Document/Exhibit Description Pages Size
1: S-1MEF Registration of Additional Securities 180 1.20M
2: EX-5.1 Opinion re: Legality 2 15K
3: EX-21.1 Subsidiaries of the Registrant 2 11K
4: EX-23.1 Consent of Experts or Counsel 1 6K
5: EX-23.2 Consent of Experts or Counsel 1 6K
6: EX-99.1 Miscellaneous Exhibit 4 22K
As Filed with the Securities and Exchange Commission on June 18, 2003
Registration No. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
APPLIED DIGITAL SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
[Download Table]
MISSOURI 3661 43-1641533
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) 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)
SCOTT R. SILVERMAN
APPLIED DIGITAL SOLUTIONS, INC.
400 ROYAL PALM WAY, SUITE 410
PALM BEACH, FLORIDA 33480
PHONE: (561) 805-8000
FAX: (561) 805-8001
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
Copies of all correspondence to:
HARVEY GOLDMAN, ESQ.
HOLLAND & KNIGHT LLP
701 BRICKELL AVENUE, SUITE 3000
MIAMI, FLORIDA 33131-5441
PHONE: (305) 789-7506
FAX: (305) 349-2238
Approximate date of commencement of proposed sale to the public: From
time to time after this registration statement becomes effective.
If any of the securities being registered on this form are to be
offered on a delayed or continuous basis pursuant to Rule 415 under the
Securities Act of 1933, check the following box. /X/
If this form is filed to register additional securities for an
offering pursuant to Rule 462(b) under the Securities Act, check the
following box and list the Securities Act registration statement number
of the earlier effective registration statement for the same offering. /X/
File No. 333-102165
If this form is a post-effective amendment filed pursuant to Rule
462(c) under the Securities Act, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /
If this form is a post-effective amendment filed pursuant to Rule
462(d) under the Securities Act, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to
Rule 434, check the following box. / /
[Enlarge/Download Table]
CALCULATION OF REGISTRATION FEE
==============================================================================================================
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE PER AGGREGATE OFFERING AMOUNT OF
SECURITIES TO BE REGISTERED REGISTERED UNIT(1) PRICE(1) REGISTRATION FEE
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Common Stock, $.001 par
value per share 7,200,000 shares $0.425 $3,060,000 $282
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<FN>
(1) The fee has been paid and is on account. Pursuant to Rule
457(c), the proposed offering price and registration fee have been
calculated on
the basis of the average of the high and low trading prices for the common
stock on June 16, 2003, as reported on the Nasdaq SmallCap Market.
THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE UPON FILING WITH THE
COMMISSION IN ACCORDANCE WITH RULE 462(b) UNDER THE SECURITIES ACT OF 1933.
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PROSPECTUS
DATED JUNE 18, 2003
57,200,000 SHARES
[Applied Digital Solutions logo]
Common Stock
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Under this prospectus, we are offering up to 57,200,000 shares of our
common stock, par value $.001 per share, at an estimated offering price of
$___ per share. More information about the shares can be found under the
heading "Description of Capital Stock" beginning on page 77.
We have entered into a placement agency agreement with J.P. Carey
Securities Inc., a registered broker-dealer, under which J.P. Carey
Securities will act as our underwriter on a "best efforts" basis in
connection with the offer and sale of the shares. A "best efforts"
underwriting means that J.P. Carey Securities is not obligated to purchase
any of the shares offered. There is no minimum number of shares that must be
sold in this offering.
An aggregate of 50,000,000 shares of our common stock, par value $.001
per share, have been sold in this offering as of the date of this prospectus
for an average net offering price of $0.3564 per share. These shares have
been purchased under the securities purchase agreements with each of
Cranshire Capital, L.P. and Magellan International Ltd., dated May 8, 2003,
May 22, 2003 and June 4, 2003, including 20,500,000 shares purchased by
Cranshire Capital, L.P. and 29,500,000 shares purchased by Magellan
International Ltd., resulting in net proceeds to us of $17,821,116.45, after
deduction of the 3% fee to our placement agent, J.P. Carey Securities, Inc.
More information about the shares can be found under the heading
"Description of Capital Stock" beginning on page 77.
There is no minimum number of shares that must be sold in this
offering.
Our shares are included in the Nasdaq SmallCap Market ("SmallCap")
under the symbol "ADSX." On June 17, 2003, the last reported sale price
of our common stock was $0.55 per share.
Since January 1, 2000, we have filed additional registration
statements relating to secondary sales of an aggregate of 285,892,115
shares of our common stock.
INVESTING IN THESE SECURITIES INVOLVES RISKS. YOU SHOULD CAREFULLY
CONSIDER THE RISK FACTORS BEGINNING ON PAGE 10 OF THIS PROSPECTUS BEFORE
PURCHASING THE COMMON STOCK.
[Download Table]
PER SHARE TOTAL
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Public Offering Price $ $
Underwriting Discount $ $
Proceeds, before expenses to ADSX $ $
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NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED
UPON THE ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION OF
THE CONTRARY IS A CRIMINAL OFFENSE.
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THE DATE OF THIS PROSPECTUS IS JUNE 18, 2003.
TABLE OF CONTENTS
Cautionary Statement Regarding Forward-Looking Information ii
Summary 1
Risk Factors 10
Use Of Proceeds 19
Our Business 20
Selected Financial Data 31
Management's Discussion And Analysis Of Financial Condition And Results
Of Operations 35
Management 64
Principal Shareholders 74
Related Party Transactions 75
Description Of Capital Stock 77
Price Range Of Common Stock And Dividend Information 78
Plan Of Distribution 79
Legal Matters 80
Experts 80
Where You Can Find More Information 80
Index to Financial Statements F-1
i
ABOUT THIS PROSPECTUS
This prospectus is part of a registration statement that we filed with
the Securities and Exchange Commission. This prospectus provides you with a
general description of the shares we may offer. We may add, update or change
information contained in this prospectus with a prospectus supplement. You
should read both this prospectus and any prospectus supplement together with
additional information described under the heading "Where You Can Find More
Information About Us."
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This prospectus contains forward-looking statements. The
forward-looking statements are principally contained in the sections
"Summary" beginning on page 1, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" beginning on page 35, and
"Our Business" beginning on page 20. These statements involve known and
unknown risks, uncertainties and other factors which may cause our
actual results, performances or achievements to be materially different
from any future results, performance or achievements expressed or
implied by the forward-looking statements.
Forward-looking statements include, but are not limited to:
o our ability to raise the required funds to repay our
obligations to IBM Credit Corporation (IBM Credit);
o our growth strategies including, without limitation, our
ability to deploy our products and services including
Digital Angel(TM), Thermo Life(TM), VeriChip(TM),
Bio-Thermo(TM) and PLD;
o anticipated trends in our business and demographics;
o the ability to hire and retain skilled personnel;
o relationships with and dependence on technological partners;
o uncertainties relating to customer plans and commitments;
o our ability to successfully integrate the business
operations of acquired companies;
o our future profitability and liquidity;
o governmental export and import policies, global trade
policies, worldwide political stability and economic growth; and
o regulatory, competitive or other economic influences.
In some cases, you can identify forward-looking statements by terms
such as "may," "should," "could," "would," "anticipates," "expects,"
"intends," "plans," "believes," "seeks," "estimates" and similar
expressions intended to identify forward-looking statements. These
forward-looking statements are not guarantees of future performance and
are subject to risks and uncertainties that could cause actual results
to differ materially from estimates or forecasts contained in the
forward-looking statements. Some of these risks and uncertainties are
beyond our control. Also, these forward-looking statements represent
our estimates and assumptions only as of the date the statement was made.
We discuss many of these risks in greater detail under the heading
"Risk Factors" beginning on page 10. Also, these forward-looking
statements represent our estimates and assumptions only as of the date
of this prospectus.
ii
You should read this prospectus completely and with the
understanding that our actual future results may be materially different
from what we expect. We may not update these forward-looking statements,
even though our situation may change in the future unless we have
obligations under the federal securities laws to update and disclose
material developments related to previously disclosed information. We
qualify all of our forward-looking information by these cautionary
statements.
iii
SUMMARY
This summary highlights selected information contained elsewhere in
this prospectus. This summary does not contain all of the information
you should consider before making an investment decision. You should
read the entire prospectus carefully, including "Risk Factors" beginning
on page 10 and the consolidated financial statements and the notes to
those financial statements beginning on page F-1 before making an
investment decision.
APPLIED DIGITAL SOLUTIONS, INC.
OUR BUSINESS
We are a Missouri corporation and were incorporated on May 11, 1993.
Our business has evolved during the past few years. We have grown
significantly through acquisitions and since 1996 we have completed 51
acquisitions. During the last half of 2001 and during 2002 we sold or
closed many of the businesses we had acquired that we believed did not
enhance our strategy of becoming an advanced digital technology
development company. We have emerged from being a supplier of computer
hardware, software and telecommunications products and services to
becoming an advanced technology company that focuses on a range of life
enhancing, personal safeguard technologies, early warning alert systems,
miniaturized power sources and security monitoring systems combined with
the comprehensive data management services required to support them. To
date, we have five such products in various stages of development. They
are:
o Digital Angel(TM), for monitoring and tracking people and
objects;
o Thermo Life(TM), a thermoelectric generator;
o VeriChip(TM), an implantable radio frequency verification
device that can be used for security, financial, personal
identification/safety and other applications;
o Bio-Thermo(TM), a temperature-sensing implantable microchip
for use in pets, livestock and other animals; and
o Personal Locating Device (PLD), an implantable global
positioning satellite (GPS) location device.
Over two years ago, we developed a proprietary location and
monitoring system that combines advanced biosensor technology and
location technology (such as GPS) in a watch/pager device that
communicates through proprietary software to a secure 24/7 operations
center in California. This system is covered under the United States
patent registration # 5,629,678, which we acquired in 1999. In
addition, we filed an International Patent Application directed to the
system, which has been published under publication no. W/0 02/44865.
The application, which is in the name of Digital Angel Corporation, is
currently pending in several countries. 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, personal digital assistant
(PDA) or wireless telephone. 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, which we refer to as
pre-merger Digital Angel. Effective March 27, 2002, pre-merger Digital
Angel became its own public company through its merger into Medical
Advisory Systems, Inc. (MAS) (AMEX:DOC). Currently, we are the
beneficial owner of approximately 73.12% of this new company which has
been renamed Digital Angel Corporation. We launched the Digital Angel
product on November 26, 2001.
In October 2001, we announced that our wholly-owned subsidiary,
Thermo Life Energy Corp., formerly Advanced Power Solutions, Inc., will
develop, market and license our product, Thermo Life, a small
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. On July 9, 2002, we announced that we had achieved an
important breakthrough: 3.0-volts of electrical power were
1
successfully generated by Thermo Life in laboratory tests. We expect to
begin marketing Thermo Life during the second half of 2003.
We have developed a miniaturized, implantable verification chip
called VeriChip that can be used in a variety of security, financial,
personal identification/safety and other applications. On February 7,
2002, we announced that we had created a new wholly-owned subsidiary,
VeriChip Corporation that will develop, market and license VeriChip.
About the size of a grain of rice, each VeriChip product contains a
unique verification number. Utilizing our proprietary external radio
frequency identification (RFID) 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. VeriChip technology is produced under patent
registrations #6,400,338 and #5,211,129. This technology is owned by
Digital Angel Corporation and licensed to VeriChip under an exclusive
product and technology license with a remaining term of approximately
ten years.
On October 22, 2002, we announced that the Food and Drug
Administration (FDA) had determined that VeriChip is not a regulated
medical device for security, financial and personal identification/safety
applications. The FDA specified in its ruling that VeriChip is a regulated
medical device for health information applications when marketed to provide
information to assist in the diagnosis or treatment of injury or illness. On
November 8, 2002, we received a letter from the FDA, based upon
correspondence from us to the FDA, warning us not to market VeriChip for
medical applications. We currently intend to market and distribute the
VeriChip product for security, financial and personal identification/safety
applications and, in the future, we plan to expand our marketing and
distribution efforts to health information applications of the product,
subject to any and all necessary FDA and other approvals. We are currently
in the process of preparing a 510-K application to obtain FDA approval to
market VeriChip for certain health information applications. We intend to
submit the 510-K application to the FDA within the next several months.
We began marketing VeriChip for security, financial and personal
identification/safety applications within the United States on October 24,
2002.
On February 1l, 2003, we announced that we received written
clearances from the FDA and the United States Department of Agriculture
to market our new product, Bio-Thermo, for use in pets, livestock and
other animals. Bio-Thermo is our first fully integrated implantable bio-
sensing microchip that can transmit a signal containing accurate
temperature readings to our proprietary RFID scanners. With this new
technology, accurate temperature readings can be obtained by simply
passing the RFID handheld scanner over the animal or by having the
animal walk through a portal scanner. We believe that Bio-Thermo and
other biosensors developed in the future will provide vital internal
diagnostics about the health of animals more efficiently and accurately
than the invasive techniques used in the industry today.
On May 13, 2003, we announced that we have developed and
successfully field-tested a working prototype of, what we believe to be,
the first-ever sub-dermal GPS personal location device called
PLD. The dimensions of this initial PLD prototype are 2.5 inches in
diameter by 0.5 inches in depth, roughly the size of a pacemaker. As
the process of miniaturization proceeds in the coming months, we expect
to be able to shrink the size of the device to at least one-half and
perhaps to as little as one-tenth of the current size. The PLD is
charged by an induction-based power-recharging method which is similar
to that used to recharge implantable pacemakers. This recharging
technique functions without requiring any physical connection between
the power source and the implant. The exact timing of the commercial
availability of PLD is unclear pending further technological refinements
and the obtainment of any and all required regulatory clearances. The
PLD technology builds on our United States patent registration #5,629,678.
The majority of our operations are the result of acquisitions
completed during the last six years. Our revenues from continuing
operations were $25.1 million for the three-months ended March 31, 2003,
and were $99.6 million, $156.3 million, $134.8 million, $129.1 million
and $74.3 million, respectively, in 2002, 2001, 2000, 1999 and 1998.
2
RECENT DEVELOPMENTS
Digital Angel/MAS Merger
On March 27, 2002, pre-merger Digital Angel merged with MAS, and
MAS changed its name to Digital Angel Corporation. Also, pursuant to the
merger agreement, we contributed all of our stock in Timely Technology
Corp., our wholly-owned subsidiary, and Signature Industries, Limited,
our 85% owned subsidiary. Prior to the merger, pre-merger Digital Angel,
Timely Technology Corp. and Signature Industries, Limited were
collectively referred to as the Advanced Wireless Group (AWG). In
satisfaction of a condition to the consent to the merger by IBM Credit,
we transferred all shares of Digital Angel Corporation common stock
owned by us to a Delaware business trust, which we refer to herein as
the Digital Angel Trust, controlled by an advisory board and, as a
result, the Digital Angel Trust has legal title to approximately 73.12%
of the Digital Angel Corporation common stock. The Digital Angel Trust
has voting rights with respect to the Digital Angel Corporation common
shares until we repay our obligations to IBM Credit in full. We have
retained beneficial ownership of the shares. The Digital Angel 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 our IBM Credit Agreement as
more fully discussed below.
IBM Credit Agreement
Our Third Amended and Restated Term Credit Agreement with IBM
Credit, which we refer to herein as the IBM Credit Agreement, contained
covenants relating to our financial position and performance, as well as
the financial position and performance of Digital Angel Corporation as
of December 31, 2002. The Company was not in compliance with certain of
these covenants at December 31, 2002. Also, under the terms of the IBM
Credit Agreement, we were required to repay IBM Credit $29.8 million of
the $77.2 million outstanding principal balance owed to them, plus $16.4
million of accrued interest and expenses (totaling approximately $46.2
million), on or before February 28, 2003. We did not make such payment
by February 28, 2003. On March 3, 2003, IBM Credit notified us that we
had until March 6, 2003, to make the payment. We did not make the
payment on March 6, 2003, as required. Our failure to comply with the
payment terms imposed by the IBM Credit Agreement and to maintain
compliance with the financial covenants constitute events of default
under the IBM Credit Agreement. IBM Credit did not provide a waiver of
such defaults. On March 7, 2003, we received a letter from IBM Credit
declaring the loan in default and indicating that IBM Credit would
exercise any and/or all of its remedies.
In addition, as of March 31, 2003, and December 31, 2002, Digital
Angel Corporation did not maintain compliance with certain financial
covenants under its credit agreement with its lender, Wells Fargo
Business Credit, Inc. (Wells Fargo). Well Fargo provided Digital Angel
Corporation with waivers of such non-compliance.
Forbearance Agreement
On March 27, 2003, we announced that we had executed a forbearance
agreement term sheet with IBM Credit. The Forbearance Agreement was
executed on April 2, 2003. In turn, we also agreed to dismiss with
prejudice a lawsuit we filed against IBM Credit and IBM Corporation in
Palm Beach County, Florida on March 6, 2003.
The payment provisions of the Forbearance Agreement are as
follows:
o the Tranche A Loan, consisting of $68.0 million plus accrued
interest, must be repaid in full no later than September 30,
2003, provided that all but $3 million of the Tranche A Loan
(the "Tranche A Deficiency Amount") will be deemed to be
paid in full on such date if less than the full amount of
the Tranche A Loan is repaid but all of the net cash
proceeds of the Digital Angel Corporation shares held in the
Digital Angel Trust are applied to the repayment of the
Tranche A Loan. The Tranche A Deficiency Amount (if any)
must be repaid no later than March 31, 2004; and The Tranche
A Loan bore interest
3
at seventeen percent (17%) per annum through February 28, 2003.
Effective March 1, 2003, the interest rate increased to twenty-
five percent (25%) per annum; and
o the Tranche B Loan, consisting of $9.2 million plus accrued
interest, must be repaid in full no later than March 31,
2004. The Tranche B Loan bore interest at seventeen percent
(17%) per annum through February 28, 2003, and from March 1,
2003, to March 24, 2003, the Tranche B Loan bore interest at
twenty-five percent (25%) per annum. Effective March 25,
2003, the interest rate decreased to seven percent (7%) per
annum.
The Tranche A and B Loans may be purchased under the terms of the
Forbearance Agreement by or on our behalf as follows:
o the loans and all the other obligations may be purchased on
or before June 30, 2003, for $30 million in cash;
o the loans and all the other obligations may be purchased on
or before September 30, 2003, for $50 million in cash; and
o the Tranche A Loan may be purchased on or before September 30,
2003, for $40 million in cash with an additional $10 million
cash payment in respect of the Tranche A Deficiency Amount
and the Tranche B Loan due on or before December 31, 2003.
Payment of any of these amounts by the dates set forth herein will
constitute complete satisfaction of any and all of our obligations to
IBM Credit under the IBM Credit Agreement, provided that there has not
earlier occurred a "Termination Event," as defined in the Forbearance
Agreement.
In addition, we have agreed under the terms of the Forbearance
Agreement that the Digital Angel Trust will immediately engage an
investment bank to pursue the sale of the 19,600,000 shares of Digital
Angel Corporation common stock that are currently held in the Digital
Angel Trust. In May 2003, an investment bank was engaged. All proceeds
from the sale of the Digital Angel Corporation common stock will be
applied to the loans and other obligations to satisfy the Tranche A
payment provisions as discussed above, in the event that the Company has
not satisfied its purchase rights by September 30, 2003.
The Forbearance Agreement also modifies other provisions of the
IBM Credit Agreement, including but not limited to, the imposition of
additional limitations on permitted expenditures.
Provided there has not earlier occurred a "Termination Event," as
defined, at the end of the forbearance period, the provisions of the
Forbearance Agreement shall become of no force and effect. At that
time, if the repayment terms of the Forbearance Agreement are not met,
IBM Credit will be free to exercise and enforce, or to take steps to
exercise and enforce, all rights, powers, privileges and remedies
available to them under the IBM Credit Agreement, as a result of the
payment and covenant defaults existing on March 24, 2003. If we are not
successful in satisfying the repayment obligations under the Forbearance
Agreement or we do not comply with the terms of the Forbearance
Agreement or the IBM Credit Agreement, and IBM Credit were to enforce
its rights against the collateral securing the obligations to IBM
Credit, there would be substantial doubt that we would be able to
continue operations in the normal course of business.
As a result of the payment and financial covenant defaults
discussed above, IBM Credit has exercised its rights to control our
cash, excluding the cash of Digital Angel Corporation and InfoTech USA,
Inc. (formerly SysComm International Corporation). At March 31, 2003,
IBM held in its possession $2.0 million of our cash, which it
subsequently remitted back to us. IBM Credit continues to maintain
control our deposits and disbursements. Under the terms of the
forbearance agreement, we are required to be cash flow positive
beginning May 1, 2003. We request weekly from IBM Credit a release of
funds for the prior weeks cash collections and provide to IBM Credit a
schedule detailing cash disbursements complying with the cash flow
positive requirement.
4
OTHER
The Staff of the Securities and Exchange Commission's Southeast
Regional Office is conducting an informal inquiry concerning us. We are
fully and voluntarily cooperating with this informal inquiry. At this
point, we are unable to determine whether this informal investigation
may lead to potentially adverse action.
As of December 31, 2002, the net book value of our goodwill was
$67.8 million. There was no impairment of goodwill upon our adoption of
FAS 142 on January 1, 2002. However, based upon our annual review for
impairment during the fourth quarter of 2002, we recorded an impairment
charge of $62.2 million associated with our Digital Angel Corporation
segment. The impairment relates to the goodwill associated with the
acquisition of MAS in March 2002, and to Digital Angel Corporation's
Wireless and Monitoring segment. Future goodwill impairment reviews may
result in additional periodic write-downs. In addition, Digital Angel
Corporation wrote down $6.4 million of property and equipment related to
software associated with its Wireless and Monitoring segment. As of
December 31, 2002, Digital Angel Corporation's Wireless and Monitoring
segment has not recorded any significant revenue from its Digital Angel
product, and therefore, it was determined that the goodwill and software
were impaired.
Our common stock has traded on the Nasdaq SmallCap Market
(SmallCap) since November 12, 2002, under the symbol "ADSX." Prior to
November 12, 2002, our common stock traded on the Nasdaq National Market
at all times, except for the period between July 12, 2002 and July 30,
2002, when our common stock traded on the Pink Sheets under the symbol
"ADSX.PK." To maintain our SmallCap listing, we must continue to comply
with the SmallCap's listing requirements and, prior to October 2003,
regain the minimum bid requirement of at least $1.00 per share for a
minimum of ten (10) consecutive trading days.
Effective May 9, 2003, Michael Zarriello joined our Board of
Directors. Mr. Zarriello was most recently a Senior Managing Director
of Jesup & Lamont Securities Corporation and served as President of
Jesup and Lamont Merchant Partners LLC. Prior to that, he was Managing
Director and Principal of Bear Stearns & Co., Inc. He has extensive
financial experience having served earlier in his career as Chief
Financial Officer of the Principal Activities Group that invested the
Bear Stearns & Co., Inc. capital in middle market companies, Chief
Financial Officer of United States Leather Holdings, Inc. and Chief
Financial Officer of Avon Products, Inc.'s Healthcare Division. On June
17, 2003, Mr. Zarriello was appointed to the Audit Committee of our
Board of Directors.
Effective May 12, 2003, Kevin H. McLaughlin was appointed our
President and Chief Operating Officer. Prior to his appointment as
President, Mr. McLaughlin served as our Senior Vice President and Chief
Operating Officer.
Effective June 4, 2003, Arthur F. Noterman resigned from our Board of
Directors to pursue other interests. Mr. Noterman's term was due to expire
at our Annual Meeting of Shareholders, which is being held on July 25, 2003.
At present, we have not filled the position vacated by Mr. Noterman.
On March 21, 2003, Richard J. Sullivan, our then Chairman of the
Board of Directors and Chief Executive Officer, retired from such
positions. Our Board of Directors negotiated a severance agreement with
Richard Sullivan under which he is to receive a one-time payment of 56.0
million shares of our common stock. In addition, stock options held by
him exercisable for approximately 10.9 million shares of our common
stock were re-priced. The options surrendered had exercise prices
ranging from $0.15 to $0.32 per share and were replaced with options
exercisable at $0.01 per share. Richard Sullivan's severance agreement
provides that the payment of shares and re-pricing of options provided
for under that agreement is in lieu of all future compensation and other
benefits that would have been owed to him under his employment
agreement. His employment agreement required us to make payments of
approximately $17 million to him, a portion of such payments of which
could be made in either cash or stock, at our option.
On March 21, 2003, Jerome C. Artigliere, our then Senior Vice President
and Chief Operating Officer, resigned from such positions. Under the terms
of his severance agreement, Mr. Artigliere is to receive 4.75 million shares
of our common stock. In addition, stock options held by him exercisable for
approximately 2.3 million shares of our common stock were re-priced. The
options surrendered had exercise prices ranging from $0.15 to $0.32 per
share and were replaced with options exercisable at $0.01 per share. Mr.
Artigliere's severance agreement provides
5
that the payment of shares and re-pricing of options provided under that
agreement is in lieu of all future compensation and other benefits that
would have been owed to him under his employment agreement. His employment
agreement required us to make payments of approximately $1.5 million to Mr.
Artigliere.
As a result of the termination of Richard Sullivan's employment
with us, a "triggering event" provision in the severance agreement we
entered into with Garrett Sullivan, our former Vice Chairman of the
Board (who is not related to Richard Sullivan), at the time of his
ceasing to serve in such capacity in December 2001, has been triggered.
We recently negotiated a settlement of our obligations under Garrett
Sullivan's severance agreement that requires us to issue to him 7.5
million shares of our common stock on or before August 31, 2003.
The terms of each of the severance agreements are subject to
shareholder approval, in accordance with applicable Nasdaq rules,
because the agreements (i) are deemed to be compensatory arrangements
under which our common stock may be acquired by officers or directors,
and (ii) in Richard Sullivan's case, it may result in his potentially
holding more than 20% of the outstanding shares of our common stock
following the issuance of the shares and exercise of options covered by
his severance agreement. In connection with such shareholder approval,
we also intend to seek shareholder approval of an increase in the number
of authorized shares of our common stock.
As a result of the terminations of Messrs. Sullivan and
Artigliere, we have recorded severance expense of $22.0 million during
the three-months ended March 31, 2003. This expense is reflected in our
condensed consolidated financial statements for the three-months ended
March 31, 2003, as selling, general and administrative expense and
represents, in all material respects, the total amount due to these
former officers and director and to Garrett Sullivan under their
respective employment agreements.
We have included proposals in our proxy statement for our 2003
annual meeting of shareholders to solicit shareholder approval of the
terms of such agreements and the increase in the number of authorized
shares of our common stock. Should shareholders not approve the terms
of the severance agreements or we lack a sufficient number of authorized
shares to effect the share issuances provided for by the severance
agreements, our former executive officers and directors may take actions
against us to enforce the terms of their employment agreements. Under
such circumstances, there would be substantial doubt that we would be
able to continue operations in the normal course of business. In such
event, holders of our securities may face the loss of their entire
investment.
Furthermore, the surrender of the options held by Messrs. Sullivan and
Artigliere in exchange for the re-priced options has already occurred and
Messrs. Sullivan and Artigliere have exercised these options. Without
shareholder approval, we would need to unwind the transactions or otherwise
risk having our common stock delisted by Nasdaq. If the transactions were to
be unwound or if, in the course of seeking to renegotiate the terms of the
severance agreements, either Richard Sullivan or Jerome Artigliere were to
insist on a cash payment for any portion of the obligations due them under
their employment agreements, we would risk violating the terms of the
Forbearance Agreement which, as noted above, requires us to be cash flow
positive on a consolidated operational basis at all times from and after May
1, 2003. In such event, we would face the possibility of a cessation of
business operations in the normal course.
By virtue of the need to obtain shareholder approval of the terms
of the severance agreements, the date by which we would otherwise have
been obligated to file a registration statement covering the resale of
the shares to be issued to our former executive officers and directors
under their severance agreements has been extended and the issuance of
the shares will await the outcome of the shareholder vote. However, in
order to ensure the timely registration of the shares, we may file a
registration statement with the SEC prior to the issuance of the shares.
OUR BUSINESS STRATEGY
Our business strategy is to position ourselves as an advanced
technology development company through the development and
commercialization of proprietary technology such as Digital Angel,
Thermo Life, VeriChip, Bio-Thermo and PLD.
6
ABOUT US
We are a Missouri corporation and were incorporated on May 11,
1993. Our principal executive offices are located at 400 Royal Palm Way,
Suite 410, Palm Beach, Florida 33480, and our telephone number is (561)
805-8000.
7
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THE OFFERING
Common stock offered by us 57,200,000 shares
Common stock outstanding after this offering 363,911,563 shares(1)(2)(3) as of June 18, 2003
Plan of distribution We are offering the shares through J.P. Carey
Securities, Inc., a registered broker-dealer and
member of the NASD. We have engaged J.P. Carey
Securities to act as our placement agent under the
terms of a placement agency agreement. J.P. Carey
Securities has agreed to offer the shares on a
best efforts basis. J.P. Carey Securities is an
"underwriter" within the meaning of Section
2(a)(11) of the Securities Act of 1933. We have
agreed to pay J.P. Carey Securities a fee of 3% of
the gross subscription proceeds of the shares sold
to purchasers identified (or deemed to be
identified) to us by J.P. Carey Securities.
We have sold an aggregate of 50,000,000 shares of
our common stock, par value $.001 per share, in this
offering as of the date of this prospectus for an
average net offering price of $0.3564 per share.
These shares have been purchased under the
securities purchase agreements with each of
Cranshire Capital, L.P. and Magellan International
Ltd., dated May 8, 2003, May 22, 2003 and June 4,
2003, including 20,500,000 shares purchased by
Cranshire Capital, L.P. and 29,500,000 shares
purchased by Magellan International Ltd., resulting
in net proceeds to us of $17,821,116.45, after
deduction of the 3% fee to our placement agent, J.P.
Carey Securities, Inc.
Use of proceeds Unless otherwise indicated in the applicable
supplement to this prospectus, we expect to use
the net proceeds we receive from the sale of
shares offered by this prospectus for the payment
of debt. Our use of proceeds is more fully
described under the section "Use of Proceeds" on
page 19.
Offering price Estimated at $0.__ per share.
Dividend policy We have not paid, and do not anticipate paying
dividends on our common stock. See "Price Range of
Common Stock and Dividend Information" on page 78.
Market price of common stock The market price of our common stock has ranged
from a high of $0.84 to a low of $0.03 during the
12 months preceding the date of this prospectus.
See "Price Range of Common Stock and Dividend
Information" on page 78.
Risk factors See "Risk Factors" beginning on page 10, for a
discussion of factors you should carefully consider
before deciding to invest in our common stock.
Nasdaq SmallCap Market symbol ADSX
8
<FN>
--------
(1) Excludes (i) warrants to purchase up to 828,341 shares of our
common stock at $4.57 per share, and (ii) options, 17,110,206 of which
are currently exercisable at a weighted average exercise price of $1.21
per share.
(2) Does not include 56,000,000, 4,750,000 and 7,500,000 shares of our
common stock, which will be issued to our former Chairman of the Board,
Richard J. Sullivan, our former Chief Operating Officer, Jerome C.
Artigliere, and Garrett Sullivan (who is not related to Richard
Sullivan), our former Vice Chairman of the Board, respectively, under
the terms of their severance agreements. The terms of the severance
agreements, including the share issuances, have been approved by our
Board of Directors and are to being submitted to our shareholders for
approval. The agreements with Richard J. Sullivan and Jerome C.
Artigliere provide for the issuance of the shares on or before December
31, 2003. The agreement with Garrett Sullivan provides for the issuance
of the shares on or before August 31, 2003.
(3) Includes 13,313,782 shares of our common stock included under a
registration statement, which we filed with the SEC on June 4, 2003.
SUBSCRIPTION PROCEDURE
If you decide to subscribe for shares of our common stock in this
offering, you may be required to execute a subscription agreement and tender
it, together with a check or wired funds in the amount of the purchase price
of the purchased shares. A copy of a form of subscription agreement, which
we believe is substantially in the form we would use, is included in this
prospectus as Exhibit A.
If we utilize a subscription agreement, we will accept or reject all
subscriptions for shares of our common stock within five business days,
providing time for checks to be cleared. Subscriptions for our shares paid
by wired funds will be accepted or rejected within one day of receipt. All
monies from rejected subscriptions will be returned immediately to the
subscriber, without interest or deductions. We have the right to accept or
reject subscriptions in whole or in part, for any reason or for no reason.
No subscriptions or monies will be accepted until the final prospectus is
delivered to investors.
9
RISK FACTORS
You should carefully consider the risks described below and all
other information contained in this prospectus before making an
investment decision. If any of the following risks, or other risks and
uncertainties that are not yet identified or that we currently think are
not material, actually occur, our business, financial condition and
results of operations could be materially and adversely affected. In
that event, the trading price of our shares could decline, and you may
lose part or all of your investment.
IF WE ARE NOT SUCCESSFUL IN SATISFYING THE PAYMENT OBLIGATIONS
UNDER THE FORBEARANCE AGREEMENT OR WE DO NOT COMPLY WITH THE TERMS OF
THE FORBEARANCE AGREEMENT OR THE IBM CREDIT AGREEMENT, THERE IS
SUBSTANTIAL DOUBT THAT WE WILL BE ABLE TO CONTINUE AS A GOING CONCERN
AND YOU ARE AT RISK OF LOSING YOUR ENTIRE INVESTMENT.
Under the terms of the IBM Credit Agreement we were required to
repay IBM Credit Corporation $29.8 million of the $77.2 million
outstanding principal balance currently owed to them, plus $16.4 million
of accrued interest and expenses (totaling approximately $46.2 million),
on or before February 28, 2003. We did not make such payment by February
28, 2003. On March 3, 2003, IBM Credit notified us that we had until
March 6, 2003, to make the payment. We did not make the payment on March
6, 2003, as required. Our failure to comply with the payment terms
imposed by the IBM Credit Agreement and to maintain compliance with the
financial performance covenant constitute events of default under the
IBM Credit Agreement. On March 7, 2003, we received a letter from IBM
Credit declaring the loan in default and indicating that IBM Credit
would exercise any and/or all of its remedies.
On March 27, 2003, we announced that we had executed a forbearance
agreement term sheet with IBM Credit. The Forbearance Agreement was
executed on April 2, 2003, and grants us more favorable loan repayment
terms and more time in which to meet our current obligations to IBM
Credit. It contains various purchase rights for us to buy back our
existing indebtedness from IBM Credit, including a one-time payment on
or before June 30, 2003 of $30 million. Payment of this amount will
constitute complete satisfaction of any and all of our obligations to
IBM Credit. Provided that there has not earlier occurred a "Termination
Event," as defined, at the end of the forbearance period, the provisions
of the Forbearance Agreement shall become of no force and effect. At
that time, if the repayment terms of the Forbearance Agreement are not
met, IBM Credit shall be free to exercise and enforce, or to take steps
to exercise and enforce, all rights, powers, privileges and remedies
available to them under the IBM Credit Agreement, as a result of the
payment and covenant defaults existing on March 24, 2003. If we are not
successful in satisfying the payment obligations under the Forbearance
Agreement or we do not comply with the terms of the Forbearance
Agreement or the IBM Credit Agreement, IBM Credit will enforce its
rights against the collateral securing the obligations to IBM Credit
and, as a result there would be substantial doubt that we would be able
to continue as a going concern and you are at risk of losing your entire
investment.
OUR FAILURE TO BE CASH FLOW POSITIVE ON A CONSOLIDATED BASIS AT
ALL TIMES AFTER MAY 1, 2003, WILL RESULT IN A TERMINATION EVENT AS
DEFINED UNDER THE FORBEARANCE AGREEMENT ALLOWING IBM CREDIT TO
IMMEDIATELY EXERCISE ITS RIGHTS AND REMEDIES UNDER THE TERMS OF THE IBM
CREDIT AGREEMENT.
Since May 1, 2003, we have been able to provide for our operating
expenses with funds provided by our business operations as required
under the Forbearance Agreement. However, if we fail to maintain a
positive cash flow from operations at all times after May 1, 2003, it
would result in a "Termination Event," as defined in the Forbearance
Agreement, and IBM Credit shall be free to exercise and enforce, or to
take steps to exercise and enforce, all rights, powers, privileges and
remedies available to them under the IBM Credit Agreement.
OUR FAILURE TO OBTAIN ADDITIONAL FUNDING WILL HAVE A SUBSTANTIAL
NEGATIVE IMPACT ON OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
The IBM Credit Agreement prohibits us from borrowing funds from
other lenders without IBM Credit's approval and does not provide for
additional funding. Accordingly, there can be no assurance that we will
have
10
access to funds necessary to provide for our ongoing operating expenses.
Failure to obtain additional funding will have a material adverse effect on
our business, financial condition and results of operations.
See the risk factor entitled, "If we are not successful in
satisfying the payment obligations under the Forbearance Agreement or we
do not comply with the terms of the Forbearance Agreement or the IBM
Credit Agreement, there is substantial doubt that we will be able to
continue as a going concern and you are at risk of losing your entire
investment"
IF WE ARE REQUIRED TO SELL THE SHARES HELD IN THE DIGITAL ANGEL
TRUST, IT WILL HAVE A SUBSTANTIAL NEGATIVE IMPACT ON OUR BUSINESS,
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
According to the terms of the trust agreement for the Digital
Angel Trust, if the amounts we owe IBM Credit are not paid when due, or
if we otherwise default under the Forbearance Agreement or the IBM
Credit Agreement (as more fully discussed in Note 4 to the condensed
consolidated financial statements), IBM Credit will have the right to
require that the shares of the Digital Angel Corporation common stock
held in the Digital Angel Trust be sold to provide funds to satisfy our
obligations to IBM Credit. We have agreed under the terms of the
Forbearance Agreement that the Digital Angel Trust would immediately
engage an investment bank to pursue the sale of the 19,600,000 shares of
Digital Angel Corporation common stock that are currently held in the
Digital Angel Trust. In May 2003, an investment bank was engaged. All
proceeds from the sale of the Digital Angel Corporation common stock
will be applied to the loans and other obligations to satisfy certain
obligations to IBM Credit, in the event that the Company has not
satisfied its purchase rights by September 30, 2003.
If we are required to sell the shares held in the Digital Angel
Trust for an amount less than our current book value, we would incur a
significant non-cash charge and our financial position and operating
results would be materially adversely effected.
In addition, under the terms of the employment agreement dated
March 8, 2002, as amended, by and between Digital Angel Corporation and
Randolph K. Geissler (the President and Chief Executive Officer of
Digital Angel Corporation), a "change in control" occurs under that
employment agreement if any person becomes the "beneficial owner" (as
defined in Rule 13d 3 under the Securities Exchange Act of 1934),
directly or indirectly, of securities of Digital Angel Corporation
representing 20% or more of the combined voting power of the then
outstanding shares of common stock. Therefore, if the Digital Angel
Trust were required to sell more than approximately 5.3 million shares
of Digital Angel Corporation's common stock, such sale would constitute
a change in control under the employment agreement with Mr.
Geissler. Upon the occurrence of a change in control, Mr. Geissler, at
his sole option and discretion, may terminate his employment with
Digital Angel Corporation at any time within one year after such change
in control upon 15 days' notice. In the event of such termination, the
employment agreement provides that Digital Angel Corporation must pay to
Mr. Geissler a severance payment equal to three times the base amount as
defined in Section 280G(b)(3) of the Internal Revenue Code of 1986, as
amended ("Code") minus $1.00 (or a total of approximately $750,000),
which would be payable no later than one month after the effective date
of Mr. Geissler's termination of employment. In addition, upon the
occurrence of a change of control under the employment agreement, all
outstanding stock options held by Mr. Geissler would become fully
exercisable.
The employment agreement also provides that upon:
o a change of control;
o the termination of Mr. Geissler's employment for any reason
other than due to his material default under the employment
agreement; or
o if he ceases to be Digital Angel Corporation's President and
Chief Executive Officer for any reason other than termination
due to his material default under the employment agreement, within
10 days of the occurrence of any such events, Digital Angel
Corporation is to pay to Mr. Geissler $4,000,000. Digital Angel
Corporation may pay such amount in cash or in its common stock or
with a combination of cash and common stock. The employment
agreement also provides that if
11
the $4,000,000 is paid in cash and stock, the amount of cash paid
must be sufficient to cover the tax liability associated with such
payment, and such payment shall otherwise be structured to
maximize tax efficiencies to both Digital Angel Corporation and
Mr. Geissler.
Also, effective October 30, 2002, Digital Angel Corporation
entered into a Credit and Security Agreement with Wells Fargo. The
Credit and Security Agreement provides that a "change in control" under
that agreement results in a default. A change in control is defined as
either Mr. Geissler ceasing to actively manage Digital Angel
Corporation's day-to-day business activities or the transfer of at least
25% of the outstanding shares of Digital Angel Corporation's common
stock. Also, if Digital Angel Corporation owes Mr. Geissler $4,000,000
under his employment agreement, the obligation would most likely result
in a breach of Digital Angel Corporation's financial covenants under the
Credit and Security Agreement. If these defaults occurred and were not
waived by Wells Fargo, and if Wells Fargo were to enforce these defaults
under the terms of the Credit and Security Agreement and related
agreements, Digital Angel Corporation's and our business and financial
condition would be materially and adversely affected, and it may force
Digital Angel Corporation to cease operations.
WE ARE REQUIRED TO ISSUE ADDITIONAL SHARES OF COMMON STOCK IN
CONNECTION WITH SEVERANCE AGREEMENTS WITH OUR FORMER EXECUTIVE OFFICERS
AND DIRECTORS AND, AS A RESULT, YOUR INVESTMENT IN OUR COMMON STOCK WILL
BE FURTHER DILUTED.
On March 21, 2003, we entered into severance agreements with
Richard J. Sullivan, our then Chairman of the Board of Directors and
Chief Executive Officer, and Jerry C. Artigliere, our then Senior Vice
President and Chief Operating Officer. The severance agreements provide
for the payment of 56.0 million and 4.8 million shares of our common
stock to Richard Sullivan and Jerome Artigliere, respectively. In
addition, stock options held by Richard Sullivan and Jerome Artigliere,
which were exercisable for approximately 10.9 and 2.3 million shares of
our common stock, respectively, were re-priced. The options surrendered
had exercise prices ranging from $0.15 to $0.32 per share and were
replaced with options exercisable at $0.01 per share. As a result of
the termination of Richard Sullivan's employment with us, a "triggering
event" provision in the severance agreement we entered into with Garrett
Sullivan, our former Vice Chairman of the Board (who is not related to
Richard Sullivan), at the time of Garrett Sullivan's ceasing to serve in
such capacity in December 2001, has been triggered. We recently
negotiated a settlement of our obligations under Garrett Sullivan's
severance agreement that requires us to issue to him 7.5 million shares
of our common stock on our before August 31, 2003. The issuance of these
shares to our former executive officers and directors, and the exercise
of the re-priced options, which are subject to shareholder approval,
will result in an increase in the total number of our shares outstanding
and may result in investors in the shares being offered by this
prospectus experiencing a dilution in the net tangible book value per
share of our common stock.
IF SHAREHOLDERS DO NOT APPROVE THE TERMS OF THE SEVERANCE
AGREEMENTS WITH OUR FORMER EXECUTIVE OFFICERS AND DIRECTORS OR WE LACK A
SUFFICIENT NUMBER OF AUTHORIZED SHARES OF COMMON STOCK TO EFFECT THE
SHARE ISSUANCES PROVIDED FOR BY SUCH SEVERANCE AGREEMENTS, OUR FORMER
EXECUTIVE OFFICERS AND DIRECTORS MAY TAKE ACTION TO ENFORCE THEIR RIGHTS
UNDER THEIR EMPLOYMENT AGREEMENTS WITH US. THIS COULD RESULT IN OUR
BEING UNABLE TO CONTINUE OPERATIONS IN THE NORMAL COURSE OF BUSINESS.
The severance agreements entered into with our former executive
officers and directors provide for their receipt of shares of our common
stock and re-priced options in lieu of all future compensation and other
benefits that would have been owed to them under their employment
agreements. The employment agreements required us to make payments in
the aggregate amount of approximately $22.0 million. The terms of each
of the severance agreements are subject to shareholder approval, in
accordance with applicable Nasdaq rules, because the agreements (i) are
deemed to be compensatory arrangements under which our common stock may
be acquired by officers or directors, and (ii) in Richard Sullivan's
case, it may result in his potentially holding more than 20% of the
outstanding shares of our common stock following the issuance of the
shares and exercise of options covered by his severance agreement. We
have included proposals in our proxy statement for our 2003 annual
meeting of shareholders to solicit shareholder approval of the terms of
such agreements, as well as an increase in the number of authorized
shares of our common stock, which may be necessary to affect the share
issuances under the severance agreements. Should shareholders not
approve the terms of the severance agreements or we lack a sufficient
number
12
of authorized shares of common stock to effect the share issuances provided
under such agreements, our former officers and directors may take actions
against us to enforce the terms of their employment agreements. Under such
circumstances, there would be substantial doubt that we would be able to
continue operations in the normal course of business. In such event, holders
of our securities may face the loss of their entire investment.
Furthermore, the surrender of the options held by Messrs. Sullivan and
Artigliere in exchange for the re-priced options has already occurred and
Messrs. Sullivan and Artigliere have exercised these options. Without
shareholder approval, we would need to unwind the transactions or otherwise
risk having our common stock delisted by Nasdaq. If the transactions were to
be unwound or if, in the course of seeking to renegotiate the terms of the
severance agreements, either Richard Sullivan or Jerome Artigliere were to
insist on a cash payment for any portion of the obligations due them under
their employment agreements, we would risk violating the terms of the
Forbearance Agreement which, as noted above, requires us to be cash flow
positive on a consolidated operational basis at all times from and after May
1, 2003. In such event, we would face the possibility of a cessation of
business operations in the normal course.
WE CANNOT BE CERTAIN OF FUTURE FINANCIAL RESULTS.
We incurred losses from continuing operations of $26.8 million for
the three-months ended March 31, 2003, and $113.9 million, $198.1
million and $29.2 million for the years ended December 31, 2002, 2001
and 2000, respectively. Our business plan depends on our attaining and
maintaining profitability; however, we cannot predict whether we will be
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. As of March 31, 2003, we
reported no revenues from the sale of our VeriChip(TM), Bio Thermo(TM),
Thermo Life(TM) and PLD products and we have had minimal sales of our
Digital Angel product. We can give no assurance that we will be able to
achieve profitable operations. In addition, if we fail to experience
profits within the time frame expected by investors, this could have a
detrimental effect on the market price of our common stock and there
would be substantial doubt that we would be able to continue operations
in the normal course of business.
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 $0.03. 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:
o Significant changes to our business resulting from
acquisitions and/or expansions into different product lines;
o quarterly fluctuations in our financial results or cash
flows;
o changes in investor perception of us or the market for our
products and services;
o changes in economic and capital market conditions for other
companies in our market sector; and
o changes in general economic and market conditions.
In addition, the stock market in general, 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 additional securities litigation,
which is costly and time-consuming to defend. Because of recent periods
of volatility in the market price of our securities, we face a
heightened risk of securities class action litigation. In March 2003, we
settled subject to court approval a purported securities fraud
13
class action, which was filed against us and one of our directors. While the
class action was tentatively settled in March 2003, additional litigation of
this type could result in substantial costs and a diversion of management's
attention and resources, which could significantly harm our business
operations and financial condition.
WE MAY ISSUE PREFERRED STOCK, WHICH WILL RANK SENIOR TO THE SHARES
OF OUR COMMON STOCK AND WHICH MAY DELAY OR PREVENT A CHANGE IN CONTROL OF US.
Preferred stock may be created and issued from time to time by our
Board of Directors, with such rights and preferences as our Board of
Directors may determine. Because of our Board of Directors' broad
discretion with respect to the creation and issuance of any series of
preferred stock without shareholder approval, our Board of Directors could
adversely affect the voting power of our common stock. The issuance of
preferred stock may also have the effect of delaying, deferring or
preventing a change in control of us.
WE CANNOT PROVIDE ASSURANCES THAT WE WILL BE ABLE TO MAINTAIN OUR
LISTING ON THE SMALLCAP.
Our ability to remain listed on Nasdaq depends on our ability to
satisfy applicable Nasdaq criteria including our ability to maintain a
minimum bid price of $1.00 per share. Our common stock has traded on
the SmallCap since November 12, 2002, under the symbol "ADSX." Prior to
November 12, 2002, our common stock traded on the Nasdaq National Market
at all times, except for the period between July 12, 2002 and July 30,
2002, when our common stock traded on the Pink Sheets under the symbol
"ADSX.PK." To maintain our SmallCap listing, we must continue to comply
with the SmallCap's listing requirements and, prior to October 2003,
regain the minimum bid requirement of at least $1.00 per share for a
minimum of ten (10) consecutive trading days.
IF WE ARE REQUIRED TO ISSUE ADDITIONAL SHARES OF COMMON STOCK IN
CONNECTION WITH PRIOR ACQUISITIONS YOUR INVESTMENT IN OUR COMMON STOCK
MAY BE FURTHER DILUTED. IN ADDITION, WE MAY ISSUE ADDITIONAL
SECURITIES, WHICH WOULD ALSO DILUTE THE VALUE OF YOUR INVESTMENTS IN OUR
COMMON STOCK.
As of June 18, 2003, there were 350,759,635 shares of our common stock
outstanding. Since January 1, 2001, we have issued a net aggregate of
249,272,934 shares of common stock, of which 97,261,634 shares were issued
in connection with acquisitions of businesses and assets, 64,810,635 shares
were issued upon conversion of our Series C preferred stock and 50,000,000
shares were issued in connection with the current offering of our common
stock on a best efforts basis through the efforts of a placement agent J.P.
Carey Securities, Inc. under the terms of a placement agency agreement. We
are currently planning to sell an additional 7,200,000 shares of our common
stock in connection with this best efforts offering, some or all of which
may be offered through J.P. Carey Securities, Inc. 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 future earnout and "price protection" provisions
in prior acquisition and other agreements. Such issuances of additional
securities may be dilutive to the value of our common stock and may have a
material adverse impact on the market price of our common stock.
Certain events over which you will have no control could result in
the issuance of additional shares of our common stock or other
securities, which could dilute the value of your shares of common stock.
We may issue additional shares of common stock:
o to raise additional capital;
o upon the exercise of outstanding options and stock purchase
warrants or additional options and warrants issued in the future;
o in connection with loans or other capital raising transactions; and
o in connection with acquisitions of other businesses or assets.
As of June 16, 2003, there were outstanding warrants and options to
acquire up to 26,076,939 additional shares of our common stock. If
exercised, these securities could dilute the value of the shares of
common stock. In
14
addition, we have the authority to issue up to a total of 435,000,000 shares
of common stock and up to 5,000,000 shares of preferred stock without further
shareholder approval, including shares that could be convertible into our
common stock, subject to applicable SmallCap requirements for issuing
additional shares of stock. Were we to issue any such shares, or enter into
any other financing transactions, the terms may have the effect of
significantly diluting or adversely affecting the holdings or the rights of
the holders of the common stock.
OUR SHARES ARE BEING OFFERED ON A BEST EFFORTS BASIS AND THERE IS NO
GUARANTEE THAT WE WILL SELL THE MAXIMUM SHARES OFFERED.
As of June 18, 2003, we have sold 50,000,000 shares of our common stock
in this offering. There can be no assurance, however, that the remaining
shares being offered by this prospectus will be sold or that we will receive
all of the estimated net proceeds generated from a sale of all of such
shares. If all of the 57,200,000 shares offered are not sold, we may be
unable to fund all of the intended uses for the net proceeds anticipated
from this offering without obtaining funds from alternative sources or using
working capital generated by our operations. Alternative sources of funds
may not be available to us at a reasonable cost.
COMPETITION COULD REDUCE OUR MARKET SHARE AND DECREASE OUR REVENUE.
Each of our business units operates in a highly competitive
environment, 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 that 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
have a material adverse effect on our business, financial condition or
results of operations.
WE DEPEND ON OUR SMALL TEAM OF SENIOR MANAGEMENT, AND WE MAY
HAVE DIFFICULTY ATTRACTING AND RETAINING ADDITIONAL PERSONNEL.
The success of our business depends on the continued service
of our executive officers and key personnel. 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.
WE DEPEND ON A SINGLE PRODUCTION ARRANGEMENT WITH RAYTHEON
CORPORATION FOR OUR PATENTED SYRINGE-INJECTABLE MICROCHIPS WITHOUT THE
BENEFIT OF A FORMAL WRITTEN AGREEMENT, AND THE LOSS OF OR ANY
SIGNIFICANT REDUCTION IN THE PRODUCTION COULD HAVE AN ADVERSE EFFECT ON
OUR BUSINESS.
We rely solely on a production arrangement with Raytheon
Corporation for the manufacture of our patented syringe-injectable
microchips that are used in all of our implantable electronic
identification products, but we do not have a formal written agreement
with Raytheon. Raytheon utilizes our proprietary technology and our
15
equipment in the production of our syringe-injectable microchips. The
termination, or any significant reduction, by Raytheon of the assembly
of our microchips or a material increase in the price charged by
Raytheon for the assembly of our microchips could have an adverse effect
on our financial condition and results of operations. In addition,
Raytheon may not be able to produce sufficient quantities of the
microchips to meet any significant increased demand for our products or
to meet any such demand on a timely basis. Any inability or
unwillingness of Raytheon to meet our demand for microchips would
require us to utilize an alternative production arrangement and remove
our automated assembly production machinery from the Raytheon facility,
which would be costly and could delay production. Moreover, if Raytheon
terminates our production arrangement, we cannot ensure that the
assembly of our microchips from another source would be on comparable or
acceptable terms. The failure to make such an alternative production
arrangement could have an adverse effect on our business.
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 have never declared or paid dividends on our common stock, and we
cannot assure you that any dividends will be paid in the foreseeable future.
The IBM Credit Agreement places restrictions on the declaration and payment
of dividends. We intend to use any earnings that we generate to finance
our operations and to repay the amounts outstanding under the IBM Credit
Agreement, and, 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.
WE MAY NOT PREVAIL IN ONGOING LITIGATION AND MAY BE REQUIRED TO PAY
SUBSTANTIAL DAMAGES.
In addition to the litigation described under Legal Proceedings
beginning on page 30, 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 CANNOT ENSURE THE VALIDITY OR PROTECTION OF OUR INTELLECTUAL PROPERTY
RIGHTS OR PATENT RIGHTS.
Our ability to commercialize any of our products under development will
depend, in part, on our ability to obtain patents, enforce those patents,
preserve trade secrets, and operate without infringing on the proprietary
rights of third parties. There can be no assurance that the patent
applications licensed to or owned by us will result in issued patents, that
patent protection will be secured for any particular technology, that any
patents that have been or may be issued to us will be valid or enforceable
or that any patents will provide meaningful protection to us. Furthermore,
we do not own the VeriChip technology that is produced under patents
#6,400,338 and #5,211,129. This technology is owned by Digital Angel
Corporation and licensed to VeriChip under an exclusive product and
technology license with a remaining term of approximately ten years. We
cannot provide assurances that VeriChip Corporation will retain licensing
rights to the use of these patents beyond the licensing period or that the
license will not be terminated early.
THERE CAN BE NO ASSURANCE THAT THE PATENTS OWNED AND LICENSED BY US, OR
ANY FUTURE PATENTS, WILL PREVENT OTHER COMPANIES FROM DEVELOPING SIMILAR OR
EQUIVALENT PRODUCTS.
Furthermore, there can be no assurance that any of our future
products or methods will be patentable, that such products or methods
will not infringe upon the patents of third parties, or that our patents
or future patents will give us an exclusive position in the subject
matter claimed by those patents. We may be unable to avoid infringement
of third party patents and may have to obtain a license, defend an
infringement action, or challenge the validity of the patents in court.
There can be no assurance that a license will be available to us, if at
all, on terms and conditions acceptable to us, or that we will prevail
in any patent litigation. Patent litigation is costly and time
consuming, and there can be no assurance that we will have or will
devote sufficient resources to pursue such litigation. If we do not
obtain a license under such patents and if we are found liable for
infringement or if we are not able to have such patents declared
invalid, we may be liable for significant money damages, may encounter
significant delays in bringing products to market, or may be precluded
from participating in the manufacture, use, or sale of products
requiring such licenses.
16
We also rely on trade secrets and other unpatented proprietary
information in our product development activities. To the extent that we
rely on trade secrets and unpatented know-how to maintain our competitive
technological position, there can be no assurance that others may not
independently develop the same or similar technologies. We seek to protect
trade secrets and proprietary knowledge in part through confidentiality
agreements with our employees, consultants, advisors and collaborators.
Nevertheless, these agreements may not effectively prevent disclosure of our
confidential information and may not provide us with an adequate remedy in
the event of unauthorized disclosure of such information.
OUR BUSINESS IS SUBJECT TO GOVERNMENT REGULATION.
Some of our current or future products may be subject to
government regulation and, in some cases, pre-approval. By letter dated
October 17, 2002, the Food and Drug Administration (the "FDA") issued a
determination that the VeriChip product is not a medical device under
Section 513(g) of the Federal Food, Drug and Cosmetic Act with respect
to the intended security, financial and personal identification/safety
applications. However, the FDA further stated in its determination
letter that with respect to the use of the VeriChip product in health
information applications, VeriChip is a medical device subject to the
FDA's jurisdiction. On November 8, 2002, we received a letter from the FDA,
based upon correspondence from us to the FDA, warning us not to market
VeriChip for medical applications. While we currently intend to market and
distribute the VeriChip product for security, financial and personal
identification/safety applications, in the future, we plan to expand our
marketing and distribution efforts to health information applications of the
product, subject to any and all necessary FDA and other approvals. We are
currently in the process of preparing a 510-K application to obtain FDA
approval to market VeriChip for certain health information applications. We
intend to submit the 510-K application to the FDA within the next several
months. There can be no assurances that the required FDA regulatory reviews
will be conducted in a timely manner or that regulatory approvals will be
obtained. Our future failure to comply with the applicable regulatory
requirements can, among other things, result in fines, suspensions of
regulatory approvals, product recalls, operating restrictions and criminal
prosecution, any of which could have a material adverse effect on us.
