed to the United States District Court for the District of New Jersey. This suit was commenced to pursue alleged damages of approximately $350,000 due to the Company’s and US Bank’s alleged failure to register transfers of restricted Digital Angel shares sold by ERT in May 2002. This matter was settled prior to trial without either party paying any amounts to the other party.
Electronic Identification Devices Litigation
In February 2004, Electronic Identification Devices, Ltd. (“EID”) commenced a Declaratory Judgment Action against the Company in the United States District Court for the Western District of Texas. This action seeks a declaration of patent non-infringement relating to the Company’s patented syringe implantable identification transponder. The lawsuit alleges that EID has developed a new transponder that it believes does not infringe on the Company’s patent. The lawsuit acknowledges that the Company obtained a Judgment of infringement and two contempt orders against EID based on selling certain systems that infringed the Company’s patent in 1997, 1998 and 1999. On March 10, 2004 the Company filed a motion seeking the dismissal of the Declaratory Judgment Complaint or, in the alternative, that the action be transferred to Minnesota. The Court has not yet ruled on the Company’s motion. Given the very early stage of this matter, the ultimate outcome of this proceeding cannot be predicted at this time. The
11
Company is currently unable to determine the potential effect of this litigation on its consolidated financial position, results of operation or cash flows.
John Fernandez vs. United States of America vs. Medical Advisory Systems, Inc.
On December 29, 2003, John Fernandez filed a lawsuit in the Orlando Division of the United States District Court for the Middle District of Florida. The plaintiff filed the lawsuit against the Unites States of America as the operator of the ship on which the plaintiff served. He alleged that the United States had contracted with Medical Advisory Systems to provide medical advice and that the physician at Medical Advisory Systems had rendered an incorrect long-distance diagnosis, resulting to injury to the plaintiff. Mr. Fernandez asserted against the United States claims of negligence under the Jones Act, unseaworthiness and maintenance and cure. He alleged damages in excess of $75,000, plus prejudgment and post-judgment interest at the legal rate and costs and disbursements of the action. On April 14, 2004, the United States served Medical Advisory Systems with a third part complaint in Admirality in which it alleged that Medical Advisory Systems is liable to it for all or part of the plaintiff’s claim in that Medical Advisory Systems and/or its employee/physician rendering the medical advice was negligent. In response, on May 12, 2004, Medical Advisory Systems filed a motion to dismiss the third party complaint. Given the very early stage of the lawsuit, the ultimate outcome of this proceeding cannot be predicted at this time. The Company is currently unable to determine the potential effect of this litigation on our consolidated financial position, results of operations or cash flows.
12. Supplemental Cash Flow Information (in thousands)
|
|
|
Six Months Ended June 30, |
|
||||
|
|
|
2004 |
|
2003 |
|
||
|
Interest paid |
|
$ |
281 |
|
$ |
254 |
|
|
Non-cash activity: |
|
|
|
|
|
||
|
Issuance of preferred stock for business acquisition |
|
$ |
8,300 |
|
— |
|
|
|
Issuance of common stock for Applied Digital common stock |
|
7,920 |
|
— |
|
||
|
Conversion of debt into common stock |
|
583 |
|
— |
|
||
13. Related Party Activity
In 2003, Applied Digital charged the Company for research expenses and directors and officers insurance. Amounts due to Applied Digital were offset by receivables due from Applied Digital resulting from the Distribution and Licensing Agreement with Verichip Corporation, a wholly-owned subsidiary of Applied Digital. At June 30, 2004, these transactions resulted in a net amount due to Applied Digital of $0.1 million.
The Company has executed an exclusive eleven year Distribution and Licensing Agreement dated March 4, 2002 with Verichip Corporation (Verichip), a wholly-owned subsidiary of Applied Digital, covering the manufacturing, purchasing and distribution of Verichip’s implantable microchip and the maintenance of the Verichip Registry by the Company. The agreement includes a license for the use of the Company’s technology in Verichip’s identified markets. The Company will be the sole manufacturer and supplier to Verichip. Revenue recognized under the Distribution and Licensing Agreement was $57,000 and $87,000 for the six months ended June 30, 2004 and 2003, respectively.