Digital Angel Corporation is subject to federal, state and local
regulation in the United States and other countries, and it cannot predict
the extent to which it may be affected by future legislative and other
regulatory developments concerning its products and markets. Digital Angel
Corporation develops, assembles and markets a broad line of electronic and
visual identification devices for the companion animal, livestock and
wildlife markets. Digital Angel Corporation's readers must and do comply
with the FCC Part 15 Regulations for Electromagnetic Emissions, and the
insecticide products purchased and resold by Digital Angel Corporation have
been approved by the U.S. Environmental Protection Agency (EPA) and are
produced under EPA regulations. Sales of insecticide products are incidental
to Digital Angel Corporation's primary business and do not represent a
material part of its operations or revenues. Digital Angel Corporation's
products also are subject to compliance with foreign government agency
requirements. Digital Angel Corporation's contracts with its distributors
generally require the distributor to obtain all necessary regulatory
approvals from the governments of the countries into which they sell Digital
Angel Corporation's products. However, any such approval may be subject to
significant delays. Some regulators also have the authority to revoke
approval of previously approved products for cause, to request recalls of
products and to close manufacturing plants in response to violations. Any
actions by these regulators could materially adversely affect Digital Angel
Corporation's business.
WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS FROM THE USE OF OUR
PRODUCTS.
Manufacturing, marketing, selling, and testing our products
under development entails a risk of product liability. We could be
subject to product liability claims in the event our products or
products under development fail to perform as intended. Even
unsuccessful claims could result in the expenditure of funds in
litigation and the diversion of management time and resources and could
damage our reputation and impair the marketability of our products.
While we maintain liability insurance, there can be no assurance that a
successful claim could not be made against us, that the amount of
indemnification payments or insurance would be adequate to cover the
costs of defending against or paying such a claim, or that damages
payable by us would not have a material adverse effect on our business,
financial condition, and results of operations and on the price of our
common stock.
17
THE THERMO LIFE AND PLD TECHNOLOGIES HAVE NOT YET BEEN DEVELOPED FOR
COMMERCIAL DEPLOYMENT.
The Thermo Life and PLD technologies have been successfully
tested in the laboratory. Our ability to develop and commercialize
products based on these proprietary technologies will depend on our
ability to develop our products internally on a timely basis. No
assurances can be given as to when or if the Thermo Life and PLD
technologies will be successfully marketed.
OUR SUCCESS DEPENDS ON OUR ABILITY TO SELL INCREASING QUANTITIES OF OUR
PRODUCTS.
Our success currently depends primarily upon our ability to successfully
market and sell increasing quantities of our products. Our ability to
successfully sell increasing quantities of our products will depend
significantly on increased market acceptance of our products. Our failure to
sell our products would have a material adverse effect on us. Unfavorable
publicity concerning our products or technology also could have an adverse
effect on our ability to obtain regulatory approvals and to achieve
acceptance by intended users any of which would have a material adverse
effect on us.
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 worsened 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, which resulted in a decrease in our revenues during 2002. Also,
letters of intent that we had received during the last half of 2001 and the
first and second quarters 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. In addition, based upon our annual
goodwill impairment review performed during the fourth quarter of 2002, we
impaired certain goodwill and software related to Digital Angel Corporation.
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.
18
USE OF PROCEEDS
We expect the net proceeds from this offering, assuming an offering
price of $ per share, to vary depending on the quantity of the shares sold.
If we raise the maximum projected, the net proceeds would be approximately
$ , an estimated placement fee of $ , or ___ percent (_%) of the net
proceeds excluding offering expenses, and estimated offering expenses of
$250,000. We cannot assure you that the placement agency fee will not exceed
3%, and that the offering expenses will not exceed $250,000. However, in no
event will the placement agency fee exceed eight percent (8%).
We intend to use the net proceeds, along with any other financing
sources that may become available to us, for the payment of debt. Assuming
we are successful in raising the estimated maximum amount, we intend to
apply the net proceeds as follows:
[Download Table]
Maximum Raise
Use of Capital Amount %
--------------
Payment of debt $ 100.0
-----------------------------
Total $ 100.0
=============================
19
OUR BUSINESS
GENERAL
Our company, Applied Digital Solutions, Inc., together with our
subsidiaries, is an advanced technology development company. We have grown
significantly through acquisitions. Since 1996, we have completed 51
acquisitions. During the last half of 2001 and during 2002, we sold or
closed many of these business that we had acquired that we believed did not
enhance our strategy of becoming an advanced technology development company.
We have emerged from being a supplier of computer hardware, software and
telecommunications products and services to becoming an advanced technology
company that focuses on a range of life enhancing, personal safeguard
technologies, early warning systems, miniaturized power sources and security
monitoring systems combined with comprehensive data management services
required to support them. To date, we have five such products in various
states of development. They are:
o Digital Angel(TM), for monitoring and tracking people and objects;
o Thermo Life(TM), a thermoelectric generator powered by body heat;
o VeriChip(TM), an implantable radio frequency verification device that
can be used for security, financial, personal identification/safety
and other applications;
o Bio-Thermo(TM), a temperature-sensing implantable microchip for
use in pets, livestock and other animals; and
o Personal Locating Device (PLD), an implantable global positioning
satellite (GPS) location device.
Over two years ago, we developed a proprietary location and
monitoring system that combines advanced biosensor technology and
location technology (such as global positioning satellite (GPS)), in a
watch/pager device that communicates through proprietary software to a
secure 24/7 operations center in California. This system is covered
under the United States patent registration # 5,629,678, which we
acquired in 1999. We filed an International Patent Application directed
to the system, which has been published under publication no. W/0
02/44865. The application, which is in the name of Digital Angel
Corporation, is currently pending in several countries. 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, personal digital assistant
(PDA) or wireless telephone. 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,
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, which we refer to as pre-merger
Digital Angel. Digital Angel, the product, is now developed and was
launched on November 26, 2001. Effective March 27, 2002, pre-merger
Digital Angel became its own public company through its merger into
Medical Advisory Systems, Inc. (MAS) (AMEX:DOC). Currently we are the
beneficial owner of approximately 73.12% of this new company which has
been renamed Digital Angel Corporation.
Our wholly-owned subsidiary, Thermo Life Energy Corp., formerly
Advanced Power Solutions, Inc., will develop, market and license our
product, Thermo Life, a small 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. On July 9, 2002, we announced that we had
achieved an important breakthrough: 3.0-volts of electrical power were
successfully generated by Thermo Life in laboratory tests. We expect to
begin marketing Thermo Life during the second half of 2003.
We have developed a miniaturized, implantable identification
chip, called VeriChip that can be used in a variety of security,
financial, personal identification/safety and other applications. On
February 7, 2002, we announced that we had created of a wholly-owned
subsidiary, VeriChip Corporation, which will develop, market and license
VeriChip. About the size of a grain of rice, each VeriChip product
contains a unique verification number. Utilizing our proprietary
external radio frequency identification (RFID) scanner, radio frequency
passes
20
through the skin energizing the dormant VeriChip, which then emits a radio
frequency signal transmitting the verification number contained in the
VeriChip.
On October 22, 2002, we announced that the Food and Drug
Administration (FDA) had determined that VeriChip is not a regulated
medical device for security, financial and personal
identification/safety applications. The FDA specified in its ruling
that VeriChip is a regulated medical device for health information
applications when marketed to provide information to assist in the
diagnosis or treatment of injury or illness. On November 8, 2002, we
received a letter from the FDA, based upon correspondence from us to the
FDA, warning us not to market VeriChip for medical applications. We
currently intend to market and distribute the VeriChip product for
security, financial and personal identification/safety applications and,
in the future, we plan to expand our marketing and distribution efforts
to health information applications of the product, subject to any and
all necessary FDA and other approvals. We are currently in the
process of preparing a 510-K application to obtain FDA approval to
market VeriChip for certain health information applications. We intend
to submit the 510-K application to the FDA within the next several
months.
We began marketing VeriChip for security, financial and
personal identification/safety applications within the United States on
October 24, 2002.
On February 1l, 2003, we announced that we received written
clearances from the FDA and the United States Department of Agriculture
to market our new product, Bio-Thermo, for use in pets, livestock and
other animals. Bio-Thermo is our first fully integrated implantable bio-
sensing microchip that can transmit a signal containing accurate
temperature readings to our proprietary RFID scanners. With this new
technology, accurate temperature readings can be obtained by simply
passing the RFID handheld scanner over the animal or by having the
animal walk through a portal scanner. We believe that Bio-Thermo and
other biosensors developed in the future will provide vital internal
diagnostics about the health of animals more efficiently and accurately
than the invasive techniques used in the industry today.
On May 13, 2003, we announced that we have developed and
successfully field-tested a working prototype of, what is to our
knowledge, the first-ever sub-dermal GPS personal location device called
PLD. The dimensions of this initial PLD prototype are 2.5 inches in
diameter by 0.5 inches in depth, roughly the size of a pacemaker. As
the process of miniaturization proceeds in the coming months, we expect
to be able to shrink the size of the device to at least one-half and
perhaps to as little as one-tenth of the current size. The PLD is
charged by an induction-based power-recharging method which is similar
to that used to recharge implantable pacemakers. This recharging
technique functions without requiring any physical connection between
the power source and the implant. The exact timing of the commercial
availability of PLD is unclear pending further technological refinements
and the obtainment of any and all required regulatory clearances. The
PLD technology builds on our United States patent registration #5,629,678.
The majority of our operations are the result of acquisitions
completed during the last six years. Our revenues from continuing
operations were $25.1 million for the three-months ended March 31, 2003,
and $99.6 million, $156.3 million, $134.8 million, $129.1 million and
$74.3 million, respectively, in 2002, 2001, 2000, 1999 and 1998.
We are a Missouri corporation and were incorporated on May
11, 1993. Our principal office is located at 400 Royal Palm Way, Suite 410,
Palm Beach, Florida 33480, and our phone number is (561) 805-8000.
RECENT DEVELOPMENTS
Digital Angel/MAS Merger
On March 27, 2002, pre-merger Digital Angel merged with MAS,
and MAS changed its name to Digital Angel Corporation. Also, pursuant to
the merger agreement, we contributed all of our stock in Timely
Technology Corp., our wholly-owned subsidiary, and Signature Industries,
Limited, our 85% owned subsidiary. Prior to the merger, pre-merger
Digital Angel, Timely Technology Corp. and Signature Industries, Limited
were collectively referred to as the Advanced Wireless Group (AWG). In
satisfaction of a condition to the consent to the merger by IBM Credit,
we transferred all shares of Digital Angel Corporation common stock
owned by us to a Delaware
21
business trust, which we refer to herein as the Digital Angel Trust,
controlled by an advisory board and, as a result, the Digital Angel Trust
has legal title to approximately 73.12% of the Digital Angel Corporation
common stock as of March 31, 2003. The Digital Angel Trust has voting rights
with respect to the Digital Angel Corporation common shares until we repay
our obligations to IBM Credit in full. We have retained beneficial ownership
of the shares. The Digital Angel 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 our IBM Credit Agreement as more fully discussed below.
IBM Credit Agreement
Our IBM Credit Agreement, contained covenants relating to our
financial position and performance, as well as the financial position
and performance of Digital Angel Corporation. At December 31, 2002, we
did not maintain compliance with the revised financial performance
covenant under the IBM Credit Agreement. In addition, under the terms of
the IBM Credit Agreement we were required to repay IBM Credit $29.8
million of the $77.2 million outstanding principal balance currently
owed to them, plus $16.4 million of accrued interest and expenses
(totaling approximately $46.2 million), on or before February 28, 2003.
We did not make such payment by February 28, 2003. On March 3, 2003, IBM
Credit notified us that we had until March 6, 2003, to make the payment.
We did not make the payment on March 6, 2003, as required. Our failure
to comply with the payment terms imposed by the IBM Credit Agreement and
to maintain compliance with the financial performance covenant
constitute events of default under the IBM Credit Agreement. On March
7, 2003, we received a letter from IBM Credit declaring the loan in
default and indicating that IBM Credit would exercise any and/or all of
its remedies.
In addition, as of December 31, 2002, and March 31, 2003, Digital
Angel Corporation did not maintain compliance with certain financial
covenants under its credit agreement with its lender, Wells Fargo Business
Credit, Inc. (Wells Fargo). Well Fargo provided Digital Angel Corporation
with waivers of such non-compliance.
Forbearance Agreement
On March 27, 2003, we announced that we had executed a forbearance
agreement term sheet with IBM Credit. The forbearance agreement was executed
on April 2, 2003 (the "Forbearance Agreement"). In turn, we also agreed to
dismiss with prejudice a lawsuit we filed against IBM Credit and IBM
Corporation in Palm Beach County, Florida on March 6, 2003.
The payment provisions of the Forbearance Agreement are as follows:
o the Tranche A Loan, consisting of $68.0 million plus
accrued interest, must be repaid in full no later than September 30,
2003, provided that all but $3 million of the Tranche A Loan (the
"Tranche A Deficiency Amount") will be deemed to be paid in full on such
date if less than the full amount of the Tranche A Loan is repaid but
all of the net cash proceeds of the Digital Angel Corporation shares
held in the Digital Angel Trust are applied to the repayment of the
Tranche A Loan. The Tranche A Deficiency Amount (if any) must be repaid
no later than March 31, 2004. The Tranche A Loan bore interest at
seventeen percent (17%) per annum through February 28, 2003. Effective
March 1, 2003, the interest rate increased to twenty-five percent (25%)
per annum; and
o the Tranche B Loan, consisting of $9.2 million plus accrued
interest, must be repaid in full no later than March 31, 2004. The
Tranche B Loan bore interest at seventeen percent (17%) per annum
through February 28, 2003, and from March 1, 2003, to March 24, 2003,
the Tranche B Loan bore interest at twenty-five percent (25%) per annum.
Effective March 25, 2003, the interest rate decreased to seven percent
(7%) per annum.
o The Tranche A and B Loans may be purchased under the terms of the
Forbearance Agreement by or on our behalf as follows:
o the loans and all the other obligations may be purchased on
or before June 30, 2003, for $30.0 million in cash;
22
o the loans and all the other obligations may be purchased on
or before September 30, 2003, for $50.0 million in cash; and
o the Tranche A Loan may be purchased on or before September
30, 2003, for $40.0 million in cash with an additional $10.0 million
cash payment in respect of the Tranche A Deficiency Amount and the
Tranche B Loan due on or before December 31, 2003.
Payment of any of these amounts by the dates set forth herein will
constitute complete satisfaction of any and all of our obligations to IBM
Credit under the IBM Credit Agreement provided that there has not earlier
occurred a "Termination Event," as defined in the Forbearance Agreement.
In addition, we have agreed under the terms of the Forbearance
Agreement that the Digital Angel Trust will immediately engage an investment
bank to pursue the sale of the 19,600,000 shares of Digital Angel
Corporation common stock that are currently held in the Digital Angel Trust.
In May 2003, an investment bank was engaged. All proceeds from the sale of
the Digital Angel Corporation common stock will be applied to the loans and
other obligations to satisfy the Tranche A payment provisions as discussed
above, in the event that we have not satisfied our purchase rights by
September 30, 2003.
The Forbearance Agreement also modifies other provisions of the IBM
Credit Agreement, including but not limited to, the imposition of additional
limitations on permitted expenditures.
Provided there has not earlier occurred a "Termination Event," as
defined, at the end of the forbearance period, the provisions of the
Forbearance Agreement shall become of no force and effect. At that
time, if the repayment terms of the Forbearance Agreement are not met,
IBM Credit will be free to exercise and enforce, or to take steps to
exercise and enforce, all rights, powers, privileges and remedies
available to them under the IBM Credit Agreement, as a result of the
payment and covenant defaults existing on March 24, 2003. If we are not
successful in satisfying the repayment obligations under the Forbearance
Agreement or we do not comply with the terms of the Forbearance
Agreement or the IBM Credit Agreement, and IBM Credit were to enforce
its rights against the collateral securing the obligations to IBM
Credit, there would be substantial doubt that we would be able to
continue operations in the normal course of business.
As a result of the payment and financial covenant defaults
discussed above, IBM Credit has exercised its rights to control our
cash, excluding the cash of Digital Angel Corporation and InfoTech USA,
Inc (formerly SysComm International Corporation). At March 31, 2003,
IBM held in its possession $2.0 million of our cash, which it
subsequently remitted back to us. IBM Credit continues to maintain
control over our deposits and disbursements. Under the terms of the
forbearance agreement, we are required to be cash flow positive
beginning May 1, 2003. We request weekly from IBM Credit a release of
funds for the prior weeks cash collections and provide to IBM Credit a
schedule detailing cash disbursements complying with the cash flow
positive requirement.
OTHER
The Staff of the Securities and Exchange Commission's Southeast
Regional Office is conducting an informal inquiry concerning us. We are
fully and voluntarily cooperating with this informal inquiry. At this
point, we are unable to determine whether this informal investigation
may lead to potentially adverse action.
As of December 31, 2002, the net book value of our goodwill was $67.8
million. There was no impairment of goodwill upon our adoption of FAS 142 on
January 1, 2002. However, based upon our annual review for impairment during
the fourth quarter of 2002, we recorded an impairment charge of $62.2 million
associated with our Digital Angel Corporation segment. The impairment relates
to the goodwill associated with the acquisition of MAS in March 2002, and to
Digital Angel Corporation's Wireless and Monitoring segment. Future goodwill
impairment reviews may result in additional periodic write-downs. In
addition, Digital Angel Corporation wrote down $6.4 million of property and
equipment related to software associated with its Wireless and Monitoring
segment. As of December 31, 2002, Digital Angel Corporation's Wireless and
Monitoring segment has not recorded any significant revenue from its Digital
Angel product, and therefore, it was determined that the goodwill and
software were impaired.
23
Our common stock has traded on the SmallCap since November 12,
2002, under the symbol "ADSX." Prior to November 12, 2002, our common
stock traded on the Nasdaq National Market at all times, except for the
period between July 12, 2002 and July 30, 2002, when our common stock
traded on the Pink Sheets under the symbol "ADSX.PK." To maintain our
SmallCap listing, we must continue to comply with the SmallCap's listing
requirements and, prior to October 2003, regain the minimum bid
requirement of at least $1.00 per share for a minimum of ten (10)
consecutive trading days.
On March 21, 2003, Richard J. Sullivan, our then Chairman of
the Board of Directors and Chief Executive Officer, retired from such
positions. Our Board of Directors negotiated a severance agreement with
Richard Sullivan under which he is to receive a one-time payment of 56.0
million shares of our common stock. In addition, stock options held by
him exercisable for approximately 10.9 million shares of our common stock
were re-priced. The options surrendered had exercise prices ranging
from $0.15 to $0.32 per share and were replaced with options exercisable
at $0.01 per share. Richard Sullivan's severance agreement provides that
the payment of shares and re-pricing of options provided for under that
agreement is in lieu of all future compensation and other benefits that
would have been owed to him under his employment agreement. That
agreement required us to make payments of roughly $17 million to him, a
portion of such payments of which could be made in either cash or stock,
at our option.
On March 21, 2003, Jerome C. Artigliere our then Senior Vice President
and Chief Operating Officer, resigned from such positions. Under the terms
of his severance agreement, Mr. Artigliere is to receive 4.8 million shares
of our common stock. In addition, stock options held by him exercisable for
approximately 2.3 million shares of our common stock were re-priced. The
options surrendered had exercise prices ranging from $0.15 to $0.32 per
share and were replaced with options exercisable at $0.01 per share. Mr.
Artigliere's severance agreement provides that the payment of shares and
re-pricing of options provided under that agreement is in lieu of all future
compensation and other benefits that would have been owed to him under his
employment agreement. That agreement required us to make payments of
approximately $1.5 million to Mr. Artigliere.
As a result of the termination of Richard Sullivan's employment with
us, a "triggering event" provision in the severance agreement we entered
into with Garrett Sullivan, our former Vice Chairman of the Board, (who is
not related to Richard Sullivan) at the time of his ceasing to serve in such
capacity in December 2001, has been triggered. We recently negotiated a
settlement of our obligations under Garrett Sullivan's severance agreement
that requires us to issue to him 7.5 million shares of our common stock on
our before August 31, 2003.
As a result of the terminations of Messrs. Sullivan and Artigliere, we
have recorded severance expense of $22.0 million during the three-months
ended March 31, 2003. This expense is reflected in our condensed
consolidated financial statements for the three-months ended March 31, 2003,
as selling, general and administrative expense and represents, in all
material respects, the total amount due to these former officers and
director and to Garrett Sullivan under their respective employment
agreements.
The terms of each of the severance agreements are subject to
shareholder approval, in accordance with applicable Nasdaq rules,
because the agreements (i) are deemed to be compensatory arrangements
under which our common stock may be acquired by officers or directors,
and (ii) in Richard Sullivan's case, it may result in his potentially
holding more than 20% of the outstanding shares of our common stock
following the issuance of the shares and exercise of options covered by
his severance agreement. In connection with such shareholder approval,
we intend to seek shareholder approval of an increase in the number of
authorized shares of our common stock.
We have included proposals in our proxy statement for our 2003 annual
meeting of shareholders to solicit shareholder approval of the terms of such
agreements and the increase in the number of authorized shares of our common
stock. Should shareholders not approve the terms of the severance agreements
or we lack a sufficient number of authorized shares to effect the share
issuances provided for by the severance agreements, our former executive
officers and directors may take actions against us to enforce the terms of
their employment agreements. Under such circumstances, there would be
substantial doubt that we would be able to continue operations in the normal
course of business. In such event, holders of our securities may face the
loss of their entire investment.
Furthermore, the surrender of the options held by Messrs. Sullivan and
Artigliere in exchange for the re-priced options has already occurred and
Messrs. Sullivan and Artigliere have exercised these options. Without
shareholder approval, we would need to unwind the transactions or otherwise
risk having our common stock delisted
24
by Nasdaq. If the transactions were to be unwound or if, in the course of
seeking to renegotiate the terms of the severance agreements, either Richard
Sullivan or Jerome Artigliere were to insist on a cash payment for any
portion of the obligations due them under their employment agreements, we
would risk violating the terms of the Forbearance Agreement which, as noted
above, requires us to be cash flow positive on a consolidated operational
basis at all times from and after May 1, 2003. In such event, we would face
the possibility of a cessation of business operations in the normal course.
By virtue of the need to obtain shareholder approval of the terms
of the severance agreements, the date by which we would otherwise have
been obligated to file a registration statement covering the resale of
the shares to be issued to our former executive officers and directors
under their severance agreements has been extended and the issuance of the
shares will await the outcome of the shareholder vote. However, in
order to ensure the timely registration of the shares, we may file a
registration statement with the SEC prior to the issuance of the shares.
Effective May 9, 2003, Michael Zarriello joined our Board of
Directors. Mr. Zarriello was most recently a Senior Managing Director
of Jesup & Lamont Securities Corporation and served as President of
Jesup and Lamont Merchant Partners LLC. Prior to that, he was Managing
Director and Principal of Bear Stearns & Co., Inc. He has extensive
financial experience having served earlier in his career as Chief
Financial Officer of the Principal Activities Group that invested the
Bear Stearns & Co., Inc. capital in middle market companies, Chief
Financial Officer of United States Leather Holdings, Inc. and Chief
Financial Officer of Avon Products, Inc. Healthcare Division. On June
17, 2003, Mr. Zarriello was appointed to the Audit Committee of our
Board of Directors.
Effective May 12, 2003, Kevin H. McLaughlin was appointed our
President and Chief Operating Officer. Prior to his appointment as
President, Mr. McLaughlin served as our Senior Vice President and Chief
Operating Officer.
Effective June 4, 2003, Arthur F. Noterman resigned from our Board of
Directors to pursue other interests. Mr. Noterman's term was due to expire
at our Annual Meeting of Shareholders, which is being held on July 25, 2003.
At present, we have not filled the position vacated by Mr. Noterman.
BUSINESS SEGMENTS
As a result of the merger of pre-merger Digital Angel and MAS, which
occurred on March 27, 2002, the significant restructuring of the Company's
business during the past year and the Company's emergence as an advanced
technology development company, we have re-evaluated and realigned our
reporting segments. Effective January 1, 2002, we currently operate in three
business segments: Advanced Technology, Digital Angel Corporation and
InfoTech USA, Inc. (formerly the segment known as SysComm International)
Advanced Technology
Our Advanced Technology segment represents those businesses
that we believe will provide the necessary synergies, support and
infrastructure to allow us to develop, promote and fully integrate our
technology products and services. This segment specializes in security-
related data collection, value-added data intelligence and complex data
delivery systems for a wide variety of end users including government
agencies, commercial operations and consumers. Our VeriChip, Thermo Life
and PLD products are included in the Advanced Technology segment.
Revenues from this segment amount to 44.9% of our total revenues for
the three-months ended March 31, 2003. As of December 31, 2002, 2001 and
2000, revenues from this segment accounted for 42.1%, 28.5%, and 24.0%,
respectively, of our total revenues.
Customers
---------
Our Advanced Technology segment delivers products and services across a
multitude of industries, including government, insurance, utilities,
communications and high tech. Some of this segment's largest customers
include several agencies of the United States federal government and PSE&G.
Other than customary payment terms, we do not offer any financing to our
customers.
25
Approximately $9.3 million, or 82.7%, $31.3 million, or 74.7%, and
$27.4 million, or 61.5%, of our Advanced Technology segment's revenues
for the three-months ended March 31, 2003, 2002 and 2001, respectively,
were generated by our wholly-owned subsidiary, Computer Equity
Corporation. Approximately 99.0%, 99.1% and 77.7% of Computer Equity
Corporation's revenues during the three-months ended March 31, 2003,
2002 and 2001, respectively, were generated through sales to various
agencies of the United States Federal Government. Computer Equity
Corporation provides telecommunications products and services. Most of
Computer Equity Corporation's business was being performed under a
contract vehicle entitled Wire and Cable Service (WACS) that was
managed by the General Services Administration (GSA). WACS allowed
Computer Equity Corporation to provide government agencies with equipment
and services for campus and building communications networks and related
infrastructure without the need to follow the full procurement process for a
new contract.
The GSA contracting official responsible for WACS had notified
Computer Equity Corporation that the WACS contract was expiring on
September 30, 2003. Upon the expiration of WACS, no new WACS tasks can
be started; however, tasks started prior to the expiration date can be
completed. Due to the nature of the government's budget cycle, projects
funded in 2003 with fiscal year 2002 and 2003 funds will be continued
with an expected completion date by the end of 2004.
In January 2003, the WACS contract was replaced with the
CONNECTIONS contract. The CONNECTIONS contract has a three-year base
term and five successive one-year renewal options and a contract ceiling
of $35 billion. The CONNECTIONS contract is similar to the WACS
contract in that it will allow Computer Equity Corporation to provide
government agencies with equipment and services for campus and building
communications networks and related infrastructure without the need to
follow the full procurement process for a new contract.
Competitors
-----------
Our Advanced Technology segment's competitors include General
Dynamics, Inc., Engineering and Professional Services, Inc., CC-ops of
California, American Systems Corporation, Nortel, Genesys, Avaya,
Aestea, Metrix, People Soft, Cap Gemini, Datalan Corp. and Plural, Inc.
We have less than one percent of the federal telecommunications market
share. We believe our business to be highly competitive, and we expect
that the competitive pressures we face will not diminish. Many of our
competitors have greater financial, technological, marketing and other
resources than we do.
Digital Angel Corporation
Our Digital Angel Corporation segment consists of the
business operations of Digital Angel Corporation, our approximately
73.12% owned subsidiary and is engaged in the business of developing and
bringing to market proprietary technologies used to identify, locate and
monitor people, animals and objects. Before March 27, 2002, the business
of Digital Angel Corporation was operated in four divisions: Animal
Tracking, Digital Angel Technology, Digital Angel Delivery System, and
Radio Communications and Other. With the acquisition of MAS on March 27,
2002, Digital Angel Corporation re-organized into four new divisions:
Animal Applications (formerly Animal Tracking), Wireless and Monitoring
(a combination of the former Digital Angel Technology and the Digital
Angel Delivery System segments), GPS and Radio Communications (formerly
Radio Communications and Other), and Medical Systems (formerly Physician
Call Center and Other). Medical systems represents the business activity
of the newly acquired MAS.
Revenues from this segment amount to 45.0% of our total
revenues for the three-months ended March 31, 2003. As of December 31,
2002, 2001 and 2000, revenues from this segment accounted for 33.7%,
22.9% and 16.5%, respectively, of our total revenues.
Customers
---------
During 2002, the top five customers, Schering-Plough, US Army
Corps of Engineers, Biomark, Pacific States Marine and San Bernardino
County accounted for 31.8% of Digital Angel Corporation's revenues;
however, no single customer accounted for more than 10% of revenues.
During 2001, the top five customers, Schering
26
Plough, Merial, Pacific States Marine, San Bernardino County and the US Army
Corps of Engineers accounted for 30.6% of this segment's revenues, one of
which accounted for 10.4% of the segment's revenues.
Competitors
-----------
The animal identification market is highly competitive. The principal
competitors in the visual identification market are AllFlex USA, Inc. and
Y-Tex Corporation and the principal competitors in the electronic
identification market are AllFlex, USA, Inc., Datamars SA and Avid Plc.
The principal competitor for the Digital Angel product is Whereify
Wireless, Inc. We are not aware of any other competitors currently marketing
products that compete with the Digital Angel product. However, we are aware
of several potential competitors that have expressed an interest in
developing and marketing similar technologies. There is no substantial
revenue from product sales of any participant in this market.
The principal competitors for the GPS and Radio Communications division
are Tadiran Spectralink Ltd., Smith Group of Companies, Becker Avionic
Systems, A.C.R. Electronics Inc. and Securicor Information Systems Ltd.
Medical Systems competes in the maritime medical advice market with a
few foreign government-operated entities. Further, there are several U.S.
companies, as well as hospitals, that provide radio medical advice to ships
at sea. While we believe that we have a competitive advantage, the barriers
to entry into this market are relatively low, and there can be no assurance
that other companies will not commence operations similar to those provided
by Medical Systems and generate competition that does not now exist.
InfoTech USA, Inc. (formerly the segment known as SysComm
International)
Our InfoTech USA, Inc. segment consists of the business operations of
our 52.5% owned subsidiary, InfoTech USA, Inc. Corporation. This segment is
a full service provider of Information Technology, or IT, solutions and
products. Doing business as "InfoTech," this segment provides IT consulting,
networking, procurement, deployment, integration, migration and security
services and solutions. It also provides on-going system and networking
maintenance services. During 2002, this segment continued its strategy of
moving away from a product-driven systems integration business model to a
customer-oriented IT solutions-based business model. It has further
developed its deliverable IT solutions by adding new consulting and service
offerings, and increasing the number of strategic alliances with outside
technical services firms and manufacturers of high-end IT products.
Revenues from this segment amount to 10.1% of our total revenues for
the three-months ended March 31, 2003. As of December 31, 2002, 2001 and
2000, revenues from this segment accounted for 22.8%, 21.9% and 20.2%,
respectively, of our total revenues.
Customers
---------
A significant percentage of InfoTech USA, Inc.'s revenue is
derived from sales to customers in educational institutions, the legal
and financial community, medical facilities, museums and New York City
agencies. Its customer base also includes retailers, manufacturers and
distributors. During 2002, five customers, Deutsche Bank, Hackensack
University Medical Center, Liberty Mutual, Morgan Stanley and
Polytechnic University accounted for 23%, 22%, 11%, 11% and 11% of
InfoTech USA, Inc.'s revenues, respectively. During 2001, two
customers, Liberty Mutual and Mass Mutual Life Insurance accounted for
40% and 31% of InfoTech USA, Inc.'s revenues, respectively.
Competitors
-----------
InfoTech USA, Inc. competes in a highly competitive market with IT
products and solutions providers that vary greatly in their size and
technical expertise. Its primary competitors are Manchester Technologies,
Inc., AlphaNet Solution, Inc., En Pointe Technologies, Inc.
Micros-to-Mainframes, Inc. and Pomeroy Computer Resources. Additionally, we
expect InfoTech USA, Inc. to face further competition from new market
entrants and possible alliances between competitors in the future.
27
All Other
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."
The "Corporate/Eliminations" category includes all amounts recognized
upon consolidation our subsidiaries such as the elimination of intersegment
revenues, expenses, assets and liabilities. "Corporation/Eliminations" also
includes certain interest expense and other expenses associated with
corporate activities and functions. Included in "Corporate/Eliminations" for
the three-months ended March 31, 2003, is a severance charge of $22.0
million associated with the termination of certain former officers and
director. Included in "Corporate/Eliminations" for the three-months ended
March 31, 2002, is a non-cash compensation charge of $18.7 million
associated with pre-merger Digital Angel options, which were converted into
options to acquire shares of MAS in connection with the merger of pre-merger
Digital Angel and MAS.
Prior Segments
Prior to January 1, 2002, our business was organized into three
industry groups or business segments: Applications, Services, and Advanced
Wireless. Prior period information has been restated to present our
reportable segments on a comparative basis.
DISCONTINUED OPERATIONS
On March 1, 2001, our Board of Directors approved a plan to sell
Intellesale, Inc. and all of our other non-core businesses. The results of
operations, financial condition and cash flows of Intellesale and all of our
other non-core businesses have been reported as Discontinued Operations in
our financial statements.
RAW MATERIALS AND SUPPLIES
To date, we have not been materially adversely affected by the
inability to obtain raw material or products. Our Digital Angel Corporation
segment relies solely on a production arrangement with Raytheon Corporation
for the assembly of its patented syringe-injectable microchips, which are
used in all of our implantable electronic identification products. The loss
of, or any significant reduction in, the production could have an adverse
effect on our and Digital Angel Corporation's businesses.
SEASONALITY
No material portion of our business is considered to be seasonal.
BACKLOG
At June 1, 2003, we, and our subsidiaries had a backlog of orders of
approximately $21.9 million. We expect the majority of the backlog at June 1,
2003 to be filled in 2003 and 2004.
COMPLIANCE WITH ENVIRONMENTAL REGULATIONS
Federal, state, and local laws or regulations which have been enacted or
adopted regulating the discharge of materials into the environment have not
had, and under present conditions we do not foresee that they will have, a
material adverse effect on our capital expenditures, earnings, cash flows or
our competitive position. We will continue to monitor our operations with
respect to potential environmental issues, including changes in legally
mandated standards.
28
EMPLOYEES
At June 1, 2003, we employed approximately 397 employees.
GEOGRAPHIC AREAS
Currently, we operate in two geographic areas: the United States,
which comprises the majority of our operations and the United Kingdom.
Our United Kingdom operations consist of a company in our Digital Angel
Corporation segment. The majority of our revenues and expenses in each
geographic area, both from Continuing and Discontinued Operations, were
generated in the same currencies, except as noted below.
Previously, we operated in Canada. Our Canadian operation was
comprised of an automotive manufacturing and engineering company, which
was part of our Discontinued Operations, and which we disposed of in
January 2002. Approximately 41% and 40% of the manufacturing and
engineering company's revenues were generated in U.S. dollars for the
years ended December 31, 2001 and 2000, respectively, while 94% and 100%
of its expenses were incurred in Canadian dollars during the same
respective periods.
From mid-December 2000 to April 2002, we operated a United Kingdom
company in our Advanced Technology segment. Approximately 89% of this
company's revenues were generated in foreign currencies during 2002 and
2001, while 45% of its expenses were generated in foreign currencies.
We did not incur any significant foreign currency gains or losses
during the three-months ended March 31, 2003 and the three years ended
December 31, 2002.
PROPERTIES
At June 1, 2003, we were obligated under leases for approximately
189,549 square feet of facilities, of which 124,085 square feet was for
office facilities and 65,464 square feet was for factory and warehouse
space. These leases expire at various dates through 2042. In addition, we
owned 111,977 square feet of office and manufacturing facilities, of which
78,800 square feet was for manufacturing, factory and warehouse use and
33,177 square feet was for office space.
The following table sets forth our owned and leased properties by
business divisions:
[Download Table]
FACTORY /
OFFICE WAREHOUSE TOTAL
------ --------- -----
(AMOUNTS IN SQUARE FEET)
Advanced Technology 56,658 13,464 70,122
Digital Angel Corporation 49,458 124,800 174,258
InfoTech USA, Inc. 9,262 1,000 10,262
All Other 16,900 5,000 21,900
Corporate(1) 23,484 -- 23,484
------- ------- -------
Continuing Operations 155,762 144,264 300,026
Discontinued Operations 1,500 -- 1,500
------- ------- -------
Total 157,262 144,264 301,526
======= ======= =======
<FN>
(1) Includes office space leased to others.
29
The following table sets forth the principal locations of our
properties:
[Download Table]
FACTORY /
OFFICE WAREHOUSE TOTAL
------ --------- -----
(AMOUNTS IN SQUARE FEET)
California 30,957 6,000 36,957
Florida 6,307 -- 6,307
Louisiana 1,500 -- 1,500
Maryland 15,000 4,800 19,800
Minnesota 6,000 74,000 80,000
New Hampshire 15,856 5,464 21,320
New Jersey(1) 20,838 1,000 21,838
New York 3,254 -- 3,254
Ohio 16,900 5,000 21,900
Virginia 18,500 8,000 26,500
United Kingdom 22,150 40,000 62,150
------- ------- -------
Total 157,262 144,264 301,526
======= ======= =======
<FN>
(1) Includes office space leased to others.
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 our financial statements as of March 31, 2003. 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 January 31, 2002, Treeline, Inc. filed a complaint in the Common
Pleas Court of Cuyahoga County, Ohio against us, and one of our
subsidiaries, STR, Inc., now known as 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. On May 15, 2003, we settled the dispute with
Treeline, Inc., subject to certain conditions subsequent. The settlement
provides for the issuance of 1.1 million shares of our common stock.
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 we vacated prior to the expiration of the lease and
which is no longer in use. The trial date, originally set for December 2002,
has been postponed until July 2003.
In May 2002, a purported securities fraud class action was filed
against us and one of our directors. In the following weeks, fourteen
virtually identical complaints were consolidated into a single action, In re
Applied Digital Solutions Litigation, which was filed in the United States
District Court for the Southern District of Florida. In March 2003, we
entered into a memorandum of understanding to settle the pending lawsuit.
The settlement of $5.6 million will be entirely covered by proceeds from
insurance, and is subject to approval by the District Court and review by an
independent special litigation committee.
In July 2002, SRZ Trading LLC filed a derivative complaint in the
Circuit Court of Cole County, Missouri against us, and several of our
officers and directors. The Missouri action was voluntarily dismissed and
re-filed in federal court in the Southern District of Florida. The Florida
action was voluntarily dismissed with prejudice in February 2003.
On May 29, 2001, Janet Silva, individually and as Guardian ad Litem for
Jonathan Silva, a minor, and the Estate of Clarence William Silva, Jr.
(collectively, "Plaintiffs") filed suit against Customized Services
Administrators, Incorporated ("CSA"), Pricesmart, Inc. ("Pricesmart"),
Commercial Union Insurance Company ("Commercial Union"), CGU Insurance Group,
and Digital Angel Corporation (collectively the "Defendants") in the Superior
Court of the State of California in and for the County of Santa Clara. The
allegations of the complaint arise from a vacation guarantee insurance policy
(the "Insurance Contract") allegedly purchased by Plaintiffs from Defendants
on March 6, 2000. The complaint alleges, among other things, that Defendants
breached the Insurance Contract, defrauded Plaintiffs, acted in bad faith,
and engaged in deceptive and unlawful business practices, resulting in the
wrongful death of Clarence William Silva, Jr. (the "Deceased") and the
intentional infliction of emotional distress on Plaintiffs. The complaint
seeks the cost of funeral and burial expenses of the Deceased and amounts
constituting the loss of financial support of the Deceased, general damages,
attorney's fees and costs, and exemplary damages. CSA has filed a cross-claim
against Digital Angel Corporation alleging that Digital Angel Corporation
should be held liable for any liability that CSA may have to Plaintiffs.
Digital Angel Corporation has denied the allegations of the complaint and the
CSA cross-claim and is vigorously contesting all aspects of this action.
30
SELECTED FINANCIAL DATA
You should read the following selected consolidated financial data in
conjunction with our consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing elsewhere in this prospectus. The statement of
operations for the three-months ended and as of March 31, 2003 and 2002, are
derived from our interim condensed consolidated financial statements. The
statement of operations and balance sheet data for the years ended and as of
December 31, 2002, 2001, 2000, 1999 and 1998 are derived from our
consolidated financial statements. In accordance with the requirements of
FAS 145, we have reclassified the $9.5 million gain on extinguishment of
debt recorded in 2001 as a component of continuing operations. This amount
was previously recorded as extraordinary. In the opinion of management, our
unaudited interim consolidated financial statements include all adjustments,
which are only normally recurring adjustments, necessary for a fair
presentation of the financial position and results of operations for the
unaudited periods. The historical results are not necessarily indicative of
results to be expected for future periods and results for the three-month
period ended March 31, 2003, are not necessarily indicative of results that
may be expected for the entire year ending December 31, 2003.
[Enlarge/Download Table]
THREE-MONTHS ENDED MARCH 31, FOR THE FISCAL YEAR ENDED DECEMBER 31,
---------------------------- --------------------------------------------------
2003 2002 2002 2001 2000 1999 1998
---- ---- ---- ---- ---- ---- ----
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Net revenue $ 25,106 $ 28,219 $ 99,600 $ 156,314 $ 134,766 $129,064 $74,343
Cost of goods and services sold 16,137 18,841 67,718 109,839 82,475 74,299 39,856
-------- -------- --------- --------- --------- -------- -------
Gross profit 8,969 9,376 31,882 46,475 52,291 54,765 34,487
Selling, general and administrative expense 29,468 28,900 66,450 102,316 61,996 58,960 32,120
Research and development 1,201 1,448 3,518 8,610 2,504 -- --
Depreciation and amortization 626 1,004 4,773 28,899 11,073 6,560 2,913
Asset impairment restructuring and unusual
costs -- -- 69,382 71,719 6,383 2,550 --
(Gain) loss on extinguishment of debt -- -- -- (9,465) -- 249 --
(Gain) loss on sale of subsidiary and assets -- -- (132) 6,058 (486) (20,075) (733)
Interest and other income (220) (98) (2,356) (2,076) (1,095) (422) (291)
Interest expense 4,631 2,059 17,524 8,555 5,901 3,478 1,070
-------- -------- --------- --------- --------- -------- -------
(Loss) income from continuing
operations before provision for income
taxes, minority interest, net loss
on subsidiary stock issuances and
merger transaction, equity in net loss of
affiliate (26,737) (23,935) (127,277) (168,141) (33,985) 3,465 (592)
(Benefit) provision for income taxes (192) 108 326 20,870 (5,040) 1,091 670
-------- -------- --------- --------- --------- -------- -------
(Loss) income from continuing
operations before minority interest, net loss
on subsidiary stock issuances and merger
transaction, equity in net loss of affiliate (26,545) (24,043) (127,603) (189,011) (28,945) 2,374 (1,262)
Minority interest (139) (36) (18,474) (718) 229 (46) 120
Net loss on subsidiary stock issuances and
merger transaction 377 394 4,485 -- -- -- --
Equity in net loss of affiliate -- 291 291 328 -- -- --
-------- -------- --------- --------- -------- -------- -------
(Loss) income from continuing operations (26,783) (24,692) (113,905) (188,621) (29,174) 2,420 (1,382)
Income (loss) from discontinued operations,
net of income taxes -- -- -- 213 (75,702) 3,012 6,072
(Loss) income on disposal of discontinued
operations, including provision for operating
losses during phase-out period, net of tax
benefit (157) 687 1,420 (16,695) (7,266) -- --
-------- -------- --------- --------- --------- -------- -------
Net (loss) income (26,940) (24,005) (112,485) (205,103) (112,142) 5,432 4,690
Preferred stock dividends and other -- -- -- (1,147) (191) -- (44)
accretion of beneficial conversion
feature of preferred stock -- -- -- (9,392) (3,857) -- --
-------- -------- --------- --------- --------- -------- -------
Net (loss) income available to common
shareholders $(26,940) $(24,005) $(112,485) $(215,642) $(116,190) $ 5,432 $ 4,646
======== ======== ========= ========= ========= ======== =======
31
THREE-MONTHS ENDED MARCH 31, FOR THE FISCAL YEAR ENDED DECEMBER 31,
---------------------------- -------------------------------------------------
2003 2002 2002 2001 2000 1999 1998
---- ---- ---- ---- ---- ---- ----
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net (loss) income per common
share - basic:
Continuing operations $ (0.10) $ (0.10) $ (0.42) $ (1.17) $(0.52) $ 0.06 $(0.05)
Discontinued operations -- 0.01 -- (0.10) (1.30) 0.06 0.19
------- ------- ------- ------- ------ ------ ------
Net (loss) income per common
share-basic $ (0.10) $ (0.09) $ (0.42) $ (1.27) $(1.82) $ 0.12 $ 0.14
======= ======= ======= ======= ====== ====== ======
Net (loss) income per common
share-diluted:
Continuing operations $ (0.10) $ (0.10) $ (0.42) $ (1.17) $(0.52) $ 0.05 $(0.05)
Discontinued operations -- 0.01 -- (0.10) (1.30) 0.06 0.17
------- ------- ------- ------- ------ ------ ------
Net (loss) income per common
share-diluted $ (0.10) $ (0.09) $ (0.42) $ (1.27) $(1.82) $ 0.11 $ 0.12
======= ======= ======= ======= ====== ====== ======
Average common shares outstanding:
Basic 282,329 253,938 269,232 170,009 63,825 46,814 32,318
Diluted 282,329 253,938 269,232 170,009 63,825 50,086 34,800
AS OF MARCH 31, AS OF DECEMBER 31,
--------------- ------------------------------------------------------
2003 2002 2001 2000 1999 1998
---- ---- ---- ---- ---- ----
(UNAUDITED) (AMOUNTS IN THOUSANDS)
BALANCE SHEET DATA:
Cash and cash equivalents $ 3,018 $ 5,818 $ 3,696 $ 8,039 $ 2,181 $ 1,936
Cash held by note holder 2,015 -- -- -- -- --
Due from buyers of divested subsidiary -- -- 2,625 -- 31,302 --
Property and equipment 9,553 9,822 20,185 21,368 6,649 8,933
Goodwill 67,818 67,818 90,831 166,024 24,285 23,786
Net (liabilities) assets of discontinued operations (9,397) (9,368) (9,460) 8,076 75,284 37,320
Total assets 118,404 117,233 167,489 319,451 186,605 71,613
Long-term debt 3,336 3,346 2,586 69,146 33,260 1,864
Total debt 85,294 85,225 86,422 74,374 62,915 26,055
Minority interest 18,833 18,422 4,460 4,879 1,292 1,300
Redeemable preferred stock and option -- -- 5,180 18,620 -- --
Stockholders' (deficit) equity (63,977) (36,092) 28,119 160,562 92,936 67,560
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.
The following table presents the impact of FAS 142 on our selected
financial data as indicated:
[Enlarge/Download Table]
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2001 2000 1999
---- ---- ----
Net (loss) income available to common stockholders:
Net (loss) income available to common stockholders
As reported $(215,642) $(116,190) $5,432
Add back: Goodwill amortization 21,312 9,415 2,602
Add back: Equity method investment amortization 1,161 -- --
--------- --------- ------
Adjusted net (loss) income $(193,169) $(106,775) $8,034
========= ========= ======
Earnings (loss) per common share - basic
Net (loss) income per share - basic, as reported $ (1.27) $ (1.82) $ 0.12
Goodwill amortization 0.12 0.15 0.05
Equity method investment amortization 0.01 -- --
--------- --------- ------
Adjusted net (loss) income - basic $ (1.14) $ (1.67) $ 0.17
========= ========= ======
Earnings (loss) per share - diluted
Net (loss) income per share - diluted, as reported $ (1.27) $ (1.82) $ 0.11
Goodwill amortization 0.12 0.15 0.05
Equity method investment amortization 0.01 -- --
--------- --------- ------
Adjusted net (loss) income per share - diluted $ (1.14) $ (1.67) $ 0.16
========= ========= ======
32
We have adopted FAS 145 effective January 1, 2003. Under FAS 145,
gains and losses on the extinguishment of debt are included as part of
continuing operations. SFAS 145 requires all periods presented to be
consistent, and, as such, gains and losses on extinguishment of debt
previously recorded as extraordinary must be reclassified from
extraordinary treatment and presented as a component of continuing
operations.
33
SELECTED QUARTERLY RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, our
consolidated financial information for the last twelve quarters. We prepared
this information using our unaudited interim consolidated financial
statements that, in our opinion have been prepared on a basis consistent
with our annual consolidated financial statements. We believe that these
interim consolidated financial statements include all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of this information when read in conjunction with our financial
statements and notes to financial statements. The operating results for any
quarter do not necessarily indicate the results expected for any future
period.
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. In
accordance with the requirements of FAS 145, we have reclassified the $9.5
million gain on extinguishment of debt recorded in 2001 as a component of
continuing operations. This amount was previously recorded as extraordinary.
The following tables presents the impact of FAS 142 on net loss and net
loss per share for each of the 2001 quarters presented as if the standard had
been in effect beginning January 1, 2000:
[Enlarge/Download Table]
FIRST SECOND THIRD FOURTH FULL
QUARTER QUARTER QUARTER QUARTER YEAR
------- ------- ------- ------- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
2003
Total revenue $ 25,106 N/A N/A N/A $ 25,106
Gross profit 8,969 N/A N/A N/A 8,969
Net loss from continuing operations (26,783) N/A N/A N/A (26,783)
Loss from discontinued operations (157) N/A N/A N/A (157)
Basic and diluted net loss per share from continuing
operations (0.10) N/A N/A N/A (0.10)
Basic and diluted net loss per share from discontinued
operations -- N/A N/A N/A --
2002
Total revenue $ 28,219 $ 25,836 $ 23,903 $ 21,642 $ 99,600
Gross profit 9,378 8,728 8,735 5,041 31,882
Net income (loss) from continuing operations (24,692) (19,473) (5,751) (63,989) (113,905)
Net income (loss) from discontinued operations 687 (463) (119) 1,315 1,420
Basic and diluted net income (loss) per share from
continuing operations (0.10) (0.07) (0.02) (0.23) (0.42)
Basic and diluted net income (loss) per share from
discontinued operations 0.01 (0.01) -- -- --
2001 - AS REPORTED
Net operating revenue $ 47,409 $ 39,871 $ 41,366 $ 27,668 $ 156,314
Gross profit 17,348 14,311 6,522 8,294 46,475
Loss from continuing operations (11,393) (19,881) (109,349) (47,998) (188,621)
(Loss) income from discontinued operations 213 (21,789) (748) 5,842 (16,482)
Net loss (11,180) (41,670) (110,097) (42,156) (205,103)
Basic loss per share from continuing operations (0.13) (0.15) (0.56) (0.18) (1.17)
Diluted loss per share from continuing operations (0.13) (0.15) (0.56) (0.18) (1.17)
Basic loss per share from discontinued operations -- (0.16) -- 0.02 (0.10)
Diluted loss per share from discontinued operations -- (0.16) -- 0.02 (0.10)
2001 - ADJUSTED FOR CHANGE IN METHOD OF ACCOUNTING FOR
GOODWILL
Net operating revenue $ 47,409 $ 39,871 $ 41,366 $ 27,668 $ 156,314
Gross profit 17,348 14,311 6,522 8,294 46,475
Loss from continuing operations (5,865) (13,756) (103,036) (43,491) (166,148)
(Loss) income from discontinued operations 213 (21,789) (748) 5,842 (16,482)
Net loss (5,652) (35,545) (103,784) (37,649) (182,630)
Basic loss per share from continuing operations (0.06) (0.10) (0.52) (0.18) (0.97)
Diluted loss per share from continuing operations (0.06) (0.10) (0.52) (0.18) (0.97)
Basic loss per share from discontinued operations -- (0.16) -- 0.02 (0.10)
Diluted loss per share from discontinued operations -- (0.16) -- 0.02 (0.10)
34
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 "Selected Financial
Data" and our consolidated financial statements and the notes to those
financial statements included elsewhere in this prospectus. Our discussion
contains forward-looking statements based upon current expectations that
involve risks and uncertainties, such as our plans, objectives, expectations
and intentions. Our actual results and the timing of events could differ
materially from those anticipated in these forward-looking statements as a
result of various factors, including those set forth under "Risk Factors,"
"Business" and elsewhere in this prospectus.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of
America. As such, some accounting policies have a significant impact on the
amount reported in these financial statements. The preparation of our
financial statements requires us to make estimates and assumptions that
affect the reported amount of assets and liabilities, disclosure of
contingent assets and liabilities at the date of our financial statements,
and the reported amounts of revenue and expenses during the reporting
period. There can be no assurance that actual results will not differ from
those estimates. We believe our most critical accounting policies include
revenue recognition, software revenue recognition, VeriChip revenue
recognition, stock-based compensation, proprietary software in development,
goodwill and other intangible assets and legal contingencies as explained
below.
REVENUE RECOGNITION
For programming, consulting and software licensing services
and construction contracts, we recognize revenue based on the percent
complete for fixed fee contracts, with the percent complete being
calculated as either the number of direct labor hours in the project to
date divided by the estimated total direct labor hours or based upon the
completion of specific task orders. It is our policy to record contract
losses in their entirety in the period in which such losses are
foreseeable. For nonfixed fee jobs, revenue is recognized based on the
actual direct labor hours in the job times the standard billing rate and
adjusted to realizable value, if necessary. For product sales, we
recognize revenue at the time products are 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
collectability is deemed probable. If uncertainties regarding customer
acceptance exists, revenue is recognized when such uncertainties are
resolved. Revenue from royalties is recognized when licensed products
are shipped. There are no significant post-contract support obligations
at the time of revenue recognition. Our accounting policy regarding
vendor and post-contract support obligations is based on the terms of
the customers' contract, billable upon the occurrence of the post-sale
support. Costs of goods sold are recorded as the related revenue is
recognized. We do not experience significant product returns, and
therefore, management is of the opinion that no allowance for sales
returns is necessary. We have no obligation for warranties on new
hardware sales, because the manufacturer provides the warranty. We do
not offer a warranty policy for services to our customers. Revenue
results are difficult to predict, and any shortfall in revenue or delay
in recognizing revenue could cause our operating results to vary
significantly from quarter to quarter and could result in future
operating losses.
SOFTWARE REVENUE RECOGNITION
For those arrangements where our contract calls only for the
delivery of software with no additional obligations, revenue is
recognized at the time of delivery, provided that there is a signed
contract, delivery of the product has taken place, the fee is fixed by
the contract and collectability is considered probable. For multiple
element arrangements such as a contract that includes the delivery of
software and a service arrangement, revenues allocated to the sale of
the software are recognized when the software is delivered to the
customer. Revenues related to the sale of the service agreement are
recognized ratably over the term of the service agreement. A value is
ascribed to each of the elements sold. This value is based on vendor
specific objective evidence of fair value, regardless of any separate
prices that may be stated in the contract. Vendor specific objective
evidence of fair value is the price charged when the elements are sold
separately. If an element is not yet being sold separately, the fair
35
value is the price established by management having the relevant
authority to do so. It is considered probable that the price established
by management will not change before the separate introduction of the
element. If the contract includes a discount, the discount is applied to
the components of the contract which specifically apply. For those
contracts where the discount is a fixed amount for the entire contract
(i.e. not specifically identifiable with any of the contract elements),
a proportionate amount of the discount is allocated to each element of
the contract based on that element's fair value without regard to the
discount. Our contracts do not include unspecified upgrades and
enhancements. For those arrangements where our contracts to deliver
software require significant production modification or customization of
the software, revenues are recognized using percentage of completion
accounting. The service element of these contracts is essential to the
functionality of other elements in the contract and are not accounted for
separately. The cost to complete and extent of progress towards
completion of these contracts can be reasonably ascertained based on the
detailed tracking and recording of labor hours expended. Progress
payments on these contracts are required and progress is measured using
the efforts expended input measure. Revenue results are difficult to
predict, and any shortfall in revenue or delay in recognizing revenue
could cause our operating results to vary significantly from quarter to
quarter and could result in future operating losses.
VERICHIP REVENUE RECOGNITION
Distributor Rights Fees
As of December 31, 2002, we have not yet recognized revenue associated
with our VeriChip product. All distributor fees are recorded as deferred
revenue on our balance sheet at December 31, 2002 and included in accrued
expenses. We will recognize revenue associated with the distributor rights,
product sales and monitoring services in the future based upon the following
policy:
The nonrefundable portion of the upfront fee paid for exclusive
distributor rights will be recognized over the initial term of the
distributor agreement. The initial term will start with the first
product sale under the agreement, not the contract period itself. The
formula used to calculate this amount should be an amount equal to the
percentage that each product order represents in relation to the minimum
product order quantities required by the agreement. Until the amount of
product returns can be reasonably estimated, no revenues will be
recognized until the expiration of the period of time the distributor
has to accept or reject the products as provided in their agreements.
If the distributor materially breaches their agreement and
this breach results in the loss of their exclusive distributor rights
but not their non-exclusive distributor rights, the balance of the non-
amortized upfront fees will continue to be recognized ratably over the
remaining life of their agreement. The formula previously described will
be used to recognize these remaining fees unless no orders are placed.
If this is the case, then the recognition of revenue from the remaining
portion of non-amortized fees will be delayed until the expiration of
the contract term.
If a contract breach results in the loss of all distributor
rights and the only way to remain a distributor is to pay an additional
substantial monetary penalty, then the remaining portion of the initial
distributor fee will be recognized as revenues in the month in which the
contract requirement is breached.
Product Sales
Revenue from the sale of products such as microchips and
scanners will be recorded at gross with a separate display of cost of
sales. Until the amount of returns can be reasonably estimated, revenues
will not be recognized until the expiration of the period of time the
distributor has to accept or reject the products as provided in their
distributor agreement. Once the amount of returns can be reasonably
estimated, revenues (net of expected returns) will be recognized at the
time of shipment and the passage of title.
Since the final use of the product is unknown at the time it is
shipped to the distributor, and end users may choose from a number of
non-proprietary monitoring services or choose none at all, and the
monitoring services are not essential to the functionality of all chips,
the company will not attempt to bundle the revenue from the sale of
chips with potential future revenues from a monitoring service.
36
Monitoring Services
Monitoring services will be treated as a separate earnings process from
product sales. Revenues from this service will be recognized on a
straight-line basis over the term of the service agreement.
STOCK-BASED COMPENSATION
We account for our employee stock-based compensation plans in
accordance with APB Opinion No. 25 (APB No. 25), Accounting for Stock
Issued to Employees and Financial Accounting Standards Board
Interpretation No. 44, Accounting for Certain Transactions Involving
Stock Compensation an Interpretation of APB Opinion No. 25, and the
disclosure provisions of SFAS No. 123 (SFAS No. 123), Accounting for
Stock-Based Compensation. Accordingly, no compensation cost is
recognized for any of our fixed stock options granted to employees when
the exercise price of each option equals or exceeds the fair value of
the underlying common stock as of the grant date for each stock option.
Changes in the terms of stock option grants, such as extensions of the
vesting period or changes in the exercise price, result in variable
accounting in accordance with APB Opinion No. 25. Accordingly,
compensation expense is measured in accordance with APB No. 25 and
recognized over the vesting period. If the modified grant is fully
vested, any additional compensation costs are recognized immediately. We
account for equity instruments issued to non-employees in accordance
with the provisions of SFAS No. 123. Under variable accounting, changes
in the underlying price of our stock may have a significant impact to
earnings. A rise in the stock price would be treated as additional
compensation expense and a decrease in the stock price would result in a
reduction of reported compensation expense. During 2001, we re-priced
19.3 million stock options. As a result, we have recorded non-cash
compensation expense of $0.7 million and $5.3 million in 2002 and 2001,
respectively.
PROPRIETARY SOFTWARE IN DEVELOPMENT
In accordance with Statement of Financial Accounting Standards (FAS)
86, Accounting for the Costs of Computer Software to be Sold, Leased, or
Otherwise Marketed, we have capitalized certain computer software
development costs upon the establishment of technological feasibility.
Technological feasibility is considered to have occurred upon completion of
a detailed program design that has been confirmed by documenting and tracing
the detail program design to product specifications and has been reviewed
for high-risk development issues, or to the extent a detailed program design
is not pursued, upon completion of a working model that has been confirmed
by testing to be consistent with the product design. Amortization is
provided based on the greater of the ratios that current gross revenues for
a product bear to the total of current and anticipated future gross revenues
for that product, or the straight-line method over the estimated useful life
of the product. The estimated useful life for the straight-line method is
determined to be 2 to 5 years. Future events such as market conditions,
customer demand, or technological obsolescence could cause us to conclude
that the software is impaired. The determination of the possible impairment
expense requires management to make estimates that effect our consolidated
financial statements.
GOODWILL AND OTHER INTANGIBLE ASSETS
Up through 2001, we reviewed goodwill and other intangible assets
quarterly for impairment whenever events or changes in business
circumstances indicated that the remaining useful life may have warranted
revision or that the carrying amount of the long-lived asset may not have
been fully recoverable. Included in factors considered were significant
customer losses, changes in profitability due to sudden economic or
competitive factors, change in managements' strategy for the business unit,
letters of intent received for the sale of the business unit, or other
factors arising in the quarterly period. We annually performed undiscounted
cash flows analyses by business unit to determine if impairment existed. For
purposes of these analyses, earnings before interest, taxes, depreciation
and amortization were used as the measure of cash flow. When impairment was
determined to exist, any related impairment loss was calculated based on
fair value. Fair value was determined based on discounted cash flows. The
discount rate utilized by us was the rate of return expected from the market
or the rate of return for a similar investment with similar risks. We
recorded goodwill impairment charges of $63.6 million and $0.8 million
during 2001 and 2000, respectively.
On January 1, 2002 we adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Intangible Assets" (SFAS 142). SFAS 142
eliminates the amortization of goodwill and instead requires that
37
goodwill be tested for impairment at least annually. Intangible assets
deemed to have indefinite life under SFAS 142, such as goodwill, are no
longer amortized, but instead reviewed at least annually for impairment.
Goodwill amortization amounted to $21.3 million during 2001. Intangible
assets with finite lives are amortized over the useful life. As part of the
implementation of SFAS 142, we were required to complete a transitional
impairment test of goodwill and other intangible assets. There was no
impairment of goodwill upon the adoption of FAS 142. Annually, we will test
our goodwill and intangible assets for impairment as a part of our annual
business planning cycle during the fourth quarter of each fiscal year. Based
upon this annual test, we recorded a goodwill impairment of approximately
$62.2 million at December 31, 2002, for goodwill associated with our Digital
Angel Corporation segment. In addition, future events such as market
conditions or operational performance of our acquired businesses could cause
us to conclude that additional impairment exists. Any resulting impairment
loss could also have a material adverse impact on our financial condition
and results of operations.
LEGAL CONTINGENCIES
We are currently involved in certain legal proceedings. We have accrued
our estimate of the probable costs for the resolution of these claims. This
estimate has been developed in consultation with outside counsel handling
our defense in these matters and is based upon an analysis of potential
results, assuming a combination of litigation and settlement strategies. We
do not believe these proceedings will have a material adverse effect on our
consolidated financial position. It is possible, however, that future
results of operations for any particular quarterly or annual period could be
materially affected by changes in our estimates.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2001, the FASB issued SFAS No. 141, Business Combinations (FAS
No. 141) and FAS No. 142, Goodwill and Other Intangible Assets (FAS No. 142).
FAS No. 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 No. 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 No. 142.
We recorded an impairment charge of $62.2 million based upon our annual
review of our goodwill during the fourth quarter of 2002. Future impairment
reviews may result in additional periodic write-downs.
In August 2001, the FASB issued SFAS 144, Accounting for the Impairment
or Disposal of Long-Lived Assets (FAS No. 144). This standard supersedes
SFAS 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 (APB 30), 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 No. 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 (FAS No. 145). FAS No. 145 eliminates Statement 4 (and
38
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. The adoption of FAS No.
145 had the effect of reducing our loss from continuing operations and
eliminating an extraordinary gain as previously reported for the year ended
December 31, 2001, and of reducing our income from continuing operations and
eliminating an extraordinary loss as previously reported for the year ended
December 31, 1999.
In June 2002, the FASB issued SFAS 146, Accounting for Costs Associated
with Exit or Disposal Activities (FAS No. 146). This statement requires
recording costs associated with exit or disposal activities at their fair
values when a liability has been incurred. Under previous guidance, certain
exit costs were accrued upon management's commitment to an exit plan.
Adoption of this Statement is required with the beginning of fiscal year
2003. We adopted this statement on January 1, 2003. The adoption of FAS No.
146 did not have a material impact on our operations or financial position.
In December 2002, the FASB issued SFAS 148, Accounting for Stock-
Based Compensation -- Transition and Disclosure an amendment of FASB
Statement No. 123 (FAS No. 148). This Statement amends SFAS 123,
Accounting for Stock-Based Compensation (FAS No. 123), to provide
alternative methods of transition for an entity that voluntarily changes
to the fair value based method of accounting for stock-based employee
compensation. It also amends the disclosure provisions of that Statement
to require prominent disclosure about the effects on reported net income
of an entity's accounting policy decisions with respect to stock-based
employee compensation. Finally, this Statement amends APB Opinion
No. 28, Interim Financial Reporting, to require disclosure about those
effects in interim financial information. We intend to continue to
account for stock-based compensation based on the provisions of APB
Opinion No. 25. FAS No. 148's amendment of the transition and annual
disclosure provisions of FAS No. 123 are effective for fiscal years
ending after December 15, 2002, and the disclosure requirements for
interim financial statements are effective for interim periods beginning
after December 15, 2002. We have adopted the disclosure provisions of
FAS No. 148 effective December 31, 2002.
In May 2003, the FASB issued SFAS 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity (FAS No.
150). FAS No. 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as
equity. FAS No.150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of
the first interim period beginning after June 15, 2003. It is to be
implemented by reporting the cumulative effect of a change in accounting
principle for financial instruments created before the issuance date of the
statement and still existing at the beginning of the interim period of
adoption. Restatement is not permitted. We will adopt the provisions of FAS
No. 150 effective July 1, 2003. We have not yet determined the impact, if
any, of the adoption of FAS No. 150 on our financial position.
39
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, 2003 and 2002, and is derived from the unaudited consolidated
statements of operations in Part I, Item 1 of this report.
[Enlarge/Download Table]
Relationship to
Revenue
----------------------------
THREE-MONTHS ENDED MARCH 31,
----------------------------
2003 2002
---- ----
% %
- -
Product revenue 83.7 81.7
Service revenue 16.3 18.3
----------------------------
Total revenue 100.0 100.0
Cost of goods sold 67.4 71.6
Cost of services sold 48.1 45.1
----------------------------
Total cost of goods and services sold 64.3 66.7
----------------------------
Gross profit 35.7 33.2
Selling, general and administrative expense 117.4 102.5
Research and development 4.8 5.1
Depreciation and amortization 2.5 3.6
Interest income (0.9) (0.5)
Interest expense 18.4 7.3
----------------------------
Loss from continuing operations before income taxes, minority interest,
net loss on subsidiary stock issuances and merger transaction and
equity in net loss of affiliate (106.5) (84.8)
(Benefit) provision for income taxes (0.8) 0.4
----------------------------
Loss from continuing operations before minority interest, net loss on
subsidiary stock issuances and merger transaction and equity
in net loss of affiliate (105.7) (85.2)
Minority interest (0.6) (0.1)
Net loss on subsidiary stock issuances and subsidiary merger transaction 1.6 1.4
Equity in net loss of affiliate -- 1.0
----------------------------
Loss from continuing operations (106.7) (87.5)
(Loss) income from Discontinued Operations, net of income taxes (0.6) 2.4
----------------------------
Net loss (107.3) (85.1)
============================
40
REVENUE
Revenue from continuing operations for the three-months ended March 31,
2003, decreased $3.1 million, or 11.0%, to $25.1 from $28.2 million for the
three-months ended March 31, 2002.
Revenue from continuing operations for the three-months ended March 31,
2003 and 2002, by segment was as follows:
[Enlarge/Download Table]
THREE-MONTHS ENDED MARCH 31,
(IN THOUSANDS)
-------------------------------------------------------------
2003 2002
---- ----
-------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
Advanced Technology $ 8,332 $2,950 $11,282 $ 4,904 $3,616 $ 8,520
Digital Angel Corporation 10,865 533 11,398 7,452 303 7,755
InfoTech USA, Inc. 1,934 600 2,534 9,694 811 10,505
All Other -- -- -- 1,013 375 1,388
Corporate / Eliminations (108) -- (108) -- 51 51
-------------------------------------------------------------
Total $21,023 $4,083 $25,106 $23,063 $5,156 $28,219
============================= ===============================
Advanced Technology's revenue increased $2.8 million for the
three-months ended March 31, 2003, compared to the three-months ended March
31, 2002. Product revenue increased by $3.4 million, or 69.9%, and service
revenue decreased by $0.7 million, or 18.4%. The increase in product revenue
was due to an increase in government contract sales. We attribute the
decrease in service revenue to a reduction in demand for our software and
technology related services.
Digital Angel Corporation's revenue increased $3.6 million for the
three-months ended March 31, 2003, compared to the three-months ended March
31, 2002. Product revenue increased by $3.4 million, or 45.8%, and service
revenue increased by $0.2 million, or 75.9%. We attribute the increase in
product sales primarily to an increase in sales to the fisheries industry
customers. Additionally, a portion of the increase is due to depressed sales
for the three-months ended March 31, 2002, and differences in timing of
shipments. We attribute the increase in service revenue to the inclusion of
MAS's revenue for the three-months ended March 31, 2003. We acquired MAS on
March 27, 2002.
InfoTech USA, Inc.'s revenue decreased $8.0 million for the
three-months ended March 31, 2003, compared to the three-months ended March
31, 2002. Product revenue decreased by $7.8 million, or 80.0%, and service
revenue decreased by $0.2 million, or 26.0%. We attribute the majority of
the decrease in revenue to two large orders shipped during the three-months
ended March 31, 2002. These sales to two customers were primarily product
sales and were in excess of $5.3 million. The continued soft market for IT
products also contributed to the decrease in revenue.
All Other's revenue decreased $1.4 million, or 100.0%, for the
three-months ended March 31, 2003, compared to the three-months ended March
31, 2002. The decrease was due to the sale or closure of all of the business
units comprising this group during the last half of 2001 and the first half
of 2002.
41
GROSS PROFIT AND GROSS PROFIT MARGIN
Gross profit from continuing operations for the three-months ended
March 31, 2003, decreased $0.4 million, or 4.4%, to $9.0 million from $9.4
million for the three-months ended March 31, 2002. Gross profit margin was
35.7% and 33.2% of revenue for the three-months ended March 31, 2003 and
2002, respectively.
Gross profit from continuing operations during the three-months ended
March 31, 2003 and 2002, by segment was as follows:
[Enlarge/Download Table]
THREE-MONTHS ENDED MARCH 31,
(IN THOUSANDS)
-------------------------------------------------------------
2003 2002
---- ----
-------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
Advanced Technology $1,286 $1,769 $3,055 $1,611 $1,983 $3,594
Digital Angel Corporation 5,382 138 5,520 3,151 52 3,203
InfoTech USA, Inc. 277 211 488 960 405 1,365
All Other -- -- -- 825 340 1,165
Corporate / Eliminations (94) -- (94) -- 51 51
-------------------------------------------------------------
Total $6,851 $2,118 $8,969 $6,547 $2,831 $9,378
============================= ===============================
Gross profit margin from continuing operations during the three-months
ended March 31, 2003 and 2002, by segment was as follows:
[Enlarge/Download Table]
THREE-MONTHS ENDED MARCH 31,
(IN THOUSANDS)
-------------------------------------------------------------
2003 2002
---- ----
-------------------------------------------------------------
Product Service Total Product Service Total
------- ------- ----- ------- ------- -----
% % % % % %
- - - - - -
Advanced Technology 15.4 60.0 27.1 32.8 54.8 42.2
Digital Angel Corporation 49.5 25.9 48.4 42.3 17.2 41.3
InfoTech USA, Inc. 14.3 35.2 19.3 9.9 49.9 14.1
All Other -- -- -- 81.5 90.7 83.9
Corporate / Eliminations 87.0 -- 87.0 -- 100.0 100.0
-------------------------------------------------------------
Total 32.6 51.9 35.7 28.4 54.9 33.2
============================= ===============================
Advanced Technology's gross profit decreased $0.5 million for the
three-months ended March 31, 2003, and gross profit margin decreased to
27.1% from 42.2% for the three-months ended March 31, 2002. We attribute the
decrease in gross profit primarily to the decrease in software and
technology related sales during the three-months ended March 31, 2003. We
attribute the decrease in gross profit margin to a higher percentage of
government contract revenue during the three-months ended March 31, 2003, as
we achieve lower margins on these sales.
Digital Angel Corporation's gross profit increased $2.3 million for the
three-months ended March 31, 2003, and gross profit margin increased to
48.4% for the three-months ended March 31, 2003, from 41.3% for the
three-months ended March 31, 2002. We attribute the increase in gross profit
primarily to the previously mentioned sales increase. We attribute the
increase in gross profit margin primarily to a higher-margin product mix
associated with Animal Applications sales.
42
InfoTech USA, Inc.'s gross profit decreased $0.9 million for the
three-months ended March 31, 2003, and gross profit margin increased to
19.3% for the three-months ended March 31, 2003, from 14.1% for the
three-months ended March 31, 2002. We attribute the decrease in gross profit
to the overall decrease in revenue. We attribute the increase in gross
profit margin primarily to our strategy to cease selling some of our
lower-margin computer hardware and to focus more of our efforts on selling
higher-margin products and technical services.
All Other's gross profit decreased $1.2 million, or 100%, for the
three-months ended March 31, 2003, compared to the three-months ended March
31, 2002. Gross margin percentage decreased to 0% for the three-months ended
March 31, 2003, from 83.9% for the three-months ended March 31, 2002. The
decrease in gross profit and margins resulted from the sale or closure of
all of the business units comprising this group during the last half of 2001
and the first half 2002.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expense from continuing operations
was $29.5 million for the three-months ended March 31, 2003, an increase of
$0.6 million, or 2.0%, from $28.9 million for the three-months ended March
31, 2002. As a percentage of total revenue, selling, general and
administrative expense from continuing operations increased to 117.4% for
the three-months ended March 31, 2003, from 102.5% for the three-months
ended March 31, 2002.
Selling, general and administrative expense from continuing operations
for the three-months ended March 31, 2003 and 2002, by segments was as
follows:
[Download Table]
THREE-MONTHS ENDED MARCH 31,
(IN THOUSANDS)
----------------------------
2003 2002
---- ----
Advanced Technology $ 2,273 $ 1,909
Digital Angel Corporation 4,001 2,660
InfoTech USA, Inc. 894 1,184
All Other -- 914
Corporate / Eliminations 22,300 22,233
----------------------------
Total $29,468 $28,900
============================
Selling, general and administrative expense from continuing operations
as a percentage of revenue for the three-months ended March 31, 2003 and
2002, by segments was as follows:
[Download Table]
THREE-MONTHS ENDED MARCH 31,
(IN THOUSANDS)
----------------------------
2003 2002
---- ----
% %
Advanced Technology 20.1 22.4
Digital Angel Corporation 35.1 34.3
InfoTech USA, Inc. 35.3 11.3
All Other -- 65.9
Corporate / Eliminations(1) 88.8 78.8
----------------------------
Total 117.4 102.5
============================
<FN>
(1) Corporate / Eliminations percentage has been calculated as a
percentage of total revenue.
Advanced Technology's selling general and administrative expense
increased $0.4 million, or 19.1%, to $2.3 million for the three-months
ended March 31, 2003, from $1.9 million for the three-months ended March 31,
2002. We attribute the increase primarily to $0.2 million of severance
expense as a result of extending the expiration date of stock options to
acquire VeriChip Corporation common stock in connection with the termination
of one of our former officers during the three-months ended March 31, 2003,
(additional severance expense associated with the termination of officers
and director during the three-months ended March 31, 2003, is included in
the "Corporate/Eliminations" segment below), and to costs associated with
the VeriChip product, which we began
43
marketing during the latter part of 2002. Selling, general and
administrative expense decreased as a percentage of revenue due to the
previously mentioned sales increase.
Digital Angel Corporation's selling general and administrative expense
increased $1.3 million, or 50.4%, to $4.0 million for the three-months ended
March 31, 2003, from $2.7 million for the three-months ended March 31, 2002.
We attribute the increase primarily to expenses associated with the Animal
Applications group, and with MAS, which were acquired on March 27, 2002.
Selling, general and administrative expense as a percentage of revenue
remained relatively constant at 35.1% for the three-months ended March 31,
2003, as compared to 34.3% for the three-months ended March 31, 2002.
InfoTech USA, Inc.'s selling general and administrative expense
decreased $0.3 million, or 24.5%, to $0.9 million for the three-months
ended March 31, 2003, from $1.2 million for the three-months ended March 31,
2002. As a percentage of revenue, selling general and administrative expense
increased to 35.3% of revenue for the three-months ended March 31, 2003,
from 11.3% of revenue for the three-months ended March 31, 2002. We
attribute the decrease primarily to headcount reduction, the elimination of
expenses related to the Shirley, New York facility, which was sold in
January 2002, and reduced commissions on lower sales and other cost control
programs. The increase in selling, general and administrative expense as a
percentage of revenue resulted from the decrease in sales for the
three-months ended March 31, 2003.
All Other's selling, general and administrative expense decreased $0.9
million, or 100.0%, to $0.0 million for the three-months ended March 31,
2003, from the $0.9 million for the three-months ended March 31, 2002. The
decrease resulted from the sale or closure of all of the business units
comprising this group during the last half of 2001 and the first half of
2002.
"Corporate / Eliminations" selling, general and administrative expense
increased $0.1 million, or 0.3%, to $22.3 million for the three-months ended
March 31, 2003, from $22.2 million for the three-months ended March 31,
2002. Included in selling, general and administrative expense for the
three-months ended March 31, 2003, was severance expense of $21.8 million,
which resulted from the termination of executive officers and director
during the three-months ended March 31, 2003. (An additional $0.2 million of
severance expense associated with these terminations is included in the
Advance Technology segment's selling, general and administrative expense for
the three-months ended March 31, 2003). Included in selling, general and
administrative expense for the three-months ended March 31, 2002, was
non-cash compensation expense resulting from the pre-merger Digital Angel
and MAS merger, whereby options to acquire shares of pre-merger Digital
Angel common stock were converted into options to acquire shares of MAS
common stock. The transaction resulted in a new measurement date for the
options and, as a result, we recorded non-cash compensation expense of
approximately $18.7 million during the first quarter of 2002. As all of the
option holders were our employees or directors, these options were
considered fixed awards under APB Opinion No. 25 and expense was recorded
for the intrinsic value of the options converted.
In addition, we reversed approximately $1.0 million and incurred
approximately $0.3 million of non-cash compensation expense for the
three-months ended March 31, 2003 and 2002, respectively, due primarily to
re-pricing 19.3 million stock options during 2001. The re-priced 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 result in increases and decreases of non-cash compensation expense
until the options are exercised, forfeited, modified or expired.
Excluding the effects of the severance and non-cash compensation
expense discussed above, "Corporate / Eliminations" decreased $1.7 million,
or 53.1%, to $1.5 million for the three-months ended March 31, 2003, from
the $3.2 million for the three-months ended March 31, 2002. The decrease
resulted primarily from cost reduction programs initiated during 2002.
RESEARCH AND DEVELOPMENT
Research and development expense from continuing operations was $1.2
million and $1.4 million for the three-months ended March 31, 2003 and 2002,
respectively. Research and development expense decreased to 4.8% of revenue
for the three-months ended March 31, 2003, from 5.1% of revenue for the
three-months ended March 31, 2002.
44
Research and development expense from continuing operations during the
three-months ended March 31, 2003 and 2002, by segments was as follows:
[Download Table]
THREE-MONTHS ENDED MARCH 31,
(IN THOUSANDS)
----------------------------
2003 2002
---- ----
Advanced Technology $ 55 $ 117
Digital Angel Corporation 911 1,331
InfoTech USA, Inc. -- --
All Other -- --
Corporate/Eliminations 235 --
----------------------------
Total $1,201 $1,448
============================
Research and development expense relates primarily to the development
of our advanced technology products: Digital Angel, VeriChip, Thermo Life,
Bio-Thermo and PLD.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense from continuing
operations for the three-months ended March 31, 2003, decreased $0.4
million, or 37.6%, to $0.6 million from $1.0 million for the three-
months ended March 31, 2002. As a percentage of revenue, depreciation
and amortization expense decreased to 2.5% for the three-months ended
March 31, 2003, from 3.6% for the three-months ended March 31, 2002.
Depreciation and amortization expense from continuing
operations during the three months ended March 31, 2003 and 2002, by
segments was as follows:
[Download Table]
THREE-MONTHS ENDED MARCH 31,
(IN THOUSANDS)
----------------------------
2003 2002
---- ----
Advanced Technology $ 69 $ 105
Digital Angel Corporation 434 735
InfoTech USA, Inc. 55 74
All Other -- 9
Corporate/Eliminations 68 81
----------------------------
Total $626 $1,004
============================
Advanced Technology's depreciation and amortization expense decreased
by $36,000, or 34.3%, to $69,000 for the three-months ended March 31, 2003,
from $0.1 million for the three-months ended March 31, 2002. We attribute
the decrease to fully depreciating certain assets during 2002 and our
decision to limit our expenditures for property and equipment.
Digital Angel Corporation's depreciation and amortization expense
decreased by $0.3 million, or 41.0%, to $0.4 million for the three-months
ended March 31, 2003, from $0.7 million for the three-months ended March
31, 2002. We attribute the decrease primarily to the exclusion of
depreciation expense for a license to a digital encryption and distribution
software system that Digital Angel Corporation impaired during the fourth
quarter of 2002.
InfoTech USA, Inc.'s depreciation and amortization expense decreased by
$19,000, or 25.7%, to $55,000 for the three-months ended March 31, 2003,
from $74,000 for the three-months ended March 31, 2002. We attribute the
decrease primarily to the sale of the Shirley, New York facility during the
three-months ended March 31, 2002.
All Other's depreciation and amortization expense decreased due to the
sale or closure of all of the business units comprising this group during
the last half of 2001 and the first half of 2002.
45
INTEREST AND OTHER INCOME AND EXPENSE
Interest and other income was $0.2 million and $0.1 million, for the
three-months ended March 31, 2003 and 2002, respectively. Interest income is
earned primarily from short-term investments and notes receivable.
Interest expense was $4.6 million and $2.1 million for the three-months
ended March 31, 2003 and 2002, respectively. The increase in interest
expense resulted primarily from an increase in the interest rate charged by
IBM Credit under the terms of the IBM Credit Agreement, which became
effective on March 27, 2002.
INCOME TAXES
We had an effective (benefit) income tax rate of (0.7)% and 0.4% for
the three-months ended March 31, 2003 and 2002, 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 and
state taxes net of federal benefits.
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 is one
insignificant company remaining at March 31, 2003, which had combined
revenue and net loss for the quarter ended March 31, 2003, of $7,000 million
and $0.1 million, respectively. We anticipate selling or closing the
remaining business within the next several months. We used the proceeds from
the sales of companies classified as Discontinued Operations to repay
amounts outstanding under the IBM Credit Agreement.
During the three-months ended March 31, 2003, Discontinued Operations
incurred a change in estimated operating losses accrued on the measurement
date of $0.2 million. The primary reason for the increase in the estimated
losses during the three-months ended March 31, 2003, was due to the
operations of the one remaining business within this group. During the
three-months ended March 31, 2002, we recorded a reduction of our estimated
operating loss on disposal and operating losses during the phase out period
of $0.7 million. This reduction was comprised primarily of an increase in
the estimated loss on the sale of our 85% ownership in our Canadian
subsidiary, Ground Effects Ltd., which was sold in January 2002, of $1.2
million, offset by a decrease in carrying costs as certain of these
obligations were settled during the three-months ended March 31, 2002, for
amounts less than previously anticipated. Carrying costs include the
cancellation of facility leases, employment contract buyouts, sales tax
liabilities and litigation reserves.
We do not anticipate a further loss on sale of the remaining
business comprising Discontinued Operations. However, actual losses
could differ from our estimates and any adjustments will be reflected in
our future financial statements.
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, 2002, through March 31, 2003.
[Enlarge/Download Table]
Balance Balance
Type of Cost December 31, Additions Deductions March 31,
2002 2003
------------------------------------------------------------------------------------------------
Estimated loss on sale, net of change
in estimated operating losses $ -- $157 $157 $ --
Carrying costs 4,908 -- 23 4,885
-----------------------------------------------------
Total $4,908 $157 $180 $4,885
=====================================================
46
RESULTS OF CONTINUING OPERATIONS
The following table sets forth data expressed as a percentage of
total revenue for the years indicated.
[Enlarge/Download Table]
PERCENTAGE OF TOTAL REVENUE
--------------------------------
2002 2001 2000
% % %
--------------------------------
Product revenue 81.3 72.4 77.7
Service revenue 18.7 27.6 22.3
--------------------------------
Total revenue 100.0 100.0 100.0
--------------------------------
Cost of products sold 58.6 55.4 51.1
Cost of services sold 9.4 14.8 10.1
--------------------------------
Total cost of products and services sold 68.0 70.3 61.2
Gross margin 32.0 29.7 38.8
Selling, general and administrative expense 66.7 65.5 46.0
Research and development expense 3.5 5.5 1.9
Interest and non-cash charges: -- --
Gain on extinguishment of debt (6.0)
Asset impairment 69.7 45.9 4.7
Depreciation and amortization 4.8 18.5 8.2
Loss (gain) on sales of subsidiaries and business assets (0.1) 3.9 0.4
Interest and other income (2.4) (1.3) (0.8)
Interest expense 17.6 5.5 4.4
--------------------------------
Loss before provision (benefit) for income taxes, minority
interest and equity in net loss of affiliate (127.8) (107.6) (25.2)
Provision (benefit) for income taxes 0.3 13.4 (3.7)
--------------------------------
Loss from continuing operations before minority interest and
equity in net loss of affiliate (128.1) (121.0) (21.5)
Minority interest (18.5) (0.5) 0.2
Net loss from subsidiary merger transaction, stock issuances and
loss on sale of subsidiary stock 4.5
Equity in net loss of affiliate 0.3 0.2 --
--------------------------------
Loss from continuing operations (114.4) (120.7) (21.6)
Income (loss) from discontinued operations, net of income taxes -- 0.1 (56.2)
--------------------------------
Loss on disposal and operating income (losses) during the phase
out period 1.4 (10.7) (5.4)
--------------------------------
Net loss (113.0) (131.2) (83.2)
Preferred stock dividends and other -- (0.7) (0.1)
--------------------------------
Accretion of beneficial conversion feature of preferred stock -- (6.0) (2.9)
--------------------------------
Net loss available to common stockholders (113.0) (138.0) (86.2)
================================
47
REVENUE
Revenue from continuing operations for 2002 was $99.6 million, a
decrease of $56.7 million, or 36.3%, from $156.3 million in 2001. Revenue
for 2001 represents an increase of $21.5 million, or 16.0% from $134.8
million in 2000. The decrease in 2002 was primarily attributable to the sale
or closure of all businesses that were not cash positive or that did not fit
into our strategy of becoming an advanced technology development company.
The increase in 2001 was primarily attributable to the growth through
acquisitions.
Revenue for each of the continuing operating segments was:
[Enlarge/Download Table]
2002 2001 2000
------------------------------ ------------------------------- -------------------------------
PRODUCT SERVICE TOTAL PRODUCT SERVICE TOTAL PRODUCT SERVICE TOTAL
------- ------- ----- ------- ------- ----- ------- ------- -----
(AMOUNTS IN THOUSANDS)
Advanced Technology 28,991 12,939 $41,930 $ 28,123 $16,447 $ 44,570 $ 24,384 $ 7,970 $ 32,354
Digital Angel Corporation 30,876 2,685 33,561 33,220 2,518 35,738 19,605 2,647 22,252
InfoTech USA, Inc. 20,056 2,665 22,721 30,075 4,100 34,175 24,774 2,514 27,288
All Other 1,013 375 1,388 21,318 19,974 41,292 35,805 16,876 52,681
Corporate 0 0 0 411 128 539 191 0 191
-------------------------------------------------------------------------------------------------
Total $80,936 $18,664 $99,600 $113,147 $43,167 $156,314 $104,759 $30,007 $134,766
=================================================================================================
Changes during the years were:
Our Advanced Technology's revenue decreased $2.6 million from 2001 to
2002. Product revenue increased by $0.9 million, or 3.1%, while service
revenue decreased by $3.5 million, or 21.3%. We attribute the decreases in
2002 to reduced sales of hardware and software products and reduced
technology services. The decrease in product revenue was partially offset by
an increase in product revenue for Computer Equity Corporation. During 2001,
this segment experienced an increase in sales due primarily to the inclusion
of twelve months of operating results for two significant acquisitions
acquired in 2000. These two significant acquisitions include Computer Equity
Corporation, acquired on June 1, 2000, and Pacific Decision Sciences
Corporation, acquired on October 1, 2000.
Our Digital Angel Corporation's revenue decreased $2.2 million, or
6.1%, from 2001 to 2002. Product revenue decreased by $2.3 million, or 7.1%,
while service revenue increased by $0.2 million, or 6.6%. We attribute the
decrease in product sales for 2002 primarily to a decrease in shipments of
visual identification tags for Canadian customers, customer inventory
adjustments and continued softness in the livestock market during 2002. We
attribute the increase in service revenue to the MAS merger in March 2002.
Revenue increased $13.5 million, or 60.8%, from 2000 to 2001. The increase
in revenue in 2001 was primarily the result of the acquisitions of Timely
Technology Corp. in April 2000 and Destron Fearing Corporation in September
2000.
Our InfoTech USA, Inc.'s revenue decreased $11.5 million, or 33.5%,
from 2001 to 2002. Product revenue decreased by $10.0 million, or 33.3%,
while service revenue decreased by $1.4 million, or 35.0%. The decrease in
product and service sales was a result of an industry wide softening in
demand that existed throughout 2002. Additionally, product sales declined as
a result of a decision in April 2002, to cease selling certain lower-margin
computer hardware products and to focus on sales of higher margin products
and related technical services. Revenue increased $6.9 million, or 25.2%,
from 2000 to 2001. Both product and service revenue increased as a result of
internal growth and the acquisition of InfoTech USA, Inc. Corporation.
Our All Other segment's revenue decreased $39.9 million, or 96.6%, from
2001 to 2002. Product revenue decreased by $20.3 million, or 95.2%, while
service revenue decreased by $19.6 million, or 98.1%. Revenue decreased
$11.4 million, or 21.6%, from 2000 to 2001. The decreases in revenue in 2002
as compared to 2001, and in 2001 as compared to 2000, were due to the sale
or closure of all of the business units comprising this group during the
last half of 2001 and the first half of 2002.
GROSS PROFIT AND GROSS PROFIT MARGIN
Gross profit from continuing operations for 2002 was $31.9 million, a
decrease of $14.6 million, or 31.4%, from $46.5 million in 2001. Gross
profit for 2001 represents a decrease of $5.8 million, or 11.1% from $52.3
million in 2000. As a percentage of revenue, the gross profit margin was
32.0%, 29.7% and 38.8% for the years ended December 31, 2002, 2001 and 2000,
respectively.
48
Gross profit from continuing operations for each operating segment was:
[Enlarge/Download Table]
2002 2001 2000
------------------------------ ------------------------------- -------------------------------
PRODUCT SERVICE TOTAL PRODUCT SERVICE TOTAL PRODUCT SERVICE TOTAL
------- ------- ----- ------- ------- ----- ------- ------- -----
(AMOUNTS IN THOUSANDS)
Advanced Technology $ 5,639 $ 7,288 $12,927 $ 6,867 $ 8,593 $15,460 $ 8,485 $ 5,115 $13,600
Digital Angel Corporation 13,171 469 13,640 12,968 471 13,439 8,086 1,213 9,299
InfoTech USA, Inc. 2,905 1,245 4,150 3,013 2,341 5,354 4,762 1,041 5,803
All Other 826 339 1,165 3,218 8,465 11,683 14,336 9,062 23,398
Corporate 0 0 0 411 128 539 191 0 191
-------------------------------------------------------------------------------------------------
$22,541 $ 9,341 $31,882 $26,477 $19,998 $46,475 $35,860 $16,431 $52,291
=================================================================================================
Gross profit margin from continuing operations for each operating
segment was:
[Enlarge/Download Table]
2002 2001 2000
------------------------------ ------------------------------- -------------------------------
PRODUCT SERVICE TOTAL PRODUCT SERVICE TOTAL PRODUCT SERVICE TOTAL
------- ------- ----- ------- ------- ----- ------- ------- -----
% % % % % % % % %
------- ------- ----- ------- ------- ----- ------- ------- -----
Advanced Technology 19.5 56.3 30.8 24.4 52.2 34.7 34.8 64.2 42.0
Digital Angel Corporation 42.7 17.5 40.6 39.0 18.7 37.6 41.2 45.8 41.8
InfoTech USA, Inc. 14.5 46.7 18.3 10.0 57.1 15.7 19.2 41.4 21.3
All Other 81.5 90.4 83.9 15.1 42.4 28.3 40.0 53.7 44.4
Corporate 0.0 0.0 0.0 100.0 100.0 100.0 100.0 0.0 100.0
-------------------------------------------------------------------------------------------------
27.9 50.0 32.0 23.4 46.3 29.7 34.2 54.8 38.8
=================================================================================================
Changes during the years were:
Our Advanced Technology segment's gross profit decreased $2.5
million from 2001 to 2002, and margins decreased to 30.8% in 2002
compared to 34.7% in 2001. We attribute the decrease in gross profit and
margin primarily to the reduction in sales of higher-margin services
during 2002. Gross profit increased $1.9 million from 2000 to 2001 and
margins decreased to 34.7% in 2001 compared to 42.0% in 2000. During
2001, this segment experienced an increase in gross margin due primarily
to the inclusion of twelve months of operating results for two
significant businesses acquired in 2000. These two significant
acquisitions were Computer Equity Corporation, acquired on June 1, 2000,
and Pacific Decision Sciences Corporation, acquired on October 1, 2000.
Companies acquired in 2000 contributed $9.4 million in gross profit in
2000. Gross profit and margin percentage from existing businesses
decreased in 2000 as the poor performance of the technology sector
during the fourth quarter of 2000 resulted in lower capital spending and
increased incentives, which contributed to the decline in gross margin
percentage.
Our Digital Angel Corporation segment's gross profit increased
$0.2 million, or 1.5%, from 2001 to 2002, and margins increase to 40.6%
from 37.6%. We attribute the increase in gross profit for 2002, to the
Medical Systems segment and we attribute the increase in gross margin to
a favorable shift in the product mix. Gross profit increased by $4.1
million, or 44.5%, from 2000 to 2001, and margins decreased to 37.6%
from 41.8%. Gross profit increased in 2001 primarily the result of the
acquisitions of Timely Technology Corp. in April 2000, and Destron
Fearing Corporation in September 2000. Gross profit margins decreased in
2001, primarily because the businesses acquired in 2000 earn lower
margin percentages than our existing business.
Our InfoTech USA, Inc. segment's gross profit decreased $1.2
million, or 22.5%, from 2001 to 2002. Gross margin percentage increased
to 18.3% from 15.7% in 2001. The decrease in gross profit was primarily
due to the overall decrease in revenue resulting from the soft market in
the IT industry, while the increase in gross margin is primarily
attributable to the focus on sales of higher margin products and related
technical services during 2002. Gross profit decreased $0.4 million, or
7.7%, from 2000 to 2001. Gross margin percentage decreased to 15.7% in
2001 compared to 21.3% in 2000. The poor performance of the economy,
and the technology sector in particular, resulted in lower capital
spending and increased incentives during 2001 as compared to 2000.
Our All Other segment's gross profit decreased by $10.5 million, or
90.0%, from 2001 to 2002. Gross margin percentage increased to 83.9% in 2002
compared to 28.3% in 2001. Gross profit decreased $11.7 million, or 50.1%,
from 2000 to 2001. Gross margin percentage decreased to 28.3% in 2001
compared to 44.4% in 2000. The decrease
49
in gross profit in 2002 and 2001 is primarily due to the sale or closure of
the business units comprising this segment during the last half of 2001 and
the first half of 2002. We attribute the increase in gross margin in 2002 to
inventory reserves of $4.3 million, which were recorded during 2001, and 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 half of 2002.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expenses from continuing
operations were $66.5 million in 2002, a decrease of $35.9 million, or
35.1%, over the $102.3 million reported in 2001. Selling, general and
administrative expenses from continuing operations increased $40.3
million in 2001, or 65.0%, over the $62.0 million reported in 2000. As a
percentage of revenue, selling, general and administrative expenses from
continuing operations have increased to 66.5% in 2002, from 65.5% in
2001 and 46.0% in 2000.
Selling, general and administrative expense for each of the operating
segments was:
[Download Table]
2002 2001 2000
---- ---- ----
(AMOUNTS IN THOUSANDS)
Advanced Technology $12,100 $ 12,273 $10,570
Digital Angel Corporation 15,615 9,595 7,810
InfoTech USA, Inc. 4,171 5,451 4,075
All Other 1,504 28,876 23,041
Corporate(1) 33,060 46,121 16,500
----------------------------------
$66,450 $102,316 $61,996
==================================
Selling, general and administrative expense as a percentage of
revenue for each of the operating segments was:
[Download Table]
2002 2001 2000
---- ---- ----
% % %
- - -
Advanced Technology 28.9 27.5 32.7
Digital Angel Corporation 46.4 26.8 35.1
InfoTech USA, Inc. 18.4 16.0 14.9
All Other 108.4 69.9 43.7
Corporate(1) 33.1 29.5 12.2
66.5 65.5 46.0
<FN>
(1) Corporate's percentage has been calculated as a percentage of total
revenue.
Changes during the years were:
Our Advanced Technology segment's selling, general and administrative
expenses decreased $0.2 million, or 1.4%, to $12.1 million in 2002 from
$12.3 million in 2001. We attribute the decrease primarily to the reduction
in revenues and the corresponding overhead for several of the businesses
within this segment. Partially offsetting the decrease were increases in
legal and other costs associated with a lawsuit that was settled on July 15,
2002 and marketing and administrative expenses associated with our VeriChip
product launch. As a percentage of revenue, selling, general and
administrative expense decreased in 2002 as compared to 2001. Selling,
general and administrative expenses increased $1.7 million, or 16.1%, to
$12.3 million in 2001 from $10.6 million in 2000. The acquisition of
Computer Equity in June 2000 contributed $2.6 million of the increase and
$1.2 million resulted from bad debt reserves. These increase were partially
offset by staff reductions and other cost saving measures. Selling expense
decreased as a percentage of revenue in 2001 as compared to 2000, as
companies acquired in 2000 incurred less selling, general and administrative
expenses as a percentage of revenue than the existing businesses.
Our Digital Angel Corporation segment's selling, general and
administrative expenses increased by $6.0 million, or 62.7%, to $15.6
million in 2002 from $9.6 million in 2001. As a percentage of revenue,
selling, general
50
and administrative expenses increased to 46.4% as compared to 26.8% in 2001.
We attribute the increase in 2002, primarily to expenses associated with the
merger of pre-merger Digital Angel and MAS during the first quarter of 2002
as well as the costs associated with the introduction of the Digital Angel
products. Selling, general and administrative expenses increased by $1.8
million, or 23.1% to $9.6 million in 2001 from $7.8 million in 2000. The
increase in 2001 was the result of the acquisitions of Destron Fearing
Corporation and Timely Technology Corp. during 2000.
Our InfoTech USA, Inc. segment's selling, general and administrative
expenses decreased $1.3 million, or 23.5%, to $4.2 million in 2002 from $5.5
million in 2001. The decrease in expenses was due to several cost savings
measures taken in 2002 including the centralization of the service and
administrative operations and the closure of two other small offices. Also,
we reduced our work force and payments of sales commissions, both of which
were related to the decline in revenue. Selling, general and administrative
expense increased to $5.5 million in 2001 from $4.1 million in 2000. The
increase in 2001 was due to the acquisition of InfoTech USA, Inc.
Corporation in the fourth quarter of 2000.
Our All Other segment's selling, general and administrative expenses
decreased $27.4 million, or 94.8%, to $1.5 million in 2002 from $28.9
million in 2001. The decrease resulted from the sale or closure of all of
the business units comprising this group during the last half of 2001 and
the first half of 2002. Selling, general and administrative expenses
increased $5.8 million, or 25.3%, to $28.9 million in 2001 from $23.0
million in 2000. We attribute the increase to the acquisition of a software
provider in December 2000.
Corporate/Eliminations selling, general and administrative expenses
decreased $13.1 million, or 28.3%, to $33.1 million in 2002 from $46.1
million in 2001. We attribute the decrease in 2002 primarily to the one-time
costs incurred during 2001, as more fully discussed below. Partially
offsetting the decrease were increases as discussed below.
o Pursuant to the terms of the pre-merger Digital Angel and MAS
merger agreement, which became effective March 27, 2002, options
to acquire shares of pre-merger Digital Angel common stock were
converted into options to acquire shares of MAS common stock. The
transaction resulted in a new measurement date for the options and,
as a result, we recorded non-cash compensation expense of
approximately $18.7 million during 2002. As all of the option
holders were our employees or directors, these options were
considered fixed awards under APB Opinion No. 25 and expense was
recorded for the intrinsic value of the options converted;
o We incurred an increase in professional fees during 2002; and
o During 2002, we incurred non-cash compensation expense of
approximately $0.5 million associated with interest payments that
were due on September 27, 2001 and September 27, 2002. We have
chosen not to pay the interest and related tax gross-up. We,
therefore, consider such notes to be in default and have begun
steps to foreclose on the underlying collateral (all of the stock)
in satisfaction of the notes. Our decision to take this action
relates in part to the passage of the recent corporate reform
legislation under the Sarbanes-Oxley Act of 2002, which, among
other things, prohibits further extension of credit to officers
and directors.
Corporate/Eliminations selling, general and administrative expenses
increased $29.6 million, or 179.5% to $46.1 million in 2001 from $16.5
million in 2000. The significant increase was primarily as a result of an
increase in bad debt reserves on notes and other receivables of $21.9
million. The reserves were considered necessary based upon several factors
that occurred during the third and fourth quarters of 2001. These included:
o A debtor declared bankruptcy, which resulted in a reserve of
$2.5 million;
o A $6.2 million note receivable, plus accrued interest, associated
with a business sold in December 2000 was deemed uncollectible
as the debtor has experienced significant business interruptions
to a business located in New York directly related to
September 11, 2001;
51
o Three debtors are delinquent under required payment obligations
resulting in a reserve of $3.4 million; and
o A $9.0 million note received for issuance of shares of
the Company's common stock was deemed uncollectible based upon the
financial condition of the debtor.
Also contributing to the increase in 2001 were:
o $5.3 million of non-cash compensation expense due primarily to
re-pricing 19.3 million stock options in September 2001. The
re-priced 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, accordingly, fluctuations in our common stock price result
in increases and decreases of non-cash compensation expense until
the options are exercised, forfeited or expired; and
o $3.6 million in litigation reserves.
Partially offsetting the increase was a reduction in personnel related
expenses of approximately $2.0 million.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense from continuing operations for
2002 was $3.5 million, a decrease of $5.1 million, or 59.1%, over the
$8.6 million reported in 2001. As a percentage of revenue, research and
development expense decreased to 3.5% in 2002 from 5.5% in 2001.
Research and development expense for each of the operating
segments was:
[Download Table]
2002 2001 2000
---- ---- ----
(AMOUNTS IN THOUSANDS)
Advanced Technology $ 861 $3,321 $ 269
Digital Angel Corporation 2,422 5,071 2,235
All Other -- 218 --
Corporate 235 -- --
------------------------------
$3,518 $8,610 $2,504
==============================
Research and development expense relates primarily to the development
of our products, Digital Angel, Thermo Life, VeriChip and Bio-Thermo and to
software development costs.
GAIN ON EXTINGUISHMENT OF DEBT AND IMPACT OF FAS 145
During the year ended December 31, 2001, we recorded an extraordinary
gain as a result of settling certain disputes between us and the former
owners of Bostek, Inc. and an affiliate (Bostek). As part of the settlement
agreement, the parties agreed to forgive a $9.5 million payable and the
former owners of Bostek agreed invest up to $6 million in shares of our
common stock provided the Company registered approximately 3.0 million
common shares of the Company's common stock by June 15, 2001. The Company
was successful in meeting the June 15, 2001, registration deadline and,
accordingly, the extinguishment of the $9.5 million payable was recorded in
2001 as an extraordinary gain.
CHANGE IN METHOD OF ACCOUNTING FOR EXTINGUISHMENT OF DEBT - IMPACT OF FAS 145
As required, we have adopted FAS 145 effective January 1, 2003. Under
FAS 145, gains and losses on the extinguishment of debt are included as part
of continuing operations. SFAS 145 requires all periods presented to be
consistent, and, as such, gains and losses on extinguishment of debt
previously recorded as extraordinary must be reclassified from extraordinary
treatment and presented as a component of continuing operations.
52
ASSET IMPAIRMENT
Asset impairment during the years ended December 31, 2002, 2001 and
2000 was:
[Download Table]
2002 2001 2000
---- ---- ----
(AMOUNTS IN THOUSANDS)
Goodwill:
Advanced Technology $ -- $30,453 $ --
Digital Angel Corporation 62,185 726 --
All Other -- 32,427 818
-------------------------------
Total goodwill 62,185 63,606 818
Property and equipment 6,860 2,372 --
Investment in ATEC and Burling stock -- -- 5,565
Software and other 337 5,741 --
-------------------------------
69,382 $71,719 $6,383
===============================
As of December 31, 2002, the net book value of our goodwill was $67.8
million. There was no impairment of goodwill upon the adoption of FAS 142 on
January 1, 2002. However, based upon our annual review for impairment during
the fourth quarter of 2002, we recorded an impairment charge of $62.2
million associated with our Digital Angel Corporation segment. The
impairment relates to the goodwill associated with the acquisition of MAS in
March 2002, and to Digital Angel Corporation's Wireless and Monitoring
segment. Future goodwill impairment reviews may result in additional
periodic write-downs. In addition, Digital Angel Corporation impaired $6.4
million of software associated with its Wireless and Monitoring segment. As
of December 31, 2002, Digital Angel Corporation's Wireless and Monitoring
segment has not recorded any significant revenues from its Digital Angel
product, and therefore, it was determined that the goodwill and software
were impaired.
As a result of the economic slowdown during 2001, we experienced
deteriorating sales for certain of our businesses. In addition,
management concluded that a full transition to an advanced technology
company required the sale or closure of all units that did not fit into
our new business model or were not cash-flow positive. This resulted in
the shutdown of several of our businesses during the third and fourth
quarters of 2001 and the first quarter of 2002. 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. The sales of these businesses did not
comprise the sale of an entire business segment. Based upon these
developments, we reassessed our future expected operating cash flows and
business valuations and at December 31, 2001, we performed undiscounted
cash flows analyses by business unit to determine if an impairment
existed. For purposes of these analyses, earnings before interest,
taxes, depreciation and amortization were used as the measure of cash
flow. When an impairment was determined to exist, any related impairment
loss was calculated based on fair value. Fair value was determined based
on discounted cash flows. The discount rate utilized by us was the rate
of return expected from the market or the rate of return for a similar
investment with similar risks. This reassessment resulted in the asset
impairments listed above during 2001.
As a result of the restructuring and revision to our business
model, the plan to implement an enterprise wide software system
purchased in 2000 was discontinued, and accordingly, the cost of the
software was expensed in 2002 and 2001.
During the fourth quarter of 2000, we reviewed our goodwill and
certain other investments for impairment and concluded that certain
assets were impaired. At December 31, 2000, we recorded a charge of $6.4
million for permanent asset impairment as more fully described in our
financial statements.
In addition to the impairments above, during 2002 and 2001, we
recorded inventory reserves of $1.4 million and $4.0 million,
respectively, and bad debt reserves of $1.3 million and $26.0 million,
respectively. The inventory reserves are included in our financial
statements in cost of products and the bad debt reserves are included in
selling, general and administrative expense.
53
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense from continuing operations
for 2002 was $4.8 million, a decrease of $24.1 million, or 83.5%, over
the $28.9 million reported in 2001. The 2001 expense represents an
increase of $17.8 million, or 161.0% over the $11.1 million reported in
2000. As a percentage of revenue, depreciation and amortization expense
was 4.8%, 18.5% and 8.2% in 2002, 2001 and 2000, respectively.
Under FAS 142, which we adopted on January 1, 2002, goodwill and
certain other intangible assets are no longer amortized. We incurred $22.5
million and $9.4 million in goodwill and equity method investment
amortization during 2001 and 2000, respectively.
In conjunction with our review for impairment of goodwill and
other intangible assets in the fourth quarter of 2000, we reviewed the
useful lives assigned to acquisitions and, effective October 1, 2000,
changed the lives to periods ranging from 5 to 10 years, down from
periods ranging from 10 to 20 years to reflect current economic trends
associated with the nature of recent acquisitions made. This change in
the fourth quarter of 2000 increased amortization expense by $7.2
million and $3.5 million in 2001 and 2000, respectively.
Depreciation and amortization expense from continuing operations
by segments was as follows:
[Download Table]
2002 2001 2000
---- ---- ----
(AMOUNTS IN THOUSANDS)
Advanced Technology $ 569 $ 9,088 $ 2,990
Digital Angel Corporation 3,638 12,298 2,962
InfoTech USA, Inc. 261 503 176
All Other 9 4,768 3,366
Corporate 296 2,242 1,579
--------------------------------
Total $4,773 $28,899 $11,073
================================
We attribute the decreases in 2002 primarily to a reduction in goodwill
amortization as a result of the adoption of FAS 142. In addition, All
Other's depreciation and amortization expense decreased due to the sale or
closure of all of the business units comprising this group during the last
half of 2001 and the first half of 2002. "Corporate / Eliminations"
depreciation and amortization expense decreased primarily as a result of the
impairment and sale of software and other corporate assets during the last
half of 2001.
The increases in 2001 as compared to 2000 reflect the increased
goodwill amortization associated with the business acquisitions during
2000, and the change in goodwill lives noted above.
LOSS/GAIN ON SALES OF SUBSIDIARIES AND BUSINESS ASSETS
The gain (loss) on sale of subsidiaries and business assets was
$0.1 million, $(6.1) million, and $0.5 million for the years ended
December 31, 2002, 2001 and 2000, respectively. The loss on the sales
of subsidiaries and business assets of $6.1 million for 2001 was due to
sales of the business assets of our wholly-owned subsidiaries as
follows: ADS Retail Inc., Signal Processors, Limited, ACT Wireless
Corp. and our ATI Communications companies. In addition, we sold our 85%
ownership interest in Atlantic Systems, Inc. Proceeds from the sales
were $3.5 million and were used primarily to repay debt.
INTEREST AND OTHER INCOME AND INTEREST EXPENSE
Interest and other income was $2.4 million, $2.1 million and $1.1
million for 2002, 2001 and 2000, respectively. Interest income is
earned primarily from short-term investments and notes receivable.
Interest expense was $17.5 million, $8.6 million and $5.9 million
for 2002, 2001 and 2000, respectively. Interest expense is a function
of the level of outstanding debt and is principally associated with
notes payable and
54
term loans.
INCOME TAXES
We had effective income tax (benefit) rates of 0.3%, 12.4%, and (14.8)%
in 2002, 2001 and 2000, respectively. Differences in the effective income
tax rates from the statutory federal income tax rate arise from goodwill
amortization associated with acquisitions, state taxes net of federal
benefits and the increase or reduction of valuation allowances related to
net operating loss carryforwards and other deferred tax assets. As of
December 31, 2002, we have provided a valuation allowance to fully reserve
our net operating loss carryforwards and our other existing net deferred tax
assets. Our tax provision for 2001 was primarily the result of an increase
in the valuation allowance due to the losses incurred during the year ended
December 31, 2001, as well as our projections of future taxable income.
RESULTS OF DISCONTINUED OPERATIONS
The following discloses the results of Intellesale and all other
non-core businesses comprising discontinued operations for the period
January 1 through March 1, 2001 and the year ended December 31, 2000:
[Enlarge/Download Table]
Discontinued Intellesale business: January 1,
through
March 1, Year Ended
2001 2000
---- ----
(amounts in thousands)
Product revenue $7,965 $ 95,666
Service revenue 370 6,826
--------------------------
Total revenue 8,335 102,492
Cost of products sold 6,974 104,396
Cost of services sold -- 5,315
--------------------------
Total cost of products and services sold 6,974 109,711
--------------------------
Gross profit 1,361 (7,219)
Selling, general and administrative expenses 1,602 32,772
Gain on sale of subsidiary -- (5,145)
Depreciation and amortization 121 2,949
Interest, net -- --
Impairment of investments -- 46,600
(Benefit) provision for income taxes (151) (13,357)
Minority interest (11) 140
--------------------------
(Loss) income from discontinued Intellesale businesses $(200) $(71,178)
==========================
55
Discontinued non-core businesses: January 1,
through
March 1, Year Ended
2001 2000
---- ----
(amounts in thousands)
Product revenue $5,074 $42,235
Service revenue 476 --
-----------------------------
Total revenue 5,550 42,235
Cost of products sold 3,525 33,428
Cost of services sold 259 --
-----------------------------
Total cost of products and services sold 3,784 33,428
-----------------------------
Gross profit 1,766 8,807
Selling, general and administrative expenses 932 7,926
Loss on sale of subsidiary -- 528
Depreciation and amortization 143 1,268
Interest, net 29 187
Impairment of investments -- 3,619
(Benefit) provision for income taxes 185 (257)
Minority interest 64 61
-----------------------------
(Loss) income from discontinued non-core businesses $ 413 $(4,525)
=============================
Total Discontinued Operations: January 1,
through
March 1, Year Ended
2001 2000
---- ----
(amounts in thousands)
Product revenue $13,039 $137,901
Service revenue 846 6,826
-------------------------------
Total revenue 13,885 144,727
Cost of products sold 10,499 137,824
Cost of services sold 259 5,315
-------------------------------
Total cost of products and services sold 10,758 143,139
-------------------------------
Gross profit 3,127 1,588
Selling, general and administrative expenses 2,534 40,697
Gain on sale of subsidiary -- (4,617)
Depreciation and amortization 264 4,217
Interest, net 29 187
Impairment of investments -- 50,219
(Benefit) provision for income taxes 34 (13,614)
Minority interest 53 201
-------------------------------
(Loss) income from discontinued operations $ 213 $(75,702)
===============================
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 that was repaid when the business was sold
in January 2002.
56
As of March 31, 2003, we have sold or closed substantially all of the
businesses comprising Discontinued Operations. There is one insignificant
company remaining, which had revenue and net loss for the year ended
December 31, 2002 of $0.7 million and $0.2 million, respectively. We
anticipate selling this remaining company in the next several months.
Proceeds from the sales of Discontinued Operations companies were used to
repay amounts outstanding under our credit agreement with IBM Credit. Any
additional proceeds on the sale of the remaining business will also be used
to repay debt.
Provision for operating losses and carrying costs during the phase-out
period included the estimated loss on sale of the business units as well as
operating and other disposal costs incurred in selling the businesses.
Carrying costs include the cancellation of facility leases, employment
contract buyouts, sales tax liabilities and reserves for certain legal
expenses related to on-going litigation.
During 2002 and 2001, Discontinued Operations incurred a change in
estimated loss on disposal and operating losses accrued on the measurement
date of $1.4 million and $(16.7) million, respectively. The primary reason
for the reduction in estimated losses for 2002 was due to the settlement of
litigation for an amount less than anticipated. The primary reasons for the
excess losses in 2001 were due to inventory write-downs of $4.5 million
during the second quarter of 2001, a decrease in estimated sales proceeds as
certain of the businesses were closed in the second and third quarters of
2001, an increase in legal expenses related to ongoing litigation,
additional sales tax liabilities and additional facility lease costs.
The business closures in 2001 were the result of a combination of the
deteriorating market conditions for the technology sector as well as our
strategic decision to reallocate funding to our core businesses. We also
increased our estimated loss on the sale of Innovative Vacuum Solutions,
Inc., which was sold during the second quarter of 2001, by $0.2 million and
on Ground Effects Ltd., which was sold in the first quarter of 2002, by $1.2
million.
We do not anticipate a further loss on sale of the remaining business
comprising Discontinued Operations. However, actual losses could differ from
our estimates and any adjustments will be reflected in our future financial
statements. During the years ended December 31, 2002, 2001 and 2000, the
estimated amounts recorded were as follows:
[Enlarge/Download Table]
-------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(amounts in thousands)
Operating losses and estimated loss on the sale of business units $ 684 $13,010 $ 1,619
Carrying Costs (2,104) 3,685 6,954
Less: Benefit for income taxes -- -- (1,307)
------------------------------------------
$(1,420) $16,695 $ 7,266
===================================================================================================================
57
The following table sets forth the roll forward of the liabilities for
operating losses and carrying costs from December 31, 2000, through December
31, 2002.