12
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 thereto.
We consist of Digital Angel Corporation and its four subsidiaries — Digital Angel Technology Corporation (“DATC”), Timely Technology Corp., Signature Industries, Limited, and OuterLink Corporation
RESULTS OF OPERATIONS
The following table summarizes our results of operations as a percentage of net operating revenue for the three and six months ended June 30, 2004 and 2003 and is derived from the accompanying consolidated statements of operations included in this report.
|
|
|
Three Months Ended |
|
Six Months Ended |
|
||||
|
|
|
2004 |
|
2003 |
|
2004 |
|
2003 |
|
|
|
|
% |
|
% |
|
% |
|
% |
|
|
Product revenue |
|
93.4 |
|
95.6 |
|
95.5 |
|
95.5 |
|
|
Service revenue |
|
6.6 |
|
4.4 |
|
4.5 |
|
4.5 |
|
|
Total net revenue |
|
100.0 |
|
100.0 |
|
100.0 |
|
100.0 |
|
|
Cost of products sold |
|
54.4 |
|
62.9 |
|
55.7 |
|
56.3 |
|
|
Cost of services sold |
|
4.3 |
|
0.0 |
|
2.6 |
|
0.3 |
|
|
Total cost of products and services sold |
|
58.7 |
|
62.9 |
|
58.3 |
|
56.6 |
|
|
Gross profit |
|
41.3 |
|
37.1 |
|
41.7 |
|
43.4 |
|
|
Selling, general and administrative expenses |
|
42.7 |
|
48.8 |
|
41.9 |
|
42.0 |
|
|
Research and development expenses |
|
8.4 |
|
14.8 |
|
7.3 |
|
11.2 |
|
|
Operating loss |
|
(9.8 |
) |
(26.5 |
) |
(7.5 |
) |
(9.8 |
) |
|
Interest income |
|
0.1 |
|
0.0 |
|
0.1 |
|
0.0 |
|
|
Interest expense |
|
(2.5 |
) |
(1.9 |
) |
(2.4 |
) |
(1.4 |
) |
|
Loss on Applied Digital common stock |
|
(0.3 |
) |
0.0 |
|
(12.6 |
) |
0.0 |
|
|
Other income |
|
0.2 |
|
0.4 |
|
0.3 |
|
0.4 |
|
|
Loss before minority interest share of losses and discontinued operations |
|
(12.3 |
) |
(28.0 |
) |
(22.1 |
) |
(10.8 |
) |
|
Minority interest share of losses |
|
0.0 |
|
1.0 |
|
0.0 |
|
0.6 |
|
|
Net loss from continuing operations |
|
(12.3 |
) |
(27.0 |
) |
(22.1 |
) |
(10.2 |
) |
|
Loss from discontinued operations |
|
(7.4 |
) |
(3.1 |
) |
(5.4 |
) |
(2.0 |
) |
|
Net loss |
|
(19.7 |
) |
(30.1 |
) |
(27.5 |
) |
(12.2 |
) |
13
Three Months Ended June 30, 2004 Compared to the Three Months Ended June 30, 2003
Revenue
Revenue for the three months ended June 30, 2004 increased $2.2 million, or 27.5%, to $ 10.1 million when compared to $7.9 million in revenue for the three months ended June 30, 2003.
Revenue for each of the operating segments was as follows (in thousands):
|
|
|
Three Months |
|
Three Months |
|
||
|
Animal Applications |
|
$ |
6,113 |
|
$ |
5,188 |
|
|
GPS and Radio Communications |
|
3,957 |
|
2,713 |
|
||
|
Total |
|
$ |
10,070 |
|
$ |
7,901 |
|
The Animal Applications segment’s revenue increased $0.9 million, or 17.8%, in the three months ended June 30, 2004 compared to the three month period ended June 30, 2003. The increase is the result of increased sales to our livestock customers of $0.3 million, fish and wildlife customers of $0.3 million, and companion animal customers of $0.3 million.