[Enlarge/Download Table]
BALANCE BALANCE
DECEMBER 31, DECEMBER 31,
TYPE OF COST 2000 ADDITIONS DEDUCTIONS 2001
------------ ---- --------- ---------- ----
Operating losses and
estimated loss on sale $1,619 $13,010 $13,456 $1,173
Carrying costs 6,954 3,685 3,421 7,218
------ ------- ------- ------
Total $8,573 $16,695 $16,877 $8,391
====== ======= ======= ======
BALANCE BALANCE
DECEMBER 31, DECEMBER 31,
TYPE OF COST 2001 ADDITIONS DEDUCTIONS 2002
------------ ---- --------- ---------- ----
Operating losses and
estimated loss on sale $1,173 $ 684 $1,857 $ --
Carrying costs(1) 7,218 (2,104) 206 4,908
------ ------- ------ ------
Total $8,391 $(1,420) $2,063 $4,908
====== ======= ====== ======
<FN>
(1) Carrying costs at December 31, 2002, include all estimated costs to
dispose of the discontinued businesses including $2.0 million for future
lease commitments, $1.8 million for severance and employment contract
settlements, $1.0 million for sales tax liabilities and $0.1 million for
litigation settlement.
During 2000, Intellesale refocused its business model away from
the Internet segment and began concentrating on its traditional business of
asset management and brokerage services and the sale of refurbished and new
desktop and notebook computers, monitors and related components as a
wholesale, business to business supplier. The transition resulted in
significantly reduced revenues from its Bostek business unit in the first
half of 2000 compared to substantial sales from this unit in the second half
of 2000, contributing to the decline in revenue from 1999 to 2000. Gross
profit was significantly impacted by lower margin business in the first half
of 2000 coupled with an inventory charge of $8.5 million, as discussed
below.
In the second quarter of 2000, Intellesale recorded a pre-tax charge of
$17.0 million. Included in this charge was an inventory reserve of $8.5
million for products Intellesale expected to sell below cost (included in
cost of goods sold), $5.5 million related to specific accounts and other
receivables, and $3.0 million related to fees and expenses incurred in
connection with Intellesale's cancelled public offering and certain other
intangible assets. This charge reflects the segment's decreasing revenue
trend, lower quarterly gross profits and the expansion of Intellesale's
infrastructure into a major warehouse facility. In addition, a more
competitive business environment resulting from an overall slowdown in
Intellesale's business segment, and management's attention to the Bostek
operational and legal issues, discussed above under "Legal Proceedings",
contributed to the negative results. The impact of the loss resulted in
Intellesale restructuring its overhead and refocusing its business model
away from the Internet segment and back to its traditional business lines.
This restructuring was completed in the fourth quarter of 2000 and during
that quarter an additional $5.5 million of inventory acquired for retail
distribution was written down to realizable value.
58
LIQUIDITY AND CAPITAL RESOURCES FROM CONTINUING OPERATIONS
Debt, Covenant Compliance and Liquidity
As of March 31, 2003, cash and cash equivalents totaled $3.0 million, a
decrease of $2.8 million, or 48.1%, from $5.8 million at December 31, 2002.
Operating activities used cash of $3.7 million and provided cash of
$2.5 million during the three-months ended March 31, 2003 and 2002,
respectively. During the three-months ended March 31, 2003, an increase in
cash held by note holder, an increase in accounts receivable, and purchases
of inventory resulted in the use of cash from operating activities. During
the three months ended March 31, 2002, cash was provided primarily by
collections on accounts receivable and cash was used primarily to purchase
inventory and for other assets.
Accounts and unbilled receivables, net of allowance for doubtful
accounts, increased by $2.6 million, or 15.6%, to $19.1 million at March 31,
2003, from $16.5 million at December 31, 2002. We attribute the increase
primarily to a significant number of shipments made by Digital Angel
Corporation during the month of March 2003.
Inventory levels increased by $1.4 million, or 21.5%, to $7.8 million
at March 31, 2003, from $6.4 million at December 31, 2002. We attribute the
increase primarily to the accumulation of inventory by Digital Angel
Corporation in anticipation of current year sales.
Accounts payable increased by $2.5 million, or 25.5%, to $12.3 million
at March 31, 2003, from $9.8 million at December 31, 2002, due primarily to
an increase in inventory and improved cash management.
Investing activities provided cash of $0.6 million and $5.8 million
during the three-months ended March 31, 2003 and 2002, respectively. During
the three-months ended March 31, 2003, $1.0 million was provided from the
collection of notes receivable and $0.3 million was used to purchase
property and equipment. During the three-months ended March 31, 2002, cash
was provided primarily from 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 $1.1 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.
Financing activities provided cash of $0.4 million and used cash of
$4.1 million during the three-months ended March 31, 2003 and 2002,
respectively. The primary source of cash during the three-months ended March
31, 2003, was the proceeds of subsidiary stock issuance of $0.2 million and
proceeds of the issuance of common stock of $0.1 million. During the
three-months ended March 31, 2002, cash was used primarily to repay $3.6
million against notes payable and $1.1 million against long-term debt.
Partially offsetting the use of cash during the three-months ended March 31,
2002, was cash of $0.9 million provided from the issuance of common shares.
Debt, Covenant Compliance and Liquidity
On March 1, 2002, we and the Digital Angel Trust entered into the IBM
Credit Agreement with IBM Credit, which became effective on March 27, 2002,
the effective date of the merger between pre-merger Digital Angel and MAS.
The principal amount outstanding had an annual rate of 17% and matured on
February 28, 2003. If certain amounts were not repaid on or before February
28, 2003, the interest rate increased to an annual rate of 25%. On September
30, 2002, we entered into an amendment to the IBM Credit Agreement, which
revised certain financial covenants relating to our financial performance
and the financial position and performance of Digital Angel Corporation for
the quarter ended September 30, 2002, and the fiscal year ending December
31, 2002. On November 1, 2002, we entered into another amendment to the IBM
Credit Agreement, which further revised certain covenants relating to the
financial performance of Digital Angel Corporation for the quarter ended
September 30, 2002, and the fiscal year ending December 31, 2002. At
September 30, 2002, we were in compliance with the revised covenants under
IBM Credit Agreement, however, at December 31, 2002, we failed to maintain
compliance with the revised financial performance covenant. In addition, as
of March 31, 2003 and December 31, 2002, Digital Angel Corporation did not
maintain compliance with certain financial covenants under its credit
agreement with its lender, Wells Fargo Business Credit, Inc. (Wells Fargo).
Well Fargo provided Digital Angel Corporation with waivers of such
non-compliance. IBM did not provide a waiver.
59
Under the terms of the IBM Credit Agreement we were required to repay
IBM Credit $29.8 million of the $77.2 million outstanding principal balance
owed to them plus $16.4 million of accrued interest and expenses (totaling
approximately $46.2 million), on or before February 28, 2003. We did not
make such payment by February 28, 2003, and on March 3, 2003, IBM Credit
notified us that we had until March 6, 2003, to make the payment. Our
failure to comply with the payment terms imposed by the IBM Credit Agreement
and our failure to maintain compliance with the financial performance
covenant constitute events of default under the IBM Credit Agreement. On
March 7, 2003, we received a letter from IBM Credit declaring the loan in
default and indicating that IBM Credit would exercise any and/or all of its
remedies.
On March 27, 2003, we announced that we had executed a forbearance
agreement term sheet with IBM Credit. The Forbearance Agreement became
effective on April 2, 2003 and grants us more favorable loan repayment terms
and more time in which to meet our current obligations to IBM Credit. It
contains various purchase rights for us to buy back our existing
indebtedness from IBM Credit, including a one-time payment on or before June
30, 2003 of $30.0 million. Payment of this amount will constitute complete
satisfaction of any and all of our obligations to IBM Credit. Provided there
has not earlier occurred a "Termination Event," as defined in the
Forbearance Agreement, at the end of the forbearance period, the provisions
of the Forbearance Agreement shall become of no force and effect. At that
time, if the repayment terms of the Forbearance Agreement are not met, IBM
Credit shall be free to exercise and enforce, or to take steps to exercise
and enforce, all rights, powers, privileges and remedies available to them
under the IBM Credit Agreement, as a result of the payment and covenant
defaults existing on March 24, 2003. If we are not successful in satisfying
the payment obligations under the Forbearance Agreement or we do not comply
with the terms of the Forbearance Agreement or the IBM Credit Agreement, and
IBM Credit were to enforce its rights against the collateral securing the
obligations to IBM Credit, there would be substantial doubt that we would be
able to continue operations in the normal course of business.
Sources of Liquidity
While we anticipate that our operations will provide positive cash flow
during 2003, our operating activities did not provide positive cash flow
during 2002 and 2001. In addition, during 2003, we are required to make
substantial debt payments under the terms of the Forbearance Agreement with
IBM Credit. Accordingly, there can be no assurance that we will have access
to funds necessary to provide for our ongoing operations or to make the
required debt payments. Our sources of liquidity may include proceeds from
the sale of common stock and preferred shares, proceeds for the sale of
businesses, proceeds from the sale of the Digital Angel Corporation common
stock held in the Digital Angel Trust, proceeds from the exercise of stock
options and warrants, and the raising of other forms of debt or equity
through private placement or public offerings. There can be no assurance
however, that these options will be available, or if available, on favorable
terms. Our capital requirements depend on a variety of factors, including
but not limited to, repayment obligations under the IBM Credit Agreement,
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.
Failure to obtain additional funding, to generate positive cash flow
from operations and to comply with the payment and other provisions of the
Forbearance Agreement with IBM Credit will have a materially adverse effect
on our business, financial condition and results of operations.
Contractual Obligations
The following table shows the aggregate of our contractual cash
obligations at December 31, 2002:
[Enlarge/Download Table]
Less Than 1 4-5 After 5
Contractual Cash Obligations Total Year 1-3 Years Years Years
-------------------------------------------------------------------------------------------------------------------------------
(amounts in thousands)
-------------------------------------------------------------------------------------------------------------------------------
Notes payable, long-term debt and other
long-term liabilities $ 86,280 $81,879 $1,088 $ 81 $ 3,232
Operating leases 15,039 1,385 1,061 696 11,897
Employment contracts 5,398 2,483 1,404 789 722
----------------------------------------------------------------------------------
Total contractual cash obligations $106,717 $85,747 $3,553 $1,566 $15,851
==================================================================================
60
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 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.
QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Digital Angel Corporation has a foreign subsidiary operating in the
United Kingdom, which has very limited foreign currency related
transactions. 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 IBM Credit
Agreement 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.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
On April 11, 2002, we notified our independent accountants,
PricewaterhouseCoopers LLP, that our board of directors had approved our
decision to transition our audit work to another firm and dismissed
PricewaterhouseCoopers, LLP. We had selected Grant Thornton LLP as our new
independent accountants.
The reports of PricewaterhouseCoopers LLP on the financial statements
for the past two fiscal years contained no adverse opinion or disclaimer of
opinion and were not qualified or modified as to uncertainty, audit scope or
accounting principle, except that the reports for each of the years ended
December 31, 2000 and December 31, 2001 contained an explanatory paragraph
expressing doubt about our ability to continue as a going concern. In
connection with its audits for the three most recent fiscal years and
through April 11, 2002, there had been no disagreements with
PricewaterhouseCoopers LLP on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure,
which disagreements if not resolved to the satisfaction of
PricewaterhouseCoopers LLP would have caused them to make reference thereto
in their report on the financial statements for such years. The following
were the only reportable events as defined under Regulation S-K Item
304(a)(1)(v). During the two most recent fiscal years and through April 11,
2002, PricewaterhouseCoopers LLP discussed with the Audit Committee of the
Board of Directors the following findings, all of which we agreed with and
all of which have been remedied. During the year ended December 31, 2001,
one of our subsidiaries lacked evidence of customer acceptance prior to the
recognition of certain revenue and did not have proper restrictions to
vendor access within its accounts payable system. During the year ended
December 31, 2000, a second subsidiary lacked monitoring controls over its
accounts receivable and was unable to provide certain detailed inventory
listings for certain general ledger balances. That subsidiary was part of
our Discontinued Operations and has been closed since 2001.
On April 17, 2002, we engaged Grant Thornton LLP as our new independent
accountants to audit the financial statements for the year ending December
31, 2002. During 2000 and 2001 and in the subsequent interim period, we had
not consulted with Grant Thornton LLP on items which concerned the
application of accounting principles generally, or to a specific transaction
or group of either completed or proposed transactions, or the type of audit
opinion that might be rendered on our financial statements.
61
On April 22, 2002, we filed a Current Report on Form 8-K with the SEC
to report the engagement of Grant Thornton LLP. Attached to that report as
an exhibit was a letter from PricewaterhouseCoopers LLP addressed to the SEC
stating the following: "We have read the statements made by Applied Digital
Solutions, Inc. (copy attached), which was filed with the Commission,
pursuant to Item 4 of Form 8-K, as part of our Form 8-K report dated April
11, 2002. On March 27, 2002, we issued a report to the Audit Committee
listing two material weaknesses from prior years. Management has represented
they have implemented remedial action plans. Since we have performed no
audit procedures subsequent to the date of our report, we cannot confirm the
effectiveness of these remedial actions. Otherwise, we agree with the
statements concerning our Firm in such Form 8-K."
On May 21, 2002, we filed a Current Report on Form 8-K with the SEC to
report that, by letter dated May 14, 2002, Grant Thornton LLP resigned as
our outside auditing firm. We, and Grant Thornton, had a disagreement on the
proper accounting treatment with respect to a non-cash item in connection
with the merger of pre-merger Digital Angel and MAS. As a result, of the
nature of the disagreement as outlined below, Grant Thornton communicated
its resignation as our auditors. Grant Thornton advised us that our proposed
treatment of the non-cash item was inconsistent with the position taken in
MAS's definitive proxy statement dated February 14, 2002, related to the
merger. Grant Thornton advised that we had not brought to Grant Thornton's
attention the change in accounting position and that it did not believe it
could rely upon future representations made by our management. Grant
Thornton also advised us that it had not completed its review of our
quarterly report on Form 10-Q for the first quarter of 2002.
The accounting item in question (about which we, and Grant Thornton
LLP, had the disagreement) related to options that MAS was to assume or
convert into MAS options under the terms of an Agreement and Plan of Merger,
dated November 1, 2001, by and among MAS, an MAS wholly-owned subsidiary,
and pre-merger Digital Angel. On March 27, 2002, the MAS wholly-owned
subsidiary was merged with and into pre-merger Digital Angel under the terms
of the merger agreement. We also contributed certain other subsidiaries in
the merger. Pre-merger Digital Angel, as the surviving corporation, became a
wholly-owned subsidiary of MAS, which has since been renamed Digital Angel
Corporation. Grant Thornton has also communicated by letter dated May 14,
2002, the termination of its auditor relationship with Digital Angel
Corporation.
With respect to the dispute as to the proper accounting treatment for
these options, Grant Thornton's position was that we should recognize in the
first quarter of 2002 a one-time, non-cash, compensation expense, in the
amount of approximately $14.5 million, under the guidance provided by
Accounting Principles Board Opinion No. 25 (APB 25), as amended by FASB
Interpretation No. 44 and Emerging Issues Task Force Issue 00-23. We were of
the view that the cost of the assumed- or to-be-converted options represents
part of the merger consideration and should be capitalized and reflected on
our balance sheet, consistent with accounting for the transaction as a
business combination using the purchase method of accounting, in accordance
with Accounting Principles Board Opinion No. 16 (APB 16). We stated that we
were intending to contact the staff of the SEC with respect to this issue
and that the Audit Committee of the board of directors was advised of
management's handling of the proposed accounting treatment for the stock
options. We also stated that we had authorized Grant Thornton to respond
fully to inquiries of the successor accountant concerning the subject matter
of the foregoing disagreement and that we were in negotiations with a new
independent accounting firm with respect to the auditing of our financial
statements.
On May 22, 2002, we filed a Current Report on Form 8-K/A with the SEC
to include as an exhibit a letter from Grant Thornton LLP addressed to the
SEC in which Grant Thornton LLP stated the following: "We have read Item 4
of Form 8-K/A of Applied Digital Solutions, Inc. dated May 21, 2002, and
agree with the statements concerning our Firm contained therein. As to the
discussion of having contacted the SEC and of the new accountants, we have
no basis for agreeing or disagreeing with such statements."
On May 28, 2002, we filed a Current Report on Form 8-K to announce that
on May 23, 2002, we engaged Eisner LLP as our new independent accountants to
audit our financial statements for the fiscal year ending December 31, 2002.
During 2000 and 2001 and in the subsequent interim period, we had not
consulted with Eisner LLP on items which concerned the application of
accounting principles generally, or to a specific transaction or group of
either completed or proposed transactions, or the type of audit opinion that
might be rendered on our financial statements, or any other matters or
reportable events as set forth in Items 304(a)(2)(i) and (ii) of Regulation
S-K.
We also reported that due to the timing of the resignation of Grant
Thornton LLP, the interim financial statements contained in our Quarterly
Report on Form 10-Q for the quarter ended March 31, 2002, which were filed
62
with the SEC on May 20, 2002, were not reviewed by an independent accountant
as required pursuant to Rule 10-01 (d) of Regulation S-X, and that our new
independent accountants, Eisner LLP, would complete the SAS 71 review of the
Registrant's first quarter financial statements and we would file an amended
Form 10-Q/A.
On May 24, 2002, we filed a Current Report on Form 8-K to disclose that
we had issued a press release on May 22, 2002, stating that the timing of
Grant Thornton's resignation as our outside auditors prevented us from
filing its Form 10-Q with an auditor's review. As a result, we received a
letter from the Nasdaq staff indicating that the Form 10-Q did not comply
with Marketplace Rule 4310(c)(14), and, accordingly, that an "E" would be
added to our trading symbol. The letter indicated that our common stock was
subject to delisting unless we requested a hearing before a Nasdaq listing
qualifications panel. We informed Nasdaq that it intended to make such a
request. In accordance with applicable Marketplace Rules, the hearing
request had the effect of staying any action pending the decision of the
hearing panel. In the interim, the letter "E" was appended to our trading
symbol and from July 12, 2002, to July 30, 2002, our common stock was
delisted by Nasdaq and was traded on the Pink Sheets under the symbol
"ADSX.PK." On July 18, 2002, we filed an amended quarterly report on Form
10-Q, which presented condensed financial statements that had been reviewed
by our independent public accountants, Eisner LLP. As a result, the Nasdaq
hearing panel relisted our common stock effective July 31, 2002. However, we
were unable to satisfy the required minimum closing bid price requirement by
October 25, 2002, and as a result, effective November 12, 2002, our common
stock began trading on the Small Cap under our existing symbol ADSX.
63
MANAGEMENT
Our directors are:
Scott R. Silverman: Mr. Silverman, age 39, had served since August 2001
as a special advisor to the Board of Directors. In March 2002, he was
appointed to the Board of Directors and named President. In March 2003, he
was appointed Chairman of the Board and Chief Executive Officer. From
September 1999 to March 2002, Mr. Silverman operated his own private
investment-banking firm and prior to that time, from October 1996 to
September 1999, he served in various capacities for us including positions
related to business development, corporate development and legal affairs.
From July 1995 to September 1996, he served as President of ATI
Communications, Inc., one of our subsidiaries. He began his career as an
attorney specializing in commercial litigation and communications law at the
law firm of Cooper Perskie in Atlantic City, New Jersey, and Philadelphia,
Pennsylvania. Mr. Silverman is a graduate of the University of Pennsylvania
and Villanova University School of Law.
Daniel E. Penni: Mr. Penni, age 55, has served as a director since
March 1995, and is Chairman of the Compensation Committee and serves on
the Audit Committee of the Board of Directors. Since March 1998, he has
been an Area Executive Vice President for Arthur J. Gallagher & Co.
(NYSE:AJG). He has worked in many sales and administrative roles in the
insurance business since 1969. He is the managing member of the Norsman
Group Northeast, LLC, a private sales and marketing company focused on
Internet-based education and marketing and serves as Treasurer and
Chairman of the Finance Committee of the Board of Trustees of the
Massachusetts College of Pharmacy and Health Sciences. Mr. Penni
graduated with a bachelor of science degree in 1969 from the School of
Management at Boston College.
Dennis G. Rawan: Mr. Rawan, age 59, was appointed a director
effective December 10, 2002, and serves as Chairman of the Audit
Committee of the Board of Directors. Mr. Rawan was Chief Financial
Officer of Expo International, Inc. (Expo) from 1996 until his
retirement in 2000. Expo provides information technology products and
services to the event industry. For over 20 years prior to joining
Expo, Mr. Rawan was a certified public accountant (CPA) providing audit,
review, tax and financial statement preparation services for a variety
of clients. From 1970 to 1988, while working as a CPA, Mr. Rawan taught
graduate level accounting courses at Babson College. Mr. Rawan earned a
Bachelor of Arts degree and a Master of Business Administration degree
from Northeastern University.
Constance K. Weaver: Ms. Weaver, age 50, was elected to the Board of
Directors in July 1998 and serves on the Compensation Committee of the Board
of Directors. Ms. Weaver is Executive Vice President, Public Relations,
Marketing Communications and Brand Management for AT&T Corporation (AT&T)
(NYSE:T). From 1996 to October 2002, Ms. Weaver was Vice President, Investor
Relations and Financial Communications for AT&T. From 1995 through 1996, she
was Senior Director, Investor Relations and Financial Communications for
Microsoft Corporation. From 1993 to 1995, she was Vice President, Investor
Relations, and, from 1991 to 1993, she was director of Investor Relations
for MCI Communications, Inc. She earned a Bachelor of Science degree from
the University of Maryland in 1975 and has completed post-graduate financial
management, marketing and strategic planning courses at The Wharton School
of the University of Pennsylvania, Stanford University, Columbia University
and Imede (Switzerland).
Michael S. Zarriello: Mr. Zarriello, age 53, was appointed a director
effective May 9, 2003 and serves on the Audit Committee of the Board of
Directors. Mr. Zarriello was a Senior Managing Director of Jesup & Lamont
Securities Corporation and President of Jesup & Lamont Merchant Partners LLC
from 1998 to 2003. From 1989 to 1997, Mr. Zarriello was a Managing
Director-Principal of Bear Stearns & Co., Inc. and from 1989 to 1991 he
served as Chief Financial Officer of the Principal Activities Group that
invested the Bear Stearns' capital in middle market companies. Prior to that
time, he has held positions as Chief Financial Officer of United States
Leather Holdings, Inc., Chief Financial Officer of Avon Products, Inc.
Healthcare Division and Assistant Corporate Controller for Avon. He
graduated with a Bachelors of Science degree from the State University of
New York at Albany; he holds a Masters in Business Administration from
Fairleigh Dickinson University and an Advanced Professional Certificate from
New York University. Mr. Zarriello holds several licenses from the National
Association of Securities Dealers.
64
Our executive officers are:
[Enlarge/Download Table]
NAME AGE POSITION POSITION HELD SINCE
---- --- -------- -------------------
Scott R. Silverman 39 Chairman of the Board and Chief Executive Officer (March 2003 Chairman and CEO)
Kevin H. McLaughlin 61 President and Chief Operating Officer (March 2003 Chief Operating Officer)
(May 2003 President)
Michael E. Krawitz 33 Executive Vice President, General Counsel and (April 1999 General Counsel) (March
Secretary 2003 Secretary) (April 2003 Executive
Vice President)
Evan C. McKeown 45 Senior Vice President and Chief Financial Officer (March 2002 Chief Financial Officer)
(March 2003 Senior Vice President)
Peter Y. Zhou 63 Vice President and Chief Scientist January 2000
Following is a summary of the background and business experience of the
Company's executive officers other than Scott R. Silverman (whose background
and business experience is described above in connection with his status as
a director of the Company):
Kevin H. McLaughlin: Mr. McLaughlin, age 61, was appointed the
Company's President in May 2003 and its Chief Operating Officer in March
2003. From April 12, 2002, Mr. McLaughlin served as a director and Chief
Executive Officer of InfoTech USA, Inc., formerly SysComm International
Corporation, the Company's 52.5% owned subsidiary. Prior to that time, he
served as Chief Executive Officer of Computer Equity Corporation, the
Company's wholly-owned subsidiary. Mr. McLaughlin joined the Company as Vice
President of Sales and Marketing in June 2000. From June 1995 to May 2000,
he served as Senior Vice President of Sales for SCB Computer Technology,
Inc.
Michael E. Krawitz: Mr. Krawitz, age 33, joined the Company as
Assistant Vice President and General Counsel in April 1999, and was
appointed Vice President and Assistant Secretary in December 1999, Senior
Vice President in December 2000, Secretary in March 2003 and Executive Vice
President in April 2003. From 1994 to April 1999, Mr. Krawitz was an
attorney with Fried, Frank, Harris, Shriver & Jacobson in New York. Mr.
Krawitz earned a Bachelor of Arts degree from Cornell University in 1991 and
a juris doctorate from Harvard Law School in 1994.
Evan C. McKeown: Mr. McKeown, age 45, joined the Company as Vice
President, Chief Accounting Officer and Corporate Controller in March 2001.
He was appointed Vice President, Chief Financial Officer in March 2002 and
Senior Vice President in March 2003. Prior to joining the Company, Mr.
McKeown served as Corporate Controller at Orius Corporation in West Palm
Beach, Florida. From 1992 to 1999, he served as Controller and then Chief
Financial Officer of Zajac, Inc., in Portland, Maine. Mr. McKeown has more
that 20 years experience in accounting and financial reporting, including
serving as a Tax Manager for Ernst & Young and public accountant with
Coopers & Lybrand. He is a graduate of the University of Maine and is a
certified public accountant.
Peter Zhou: Dr. Zhou, age 63, joined the Company as Vice President and
Chief Scientist in January 2000. From 1988 to 1999, Dr. Zhou served as Vice
President, Technology for Sentry Technology Corp., and from 1985 to 1988, he
served as Research Investigator for the University of Pennsylvania's
Department of Science & Engineering. Prior to that, he was a research
scientist for Max-Planck Institute, Metallforschung in Stuttgart, Germany and
a post-doctoral research fellow at the University of Pennsylvania. Dr. Zhou
has a PhD in materials science/solid state physics from the University of
Pennsylvania and a Master of Sciences degree in physics from the Beijing
University of Sciences and Technology.
65
Directorships
Messrs. Silverman and McLaughlin serve on the Board of Directors of
InfoTech USA, Inc. Corporation (formerly SysComm International Corporation).
No other directors or executive officers hold directorships in any other
company that has a class of securities registered pursuant to Section 12 of
the Securities Exchange Act of 1934, or subject to the requirements of
Section 15(d) of the Exchange Act or any company registered as an investment
company under the Investment Company Act of 1940.
BOARD COMMITTEES AND MEETINGS
The Company has standing Audit and Compensation Committees of the Board
of Directors.
The Audit Committee consists of Dennis G. Rawan, Daniel E. Penni and
Michael S. Zarriello. Mr. Rawan is Chairman of the Audit Committee. The
Audit Committee recommends for approval by the Board of Directors a firm of
certified public accountants whose duty it is to audit the Company's
consolidated financial statements for the fiscal year in which they are
appointed, and monitors the effectiveness of the audit effort, the internal
and financial accounting organization and controls and financial reporting.
The Audit Committee held five meetings during 2002. The duties of the Audit
Committee are also to oversee and evaluate the Company's independent
certified public accountants, to meet with the Company's independent
certified public accountants to review the scope and results of the audit,
to approve non-audit services provided to the Company by its independent
certified public accountants, and to consider various accounting and
auditing matters related to the Company's system of internal controls,
financial management practices and other matters. The Audit Committee
complies with the provisions of the Sarbanes-Oxley Act of 2002. The Audit
Committee members are independent as defined in Rule 4200(a)(15) of the
National Association of Securities Dealers listing standards, as applicable
and as may be modified or supplemented and as defined by the Sarbanes-Oxley
Act of 2002.
The Compensation Committee consists of Daniel E. Penni and Constance K.
Weaver. Mr Penni is Chairman of the Compensation Committee. The Compensation
Committee administers the Company's 1996 Non-Qualified Stock Option Plan,
the 1999 Flexible Stock Plan, the 2003 Flexible Stock Plan and the 1999
Employees Stock Purchase Plan, including the review and grant of stock
options to officers and other employees under such plans, and recommends the
adoption of new plans. The Compensation Committee also reviews and approves
various other compensation policies and matters and reviews and approves
salaries and other matters relating to the Company's executive officers. The
Compensation Committee reviews all senior corporate employees after the end
of each fiscal year to determine compensation for the subsequent year.
Particular attention is paid to each employee's contributions to our current
and future success along with their salary level as compared to the market
value of personnel with similar skills and responsibilities. The
Compensation Committee also looks at accomplishments, which are above and
beyond management's normal expectations for their positions. The
Compensation Committee met two times and acted by written consent eight
times during 2002.
The Board of Directors held eight meetings during 2002 and acted by
written consent 32 times. During the year, all Directors attended 75% or
more of the meetings of the Board of Directors and Committees to which they
were assigned.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires our officers and directors
and persons who own more than 10% of our common stock to file reports of
ownership and changes in ownership with the Securities and Exchange
Commission and to furnish copies of all such reports to us. We believe, based
on our stock transfer records and other information available to us, that all
reports required under Section 16(a) were timely filed during 2002 except as
follows: 1) A Form 4 for Mr. Richard Sullivan, our former Chairman and Chief
Executive Officer, was filed approximately two weeks late; 2) A Form 5 for
Mrs. Angela Sullivan, a former director, was filed two weeks late; 3)
66
Form 4s for the month of February 2002 for the following directors were filed
several months late: Mrs. Angela Sullivan, Mr. Daniel Penni, Ms. Constance
Weaver and Mr. Arthur Noterman.
67
EXECUTIVE COMPENSATION
The following table sets forth certain summary information concerning
the total remuneration paid in 2002 and the two prior fiscal years to our
Chief Executive Officer and our four other most highly compensated executive
officers (collectively, the "Named Executive Officers").
[Enlarge/Download Table]
SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION
--------------------------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
--------------------------------------- ---------------------------- -------
RESTRICTED
OTHER ANNUAL STOCK OPTIONS / LTIP ALL OTHER
NAME AND PRINCIPAL SALARY BONUS COMPENSATION AWARDS SARS PAYOUTS COMPENSATION
POSITION (1) YEAR ($) ($)(2) ($)(3) ($) (#)(4) (#) ($)
------------ ---- --- ------ ------ --- ------ --- ---
Richard J. Sullivan (5) 2002 $450,000 $140,000 $326,841 $ -- 3,200,000 $ -- $ --
Former Chairman, CEO 2001 450,000 448,801 57,424 -- 10,675,000(9) -- --
and Secretary 2000 450,000 180,000 936,672 -- 4,000,000 -- --
Scott R. Silverman (6) 2002 165,577 22,030 2,563 -- 1,600,000 -- --
Chairman, CEO, and 2001 N/A N/A N/A N/A N/A N/A N/A
President 2000 N/A N/A N/A N/A N/A N/A N/A
Jerome C. Artigliere (7) 2002 178,365 22,030 31,588 -- 1,300,000 -- --
Former Senior Vice, 2001 175,000 14,174 87,688 -- 1,129,000(9) -- --
President, COO and 2000 134,616 35,000 -- -- 100,000 -- --
Assistant Treasurer
Michael E. Krawitz (8) 2002 170,769 22,030 -- -- 1,000,000 -- --
Senior Vice President, 2001 160,000 14,174 -- -- 504,000(9) -- --
General Counsel and 2000 151,853 35,000 -- -- 100,000 -- --
Secretary
Peter Zhou 2002 216,058 7,500 -- -- 200,000 -- --
Vice President, Chief 2001 212,839 -- -- -- 229,000(9) -- --
Scientist 2000 151,456 25,000 -- -- 150,000 -- --
<FN>
----------------
(1) See "Related Party Transactions."
(2) The amounts in the Bonus column were discretionary awards granted by
the Compensation Committee in consideration of the contributions of the
respective named executive officers.
(3) Other annual compensation includes: (a) in 2002, for Richard J.
Sullivan $296,190 related to the difference between the price used to
determine the number of shares of common stock issued to Mr. Sullivan
in lieu of cash compensation and the market price of stock at the time
of issuance, an auto allowance and other discretionary payments, and
for Mr. Silverman, an auto allowance; (b) in 2001, for Richard J.
Sullivan, an auto allowance and other discretionary payments, and for
Jerome C. Artigliere, $50,000 in moving expenses, an auto allowance and
other discretionary payments; and (c) in 2000, for Richard J. Sullivan,
$936,672 of other compensation representing the fair value of property
distributed to Richard J. Sullivan, including the associated payment of
taxes on his behalf, pursuant to his employment agreement.
(4) Indicates number of securities underlying options. (5) Mr. Sullivan
retired in March 2003.
(6) Mr. Silverman joined us as a Director and President in March 2002. He
assumed the positions of Chairman of the Board of Directors and Chief
Executive Officer in March 2003.
(7) Mr. Artigliere resigned in March 2003.
(8) Mr. Krawitz assumed the position of Secretary in March 2003.
(9) Includes options granted in prior years that were re-priced during
2001 as follows: (a) for Richard J. Sullivan, 7,675,000; (b) for Jerome
C. Artigliere, 254,000; (c) for Michael E. Krawitz, 154,000; and (d)
for Peter Zhou, 129,000.
68
The following table contains information concerning the grant of stock
options under our 1999 Flexible Stock Plan to the Named Executive Officers
during 2002:
[Enlarge/Download Table]
OPTION GRANTS IN 2002
INDIVIDUAL GRANTS
------------------------------------------------------------------------------------------------------------------------------------
Potential Realizable Value At Assumed
Rates of Stock Appreciation for Option
Term
------------------------------------------------------------------------------------------ -----------------------------------------
% of Total
Options
Number of Securities Granted to
Underlying Options Employees in Exercise
Name Granted (#)(1)(2) 2002 Price ($/Sh) Expiration Date 5%($) 10%($)
------------------- -------------------- -------------- ------------- --------------- ---------- ----------
Richard J. Sullivan 1,200,000 11.9% $0.32 February-08 $130,666 $296,457
2,000,000 19.8 0.28 July-08 190,654 432,592
Scott R. Silverman 1,000,000 9.9 0.32 February-08 108,888 247,048
600,000 5.9 0.28 July-08 57,196 129,778
Jerome C. Artigliere 850,000 8.4 0.32 February-08 92,555 209,990
450,000 4.4 0.28 July-08 42,897 97,333
Michael E. Krawitz 600,000 5.9 0.32 February-08 65,333 148,229
400,000 4.0 0.28 July-08 38,131 86,518
Peter Zhou 150,000 1.5 0.32 February-08 16,333 37,057
50,000 0.5 0.28 July-08 4,766 10,815
<FN>
----------------
(1) These options were granted at an exercise price equal to the fair
market value of our common stock on the date of grant.
(2) Table excludes options granted to the named executives by our
subsidiaries. The table also excludes 23,669 options that were granted
to Mr. Artigliere and 12,657 options that were granted to Mr. Krawitz.
These options were granted under the 1999 Employees Stock Purchase Plan
at a price per share equal to 85% of the fair market value of our
common stock on (i) the date on which the option was granted (i.e., the
first business day of the offering) and (ii) the date on which the
option was exercised (i.e., the last business day of the offering),
whichever is less.
The terms of the 1996 Non-Qualified Stock Option Plan and the 1999
Flexible Stock Plan include change of control provisions. Upon a change of
control, as defined in the plans, all stock options become fully vested,
exercisable or payable.
The following table sets forth information with respect to the Named
Executive Officers concerning the exercise of options during 2002 and
unexercised options held on December 31, 2002:
[Enlarge/Download Table]
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
Number of Securities
Underlying Unexercised Value of Unexercised In-The-Money
Exercised in 2002 Options at Year End 2002(#) Options at Year End 2002($)(2)
------------------------------------- -------------------------------- ---------------------------------
Shares Acquired Value
Name Upon Exercise(#) Realized($)(1) Exercisable Unexercisable Exercisable Unexercisable
--------------------- ------------------ ----------------- ------------- --------------- ------------- ---------------
Richard J. Sullivan 646,297 $171,837 8,285,000(3) 3,300,000(3) $2,154,100 $377,000
Scott R. Silverman -- -- 325,000 1,600,000 84,500 168,000
Jerome C. Artigliere 104,577 4,049 1,029,000 1,300,000 267,540 135,000
Michael E. Krawitz 13,178 828 504,000 1,000,000 131,040 106,000
Peter Zhou 100,000 58,000 112,333 216,667 26,787 24,333
<FN>
---------
(1) The values realized represents the aggregate market value of the shares
covered by the option on the date of exercise less the aggregate
exercise price paid by the executive officer, but do not include
deduction for taxes or other expenses associated with the exercise of
the option or the sale of the underlying shares. Amounts do not include
value realized upon the exercise of stock options issued by our
subsidiaries.
(2) The value of the unexercised in-the-money options at December 31, 2002
assumes a fair market value of $0.41, the closing price of our common
stock as reported on The Nasdaq SmallCap Market on December 31, 2002.
The values shown are net of the option exercise price, but do not
include deduction for taxes or other expenses associated with the
exercise of the option or the sale of the underlying shares.
(3) Includes 600,000 exercisable and 100,000 unexercisable options, which
are owned by Mr. Sullivan's wife.
69
INCENTIVE PLANS
Cash and Stock Incentive Compensation Programs. To reward performance,
the Company provides its executive officers and its divisional executive
officers with additional compensation in the form of a cash bonus and/or
stock awards. No fixed formula or weighting is applied by the Compensation
Committee to corporate performance versus individual performance in
determining these awards. The amounts of such awards are determined by the
Compensation Committee acting in its discretion. Such determination, except
in the case of the award for the Chairman, is made after considering the
recommendations of the Chairman and President and such other matters as the
Compensation Committee deems relevant. The Compensation Committee, acting in
its discretion, may determine to pay a lesser award than the maximum
specified. The amount of the total incentive is divided between cash and
stock at the discretion of the Compensation Committee.
Stock Options and Other Awards Granted under the 1996 Non-Qualified
Stock Option Plan, the 1999 Flexible Stock Plan and the 2003 Flexible Stock
Plan. The 1996 Non-Qualified Stock Option Plan, the 1999 Flexible Stock Plan
and the 2003 Flexible Stock Plan, which is subject to shareholder approval,
are long-term plans designed to link rewards with shareholder value over
time. Stock options are granted to aid in the retention of employees and to
align the interests of employees with shareholders. The value of the stock
options to an employee increases as the price of the Company's stock
increases above the fair market value on the grant date, and the employee
must remain in the Company's employ for the period required for the stock
option to be exercisable, thus providing an incentive to remain in the
Company's employ.
These Plans allow grants of stock options to all of the Company's
employees, including executive officers. Grants to the Company's executive
officers and to officers of the Company's subsidiaries are made at the
discretion of the Compensation Committee. The Compensation Committee may
also make available a pool of options to each subsidiary to be granted at
the discretion of such subsidiary's president.
The 2003 Flexible Stock Plan is also designed to encourage ownership of
the Company's common stock by employees, directors and other individuals,
and to promote and further the best interests of the Company by granting
cash and other stock awards. The Company also intends to grant awards of its
common stock in lieu of payments of cash compensation pursuant to the mutual
agreement of the participant and the Company.
Stock Options Granted under the 1999 Employees Stock Purchase Plan. The
1999 Employees Stock Purchase Plan, which is intended to qualify as an
"employee stock purchase plan" under Section 423 of the Internal Revenue
Code, provides eligible employees with an opportunity to accumulate, through
payroll deductions, funds to be used toward the purchase of the Company's
stock pursuant to options granted under the Plan. Options granted in
connection with an offering under the plan, permit the option holder to
purchase the Company's stock at a price per share equal to 85% of the fair
market value of the stock on (i) the date on which the option is granted
(i.e., the first business day of the offering) and (ii) the date on which
the option is exercised (i.e., the last business day of the offering),
whichever is less. Section 423 of the Internal Revenue Code also provides
certain favorable tax consequences to the option holder, provided that the
stock acquired under the plan is held for a specified minimum period of
time.
Other than as otherwise disclosed herein, the Company has no plans
pursuant to which cash or non-cash compensation was paid or distributed
during the last fiscal year, or is proposed to be paid or distributed in the
future, to the individuals described above.
COMPENSATION OF DIRECTORS
Our non-employee directors receive a fixed quarterly fee in the amount
of $5,000. In addition, non-employee directors receive a quarterly fee in
the amount of $1,000 for each committee of which they are a member.
Reasonable travel expenses are reimbursed when incurred. During 2002,
Messrs. Noterman and Penni and Ms. Weaver each received $28,000 in
additional non-cash compensation in the form of the Company's common stock.
Individuals who become directors are automatically granted an initial option
to purchase 25,000 shares of common stock on the date they become directors.
Each of such options is granted pursuant to our 1996 Non-Qualified Stock
Option Plan or the 1999 Flexible Stock Plan on terms and conditions
determined by the Board of Directors. During 2002, Messrs. Penni and Rawan
and Ms. Weaver were granted 200,000, 25,000 and 200,000 options to
purchase shares of common stock, respectively. Directors who are not also
executive officers are not eligible to participate in any of our other
benefit plans.
70
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
None.
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-
CONTROL ARRANGEMENTS
The Company, or its subsidiary, has entered into an employment
agreement with the following Named Executive Officer:
[Download Table]
-------------------------- ------------ -------------------- ---------------
Name Length Commencing Base Salary
Michael E. Krawitz 5 Years April 12, 1999 185,000(1)
--------------------------
<FN>
(1) Effective April 2003.
The Company has not entered into an employment contract with any of its
other executive officers.
In March 1999, the Company entered into an employment agreement with
Michael Krawitz, Executive Vice President, General Counsel, and Secretary.
The agreement was amended in June 1999 and in April 2000. The agreement
provides that in the event Mr. Krawitz's employment is terminated either by
the Company other than for "cause" or by Mr. Krawitz for "good reason," Mr.
Krawitz will continue to receive his base compensation for the remainder of
the employment term under the agreement as if such termination had not
occurred. Upon any such termination, the payment of any other benefits will
be determined by the Board of Directors in accordance with the Company's
plans, policies and practices.
On March 21, 2003, Richard J. Sullivan, the Company's then Chairman of
the Board of Directors and Chief Executive Officer, retired from such
positions. The Company's Board of Directors negotiated a severance agreement
with Richard Sullivan under which he is to receive a one-time payment of
56.0 million shares of the Company's common stock. In addition, stock
options held by him exercisable for approximately 10.9 million shares of the
Company's common stock were re-priced. Richard Sullivan's severance
agreement provides that the payment of shares and re-pricing of options
provided for under that agreement is in lieu of all future compensation and
other benefits that would have been owed to him under his employment
agreement. His employment agreement required the Company to make payments of
approximately $17.0 million to him, a portion of such payments of which
could be made in either cash or stock, at the Company's option.
On March 21, 2003, Jerome C. Artigliere, the Company's then Senior Vice
President and Chief Operating Officer, resigned from such positions. Under
the terms of his severance agreement, Mr. Artigliere is to receive 4.8
million shares of the Company's common stock. In addition, stock options
held by him exercisable for approximately 2.3 million shares of the
Company's common stock were re-priced. Mr. Artigliere's severance agreement
provides that the payment of shares and re-pricing of options provided under
that agreement is in lieu of all future compensation and other benefits that
would have been owed to him under his employment agreement. His employment
agreement required the Company to make payments of approximately $1.5
million to Mr. Artigliere.
As a result of the termination of Richard Sullivan's employment with
the Company, a "triggering event" provision in the severance agreement the
Company entered into with Garrett Sullivan, the Company's former Vice
Chairman of the Board (who is not related to Richard Sullivan), at the time
of his ceasing to serve in such capacity in December 2001, has been
triggered. The Company recently negotiated a settlement of its obligations
under Garrett Sullivan's severance agreement that requires the Company to
issue to him 7.5 million shares of the Company's common stock on or before
August 31, 2003.
71
BOARD COMPENSATION COMMITTEE REPORT ON
EXECUTIVE COMPENSATION
COMPENSATION COMMITTEE OF THE BOARD
The Compensation Committee is composed of two members of the Board of
Directors. It is the Compensation Committee's responsibility to review,
recommend and approve changes to the Company's compensation policies and
programs. It is also the Committee's responsibility to review and approve
all compensation actions for the Company's executive officers and various
other compensation policies and matters and administer the Company's 1996
Non-Qualified Stock Option Plan, the 1999 Flexible Stock Plan, and the 1999
Employee Stock Purchase Plan, including the review and approval of stock
option grants to the Company's executive officers. If approved, the
Compensation Committee will also administer the Company's 2003 Flexible
Stock Plan.
GENERAL COMPENSATION PHILOSOPHY
The Company's executive compensation programs are designed to enable it to
attract, retain and motivate the Company's executives and those of its
subsidiaries. The Company's general compensation philosophy is that total
cash compensation should vary with the Company's performance in attaining
financial and non-financial objectives and that any long-term incentive
compensation should be closely aligned with the interests of shareholders.
Total cash compensation for the majority of the Company's employees,
including the Company's executive officers, includes a base salary and a
cash bonus based on the Company's profitability and the profitability of its
individual subsidiaries. Long-term incentive compensation is realized
through the granting of stock options to most employees, at the discretion
of the presidents of the Company's divisions, as well as eligible executive
officers.
SETTING EXECUTIVE COMPENSATION
In setting the base salary and individual bonuses (hereafter together
referred to as "BSB") for executives, the Compensation Committee reviews
information relating to executive compensation of U.S. based companies that
are of the same size as the Company. While there is no specific formula that
is used to set compensation in relation to this market data, executive
officer BSB is generally set at or below the median salaries for comparable
jobs in the market place. However, when specific financial and non-financial
goals are met, additional compensation in the form of either cash
compensation or long-term incentive compensation may be paid to the
Company's executive officers.
BASE SALARY
The Compensation Committee reviews the history and proposals for the
compensation package of each of the executive officers, including base
salary. Increases in base salary are governed by three factors: merit (an
individual's performance); market parity (to adjust salaries based on the
competitive market); and promotions (to reflect increases in
responsibility). In assessing market parity, the Company relies on market
surveys of similarly sized publicly traded companies and generally pays
below the median of these companies. The guidelines are set each year and
vary from year to year to reflect the competitive environment and to control
the overall cost of salary growth. Individual merit increases are based on
performance and can range from 0% to 100%.
The salary guidelines for all presidents of the Company's subsidiaries are
generally based upon individually negotiated employment agreements. Merit
increases are submitted by the Company's President to the Compensation
Committee for approval based upon individual performance and the performance
of the subsidiary. Merit increases for non-executive employees are at the
discretion of the presidents of the Company's divisions.
CASH AND STOCK INCENTIVE COMPENSATION PROGRAMS
To reward performance, the Company provides its executive officers and its
divisional executive officers with additional compensation in the form of a
cash bonus and/or stock awards. No fixed formula or weighting is applied by
the Compensation Committee to corporate performance versus individual
performance in determining these awards. The amounts of such awards are
determined by the Compensation Committee acting in its discretion. Such
determination, except in the case of the award for the Chairman, is made
after considering the recommendations of the Chairman and President and such
other matters as the Compensation Committee deems relevant. The Compensation
Committee, acting in its discretion, may determine to pay a lesser award
than the maximum specified. The amount of the total incentive is divided
between cash and stock at the discretion of the Compensation Committee.
72
STOCK OPTIONS AND OTHER AWARDS GRANTED UNDER THE 1996 NON-QUALIFIED STOCK
OPTION PLAN, THE 1999 FLEXIBLE STOCK PLAN AND THE 2003 FLEXIBLE STOCK PLAN
The 1996 Non-Qualified Stock Option Plan, the 1999 Flexible Stock Plan, and
the 2003 Flexible Stock Plan, which the Board of Directors authorized and
recommended that it be submitted to shareholders for approval on May 14,
2003, are long-term plans designed to link rewards with shareholder value
over time. Stock options are granted to aid in the retention of employees
and to align the interests of employees with shareholders. The value of the
stock options to an employee increases as the price of the Company's stock
increases above the fair market value on the grant date, and the employee
must remain in the Company's employ for the period required for the stock
option to be exercisable, thus providing an incentive to remain in the
Company's employ.
These Plans allow grants of stock options to all of the Company's employees,
including executive officers. Grants to the Company's executive officers and
to officers of the Company's subsidiaries are made at the discretion of the
Compensation Committee. The Compensation Committee may also make available a
pool of options to each subsidiary to be granted at the discretion of such
subsidiary's president. In 2002, stock options for the executive officers
were granted upon the recommendation of management and approval of the
Compensation Committee based on their subjective evaluation of the
appropriate amount for the level and amount of responsibility for each
executive officer.
The 2003 Flexible Stock Plan is also intended to encourage ownership of the
Company's common stock by executives and other employees, directors and
other individuals, and to promote and further the best interests of the
Company by granting cash and other stock awards. The Company also intends to
grant awards of its common stock in lieu of payments of cash compensation
pursuant to the mutual agreement of the participant and the Company.
STOCK OPTIONS GRANTED UNDER THE 1999 EMPLOYEE STOCK PURCHASE PLAN
The 1999 Employee Stock Purchase Plan, which is intended to qualify as an
"employee stock purchase plan" under Section 423 of the Internal Revenue
Code, provides eligible employees with an opportunity to accumulate, through
payroll deductions, funds to be used toward the purchase of the Company's
stock pursuant to options granted under the Plan. Options granted in
connection with an offering under the plan, permit the option holder to
purchase the Company's stock at a price per share equal to 85% of the fair
market value of the stock on (i) the date on which the option is granted
(i.e., the first business day of the offering) and (ii) the date on which
the option is exercised (i.e., the last business day of the offering),
whichever is less. Section 423 of the Internal Revenue Code also provides
certain favorable tax consequences to the option holder, provided that the
stock acquired under the plan is held for a specified minimum period of
time.
Other than as otherwise disclosed herein, the Company has no plans pursuant
to which cash or non-cash compensation was paid or distributed during the
last fiscal year, except for plans provided by certain of the Company's
subsidiaries.
DECISIONS ON 2002 COMPENSATION
The Company's compensation program is leveraged towards the achievement of
corporate and business objectives. This pay-for-performance program is most
clearly exemplified in the compensation of the Company's former Chief
Executive Officer, Richard J. Sullivan. Mr. Sullivan's compensation awards
were made based upon the Compensation Committee's assessment of the
Company's financial and non-financial performance. The results were
evaluated based on the overall judgment of the Compensation Committee.
During 2002, the Company paid Mr. Sullivan a base salary of $450,000. Under
the terms of the Company's employment agreement with Mr. Sullivan, the
Company agreed to pay Mr. Sullivan a minimum annual bonus of $140,000.
During 2002, Mr. Sullivan was also granted 3,200,000 stock options at
exercise prices ranging from $0.28 to $0.32 per share.
The Compensation Committee is pleased to submit this report with regard
to the above matters.
Daniel E. Penni, Chairman
Constance K. Weaver
73
PRINCIPAL SHAREHOLDERS
The following table shows information regarding beneficial ownership of
our common stock as of June 16, 2003, and as adjusted to reflect the sale of
the common stock in this offering for:
o each of our directors and named executive officers;
o all directors and executive officers as a group; and
[Enlarge/Download Table]
BEFORE OFFERING AFTER OFFERING
-------------------------------------------- -------------------------------------
NUMBER OF
SHARES OF PERCENT OF NUMBER OF PERCENT OF
COMMON COMMON SHARES OF COMMON
STOCK STOCK COMMON STOCK STOCK
BENEFICIALLY BENEFICIALLY BENEFICIALLY BENEFICIALLY
NAME OF BENEFICIAL OWNER OWNED(1) OWNED OWNED(1) OWNED
------------------------ -------- ----- -------- -----
Scott R. Silverman 1,925,000 *% 1,925,000 *%
400 Royal Palm Way, Palm Beach, FL 33480
Daniel E. Penni 1,949,065 * 1,949,065 *
260 Eliot Street, Ashland, MA 01721
Dennis G. Rawan -- * -- *
400 Royal Palm Way, Palm Beach, FL 33480
Constance K. Weaver 1,223,000 * 1,223,000 *
295 North Maple Ave, Basking Ridge, NJ 07920
Michael S. Zarriello -- * -- *
400 Royal Palm Way, Palm Beach, FL 33480
Kevin H. McLaughlin 402,333 * 402,333 *
400 Royal Palm Way, Palm Beach, FL 33480
Michael E. Krawitz 1,559,567 * 1,559,567 *
400 Royal Palm Way, Palm Beach, FL 33480
Evan C. McKeown 234,327 * 234,327 *
400 Royal Palm Way, Palm Beach, FL 33480
Peter Zhou 352,526 * 352,526 *
5750 Division Street, Riverside, CA 92506
All directors and executive officers as
a group (10 persons) 8,047,989 2.2% 8,047,989 2.2%
<FN>
---------
* Represents less than 1% of the issued and outstanding shares of our
common stock.
(1) This table includes presently exercisable stock options. The following
directors and executive officers hold the number of exercisable options
set forth following their respective names: Scott R. Silverman -
1,925,000; Daniel E. Penni - 1,164,000; Constance K. Weaver - 989,000;
Kevin H. McLaughlin - 391,333; Michael E. Krawitz - 1,504,000; Evan C.
McKeown - 233,334; Peter Zhou - 329,000; and all directors and officers as
a group - 6,909,667.
74
RELATED PARTY TRANSACTIONS
INDEBTEDNESS OF MANAGEMENT
Daniel E. Penni, a member of the Company's Board of Directors, has
executed a revolving line of credit promissory note in favor of Applied
Digital Solutions Financial Corp., the Company's subsidiary, in the amount
of $450,000. The promissory note is payable on demand, with interest payable
monthly on the unpaid principal balance at the rate equal to one percentage
point above the base rate announced by State Street Bank and Trust Company
(which interest rate shall fluctuate contemporaneously with changes in such
base rate). The largest principal amount outstanding under the promissory
note during 2002 was $420,000, and as of May 12, 2003, $420,000 had been
advanced under this note.
Mr. Richard Sullivan, our former Chairman of the Board, Chief Executive
Officer and Secretary, executed a promissory note in our favor in the amount
of $59,711. The promissory note was payable on demand and interest accrued
at a rate of 7.0% per annum. The largest amount outstanding under the
promissory note during 2002 was $59,711, plus accrued interest, and on March
21, 2003, this note was paid in full.
On September 27, 2000, the following named executive officers and
directors exercised options granted to them under the Company's 1999
Flexible Stock Plan to purchase shares of the Company's common stock. Under
the terms of the grant, the named executive officers each executed and
delivered a non-recourse, interest bearing promissory note and stock pledge
agreement to the Company in consideration for the purchase of the shares
(the officers and directors received no cash proceeds from these loans) as
follows:
[Download Table]
Named Executive Officer Amount Interest Rate Due Date
----------------------- ------ ------------- --------
Richard J. Sullivan $1,375,000 6.0% September 27, 2003
Kevin H. McLaughlin 30,250 6.0 September 27, 2003
Jerry C. Artigliere 57,750 6.0 September 27, 2003
Michael E. Krawitz 57,750 6.0 September 27, 2003
Peter Zhou 57,750 6.0 September 27, 2003
Directors Amount Interest Rate Due Date
--------- ------ ------------- --------
Daniel E. Penni $236,500 6.0% September 27, 2003
Constance K. Weaver 236,500 6.0 September 27, 2003
In September 2000, when the loans were originated, the Company notified
these officers and directors that we intended to pay their annual interest
as part of their compensation expense/directors remuneration and to provide
a gross-up for the associated income taxes. Annual interest payments were
due on September 27, 2001 and September 27, 2002. The Company has chosen not
to pay the interest and related tax gross-up. The Company, therefore,
considers such notes to be in default and is in the process of foreclosing
on the underlying collateral (all of the stock) in satisfaction of the
notes. The Company's decision to take this action relates in part to the
passage of the recent corporate reform legislation under the Sarbanes-Oxley
Act of 2002, which, among other things, prohibits further extension of
credit to officers and directors.
Marc Sherman, the former Chief Executive Officer of Intellesale, Inc.
and brother-in-law of Constance Weaver, a member of the Company's Board of
Directors, has executed six promissory notes in the aggregate amount of
$595,000. The promissory notes are due on demand and bear interest at the
rate of 6% per annum. Mr. Sherman was also indebted to the Company under a
mortgage note with a principal balance of $825,000. During 2001, the
75
highest balance outstanding on the note was $345,119. The note, which had an
interest rate equal to the prime rate published by the Wall Street Journal
plus 1%, was paid in full in May 2001. In addition, Mr. Sherman is indebted
to the Company under a non-interest bearing promissory note in the amount of
$200,000, the proceeds of which were used by Mr. Sherman to acquire 100,000
shares of the Company's common stock. This note is due upon the sale of the
Company's common stock by Mr. Sherman.
CHANGE IN CONTROL
Except as provided with respect to the IBM Credit Agreement and related
Forbearance Agreement, there are no arrangements known to us, including any
pledge by any person of securities of us, the operation of which may at a
subsequent date result in a change in control of us.
SARBANES-OXLEY ACT OF 2002
The Sarbanes-Oxley Act of 2002, referred to herein as the Act, makes it
unlawful for a public company to make material modifications to any existing
loans made to its executive officers and directors. The Act does not provide
guidance as to whether a company's election not to make demand on a demand
promissory note will be deemed a material modification.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
During 2002, the Company granted 10,126,000 options under its 1999
Flexible Stock Plan and 1996 Non-Qualified Stock Option Plan. As of December
31, 2002, the following shares of the Company's common stock were authorized
for issuance under the Company's equity compensation plans:
[Enlarge/Download Table]
EQUITY COMPENSATION PLAN INFORMATION
(a) (b) (c)
Plan Category (1) Number of securities to Weighted-average Number of securities
be issued upon exercise exercise price remaining available for
of outstanding options, per share of future issuance under
warrants and rights outstanding equity compensation
options, warrants plans (excluding
and rights securities reflected in
column (a))
Equity compensation plans
approved by security holders 34,039,000 $0.71 7,183,000 (2) (3)
Equity compensation plans not
approved by security holders -- -- --
----------------------------------------------------------------------------------
Total 34,039,000 $0.71 7,183,000
------------------------------- ==================================================================================
<FN>
(1) A narrative description of the material terms of the Company's equity
compensation plans is set forth in Note 13 to the Company's
consolidated financial statements, which are set forth in the Company's
Annual Report on Form 10-K/A filed with the Securities and Exchange
Commission on April 4, 2003.
(2) In addition to the shares available for future issuance reflected in
the above table, the shares available for future issuance under the
2003 Flexible Stock Plan, if approved, would be 14,000,000.
(3) Includes 6,900,000 shares available for future issuance under the
Company's 1999 Employees Stock Purchase Plan.
76
DESCRIPTION OF CAPITAL STOCK
The following description of our capital stock is subject to The
General and Business Corporation Law of Missouri and to provisions contained
in our Articles of Incorporation and Bylaws, copies of which are exhibits to
our registration statement on Form S-1 of which this prospectus is a part
and which are incorporated by reference into this prospectus. Reference is
made to such exhibits for a detailed description of the provisions thereof
summarized below.
AUTHORIZED CAPITAL
Our authorized capital stock consists of 435,000,000 shares of common
stock, $.001 par value, and 5,000,000 shares of preferred stock, $10.00 par
value. Holders of our common stock have no preemptive or other subscription
rights.
COMMON STOCK
As of June 18, 2003, there were 350,759,635 shares of our common stock
outstanding and approximately 2,445 holders of record of our common stock.
The holders of our common stock are entitled to one vote per share on
all matters submitted to a vote of the shareholders. Holders of our common
stock do not have cumulative voting rights. Therefore, holders of more than
50% of the shares of our common stock are able to elect all directors
eligible for election each year. The holders of common stock are entitled to
dividends and other distributions out of assets legally available if and
when declared by our board of directors. Upon our liquidation, dissolution
or winding up, the holders of our common stock are entitled to share pro
rata in the distribution of all of our assets remaining available for
distribution after satisfaction of all liabilities, including any prior
rights of any preferred stock which may be outstanding. There are no
redemption or sinking fund provisions applicable to our common stock.
The transfer agent and registrar for common stock is The Registrar and
Transfer Co.
PREFERRED STOCK
Preferred stock may be created and issued from time to time by our
board of directors, with such rights and preferences as it may determine.
Because of its broad discretion with respect to the creation and issuance of
any series of preferred stock without shareholder approval, our board of
directors could adversely affect the voting power of our common stock. The
issuance of preferred stock may also have the effect of delaying, deferring
or preventing a change in control of us.
OPTIONS AND WARRANTS
As of June 16, 2003, there were:
o 5,789,428 issued and outstanding warrants to purchase shares of
our common stock at a weighted average exercise price of $0.15 per
share;
o warrants issued in connection with the sale of Series C preferred
stock to purchase up to 828,341 shares of our common stock at
$4.57 per share, subject to adjustment; and
o options held by our employees and others to purchase 19,459,170
shares of our common stock at a weighted average exercise price of
$1.16 per share.
77
All of the warrants are currently exercisable. Of the outstanding
options, 17,110,206 options are now exercisable at a weighted average
exercise price of $1.21 per share, and the rest become exercisable at
various times over the next three years.
The exercise price of the warrants issued in connection with the Series
C preferred stock is $4.57 per share, subject to adjustment upon:
o the issuance of shares of common stock, or options or other rights
to acquire common stock, at an issuance price lower than the
exercise price under the warrants;
o the declaration or payment of a dividend or other distribution on
our common stock;
o issuance of any other of our securities on a basis which would
otherwise dilute the purchase rights granted by the warrants.
The exercise price may be paid in cash, in shares of common stock or by
surrendering other warrants.
INDEMNIFICATION
Our bylaws require us to indemnify each of our directors and officers
to the fullest extent permitted by law. An amendment to such article does
not affect the liability of any director for any act or omission occurring
prior to the effective time of such amendment.
PRICE RANGE OF COMMON STOCK AND DIVIDEND INFORMATION
Our common stock has traded on the SmallCap since November 12, 2002,
under the symbol "ADSX." Prior to November 12, 2002, our common stock traded
on the Nasdaq National Market at all times, except for the period between
July 12, 2002 and July 30, 2002, when our common stock traded on the Pink
Sheets under the symbol "ADSX.PK."
The following table shows, for the periods indicated, the high and low
sale prices per share of the common stock based on published financial
sources.
[Download Table]
HIGH LOW
---- ---
2001
----
First Quarter $ 2.97 $0.75
Second Quarter 1.75 0.39
Third Quarter 0.48 0.11
Fourth Quarter 0.67 0.18
2002
----
First Quarter $ 0.55 $0.28
Second Quarter 2.40 0.29
Third Quarter 0.84 0.03
Fourth Quarter 0.70 0.36
2003
----
First Quarter $0.64 $ .18
Second Quarter (through June 17, 2003) 0.55 0.35
78
DIVIDENDS
We have never paid cash dividends on our common stock. Our existing
credit agreement with IBM Credit provides that we may not declare or pay any
dividend, other than dividends payable solely in our common stock, on any
shares of any class of our capital stock or any warrants, options or rights
to purchase any such capital stock, or make any other distribution in
respect of such stock or other securities, whether in cash, property or
other obligations of us.
PLAN OF DISTRIBUTION
As of the date of this prospectus, we have entered into a placement
agency agreement with J.P. Carey Securities Inc., a registered broker-dealer
and member of the National Association of Securities Dealers (the "NASD").
J.P. Carey Securities is an "underwriter" within the meaning of Section
2(a)(11) of the Securities Act of 1933. Under the terms of that agreement,
J.P. Carey Securities has agreed to sell the 57,200,000 shares of our stock
being offered by this prospectus on a "best efforts" basis. As such, J.P.
Carey Securities has no obligation to take or purchase any of the shares.
Further, the agreement with J.P. Carey Securities does not ensure the
successful placement of any of the shares. We have agreed to pay J.P. Carey
Securities a fee of 3% percent of the gross subscription proceeds of the
shares sold to purchasers identified (or deemed to be identified) to us by
J.P. Carey Securities. The proceeds from the sales of our shares may be
placed in an escrow account, out of which the fees due J.P. Carey Securities
are to be paid, and subject to the escrow procedures provided below.
Notwithstanding our agreement with J.P. Carey Securities, we may retain
other broker-dealers to advise and assist in the distribution of the shares
in the offering.
An aggregate of 50,000,000 shares of our common stock, par value $.001
per share, have been sold in this offering as of the date of this prospectus
for an average net offering price of $0.3564 per share. These shares have
been purchased under the securities purchase agreements with each of
Cranshire Capital, L.P. and Magellan International Ltd., dated May 8, 2003,
May 22, 2003 and June 4, 2003, including 20,500,000 shares purchased by
Cranshire Capital, L.P. and 29,500,000 shares purchased by Magellan
International Ltd., resulting in net proceeds to us of $17,821,116.45, after
deduction of the 3% fee to our placement agent, J.P. Carey Securities, Inc.
Each of Cranshire Capital, L.P. and Magellan International Ltd. may be
deemed to be an "underwriter" within the meaning of Section 2(a)(11) of the
Securities Act of 1933, in connection with its sale of any shares acquired
under the respective securities purchase agreements. Broker-dealers or other
persons acting on account of either of them or each other may also be deemed
to be underwriters. Underwriters and entities acting on their behalf would
not be able to resell the shares purchased from us in reliance on the
exemption from registration provided by Section 4(1) of the Securities Act
of 1933.
Notwithstanding our agreement with J.P. Carey Securities, we may retain
other broker-dealers to advise and assist in the distribution of the
remaining shares in the offering.
Subject to the requirements of the Securities Act of 1933 and
applicable state securities laws, J.P. Carey Securities plans to offer and
sell the shares in specific states in which the shares are registered or are
exempt from registration, following the procedures for subscribing as
outlined in this prospectus, and in compliance with Regulation M. J.P. Carey
Securities will offer the shares by prospectus to, among other persons,
prospective investors who have indicated an interest in the offering.
The agreement with J.P. Carey provides that it will automatically
terminate on July 30, 2003. In the event of such termination, we would
remain liable to pay J.P. Carey the fees actually earned that the agreement
provides we are to pay. We have also agreed to indemnify J.P. Carey
Securities against liabilities, including liabilities under the Securities
Act of 1933, as amended. The offering will remain open for at least as long
as the placement agency agreement remains in effect. While we have no plans
to extend the period of the offering beyond that time period, we may decide,
in our sole discretion, to do so. J.P. Carey Securities may engage other
broker-dealers to assist in the selling efforts but in no event will we pay
any broker-dealer fees or commissions in excess of 8%. The commissions to be
paid to any such broker-dealers will be at a rate to be determined by J.P.
Carey Securities and will be subject to and in accordance with NASD rules
and regulations. Any broker-dealers that participate in the distribution of
the shares offered by this prospectus may be deemed to be "underwriters"
within the meaning of the Securities Act of 1933, and any underwriting
discounts, commissions or fees received by such persons and any profit on
the resale of the shares purchased by such persons may be deemed to be
underwriting commissions or discounts under the Securities Act of 1933.
79
We will have use of any proceeds received once a subscription agreement
or other form of stock purchase agreement is executed and delivered to us
and the funds have been delivered directly to us or have been released from
escrow, as the case may be. Should we and J.P. Carey Securities elect to
utilize the escrow procedure, all funds received by J.P. Carey Securities,
in its capacity as placement agent, will be immediately deposited (by Noon
on the first business day after receipt) in the escrow account with an
acceptable institution as escrow agent, under the terms of an escrow
agreement entered into by us, J.P. Carey Securities and the escrow agent.
The proceeds of the offering shall be non-refundable except as may be
required by applicable law. We reserve the right to reject any subscription
in whole or in part, or to allot to any prospective investor less than the
number of shares subscribed for by such investor.
Our shares are covered by Section 15(g) of the Exchange Act and Rules
15g-1 through 15g-6 promulgated thereunder. These rules impose additional
sales practice requirements on broker/dealers who sell our securities to
persons other than established customers and accredited investors (generally
institutions with assets in excess of $5,000,000 or individuals with net
worth in excess of $1,000,000 or annual income exceeding $200,000 or
$300,000 jointly with their spouses).
Rule 15g-1 exempts a number of specific transactions from the scope of
the penny stock rules. Rule 15g-2 declares unlawful broker/dealer
transactions in penny stocks unless the broker broker/dealer has first
provided to the customer a standardized disclosure document. Rule 15g-3
provides that it is unlawful for a broker/dealer to engage in a penny stock
transaction unless the broker/dealer first discloses and subsequently
confirms to the customer current quotation prices or similar market
information concerning the penny stock in question. Rule 15g-4 prohibits
broker/dealers from completing penny stock transactions for a customer
unless the broker/dealer first discloses to the customer the amount of
compensation or other remuneration received as a result of the penny stock
transaction. Rule 15g-5 requires that a broker/dealer executing a penny
stock transaction, other than one exempt under Rule 15g-1, disclose to its
customer, at the time of or prior to the transaction, information about the
sales person's compensation. Rule 15g-6 requires broker/dealers selling
penny stocks to provide their customers with monthly account statements. The
application of the penny stock rules may affect your ability to resell your
shares.
LEGAL MATTERS
Holland & Knight LLP (a registered limited liability partnership),
Miami, Florida, relying on the opinion of special Missouri counsel, has
issued an opinion as to the legality of the common stock.
EXPERTS
The consolidated financial statements of Applied Digital Solutions,
Inc. and subsidiaries as of December 31, 2002 and for the year ended
December 31, 2002, included in this prospectus have been so included in
reliance on the report (which contains an explanatory paragraph relating to
our ability to continue as a going concern as described in Notes 1 and 2 to
the financial statements) of Eisner LLP, independent accountants, given on
the authority of said firm as experts in auditing and accounting.
The consolidated financial statements of Applied Digital Solutions,
Inc. and subsidiaries as of December 31, 2001 and for each of the two years
in the period ended December 31, 2001, included in this prospectus have been
so included in reliance on the report (which contains an explanatory
paragraph relating to our ability to continue as a going concern as
described in Notes 1 and 2 to the financial statements) of
PricewaterhouseCoopers LLP, independent accountants, given on the authority
of said firm as experts in auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement, of which this prospectus is a
part, with the SEC under the Securities Act with respect to our common
stock. This prospectus, which constitutes a part of the registration
statement, does not contain all of the information set forth in the
registration statement, parts of which are omitted as permitted by the rules
and regulations of the SEC. Statements contained in this prospectus as to
the contents of any contract or other document are not necessarily complete.
For further information pertaining to us and our common stock, we
80
refer you to our registration statement and the exhibits thereto, copies of
which may be inspected without charge at the SEC's Public Reference Room,
450 Fifth Street, N.W., Washington, D.C. 20549. Information concerning the
operation of the SEC's Public Reference Room is available by calling the SEC
at 1-800-SEC-0330. Copies of all or any part of the registration statement
may be obtained at prescribed rates from the SEC. The SEC also makes our
filings available to the public on its Internet site (http:\\www.sec.gov).
Quotations relating to our common stock appear on Nasdaq, and such reports,
proxy statements and other information concerning us can also be inspected
at the offices of the National Association of Securities Dealers, Inc., 1735
K Street, N.W., Washington, D.C. 20006.
We file annual, quarterly and special reports, proxy statements and
other information with the SEC. Such periodic reports, proxy and information
statements and other information are available for inspection and copying at
the public reference facilities and Internet site of the SEC referred to
above.
WE HAVE NOT AUTHORIZED ANYONE TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATION CONCERNING THIS OFFERING EXCEPT THE INFORMATION AND
REPRESENTATIONS WHICH ARE CONTAINED IN THIS PROSPECTUS OR WHICH ARE
INCORPORATED BY REFERENCE IN THIS PROSPECTUS. IF ANYONE GIVES OR MAKES ANY
OTHER INFORMATION OR REPRESENTATION, YOU SHOULD NOT RELY ON IT. THIS
PROSPECTUS IS NOT AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO
PURCHASE, ANY SECURITIES OTHER THAN THOSE TO WHICH IT RELATES, NOR DOES IT
CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO PURCHASE BY ANY
PERSON IN ANY CIRCUMSTANCES IN WHICH AN OFFER OR SOLICITATION IS UNLAWFUL.
YOU SHOULD NOT INTERPRET THE DELIVERY OF THIS PROSPECTUS OR ANY SALE MADE
HEREUNDER AS AN INDICATION THAT THERE HAS BEEN NO CHANGE IN OUR AFFAIRS
SINCE THE DATE OF THIS PROSPECTUS. YOU SHOULD ALSO BE AWARE THAT THE
INFORMATION IN THIS PROSPECTUS MAY CHANGE AFTER THIS DATE.
81
APPLIED DIGITAL SOLUTIONS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
CONTENTS
========================================================================
PAGE
REPORT OF MANAGEMENT F-2
REPORTS OF INDEPENDENT ACCOUNTANTS F-3
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2002 AND 2001 F-5
CONSOLIDATED STATEMENTS OF OPERATIONS FOR EACH OF THE YEARS
IN THE THREE YEAR PERIOD ENDED DECEMBER 31, 2002 F-6
CONSOLIDATED STATEMENTS OF PREFERRED STOCK, COMMON STOCK
AND OTHER STOCKHOLDERS' (DEFICIT) EQUITY FOR EACH OF THE
YEARS IN THE THREE YEAR PERIOD ENDED DECEMBER 31, 2002 F-7
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR EACH OF THE YEARS
IN THE THREE YEAR PERIOD ENDED DECEMBER 31, 2002 F-10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-11
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS F-57
UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL
INFORMATION:
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF MARCH 31,
2003 (UNAUDITED) AND DECEMBER 31, 2002 F-58
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE
THREE-MONTHS ENDED MARCH 31, 2003 AND 2002 (UNAUDITED) F-59
CONDENSED CONSOLIDATED STATEMENTS OF PREFERRED STOCK,
COMMON STOCK AND OTHER STOCKHOLDERS' EQUITY FOR THE
THREE-MONTHS ENDED MARCH 31, 2003 (UNAUDITED) F-60
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE
THREE-MONTHS ENDED MARCH 31, 2003 AND 2002 (UNAUDITED) F-61
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) F-62
Page F-1
REPORT OF MANAGEMENT
Management is responsible for the preparation, integrity and objectivity
of the accompanying financial statements and related information. These
statements have been prepared in conformity with accounting principles
generally accepted in the United States of America, and include amounts
that are based on our best judgments with due consideration given to
materiality.
Management maintains a system of internal accounting controls. The
system is designed to provide reasonable assurance, at reasonable cost,
that assets are safeguarded and that transactions and events are
recorded properly. The internal accounting control system is augmented
by appropriate reviews by management, written policies and guidelines,
careful selection and training of qualified personnel and a written Code
of Business Conduct adopted by the Company's Board of Directors,
applicable to all employees of the Company and its subsidiaries. In our
opinion, the Company's internal accounting controls provide reasonable
assurance that assets are safeguarded against material loss from
unauthorized use or disposition and that the financial records are
reliable for preparing financial statements and other data and for
maintaining accountability of assets.
Eisner LLP, the Company's independent accountants, were recommended by
the Audit Committee of the Board of Directors and selected by the Board
of Directors. Eisner LLP maintains an understanding of internal controls
and conducts such tests and other auditing procedures considered
necessary in the circumstances to express their opinion in the report
that follows.
The Audit Committee of the Company's Board of Directors meets with the
independent accountants, management and internal auditors periodically
to discuss internal accounting controls and auditing and financial
reporting matters. The Committee reviews with the independent
accountants, the scope and results of the audit effort. The Committee
also meets periodically with the independent accountants and the
director of internal audit without management present to ensure that the
independent accountants and the director of internal audit have free
access to the Committee.
SCOTT R. SILVERMAN EVAN C. MCKEOWN
Chairman of the Board of Directors, Vice President and
Chief Executive Officer and President Chief Financial Officer
March 31, 2003
Page F-2
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Stockholders
Applied Digital Solutions, Inc.
We have audited the accompanying consolidated balance sheet of Applied
Digital Solutions, Inc. and subsidiaries (the "Company") as of
December 31, 2002, and the related consolidated statements of
operations, preferred stock, common stock and other stockholders' equity
and cash flows for the year then ended. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that
we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Applied Digital Solutions, Inc. and subsidiaries as of December 31,
2002, and the consolidated results of their operations and their
consolidated cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of
America.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As
discussed in Note 2 to the consolidated financial statements, the
Company has experienced a substantial net loss, has a working capital
deficit, a net capital deficiency and was informed by a lender that the
Company was in default on its loan agreement. These matters, among
others, raise substantial doubt about its ability to continue as a going
concern. Management's plans in regard to these matters are also
described in Note 2. The consolidated financial statements do not
include any adjustments that might result from the outcome of this
uncertainty.
As discussed in Note 1 to the consolidated financial statements, in
2002, the Company adopted the new standard addressing financial
accounting and reporting for goodwill subsequent to an acquisition.
In connection with our audit of the financial statements referred to
above, we audited the financial schedule of Valuation and Qualifying
Accounts for 2002. In our opinion, this financial schedule, when
considered in relation to the financial statements taken as a whole,
presents fairly, in all material respects, the information stated
therein.
Eisner LLP
New York, New York
March 27, 2003
Page F-3
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Applied Digital Solutions, Inc.
In our opinion, the consolidated financial statements as of December 31,
2001 and for the years ended December 31, 2001 and 2000 listed in the
index appearing on page F-1, present fairly, in all material respects,
the financial position of Applied Digital Solutions, Inc. and its
subsidiaries at December 31, 2001 and the results of their operations
and their cash flows for each of the two years in the period ended
December 31, 2001 in conformity with accounting principles generally
accepted in the United States of America. In addition, in our opinion,
the financial statement schedule for the years ended December 31, 2001
and 2000 listed in the index on page F-1 presents fairly, in all
material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements. These
financial statements and financial statement schedule are the
responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in
the United States of America, which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Notes 1and
2 to the financial statements, the Company has suffered significant
losses from continuing operations and discontinued operations and was in
violation of certain covenants and payment obligations of its debt
agreement at December 31, 2001. The Company amended its credit agreement
on March 27, 2002. This debt agreement requires the Company to maintain
compliance with certain covenants. In order to maintain compliance with
these covenants, the Company will be required to substantially improve
its operating results in 2002. If the Company violates these covenants
in 2002, it could result in the lender's declaration that amounts are
due and immediately payable. These factors raise substantial doubt about
the Company's ability to continue as a going concern. Management's plans
in regard to these matters are also discussed in Note 2. The financial
statements do not include any adjustments that might result from the
outcome of this uncertainty.
PricewaterhouseCoopers LLP
St. Louis, Missouri
March 27, 2002, except for the segment
information for 2001 and 2000 as included in Note 25,
which is as of August 23, 2002, and Note 19,
which is as of May 30, 2003.
Page F-4
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APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE)
ASSETS DECEMBER 31,
--------------------------
2002 2001
--------------------------
CURRENT ASSETS
Cash and cash equivalents $ 5,818 $ 3,696
Due from buyers of divested subsidiaries -- 2,625
Accounts receivable and unbilled receivables (net of allowance
for doubtful accounts of $1,263 in 2002 and $2,581 in 2001) 16,548 21,871
Inventories 6,409 6,174
Notes receivable 2,801 2,256
Other current assets 2,920 4,786
----------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 34,496 41,408
PROPERTY AND EQUIPMENT, NET 9,822 20,185
NOTES RECEIVABLE, NET 758 4,004
GOODWILL, NET 67,818 90,831
INVESTMENT IN AFFILIATE -- 6,779
OTHER ASSETS, NET 4,339 4,282
----------------------------------------------------------------------------------------------------------------
$ 117,233 $ 167,489
================================================================================================================
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
CURRENT LIABILITIES
Notes payable and current maturities of long-term debt $ 81,879 $ 83,836
Accounts payable 9,761 15,441
Accrued interest 10,149 2,173
Other accrued expenses 19,145 15,006
Put accrual 200 200
Net liabilities of Discontinued Operations 9,368 9,460
----------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 130,502 126,116
LONG-TERM DEBT AND NOTES PAYABLE 3,346 2,586
OTHER LONG-TERM LIABILITIES 1,055 1,028
----------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 134,903 129,730
----------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES
----------------------------------------------------------------------------------------------------------------
MINORITY INTEREST 18,422 4,460
----------------------------------------------------------------------------------------------------------------
REDEEMABLE PREFERRED STOCK OPTIONS - SERIES C -- 5,180
----------------------------------------------------------------------------------------------------------------
PREFERRED STOCK, COMMON STOCK AND OTHER STOCKHOLDERS' (DEFICIT) 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 435,000 shares in 2002 and 345,000 shares in 2001 of
$.001 par value; 285,069 shares issued and 284,134 shares outstanding in 2002
and 252,449 shares issued and 251,514 shares outstanding in 2001 285 252
Additional paid-in capital 377,621 342,189
Accumulated deficit (417,066) (304,581)
Common stock warrants 5,650 3,293
Treasury stock (carried at cost, 935 shares in 2002 and 2001) (1,777) (1,777)
Accumulated other comprehensive income (loss) 31 (747)
Notes received for shares issued (836) (10,510)
----------------------------------------------------------------------------------------------------------------
TOTAL PREFERRED STOCK, COMMON STOCK, AND OTHER STOCKHOLDERS' (DEFICIT) EQUITY (36,092) 28,119
----------------------------------------------------------------------------------------------------------------
$ 117,233 $ 167,489
================================================================================================================
See the accompanying notes to consolidated financial statements.
------------------------------------------------------------------------------
Page F-5
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APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------
2002 2001 2000
-------------------------------------------
PRODUCT REVENUE $ 80,936 $ 113,147 $ 104,759
SERVICE REVENUE 18,664 43,167 30,007
------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUE 99,600 156,314 134,766
COSTS OF PRODUCTS SOLD 58,395 86,670 68,899
COST OF SERVICES SOLD 9,323 23,169 13,576
------------------------------------------------------------------------------------------------------------------------------
GROSS PROFIT 31,882 46,475 52,291
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE 66,450 102,316 61,996
RESEARCH AND DEVELOPMENT EXPENSE 3,518 8,610 2,504
INTEREST AND NON-CASH CHARGES:
GAIN ON EXTINGUISHMENT OF DEBT 9,465
ASSET IMPAIRMENT 69,382 71,719 6,383
DEPRECIATION AND AMORTIZATION 4,773 28,899 11,073
(GAIN) LOSS ON SALE OF SUBSIDIARIES AND BUSINESS ASSETS (132) 6,058 (486)
INTEREST AND OTHER INCOME (2,356) (2,076) (1,095)
INTEREST EXPENSE 17,524 8,555 5,901
------------------------------------------------------------------------------------------------------------------------------
LOSS FROM CONTINUING OPERATIONS BEFORE PROVISION (BENEFIT)
FOR INCOME TAXES AND MINORITY INTEREST (127,277) (168,141) (33,985)
PROVISION (BENEFIT) FOR INCOME TAXES 326 20,870 (5,040)
------------------------------------------------------------------------------------------------------------------------------
LOSS FROM CONTINUING OPERATIONS BEFORE MINORITY INTEREST (127,603) (189,011) (28,945)
MINORITY INTEREST (18,474) (718) 229
NET LOSS ON SUBSIDIARY MERGER TRANSACTION, STOCK ISSUANCES AND LOSS ON SALE OF
SUBSIDIARY STOCK 4,485 -- --
EQUITY IN NET LOSS OF AFFILIATE 291 328 --
------------------------------------------------------------------------------------------------------------------------------
LOSS FROM CONTINUING OPERATIONS (113,905) (188,621) (29,174)
INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF INCOME TAXES
(BENEFIT) OF $0 IN 2002, $0 IN 2001 AND $(13,614) IN 2000 -- 213 (75,702)
CHANGE IN ESTIMATE ON LOSS ON DISPOSAL AND OPERATING
LOSSES DURING THE PHASE OUT PERIOD 1,420 (16,695) (7,266)
------------------------------------------------------------------------------------------------------------------------------
NET LOSS (112,485) (205,103) (112,142)
PREFERRED STOCK DIVIDENDS AND OTHER -- 1,147 191
ACCRETION OF BENEFICIAL CONVERSION FEATURE OF
REDEEMABLE PREFERRED STOCK - SERIES C -- 9,392 3,857
------------------------------------------------------------------------------------------------------------------------------
NET LOSS AVAILABLE TO COMMON SHAREHOLDERS $(112,485) $(215,642) $(116,190)
==============================================================================================================================
EARNINGS (LOSS) PER COMMON SHARE - BASIC AND DILUTED
LOSS FROM CONTINUING OPERATIONS $ (0.42) $ (1.17) $ (.52)
(LOSS) INCOME FROM DISCONTINUED OPERATIONS -- (.10) (1.30)
------------------------------------------------------------------------------------------------------------------------------
NET LOSS PER COMMON SHARE - BASIC AND DILUTED $ (0.42) $ (1.27) $ (1.82)
==============================================================================================================================
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING -
BASIC AND DILUTED 269,232 170,009 63,825
==============================================================================================================================
See the accompanying notes to consolidated financial statements.
------------------------------------------------------------------------------
Page F-6
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APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF PREFERRED STOCK
COMMON STOCK AND OTHER STOCKHOLDERS' (DEFICIT) EQUITY
PAGE 1 OF 3
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(IN THOUSANDS)
RETAINED
PREFERRED STOCK COMMON STOCK ADDITIONAL EARNINGS
---------------------------------------------- PAID-IN (ACCUMULATED
NUMBER AMOUNT NUMBER AMOUNT CAPITAL DEFICIT)
-------------------------------------------------------------------------
BALANCE - DECEMBER 31, 1999 -- $-- 51,116 $ 51 $ 87,470 $ 12,664
(BROUGHT FORWARD)
Net loss -- -- -- -- -- (112,142)
Comprehensive loss -
Foreign currency translation -- -- -- -- -- --
------------
Total comprehensive loss -- -- -- -- -- (112,142)
Issuance of warrants attached to
redeemable preferred shares -- -- -- -- -- --
Accretion of beneficial conversion
feature of redeemable preferred
shares -- -- -- -- (3,857) --
Dividends accrued on redeemable
preferred stock -- -- -- -- (191) --
Beneficial conversion feature of
redeemable preferred stock -- -- -- -- 3,857 --
Issuance of common shares -- -- 1,862(1) 2 4,838 --
Issuance of common shares for
investment in MAS -- -- 3,123 3 7,997 --
Issuance of common shares for
acquisitions -- -- 46,226 46 160,273 --
Issuance of common stock warrants
for acquisition -- -- -- -- -- --
Warrants redeemed for common shares -- -- 736 1 2,118 --
Notes receivable for shares issued -- -- -- -- -- --
Tax effect of exercise of
nonqualified stock options -- -- -- -- 4,068 --
-------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2000
(CARRIED FORWARD) -- $-- 103,063 $ 103 $ 266,573 $ (99,478)
ACCUMULATED
COMMON OTHER NOTES TOTAL
STOCK TREASURY COMPREHENSIVE RECEIVED FOR STOCKHOLDERS'
WARRANTS STOCK (LOSS) INCOME SHARES ISSUED EQUITY
-----------------------------------------------------------------------
BALANCE - DECEMBER 31, 1999 $ -- $ (7,313) $ 64 $ -- $ 92,936
(BROUGHT FORWARD)
Net loss -- -- -- -- (112,142)
Comprehensive loss -
Foreign currency translation -- -- (793) -- (793)
------------ -------------
Total comprehensive loss -- -- (793) -- (112,935)
Issuance of warrants attached to
redeemable preferred shares 627 -- -- -- 627
Accretion of beneficial conversion
feature of redeemable preferred
shares -- -- -- -- (3,857)
Dividends accrued on redeemable
preferred stock -- -- -- -- (191)
Beneficial conversion feature of
redeemable preferred stock -- -- -- -- 3,857
Issuance of common shares -- -- -- -- 4,840
Issuance of common shares for
investment in MAS -- -- -- -- 8,000
Issuance of common shares for
acquisitions -- -- -- -- 160,319
Issuance of common stock warrants
for acquisition 1,656 -- -- -- 1,656
Warrants redeemed for common shares (877) -- -- -- 1,242
Notes receivable for shares issued -- 4,510(2) -- (4,510) --
Tax effect of exercise of
nonqualified stock options -- -- -- -- 4,068
-----------------------------------------------------------------------
BALANCE - DECEMBER 31, 2000
(CARRIED FORWARD) $ 1,406 $ (2,803) $ (729) $(4,510) $ 160,562
<FN>
----------------
(1) Includes 208 shares exercised under the employee stock purchase plan and 37 shares issued for services.
(2) Includes 1,640 shares for options exercised.
See the accompanying notes to consolidated financial statements.
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APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF PREFERRED STOCK
COMMON STOCK AND OTHER STOCKHOLDERS' (DEFICIT) EQUITY
PAGE 2 OF 3
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(IN THOUSANDS)
PREFERRED STOCK COMMON STOCK ADDITIONAL
---------------------------------------------- PAID-IN (ACCUMULATED
NUMBER AMOUNT NUMBER AMOUNT CAPITAL DEFICIT)
-------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2000
(BROUGHT FORWARD) -- $-- 103,063 $ 103 $ 266,573 $ (99,478)
Net loss -- -- -- -- -- (205,103)
Comprehensive loss -
Foreign currency translation -- -- -- -- -- --
---------------
Total comprehensive loss -- -- -- -- -- (205,103)
Conversion of redeemable
preferred shares to common shares -- -- 64,811 65 14,485 --
Accretion of beneficial
conversion feature of redeemable
preferred shares -- -- -- -- (9,392) --
Dividends accrued on redeemable
preferred stock -- -- -- -- (535) --
Beneficial conversion feature of
redeemable preferred stock -- -- -- -- 9,392 --
Penalty paid by issuance of
redeemable preferred stock -- -- -- -- (612) --
Stock option repricing -- -- -- -- 5,274 --
Stock option discounts -- -- -- -- 246 --
Issuance of warrants -- -- -- -- 115 --
Issuance of common shares -- -- 7,631 8 1,980 --
Issuance of common shares for
software license purchase -- -- 6,278 6 10,195 --
Issuance of common shares for
investment -- -- 3,322 3 8,070 --
Issuance of common shares under
earnout, put and price
protection provisions of
acquisition agreements -- -- 61,806 61 27,030 --
Common shares repurchased -- -- -- -- -- --
Note receivable for shares issued -- -- 5,538 6 9,368 --
Note receivable charged to bad
debt expense -- -- -- -- -- --
-------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2001 -- $-- 252,449 $ 252 $ 342,189 $(304,581)
ACCUMULATED
COMMON OTHER NOTES TOTAL
STOCK TREASURY COMPREHENSIVE RECEIVED FOR STOCKHOLDERS'
WARRANTS STOCK (LOSS) INCOME SHARES ISSUED EQUITY
-----------------------------------------------------------------------
BALANCE - DECEMBER 31, 2000
(BROUGHT FORWARD) $1,406 $(2,803) $ (729) $ (4,510) $ 160,562
Net loss -- -- -- -- (205,103)
Comprehensive loss -
Foreign currency translation -- -- (18) -- (18)
----------- --------------
Total comprehensive loss -- -- (18) -- (205,121)
Conversion of redeemable
preferred shares to common shares -- -- -- -- 14,550
Accretion of beneficial
conversion feature of redeemable
preferred shares -- -- -- -- (9,392)
Dividends accrued on redeemable
preferred stock -- -- -- -- (535)
Beneficial conversion feature of
redeemable preferred stock -- -- -- -- 9,392
Penalty paid by issuance of
redeemable preferred stock -- -- -- -- (612)
Stock option repricing -- -- -- -- 5,274
Stock option discounts -- -- -- -- 246
Issuance of warrants 1,887 -- -- -- 2,002
Issuance of common shares -- -- -- -- 1,988
Issuance of common shares for
software license purchase -- -- -- -- 10,201
Issuance of common shares for
investment -- -- -- -- 8,073
Issuance of common shares under
earnout, put and price
protection provisions of
acquisition agreements -- -- -- -- 27,091
Common shares repurchased -- (4,600) -- -- (4,600)
Note receivable for shares issued -- 5,626 -- (15,000) --
Note receivable charged to bad
debt expense -- -- -- 9,000 9,000
-------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2001 $3,293 $(1,777) $ (747) $(10,510) $ 28,119
See the accompanying notes to consolidated financial statements.
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APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF PREFERRED STOCK
COMMON STOCK AND OTHER STOCKHOLDERS' (DEFICIT) EQUITY
PAGE 3 OF 3
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(IN THOUSANDS)
PREFERRED STOCK COMMON STOCK ADDITIONAL
---------------------------------------------- PAID-IN (ACCUMULATED
NUMBER AMOUNT NUMBER AMOUNT CAPITAL DEFICIT)
-------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2001
(BROUGHT FORWARD) -- $-- 252,449 $ 252 $342,189 $(304,581)
Net loss -- -- -- -- -- (112,485)
Comprehensive loss -
Foreign currency translation -- -- -- -- -- --
--------------
Total comprehensive loss -- -- -- -- -- (112,485)
Expiration of redeemable preferred
stock options - Series C -- -- -- -- 5,180 --
Adjustment for notes received for
shares issued -- -- -- -- (4,424) --
Allowance for uncollectible portion
of note receivable -- -- -- -- -- --
Collection of notes receivable
received for shares issued -- -- -- -- -- --
Treasury stock transaction -- -- -- -- 1,878 --
Retirement of treasury stock -- -- (984) (1) (1,877) --
Shares issuable for settlement of
liability -- -- -- -- 63 --
Obligation for shares issuable in
settlement of liability -- -- -- -- (63) --
Stock option repricing -- -- -- -- 254 --
Stock options - Digital Angel
Corporation -- -- -- -- 18,800 --
Stock options - VeriChip Corporation 200 --
Issuance of warrants -- -- -- -- -- --
Issuance of warrants - Digital
Angel Corporation -- -- -- -- 163 --
Issuance of warrants - VeriChip
Corporation -- -- -- -- 44 --
Remeasurement of warrants -
Digital Angel Corporation -- -- -- -- 1,066 --
Issuance of common shares for exercise
of stock options -- -- 7,458 8 1,169 --
Issuance of common shares and
options for services, compensation
and other -- -- 26,146 26 12,979 --
-------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2002 -- $-- 285,069 $ 285 $377,621 $(417,066)
=========================================================================
ACCUMULATED
COMMON OTHER NOTES TOTAL
STOCK TREASURY COMPREHENSIVE RECEIVED FOR STOCKHOLDERS'
WARRANTS STOCK (LOSS) INCOME SHARES ISSUED EQUITY
-----------------------------------------------------------------------
BALANCE - DECEMBER 31, 2001
(BROUGHT FORWARD) $3,293 $(1,777) $ (747) $(10,510) $ 28,119
Net loss -- -- -- -- (112,485)
Comprehensive loss -
Foreign currency translation -- -- 778 -- 778
------------ -------------
Total comprehensive loss -- -- 778 -- (111,707)
Expiration of redeemable preferred
stock options - Series C -- -- -- -- 5,180
Adjustment for notes received for
shares issued -- -- -- 4,424 --
Allowance for uncollectible portion
of note receivable -- -- -- 4,094 4,094
Collection of notes receivable
received for shares issued -- -- -- 1,156 1,156
Treasury stock transaction -- (1,878) -- -- --
Retirement of treasury stock -- 1,878 -- -- --
Shares issuable for settlement of
liability -- -- -- -- 63
Obligation for shares issuable in
settlement of liability -- -- -- -- (63)
Stock option repricing -- -- -- -- 254
Stock options - Digital Angel
Corporation -- -- -- -- 18,800
Stock options - VeriChip Corporation -- -- -- -- 200
Issuance of warrants 2,357 -- -- -- 2,357
Issuance of warrants - Digital
Angel Corporation -- -- -- -- 163
Issuance of warrants - VeriChip
Corporation -- -- -- -- 44
Remeasurement of warrants -
Digital Angel Corporation -- -- -- -- 1,066
Issuance of common shares for exercise
of stock options -- -- -- -- 1,177
Issuance of common shares and
options for services, compensation
and other -- -- -- -- 13,005
---------------------------------------------------------------------
BALANCE - DECEMBER 31, 2002 $5,650 $(1,777) $ 31 $ (836) $(36,092)
=====================================================================
See the accompanying notes to consolidated financial statements.
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APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
---------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------
2002 2001 2000
--------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) income $(112,485) $(205,103) $(112,142)
Adjustments to reconcile net loss to net
cash used in operating activities:
Asset impairment, restructuring and unusual charges 69,382 71,719 6,383
(Income) loss from discontinued operations (1,420) 16,482 82,968
Depreciation and amortization 4,773 28,899 11,073
Non-cash interest expense 5,770 -- --
Deferred income taxes (69) 21,435 (3,365)
Impairment of notes receivable 4,472 21,873 --
Interest income on notes received for shares issued (475) -- --
Net loss on subsidiary merger transaction 4,485 -- --
Gain from extinguishment of debt -- (9,465) --
Minority interest (18,474) (718) 229
(Gain) loss on sale of subsidiaries and business assets (132) 6,058 (486)
Gain on sale of equipment and assets (406) -- (466)
Non-cash compensation and administrative expenses 20,143 5,274 --
Equity in net loss of affiliate 291 328 --
Issuance of stock for services 2,958 -- --
Net change in operating assets and liabilities 17,166 28,365 (5,577)
Net cash provided by (used in) discontinued operations 116 (3,127) (22,035)
----------------------------------------------------------------------------------------------------------------------
NET CASH USED IN OPERATING ACTIVITIES (3,905) (17,980) (43,418)
----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Decrease in notes receivable 3,155 1,299 31,457
Received from buyers of divested subsidiaries 2,625 -- --
Proceeds from sale of property and equipment 3,535 1,347 939
Proceeds from sale of subsidiaries and business assets 1,382 1,673 2,821
Payments for property and equipment (1,858) (2,757) (8,391)
Payment for asset and business acquisition (net of
cash balances acquired) (261) -- (9,141)
Decrease (increase) in other assets 3 944 (963)
Net cash (used in) provided by discontinued operations (507) 208 1,708
----------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY INVESTING ACTIVITIES 8,074 2,714 18,430
----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net amounts (paid) borrowed on notes payable (4,778) 13,981 2,234
Proceeds on long-term debt 1,287 553 15,971
Payments for long-term debt (1,422) (2,485) (11,553)
Other financing costs (875) (375) (835)
Issuance of common shares 1,695 678 6,137
Collection of notes receivable for shares issued 1,156 -- --
Issuance of preferred shares, related options and warrants -- -- 19,056
Proceeds from subsidiary issuance of common stock 630 126 --
Stock issuance costs (518) (798) (180)
Net cash (used in) provided by discontinued operations -- (757) 16
----------------------------------------------------------------------------------------------------------------------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (2,825) 10,923 30,846
----------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,344 (4,343) 5,858
EFFECT OF EXCHANGE RATES CHANGES ON CASH AND CASH EQUIVALENTS 778 -- --
----------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 3,696 8,039 2,181
----------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS - END OF YEAR $ 5,818 $ 3,696 $ 8,039
======================================================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes (refunds received) paid $ (971) $ (2,227) $ 660
Interest paid 3,778 4,071 5,722
----------------------------------------------------------------------------------------------------------------------
See the accompanying notes to consolidated financial statements.
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--------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying financial statements have been prepared on a going
concern basis and do not reflect any adjustments that might result from
the outcome of the uncertainties described in Note 2.
Certain items in the condensed consolidated financial statements for the
2001 and 2000 periods have been reclassified for comparative purposes.
ORGANIZATION
Applied Digital Solutions, Inc. and subsidiaries (the "Company"), a
Missouri corporation, is an advanced technology development company.
During the last half of 2001 and during 2002, the Company sold or closed
many of the businesses the Company had acquired that it believed did not
enhance its strategy of becoming an advanced digital technology
development company. The Company has emerged from being a supplier of
computer hardware, software and telecommunications products and services
to becoming an advanced technology company that focuses on a range of
life enhancing, personal safeguard technologies, early warning alert
systems, miniaturized power sources and security monitoring systems
combined with the comprehensive data management services required to
support them. The Company has four such products in various stages of
development. They are:
* Digital Angel(TM), for monitoring and tracking people and objects;
* Thermo Life(TM), a thermoelectric generator;
* VeriChip(TM), an implantable radio frequency verification device
that can be used for security, financial, personal
identification/safety and other applications; and
* Bio-Thermo(TM), a temperature-sensing implantable microchip for
use in pets, livestock and other animals.
BUSINESS SEGMENTS
As a result of the merger of pre-merger Digital Angel and MAS, which
occurred on March 27, 2002, the significant restructuring of the
Company's business during the past year and our emergence as an advanced
technology development company, the Company has re-evaluated and
realigned its reporting segments. Effective January 1, 2002, the Company
currently operates in three business segments: Advanced Technology,
Digital Angel Corporation and SysComm International.
Prior to January 1, 2002, the Company was 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.
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Page F-11
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Advanced Technology
This segment specializes in security-related data collection, value-
added data intelligence and complex data delivery systems for a wide
variety of end users including commercial operations, government
agencies and consumers. VeriChip and Thermo Life products are included
in the Company's Advanced Technology segment.
Digital Angel Corporation
The Digital Angel Corporation segment consists of the business
operations the Company's 73.91% owned subsidiary, Digital Angel
Corporation (AMEX:DOC). This segment is engaged in the business of
developing and bringing to market proprietary technologies used to
identify, locate and monitor people, animals and objects. Before March
27, 2002, the business of Digital Angel Corporation was operated in four
divisions: Animal Tracking, Digital Angel Technology, Digital Angel
Delivery System, and Radio Communications and Other. With the
acquisition of MAS on March 27, 2002, Digital Angel Corporation
re-organized into four new divisions: Animal Applications (formerly
Animal Tracking), Wireless and Monitoring (a combination of the former
Digital Angel Technology and the Digital Angel Delivery System
segments), GPS and Radio Communications (formerly Radio Communications
and Other), and Medical Systems (formerly Physician Call Center and
Other). Medical Systems represents the business activity of the newly
acquired MAS.
SysComm International
The SysComm International segment consists of the business operations of
the Company's 52.5% owned subsidiary, SysComm International Corporation
(OTC:SYCM). This segment is a full service provider of Information
Technology, or IT, solutions and products. It specializes in tailoring
its approach to the individual customer's needs. Doing business as
"InfoTech," this segment provides IT consulting, networking,
procurement, deployment, integration, migration and security services
and solutions. It also provides on-going system and network maintenance
services. In 2002, this segment continued its strategy of moving away
from a product-driven systems integration business model to a customer-
oriented IT solutions-based business model. It has further developed
its deliverable IT solutions by adding new consulting and service
offerings, and increasing the number of strategic alliances with outside
technical service firms and manufacturers of high-end IT products.
Business units that were part of the Company's continuing operations and
that were closed or sold during 2001 and 2002 are reported as All Other.
The "Corporate/Eliminations" category includes all amounts recognized
upon consolidation of the Company's subsidiaries such as the elimination
of intersegment revenues, expenses, assets and liabilities.
"Corporation/Eliminations" also includes certain interest expense and
other expenses associated with corporate activities and functions.
Included in "Corporate/Eliminations" for the year ended December 31,
2002, is a non-cash compensation charge of $18.7 million associated with
pre-merger Digital Angel options, which were converted into options to
acquire shares of MAS in connection with the merger of pre-merger
Digital Angel and MAS.
On March 1, 2001, the Company's Board of Directors approved a plan to
sell or close Intellesale, Inc. and all of the Company's other non-core
businesses. The results of operations, financial condition and cash
flows of now reflect these operations as "Discontinued Operations" and
prior periods have been restated.
PRINCIPLES OF CONSOLIDATION
The financial statements include the accounts of the Company and its
wholly-owned and majority-owned subsidiaries, including Digital Angel
Corporation and SysComm International Corporation. The minority interest
represents outstanding voting stock of the subsidiaries not owned by the
Company or the Digital Angel Trust (as
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Page F-12
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
defined in Note 2). All significant intercompany accounts and
transactions have been eliminated in consolidation.
Our majority-owned subsidiary, SysComm International Corporation
operates on a fiscal year ending September 30. Their results of
operations have been reflected in the Company's consolidated financial
statements on a calendar year basis.
USE OF ESTIMATES
The preparation of the financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make certain estimates and assumptions that
affect the amounts reported in the financial statements and accompanying
notes. Although these estimates are based on the knowledge of current
events and actions the Company may undertake in the future, they may
ultimately differ from actual results. The Company uses estimates,
among others, to determine whether any impairment is to be recognized.
FOREIGN CURRENCIES
The Company's foreign subsidiaries use their local currency as their
functional currency. Results of operations and cash flow are translated
at average exchange rates during the period, and assets and liabilities
are translated at end of period exchange rates. Translation adjustments
resulting from this process are included in accumulated other
comprehensive (loss) income in the statement of preferred stock, common
stock and other stockholders' (deficit) equity.
Transaction gains and losses that arise from exchange rate fluctuations
on transactions denominated in a currency other than the functional
currency are included in the results of operations as incurred. These
amounts are not material to the financial statements.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
UNBILLED RECEIVABLES
Unbilled receivables consist of certain direct costs and profits
recorded in excess of amounts currently billable pursuant to contract
provisions in connection with system installation projects and software
licensing. Unbilled receivables included in accounts receivable was $0.1
million in 2002 and $0.2 million in 2001.
INVENTORIES
Inventories consist of raw materials, work in process and finished goods
The majority of the components are plastic ear tags, electronic
microchips, electronic readers and components as well as products and
components related to GPS search and rescue equipment. Inventory is
valued at the lower of cost or market, determined by the first-in,
first-out method. The Company closely monitors and analyzes inventory
for potential obsolescence and slow-moving items based upon the aging of
the inventory and the inventory turns by product. Inventory items
designated as obsolete or slow moving are reduced to net realizable
value.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost, less accumulated
depreciation and amortization computed using straight-line and
accelerated methods. Building and leasehold improvements are depreciated
and amortized over periods ranging from 10 to 40 years and equipment is
depreciated over periods ranging from 3 to 10 years. Repairs
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Page F-13
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
and maintenance, which do not extend the useful life of the asset, are
charged to expense as incurred. Gains and losses on sales and
retirements are reflected in income.
GOODWILL AND OTHER INTANGIBLE ASSETS
In conjunction with the Company's review for impairment of goodwill and
other intangible assets in the fourth quarter of 2000, the Company
reviewed the useful lives assigned to goodwill and, effective October 1,
2000, changed the lives to periods ranging from 5 to 10 years, down from
periods ranging from 10 to 20 years. The impact in 2001 and 2000 of this
change was an increase in amortization of $7.2 million and $3.5 million,
respectively and a decrease in earnings per share of $0.04 and $0.05,
respectively. Goodwill and other intangible assets are stated on the
cost basis and have been amortized, principally on a straight-line
basis, over the estimated future periods to be benefited (ranging from 5
to 10 years) through December 31, 2001. Prior to the adoption of
Statement of Financial Accounting Standards No. 142, "Goodwill and
Intangible Assets" (SFAS 142) on January 1, 2002, the Company reviewed
goodwill and other intangible assets quarterly for impairment whenever
events or changes in business circumstances indicated that the remaining
useful life may have warranted revision or that the carrying amount of
the long-lived asset may not have been fully recoverable. Included in
factors considered were significant customer losses, changes in
profitability due to sudden economic or competitive factors, change in
managements' strategy for the business unit, letters of intent received
for the sale of the business unit, or other factors arising in the
quarterly period. The Company annually performed undiscounted cash flow
analyses by business unit to determine if an impairment existed. For
purposes of these analyses, earnings before interest, taxes,
depreciation and amortization were used as the measure of cash flow.
When an impairment was determined to exist, any related impairment loss
was calculated based on fair value. Fair value was determined based on
discounted cash flows. The discount rate utilized by the Company was the
rate of return expected from the market or the rate of return for a
similar investment with similar risks. The Company recorded goodwill
impairment charges of $63.6 million and $0.8 million during 2001 and
2000, respectively. See Note 15.
According to the provision of SFAS 142, in 2002, the Company ceased the
amortization of goodwill and other intangible assets deemed to have
indefinite lives. Instead, the Company is required to test these assets
for impairment annually as part of its annual business planning cycle
during the fourth quarter of each year. See Note 8. As part of the
implementation of SFAS 142 on January 1, 2002, the Company was required
to complete a transitional impairment test of goodwill and other
intangible assets. The adoption of SFAS 142 did not result in an
impairment charge. The annual test performed by the Company during the
fourth quarter of 2002, resulted in an impairment charge of $62.2
million associated with the Company's Digital Angel Corporation segment.
PROPRIETARY SOFTWARE IN DEVELOPMENT
In accordance with Statement of Financial Accounting Standards (FAS) 86,
Accounting for the Costs of Computer Software to be Sold, Leased, or
Otherwise Marketed, the Company has capitalized certain computer
software development costs upon the establishment of technological
feasibility. Technological feasibility is considered to have occurred
upon completion of a detailed program design which has been confirmed by
documenting and tracing the detail program design to product
specifications and has been reviewed for high-risk development issues,
or to the extent a detailed program design is not pursued, upon
completion of a working model that has been confirmed by testing to be
consistent with the product design. Amortization is provided based on
the greater of the ratios that current gross revenues for a product bear
to the total of current and anticipated future gross revenues for that
product, or the straight-line method over the estimated useful life of
the product. The estimated useful life for the straight-line method is
determined to be 2 to 5 years.
ADVERTISING COSTS
The Company expenses production costs of print advertisements the first
date the advertisements take place. Advertising expense, included in
selling, general and administrative expenses, was $0.3 million in 2002,
$0.3 million in 2001, $0.4 million in 2000.
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Page F-14
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
REVENUE RECOGNITION
For programming, consulting and software licensing services and
construction contracts, the Company recognizes revenue based on the
percent complete for fixed fee contracts, with the percent complete
being calculated as either the number of direct labor hours in the
project to date divided by the estimated total direct labor hours or
based upon the completion of specific task orders. It is the Company's
policy to record contract losses in their entirety in the period in
which such losses are foreseeable. For nonfixed fee jobs, revenue is
recognized based on the actual direct labor hours in the job times the
standard billing rate and adjusted to realizable value, if necessary.
For product sales, the Company recognizes revenue at the time products
are 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 collectability is deemed probable. If uncertainties
regarding customer acceptance exist, revenue is recognized when such
uncertainties are resolved. Revenue from royalties is recognized when
licensed products are shipped. There are no significant post-contract
support obligations at the time of revenue recognition. The Company's
accounting policy regarding vendor and post-contract support obligations
is based on the terms of the customers' contract, billable upon the
occurrence of the post-sale support. Costs of goods sold are recorded as
the related revenue is recognized. The Company does not experience
significant product returns, and therefore, management is of the opinion
that based on the most recent information available, no allowance for
sales returns is necessary. The Company has no obligation for warranties
on new hardware sales, because the warranty is provided by the
manufacturer. The Company does not offer a warranty policy for services
to customers.
SOFTWARE REVENUE RECOGNITION
For those arrangements where the Company's contract calls only for the
delivery of software with no additional obligations, revenue is
recognized at the time of delivery, provided that there is a signed
contract, delivery of the product has taken place, the fee is fixed by
the contract and collectability is considered probable. For multiple
element arrangements such as a contract that includes the delivery of
software and a service arrangement, revenues allocated to the sale of
the software are recognized when the software is delivered to the
customer. Revenues related to the sale of the service agreement are
recognized ratably over the term of the service agreement. A value is
ascribed to each of the elements sold. This value is based on vendor
specific objective evidence of fair value, regardless of any separate
prices that may be stated in the contract. Vendor specific objective
evidence of fair value is the price charged when the elements are sold
separately. If an element is not yet being sold separately, the fair
value is the price established by management having the relevant
authority to do so. It is considered probable that the price established
by management will not change before the separate introduction of the
element. If the contract includes a discount, the discount is applied to
the components of the contract, which specifically apply. For those
contracts where the discount is a fixed amount for the entire contract
(i.e. not specifically identifiable with any of the contract elements),
a proportionate amount of the discount is allocated to each element of
the contract based on that element's fair value without regard to the
discount. The Company's contracts do not include unspecified upgrades
and enhancements. For those arrangements where the Company's contract to
deliver software requires significant production modification or
customization of the software, revenues are recognized using percentage
of completion accounting. The service element of these contracts are
essential to the functionality of other elements in the contract and are
not accounted for separately. The cost to complete and extent of
progress towards completion of these contracts can be reasonably
ascertained based on the detailed tracking and recording of labor hours
expended. Progress payments on these contracts are required and progress
is measured using the efforts expended input measure.
STOCK-BASED COMPENSATION
As permitted under SFAS No. 123, Accounting for Stock-based
Compensation, the Company has elected to continue follow the guidance of
APB Opinion No. 25 (APB No. 25), Accounting for Stock Issued to
Employees and Financial Accounting Standards Board Interpretation No.
44, Accounting for Certain Transactions Involving Stock Compensation--an
Interpretation of APB Opinion No. 25, in accounting for its stock-based
employee compensation arrangements. Accordingly, no compensation cost
is recognized for any of the Company's fixed stock options granted to
employees when the exercise price of each option equals or exceeds the
fair value of the
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Page F-15
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
underlying common stock as of the grant date for each stock option.
Changes in the terms of stock option grants, such as extensions of the
vesting period or changes in the exercise price, result in variable
accounting in accordance with APB Opinion No. 25. Accordingly,
compensation expense is measured in accordance with APB No. 25 and
recognized over the vesting period. If the modified grant is fully
vested, any additional compensation costs is recognized immediately. The
Company accounts for equity instruments issued to non-employees in
accordance with the provisions of SFAS No. 123.
At December 31, 2002, the Company had four stock-based employee
compensation plans, which are described more fully in Note 13 and the
Company's subsidiaries had six stock-based employee compensation plans.
As permitted under SFAS No. 148, Accounting for Stock-Based
Compensation--Transition and Disclosure, which amended SFAS No. 123,
Accounting for Stock-Based Compensation, the Company has elected to
continue to follow the intrinsic value method in accounting for its
stock-based employee compensation arrangement as defined by Accounting
Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to
Employees, and related interpretations including Financial Accounting
Standards Board Interpretation No. 44, Accounting for Certain
Transactions involving Stock Compensation, an interpretation of APB No.
25. The following table illustrates the effect on net loss and loss per
share if the Company had applied the fair value recognition provisions
of SFAS No. 123 to stock-based employee compensation for options granted
under its plans as well as to the plans of its subsidiaries:
[Enlarge/Download Table]
YEAR ENDED DECEMBER 31,
------------------------------------------
2002 2001 2000
--------- --------- --------
Net loss, as reported $(113,961) $(208,625) $(33,222)
Deduct: Total stock-based employee
compensation expense determined under
fair value-based method for all awards,
net of related tax effects (1) (3,272) (2,708) (2,678)
--------- --------- --------
Pro forma net loss $(117,233) $(211,333) $(35,901)
Loss per share:
Basic and diluted--as reported $ (0.42) $ (1.23) $ (0.52)
--------- --------- --------
Basic and diluted--pro forma $ (0.44) $ (1.24) $ (0.56)
--------- --------- --------
<FN>
(1) For 2002, amount includes $1.8 million of compensation expense associated with
subsidiary options.
The weighted average per share fair values of grants made in 2002,
2001 and 2000 for the Company's incentive plans were $0.19, $0.36
and $0.67, respectively. The fair values of the options granted were
estimated on the grant date using the Black-Scholes option-pricing
model based on the following weighted average assumptions:
[Download Table]
2002 2001 2000
---- ---- ----
Estimated option life 5.5 years 5 years 5 years
Risk free interest rate 2.89% 4.49% 4.98%
Expected volatility 76.00% 68.75% 53.32%
Expected dividend yield 0.00% 0.00% 0.00%
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Page F-16
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
RESEARCH AND DEVELOPMENT
Research and development expense consists of personnel costs, supplies,
other direct costs and indirect costs, primarily rent and other
overhead, of developing new products and technologies and are charged to
expense as incurred.
ISSUANCE OF SHARES OF STOCK BY SUBSIDIARY
Gains where realizable and losses on issuance of shares of stock by a
consolidated subsidiary are reflected in the consolidated statement of
operations.
INCOME TAXES
The Company accounts for income taxes under the asset and liability
approach for the financial accounting and reporting for income taxes.
Deferred taxes are recorded based upon the tax impact of items affecting
financial reporting and tax filings in different periods. A valuation
allowance is provided against net deferred tax assets where the Company
determines realization is not currently judged to be more likely than
not. Income taxes include U.S. and international taxes. The Company and
its 80% or more owned U.S. subsidiaries file a consolidated federal
income tax return.