The GPS and Radio Communications segment’s revenue increased $1.2 million, or 45.9%, in the three months ended June 30, 2004 compared to the three month period ended June 30, 2003. The increase is primarily due to increased revenues of $0.8 million at our subsidiary, Signature Industries, located in the United Kingdom. The increase in revenue at Signature Industries relates to initial shipments of the G2R pilot locator beacon and increased sales in Signature’s Clifford and Snell division. OuterLink Corporation revenue was $0.4 million for the three months ended June 30, 2004. OuterLink Corporation was acquired on January 22, 2004 and is not included in our results for the three months ended June 30, 2003.
Gross Profit and Gross Profit Margin
Gross profit for the three month period ended June 30, 2004 was $4.2 million, an increase of $1.2 million, or 41.8%, compared to $3.0 million in the three month period ended June 30, 2003. As a percentage of revenue, the gross profit margin was 41.3% and 37.1% for the three months ended June 30, 2004 and 2003, respectively.
Gross profit from operations for each operating segment was as follows (in thousands):
|
|
|
Three Months |
|
Three Months |
|
||
|
Animal Applications |
|
$ |
2,328 |
|
$ |
1,705 |
|
|
GPS and Radio Communications |
|
1,828 |
|
1,226 |
|
||
|
Total |
|
$ |
4,156 |
|
$ |
2,931 |
|
Gross profit margin from operations for each operating segment was:
|
|
|
Three Months |
|
Three Months |
|
|
|
|
% |
|
% |
|
|
Animal Applications |
|
38.1 |
|
32.9 |
|
|
GPS and Radio Communications |
|
46.2 |
|
45.2 |
|
The Animal Applications segment’s gross profit increased $0.6 million, or 36.5%, in the three month period ended June 30, 2004 compared to the three months ended June 30, 2003. The increase is primarily due to the increase in sales as mentioned above and lower freight costs in the 2004 period. The gross margin percentage increased to 38.1% in the three month period ended June 30, 2004 as compared to 32.9% in the three month period ended June 30, 2003. The gross margin percentage increase is the primarily the result of lower freight costs and fixed costs remaining constant as revenue increased.
The GPS and Radio Communications segment’s gross profit increased $0.6 million, or 49.1%, in the three month period ended June 30, 2004 as compared to the three month period ended June 30, 2003. The GPS and Radio Communications segment’s gross profit is attributable increased gross profit at our subsidiary Signature Industries of $0.5 million. The gross margin percentage increased to 46.2% in the three month period ended June 30, 2004 as compared to 45.2% in the three month period ended June 30, 2003 primarily due to lower material costs at Signature Industries. OuterLink Corporation gross profit was $0.1 million in the three
14
months ended June 30, 2004. OuterLink Corporation was acquired in January 2004.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $0.5 million, or 11.8%, in the three month period ended June 30, 2004 as compared to the three month period ended June 30, 2003. As a percentage of revenue, selling, general and administrative expenses were 42.7% and 48.8% for the three months ended June 30, 2004 and 2003, respectively.
Selling, general and administrative expenses for each of the operating segments were as follows (dollars in thousands):
|
|
|
Three Months |
|
Three Months |
|
||
|
Animal Applications |
|
$ |
1,909 |
|
$ |
1,844 |
|
|
GPS and Radio Communications |
|
2,394 |
|
2,006 |
|
||
|
Total |
|
$ |
4,303 |
|
$ |
3,850 |
|
Selling, general and administrative expenses as a percentage of revenue for each of the operating segments were:
|
|
|
Three Months |
|
Three Months |
|
|
|
|
% |
|
% |
|
|
Animal Applications |
|
31.2 |
|
35.5 |
|
|
GPS and Radio Communications |
|
60.5 |
|
73.9 |
|
The Animal Applications segment’s selling, general and administrative expenses increased $0.07 million in the three month period ended June 30, 2004 as compared to the three month period ended June 30, 2003 and as a percentage of revenue decreased to 31.2% from 35.5% in the same respective period. The increase in selling, general and administrative expense is primarily due to additional consulting expenses associated with the preparation of the 510K application for FDA approval of the Verichip product in the prior period.
The GPS and Radio Communications segment’s selling, general and administrative expenses increased $0.4 million in the three month period ended June 30, 2004 as compared to the three month period ended June 30, 2003. The increase of $0.4 million results from increased expenses of $0.2 million at Signature Industries, $0.5 million of expense at OuterLink, which was acquired in January 2004, offset by a decrease of $0.3 million related to the scaleback of the Digital Angel TM technology development. As a percentage of revenue, selling, general and administrative expenses decreased to 60.5% in the three month period ended June 30, 2004 from 73.9% in the three month period ended June 30, 2003.
Research and Development Expense
Research and development expense was $0.9 million in the three month period ended June 30, 2004, a decrease of $0.3 million, or 27.5%, from $1.2 million for the three month period ended June 30, 2003. As a percentage of revenue, research and development expense was 8.4% and 14.8% for the three months ended June 30, 2004 and 2003, respectively.
Research and development expense for each of the operating segments was as follows (in thousands):
|
|
|
Three Months |
|
Three Months |
|
||
|
Animal Applications |
|
$ |
653 |
|
$ |
691 |
|
|
GPS and Radio Communications |
|
197 |
|
481 |
|
||
|
Total |
|
$ |
850 |
|
$ |
1,172 |
|
The decrease in research and development expense is due primarily to the continued scaleback of research and development on the Digital AngelTM technology and completion of development on Signature Industries’ pilot locator beacon.
Interest Expense
Interest expense was $0.2 million for the three month periods ended June 30, 2004 and 2003, respectively.
15
Loss on Applied Digital Common Stock
On March 1, 2004, Digital Angel Corporation issued 3,000,000 shares of its common stock and a warrant to purchase up to 1,000,000 shares of the Company’s common stock to Applied Digital in exchange for 1,980,000 shares of Applied Digital’s common stock, exclusive of the proceeds which may be received when the warrant is exercised. The Company has accounted for the Applied Digital stock as a trading security under SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities”. In the quarter ended June 30, 2004, the Company sold approximately 380,000 shares of Applied Digital common stock sold. The Company recorded realized losses of $253,000 and unrealized gains of $227,000 in the quarter ended June 30, 2004. Fair value of the Applied Digital common stock is determined by quoted values reported on the NASDAQ.
Income Taxes
The Company had an effective income tax rate of 0.0% for the three month periods ended June 30, 2004 and 2003. The Company accounts for income taxes under the asset and liability approach. Deferred tax assets and liabilities are recognized for the expected future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. A valuation allowance is provided against net deferred tax assets when it is more likely than not that a tax benefit will not be realized. Income taxes included U.S. and foreign taxes.
Discontinued Operations
On April 19, 2004, the Company sold certain assets of its Medical Systems segment’s medical services business pursuant to an Asset Purchase Agreement dated April 8, 2004 by and between Digital Angel Corporation and MedAire, Inc. Assets sold include all of the tangible and intangible intellectual property developed for the operation of the Medical Systems segment’s medical services business, pharmaceutical supplies and other inventory items, customer and supplier contracts, computer software licenses, internet website and domain name and mailing lists.
Under the terms of the agreement, the purchase price, in addition to MedAire, Inc.’s assumption of certain liabilities was $420,000 plus any prepaid deposits and the cost of the pharmaceutical inventory and supplies reduced by any pre-billing to or pro-rata prepayment by the Company’s customers.
In connection with exiting this activity, the Company recognized obligations and recorded a loss of approximately $0.5 million in the three months ended June 30, 2004. In addition, the Company sold the Medical Systems segment’s land and buildings in a separate transaction on July 30, 2004 for $1.5 million. Net cash received on the sale, after paying off the related building mortgage, was approximately $0.4 million.