EARNINGS (LOSS) PER COMMON SHARE AND COMMON SHARE EQUIVALENT
Income (loss) available to common stockholders has been adjusted to
reflect preferred stock dividends and the accretion to the redemption
value and beneficial conversion charge associated with the Series C
redeemable preferred stock for the purpose of calculating earnings per
share. Basic EPS is computed by dividing income (loss) available to
common stockholders by the weighted average number of common shares
outstanding for the period. Diluted EPS is computed giving effect to all
dilutive potential common shares that were outstanding during the
period. Dilutive potential common shares consist of incremental shares
issuable upon exercise of stock options and warrants and conversion of
preferred stock outstanding.
COMPREHENSIVE INCOME (LOSS)
The Company's comprehensive accumulated other (loss) income consists of
foreign currency translation adjustments, and is reported in the
consolidated statements of preferred stock, common stock and other
stockholders' (deficit) equity.
METHOD OF ACCOUNTING FOR DIGITAL ANGEL CORPORATION
Effective March 27, 2002, the Company's 93% owned subsidiary, Digital
Angel Corporation, which we refer to as pre-merger Digital Angel, merged
with and into a wholly-owned subsidiary of a publicly traded company,
Medical Advisory Systems, Inc. (MAS), and MAS changed its name to
Digital Angel Corporation. Under the terms of the merger agreement, each
issued and outstanding share of common stock of pre-merger Digital Angel
(including each share issued upon exercise of options prior to the
effective time of the merger) was cancelled and converted into the right
to receive 0.9375 shares of MAS's common stock. The Company obtained
18.75 million shares of MAS common stock in the merger (representing
approximately 61% of the shares then outstanding). Prior to the
transaction, the Company owned 850,000 shares of MAS, or approximately
16.7%. On December 31, 2002, the Company owned 19.6 million shares, or
approximately 73.91% of the shares outstanding. Also, pursuant to the
merger agreement, the Company contributed to MAS all of its stock in
Timely Technology Corp., a wholly-owned subsidiary, and Signature
Industries, Limited, an 85% owned subsidiary. Pre-merger Digital Angel,
Timely Technology Corp. and Signature Industries, Limited were
collectively referred to as the Advanced Wireless Group (AWG). The
merger has been treated as a reverse acquisition for accounting
purposes, with the AWG treated as the accounting acquirer.
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Page F-17
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
The total purchase price of the transaction was $32.0 million, which was
comprised of the $25.0 million fair market value of MAS stock
outstanding not held by the Company immediately preceding the merger,
the $3.4 million estimated fair market value of MAS options and warrants
outstanding as well as the direct costs of the acquisition of $3.6
million. The transaction resulted in Digital Angel Corporation
allocating approximately $28.3 million of the purchase price to
goodwill.
The consolidated financial statements included in this Form 10-K include
the accounts of Digital Angel Corporation and reflect the outstanding
voting stock not owned by the Digital Angel Share Trust (the "Digital
Angel Trust") (as defined in Note 2) as a minority ownership interest in
Digital Angel Corporation on the balance sheet as of December 31, 2002.
Significant intercompany balances and transactions have been eliminated
in consolidation. Digital Angel Corporation is publicly traded on the
American Stock Exchange under the symbol DOC, with a closing market
price per share at December 31, 2002, and March 21, 2003, of $2.55 and
$1.22, respectively.
During 2002, the Company recorded a net loss of $0.4 million occasioned
by the merger transaction, comprised of a loss of approximately $5.1
million resulting from the exercise of 1.5 million pre-merger Digital
Angel options (representing the difference between the carrying amount
of the Company's pro-rata share of the investment in pre-merger Digital
Angel and the exercise price of the options) and a gain of approximately
$4.7 million from the deemed sale of 22.85% of the AWG, as a result of
the merger with MAS. In addition, during 2002, the Company recorded a
loss of $4.1 million on the issuances of 1.1 million shares of Digital
Angel Corporation common stock resulting primarily from the exercise of
stock options. The loss represents the difference between the carrying
amount of the Company's pro-rata share of its investment in Digital
Angel Corporation and the net proceeds from the issuances of the stock
and other changes in the minority interest ownership.
By operation of the Digital Angel Trust agreement, the Company's share
of Digital Angel Corporation's net assets is effectively restricted.
Although Digital Angel Corporation may pay dividends, the Company's
access to this subsidiary's funds is restricted. The following
condensed consolidating balance sheet data at December 31, 2002, shows,
among other things, the Company's investment in Digital Angel
Corporation. The following consolidating financial data provides
supplementary information about the results of operations and cash flows
for 2002.
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Page F-18
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
[Enlarge/Download Table]
CONDENSED CONSOLIDATING BALANCE SHEET DATA
DECEMBER 31, 2002
APPLIED DIGITAL DIGITAL ANGEL CONSOLIDATION
SOLUTIONS, INC. CORPORATION ELIMINATIONS CONSOLIDATED
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(in thousands)
Current Assets
Cash and cash equivalents $ 5,604 $ 214 $ -- $ 5,818
Accounts receivable, net 12,422 4,126 -- 16,548
Inventories 1,464 4,945 -- 6,409
Notes receivable 2,801 -- -- 2,801
Other current assets 1,442 1,478 -- 2,920
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Total Current Assets 23,733 10,763 -- 34,496
Property And Equipment, net 2,053 7,769 -- 9,822
Notes Receivable, net 758 -- -- 758
Goodwill, net 20,366 47,452 -- 67,818
Investment in Digital Angel Corporation 40,656 -- (40,656) --
Other Assets, net 2,525 1,814 -- 4,339
------------------------------------------------------------------
Total Assets $ 90,091 $67,798 $(40,656) $117,233
==================================================================
Current Liabilities
Notes payable and current maturities of long-
term debt $ 81,063 $ 816 $ -- $ 81,879
Accounts payable and accrued expenses 31,209 7,846 -- 39,055
Put accrual 200 -- -- 200
Intercompany (receivable) payable (462) 462 -- --
Net liabilities of Discontinued Operations 9,368 -- -- 9,368
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Total Current Liabilities 121,378 9,124 -- 130,502
Long-Term Debt, Notes Payable and Other Liabilities 1,037 3,364 -- 4,401
------------------------------------------------------------------
Total Liabilities 122,415 12,488 -- 134,903
Minority Interest 3,768 298 14,356 18,422
Accumulated other comprehensive income (loss) 31 (185) 185 31
Other stockholders' (deficit) equity (36,123) 55,197 (55,197) (36,123)
------------------------------------------------------------------
Total Stockholders' (Deficit) Equity (36,092) 55,012 (55,012) (36,092)
------------------------------------------------------------------
Total Liabilities and Stockholders' (Deficit) Equity $ 90,091 $67,798 $(40,656) $117,233
==================================================================
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Page F-19
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
[Enlarge/Download Table]
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS DATA
YEAR ENDED DECEMBER 31, 2002
APPLIED DIGITAL DIGITAL ANGEL CONSOLIDATION
SOLUTIONS, INC. CORPORATION ELIMINATIONS CONSOLIDATED
------------------------------------------------------------------
(in thousands)
Product revenue $ 50,060 $ 30,946 $ (70) $ 80,936
Service revenue 15,979 2,685 -- 18,664
------------------------------------------------------------------
Total revenue 66,039 33,631 (70) 99,600
Cost of products sold 40,690 17,705 -- 58,395
Cost of services sold 7,107 2,216 -- 9,323
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Gross profit 18,242 13,710 (70) 31,882
Selling, general and administrative expenses 32,218 34,302 (70) 66,450
Intercompany management fees (193) 193 -- --
Research and development 1,096 2,422 -- 3,518
Asset impairment 5,564 63,818 -- 69,382
Depreciation and amortization 1,142 3,631 -- 4,773
Gain on sale of subsidiaries and business assets (132) -- -- (132)
Interest and other income (1,755) (601) -- (2,356)
Interest expense 17,221 2,109 (1,806) 17,524
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Loss from continuing operations before taxes,
minority interest, loss on subsidiary stock
issuances and sale of subsidiary stock, and
equity in net loss of affiliate (36,919) (92,164) 1,806 (127,277)
Provision for income taxes 326 -- -- 326
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Loss from continuing operations before minority
interest, loss on subsidiary stock issuances
and sale of subsidiary stock and equity in net
loss of affiliate (37,245) (92,164) 1,806 (127,603)
Minority interest (18,378) (96) -- (18,474)
Loss on subsidiary stock issuances and sale
of subsidiary stock 4,485 -- -- 4,485
Equity in net loss of affiliate(1) 90,553 291 (90,553) 291
------------------------------------------------------------------
Loss from continuing operations $(113,905) $(92,359) $ 92,359 $(113,905)
==================================================================
<FN>
(1) Digital Angel Corporation's separate financial statements include a
"push down" of $1.8 million of interest expense associated with the
Company's obligation to IBM Credit. Thus the equity in net loss of affiliate
on the Company's unconsolidated financial statements differs from Digital
Angel Corporation's loss by the $1.8 million.
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Page F-20
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
[Enlarge/Download Table]
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS DATA
YEAR ENDED DECEMBER 31, 2002
APPLIED DIGITAL DIGITAL ANGEL CONSOLIDATION
SOLUTIONS, INC. CORPORATION ELIMINATIONS CONSOLIDATED
------------------------------------------------------------------
(in thousands)
Cash Flows From Operating Activities
Net loss $(21,932) $(92,359) $ 1,806 $(112,485)
Adjustment to reconcile net loss to net cash
used in operating activities:
Non-cash adjustments 5,229 87,875 (1,806) 91,298
Net change in operating assets and liabilities 15,412 1,754 -- 17,166
Net cash provided by discontinued operations 116 -- -- 116
-------- -------- ------- ---------
Net Cash Used In Operating Activities (1,175) (2,730) -- (3,905)
-------- -------- ------- ---------
Cash Flows From Investing Activities
Decrease in notes receivable 3,155 -- -- 3,155
Received from buyers of divested subsidiaries 2,625 2,625
(Increase) decrease in other assets (105) 108 -- 3
Proceeds from the sale of property and equipment 3,535 -- 3,535
Proceeds from the sale of subsidiaries and business
assets and investments 357 1,025 -- 1,382
Payment for property and equipment (419) (1,439) -- (1,858)
Investment in subsidiaries (684) -- 684 --
Payment for asset and business acquisitions 0 (261) -- (261)
Net cash used in discontinued operations (507) -- -- (507)
-------- -------- ------- ---------
Net Cash Provided By (Used In) Investing Activities 7,957 (567) 684 8,074
-------- -------- ------- ---------
Cash Flows From Financing Activities
Net amounts borrowed (paid) on notes payable and
line of credit (569) (4,209) -- (4,778)
(Payments on) proceeds from line of credit and
long-term debt (4,243) 5,530 -- 1,287
Payments on long-term debt (1,379) (43) -- (1,422)
Other financing costs (875) -- -- (875)
Issuance of common shares 1,695 631 (631) 1,695
Collection of notes receivable for shares issued 1,156 -- -- 1,156
Stock issuance costs (519) -- -- (519)
Subsidiary Issuance of Common Shares 0 631 631
Intercompany transactions 0 684 (684) --
-------- -------- ------- ---------
Net Cash (Used In) Provided By Financing Activities (4,734) 2,593 (684) (2,825)
-------- -------- ------- ---------
Net Increase (Decrease) in Cash and Cash Equivalents 2,048 (704) -- 1,344
Effect of exchange rates changes on cash and cash
equivalents 456 322 -- 778
Cash and Cash Equivalents - Beginning of Period 3,100 596 -- 3,696
-------- -------- ------- ---------
Cash and Cash Equivalents - End of Period $ 5,604 $ 214 $ -- $ 5,818
-------- -------- ------- ---------
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Page F-21
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
There are no restrictions on Digital Angel Corporation's ability to
declare or pay dividends under the IBM Credit Agreement (defined in
Note 2). All of the consolidated assets of the Company, exclusive of
the assets of Digital Angel Corporation, are collateral under the
IBM Credit Agreement. In addition, the shares of Digital Angel
Corporation common stock held in the Digital Angel Trust (as defined
in Note 2) also collateralize the amounts outstanding under the IBM
Credit Agreement.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standards Board (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. The Company 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 the Company's amortization of
goodwill commencing January 1, 2002.
In August 2001, the Financial Accounting Standards Board (FASB)
issued FAS 144, Accounting for the Impairment of 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 required by APB 30. This
statement is effective for fiscal years beginning after December 15,
2001. The Company adopted this statement on January 1, 2002. The
adoption of FAS 144 did not have a material impact on the Company's
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 (FAS 145). FAS 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. The adoption of FAS 145
had the effect of reducing the Company's loss from continuing
operations and eliminating an extraordinary gain as previously
reported for the year ended December 31, 2001.
In June 2002, the FASB issued Statement No. 146, Accounting for
Costs Associated with Exit or Disposal Activities. This statement
requires recording costs associated with exit or disposal activities
at their fair values when a liability has been incurred. Under
previous guidance, certain exit costs were accrued upon management's
commitment to an exit plan. Adoption of this Statement is required
with the beginning of fiscal year 2003. The Company has not yet
determined what impact the adoption of FAS 146 will have on its
operations and financial position.
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Page F-22
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation -- Transition and Disclosure -- an amendment
of FASB Statement No. 123. This Statement amends SFAS No. 123,
Accounting for Stock-Based Compensation, to provide alternative
methods of transition for an entity that voluntarily changes to the
fair value based method of accounting for stock-based employee
compensation. It also amends the disclosure provisions of that
Statement to require prominent disclosure about the effects on
reported net income of an entity's accounting policy decisions with
respect to stock-based employee compensation. Finally, this
Statement amends APB Opinion No. 28, Interim Financial Reporting, to
require disclosure about those effects in interim financial
information. The Company intends to continue to account for stock-
based compensation based on the provisions of APB Opinion No. 25.
SFAS 148's amendment of the transition and annual disclosure
provisions of SFAS 123 are effective for fiscal years ending after
December 15, 2002, and the disclosure requirements for interim
financial statements are effective for interim periods beginning
after December 15, 2002. The Company adopted the disclosure
provisions of SFAS 148 on December 31, 2002.
2. DEBT COVENANT COMPLIANCE AND LIQUIDITY AND GOING CONCERN
CONSIDERATIONS
The Company generated significant net losses during 2002, 2001 and
2000. As a result, the Company was not in compliance with certain
financial covenants of its loan agreement as of December 31, 2002,
2001 and 2000. Accordingly, substantial doubt exists about the
Company's ability to continue as a going concern. The Company's
Second Restated Term and Revolving Credit Agreement with IBM Credit
Corporation (IBM Credit) was amended and restated on October 17,
2000 and further amended on March 30, 2001, July 1, 2001, September
15, 2001, November 15, 2001, December 31, 2001, January 31, 2002 and
February 27, 2002. These amendments extended the due dates of
principal and interest payments of $4.2 million and $2.9 million,
respectively, until April 2, 2002.
On March 1, 2002, the Company and Digital Angel Trust, a newly
created Delaware business trust, entered into the Third Amended and
Restated Term Credit Agreement (the IBM Credit Agreement) with IBM
Credit, which became effective on March 27, 2002, the effective date
of the merger between pre-merger Digital Angel and MAS. Upon
completion of the merger, and in satisfaction of a condition to the
consent to the merger by IBM Credit, the Company transferred to the
Digital Angel Trust, which is controlled by an advisory board, all
shares of Digital Angel Corporation common stock owned by it and, as
a result, the Digital Angel Trust has legal title to approximately
73.91% of the Digital Angel Corporation common stock at December 31,
2002. The Digital Angel Trust has voting rights with respect to the
Digital Angel Corporation common stock until the Company's
obligations to IBM Credit are repaid in full. The Company retained
beneficial ownership of the shares.
The IBM Credit Agreement contained covenants relating to the Company's
financial position and performance, as well as the financial position and
performance of Digital Angel Corporation. On September 30, 2002, the Company
entered into an amendment to the IBM Credit Agreement, which revised certain
financial covenants relating to its financial performance and the financial
position and performance of Digital Angel Corporation for the quarter ended
September 30, 2002 and the fiscal year ending December 31, 2002. On November
1, 2002, the Company entered into another amendment to the IBM Credit
Agreement, which further revised certain covenants relating to the financial
performance of Digital Angel Corporation for the quarter ended September 30,
2002, and the fiscal year ending December 31, 2002. At September 30, 2002,
the Company and Digital Angel Corporation were in compliance with the
revised covenants under the IBM Credit Agreement. At June 30, 2002, the
Company was not in compliance with our Minimum Cumulative Modified EBITDA
debt covenant and with other provisions of the IBM Credit Agreement and
Digital Angel Corporation was not in compliance with its Minimum Cumulative
Modified EBITDA and Current Assets to Current Liabilities debt covenants. On
August 21, 2002, IBM Credit provided the Company with a waiver of such
noncompliance. As consideration for the waiver, the Company issued to IBM
Credit a five year-warrant to acquire 2.9 million shares of its common stock
at $0.15 per share, valued at approximately $1.3 million, and a five
year-warrant to purchase approximately 1.8 million shares of its
wholly-owned subsidiary, VeriChip Corporation's, common stock at $0.05 per
share, valued at approximately $44 thousand. At December 31, 2002, the
Company was not in compliance with the revised covenants under the IBM
Credit Agreement. Digital Angel Corporation did not maintain compliance with
certain financial covenants under its credit agreement with its lender,
Wells Fargo Business Credit, Inc. (Wells Fargo). Well Fargo provided Digital
Angel Corporation with a waiver of non-compliance. IBM Credit did not
provide a waiver.
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Page F-23
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Under the terms of the IBM Credit Agreement, the Company was
required to repay IBM Credit Corporation $29.8 million of the $77.2
million outstanding principal balance currently owed to them, plus
$16.4 million of accrued interest and expenses (totaling
approximately $46.2 million), on or before February 28, 2003. The
Company did not make such payment by February 28, 2003. On March 3,
2003, IBM Credit notified the Company that it had until March 6,
2003, to make the payment. The Company did not make the payment on
March 6, 2003, as required. The Company's failure to comply with the
payment terms imposed by the IBM Credit Agreement and to maintain
compliance with the financial performance covenant constitute events
of default under the IBM Credit Agreement. On March 7, 2003, the
Company received a letter from IBM Credit declaring the loan in
default and indicating that IBM Credit would exercise any and/or all
of its remedies.
FORBEARANCE AGREEMENT
On March 27, 2003, the Company announced that it had executed a
forbearance agreement term sheet with IBM Credit. The forbearance
agreement becomes effective on or about March 31, 2003. In turn,
the Company has agreed to dismiss a lawsuit it had filed against IBM
Credit and IBM Corporation in Palm Beach County, Florida on March 6,
2003.
The payment provisions and purchase rights under the terms of the
forbearance agreement term sheet are as follows:
* the Tranche A Loan, consisting of $68.0 million plus accrued
interest, must be repaid in full no later than September 30,
2003, provided that all but $3 million of the Tranche A Loan
(the "Tranche A Deficiency Amount") will be deemed to be paid
in full on such date if less than the full amount of the
Tranche A Loan is repaid but all of the net cash proceeds of
the Digital Angel Corporation shares held in the Digital Angel
Trust are applied to the repayment of the Tranche A Loan. The
Tranche A Deficiency Amount (if any) must be repaid no later
than March 31, 2004; and
* (b) the Tranche B Loan, consisting of $9.2 million plus
accrued interest, must be repaid in full no later than
March 31, 2004. Effective March 25, 2003, the Tranche B Loan
will bear interest at seven percent (7%) per annum.
The Tranche A and B Loans may be purchased under the terms of the
forbearance agreement term sheet by or on behalf of the Company as
follows:
* the loans and all the other obligations may be purchased on or
before June 30, 2003, for $30 million in cash;
* the loans and all the other obligations may be purchased on or
before September 30, 2003, for $50 million in cash; and
* the Tranche A Loan may be purchased on or before September 30,
2003, for $40 million in cash with an additional $10 million
cash payment due on or before December 31, 2003.
Payment of the specified amounts by the dates set forth herein will
constitute complete satisfaction of any and all of the Company's
obligations to IBM Credit under the IBM Credit Agreement, provided
that there has not earlier occurred a "Termination Event," as
defined.
In addition, the Company has agreed under the terms of the
forbearance agreement term sheet that the Digital Angel Trust will
immediately engage an investment bank to pursue the sale of the
19,600,000 shares of Digital Angel Corporation common stock that are
currently held in the Digital Angel Trust. All proceeds from the
sale of the Digital Angel Corporation common stock will be applied
to the loans and other obligations to satisfy the Tranche A
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Page F-24
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
payment provisions as discussed above, in the event that the Company has not
satisfied its purchase rights by September 30, 2003.
The forbearance agreement term sheet also modifies other provisions
of the IBM Credit Agreement, including but not limited to, the
imposition of additional limitations on permitted expenditures.
At the end of the forbearance period, the provisions of the
forbearance agreement shall become of no force and effect. At that
time, IBM Credit will be free to exercise and enforce, or to take
steps to exercise and enforce, all rights, powers, privileges and
remedies available to them under the IBM Credit Agreement, as a
result of the payment and covenant defaults existing on March 24,
2003. If the Company is not successful in satisfying the payment
obligations under the forbearance agreement or does not comply with
the terms of the forbearance agreement or the IBM Credit Agreement,
and IBM Credit were to enforce its rights against the collateral
securing the obligations to IBM Credit, there would be substantial
doubt that the Company would be able to continue operations in the
normal course of business.
The ability of the Company to continue as a going concern is
predicated upon numerous issues including its ability to:
* Raise the funds necessary to satisfy its obligations to IBM
Credit;
* Successfully implement its business plans, manage expenditures
according to its budget, and generate positive cash flow from
operations;
* Realize positive cash flow with respect to its investment in
Digital Angel Corporation;
* Develop an effective marketing and sales strategy;
* Obtain the necessary approvals to expand the market for its
VeriChip product;
* Complete the development of its second generation Digital
Angel product; and
* Attract, motivate and/or retain key executives and employees.
The Company is continually seeking operational efficiencies and
synergies within each of its operating segments as well as
evaluating acquisitions of businesses and customer bases which
complement its 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 the Company's long-term strategy or other restructurings
or rationalization of existing operations. The Company will continue
to review all alternatives to ensure maximum appreciation of our
shareholder's investments. There can be no assurance, however, that
any initiative will be found, or if found, that they will be on
terms favorable to the Company.
3. 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 stockholder 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 $7.0
million and was being amortized on a straight-line basis over five
years. Under FAS 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's 2002 net income increased by $1.2 million.
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Page F-25
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Effective March 27, 2002, the Company's 93% owned subsidiary, pre-
merger Digital Angel, merged with MAS. As a result of the merger,
the Company now owns approximately 73.91% of Digital Angel
Corporation, as more fully discussed in Note 1.
Unaudited pro forma results of operations for 2002 and 2001 are
included below. Such pro forma information assumes that the merger
of pre-merger Digital Angel and MAS had occurred as of January 1,
2001.
[Enlarge/Download Table]
(UNAUDITED) (UNAUDITED)
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
2002 2001
---- ----
Net operating revenue from continuing operations $ 100,486 $ 161,677
Loss from continuing operations $(114,595) $(208,007)
Loss available to common stockholders from continuing operations $(114,595) $(218,546)
Loss per common share from continuing operations - basic and diluted $ (0.43) $ (1.29)
DISPOSITIONS
The gain (loss) on sale of subsidiaries and business assets was $0.1
million, $(6.1) million, and $0.5 million for the years ended December 31,
2002, 2001 and 2000, respectively. The loss on the sale of subsidiaries and
business assets of $6.1 million for 2001 was due to sales of the business
assets of our wholly-owned subsidiaries as follows: ADS Retail Inc., Signal
Processors, Limited, ACT Wireless Corp. and our ATI Communications
companies. In addition, the Company sold its 85% ownership interest in
Atlantic Systems, Inc. Proceeds from the sales were $3.5 million and were
used primarily to repay debt.
EARNOUT AND PUT AGREEMENTS
Certain acquisition agreements included additional consideration,
generally payable in shares of the Company's common stock,
contingent on profits of the acquired subsidiary. Upon earning this
additional consideration, the value is recorded as additional
goodwill. At December 31, 2002, there is one remaining earnout
arrangement. Assuming the current expected profits are achieved, the
Company is contingently liable for additional consideration of
approximately $0.5 million and $0.5 million in 2003 and 2004,
respectively, all of which would be payable in shares of the
Company's common stock.
In January 2001, the Company entered into an agreement with the
minority shareholders of Intellesale to terminate all put rights and
employment agreements that each shareholder had with or in respect
of Intellesale. In exchange, the Company issued an aggregate of 6.6
million shares of the Company's common stock valued at $10.3
million. In addition, during the years ended December 31, 2002 and
2001, 13.6 million common shares valued at $6.6 million and 27.5
million common shares valued at $16.9 million, respectively, were
issued to satisfy earnouts and to purchase minority interests.
4. INVENTORIES
[Download Table]
DECEMBER 31,
------------
2002 2001
---- ----
Raw materials $1,725 $1,474
Work in process 1,447 176
Finished goods 4,659 6,226
------ ------
7,831 7,876
Less: Allowance for excess and obsolescence 1,422 1,702
------ ------
$6,409 $6,174
------ ------
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Page F-26
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
5. NOTES RECEIVABLE
[Enlarge/Download Table]
DECEMBER 31,
------------
2002 2001
---- ----
Due from purchaser of subsidiary, collateralized
by pledge of rights to distributions from a joint
venture of the purchaser and an unrelated entity,
bears interest at the London Interbank Offered Rate
plus 1.65%, payable in quarterly installments of
principal and interest totaling $332. $ 1,023 $ 9,073
Due from purchaser of four subsidiaries, bears
interest at 5%, interest payable quarterly,
principal due October 2004. Allowance of $2,700
reflected in allowance for bad debts in 2002 and 2001. 2,700 2,700
Due from purchaser of subsidiary, collateralized by
pledge of investment securities, bears interest at
prime, interest payable semi-annually, principal due
November 2004. Allowance of $2,328 reflected in
allowance for bad debts in 2002 and 2001. 2,328 2,328
Due from officers, directors and employees of the
Company, unsecured, bear interest at varying interest
rates, due on demand. Allowance of $200 reflected
in allowance for bad debts in 2001. 677 784
Due from individuals and corporations, bearing
interest at varying rates above prime, secured
by business assets, personal guarantees, and
securities, due various dates through July 2004.
Allowance of $912 reflected in allowance for bad debts
in 2001. 858 1,851
Due from purchaser of divested subsidiary,
collateralized by business assets, bears interest
at 8%, payable in monthly installments of principal
and interest of $10, balance due in February 2006.
Allowance of $1,266 reflected in allowance for bad
debts in 2002. 1,266 1,272
Due from purchaser of divested subsidiary,
collateralized by personal guarantee and securities
of the purchaser, bears interest at prime plus 1%,
payable in monthly installments of interest only
through March 2003, and then payable in monthly
installments of principal and interest of $11
through December 2007. 497 550
Due from purchaser of divested subsidiary,
collateralized, bears interest at 5%, payable in
monthly payments of interest, and annual payments
of principal through March 2005. 478 --
Other 26 --
Due from purchaser of business assets, secured by
maker's assets, bears interest at 8.7% and provides
for monthly payments of principal and interest equal
to 10% of the maker's net cash revenue for each preceding
month, balance due October 2001. Allowance of $373
reflected in allowance for bad debts in 2002 and 2001. 373 373
-------------------------------------------------------------------------------------
10,226 18,931
Less: Allowance for bad debts 6,667 12,671
Less: Current portion 2,801 2,256
-------------------------------------------------------------------------------------
$ 758 $ 4,004
=====================================================================================
These notes receivable have been pledged as collateral
under the Company's debt agreements. See Note 10.
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Page F-27
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
6. OTHER CURRENT ASSETS
[Enlarge/Download Table]
DECEMBER 31,
------------
2002 2001
------------------------------------
Deferred tax asset $ 13 $ 171
Prepaid expenses 2,787 3,336
Income tax refund receivable -- 806
Other 120 473
----------------------------------------------------------------------------------------
$ 2,920 $4,786
========================================================================================
7. PROPERTY AND EQUIPMENT
[Download Table]
DECEMBER 31,
------------
2002 2001
-------------------------------
Land $ 611 $ 956
Building and leasehold improvements 7,770 8,351
Equipment 14,505 14,387
Software 94 10,001
------------------------------------------------------------------------------------
22,980 33,695
Less: Accumulated depreciation 13,158 13,510
------------------------------------------------------------------------------------
$ 9,822 $ 20,185
====================================================================================
Included above are vehicles and equipment acquired under capital
lease obligations in the amount of $1.0 million and $1.2 million at
December 31, 2002 and 2001, respectively. Related accumulated
depreciation amounted to $0.7 million and $0.7 million at December
31, 2002 and 2001, respectively.
Depreciation expense charged against income amounted to $4.1
million, $4.6 million and $2.1 million for the years ended December
31, 2002, 2001 and 2000, respectively. Accumulated depreciation
related to disposals of property and equipment amounted to $4.0
million and $0.6 million in 2002 and 2001, respectively.
During 2002, the Company recorded an impairment charge of $6.4
million to write-down certain software related to its Digital Angel
Corporation segment.
8. GOODWILL
Goodwill consists of the excess of cost over fair value of net
tangible and identifiable intangible assets of companies purchased.
The Company applies the principles of SFAS 141, and uses the
purchase method of accounting for acquisitions of wholly owned and
majority owned subsidiaries.
[Download Table]
DECEMBER 31,
------------
2002 2001
----------------------------
Balance $123,221 $186,827
Acquisitions and earnout payments 39,172 --
Less goodwill impairment (62,185) (63,606)
Accumulated amortization (32,390) (32,390)
---------------------------------------------------------------------------------
Carrying value $ 67,818 $ 90,831
=================================================================================
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Page F-28
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Goodwill amortization expense, including in 2001 goodwill
amortization associated with the Company's equity investment in MAS
of $1.2 million, amounted to $22.5 million and $7.5 million for the
years ended December 31, 2001, 2000, respectively. Accumulated
amortization of goodwill related to subsidiaries sold during 2001
and 2000 amounted to $0.1 million and $0.2 million, respectively.
CHANGE IN METHOD OF ACCOUNTING FOR GOODWILL
Effective January 1, 2002, the Company adopted SFAS 142. SFAS 142
requires that goodwill and certain intangibles no longer be
amortized, but instead tested for impairment at least annually. The
Company tests its goodwill and intangible assets for impairment as a
part of its annual business planning cycle during the fourth quarter
of each fiscal year or earlier depending on specific changes in
conditions surrounding the business units.
The adoption of SFAS 142 did not result in an impairment charge,
however, the annual test performed by the Company during the fourth
quarter of 2002 resulted in an impairment charge of $62.2 million.
In addition, there can be no assurance that future goodwill
impairment tests will not result in additional impairment charges.
The following table presents the impact of SFAS 142 on (loss) income
before extraordinary (loss) gain and net loss and (loss) income
before extraordinary (loss) gain per share and net loss per share
had the standard been in effect beginning January 1, 2000:
[Download Table]
YEAR ENDED DECEMBER 31,
2001 2000
---------- ----------
Net (loss) income available to common stockholders:
Net (loss) income available to common stockholders
as reported $ (215,642) $(116,190)
Add back: Goodwill amortization 21,312 9,415
Add back: Equity method investment amortization 1,161 --
---------- ---------
Adjusted net (loss) income $ (193,169) $(106,775)
---------- ---------
Earnings (loss) per common share - basic
Net (loss) income per share - basic, as reported $ (1.27) $ (1.82)
Goodwill amortization 0.12 0.15
Equity method investment amortization 0.01 --
---------- ---------
Adjusted net (loss) income - basic $ (1.14) $ (1.67)
---------- ---------
Earnings (loss) per share - diluted
Net (loss) income per share - diluted, as reported $ (1.27) $ (1.82)
Goodwill amortization 0.12 0.15
Equity method investment amortization 0.01 --
---------- ---------
Adjusted net (loss) income per share - diluted $ (1.14) $ (1.67)
---------- ---------
The Company had entered into various earnout arrangements with the
selling shareholders of certain acquired subsidiaries. These
arrangements provided for additional consideration to be paid in
future years if certain earnings levels were met. As of December 31,
2002, the Company is obligated under one remaining earnout
arrangement. Payments made under earnout arrangements are added to
goodwill as earned.
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Page F-29
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
9. OTHER ASSETS
[Enlarge/Download Table]
DECEMBER 31,
------------
2002 2001
------- -------
Proprietary software $ 2,636 $ 2,368
Loan acquisition costs 10,569 3,746
Other assets 2,206 1,120
-------------------------------------------------------------------------------------
15,411 7,234
Less: Accumulated amortization 12,936 5,247
-------------------------------------------------------------------------------------
2,475 1,987
Other investments 202 771
Deferred tax asset 1,223 996
Other 439 528
-------------------------------------------------------------------------------------
$ 4,339 $ 4,282
=====================================================================================
Amortization of other assets charged against income amounted to $6.4
million, $1.8 million and $1.4 million for the years ended December
31, 2002, 2001 and 2000, respectively. Accumulated amortization of
other assets related to subsidiaries sold during 2001 amounted to
$3.5 million.
10. NOTES PAYABLE AND LONG-TERM DEBT
On May 25, 1999, the Company entered into a credit agreement with IBM
Credit. The credit agreement was amended and restated on October 17,
2000, and further amended on March 30, 2001. Effective July 1, 2001,
the Company and IBM Credit amended the credit agreement extending
until October 1, 2001 the payments due on July 1, 2001, which the
Company was unable to pay. On September 15, 2001, November 15, 2001,
December 31, 2001, January 31, 2002, and again on February 27, 2002,
the Company and IBM Credit amended the credit agreement further
extending the payments due under the agreement until April 2, 2002.
On March 1, 2002, the Company entered into the IBM Credit Agreement,
which became effective on March 27, 2002 as more fully discussed in
Note 2.
As part of the amendments and restatements to the agreements with IBM
Credit as discussed above, the Company paid bank fees of $0.4 million
and $0.3 million in March 2002 and April 2001, respectively, and in
April 2001, the Company issued a five-year warrant to acquire 2.9
million shares of common stock to IBM Credit valued at $1.9 million.
In March 2002, the Company agreed to re-price these warrants. The re-
priced warrants were valued at $1.0 million. In addition, as a
result of the merger between pre-merger Digital Angel and MAS,
warrants convertible into common stock of Digital Angel Corporation
that were previously issued to IBM Credit were revalued using the
Black Scholes method, resulting in additional deferred financing
costs of $1.1 million. The bank fees and fair value of the warrants
have been recorded as deferred financing fees and are being amortized
over the life of the debt as interest expense. These deferred
financing fees are being amortized through February 28, 2003, the
maturity of the principal balance.
At September 30, 2002, the Company and Digital Angel Corporation were
in compliance with the revised covenants under the IBM Credit
Agreement. At June 30, 2002, the Company was not in compliance with
its Minimum Cumulative Modified EBITDA debt covenant and with other
provisions of the IBM Credit Agreement and Digital Angel Corporation
was not in compliance with the Minimum Cumulative Modified EBITDA and
Current Assets to Current Liabilities debt covenants. On August 21,
2002, IBM Credit provided the Company with a waiver of such
noncompliance. As consideration for the waiver, the Company issued
to IBM Credit a five year warrant to acquire 2.9 million shares of
the Company's common stock at $0.15 per share, valued at
approximately $1.3 million, and a five year-warrant to purchase
approximately 1.8 million shares of the Company's wholly-owned
subsidiary, VeriChip Corporation's common stock at $0.05 per share,
valued at approximately $44 thousand. The fair value of the warrants
has been recorded as interest expense in 2002.
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Page F-30
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Amounts outstanding under the IBM Credit Agreement carried interest
at an annual rate of 17% and matured on February 28, 2003, subject to
extensions if certain portions of principal and interest payments
were made. Under the terms of the IBM Credit Agreement, the Company
was required to repay IBM Credit Corporation $29.8 million of the
$77.2 million outstanding principal balance currently owed to them,
plus $16.4 million of accrued interest and expenses (totaling
approximately $46.2 million), on or before February 28, 2003. The
Company did not make such payment by February 28, 2003. On March 3,
2003, IBM Credit notified the Company that it had until March 6,
2003, to make the payment. The Company did not make the payment on
March 6, 2003, as required. The Company's failure to comply with the
payment terms constitutes an event of default under the IBM Credit
Agreement. On March 7, 2003, the Company received a letter from IBM
Credit declaring the loan in default and indicating that IBM Credit
would exercise any and/or all of its remedies. On March 27, 2003, the
Company announced that it had agreed to the terms of a forbearance
agreement with IBM Credit. The forbearance agreement, which becomes
effective on or about March 31, 2003, allows for the forbearance of
the obligations due under the IBM Credit Agreement, provides for more
favorable loan repayment terms, reduces the Tranche B interest rate
to 7% per annum and provides for purchase rights. The forbearance
agreement is more fully describe in Note 2.
The Company's covenants under the IBM Credit Agreement, as amended
were as follows:
[Download Table]
COVENANT COVENANT REQUIREMENT
-------- --------------------
As of the following date not less than:
Current Assets to Current Liabilities December 31, 2002 .11:1
Minimum Cumulative Modified EBITDA December 31, 2002 $(7,648,300)
In addition, the IBM Credit Agreement contained covenants for
Digital Angel Corporation, as follows:
[Download Table]
COVENANT COVENANT REQUIREMENT
-------- --------------------
As of the following date not less than:
Current Assets to Current Liabilities December 31, 2002 1.09:1
Minimum Cumulative Modified EBITDA December 31, 2002 $732,000
The Company did not meet the Minimum Cumulative Modified EBITDA
covenant at December 31, 2002. IBM did not provide the Company of a
waiver of the default -See Note 2.
The IBM Credit Agreement also contains restrictions on the
declaration and payment of dividends.
Amounts outstanding under the IBM Credit Agreement are collateralized
by a security interest in substantially all of the Company's assets,
excluding the assets of the newly merged Digital Angel and MAS. The
shares of the Company's subsidiaries, including the MAS common stock
held in the Digital Angel Trust, also secure the amounts outstanding
under the IBM Credit Agreement.
See Note 2 for a discussion of the Company's violation of payment
obligations and the violation of a financial covenant under the IBM
Credit Agreement.
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Page F-31
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
NOTES PAYABLE AND LONG-TERM DEBT CONSISTS OF THE FOLLOWING:
[Enlarge/Download Table]
DECEMBER 31,
-------------------------
2002 2001
-------------------------
Term Loan - IBM Credit, collateralized by all domestic assets
of the Company and a pledge of the stock of the Company's
subsidiaries, bearing interest at 17% through February 28,
2003, due February 28, 2003; currently bearing interest at 25% $ 80,655 $ --
Revolving credit line - IBM Credit, collateralized by all
domestic assets of the Company and a pledge of the stock
of the Company's subsidiaries, bearing interest at the 30
day London Interbank Offered Rate plus 3.25% in 2001,
originally due in May 2002 and subsequently refinanced -- 61,060
Term Loan - IBM Credit, collateralized by all domestic
assets of the Company and a pledge of the stock of the
Company's subsidiaries, bearing interest at the 30 day
London Interbank Offered Rate plus 4.0% in 2001, payable
in quarterly principal installments of $1,041 plus interest,
originally due in May 2002 and subsequently refinanced -- 21,495
Term loans, payable in monthly or quarterly installments,
bearing interest at rates ranging from 4% to 10%, due through
April 2009 77
SYSCOMM INTERNATIONAL CORPORATION
Mortgage notes payable, collateralized by land and building,
payable in monthly installments of principal and interest
totaling $15,000, bearing interest at 7.16%, paid in full
in March 2002 -- 880
DIGITAL ANGEL CORPORATION
Mortgage notes payable, collateralized by land and buildings,
payable in monthly installments of principal and interest
totaling $30,000, bearing interest at 8.18% in 2002, due
through November 2010 2,419 2,465
Mortgage notes payable, collateralized by land and
building, interest only payable monthly, principal
amount of $910 due October 1, 2004, bearing interest
at 12% at December 31, 2002. 910
-------------------------
DECEMBER 31,
------------
2002 2001
DIGITAL ANGEL CORPORATION
Line of credit, collateralized by all Digital Angel
Corporation assets, interest payable monthly at prime
plus 3%, due in October 2005 (1) 709 --
Notes payable - other 299 11
Capital lease obligations 233 434
------------------------------------------------------------------------------------------
85,225 86,422
Less: Current maturities 81,879 83,836
------------------------------------------------------------------------------------------
$ 3,346 $ 2,586
==========================================================================================
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Page F-32
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
<FN>
(1) The Digital Angel Corporation line of credit contains certain
financial covenants, including a monthly minimum book net worth and
monthly minimum earnings before taxes, and it limits Digital Angel
Corporation's capital expenditures during 2002 and 2003. Any breach
of the financial covenants by Digital Angel Corporation will
constitute an event of default under the line of credit. As of
December 31, 2002, Digital Angel Corporation was not in compliance
with the minimum book net worth and monthly minimum earnings before
taxes covenants. Digital Angel Corporation has obtained a waiver of
these covenant violations from Wells Fargo.
The scheduled payments due based on maturities of long-term debt and
amounts subject to acceleration at December 31, 2002 are as follows:
[Download Table]
YEAR AMOUNT
---- ------
2003 $81,879
2004 1,012
2005 53
2006 54
2007 59
Thereafter 2,168
-------
$85,225
=======
Interest expense on the long and short-term notes payable amounted to
$17.5 million, $8.6 million, and $5.9 million for the years ended
December 31, 2002, 2001 and 2000, respectively.
The weighted average interest rate was 21% and 7.3% for the years
ended December 31, 2002 and 2001, respectively.
Certain of the Company's subsidiaries included in discontinued
operations also have notes payable and long-term debt as follows:
[Enlarge/Download Table]
DECEMBER 31,
------------
2002 2001
--------------------------------
Revolving credit line - IBM Credit, collateralized by all
domestic assets of the Company and a pledge of the stock
of the Company's subsidiaries, bearing interest at the
base rate as announced by the Toronto-Dominion Bank of
Canada plus 1.17% in 2000, due in May 2002. Amounts
paid in full upon sale of the discontinued Canadian
subsidiary in January 2002 $ -- $ 3,373
Term Loan - IBM Credit, collateralized by all Canadian
assets of the Company and a pledge of two-thirds of the
stock of the Company's Ground Effects, Ltd. subsidiary,
bearing interest at the base rate as announced by the
Toronto-Dominion Bank of Canada plus 1.17% in 2000, payable
in quarterly principal installments of $113 plus interest,
due in May 2002. Amounts paid in full upon sale of the
discontinued Canadian subsidiary in January 2002 -- 1,570
Term loans, other -- 59
Capital lease obligations 26 38
-------------------------------------------------------------------------------------------------
26 5,040
Less: Current maturities 26 5,040
-------------------------------------------------------------------------------------------------
$ -- $ --
=================================================================================================
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Page F-33
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
The obligations to IBM Credit noted above, were repaid in connection
with the sale of Ground Effects, Ltd, which was sold on January 31,
2002.
11. FAIR VALUE OF FINANCIAL INSTRUMENTS
CASH AND CASH EQUIVALENTS
The carrying amount approximates fair value because of the short
maturity of those instruments.
NOTES RECEIVABLE
The carrying value of the notes, net of the allowance for doubtful
accounts, approximate fair value because either the interest rates of
the notes approximate the current rate that the Company could receive
on a similar note, or because of the short-term nature of the notes.
NOTES PAYABLE
The carrying amount approximates fair value because of the short-term
nature of the notes and the current rates approximate market rates.
LONG-TERM DEBT
Due to the current default and resulting Forbearance Agreement with
respect to the IBM debt, it is not practicable to determine the fair
value of the Company's Long-Term Debt.
ACCOUNTS PAYABLE AND ACCRUED EXPENSES
The carrying amount approximates fair value.
12. REDEEMABLE PREFERRED SHARES - SERIES C
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 and
options was an aggregate of $20.0 million. The preferred stock was
convertible into shares of the Company's common stock at various
conversion rates.
The proceeds upon issuance were allocated to the preferred stock, the
warrants and the option based upon their relative fair values. The
value assigned to the warrants and option increased the discount on
preferred stock, as follows:
[Download Table]
Face value of preferred stock $26,000
Discount on preferred stock (6,000)
Relative fair value of warrants (627)
Relative fair value of option (5,180)
--------------------------------------------------------
Relative fair value of preferred shares $14,193
========================================================
For the year ended December 31, 2001, the beneficial conversion
feature (BCF) associated with the Company's preferred stock charged
to earnings per share was $9.4 million. The Company has cumulatively
recorded a charge to earnings per share of $13.2 million, since the
issuance of the preferred stock. As of June 30, 2001, the BCF was
fully accreted. As of December 31, 2001, all of the preferred shares
have been converted into shares of the Company's common stock.
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Page F-34
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
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.
The holders of the preferred stock also received 0.8 million warrants
to purchase up to 0.8 million shares of the Company's common stock.
The warrants expire in October 2005. At December 31, 2002, the
exercise price was $4.66 per share, subject to adjustment for various
events, including the issuance of shares of common stock, or options
or other rights to acquire common stock, at an issuance price lower
than the exercise price under the warrants. The exercise price may be
paid in cash, in shares of common stock or by surrendering warrants.
See Note 13 for the valuation and related assumptions.
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. Upon expiration, the value
of the options was reclassified to Additional Paid-in-Capital.
13. PREFERRED STOCK, COMMON STOCK AND OTHER STOCKHOLDERS' EQUITY
PREFERRED SHARES
The Company has authorized 5 million shares of preferred stock,
$10.00 par value, to be issued from time to time on such terms as is
specified by the board of directors. At December 31, 2002, no
preferred shares were issued or outstanding.
WARRANTS
The Company has issued warrants convertible into shares of common
stock for consideration, as follows (in thousands, except exercise
price):
[Enlarge/Download Table]
BALANCE
CLASS OF DECEMBER 31, EXERCISE DATE OF EXERCISABLE
WARRANTS AUTHORIZED ISSUED EXERCISED EXPIRED 2002 PRICE ISSUE PERIOD
-------- ---------- ------ --------- ------- ---- ----- ----- ------
Class P 520 520 480 40 -- 3.00 September 1997 5 years
Class S 600 600 223 -- 377 2.00 April 1998 5 years
Class U 250 250 -- -- 250 8.38 November 1998 5 years
Class V 828 828 429 399 -- .67 -3.32 September 2000 Up to 2.2 years
Class W 800 800 -- -- 800 4.66 October 2000 5 years
Class X 2,895 2,895 -- -- 2,895 0.15 April 2001 5 years
Class Y 2,895 2,895 -- -- 2,895 0.15 August 2002 5 years
----- ----- ----- --- -----
8,788 8,788 1,132 439 7,217
----- ----- ----- --- -----
Warrants in classes P through U were issued at the then-current
market value of the common stock in consideration for investment
banking services provided to the Company.
Class V warrants were issued in connection with the merger of the
Company's wholly owned subsidiary, Digital Angel.net, Inc. into
Destron Fearing. These warrants were valued at $1.7 million and
included as part of the initial purchase price.
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Page F-35
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Class W warrants were issued in connection with the Series C
preferred stock issuance. These warrants were valued at $0.6 million,
and were recorded as a discount on the preferred stock at issuance.
Class X warrants were issued to IBM Credit Corporation in connection
with an "Acknowledgement, Waiver and Amendment No. 1 to the Second
Amended and Restated Term and Revolving Credit Agreement" with IBM
Credit. The warrants were valued at $1.9 million. The fair value of
the warrants was reflected as deferred financing fees and was
amortized as interest expense. Under the terms of the IBM Credit
Agreement, which became effective on March 27, 2002, these warrants
were re-priced from an exercise price of $1.25 per share to an
exercise price of $0.15 per share. The re-priced warrants were valued
at $1.0 million.
Class Y warrants were issued to IBM Credit Corporation in connection
with the IBM Credit Agreement. The warrants were valued at $1.3
million. The fair value of the warrants was reflected as deferred
financing fees and is being amortized as interest expense.
The valuation of warrants utilized the following assumptions in the
Black-Scholes model:
[Enlarge/Download Table]
WARRANT SERIES DIVIDEND YIELD VOLATILITY EXPECTED LIVES (YRS.) RISK FREE RATES
-------------- -------------- ---------- --------------------- ---------------
P 0% 44.03% 1.69 8.5%
S & U 0% 43.69% 1.69 8.5%
V 0% 43.41% 0.10 6.4%
W 0% 43.41% 1.69 6.4%
X (initial grant) 0% 53.32% 5.0 4.6%
X (re-pricing) 0% 68.75% 4.0 4.4%
Y 0% 68.75% 5.0 3.3%
STOCK OPTION PLANS
During 1996, the Company adopted a nonqualified stock option plan (the
Option Plan). During 2000, the Company adopted a nonqualified Flexible
Stock Plan (the Flexible Plan). With the 2000 acquisition of Destron
Fearing, the Company acquired two additional stock option plans, an
Employee Stock Option Plan and Nonemployee Director Stock Option Plan. The
names of the plans were changed to Digital Angel.net Inc. Stock Option
Plan (the Employee Plan) and the Digital Angel.net Inc. Nonemployee
Director Stock Option Plan (the Director Plan).
Under the Option Plan, options for 10 million common shares were
authorized for issuance to certain officers and employees of the Company
as of December 31, 2002, of which 9.8 million have been issued through
December 31, 2002. The options may not be exercised until one to three
years after the options have been granted, and are exercisable for a
period of five years.
Under the Flexible Plan, the number of shares which may be issued or sold,
or for which options, Stock Appreciation Rights (SARs) or Performance
Shares may be granted to certain officers and employees of the Company is
36.0 million as of December 31, 2002, of which 35.9 million options have
been issued through December 31, 2002. Some of the options may not be
exercised until one to three years after the options have been granted,
and are exercisable over a period of five years.
Under the Employee Plan, the Plan authorized the grant of options to the
employees to purchase 1.6 million shares of common stock as of December
31, 2002, of which 1.4 million options have been issued through December
31, 2002. The Plan provides for the grant of incentive stock options, as
defined in the Internal Revenue Code, and non-incentive options. The Plan
has been discontinued with respect to any future grant of options.
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Page F-36
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Under the Director Plan, the Plan authorized the grant of options to the
nonemployee directors to purchase shares of common stock. As of December
31, 2002, 0.5 million options have been granted of which 0.3 million
options have been issued through December 31, 2002. The Plan has been
discontinued with respect to any future grant of options.
A summary of stock option activity for 2002, 2001 and 2000 is as follows
(in thousands, except weighted average exercise price):
[Enlarge/Download Table]
2002 2001 2000
------------------------ ------------------------ ------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
NUMBER AVERAGE NUMBER AVERAGE NUMBER AVERAGE
OF EXERCISE OF EXERCISE OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
------- ----- ------- ----- ------- -----
Outstanding on January 1 30,230 $0.76 22,457 $2.87 12,172 $3.01
Granted 10,126 .32 12,287 .33 13,725 2.76
Exercised (6,290) .23 (2,369) .15 (3,257) 2.89
Forfeited (27) 1.09 (2,145) .88 (183) 3.28
------ ----- ------ ----- ------ -----
Outstanding on December 31 34,039 0.71 30,230 .76(1) 22,457 2.87
------ ----- ------ ----- ------ -----
Exercisable on December 31 23,721 0.87 19,999 .99(1) 11,821 2.87
------ ----- ------ ----- ------ -----
Shares available on December 31
for options that may
be granted 283 2,043 12,878
------ ------ ------
<FN>
---------
(1) Options to acquire 19.3 million shares of the Company's common stock were re-priced during 2001.
See Note 14.
The following table summarizes information about stock options at
December 31, 2002 (in thousands, except weighted average exercise price):
[Download Table]
OUTSTANDING STOCK OPTIONS EXERCISABLE STOCK OPTIONS
-------------------------------------- -------------------------
WEIGHTED-
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF CONTRACTUAL EXERCISE EXERCISE
EXERCISE PRICE SHARES LIFE PRICE SHARES PRICE
-------------- ------ ---- ----- ------ -----
$0.01 to $1.00 27,100 4.20 $0.24 16,986 $0.20
$1.01 to $2.00 1,614 4.00 1.47 1,505 1.49
$2.01 to $3.00 4,037 2.90 2.51 4,037 2.51
$3.01 to $4.00 791 2.60 3.53 700 3.56
$4.01 to $5.00 307 2.20 4.45 306 4.45
$5.01 to $8.00 190 2.50 5.59 187 5.56
------ ----- ------ -----
$0.01 to $8.00 34,039 $0.71 23,721 $0.87
------ ----- ------ -----
The number of options granted for the year ended December 31, 2000
includes 1,903 stock options acquired in conjunction with the Destron
Fearing acquisition.
In addition to the above options, certain wholly-owned subsidiaries of the
Company have issued options to various employees, officers and directors.
Information pertaining to options granted by Digital Angel Corporation is
as follows: During 1999, Digital Angel Corporation adopted a non-qualified
stock option plan (the "Stock Option Plan"). In connection with the merger
with MAS, Digital Angel Corporation assumed the options granted under the
Stock Option Plan under its Amended and Restated Digital Angel Corporation
Transition Stock Option Plan ("DAC Stock Option Plan"). As amended, the
DAC Stock Option Plan provides 11,195,000 shares of common stock for which
options may be granted. As of December 31, 2002, options to purchase
7,816,000 shares were outstanding and 2,137,000 shares were available for
the grant of options under the DAC Stock Option Plan. The options vest as
determined by Digital Angel Corporation's Board of Directors and are
exercisable for a period of no more than ten years.
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Page F-37
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Under MAS's nonqualified stock option plan (the "MAS Stock Option Plan")
options may be granted at or below the fair market value of the stock and
have five and 10 year lives. Options granted to certain individuals vest
ratably over three years. As of December 31, 2002 options to purchase
1,150,000 shares were outstanding and 233,000 shares were available for the
grant of options under the plan. The MAS Stock Option Plan provides for
1,650,000 shares of common stock for which options may be granted.
A summary of stock option activity for the aforementioned plans for 2002 is
as follows (in thousands, except weighted average exercise price data):
[Download Table]
2002
------------------------
WEIGHTED-
AVERAGE
EXERCISE
SHARES PRICE
------ ---------
Outstanding on January 1 5,148 $ 0.44
Granted 3,910 3.39
Assumed in MAS Acquisition
1,211 4.23
Exercised (2,452) 0.25
Forfeited (1) 10.00
------
Outstanding on December 31 7,816 2.56
------
Exercisable on December 31 3,893 1.70
======
Shares available for grant on
December 31 2,370 --
======
The following table summarizes information about the Digital Angel
Corporation's stock options at December 31, 2002 (in thousands, except
weighted average exercise price data):
[Download Table]
OUTSTANDING STOCK OPTIONS EXERCISABLE STOCK OPTIONS
--------------------------------------- -------------------------
WEIGHTED-
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF CONTRACTUAL EXERCISE EXERCISE
EXERCISE PRICE SHARES LIFE PRICE SHARES PRICE
-------------- ------ ---- ----- ------ -----
$0.01 to $2.00 2,898 7.31 $ 0.60 2,898 $ 0.60
$2.01 to $4.00 4,214 9.40 3.43 304 3.90
$4.01 to $6.00 550 8.11 4.15 550 4.15
$6.01 to $8.00 -- -- -- -- --
$8.00 to $10.00 154 7.31 10.00 141 10.00
----- ------ ----- ------
7,816 8.49 $ 2.56 3,893 $ 1.70
===== ====== ===== ======
QUALIFIED EMPLOYEE STOCK PURCHASE PLAN
During 1999, the Company adopted a non-compensatory, qualified Employee
Stock Purchase Plan (the Stock Purchase Plan). Under the Stock Purchase
Plan, options are granted at an exercise price of the lesser of 85% of the
fair market value on the date of grant or 85% of the fair market value on
the exercise date. Under the Stock Purchase Plan, options for 9.0 million
common shares were authorized for issuance to substantially all full-time
employees of the
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Page F-38
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Company, of which 2.1 million shares have been issued and exercised through
December 31, 2002. Each participant's options to purchase shares will be
automatically exercised for the participant on the exercise dates determined
by the board of directors.
14. NON-CASH COMPENSATION EXPENSE ASSOCIATED WITH OPTIONS AND NOTES
RECEIVABLE FOR STOCK ISSUANCES
Pursuant to the terms of the pre-merger Digital Angel and MAS merger
agreement, effective March 27, 2002, options to acquire shares of pre-merger
Digital Angel common stock were converted into options to acquire shares of
MAS common stock. The transaction resulted in a new measurement date for the
options and, as a result, the Company recorded a non-cash compensation
expense of approximately $18.7 million on March 27, 2002. This charge is
included in the condensed consolidated statement of operations in selling,
general and administrative expenses.
In addition, the Company incurred approximately $0.7 million and $5.3
million of non-cash compensation expense during 2002 and 2001, respectively,
due primarily to re-pricing 19.3 million stock options during 2001. The
re-priced 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, accordingly, fluctuations in the
Company's common stock price result in increases and decreases of non-cash
compensation expense until the options are exercised, forfeited or expired.
This non-cash charge is reflected in the condensed consolidated statement of
operations in selling, general and administrative expenses.
During 2002, the Company incurred approximately $4.1 million for charges to
increase valuation reserves associated with the uncollectibility of notes
receivable for stock issuances of which $3.8 million related to notes
receivable for stock issuances to directors and officers held in escrow by
the Company.
15. ASSET IMPAIRMENT
Asset impairment during the years ended December 31, 2002, 2001 and 2000 was:
[Download Table]
2002 2001 2000
---- ---- ----
(AMOUNTS IN THOUSANDS)
Goodwill:
Advanced Technology $ -- $30,453 $ --
Digital Angel Corporation 62,185 726 --
All Other -- 32,427 818
----------------------------------------------------------------------------------
Total goodwill 62,185 63,606 818
Property and equipment 6,860 2,372 --
Investment in ATEC and Burling stock -- -- 5,565
Software and other 337 5,741 --
----------------------------------------------------------------------------------
$69,382 $71,719 $6,383
==================================================================================
As of December 31, 2002, the net book value of the Company's goodwill was
$67.8 million. There was no impairment of goodwill upon the adoption of FAS
142 on January 1, 2002. However, based upon the Company's annual review for
impairment during the fourth quarter of 2002, the Company recorded an
impairment charge of $62.2 million associated with its Digital Angel
Corporation segment. The impairment relates to the goodwill associated with
the acquisition of MAS in March 2002, and to Digital Angel Corporation's
Wireless and Monitoring segment. Future goodwill impairment reviews may
result in additional periodic write-downs. In addition, Digital Angel
Corporation impaired $6.4 million of software associated with its Wireless
and Monitoring segment. As of December 31, 2002, Digital Angel Corporation's
Wireless and Monitoring segment has not recorded any significant revenues
from its Digital Angel product, and therefore, it was determined that the
goodwill and software were impaired.