The following discloses the operating losses from discontinued operations for the three-months ended June 30, 2004 and 2003, consisting of losses attributable to the Medical Systems segment:
|
|
|
Three-Months |
|
||||
|
|
|
2004 |
|
2003 |
|
||
|
Product revenue |
|
$ |
40 |
|
$ |
222 |
|
|
Service revenue |
|
32 |
|
237 |
|
||
|
Total revenue |
|
72 |
|
459 |
|
||
|
Cost of products sold |
|
20 |
|
95 |
|
||
|
Cost of services sold |
|
82 |
|
252 |
|
||
|
Total cost of products and services sold |
|
102 |
|
347 |
|
||
|
Gross (loss) profit |
|
(30 |
) |
112 |
|
||
|
Selling, general and administrative expenses |
|
648 |
|
325 |
|
||
|
Other income and expense |
|
72 |
|
35 |
|
||
|
Loss from discontinued operations |
|
$ |
(750 |
) |
$ |
(248 |
) |
Six Months Ended June 30, 2004 Compared to the Six Months Ended June 30, 2003
Revenue
Revenue for the six months ended June 30, 2004 increased $2.3 million, or 12.3%, to $20.8 million when compared to $18.6
16
million in revenue for the six months ended June 30, 2003.
Revenue for each of the operating segments was as follows (in thousands):
|
|
|
Six Months |
|
Six Months |
|
||
|
Animal Applications |
|
$ |
13,185 |
|
$ |
12,989 |
|
|
GPS and Radio Communications |
|
7,656 |
|
5,566 |
|
||
|
Total |
|
$ |
20,841 |
|
$ |
18,555 |
|
The Animal Applications segment’s revenue increased $0.2 million, or 1.5%, in the six months ended June 30, 2004 compared to the six month period ended June 30, 2003. The increase is due to increased sales in the six months ended June 30, 2004 to companion animal customers of $0.3 million and livestock customers of $0.7 million, offset by decreased sales to our fish and wildlife customers of $0.8 million.
The GPS and Radio Communications segment’s revenue increased $2.1 million, or 37.5%, in the six months ended June 30, 2004 compared to the six month period ended June 30, 2003. The increase primarily relates to increased revenue at our subsidiary, Signature Industries, related to the initial shipments of the G2R pilot locator beacon and increased sales in Signature’s Clifford and Snell division. OuterLink Corporation revenue was $0.7 million for the six months ended June 30, 2004. OuterLink Corporation was acquired on January 22, 2004 and is not included in our results for the six months ended June 30, 2003.
Gross Profit and Gross Profit Margin
Gross profit for the six month period ended June 30, 2004 was $8.7 million, an increase of $0.6 million, or 7.8%, compared to $8.1 million in the six month period ended June 30, 2003. As a percentage of revenue, the gross profit margin was 41.7% and 43.4% for the six months ended June 30, 2004 and 2003, respectively.
Gross profit for each operating segment was as follows (in thousands):
|
|
|
Six Months |
|
Six Months |
|
||
|
Animal Applications |
|
$ |
5,134 |
|
$ |
5,364 |
|
|
GPS and Radio Communications |
|
3,551 |
|
2,690 |
|
||
|
Total |
|
$ |
8,685 |
|
$ |
8,054 |
|
Gross profit margin for each operating segment was:
|
|
|
Six Months |
|
Six Months |
|
|
|
|
% |
|
% |
|
|
Animal Applications |
|
38.9 |
|
41.3 |
|
|
GPS and Radio Communications |
|
46.4 |
|
48.3 |
|
The Animal Applications segment’s gross profit decreased $0.2 million, or 4.3%, in the six month period ended June 30, 2004 compared to the six months ended June 30, 2003 due to increased material cost slightly offset by lower freight costs in 2004. The gross margin percentage decreased to 38.9% in the six month period ended June 30, 2004 as compared to 41.3% in the six month period ended June 30, 2003 due primarily due to increased material costs.
The GPS and Radio Communications segment’s gross profit increased $0.9 million, or 32.0%, in the six month period ended June 30, 2004 compared to the six months ended June 30, 2003 due to increased gross profit of $0.8 million at Signature Industries and $0.1 million at OuterLink. OuterLink was acquired in January 2004. The gross margin percentage decreased to 46.4% in the six month period ended June 30, 2004 as compared to 48.3% in the six month period ended June 30, 2003 due to lower margins on the OuterLink revenue.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $0.9 million, or 11.9%, in the six month period ended June 30, 2004 as compared to the six month period ended June 30, 2003. As a percentage of revenue, selling, general and administrative expenses were
17
41.9% and 42.0% for the six months ended June 30, 2004 and 2003, respectively.
Selling, general and administrative expenses were as follows (dollars in thousands):
|
|
|
Six Months |
|
Six Months |
|
||
|
Animal Applications |
|
$ |
4,066 |
|
$ |
3,434 |
|
|
GPS and Radio Communications |
|
4,661 |
|
4,365 |
|
||
|
Total |
|
$ |
8,727 |
|
$ |
7,799 |
|
Selling, general and administrative expenses as a percentage of revenue for each of the operating segments were:
|
|
|
Six Months |
|
Six Months |
|
|
|
|
% |
|
% |
|
|
Animal Applications |
|
30.8 |
|
26.4 |
|
|
GPS and Radio Communications |
|
60.9 |
|
78.4 |
|
The Animal Applications segment’s selling, general and administrative expenses increased $0.6 million in the six month period ended June 30, 2004 as compared to the six month period ended June 30, 2003 and as a percentage of revenue increased to 30.8% from 26.4% in the same respective period. The increase relates primarily to additional legal, accounting and investor relation expenses in the six months ended June 30, 2004.
The GPS and Radio Communications segment’s selling, general and administrative expenses increased $0.3 million in the six month period ended June 30, 2004 as compared to the six month period ended June 30, 2003. This increase is primarily due to $0.9 million of OuterLink expense, $0.4 million of increased expense at our subsidiary, Signature Industries, offset by a decrease of $1.0 million related to the scaleback of Digital Angel TM technology development. OuterLink was acquired in January 2004. As a percentage of revenue, selling, general and administrative expenses decreased to 60.9% in the six month period ended June 30, 2004 from 78.4% in the six month period ended June 30, 2003.
Research and Development Expense
Research and development expense was $1.5 million in the six month period ended June 30, 2004, a decrease of $0.6 million, or 27.1%, from $2.1 million for the six month period ended June 30, 2003. As a percentage of revenue, research and development expense was 7.3% and 11.2% for the six months ended June 30, 2004 and 2003, respectively.
Research and development expense for each of the operating segments was as follows (in thousands):
|
|
|
Six Months |
|
Six Months |
|
||
|
Animal Applications |
|
$ |
1,176 |
|
$ |
1,241 |
|
|
GPS and Radio Communications |
|
343 |
|
842 |
|
||
|
Total |
|
$ |
1,519 |
|
$ |
2,083 |
|
The decrease in research and development expense is due primarily to the continued scaleback of research and development on the Digital AngelTM technology and completion of development on Signature Industries’ pilot locator beacon.
Interest Expense
Interest expense was $0.5 million and $0.3 million for the six months period ended June 30, 2004 and 2003, respectively. The increase relates to the amortization of deferred financing costs related to the financings in July and August of 2003.
Income Taxes
The Company had an effective income tax rate of 0.0% for the six month periods ended June 30, 2004 and 2003. The Company accounts for income taxes under the asset and liability approach. Deferred tax assets and liabilities are recognized for the expected future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. A valuation allowance is provided against net deferred tax assets when it is more likely than not that a tax benefit will not be realized. Income taxes included U.S. and foreign taxes.
18
Loss on Applied Digital Common Stock
On March 1, 2004, Digital Angel Corporation issued 3,000,000 shares of its common stock and a warrant to purchase up to 1,000,000 shares of the Company’s common stock to Applied Digital in exchange for 1,980,000 shares of Applied Digital’s common stock, exclusive of the proceeds which may be received when the warrant is exercised. As of June 30, 2004, the Company has sold approximately 910,000 shares of Applied Digital common stock. The Company has accounted for the Applied Digital stock as a trading security under SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities”. In the quarter ended June 30, 2004, the Company recorded realized losses of $955,000 on the approximately 910,000 shares of Applied Digital common stock sold and unrealized losses of $1,657,000 on the 1,070,000 shares held by the Company. Fair value of the Applied Digital common stock is determined by quoted values reported on the NASDAQ.