As a result of the economic slowdown during 2001, the Company experienced
deteriorating sales for certain of its businesses. In addition, management
concluded that a full transition to an advanced technology company required
the sale or closure of all units that did not fit into the Company's new
business model or were not cash-flow positive.
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Page F-39
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
This resulted in the shut down of several of its businesses during the third
and fourth quarters of 2001 and the first quarter of 2002. Also, letters of
intent that the Company had received during the last half of 2001 and the
first quarter of 2002 related to the sales of certain of its businesses
indicated a decline in their fair values. The sales of these businesses did
not comprise the sale of an entire business segment. Based upon these
developments, the Company reassessed its future expected operating cash
flows and business valuations and at December 31, 2001, the Company
performed undiscounted cash flows analyses by business unit to determine if
an impairment existed. For purposes of these analyses, earnings before
interest, taxes, depreciation and amortization were used as the measure of
cash flow. When an impairment was determined to exist, any related
impairment loss was calculated based on fair value. Fair value was
determined based on discounted cash flows. The discount rate utilized by the
Company was the rate of return expected from the market or the rate of
return for a similar investment with similar risks. This reassessment
resulted in the asset impairments listed above during 2001.
As a result of the restructuring and revision to the Company's business
model, the plan to implement an enterprise wide software system purchased in
2000 was discontinued, and accordingly, the cost of the software was
expensed in 2002 and 2001.
In addition to the impairments above, during 2002 and 2001, the Company
recorded inventory reserves of $1.4 million and $4.0 million, respectively
and bad debt reserves of $1.3 million and $25.7 million, respectively. The
inventory reserves are included in the Company's financial statements in
cost of products and the bad debt reserves are included in selling, general
and administrative expense.
During the fourth quarter of 2000, the Company reviewed its goodwill and
certain other investments for impairment and concluded that certain assets
were impaired. At December 31, 2000, the Company recorded a charge of $6.4
million for permanent impairment. The Company acquired a 16% interest in
ATEC Group, Inc. as of October 27, 2000. The Company issued 2,077,150 shares
of its stock in exchange for its investment in ATEC. As of October 27, 2000
the Company's investment in ATEC was valued at $7.2 million. Due to a
continued decline in the value of ATEC's common stock from October 27, 2000
to December 31, 2001, the Company determined its investment in ATEC had
experienced a decline in value that was other than temporary. As such, the
Company reduced the value of its investment in ATEC by $3.6 million. On
March 1, 2001, the Company rescinded the stock purchase transaction in
accordance with the rescission provision in the ATEC common stock purchase
agreement in consideration of a $1.0 million termination fee which was
payable through the issuance of the Company's common stock.
16. LOSS/GAIN ON SALES OF SUBSIDIARIES AND BUSINESS ASSETS
The gain (loss) on sale of subsidiaries and business assets reported in
continuing operations was $0.1 million, $(6.1) million, and $0.5 million for
the years ended December 31, 2002, 2001 and 2000, respectively. The loss of
$6.1 million for 2001 was due to sales of the business assets of the
Company's wholly-owned subsidiaries as follows: ADS Retail Inc., Signal
Processors, Limited, ACT Wireless Corp. and our ATI Communications
companies. In addition, the Company sold its 85% ownership interest in
Atlantic Systems, Inc. (ASI). Proceeds from the sales were $3.5 million and
were used primarily to repay debt.
See Note 18 for a discussion of dispositions related to Discontinued
Operations companies.
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Page F-40
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
17. INCOME TAXES
The provision (benefit) for income taxes consists of:
[Download Table]
2002 2001 2000
---------------------------------------
Current:
United States at statutory rates $ 392 $ -- $(1,675)
International 3 -- --
Current taxes covered by net operating
Loss -- (565) --
----------------------------------------------------------------------------------
Current income tax provision (credit) 395 (565) (1,675)
Deferred:
United States (69) 21,484 (3,005)
International -- (49) (360)
----------------------------------------------------------------------------------
Deferred income taxes provision (credit) (69) 21,435 (3,365)
----------------------------------------------------------------------------------
$ 326 $20,870 $(5,040)
==================================================================================
The tax effects of temporary differences and carryforwards that give rise to
significant portions of deferred tax assets and liabilities consist of the
following:
[Download Table]
2002 2001
---------------------------
Deferred Tax Assets:
Liabilities and reserves $ 6,000 $ 6,511
Stock-based compensation 7,779 118
Property and equipment 2,115 --
Net operating loss carryforwards 80,222 67,842
-----------------------------------------------------------------
Gross deferred tax assets 96,136 74,471
Valuation allowance (93,214) (66,932)
-----------------------------------------------------------------
2,922 7,539
-----------------------------------------------------------------
Deferred Tax Liabilities:
Accounts receivable 366 359
Installment sales 1,151 4,866
Property and equipment -- 730
Intangible assets 169 417
-----------------------------------------------------------------
1,686 6,372
-----------------------------------------------------------------
Net Deferred Tax Asset $ 1,236 $ 1,167
=================================================================
The current and long-term components of the deferred tax asset are as follows:
[Download Table]
2002 2001
--------------------------
Current deferred tax asset $ 13 $ 171
Long-term deferred tax asset 1,223 996
-----------------------------------------------------------------
$ 1,236 $ 1,167
=================================================================
The valuation allowance for deferred tax asset increased by $26.3 million
and $51.1 million in 2002 and 2001, respectively, due mainly to the
generation of net operating losses. The valuation allowance was provided for
net deferred tax assets that exceeded the Company's available carryback and
the level of existing deferred tax liabilities and projected pre-tax income.
The deferred tax asset of $1.2 million and $1.2 million at December 31, 2002
and 2001, respectively, relates entirely to the Company's 53% interest in
SysComm International Corporation subsidiary, which files a separate federal
income tax return.
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Page F-41
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
The ability of the Company to utilize its net operating losses in future
years may be limited in accordance with the provisions of Section 382 of the
Internal Revenue Code.
Approximate domestic and international loss from continuing operations
before provision for income taxes consists of:
[Download Table]
2002 2001 2000
---------------------------------------------
Domestic $ (126,764) $ (158,552) $ (32,661)
International (513) (9,589) (1,324)
--------------------------------------------------------------------------------
$ (127,277) $ (168,141) $ (33,985)
================================================================================
At December 31, 2002, the Company had aggregate net operating loss
carryforwards of approximately $194.0 million for income tax purposes that
expire in various amounts through 2022. Approximately $9.0 million of the
net operating loss carryforwards were acquired in connection with various
acquisitions and are limited as to use in any particular year based on
Internal Revenue Code sections related to separate return year and change of
ownership restrictions. Digital Angel Corporation and SysComm International
Corporation file separate federal income tax returns. Of the aggregate net
operating loss carryforwards, $17.0 million and $4.0 million relate to
Digital Angel Corporation and SysComm International Corporation,
respectively. These net operating loss carryforwards are available to only
offset future taxable income of those companies.
The reconciliation of the effective tax rate with the statutory federal
income tax benefit rate is as follows:
[Enlarge/Download Table]
2002 2001 2000
--------------------------------------
% % %
--------------------------------------
Statutory benefit rate 34 34 34
Nondeductible goodwill amortization/impairment (17) (17) (8)
State income taxes, net of federal benefits -- -- 7
International tax rates different from the
statutory US federal rate -- (2) --
Change in deferred tax asset valuation
Allowance (20) (30) (16)
Other 3 3 (2)
-----------------------------------------------------------------------------------------------
-- (12) 15
===============================================================================================
18. Discontinued Operations
On March 1, 2001, the Company's Board of Directors approved a plan to offer
for sale its IntelleSale business segment and several other noncore
businesses. Accordingly, these operating results have been reclassified and
reported as discontinued operations for all periods presented. The plan of
disposal anticipated that these entities would be sold or closed within 12
months from March 1, 2001, the defined "measurement date".
As of March 31, 2003, the Company has sold or closed all of the businesses
comprising Discontinued Operations, except one. This Company had revenue and
net loss for the year ended December 31, 2002 of $0.7 million and $0.2
million, respectively. The Company anticipates selling or closing this
remaining business in the next several months. Proceeds from the sales of
Discontinued Operations companies were used to repay amounts outstanding
under the IBM Credit Agreement. Any additional proceeds on the sale of the
remaining business will also be used to repay debt.
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Page F-42
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
The following discloses the results of the discontinued operations for the
period January 1, 2001 to March 1, 2001 and the year ended December 31,
2000:
[Download Table]
JANUARY 1, 2001 YEAR ENDED
TO DECEMBER 31,
MARCH 1, 2001 2000
--------------- ------------
Product revenue $13,039 $137,901
Service revenue 846 6,826
------- --------
Total revenue 13,885 144,727
------- --------
Cost of products sold 10,499 137,824
Cost of services sold 259 5,315
------- --------
Total cost of products and services sold 10,758 143,139
Gross profit 3,127 1,588
Selling, general and administrative expenses 2,534 40,697
Gain on sale of subsidiaries -- (4,617)
Depreciation and amortization 264 4,217
Interest, net 29 187
Impairment of assets -- 50,219
(Benefit) provision for income taxes 34 (13,614)
Minority interest 53 201
------- --------
Income (loss) income from discontinued operations $ 213 $(75,702)
------- --------
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. This debt was repaid when the business was sold on
January 31, 2002.
Assets and liabilities of discontinued operations are as follows at December 31:
[Download Table]
2002 2001
---- ----
Current Assets
Cash and cash equivalents $ 66 $ --
Accounts receivable and unbilled receivables 167 5,745
Inventories 38 4,430
Prepaid expenses and other current assets -- 291
------- -------
Total Current Assets 271 10,466
Property and equipment, net 56 3,553
Notes receivable -- 242
------- -------
$ 327 $14,261
------- -------
Current Liabilities
Notes payable and current maturities of long-term debt $ 26 $ 5,040
Accounts payable 4,189 8,670
Accrued expenses 5,334 9,610
------- -------
Total Current Liabilities 9,549 23,320
Minority interest 146 401
------- -------
9,695 23,721
------- -------
Net (Liabilities) Assets Of Discontinued Operations $(9,368) $(9,640)
------- -------
Provision for operating losses and carrying costs during the phase-out
period included the estimated loss on sale of the business units as well as
operating and other disposal costs incurred in selling the businesses.
Carrying costs includes the cancellation of facility leases, employment
contract buyouts, sales tax liabilities and reserves for certain legal
expenses related to on-going litigation.
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Page F-43
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
During 2002 and 2001, Discontinued Operations incurred a change in estimated
loss on disposal and operating losses and carrying costs accrued on the
measurement date of $(1.4) million and $16.7 million, respectively. The
primary reason for the reduction in estimated losses for 2002 was due to the
settlement of litigation for an amount less than previously anticipated. The
primary reasons for the excess losses in 2001 were due to inventory
write-downs during the second quarter of 2001, a decrease in estimated sales
proceeds as certain of the businesses were closed in the second and third
quarters of 2001, an increase is legal expenses related to on-going
litigation, additional sales tax liabilities and additional facility lease
costs. The business closures in 2001 were the result of a combination of the
deteriorating market condition for the technology sector as well as the
Company's strategic decision to reallocate funding to our core businesses.
Effective May 10, 2001, the Company sold its 80% ownership interest in
Innovative Vacuum Solutions, Inc. (IVS) for $1.4 million, or $0.2 million
less than the estimated proceeds at December 31, 2000. On October 1, 2001,
the Company sold 100% of the stock of its wholly-owned subsidiary, Hopper
Manufacturing Co., Inc. (Hopper) and on November 29, 2001, the Company sold
substantially all of the business assets of GDB Software Services, Inc.
(GDB). The sales proceeds for Hopper and GDB approximated the estimated
proceeds of $0.6 million. In addition, in November 2001, the Company ceased
operations for all of its Intellesale companies. On January 31, 2002, the
Company sold its 85% ownership interest in its Canadian subsidiary, Ground
Effects, Ltd. The sales proceeds were $1.6 million plus the repayment of the
Canadian portion of the IBM debt, which resulted in an additional loss above
the estimated loss on the measurement date of $1.2 million. On May 23, 2002,
the Company sold certain business assets of U.S. Electrical Products Corp.
for $0.1 million, which resulted in an additional loss above the estimate
loss on the measurement date of $0.2 million.
The Company does not anticipate a further loss on sale of the remaining
business comprising Discontinued Operations. However, actual losses could
differ from our estimates and any adjustments will be reflected in the
Company's future financial statements. During the years ended December 31,
2002, 2001 and 2000, the estimated amounts recorded were as follows:
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[Enlarge/Download Table]
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
(AMOUNTS IN THOUSANDS)
Operating losses and estimated loss on the sale of business units $ 684 $13,010 $ 1,619
Carrying Costs (2,104) 3,685 6,954
Less: Benefit for income taxes -- -- (1,307)
----------------------------------------
$(1,420) $16,695 $ 7,266
========================================
The following table sets forth the roll forward of the liabilities for
operating losses and carrying costs from December 31, 2000 through December
31, 2002. The additions represent changes in the estimated loss on sale or
closure and actual losses in excess of estimated operating losses and
carrying costs during the phase out period:
[Enlarge/Download Table]
BALANCE BALANCE
DECEMBER 31, DECEMBER 31,
TYPE OF COST 2000 ADDITIONS DEDUCTIONS 2001
------------ ---- --------- ---------- ----
Operating losses and
estimated loss on sale $1,619 $13,010 $13,456 $1,173
Carrying costs 6,954 3,685 3,421 7,218
------ ------- ------- ------
Total $8,573 $16,695 $16,877 $8,391
------ ------- ------- ------
BALANCE BALANCE
DECEMBER 31, DECEMBER 31,
TYPE OF COST 2001 ADDITIONS DEDUCTIONS 2002
------------ ---- --------- ---------- ----
Operating losses and
estimated loss on sale $1,173 $ 684 $1,857 $ --
Carrying costs(1) 7,218 (2,104) 206 4,908
------ ------- ------- ------
Total $8,391 $(1,420) $2,063 $4,908
------ ------- ------- ------
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Page F-44
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
<FN>
(1) Carrying costs at December 31, 2002, include all estimated costs to
dispose of the discontinued businesses including $2.0 million for future
lease commitments, $1.8 million for severance and employment contract
settlements, $1.0 million for sales tax liabilities and $0.1 million for
litigation settlement.
Included in Discontinued Operations for 2000 is an IntelleSale pre-tax
charge of $17.0 million recorded in the second quarter of 2000. This charge
was comprised of an inventory reserve of $8.5 million for products
IntelleSale expected to sell below cost (included in cost of goods and
services sold), $5.5 million related to specific accounts and other
receivables, and $3.0 million related to fees and expenses incurred in
connection with IntelleSale's cancelled initial public offering and certain
other intangible assets.
19. EXTRAORDINARY GAIN (LOSS) AND IMPACT OF FAS 145
The Company recorded an extraordinary gain as a result of settling certain
disputes between the Company and the former owners of Bostek, Inc. and an
affiliate (Bostek). As part of the settlement agreement, the parties agreed
to forgive a $9.5 million payable and the former owners of Bostek agreed
invest up to $6 million in shares of our common stock provided the Company
registered approximately 3.0 million common shares of the Company's common
stock by June 15, 2001. The Company was successful in meeting the June 15,
2001 registration deadline and, accordingly, the extinguishment of the $9.5
million payable was recorded in 2001 as an extraordinary gain.
CHANGE IN METHOD OF ACCOUNTING FOR EXTINGUISHMENT OF DEBT - IMPACT OF FAS 145
As required, the Company has adopted FAS 145 effective January 1, 2003.
Under FAS 145, gains and losses on the extinguishment of debt are included
as part of continuing operations. SFAS 145 requires all periods presented to
be consistent, and, as such, gains and losses on extinguishment of debt
previously recorded as extraordinary must be reclassified from extraordinary
treatment and presented as a component of continuing operations.
The following table presents the impact of FAS 145 on the Company's
consolidated statement of operations as indicated:
[Enlarge/Download Table]
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2002 2001 2000
---- ---- ----
Loss from continuing operations before provision (benefit) for
income taxes and minority interest:
Loss from continuing operations before provision (benefit) for
income taxes and minority interest, as previously reported $(127,277) $(177,606) $ (33,985)
Gain from extinguishment of debt, previously reported as
extraordinary -- 9,465 --
----------------------------------------------
Adjusted loss from continuing operations before provision
(benefit) for income taxes and minority interest $(127,277) $(168,141) $ (33,985)
==============================================
Loss from continuing operations before minority interest:
Loss from continuing operations before minority interest,
as previously reported $(127,603) $(198,476) $ (28,945)
Gain from extinguishment of debt, previously reported as
extraordinary -- 9,465 --
Deduct taxes on gain from extinguishment of debt (1) -- -- --
----------------------------------------------
Adjusted loss from continuing operations before minority
interest $(127,603) $(189,011) $ (28,945)
==============================================
Loss from continuing operations:
Loss from continuing operations, as previously reported $(113,905) $(198,086) $ (29,174)
Gain from extinguishment of debt, previously reported as
extraordinary -- 9,465 --
Deduct taxes on gain from extinguishment of debt(1) -- -- --
----------------------------------------------
Adjusted loss from continuing operations $(113,905) $(188,621) $ (29,174)
==============================================
Loss before extraordinary gain:
Loss before extraordinary, as previously reported $(112,485) $(214,568) $(112,142)
Gain from extinguishment of debt, previously reported
as extraordinary -- 9,465 --
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Page F-45
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Deduct taxes on gain from extinguishment of debt (1) -- -- --
----------------------------------------------
Adjusted loss before extraordinary gain $(112,485) $(205,103) $(112,142)
==============================================
Earnings (loss) per common share - basic and diluted:
Loss from continuing operations, as previously reported $ (0.42) $ (1.23) $ (0.52)
Gain from extinguishment of debt, previously reported
as extraordinary -- 0.06 --
----------------------------------------------
Adjusted loss from continuing operations $ (0.42) $ (1.17) $ (0.52)
==============================================
Earnings (loss) per common share - basic and diluted:
Extraordinary gain, previously as reported $ -- $ (0.06) $ --
Reclassify gain from extinguishment of debt -- (0.06) --
----------------------------------------------
Adjusted extraordinary gain $ -- $ -- $ --
==============================================
<FN>
(1) No taxes were provided on the gain from the extinguishment of debt due to the Company's net operating losses.
20. EARNINGS (LOSS) PER SHARE
A reconciliation of the numerator and denominator of basic and diluted EPS
is provided as follows:
[Enlarge/Download Table]
2002 2001 2000
---- ---- ----
NUMERATOR:
Loss from continuing operations $(113,905) $(188,621) $ (29,174)
Preferred stock dividends -- (1,147) (191)
Accretion of beneficial conversion feature
of redeemable preferred stock -- (9,392) (3,857)
-----------------------------------------------------------------------------------------------------------------
Numerator for basic earnings per share -
Loss from continuing operations available to common
Stockholders (113,905) (199,160) (33,222)
Net income (loss) from discontinued operations available to
common stockholders 1,420 (16,482) (82,968)
-----------------------------------------------------------------------------------------------------------------
Net loss available to common stockholders (112,485) (215,642) (116,190)
Effect of dilutive securities:
Preferred stock dividends -- -- --
Accretion of beneficial conversion feature of redeemable
preferred stock -- -- --
-----------------------------------------------------------------------------------------------------------------
Numerator for diluted earnings per share -
Net income (loss) available to common stockholders $(112,485) $(215,642) $(116,190)
=================================================================================================================
DENOMINATOR:
Denominator for basic and diluted earnings per
share - weighted-average shares outstanding(1) 269,232 170,009 63,825
-----------------------------------------------------------------------------------------------------------------
EARNINGS (LOSS) PER SHARE - BASIC AND DILUTED
Continuing operations $ (0.42) $ (1.17) $ (.52)
Discontinued operations -- (.10) (1.30)
-----------------------------------------------------------------------------------------------------------------
TOTAL - BASIC AND DILUTED $ (0.42) $ (1.27) $ (1.82)
=================================================================================================================
<FN>
--------
(1) The weighted average shares listed below were not included in the
computation of diluted loss per share for the year ended December 31, 2002,
2001 and 2000 because to do so would have been anti-dilutive.
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Page F-46
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
2002 2001 2000
---- ---- ----
Redeemable preferred stock -- 140,768 617
Warrants 2,950 -- 301
Employee stock options 15,399 4,173 2,741
------------------------------------------------------------------------
18,349 144,941 3,659
========================================================================
21. COMMITMENTS AND CONTINGENCIES
Rentals of space, vehicles, and office equipment under operating leases
amounted to approximately $2.0 million, $3.5 million and $2.9 million for
the years ended December 31, 2002, 2001 and 2000, respectively.
The approximate minimum payments required under operating leases and
employment contracts that have initial or remaining terms in excess of one
year at December 31, 2002 are as follows (in thousands):
[Download Table]
MINIMUM EMPLOYMENT
YEAR RENTAL PAYMENTS CONTRACTS
-----------------------------------------------------------
2003 $ 1,385 $ 2,483
2004 1,061 1,404
2005 696 789
2006 427 671
2007 357 51
Thereafter 11,113 --
-----------------------------------------------------------
$ 15,039 $ 5,398
===========================================================
The Company has entered into employment contracts with key officers and
employees of the Company. The agreements are for periods ranging from one to
five years through February 2007. Some of the employment contracts also call
for bonus arrangements based on earnings of a particular subsidiary. The
Company recorded $0.5 million associated with these bonus arrangements
during 2002.
On March 24, 2003, the Company terminated its employment agreements with two
of its executive officers. The terms of the IBM Credit Agreement limited the
amount of salary the Company could pay these executive officers in cash and
prevented the Company from making certain cash incentive and perquisite
payments to these executive officers. These terminations are more fully
discussed in Note 27.
Effective December 31, 2001, one of the Company's directors, who had
previously been an executive officer of the Company, retired and resigned
from the Board of Directors. As part his termination agreement, the Company
agreed to grant him 2.5 million shares of the Company's common stock the
value of which was recorded as compensation expense in the year ended
December 31, 2001.
According to the terms of the trust agreement for the Digital Angel Trust,
if amounts due IBM Credit by the Company are not paid when due, or if the
Company is otherwise in default under the forbearance agreement or IBM
Credit Agreement (as more fully discussed in Note 2) and the Company's
obligations are accelerated, IBM Credit will have the right to require that
the shares of the Digital Angel Corporation common stock held in the Digital
Angel Trust be sold to provide funds to satisfy the obligations of the
Company to IBM Credit.
POSSIBLE CONSEQUENCES OF SALES OF THE DIGITAL ANGEL TRUST SHARES
If we are required to sell the shares held in the Digital Angel Trust for an
amount less than our current book value, we would incur a significant
non-cash charge and our financial position and operating results would be
materially adversely effected.
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Page F-47
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
In addition, under the terms of the employment agreement dated March 8,
2002, as amended, by and between Digital Angel Corporation and Randolph K.
Geissler (the President and Chief Executive Officer of Digital Angel
Corporation), a "change in control" occurs under that employment agreement
if any person becomes the "beneficial owner" (as defined in Rule 13d-3 under
the Securities Exchange Act of 1934), directly or indirectly, of securities
of Digital Angel Corporation representing 20% or more of the combined voting
power of the then outstanding shares of common stock. Therefore, if the
Digital Angel Trust were to sell more than approximately 5.3 million shares
of the Digital Angel Corporation common stock, such sale would constitute a
change in control under the employment agreement with Mr. Geissler. Upon the
occurrence of a change in control, Mr. Geissler, at his sole option and
discretion, may terminate his employment with Digital Angel Corporation at
any time within one year after such change in control upon 15 days' notice.
In the event of such termination, the employment agreement provides that
Digital Angel Corporation must pay to Mr. Geissler a severance payment equal
to three times the base salary amount as defined in Section 280G(b)(3) of
the Internal Revenue Code of 1986, as amended ("Code") minus $1.00 (or a
total of approximately $750,000), which would be payable no later than one
month after the effective date of Mr. Geissler's termination of employment.
In addition, upon the occurrence of a change of control under the employment
agreement, all outstanding stock options held by Mr. Geissler would become
fully exercisable. As of December 31, 2002, Mr. Geissler owned options to
purchase 1.0 million shares for $3.39 per share none of which had vested
which would become exercisable upon the occurrence of such a change in
control.
The employment agreement also provides that upon (i) a change of control,
(ii) the termination of Mr. Geissler's employment for any reason other than
due to his material default under the employment agreement, or (iii) if he
ceases to be Digital Angel Corporation's President and Chief Executive
Officer for any reason other than termination due to his material default
under the employment agreement, within 10 days of the occurrence of any such
events, Digital Angel Corporation is to pay to Mr. Geissler $4,000,000.
Digital Angel Corporation may pay such amount in cash or in its common stock
or with a combination of cash and common stock. The employment agreement
also provides that if the $4,000,000 is paid in cash and stock, the amount
of cash paid must be sufficient to cover the tax liability associated with
such payment, and such payment shall otherwise be structured to maximize tax
efficiencies to both Digital Angel Corporation and Mr. Geissler.
Also, effective October 30, 2002, Digital Angel Corporation entered into a
Credit and Security Agreement with Wells Fargo. The Credit and Security
Agreement provides that a "change in control" under that agreement results
in a default. A change in control is defined as either Mr. Geissler ceasing
to actively manage Digital Angel Corporation's day-to-day business
activities or the transfer of at least 25% of the outstanding shares of
Digital Angel Corporation's common stock. Also, if Digital Angel Corporation
owes Mr. Geissler $4,000,000 under his employment agreement, the obligation
would most likely result in a breach of Digital Angel Corporation's
financial covenants under the Credit and Security Agreement. If these
defaults occurred and were not waived by Wells Fargo, and if Wells Fargo
were to enforce these defaults under the terms of the Credit and Security
Agreement and related agreements, Digital Angel Corporation's and the
Company's business and financial condition would be materially and adversely
affected, and it may force Digital Angel Corporation to cease operations.
22. PROFIT SHARING PLAN
The Company has a 401(k) Plan for the benefit of eligible United States
employees. The Company has made no contributions to the 401(k) Plan.
The Company's International subsidiaries operate certain defined
contribution pension plans. The Company's expense relating to the plans
approximated $0.1 million, $0.2 million and $0.2 million for the years ended
December 31, 2002, 2001 and 2000, respectively.
23. LEGAL PROCEEDINGS
The Company is party to various legal proceedings, and accordingly, has
recorded $1.7 million in reserves in its financial statements at December
31, 2002. In the opinion of management, these proceedings are not likely to
have a material adverse affect on the financial position or overall trends
in results of the Company. The estimate of potential impact on the Company's
financial position, overall results of operations or cash flows for the
above legal proceedings could change in the future.
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Page F-48
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
In May 2002, a class action was filed against the Company and one of its
directors. Fourteen virtually identical complaints were consolidated into a
single action, in re Applied Digital Solutions Litigation, which was filed
in the United States District Court for the Southern District of Florida. In
March 2003, the Company entered into a memorandum of understanding to settle
the pending lawsuit. The settlement of $5.6 million, which is subject to
various conditions, is expected to be covered by proceeds from insurance.
24. SUPPLEMENTAL CASH FLOW INFORMATION
The changes in operating assets and liabilities are as follows:
[Enlarge/Download Table]
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
2002 2001 2000
---------------------------------
(Increase) decrease in accounts receivable
and unbilled receivables $ 5,350 $16,020 $(6,359)
(Increase) decrease in inventories (247) 4,090 607
Decrease in other current assets 2,453 2,969 843
Increase in other assets 361 1,626 --
Increase (decrease) in accounts payable,
accrued expenses and other liabilities 9,249 3,660 (668)
---------------------------------------------------------------------------------------
$17,166 $28,365 $(5,577)
=======================================================================================
In the years ended December 31, 2002, 2001, and 2000, the Company had the
following noncash investing and financing activities:
[Enlarge/Download Table]
2002 2001 2000
-----------------------------------
Assets acquired for common stock $-- $10,201 $168,319
Due from buyer of divested subsidiary -- 2,625 --
Common stock issued for services -- 207 125
Assets acquired for long-term debt and capital leases -- -- 2,201
Common stock issued upon conversion of preferred stock -- 14,550 --
25. SEGMENT INFORMATION
As a result of the merger of pre-merger Digital Angel and MAS, the
significant restructuring of the Company's business during the first quarter
of 2002 and the Company's emergence as an advanced technology development
company, the Company has re-evaluated and realigned its reporting segments.
On January 1, 2002, the Company began operating in the three business
segments Advanced Technology, Digital Angel Corporation and SysComm
International.
Business units that were part of the Company's continuing operations and
that were closed or sold during 2001 and 2002 are reported as All Other.
The "Corporate/Eliminations" category includes all amounts recognized upon
consolidation of the Company's subsidiaries such as the elimination of
intersegment revenues, expenses, assets and liabilities.
"Corporation/Eliminations" also includes certain interest expense and other
expenses associated with corporate activities and functions. Included in
"Corporate/Eliminations" for the year ended December 31, 2002, is a non-cash
compensation charge of $18.7 million associated with pre-merger Digital
Angel options, which were converted into options to acquire shares of MAS in
connection with the merger of pre-merger Digital Angel and MAS.
Prior to January 1, 2002, the Company's business units were organized into
the three segments: Applications, Services and Advanced Wireless. Prior
period information has been restated to present the Company's reportable
segments on a comparative basis.
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Page F-49
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
Advanced Technology, Digital Angel Corporation and SysComm International's
product and services are as follows:
[Download Table]
OPERATING SEGMENT PRINCIPAL PRODUCTS AND SERVICES
----------------- -------------------------------
Advanced Technology
o Call center solutions
o Customer relationship management
o Website design
o Internet access
o Software development
o Cable/fiber infrastructure
o Miniaturized implantable verification chip
o Miniaturized power generator
Digital Angel Corporation
o Animal Applications
o Wireless and Monitoring
o GPS and Radio Communications
o Medical Systems
SysComm International
o Systems integration
o Information technology, procurement, and logistics
o Technology strategy
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Page F-50
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
The accounting policies of the operating segments are the same as those
described in the summary of significant accounting policies, except that
intersegment sales and transfers are generally accounted for as if the sales
or transfers were to third parties at current market prices; segment data
includes an allocated charge for the corporate headquarters costs. It is on
this basis that management utilizes the financial information to assist in
making internal operating decisions. The Company evaluates performance based
on stand-alone segment operating income. Corporate amounts have been
adjusted from amounts previously reported to reflect the reclassification of
the 2001 gain on extinguishment of debt from extraordinary to Continuing
Operations (see Note 19).
[Enlarge/Download Table]
2002 (IN THOUSANDS)
-----------------------------------------------------------------------------------
ADVANCED DIGITAL ANGEL SYSCOMM CORPORATE AND
TECHNOLOGY CORPORATION INTERNATIONAL ALL OTHER ELIMINATIONS CONSOLIDATED
---------- ------------- ------------- --------- ------------- ------------
Net revenue from external customers $41,930 $ 33,561 $22,721 $1,388 $ -- $ 99,600
Intersegment net revenue -- 70 -- -- (70) --
--------- -------- ------- ------ -------- ---------
Total revenue $41,930 $ 33,631 $22,721 $1,388 $ (70) $ 99,600
--------- -------- ------- ------ -------- ---------
Depreciation and amortization $ 569 $ 3,638 $ 262 $9 $ 295 $ 4,773
Asset impairment -- 68,597 -- -- 785 69,382
Interest income 239 601 45 -- 1,471 2,356
Interest expense 422 303 184 148 16,467 17,524
Loss from continuing operations
before provision for income taxes, minority
interest, net loss on subsidiary merger
transaction, and equity in net loss of
affiliate(1) (786) (76,439) (422) (320) (49,310) (127,277)
Goodwill, net 18,212 47,452 2,154 -- -- 67,818
Segment assets 41,404 67,798 9,340 2,753 (4,062) 117,233
Expenditures for property and equipment 340 1,439 41 -- 38 1,858
<FN>
(1) For Digital Angel Corporation, amount excludes $1.8 million of interest
expense associated with the Company's obligation to IBM Credit and $18.7
million of non-cash compensation expense associated with pre-merger Digital
Angel options which were converted into options to acquire MAS stock, both
of which have been reflected as additional expense in the separate financial
statements of Digital Angel Corporation included in its Form 10-K dated
December 31, 2002.
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Page F-51
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(2)
2001 (IN THOUSANDS)
-----------------------------------------------------------------------------------
ADVANCED DIGITAL ANGEL SYSCOMM CORPORATE AND
TECHNOLOGY CORPORATION INTERNATIONAL ALL OTHER ELIMINATIONS CONSOLIDATED
---------- ------------- ------------- --------- ------------- ------------
Net revenue from external customers $44,570 $35,738 $34,175 $41,292 $ 539 $156,314
Intersegment net revenue 232 964 -- 870 (2,066) --
------- ------- ------- ------- ------- --------
Total revenue $44,802 $36,702 $34,175 $42,162 $(1,527) $156,314
------- ------- ------- ------- ------- --------
Depreciation and amortization $ 9,088 $12,298 $ 503 $ 4,768 $ 2,242 $ 28,899
Asset impairment 30,453 726 -- 32,427 8,113 71,719
Interest and other income 20 17 68 34 1,937 2,076
Interest expense 216 529 325 1,465 6,020 8,555
Income (loss) from continuing operations
before provision for income taxes
and minority interest (41,493) (16,262) (1,322) (71,636) (37,428) (168,141)
Goodwill, net 15,379 73,095 2,357 -- -- 90,831
Segment assets 38,247 105,042 15,004 4,968 4,228 167,489
Expenditures for property and equipment 151 1,591 490 1,703 10,226 14,161
2000 (IN THOUSANDS)
-----------------------------------------------------------------------------------
ADVANCED DIGITAL ANGEL SYSCOMM CORPORATE AND
TECHNOLOGY CORPORATION INTERNATIONAL ALL OTHER ELIMINATIONS CONSOLIDATED
---------- ------------- ------------- --------- ------------- ------------
Net revenue from external customers $32,354 $22,252 $27,288 $52,681 $ 191 $134,766
Intersegment net revenue -- -- -- 5,142 (5,142) --
------- ------- ------- ------- ------- --------
Total revenue $32,354 $22,252 $27,288 $57,823 $(4,951) $134,766
------- ------- ------- ------- ------- --------
Depreciation and amortization $ 2,990 $ 2,962 $ 176 $ 3,366 $ 1,579 $ 11,073
Asset impairment -- -- -- 818 5,565 6,383
Interest and other income (431) 9 17 17 1,483 1,095
Interest expense 117 98 112 1,213 4,361 5,901
Income (loss) from continuing operations
before provision for income taxes and
minority interest (1,544) (3,816) 923 (5,714) (23,834) (33,985)
Goodwill, net 49,431 77,464 2,330 36,779 -- 166,024
Segment assets 77,463 95,582 16,434 68,741 53,155 311,375
Expenditures for property and equipment 155 758 7 1,183 6,288 8,391
Segment assets do not include net assets of discontinued operations of $0
million, $0 million and $8.1 million, in 2002, 2001, and 2000, respectively.
Approximately $31.3 million, or 74.7%, and $27.4 million, or 61.5%, of the
Company's Advanced Technology segment's revenue for 2002 and 2001,
respectively, were generated by its wholly-owned subsidiary, Computer Equity
Corporation. Approximately 99.1% and 77.7% of Computer Equity Corporation's
revenue during 2002 and 2001, respectively, were generated through sales to
various agencies of the United States Federal Government.
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Page F-52
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
For 2002, Digital Angel Corporation's top five customers, Schering-Plough,
US Army Corps of Engineers, Biomark, Pacific States Marine and San
Bernardino County, accounted for 31.8% of this segment's revenues, however,
no single customer accounted for more than 10% of this segment's revenue.
For 2001, the top five customers, Schering Plough, Merial, Pacific States
Marine, San Bernardino County and the US Army Corps of Engineers accounted
for 30.6% of this segment's revenue, one of which accounted for 10.4% of the
segment's revenue.
For 2002, five customers, SysComm International's top five customers,
Deutsche Bank, Hackensack University Medical Center, Liberty Mutual, Morgan
Stanley and Polytechnic University, accounted for 23%, 22%, 11%, 11% and
11% of SysComm International's revenue, respectively. For 2001, two
customers, Liberty Mutual and Mass Mutual Life Insurance accounted for 40%
and 31% of SysComm International's revenue, respectively.
Sales to an individual customer did not exceed 10% of a segment's revenue
during 2000.
Goodwill by segment for the year ended December 31, 2002, is as follows:
[Enlarge/Download Table]
YEAR ENDED DECEMBER 31, 2002
-----------------------------------------------------------------------------------
ADVANCED DIGITAL ANGEL SYSCOMM
TECHNOLOGY CORPORATION INTERNATIONAL ALL OTHER CORPORATE CONSOLIDATED
---------- ------------- ------------- --------- ------------- ------------
Balance As of January 1, 2002 $15,212 $ 72,876 $2,154 $-- $ 589 $ 90,831
Goodwill acquired during the year 3,000 36,761 -- -- -- 39,761
Other adjustment -- -- -- -- (589) (589)
Impairment Losses -- (62,185) -- -- -- (62,185)
------------------------------------------------------------------------------------
Balance as of December 31, 2002 $18,212 $ 47,452 $2,154 $-- $ -- $ 67,818
====================================================================================
Revenues are attributed to geographic areas based on the location of the
assets producing the revenue. Information concerning principal geographic
areas as of and for the years ended December 31, was as follows (in
thousands):
[Enlarge/Download Table]
UNITED
UNITED STATES CANADA KINGDOM CONSOLIDATED
----------------------------------------------------------
2002
Net revenue $ 88,190 $ -- $11,410 $ 99,600
Long-lived tangible assets 15,379 --- 855 16,234
Deferred tax asset 1,236 -- -- 1,236
--------------------------------------------------------------------------------------------
2001
Net revenue $138,887 $ -- $17,427 $156,314
Long-lived tangible assets 19,193 --- 992 20,185
Deferred tax asset 1,167 -- -- 1,167
--------------------------------------------------------------------------------------------
2000
Net revenue $118,849 $ 766 $15,151 $134,766
Long-lived tangible assets 20,044 -- 1,324 21,368
Deferred tax asset (liability) 21,426 (204) 564 21,786
--------------------------------------------------------------------------------------------
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Page F-53
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
26. NASDAQ LISTING REQUIREMENTS
From July 12, 2002, to July 30, 2002, the Company's common stock was traded
on the Pink Sheets under the symbol "ADSX.PK." Prior to that time, the
Company's shares were traded on the Nasdaq National Market (NasdaqNM).
Effective July 31, 2002, the Company's shares were relisted on the NasdaqNM
under the symbol "ADSX." As a condition of the relisting, NasdaqNM advised
the Company that it had until October 25, 2002, to regain compliance with
the minimum closing bid price requirement of at least $1.00 per share, and,
immediately following, a closing bid price of at least $1.00 per share for a
minimum of ten (10) consecutive trading days. The Company was unable to
satisfy the minimum closing bid price requirement by October 25, 2002, and,
as a result, effective November 12, 2002, the Company's common stock began
trading on the Nasdaq SmallCap Market (SmallCap), under its existing stock
symbol ADSX. The Company expects to have until October 2003, in which to
regain the minimum bid requirement of at least $1.00 per share for a minimum
of ten (10) consecutive trading days to maintain its SmallCap listing,
providing the Company continues to comply with the SmallCap's other listing
requirements, which as of December 31, 2002, it was in compliance with.
27. SUBSEQUENT EVENTS
On March 21, 2003, Richard J. Sullivan retired from the Company. Replacing
him as Chairman of the Board and Chief Executive Officer is Scott R.
Silverman, the Company's current President and Director. The Company's Board
of Directors negotiated a satisfactory severance agreement with Mr.
Sullivan. Under the terms, Mr. Sullivan will receive a one-time payment of
56.0 million shares of the Company's common stock, and 10.9 million
re-priced stock options. The options surrendered had exercise prices ranging
from $0.15 to $0.32 per share and were replaced with options exercisable at
$0.01 per share. Under the terms of Mr. Sullivan's employment contract, the
Company would have been obligated to make payments in cash or stock of up to
$17 million to Mr. Sullivan.
On March 21, 2003, Jerome C. Artigliere resigned from his positions of
Senior Vice President and Chief Operating Officer. Under the terms of his
severance agreement, Mr. Artigliere will receive 4.8 million shares of the
Company's common stock and 2.3 million re-priced stock options. The options
surrendered had exercise prices ranging from $0.15 to $0.32 per share and
were replaced with options exercisable at $0.01 per share. Replacing Mr.
Artigliere is Kevin H. McLaughlin. Mr. McLaughlin has served most recently
as SysComm International Corporation's Chief Executive Officer.
The terms of each of the severance agreements are subject to shareholder
approval. In connection with such shareholder approval, the Company will
also need to seek shareholder approval of an increase in the number of
authorized shares of its common stock.
On March 27, 2003, the Company announced that it had executed to a
forbearance agreement term sheet with IBM Credit. The forbearance agreement,
which becomes effective on or about March 31, 2003, allows for the
forbearance of the obligations due under the IBM Credit Agreement, provides
for more favorable loan repayment terms, reduces the interest rate on the
Tranche B portion of the debt to 7% per annum and provides for purchase
rights. The forbearance agreement term sheet is more fully describe in Note 2.
28. RECENT EVENT
The staff of the Securities and Exchange Commission's Southeast Regional
Office is conducting an informal inquiry concerning the Company. The Company
is fully and voluntarily cooperating with this informal inquiry. At this
point, the Company is unable to determine whether this informal inquiry may
lead to potentially adverse action.
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Page F-54
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
29. SUMMARIZED QUARTERLY DATA (UNAUDITED)
[Enlarge/Download Table]
FIRST SECOND THIRD FOURTH FULL
QUARTER QUARTER QUARTER QUARTER YEAR
------- ------- ------- ------- ----
2002
Total revenue $ 28,219 $ 25,836 $23,903 $ 21,642 $ 99,600
Gross profit 9,378 8,728 8,735 5,041 31,882
Net loss from Continuing Operations (1) (24,692) (19,473) (5,751) (63,989) (113,905)
Net income (loss) from Discontinued Operations 687 (463) (119) 1,315 1,420
Basic and diluted net loss per share from
Continuing Operations (4) (0.10) (0.07) (0.02) (0.23) (0.42)
Basic and diluted net income (loss) per share
from Discontinued Operations (4) 0.01 (0.01) -- -- --
FIRST SECOND THIRD FOURTH FULL
QUARTER QUARTER QUARTER QUARTER YEAR
------- ------- ------- ------- ----
2001 - AS REPORTED
Net operating revenue $ 47,409 $ 39,871 $ 41,366 $ 27,668 $ 156,314
Gross profit 17,348 14,311 6,522 8,294 46,475
Net loss from Continuing Operations(2) (11,393) (19,881) (109,349) (47,998) (188,621)
(Loss) income from Discontinued Operations(3) 213 (21,789) (748) 5,842 (16,482)
Net loss (11,180) (41,670) (110,097) (42,156) (205,103)
Basic and diluted loss per share from
Continuing Operations(4) (0.13) (0.15) (0.56) (0.18) (1.17)
Basic and diluted loss per share from
Discontinued Operations(4) -- (0.16) -- 0.02 (0.10)
2001 - ADJUSTED FOR CHANGE IN METHOD OF
ACCOUNTING FOR GOODWILL(A)
Net operating revenue $47,409 $ 39,871 $ 41,366 $ 27,668 $ 156,314
Gross profit 17,348 14,311 6,522 8,294 46,475
Net loss from Continuing Operations(2) (5,865) (13,756) (103,036) (43,491) (166,148)
(Loss) income from Discontinued Operations(3) 213 (21,789) (748) 5,842 (16,482)
Net loss (5,652) (35,545) (103,784) (37,649) (182,630)
Basic and diluted loss per share from
Continuing Operations(4) (0.06) (0.10) (0.52) (0.18) (0.97)
Basic and diluted loss per share from
Discontinued Operations(4) -- (0.16) -- 0.02 (0.10)
<FN>
A. CHANGE IN METHOD OF ACCOUNTING FOR GOODWILL
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. The Company performed its
annual review for impairment during the fourth quarter of 2002, which
resulted in an impairment charge of $62.2 million in 2002. There can be no
assurance that future goodwill impairment tests will not result in
additional impairment charges.
(1) First quarter of 2002 loss from Continuing Operations includes a
non-cash compensation charge of approximately $18.7 million associated
with pre-merger Digital Angel options. Pursuant to the terms of the
merger of pre-merger Digital Angel and MAS, options to acquire
pre-merger Digital Angel common stock were converted into options to
acquire shares of MAS commons stock, which resulted in a new measurement
date for the options. In addition, the Company incurred a loss on
issuances of subsidiary stock of approximately $3.9 million. Second
quarter of 2002 loss from Continuing Operations includes non-cash
compensation expense of $6.1 million associated with options that were
re-priced in 2001, and valuation reserves on notes receivable from
officers and directors. Third quarter of 2002 loss from Continuing
Operations includes a reversal of approximately $2.9 million of non-cash
compensation expense associated with the options re-priced in 2001, and
a reversal of approximately $0.9 million of bad debt reserves. Fourth
quarter of 2002 loss from Continuing Operations includes asset
impairments of $69.4 million.
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Page F-55
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(2) The second quarter of 2001 reflects the reclassification of the $9.5
million gain on extinguishment of debt from an extraordinary item to
Continuing Operations (see Note 19). The third quarter of 2001 loss from
Continuing Operations includes asset impairment charges of $68,764,
inventory reserves of $4,261, loss on disposition of assets of $3,967 and
non-cash compensation expense of $1,231. Fourth quarter of 2001 loss from
Continuing Operations includes asset impairment charges of $2,955, loss on
disposition of assets of $2,091 and non-cash compensation expense of $4,042,
and bad debt reserves of $12,758.
(3) Second quarter of 2001 loss from Discontinued Operations includes a
change in estimate on loss on disposal and operating losses during the
phase out period of $21,789. Third quarter of 2001 loss from
Discontinued Operations includes a change in estimate on loss on
disposal and operating losses during the phase out period of $748.
(4) Earnings per share are computed independently for each of the quarters
presented. Therefore, the sum of the quarterly net earnings per share
will not necessarily equal the total for the year.
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Page F-56
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FINANCIAL STATEMENT SCHEDULE
VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
ADDITIONS
------------------------
BALANCE AT CHARGED TO VALUATION BALANCE AT
BEGINNING COST AND ACCOUNTS END OF
DESCRIPTION OF PERIOD EXPENSES ACQUIRED DEDUCTIONS PERIOD
-----------------------------------------------------------------------------------------------------------------
VALUATION RESERVE DEDUCTED IN THE BALANCE
SHEET FROM THE ASSET TO WHICH IT APPLIES:
ACCOUNTS RECEIVABLE:
2002 ALLOWANCE FOR DOUBTFUL ACCOUNTS $ 2,581 $ 4,236 $ -- $5,554 $ 1,263
2001 ALLOWANCE FOR DOUBTFUL ACCOUNTS 1,681 1,914 -- 1,014 2,581
2000 ALLOWANCE FOR DOUBTFUL ACCOUNTS 1,047 823 766 955 1,681
INVENTORY:
2002 ALLOWANCE FOR EXCESS AND OBSOLESCENCE $ 1,702 $ 104 $ -- $ 384 $ 1,422
2001 ALLOWANCE FOR EXCESS AND OBSOLESCENCE 1,500 570 -- 368 1,702
2000 ALLOWANCE FOR EXCESS AND OBSOLESCENCE 916 345 460 221 1,500
NOTES RECEIVABLE:
2002 ALLOWANCE FOR DOUBTFUL ACCOUNTS $12,671 $ 1,266 $ -- $7,270 $ 6,667
2001 ALLOWANCE FOR DOUBTFUL ACCOUNTS -- 12,671 -- -- 12,671
2000 ALLOWANCE FOR DOUBTFUL ACCOUNTS -- -- -- -- --
DEFERRED TAXES:
2002 VALUATION RESERVE $66,932 $26,282 $ -- $ -- $93,214
2001 VALUATION RESERVE 15,850 51,082 -- -- 66,932
2000 VALUATION RESERVE -- 15,850 -- -- 15,850
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Page F-57
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APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE)
MARCH 31 DECEMBER 31
--------------------------------------
2003 2002
--------------------------------------
(UNAUDITED)
ASSETS
CURRENT ASSETS
--------------------------------------------------------------------------------------
Cash and cash equivalents $ 3,018 $ 5,818
Cash held by note holder 2,015 --
Accounts receivable and unbilled receivables (net of allowance
for doubtful accounts of $486 in 2003 and $1,263 in 2002) 19,129 16,548
Inventories 7,788 6,409
Notes receivable 1,999 2,801
Other current assets 2,576 2,920
-----------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 36,525 34,496
======================================================================================---------------------------------------
PROPERTY AND EQUIPMENT, NET 9,553 9,822
NOTES RECEIVABLE, NET 553 758
GOODWILL, NET 67,818 67,818
OTHER ASSETS, NET 3,955 4,339
-----------------------------------------------------------------------------------------------------------------------------
$ 118,404 $ 117,233
=============================================================================================================================
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
-----------------------------------------------------------------------------------------------------------------------------
Notes payable and current maturities of long-term debt $ 81,958 $ 81,879
Accounts payable 12,344 9,761
Accrued interest 14,069 10,149
Accrued severance 21,841 --
Other accrued expenses 19,300 19,145
Put accrual 200 200
Net liabilities of Discontinued Operations 9,397 9,368
-----------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 159,109 130,502
======================================================================================---------------------------------------
LONG-TERM DEBT AND NOTES PAYABLE 3,336 3,346
OTHER LONG-TERM LIABILITIES 1,103 1,055
-----------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 163,548 134,903
======================================================================================---------------------------------------
COMMITMENTS AND CONTINGENCIES -- --
-----------------------------------------------------------------------------------------------------------------------------
MINORITY INTEREST 18,833 18,422
-----------------------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' DEFICIT
Preferred shares: Authorized 5,000 shares in 2003 and 2002 of $10 par value;
special voting, no shares issued or outstanding in 2003 and 2002, Class B
voting, no shares issued or outstanding in 2003 and 2002 -- --
Common shares: Authorized 435,000 shares in 2003 and 2002, of
$.001 par value; 285,549 shares issued and 284,614 shares outstanding
in 2003 and 285,069 shares issued and 284,134 shares outstanding in 2002 286 285
Common and preferred additional paid-in capital 376,999 377,621
Accumulated deficit (444,006) (417,066)
Common stock warrants 5,650 5,650
Treasury stock (carried at cost, 935 shares in 2002 and 2001) (1,777) (1,777)
Accumulated other comprehensive income (loss) (7) 31
Notes received for shares issued (1,122) (836)
-----------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' DEFICIT (63,977) (36,092)
-----------------------------------------------------------------------------------------------------------------------------
$ 118,404 $ 117,233
=============================================================================================================================
See the accompanying notes to condensed consolidated financial statements.
SEE NOTES 1 AND 4 REGARDING THE RESTRICTION ON APPLIED DIGITAL SOLUTIONS,
INC.'S ABILITY TO EXERCISE CONTROL OVER THE AFFAIRS, MANAGE THE RESOURCES
AND TRANSFER FUNDS FROM A SIGNIFICANT OPERATING SUBSIDIARY.
------------------------------------------------------------------------------
Page F-58
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APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
FOR THE THREE MONTHS ENDED
MARCH 31
-------------------------------
2003 2002
-------------------------------
PRODUCT REVENUE $ 21,023 $ 23,063
SERVICE REVENUE 4,083 5,156
-------------------------------------------------------------------------------------------------------------
TOTAL REVENUE 25,106 28,219
COSTS OF PRODUCTS SOLD 14,172 16,516
COST OF SERVICES SOLD 1,965 2,325
-------------------------------------------------------------------------------------------------------------
GROSS PROFIT 8,969 9,378
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE 29,468 28,900
RESEARCH AND DEVELOPMENT 1,201 1,448
DEPRECIATION AND AMORTIZATION 626 1,004
INTEREST AND OTHER INCOME (220) (98)
INTEREST EXPENSE 4,631 2,059
-------------------------------------------------------------------------------------------------------------
LOSS FROM CONTINUING OPERATIONS BEFORE TAXES,
MINORITY INTEREST, NET LOSS ON SUBSIDIARY STOCK ISSUANCES
AND MERGER TRANSACTION, AND EQUITY IN NET LOSS OF AFFILIATE (26,737) (23,935)
(BENEFIT) PROVISION FOR INCOME TAXES (192) 108
-------------------------------------------------------------------------------------------------------------
LOSS FROM CONTINUING OPERATIONS BEFORE MINORITY INTEREST, NET LOSS ON
SUBSIDIARY STOCK ISSUANCES AND MERGER TRANSACTION,
AND EQUITY IN NET LOSS OF AFFILIATE (26,545) (24,043)
MINORITY INTEREST (139) (36)
NET LOSS ON SUBSIDIARY STOCK ISSUANCES AND MERGER TRANSACTION 377 394
EQUITY IN NET LOSS OF AFFILIATE -- 291
-------------------------------------------------------------------------------------------------------------
LOSS FROM CONTINUING OPERATIONS (26,783) (24,692)
CHANGE IN ESTIMATE ON LOSS ON DISPOSAL OF DISCONTINUED
OPERATIONS AND OPERATING LOSSES DURING PHASE OUT PERIOD (157) 687
-------------------------------------------------------------------------------------------------------------
NET LOSS $(26,940) $(24,005)
=============================================================================================================
(LOSS) INCOME PER COMMON SHARE - BASIC AND DILUTED
LOSS FROM CONTINUING OPERATIONS $ (0.10) $ (.10)
(LOSS) INCOME FROM DISCONTINUED OPERATIONS -- 01
-------------------------------------------------------------------------------------------------------------
NET LOSS PER COMMON SHARE - BASIC AND DILUTED $ (0.10) $ (0.09)
=============================================================================================================
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING - BASIC AND DILUTED 282,329 253,938
See the accompanying notes to condensed consolidated financial statements.
SEE NOTES 1 AND 4 REGARDING THE RESTRICTION ON APPLIED DIGITAL SOLUTIONS,
INC.'S ABILITY TO EXERCISE CONTROL OVER THE AFFAIRS, MANAGE THE RESOURCES
AND TRANSFER FUNDS FROM A SIGNIFICANT OPERATING SUBSIDIARY.
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Page F-59
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CONDENSED CONSOLIDATED STATEMENTS OF PREFERRED STOCK
COMMON STOCK AND OTHER STOCKHOLDERS' (DEFICIT) EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2003
(IN THOUSANDS)
(UNAUDITED)
PREFERRED STOCK COMMON STOCK ADDITIONAL
------------------------------------------- PAID-IN
NUMBER AMOUNT NUMBER AMOUNT CAPITAL
--------------------------------------------------------
BALANCE - DECEMBER 31, 2002 -- $-- 285,069 $285 $377,621
Net loss -- -- -- -- --
Comprehensive loss -
Foreign currency translation -- -- -- -- --
Total comprehensive loss -- -- -- -- --
Adjustment to allowance for uncollectible
portion of notes receivable -- -- -- -- --
Stock option repricing -- -- -- (979)
Stock Options - VeriChip Corporation -- -- -- -- 160
Issuance of common shares -- -- 310 1 108
Issuance of common shares and options for
services, compensation and other -- -- 170 -- 89
----------------------------------------------------------------------------------------------------------
BALANCE - MARCH 31, 2003 -- $-- 285,549 $286 $376,999
==========================================================================================================
ACCUMULATED
COMMON OTHER NOTES TOTAL
(ACCUMULATED STOCK TREASURY COMPREHENSIVE RECEIVED FOR STOCKHOLDERS'
DEFICIT) WARRANTS STOCK INCOME (LOSS) SHARES ISSUED DEFICIT
-----------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2002 $(417,066) $5,650 $(1,777) $ 31 $ (836) $(36,092)
Net loss (26,940) -- -- -- -- (26,940)
Comprehensive loss -
Foreign currency translation -- -- (38) -- (38)
--------- ----- --------
Total comprehensive loss (26,940) -- (38) -- (26,978)
--------- ----- --------
Adjustment to allowance for uncollectible
portion of notes receivable -- -- -- -- (286) (286)
Stock option repricing -- -- -- -- (979)
Stock Options - VeriChip Corporation -- -- -- -- -- 160
Issuance of common shares -- -- -- -- -- 109
Issuance of common shares and options for
services, compensation and other -- -- -- -- -- 89
----------------------------------------------------------------------------------------------------------------------------------
BALANCE - MARCH 31, 2003 $(444,006) $5,650 $(1,777) $ (7) $(1,122) $(63,977)
==================================================================================================================================
See the accompanying notes to condensed consolidated financial statements.
SEE NOTES 1 AND 4 REGARDING THE RESTRICTION ON APPLIED DIGITAL SOLUTIONS,
INC.'S ABILITY TO EXERCISE CONTROL OVER THE AFFAIRS, MANAGE THE RESOURCES
AND TRANSFER FUNDS FROM A SIGNIFICANT OPERATING SUBSIDIARY.