Discontinued Operations
On April 19, 2004, the Company sold certain assets of its Medical Systems segment’s medical services business pursuant to an Asset Purchase Agreement dated April 8, 2004 by and between Digital Angel Corporation and MedAire, Inc. Assets sold include all of the tangible and intangible intellectual property developed for the operation of the Medical Systems segment’s medical services business, pharmaceutical supplies and other inventory items, customer and supplier contracts, computer software licenses, internet website and domain name and mailing lists.
Under the terms of the agreement, the purchase price, in addition to MedAire, Inc.’s assumption of certain liabilities was $420,000 plus any prepaid deposits and the cost of the pharmaceutical inventory and supplies reduced by any pre-billing to or pro-rata prepayment by the Company’s customers.
In connection with exiting this activity, the Company recognized obligations and recorded a loss of approximately $0.6 million in the six months ended June 30, 2004. In addition, on July 30, 2004, the Company sold the Medical Systems segment’s land and building for an amount in excess of our carrying basis. In addition, the Company sold the Medical Systems segment’s land and buildings in a separate transaction on July 30, 2004 for $1.5 million. Net cash received on the sale, after paying off the related building mortgage, was approximately $0.4 million.
The following discloses the operating losses from discontinued operations for the six-months ended June 30, 2004 and 2003, consisting of losses attributable to the Medical Systems segment:
|
|
|
Six-Months |
|
||||
|
|
|
2004 |
|
2003 |
|
||
|
Product revenue |
|
$ |
204 |
|
$ |
587 |
|
|
Service revenue |
|
223 |
|
616 |
|
||
|
Total revenue |
|
427 |
|
1,203 |
|
||
|
Cost of products sold |
|
87 |
|
258 |
|
||
|
Cost of services sold |
|
317 |
|
593 |
|
||
|
Total cost of products and services sold |
|
404 |
|
851 |
|
||
|
Gross profit |
|
23 |
|
352 |
|
||
|
Selling, general and administrative expenses |
|
1,046 |
|
656 |
|
||
|
Other income and expense |
|
105 |
|
69 |
|
||
|
Loss from discontinued operations |
|
$ |
(1,128 |
) |
$ |
(373 |
) |
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2004, the Company had cash of $0.7 million compared to $0.9 million at December 31, 2003. In addition, at June 30, 2004 we held Applied Digital common stock of $2.6 million compared to $0.0 million at December 31, 2003. Cash used in operating activities totaled $3.0 million and $2.3 million in the first six months of 2004 and 2003, respectively.
In the first six months of 2004, the use of cash was due primarily to the loss generated from operations and a significant increase in accounts receivable. Accounts receivable, net of allowance for doubtful accounts, increased by $1.7 million, or 51.3%, to $5.1 million at June 30, 2004 from $3.4 million at December 31, 2003. Approximately $0.5 million of the increase was accounts receivable acquired in the acquisition of OuterLink Corporation in January 2004. Offsetting these uses of cash was a decrease in inventory, depreciation and amortization of $1.2 million and realized and unrealized losses on Applied Digital common stock of $2.6 million.
19
Inventory levels decreased by $0.2 million to $6.3 million at June 30, 2004 from $6.5 million at December 31, 2003 due to an accumulation of inventory in December 2003 offset by inventory acquired in the OuterLink Corporation acquisition.
Accounts payable decreased by $0.7 million to $4.5 million at June 30, 2004 from $5.2 million at December 31, 2003.
Accrued expenses and other current liabilities increased by $0.6 million, or 18.7%, to $3.8 million at June 30, 2004 from $3.2 million at December 31, 2003. Accrued expenses acquired in the OuterLink acquisition totaled $0.6 million.
Investing activities provided cash of $2.8 million in the first six months of 2004 and used cash of $0.5 million in the first six months of 2003. In the first six months of 2004, cash provided was primarily from the sale of Applied Digital common stock and the sale of the Medical Systems segment’s assets. During the first six months of 2004 and 2003, $0.2 million and $0.5 million was spent to acquire property and equipment, respectively.
Financing activities used cash of $0.05 million in the first six months of 2004 and provided cash of $2.6 million in the first six months of 2003. In the six months ended June 30, 2004, cash was used primarily for payments on our debt and line of credit of $1.0 million offset by proceeds from stock option exercises of $1.0 million.
Debt and Liquidity
The following table summarizes the Company’s fixed cash obligations as of June 30, 2004 over various future periods (in thousands):
|
|
|
|
|
Payments Due by Period |
|
|||||||||||
|
Contractual cash obligations |
|
Total |
|
Less than |
|
1-3 |
|
4-5 |
|
After |
|
|||||
|
Notes Payable and Long-Term Debt |
|
$ |
7,422 |
|
$ |
5,080 |
|
$ |
144 |
|
$ |
127 |
|
$ |
2,071 |
|
|
Operating Leases |
|
17,745 |
|
811 |
|
1,284 |
|
1,129 |
|
15,521 |
|
|||||
|
Employment Contracts |
|
1,778 |
|
865 |
|
913 |
|
— |
|
— |
|
|||||
|
|
|
$ |
26,945 |
|
$ |
6,756 |
|
$ |
2,341 |
|
$ |
1,256 |
|
$ |
17,592 |
|
Convertible Note. On July 31, 2003, we entered into a Securities Purchase Agreement (“Purchase Agreement”) to sell to Laurus Master Fund, Ltd. (“Laurus”) a two-year Secured Convertible Note (the “Convertible Note”) in the original principal amount of $2,000,000 and a five-year warrant to purchase up to 125,000 shares of our common stock. The per share exercise price of the warrant is $2.68 for 75,000 shares, $2.91 for 35,000 shares and $3.38 for 15,000 shares. The Convertible Note is convertible, at Laurus’s option, into shares of our common stock at a per share price of $2.33. Laurus is not entitled to convert the amount evidenced by the Convertible Note into a number of shares of common stock which would exceed the difference between the number of shares of common stock beneficially owned by Laurus and 4.99% of the outstanding shares of our common stock. However, Laurus may acquire more than 4.99% of our outstanding common stock upon 75 days notice to the Company. Through June 30, 2004, Laurus has converted $582,500 into 250,000 shares of our common stock. In accordance with the letter agreement dated June 1, 2004, between us, Applied Digital and Laurus, Laurus sold 150,000 of the common shares to Applied Digital. As of June 30, 2004 the principal balance of the Convertible Note was $846,000. The Convertible Note accrues interest at an annual rate equal to the higher of the prime rate plus 1.75% or 6% per annum. We allocated $143,000 of the proceeds to the warrant issued. The amount allocated represents the fair value of the warrant calculated under the Black-Scholes method. The value of the warrant is included in additional paid-in capital and is being amortized to interest expense over the life of the Convertible Note.
In connection with the Convertible Note, we entered into a Security Agreement with Laurus granting to Laurus a lien and security interest in our assets. Additionally, the Securities Purchase Agreement includes default provisions should an Event of Default (as defined in the agreement) occur. Furthermore, under a related registration rights agreement, the common stock underlying the Convertible Note is registered with the Securities and Exchange Commission.
Revolving Note and Minimum Borrowing Note. On August 28, 2003, we entered into a Security Agreement with Laurus under which we may borrow from Laurus the lesser of $5,000,000 or an amount that is determined based on percentages of our eligible accounts receivable and inventory as prescribed by the terms of the Security Agreement. Under the Security Agreement, we issued to Laurus a three-year Secured Revolving Convertible Note (“Revolving Note”) in the original principal amount of $3,500,000 and a three-year Secured Minimum Borrowing Convertible Note (“Minimum Borrowing Note”) in the or