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APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
FOR THE THREE MONTHS ENDED
MARCH 31,
------------------------------
2003 2002
------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(26,940) $(24,005)
Adjustments to reconcile net loss
to net cash (used in) provided by operating activities:
Loss (income) from discontinued operations 157 (687)
Non-cash compensation and administrative expenses (798) 19,036
Issuance of stock for services 68 2,453
Depreciation and amortization 626 1,004
Non-cash interest expense 520 407
Deferred income taxes (173) 26
(Recovery) Impairment of notes receivable (271) 576
Net loss on subsidiary merger transaction 377 394
Minority interest (139) (36)
Equity in net loss of affiliate -- 291
(Gain) loss on sale of subsidiaries and business assets -- (194)
Loss on sale of equipment 9 87
Change in assets and liabilities:
Increase in cash held by note holder (2,015) --
(Increase) decrease in accounts receivable (2,581) 4,791
Increase in inventories (1,379) (1,299)
Decrease (increase) in other current assets 331 (629)
Increase (decrease) in accounts payable, accrued expenses
and other long-term liabilities 28,590 (141)
Net cash provided by (used in) discontinued operations (99) 415
-----------------------------------------------------------------------------------------------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (3,717) 2,489
===============================================================================================
CASH FLOWS FROM INVESTING ACTIVITIES
--------------------------------------------------------------------
Decrease in notes receivable 992 92
Received from buyers of divested subsidiaries -- 2,625
(Increase) decrease in other assets (90) 144
Proceeds from sale of property and equipment -- 2,469
Proceeds from sale of subsidiaries and business assets -- 1,106
Payments for property and equipment (267) (210)
Cash acquired (net of payments for costs of business acquisitions) -- 218
Net cash (used in) provided by discontinued operations (32) (658)
-----------------------------------------------------------------------------------------------
NET CASH PROVIDED BY INVESTING ACTIVITIES 603 5,786
===============================================================================================
CASH FLOWS FROM FINANCING ACTIVITIES
-----------------------------------------------------------------------------------------------
Net amounts borrowed (repaid) on notes payable 101 (3,583)
Payments on long-term debt (32) (1,137)
Other financing costs -- (39)
Issuance of common shares 143 866
Stock issuance costs (34) (177)
Proceeds from subsidiary issuance of common stock 175 --
Net cash (used in) provided by discontinued operations -- 13
-----------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 353 (4,057)
===============================================================================================
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (2,761) 4,218
-----------------------------------------------------------------------------------------------
EFFECT OF EXCHANGE RATES CHANGES ON CASH
AND CASH EQUIVALENTS (39) (6)
-----------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 5,818 3,696
-----------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 3,018 $ 7,908
===============================================================================================
See the accompanying notes to condensed consolidated financial statements.
SEE NOTES 1 AND 4 REGARDING THE RESTRICTION ON APPLIED DIGITAL SOLUTIONS,
INC.'S ABILITY TO EXERCISE CONTROL OVER THE AFFAIRS, MANAGE THE RESOURCES
AND TRANSFER FUNDS FROM A SIGNIFICANT OPERATING SUBSIDIARY.
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APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
------------------------------------------------------------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying financial statements have been prepared on a going
concern basis and do not reflect any adjustments that might result from the
outcome of the uncertainties described in Note 4.
The accompanying unaudited condensed consolidated financial statements
of Applied Digital Solutions, Inc. (the "Company") as of March 31, 2003, and
December 31, 2002, (the December 31, 2002, financial information included
herein has been extracted from the Company's audited financial statements
included in the Company's 2002 Annual Report on Form 10-K) and for the
three-months ended March 31, 2003 and 2002, 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
condensed consolidated financial statements have been made.
The condensed consolidated statements of operations for the
three-months ended March 31, 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 consolidated financial statements and related
notes thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 2002.
STOCK-BASED COMPENSATION
As permitted under SFAS No. 123, Accounting for Stock-based
Compensation (SFAS No. 123), the Company has elected to continue to follow
the guidance of APB Opinion No. 25, Accounting for Stock Issued to Employees
(APB No. 25), and Financial Accounting Standards Board Interpretation No.
44, Accounting for Certain Transactions Involving Stock Compensation--an
Interpretation of APB Opinion No. 25 (FIN No. 44), in accounting for its
stock-based employee compensation arrangements. Accordingly, no compensation
cost is recognized for any of the Company's fixed stock options granted to
employees when the exercise price of each option equals or exceeds the fair
value of the underlying common stock as of the grant date for each stock
option. Changes in the terms of stock option grants, such as extensions of
the vesting period or changes in the exercise price, result in variable
accounting in accordance with APB Opinion No. 25. Accordingly, compensation
expense is measured in accordance with APB No. 25 and recognized over the
vesting period. If the modified grant is fully vested, any additional
compensation costs is recognized immediately. The Company accounts for
equity instruments issued to non-employees in accordance with the provisions
of SFAS No. 123.
At March 31, 2003, the Company had four stock-based employee
compensation plans, and the Company's subsidiaries had six stock-based
employee compensation plans. As permitted under SFAS No. 148, Accounting for
Stock-Based Compensation--Transition and Disclosure, which amended SFAS No.
123, the Company has elected to continue to follow the intrinsic value
method in accounting for its stock-based employee compensation arrangements
as defined by APB No. 25 and related interpretations including FIN No. 44.
The following table illustrates the effect on net loss and loss per share if
the Company had applied the fair value recognition provisions of SFAS No.
123 to stock-based employee compensation for options granted under its plans
as well as to the plans of its subsidiaries:
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APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
------------------------------------------------------------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[Enlarge/Download Table]
THREE-MONTHS ENDED THREE-MONTHS ENDED
MARCH 31, MARCH 31,
-------------------------------------------
2003 2002
-------------------------------------------
Net loss, as reported $(26,940) $(24,005)
Deduct: Total stock-based employee
compensation expense determined under
fair value-based method for all awards,
net of related tax effects(1) (753) (739)
-------- --------
Pro forma net loss $(27,693) $(24,744)
======== ========
Loss per share:
Basic and diluted--as reported $ (0.10) $ (0.09)
======== ========
Basic and diluted--pro forma $ (0.10) $ (0.10)
======== ========
<FN>
(1) Amount includes $0.5 million and $0.4 million of compensation expense
associated with subsidiary options for the three-months ended March 31,
2003 and 2002, respectively.
The Company did not grant fixed stock options to acquire shares of its
common stock to its employees during the three-months ended March 31, 2003.
The weighted average per share fair value of grants made during the
three-months ended March 31, 2002, for the Company's incentive plans was
$0.20. The fair value of the options granted was estimated on the grant date
using the Black-Scholes option-pricing model based on the following weighted
average assumptions:
[Download Table]
THREE-
MONTHS
ENDED
MARCH 31,
2002
---------
Estimated option life 5.5 years
Risk free interest rate 2.89%
Expected volatility 76.00%
Expected dividend yield 0.00%
METHOD OF ACCOUNTING FOR DIGITAL ANGEL CORPORATION
Effective March 27, 2002, the Company's 93% owned subsidiary, Digital
Angel Corporation, which we refer to as pre-merger Digital Angel, merged
with and into a wholly-owned subsidiary of a publicly traded company,
Medical Advisory Systems, Inc. (MAS), and MAS changed its name to Digital
Angel Corporation. Under the terms of the merger agreement, each issued and
outstanding share of common stock of pre-merger Digital Angel (including
each share issued upon exercise of options prior to the effective time of
the merger) was cancelled and converted into the right to receive 0.9375
shares of MAS's common stock. The Company obtained 18.7 million shares of
MAS common stock in the merger (representing approximately 61% of the shares
then outstanding). Prior to the transaction, the Company owned 850,000
shares of MAS, or approximately 16.7%. On March 31, 2003, the Company owned
19.6 million, or approximately 73.12% of the shares outstanding. Also,
pursuant to the merger agreement, the Company contributed to MAS all of its
stock in Timely Technology Corp., a wholly-owned subsidiary, and Signature
Industries, Limited, an 85% owned subsidiary. Pre-merger Digital Angel,
Timely
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APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
------------------------------------------------------------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Technology Corp. and Signature Industries, Limited were collectively
referred to as the Advanced Wireless Group (AWG). The merger has been
treated as a reverse acquisition for accounting purposes, with the AWG
treated as the accounting acquirer.
The total purchase price of the transaction was $32.0 million, which
was comprised of the $25.0 million fair market value of MAS stock
outstanding not held by the Company immediately preceding the merger, the
$3.4 million estimated fair market value of MAS options and warrants
outstanding as well as the direct costs of the acquisition of approximately
$3.6 million. The transaction resulted in Digital Angel Corporation
allocating approximately $28.3 million of the purchase price to goodwill,
$25.9 million of which was deemed to be impaired during the fourth quarter
of 2002 in connection with the Company's annual goodwill impairment review.
The consolidated financial statements included in this Form 10-Q
include the accounts of Digital Angel Corporation and reflect the
outstanding voting stock not owned by the Digital Angel Share Trust, which
we refer to as Digital Angel Trust, as a minority ownership interest in
Digital Angel Corporation on the balance sheets as of March 31, 2003, and
December 31, 2002. The Digital Angel Trust is more fully discussed in Note 4.
Significant intercompany balances and transactions have been eliminated
in consolidation. Digital Angel Corporation is publicly traded on the
American Stock Exchange under the symbol DOC, with a closing market price
per share at March 31, 2003, and May 7, 2003, of $1.51 and $2.90,
respectively.
During the three-months ended March 31, 2003, the Company recorded a
loss of $0.4 million on the issuances of 0.3 million shares of Digital Angel
Corporation common stock resulting from the exercise of stock options. The
loss represents the difference between the carrying amount of the Company's
pro-rata share of its investment in Digital Angel Corporation and the net
proceeds from the issuances of the stock and other changes in the minority
interest ownership.
During the three-months ended March 31, 2002, the Company recorded a
net loss of $0.4 million occasioned by the merger transaction, comprised of
a loss of approximately $5.1 million resulting from the exercise of 1.5
million pre-merger Digital Angel options (representing the difference
between the carrying amount of the Company's pro-rata share of the
investment in pre-merger Digital Angel and the exercise price of the
options) and a gain of approximately $4.7 million from the deemed sale of
22.85% of the AWG, as a result of the merger with MAS.
By operation of the Digital Angel Trust agreement, the Company's share
of Digital Angel Corporation's net assets is effectively restricted.
Although Digital Angel Corporation may pay dividends, the Company's access
to this subsidiary's funds is restricted. The following condensed
consolidating balance sheet data at March 31, 2003, shows, among other
things, the Company's investment in Digital Angel Corporation. The following
consolidating financial data provides supplementary information about the
results of operations and cash flows for the three-months ended March 31,
2003. The merger of pre- merger Digital Angel and MAS occurred on the second
to the last business day of the quarter ended March 31, 2002, and,
therefore, supplementary information about results of operations and cash
flows are not presented for the three-months ended March 31, 2002.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[Enlarge/Download Table]
CONDENSED CONSOLIDATING BALANCE SHEET DATA
MARCH 31, 2003
(UNAUDITED)
APPLIED
DIGITAL DIGITAL ANGEL CONSOLIDATION
SOLUTIONS, INC. CORPORATION ELIMINATIONS CONSOLIDATED
------------------------------------------------------------------------
(in thousands)
Current Assets
Cash and cash equivalents $ 3,018 $ -- $ -- $ 3,018
Cash held by note holder 2,015 -- -- 2,015
Accounts receivable, net 11,453 7,676 -- 19,129
Inventories 1,869 5,919 -- 7,788
Notes receivable 1,999 -- -- 1,999
Other current assets 1,467 1,109 -- 2,576
------------------------------------------------------------------------
Total Current Assets 21,821 14,704 -- 36,525
Property And Equipment, net 1,897 7,656 -- 9,553
Notes Receivable, net 553 -- -- 553
Goodwill, net 20,365 47,453 -- 67,818
Investment in Digital Angel Corporation 40,669 -- (40,669) --
Other Assets, net 2,243 1,712 -- 3,955
------------------------------------------------------------------------
Total Assets $ 87,548 $71,525 $(40,669) $118,404
========================================================================
Current Liabilities
Notes payable, current maturities of long-
term debt $ 79,171 $ 3,809 $ -- $ 82,980
Accounts payable and accrued expenses 58,156 8,376 -- 66,532
Put accrual 200 -- -- 200
Intercompany (receivable) payable (323) 323 -- --
Net liabilities of Discontinued Operations 9,397 -- -- 9,397
------------------------------------------------------------------------
Total Current Liabilities 146,601 12,508 -- $159,109
Long-Term Debt, Notes Payable, Other
Liabilities and Deferred Revenue 1,032 3,407 -- 4,439
------------------------------------------------------------------------
Total Liabilities 147,633 15,915 -- 163,548
Minority Interest 3,669 265 14,899 18,833
------------------------------------------------------------------------
Accumulated other comprehensive income
(loss) 216 (223) -- (7)
Other stockholders' (deficit) equity (63,970) 55,568 (55,568) (63,970)
------------------------------------------------------------------------
Total Stockholders' (Deficit) Equity (63,754) 55,345 (55,568) (63,977)
------------------------------------------------------------------------
Total Liabilities and Stockholders'
(Deficit) Equity $ 87,548 $71,525 $(40,669) $118,404
========================================================================
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[Enlarge/Download Table]
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS DATA
THREE-MONTHS ENDED MARCH 31, 2003
(UNAUDITED)
APPLIED
DIGITAL DIGITAL ANGEL CONSOLIDATION
SOLUTIONS, INC. CORPORATION ELIMINATIONS CONSOLIDATED
-----------------------------------------------------------------------
(in thousands)
Product revenue $ 10,266 $10,865 $(108) $ 21,023
Service revenue 3,550 533 -- 4,083
-----------------------------------------------------------------------
Total revenue 13,816 11,398 (108) 25,106
Cost of products sold 8,703 5,483 (14) 14,172
Cost of services sold 1,570 395 -- 1,965
-----------------------------------------------------------------------
Gross profit 3,543 5,520 (94) 8,969
Selling, general and administrative
expense 25,466 4,002 -- 29,468
Research and development 290 911 -- 1,201
Depreciation and amortization 192 434 -- 626
Interest and other income (178) (42) -- (220)
Interest expense 4,493 138 -- 4,631
-----------------------------------------------------------------------
(Loss) income from continuing operations
before taxes, minority interest, loss on
subsidiary stock issuances, and equity
in net income of affiliate (26,720) 77 (94) (26,737)
Benefit for income taxes (192) -- -- (192)
-----------------------------------------------------------------------
(Loss) income from continuing operations
before minority interest, loss on
subsidiary stock issuances and equity
in net income of affiliate (26,528) 77 (94) (26,545)
Minority interest (106) (33) -- (139)
Loss on subsidiary stock issuances 377 -- -- 377
Equity in net income of affiliate 110 -- (110) --
-----------------------------------------------------------------------
(Loss) income from continuing operations $(26,689) $ 110 $(204) $(26,783)
=======================================================================
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
[Enlarge/Download Table]
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS DATA
THREE-MONTHS ENDED MARCH 31, 2003
(UNAUDITED)
APPLIED
DIGITAL DIGITAL ANGEL CONSOLIDATION
SOLUTIONS, INC. CORPORATION ELIMINATIONS CONSOLIDATED
-----------------------------------------------------------------------
(in thousands)
Cash Flows From Operating Activities
Net (loss) income $(27,050) $ 110 $-- $(26,940)
Adjustment to reconcile net (loss)
income to net cash used in
operating activities:
Non-cash adjustments (119) 495 -- 376
Net change in operating assets and
liabilities 26,501 (3,555) -- 22,946
Decrease in intercompany receivable/
payable 139 (139) -- --
Net cash used in Discontinued Operations (99) -- -- (99)
-----------------------------------------------------------------------
Net Cash Provided By (Used In) Operating
Activities (628) (3,089) -- (3,717)
-----------------------------------------------------------------------
Cash Flows From Investing Activities
Decrease in notes receivable 992 -- -- 992
Increase in other assets (99) 9 -- (90)
Payments for property and equipment (17) (250) -- (267)
Net cash used in Discontinued Operations (32) -- -- (32)
-----------------------------------------------------------------------
Net Cash Provided By (Used In)
Investing Activities 844 (241) 603
-----------------------------------------------------------------------
Cash Flows From Financing Activities
Net amounts borrowed (repaid) on
notes payable (2,899) 3,000 -- 101
Payments on long-term debt (12) (20) -- (32)
Issuance of common shares 143 -- -- 143
Stock issuance costs (34) -- -- (34)
Proceeds from subsidiary stock issuances -- 175 -- 175
-----------------------------------------------------------------------
Net Cash (Used In) Provided By Financing
Activities (2,802) 3,155 -- 353
-----------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash
Equivalents (2,586) (175) -- (2,761)
Effect of exchange rates changes on cash
and cash equivalents -- (39) -- (39)
Cash and Cash Equivalents- Beginning of Period 5,604 214 -- 5,818
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Cash and Cash Equivalents- End of Period $ 3,018 $ -- $-- $ 3,018
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. PRINCIPLES OF CONSOLIDATION
The financial statements include the accounts of the Company and
its wholly-owned and majority-owned subsidiaries, including Digital
Angel Corporation and InfoTech USA, Inc. (formerly SysComm International
Corporation) (OTC:SYCM). The minority interest represents outstanding
voting stock of the subsidiaries not owned by the Company or the Digital
Angel Trust. All significant intercompany accounts and transactions have
been eliminated in consolidation.
The Company's majority-owned subsidiary, InfoTech USA, Inc.,
operates on a fiscal year ending September 30. Their results of
operations have been reflected in the Company's consolidated financial
statements on a calendar year basis.
3. INVENTORY
[Download Table]
MARCH 31, DECEMBER 31,
--------- ------------
2003 2002
---- ----
Raw materials $1,821 $1,725
Work in process 1,830 1,447
Finished goods 5,487 4,659
------ ------
9,138 7,831
Less: Allowance for excess and obsolescence 1,350 1,422
------ ------
$7,788 $6,409
====== ======
4. DEBT COVENANT COMPLIANCE, LIQUIDITY AND GOING CONCERN CONSIDERATIONS
On March 1, 2002, the Company and Digital Angel Trust, a newly
created Delaware business trust, entered into the Third Amended and
Restated Term Credit Agreement (the IBM Credit Agreement) with IBM
Credit, which became effective on March 27, 2002, the effective date of
the merger between pre-merger Digital Angel and MAS. Upon completion of
the merger, and in satisfaction of a condition to the consent to the
merger by IBM Credit, the Company transferred to the Digital Angel
Trust, which is controlled by an advisory board, all shares of Digital
Angel Corporation common stock owned by it and, as a result, the Digital
Angel Trust has legal title to approximately 73.12% of the Digital Angel
Corporation common stock at March 31, 2003. The Company retained
beneficial ownership of the shares. The Digital Angel Trust may be
obligated to liquidate the shares of Digital Angel Corporation common
stock owned by it for the benefit of IBM Credit as discussed below.
The IBM Credit Agreement contained covenants relating to the
Company's financial position and performance, as well as the financial
position and performance of Digital Angel Corporation as of December 31,
2002. The Company was not in compliance with certain of these covenants
at December 31, 2002. Also, under the terms of the IBM Credit
Agreement, the Company was required to repay IBM Credit $29.8 million of
the $77.2 million outstanding principal balance owed to them, plus $16.4
million of accrued interest and expenses (totaling approximately $46.2
million), on or before February 28, 2003. The Company did not make such
payment by February 28, 2003. On March 3, 2003, IBM Credit notified the
Company that it had until March 6, 2003, to make the payment. The
Company did not make the payment on March 6, 2003, as required. The
Company's failure to comply with the payment terms imposed by the IBM
Credit Agreement and to maintain compliance with the financial covenants
constitute events of default under the IBM Credit Agreement. IBM Credit
did not provide a waiver of such defaults. On March 7, 2003, the
Company received a letter from IBM Credit declaring the loan in
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
default and indicating that IBM Credit would exercise any and/or all of its
remedies.
In addition, as of March 31, 2003, and December 31, 2002, Digital
Angel Corporation did not maintain compliance with certain financial
covenants under its credit agreement with its lender, Wells Fargo
Business Credit, Inc. (Wells Fargo). Well Fargo provided Digital Angel
Corporation with waivers of such non-compliance.
Forbearance Agreement
On March 27, 2003, the Company announced that it had executed a
forbearance agreement term sheet with IBM Credit. The forbearance
agreement was executed on April 2, 2003 (the "Forbearance Agreement").
In turn, the Company agreed to dismiss with prejudice a lawsuit it filed
against IBM Credit and IBM Corporation in Palm Beach County, Florida on
March 6, 2003.
The payment provisions and purchase rights under the terms of the
Forbearance Agreement are as follows:
o the Tranche A Loan, consisting of $68.0 million plus accrued
interest, must be repaid in full no later than September 30, 2003,
provided that all but $3 million of the Tranche A Loan (the
"Tranche A Deficiency Amount") will be deemed to be paid in full
on such date if less than the full amount of the Tranche A Loan is
repaid but all of the net cash proceeds of the Digital Angel
Corporation shares held in the Digital Angel Trust are applied to
the repayment of the Tranche A Loan. The Tranche A Deficiency
Amount (if any) must be repaid no later than March 31, 2004. The
Tranche A Loan bore interest at seventeen percent (17%) per annum
through February 28, 2003. Effective March 1, 2003, the interest
rate increased to twenty-five percent (25%) per annum; and
o the Tranche B Loan, consisting of $9.2 million plus accrued
interest, must be repaid in full no later than March 31, 2004. The
Tranche B Loan bore interest at seventeen percent (17%) per annum
through February 28, 2003, and from March 1, 2003, to March 24,
2003, the Tranche B Loan bore interest at twenty-five percent
(25%) per annum. Effective March 25, 2003, the interest rate
decreased to seven percent (7%) per annum.
The Tranche A and B Loans may be purchased under the terms of the
Forbearance Agreement by or on behalf of the Company as follows:
o the loans and all the other obligations may be purchased on or
before June 30, 2003, for $30.0 million in cash;
o the loans and all the other obligations may be purchased on or
before September 30, 2003, for $50.0 million in cash; and
o the Tranche A Loan may be purchased on or before September 30,
2003, for $40.0 million in cash with an additional $10.0 million
cash payment due on or before December 31, 2003.
Payment of the specified amounts by the dates set forth herein
will constitute complete satisfaction of any and all of the Company's
obligations to IBM Credit under the IBM Credit Agreement, provided that
there has not earlier occurred a "Termination Event," as defined in the
Forbearance Agreement.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In addition, the Company has agreed under the terms of the
Forbearance Agreement that the Digital Angel Trust will immediately
engage an investment bank to pursue the sale of the 19,600,000 shares of
Digital Angel Corporation common stock that are currently held in the
Digital Angel Trust. In May 2003, an investment bank was engaged. All
proceeds from the sale of the Digital Angel Corporation common stock
will be applied to the loans and other obligations to satisfy the
Tranche A payment provisions as discussed above, in the event that the
Company has not satisfied its purchase rights by September 30, 2003.
The Forbearance Agreement also modifies other provisions of the
IBM Credit Agreement, including but not limited to, the imposition of
additional limitations on permitted expenditures.
Provided there has not earlier occurred a "Termination Event," as
defined, at the end of the forbearance period, the provisions of the
Forbearance Agreement shall become of no force and effect. At that
time, if the repayment terms of the Forbearance Agreement are not met,
IBM Credit will be free to exercise and enforce, or to take steps to
exercise and enforce, all rights, powers, privileges and remedies
available to them under the IBM Credit Agreement, as a result of the
payment and covenant defaults existing on March 24, 2003. If the Company
is not successful in satisfying the repayment obligations under the
Forbearance Agreement or it does not comply with the terms of the
Forbearance Agreement or the IBM Credit Agreement, and IBM Credit were
to enforce its rights against the collateral securing the obligations to
IBM Credit, there would be substantial doubt that the Company would be
able to continue operations in the normal course of business.
As a result of the payment and financial covenant defaults
discussed above, IBM Credit has exercised its rights to control the
Company's cash, excluding the cash of Digital Angel Corporation and
InfoTech USA, Inc. At March 31, 2003, IBM held in its possession $2.0
million of the Company's cash, which it subsequently remitted back to
the Company. IBM Credit continues to maintain control over the
Company's deposits and disbursements. Under the terms of the
forbearance agreement, the Company is required to be cash flow positive
beginning May 2, 2003. The Company requests weekly from IBM Credit a
release of funds for the prior weeks cash collections and provides to
IBM Credit a schedule detailing cash disbursements complying with the
cash flow positive requirement.
The ability of the Company to continue as a going concern is
predicated upon numerous issues including its ability to:
o Raise the funds necessary to satisfy its obligations to IBM Credit
by September 30, 2003;
o Obtain shareholder approval of the terms of the severance
agreements with the Company's former officers and directors as
more fully discussed in Note 10;
o Successfully implement its business plans, manage expenditures
according to its budget, and generate positive cash flow from
operations;
o Realize positive cash flow with respect to its investment in
Digital Angel Corporation;
o Develop an effective marketing and sales strategy;
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
o Obtain the necessary approvals to expand the market for its
VeriChip product;
o Complete the development of its second generation Digital Angel
product; and
o Attract, motivate and/or retain key executives and employees.
The Company is continually seeking operational efficiencies and
synergies within each of its operating segments as well as evaluating
acquisitions of businesses and customer bases which complement its
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 the
Company's long-term strategy or other restructurings or rationalization
of existing operations. The Company will continue to review all
alternatives to ensure maximum appreciation of its shareholder's
investments. There can be no assurance, however, that any initiative
will be found, or if found, that they will be on terms favorable to the
Company.
5. LOSS PER SHARE
The following is a reconciliation of the numerator and denominator
of basic and diluted loss per share:
[Enlarge/Download Table]
----------------------------------
THREE-MONTHS ENDED MARCH 31,
----------------------------------
2003 2002
---- ----
NUMERATOR:
Loss from continuing operations $(26,783) $(24,692)
Net (loss) income from Discontinued Operations available to common
shareholders (157) 687
----------------------------------
Net loss available to common shareholders $(26,940) $(24,005)
==================================
DENOMINATOR:
DENOMINATOR FOR BASIC AND DILUTED LOSS PER SHARE (1)-
Weighted-average shares 282,329 253,938
----------------------------------
BASIC AND DILUTED LOSS PER SHARE:
CONTINUING OPERATIONS $(0.10) $(0.10)
---------------------
DISCONTINUED OPERATIONS -- .01
----------------------- ----------------------------------
TOTAL - BASIC AND DILUTED $(0.10) $(0.09)
------------------------- ==================================
<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,
2003 2002
---- ----
Employee stock options 10,802 16,020
Warrants 3,301 2,103
----------------------------------
14,103 18,123
----------------------------------
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. SEGMENT INFORMATION
The Company operates in three business segments: Advanced
Technology, Digital Angel Corporation and InfoTech USA, Inc, (formerly
the segment known as SysComm International).
Advanced Technology
The Advanced Technology segment represents those businesses that
the Company believes will provide the necessary synergies, support and
infrastructure to allow it to develop, promote and fully-integrate its
life-enhancing technology products and services. This segment
specializes in security-related data collection, value-added data
intelligence and complex data delivery systems for a wide variety of end
users including government agencies, commercial operations and
consumers. The majority of the revenue in this segment is from the
Company's wholly-owned subsidiary, Computer Equity Corporation. Expenses
associated with VeriChip and Thermo Life products are also included in
the Advanced Technology segment.
Digital Angel Corporation
The Digital Angel Corporation segment consists of the business
operations of Digital Angel Corporation, the Company's approximately
73.12% owned subsidiary and is engaged in the business of developing and
bringing to market proprietary technologies used to identify, locate and
monitor people, animals and objects. Before March 27, 2002, the business
of Digital Angel Corporation was operated in four divisions: Animal
Tracking, Digital Angel Technology, Digital Angel Delivery System, and
Radio Communications and Other. With the acquisition of MAS on March 27,
2002, Digital Angel Corporation re-organized into four new divisions:
Animal Applications (formerly Animal Tracking), Wireless and Monitoring
(a combination of the former Digital Angel Technology and the Digital
Angel Delivery System segments), GPS and Radio Communications (formerly
Radio Communications and Other), and Medical Systems (formerly Physician
Call Center and Other). Medical Systems represents the business activity
of the newly acquired MAS.
InfoTech USA, Inc.
The InfoTech USA, Inc. segment consists of the business operations
of the Company's 52.5% owned subsidiary, InfoTech USA, Inc. This segment
is a full service provider of Information Technology (IT) solutions and
provides IT consulting, networking, procurement, deployment,
integration, migration and security services and solutions. It also
provides on-going system and networking maintenance services. During
2002, this segment continued its strategy of moving away from a product-
driven systems integration business model to a customer-oriented IT
solutions-based business model. It has further developed its
deliverable IT solutions by adding new consulting and service offerings,
and increasing the number of strategic alliances with outside technical
services firms and manufacturers of high-end IT products.
All Other
Business units that were part of the Company's continuing
operations and that were closed or sold during 2001 and 2002 are
reported as "All Other."
The "Corporate/Eliminations" category includes all amounts
recognized upon consolidation of the Company's subsidiaries such as the
elimination of intersegment revenues, expenses, assets and liabilities.
"Corporation/Eliminations" also includes certain interest expense and
other expenses
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
associated with corporate activities and functions. As discussed in Note
10, included in "Corporate/Eliminations" for the three-months ended
March 31, 2003, is a severance charge of $22.0 million associated with
the termination of certain former officers and director. As discussed
in Note 9, included in "Corporate/Eliminations" for the three-months
ended March 31, 2002, is a non-cash compensation charge of $18.7 million
associated with pre-merger Digital Angel options, which were converted
into options to acquire shares of MAS common stock in connection with
the merger of pre-merger Digital Angel and MAS.
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, 2002, 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 stand-alone segment operating
income.
Following is the selected segment data as of and for the three-
months ended March 31, 2003:
[Enlarge/Download Table]
SEGMENTS
--------
Digital
Advanced Angel InfoTech All Corporate/
Technology Corporation USA, Inc. Other Eliminations Consolidated
--------------------------------------------------------------------------------------------
Net revenue from external customers:
Product $ 8,332 $10,757 $1,934 $ -- $ -- $ 21,023
Service 2,950 533 600 -- -- 4,083
--------------------------------------------------------------------------------------------
11,282 11,290 2,534 -- -- 25,106
Inter-segment revenue -- 108 -- -- (108) --
--------------------------------------------------------------------------------------------
Total revenue $11,282 $11,398 $2,534 $ -- $ (108) $ 25,106
============================================================================================
Income (loss) from continuing
operations before income taxes,
minority interest and net loss on
subsidiary stock issuances $ 621 $ 77 $ (460) $ (5) $(26,970) $(26,737)
============================================================================================
Total assets $43,364 $71,525 $8,799 $2,737 $ (8,021) $118,404
============================================================================================
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Following is the selected segment data as of and for the three-
months ended March 31, 2002:
[Enlarge/Download Table]
SEGMENTS
--------
Digital
Advanced Angel InfoTech All Corporate/
Technology Corporation USA, Inc. Other Eliminations Consolidated
--------------------------------------------------------------------------------------------
Net revenue from external customers:
Product $ 4,904 $ 7,452 $ 9,694 $1,013 $ -- $ 23,063
Service 3,616 303 811 375 51 5,156
Inter-segment revenue -- -- -- -- -- --
--------------------------------------------------------------------------------------------
Total revenue $ 8,520 $ 7,755 $10,505 $1,388 $ 51 $ 28,219
============================================================================================
Income (loss) from continuing
operations before income taxes,
minority interest, net loss on
subsidiary merger transaction and
equity in net loss of affiliate (1) $ 910 $ (1,819) $ 25 $ 134 $(23,185) $(23,935)
============================================================================================
Total assets (2) $37,943 $136,073 $14,099 $2,909 $ 6,072 $197,096
============================================================================================
<FN>
(1) For Digital Angel Corporation, amount excludes $1.8 million of
interest expense associated with the Company's obligation to IBM
Credit and $18.7 million of non-cash compensation expense
associated with pre-merger Digital Angel options which were
converted into options to acquire MAS stock, both of which have
been reflected as additional expense in the separate financial
statements of Digital Angel Corporation included in its Form 10-Q.
(2) For Digital Angel Corporation, amount includes $4.8 million of
goodwill associated with the Company's initial 16.6% investment in
MAS. This goodwill was fully impaired during the fourth quarter of
2002.
7. ACQUISITIONS AND DISPOSITIONS
Effective March 27, 2002, the Company's 93% owned subsidiary, pre-
merger Digital Angel, merged with MAS. As a result of the merger, the
Company now owns approximately 73.12% of Digital Angel Corporation, as
more fully discussed in Note 1.
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 pre-merger Digital Angel and MAS had occurred
as of January 1, 2002.
[Enlarge/Download Table]
----------------------
THREE-MONTHS ENDED
MARCH 31,
---------------------
2002
----
Net operating revenue from continuing operations $29,105
Loss from continuing operations (25,383)
Loss per common share from continuing operations - basic and diluted $(0.10)
8. 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, 2003, the Company had sold or
closed substantially all of the businesses comprising Discontinued
Operations. There is one insignificant company remaining at March 31,
2003, which had revenue and net loss for the three-months ended March
31, 2003, of $7,000 and $0.1 million, respectively.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company anticipates selling or closing the remaining company in
2003. Proceeds from the sales of Discontinued Operations companies were
used to repay amounts outstanding under the IBM Credit Agreement. Any
additional proceeds on the sale of the remaining business will also be
used to repay the IBM debt.
Assets and liabilities of Discontinued Operations at March 31,
2003, and December 31, 2002 are as follows:
[Enlarge/Download Table]
March 31, 2003 December 31, 2002
------------------------------------------------
(In thousands)
Current Assets
Cash and cash equivalents $ 97 $ 66
Accounts receivable, net 91 167
Inventories 38 38
------------------------------------------------
Total Current Assets 226 271
Property and equipment, net 34 56
------------------------------------------------
$ 260 $ 327
================================================
Current Liabilities
Notes payable and current maturities of long-term debt $ 26 $ 26
Accounts payable 4,178 4,189
Accrued expenses 5,318 5,334
------------------------------------------------
Total Current Liabilities 9,522 9,549
Minority interest 135 146
------------------------------------------------
9,657 9,695
================================================
Net Liabilities of Discontinued Operations $(9,397) $(9,368)
================================================
During the three-months ended March 31, 2003, Discontinued
Operations incurred a change in estimated operating losses accrued on
the measurement date of $0.2 million. The primary reason for the
increase in the estimated losses during the three-months ended March 31,
2003, was due to the operations of the one remaining business within
this group. During the three-months ended March 31, 2002, the Company
recorded a reduction of its estimated operating loss on disposal and
operating losses during the phase out period of $0.7 million. This
reduction was comprised primarily of an increase in the estimated loss
on the sale of the Company's 85% ownership in its Canadian subsidiary,
Ground Effects Ltd., which was sold in January 2002, of $1.2 million,
offset by a decrease in carrying costs as certain of these obligations
were settled during the three-months ended March 31, 2002, for amounts
less than previously anticipated. Carrying costs include the
cancellation of facility leases, employment contract buyouts, sales tax
liabilities and litigation reserves.
The Company does not anticipate a further loss on sale of the
remaining business comprising Discontinued Operations. However, actual
losses could differ from the Company's estimates and any adjustments
will be reflected in the Company's future financial statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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, 2002, through March 31, 2003.
[Enlarge/Download Table]
Balance Balance
Type of Cost December 31, 2002 Additions Deductions March 31, 2003
--------------------------------------------------------------------------------------------------------------------
Estimated loss on sale, net of change in
estimated operating losses $ -- $157 $157 $ --
Carrying costs 4,908 -- 23 4,885
-----------------------------------------------------------------------
Total $4,908 $157 $180 $4,885
=======================================================================
9. NON-CASH COMPENSATION EXPENSE
Included in selling, general and administrative expense for the
three-months ended March 31, 2003 and 2002, was non-cash compensation
expense as follows:
Pursuant to the terms of the pre-merger Digital Angel and MAS
merger agreement, effective March 27, 2002, options to acquire shares of
pre-merger Digital Angel common stock were converted into options to
acquire shares of MAS common stock. The transaction resulted in a new
measurement date for the options and, as a result, the Company recorded
non-cash compensation expense of approximately $18.7 million during the
three-months ended March 31, 2002. As all of the option holders were
employees or directors of the Company, these options were considered
fixed awards under APB Opinion No. 25 and expense was recorded for the
intrinsic value of the options converted.
In addition, the Company reversed approximately $1.0 million and
incurred approximately $0.3 million in non-cash compensation expense for
the three-months ended March 31, 2003 and 2002, respectively, due
primarily to re-pricing 19.3 million stock options during 2001. The re-
priced 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 result in increases and decreases of non-
cash compensation expense until the options are exercised, forfeited,
modified or expired.
10. SEVERANCE AGREEMENTS
On March 21, 2003, Richard J. Sullivan, the Company's then
Chairman of the Board of Directors and Chief Executive Officer, retired
from such positions. Replacing him in these positions is Scott R.
Silverman, the Company's then President and Director. The Company's
Board of Directors negotiated a severance agreement with Richard
Sullivan under which he is to receive a one-time payment of 56.0 million
shares of the Company's common stock. In addition, stock options held by
him exercisable for approximately 10.9 million shares of the Company's
common stock were re-priced. The options surrendered had exercise prices
ranging from $0.15 to $0.32 per share and were replaced with options
exercisable at $0.01 per share. Richard Sullivan's severance agreement
provides that the payment of shares and re-pricing of options provided
for under that agreement is in lieu of all future compensation and other
benefits that would have been owed to him under his employment
agreement. His employment agreement required the Company to make
payments of approximately $17.0 million to him, a portion of such
payments of which could be made in either cash or stock, at the
Company's option.
On March 21, 2003, Jerome C. Artigliere, the Company's then Senior
Vice President and Chief Operating Officer, resigned from such
positions. Replacing Mr. Artigliere is Kevin H. McLaughlin, the
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APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
----------------------------------------------------------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Company's President and Chief Operating Officer. Mr. McLaughlin had
served most recently as the Chief Executive Officer of the Company's
majority-owned subsidiary, InfoTech USA, Inc. Under the terms of his
severance agreement, Mr. Artigliere is to receive 4.8 million shares of
the Company's common stock. In addition, stock options held by him
exercisable for approximately 2.3 million shares of the Company's common
stock were re-priced. The options surrendered had exercise prices
ranging from $0.15 to $0.32 per share and were replaced with options
exercisable at $0.01 per share. Mr. Artigliere's severance agreement
provides that the payment of shares and re-pricing of options provided
under that agreement is in lieu of all future compensation and other
benefits that would have been owed to him under his employment
agreement. His employment agreement required the Company to make
payments of approximately $1.5 million to Mr. Artigliere.
As a result of the termination of Richard Sullivan's employment
with the Company, a "triggering event" provision in the severance
agreement the Company entered into with Garrett Sullivan, the Company's
former Vice Chairman of the Board (who is not related to Richard
Sullivan), at the time of his ceasing to serve in such capacity in
December 2001, has been triggered. The Company recently negotiated a
settlement of its obligations under Garrett Sullivan's severance
agreement that requires the Company to issue to him 7.5 million shares
of the Company's common stock on or before August 31, 2003.
The terms of each of the severance agreements are subject to
shareholder approval, in accordance with applicable Nasdaq rules,
because the agreements (i) are deemed to be compensatory arrangements
under which the Company's common stock may be acquired by officers or
directors, and (ii) in Richard Sullivan's case, it may result in his
potentially holding more than 20% of the outstanding shares of the
Company's common stock following the issuance of the shares and exercise
of options covered by his severance agreement. In connection with such
shareholder approval, the Company also intends to seek shareholder
approval of an increase in the number of authorized shares of its common
stock.
The Company intends to include proposals in its proxy statement
for its 2003 annual meeting of shareholders to solicit shareholder
approval of the terms of such agreements and the increase in the number
of authorized shares of its common stock. Should shareholders not
approve the terms of the severance agreements or the Company lacks a
sufficient number of authorized shares to effect the share issuances
provided for by the severance agreements, its former executive officers
and directors may take actions against the Company to enforce the terms
of their employment agreements. Under such circumstances, there would
be substantial doubt that the Company would be able to continue
operations in the normal course of business. In such event, holders of
the Company's securities may face the loss of their entire investment.
By virtue of the need to obtain shareholder approval of the terms
of the severance agreements, the date by which the Company would
otherwise have been obligated to file a registration statement covering
the resale of the shares to be issued to its former executive officers
and directors under their severance agreements has been extended and the
filing of such registration statement will await the outcome of the
shareholder vote.
As a result of the terminations of Messrs. Sullivan and
Artigliere, the Company has recorded severance expense of $22.0 million
during the three-months ended March 31, 2003. This expense is reflected
in the Company's condensed consolidated financial statements for the
three-months ended March 31, 2003, as selling, general and
administrative expense and represents, in all material respects, the
total amount due to these former officers and director and to Garrett
Sullivan under their respective employment agreements.
----------------------------------------------------------------------------
Page F-77
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
----------------------------------------------------------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. OTHER EVENTS
The Staff of the Securities and Exchange Commission's Southeast
Regional Office is conducting an informal inquiry concerning the
Company. The Company is fully and voluntarily cooperating with the
informal inquiry. At this point, the Company is unable to determine
whether the informal investigation may lead to potentially adverse
action.
The Company is currently offering up to 50,000,000 shares of its
common stock in a public offering registered under the Securities Act of
1933. The shares of the Company's common stock are being offered on a
best efforts basis through the efforts of a placement agent J.P. Carey
Securities, Inc. under the terms of a placement agency agreement.
Effective May 9, 2003, Michael Zarriello joined the Company's
Board of Directors. Mr. Zarriello was most recently a Senior Managing
Director of Jesup & Lamont Securities Corporation and served as
President of Jesup and Lamont Merchant Partners LLC. Prior to that, he
was Managing Director and Principal of Bear Stearns & Co., Inc. He has
extension financial experience having served earlier in his career as
Chief Financial Officer of the Principal Activities Group that invested
the Bear Stearns & Co., Inc. capital in middle market companies, Chief
Financial Officer of United States Leather Holdings, Inc. and Chief
Financial Officer of Avon Products, Inc. Healthcare Division. He serves
on the Audit Committee of the Board of Directors.
Effective May 12, 2003, Kevin H. McLaughlin was appointed
President and Chief Operating Officer of the Company. Prior to his
appointment as President, Mr. McLaughlin served as the Company's Senior
Vice President and Chief Operating Officer.
12. NASDAQ LISTING REQUIREMENTS
From July 12, 2002, to July 30, 2002, the Company's common stock
was traded on the Pink Sheets under the symbol "ADSX.PK." Prior to that
time, the Company's shares were traded on the Nasdaq National Market
(NasdaqNM). Effective July 31, 2002, the Company's shares were relisted
on the NasdaqNM under the symbol "ADSX." As a condition of the
relisting, NasdaqNM advised the Company that it had until October 25,
2002, to regain compliance with the minimum closing bid price
requirement of at least $1.00 per share, and, immediately following, a
closing bid price of at least $1.00 per share for a minimum of ten (10)
consecutive trading days. The Company was unable to satisfy the minimum
closing bid price requirement by October 25, 2002, and, as a result,
effective November 12, 2002, the Company's common stock began trading on
the Nasdaq SmallCap Market (SmallCap), under its existing stock symbol
ADSX. The Company expects to have until October 2003, in which to
regain the minimum bid requirement of at least $1.00 per share for a
minimum of ten (10) consecutive trading days to maintain its SmallCap
listing, providing the Company continues to comply with the SmallCap's
other listing requirements, which as of March 31, 2003, it was in
compliance with.
13. LEGAL PROCEEDINGS
The Company is party to various legal proceedings, and
accordingly, has recorded $1.5 million in reserves in its financial
statements at March 31, 2003. In the opinion of management, these
proceedings are not likely to have a material adverse affect on the
financial position or overall trends in results of the Company. The
estimate of potential impact on the Company's financial position,
overall results of operations or cash flows for the above legal
proceedings could change in the future.
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Page F-78
APPLIED DIGITAL SOLUTIONS, INC. AND SUBSIDIARIES
----------------------------------------------------------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In May 2002, a class action was filed against the Company and one
of its directors. Fourteen virtually identical complaints were
consolidated into a single action, in re Applied Digital Solutions
Litigation, which was filed in the United States District Court for the
Southern District of Florida. In March 2003, the Company entered into a
memorandum of understanding to settle the pending lawsuit. The
settlement of $5.6 million, which is subject to approval by the District
Court and review by an independent special litigation committee, is
expected to be covered by proceeds from insurance.
----------------------------------------------------------------------------
Page F-79
APPLIED DIGITAL SOLUTIONS, INC.
57,200,000 SHARES
COMMON STOCK
_______________
PROSPECTUS
----------
_______________
Until July 13, 2003 (25 days after the date of this prospectus),
all dealers that effect transactions in these securities, whether or not
participating in this offering, may be required to deliver a prospectus.
This is in addition to the dealers' obligation to deliver a prospectus
when acting as underwriters and with respect to their unsold allotments
or subscriptions.
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the expenses (other than
underwriting discounts and commissions), which other than the SEC
registration fee are estimates, payable by us in connection with the
sale and distribution of the shares registered hereby:
[Download Table]
SEC Registration Fee $ 282
Accounting Fees and Expenses 5,000*
Printing and Mailing Expenses 5,000*
Legal Fees and Expenses 5,000*
Due Diligence Fees 5,000*
Other Miscellaneous Expenses 718*
Total $21,000
<FN>
---------
* Estimated
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Sections 351.355(1) and (2) of The General and Business
Corporation Law of the State of Missouri provide that a corporation may
indemnify any person who was or is a party or is threatened to be made a
party to any threatened, pending or completed action, suit or proceeding
by reason of the fact that he is or was a director, officer, employee or
agent of the corporation, or is or was serving at the request of the
corporation as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust or other enterprise,
against expenses, judgments, fines and amounts paid in settlement
actually and reasonably incurred by him in connection with such action,
suit or proceeding if he acted in good faith and in a manner he
reasonably believed to be in or not opposed to the best interests of the
corporation and, with respect to any criminal action or proceeding, had
no reasonable cause to believe his conduct was unlawful, except that, in
the case of an action or suit by or in the right of the corporation, the
corporation may not indemnify such persons against judgments and fines
and no person shall be indemnified as to any claim, issue or matter as
to which such person shall have been adjudged to be liable for
negligence or misconduct in the performance of his duty to the
corporation, unless and only to the extent that the court in which the
action or suit was brought determines upon application that such person
is fairly and reasonably entitled to indemnity for proper expenses.
Section 351.355(3) provides that, to the extent that a director,
officer, employee or agent of the corporation has been successful in the
defense of any such action, suit or proceeding or any claim, issue or
matter therein, he shall be indemnified against expenses, including
attorneys' fees, actually and reasonably incurred in connection with
such action, suit or proceeding. Section 351.355(7) provides that a
corporation may provide additional indemnification to any person
indemnifiable under subsection (1) or (2), provided such additional
indemnification is authorized by the corporation's articles of
incorporation or an amendment thereto or by a shareholder-approved bylaw
or agreement, and provided further that no person shall thereby be
indemnified against conduct which was finally adjudged to have been
knowingly fraudulent, deliberately dishonest or willful misconduct or
which involved an accounting for profits pursuant to Section 16(b) of
the Exchange Act of 1934.
Our bylaws provide that we shall indemnify, to the full extent
permitted under Missouri law, any director, officer, employee or agent of
ours who has served as a director, officer, employee or agent of ours or, at
our request, has served as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust or other enterprise.
II-1
Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officers or
persons controlling us pursuant to such provisions, we has been informed
that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in such Act and is
therefore unenforceable.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
The following table lists all unregistered securities sold by us
between January 1, 1998 and June 16, 2003. These shares were issued in
acquisition or financing transactions to the persons or entities
indicated in connection with the acquisition of the indicated subsidiary
or the stockholder's minority interest or to investors in transactions
directly negotiated by the shareholders in connection with the sale of
their business or interests to us and pursuant to the "price protection"
or "earnout" provisions of the agreement of sale, or by the investors.
These shares were issued without registration in reliance upon the
exemption provided by Section 4(2) of the Securities Act of 1933, as
amended.
[Enlarge/Download Table]
NUMBER NUMBER OF
OF COMMON
DATE ISSUED PERSONS NOTE ISSUED FOR SHARES
----------- ------- ---- ---------- ------
Advanced Telecommunications, Inc. September 1998 3 1 Acquisition 775,822
Advanced Telecommunications, Inc. April 1999 1 7 Acquisition 550,000
Advanced Telecommunications, Inc. February 2001 2 2 Acquisition 1,666,667
AFAC L.P. July 2001 1 3 Services 500,000
Alacrity Systems, Inc. January 1998 45 1 Acquisition 321,768
Amherst Systems August 1998 1 4 Assets 66,667
ATEC Group, Inc. October 2000 2 5 Acquisition 2,674,934
ATEC Group, Inc. March 2001 2 6 Acquisition 448,431
ATI Communications, Inc. March 1998 1 7 Acquisition 200,000
Atlantic Systems, Inc. November 1999 1 8 Acquisition 119,832
Aurora Electric, Inc. September 1999 2 1 Acquisition 7,224
Aurora Electric, Inc. July 1998 4 9 Acquisition 1,138,039
Blue Star Electronics, Inc. August 1998 4 10 Acquisition 222,643
Caledonian Venture Holdings Limited December 2000 16 8 Acquisition 4,937,497
Caledonian Venture Holdings Limited June 2001 6 1 Acquisition 7,481,016
Canadian Network Services, Inc. January 1998 15 11 Acquisition 322,512
Charles Newman March 2001 1 12 Services 182,836
Charlie Phillips March 1999 1 8 Acquisition 7,018
Charlie Phillips October 2000 1 7 Acquisition 13,333
Commstar Limited June 1998 15 8 Acquisition 3,849,590
Computer Equity Corporation June 2001 79 7 Acquisition 14,732,200
Computer Equity Corporation April 2001 79 1 Acquisition 9,884,249
Computer Equity Corporation June 2000 79 8 Acquisition 4,804,294
Computer Equity Corporation September 2000 1 8 Acquisition 25,000
Consolidated Micro Components, Inc. June 1999 4 7 Acquisition 649,696
Consolidated Micro Components, Inc. July 1998 4 13 Acquisition 429,805
Cra-Tek Company June 1999 1 8 Acquisition 121,465
CT Specialists, Inc. August 1998 2 1 Finder's fees 7,328
Cybertech Station, Inc. March 1999 3 7 Acquisition 49,806
Cybertech Station, Inc. September 1999 3 1 Acquisition 17,629
Cybertech Station, Inc. March 1998 3 14 Acquisition 49,847
Data Path Technologies, Inc. July 1998 7 15 Acquisition 403,077
Data Path Technologies, Inc. June 1999 7 7 Acquisition 1,393,230
Data Path Technologies, Inc. April 2001 2 7 Acquisition 1,319,592
David Romano April 2001 1 16 Agreement 1,477,832
Dino Liso March 2001 1 17 Services 56,648
Doug Baker April 2001 1 18 Services 14,012
Employee Stock Sale May 1998 1 19 Stock purchase 100,000
Eric Limont April 2001 1 16 Agreement 1,477,832
GDB Software Services, Inc. July 1998 5 20 Acquisition 412,308
GDB Software Services, Inc. June 1998 5 7 Acquisition 627,879
II-2
NUMBER NUMBER OF
OF COMMON
DATE ISSUED PERSONS NOTE ISSUED FOR SHARES
----------- ------- ---- ---------- ------
GDB Software Services, Inc. July 2000 2 7 Acquisition 337,838
Ground Effects Limited June 1998 3 8 Acquisition 1,105,708
Herman J. Valdez August 2001 1 1 Acquisition 2,441,177
Hornbuckle Engineering, Inc. July 1999 3 8 Acquisition 554,563
Hornbuckle Engineering, Inc. June 2000 3 7 Acquisition 76,104
IBM Credit Corp. April 2001 1 21 Warrants 1,241,500
IBM Credit Corp. April 2001 1 22 Warrants 2,894,714
Independent Business Consultants May 2000 3 8 Acquisition 957,912
Information Products Center, Inc. March 1998 4 8 Acquisition 711,433
Information Products Center, Inc. March 1999 3 7 Acquisition 662,252
Information Products Center, Inc. September 1999 3 1 Acquisition 514,880
Innovative Vacuum Solutions, Inc. July 1998 5 8 Acquisition 298,301
Innovative Vacuum Solutions, Inc. June 1999 5 7 Acquisition 426,213
Innovative Vacuum Solutions, Inc. September 1999 3 1 Acquisition 1,461
Innovative Vacuum Solutions, Inc. January 2000 3 8 Acquisition 25,881
Intellesale, Inc. March 2001 2 2 Acquisition 6,616,522
James M. Shaver August 2001 1 1 Acquisition 5,696,078
Kerry Burst April 2001 1 2 Acquisition 463,293
Lynch, Marks & Associates, Inc. July 1999 2 8 Acquisition 773,142
Matt Hayden April 2001 1 23 Services 74,302
Matt Hayden November 2001 1 23 Services 200,000
McKinsey & Company October 2000 1 24 Services 37,994
MCY.com, Inc. November 2000 1 25 Asset purchase 11,816,141
Medical Advisory Systems, Inc. March 2001 5 26 Acquisition 3,322,313
Michael Erickson September 2001 1 27 Litigation settlement 200,000
Mpact Communications March 2001 1 24 Services 95,528
Norcom Resources, Inc. March 1998 2 7 Acquisition 74,667
Norcom Resources, Inc. September 2000 3 8 Acquisition 162,162
Pacific Decision Sciences Corp. October 2000 22 25 Acquisition 8,568,532
Perimeter Technology, Inc. June 2001 5 7 Acquisition 8,508,400
Pizarro Remarketing, Inc. March 1998 1 7 Acquisition 42,723
Pizarro Remarketing, Inc. June 2000 1 8 Acquisition 112,612
Port Consulting, Inc. March 2000 3 7 Acquisition 302,891
PPL, Ltd. June 1999 5 7 Acquisition 929,230
PPL, Ltd. September 1999 5 1 Acquisition 305,024
PPL, Ltd. June 2000 2 28 Acquisition 900,900
P-Tech, Inc. June 2000 12 29 Acquisition 1,401,180
P-Tech, Inc. October 2001 12 1 Acquisition 4,193,636
Service Transportation Company June 2000 1 8 Acquisition 101,351
Service Transportation Company April 1998 1 30 Acquisition 37,181
Services Jan. - Dec. 1998 Various 24 Services 265,598
Services Jan. - Dec. 1999 Various 31 Services 64,666
Services Oct. - Dec. 1999 1 31 Services 2,498
Signal Processors Limited February 1998 12 1 Acquisition 928,293
Signature Industries Limited June 1998 10 32 Acquisition 3,605,948
South Seas Data, Inc. December 2001 5 39 Litigation settlement 2,040,820
STC Netcom, Inc. December 1999 20 33 Acquisition 400,000
STR, Inc. July 1999 5 8 Acquisition 932,039
STR, Inc. May 2000 5 7 Acquisition 400,267
II-3
NUMBER NUMBER OF
OF COMMON
DATE ISSUED PERSONS NOTE ISSUED FOR SHARES
----------- ------- ---- ---------- ------
Sudiar Limited June 2001 1 34 Acquisition 492,940
Garrett Sullivan October 2001 1 31 Services 148,875
Richard Sullivan October 2001 1 31 Services 481,128
SysComm International Corp. Oct. - Dec. 2000 3 8 Acquisition 1,699,715
SysComm International Corp. April 2001 3 1 Acquisition 873,686
Teledata Concepts, Inc. June 1998 4 35 Acquisition 144,828
The Americom Group, Inc. March 2000 1 7 Acquisition 48,333
The Americom Group, Inc. March 1999 5 7 Acquisition 106,581
The Americom Group, Inc. September 1999 5 1 Acquisition 45,319
The Americom Group, Inc. June 1998 5 8 Acquisition 235,507
The Bay Group May 1998 1 24 Acquisition 218,682
The Fromehill Company March 1998 5 36 Acquisition 1,816,400
TigerTel Services Limited February 1999 1 24 Acquisition 43,877
Timely Technology Corp. June 2000 1 8 Acquisition 208,706
Timely Technology Corp. June 2001 1 7 Acquisition 7,109,000
Timely Technology Corp. August 2001 1 7 Acquisition 1,158,235
Timely Technology Corp. September 2002 1 7 Acquisition 5,502,439
Various January - March 2000 3 37 Warrants 317,500
Various Oct. - Dec. 2000 2 37 Warrants 415,685
Various April - June 2001 4 38 Employee stock options 43,000
Warrants April 1998 2 37 Warrants exercised 850,000
WebNet Services August 2000 3 8 Acquisition 267,857
WebNet Services November 2001 3 1 Acquisition 792,214
Winward Electric Service Inc. March 1999 4 7 Acquisition 533,333
Winward Electric Service Inc. September 1999 4 1 Acquisition 188,667
Amro Albanna January 2002 1 40 Acquisition 13,746
Arthur F. Noterman February 2002 1 41 Services 140,000
Angela Sullivan February 2002 1 41 Services 100,000
Constance Weaver February 2002 1 41 Services 140,000
Daniel Penni February 2002 1 41 Services 140,000
Garrett Sullivan February 2002 1 42 Services 2,500,000
South Seas Data, Inc. February 2002 5 43 Settlement 590,760
Scott Lines February 2002 1 44 Settlement 131,579
Kevin Barker February 2002 1 45 Settlement 73,171
Douglas Marlin February 2002 1 46 Settlement 487,805
Steve R. Matulich February 2002 1 47 Settlement 75,000
John McCarthy February 2002 1 48 Acquisition 46,512
Avnet, Inc. February 2002 1 49 Equipment 368,421
Pinacor, Inc. February 2002 1 50 Equipment 147,058
Richard Sullivan March 2002 1 42 Services 2,912,141
Garrett Sullivan March 2002 1 42 Services 184,580
Fahnestock March 2002 1 51 Services 250,000
Fahnestock & Co. Inc. March 2002 1 52 Services 205,000
John Munshour March 2002 1 53 Settlement 10,870
Foley & Lardner July 2002 1 54 Settlement 8,100,000
Sudiar Limited August 2002 1 34 Settlement 719,012
EnviroCommunications, Inc. December 2002 1 55 Services 200,000
Integral, Inc. February 2003 1 56 Settlement 170,000
Avnet, Inc. August 2002 1 49 Settlement 54,000
Ronald Kaplan April 2003 1 57 Settlement 233,000
Ovations International, Inc. May 2003 1 58 Services 81,415
Sherri Sheerr May 2003 1 59 Settlement 112,500
Peter Ciofani May - June 2003 1 60 Settlement 62,500
Treeline, Inc. June 2003 1 61 Settlement 1,100,000
-----------
Total 182,457,003
===========
<FN>
---------
1. Represents "price protection" shares issued in connection with a
prior private transaction directly negotiated by the shareholders
in connection with the sale of their business to us, which
transaction was exempt from registration pursuant to Rule 4(2) of
the Securities Act of 1933.
2. Represents shares issued in connection with the exercise of put
options granted to the shareholders in connection with the sale
of their business to us, which transaction was exempt from
registration pursuant to Rule 4(2) of the Securities Act of 1933.
3. Represents "price protection" shares issued in connection with
marketing studies and evaluation services provided by AFAC L.P.
4. Represents shares issued to Amherst Systems to acquire customer
lists for our subsidiary, Atlantic Systems, Inc.
5. Represents shares issued to the selling shareholders to acquire
such shareholders' interests in a transaction directly negotiated
by the shareholders in connection with the sale of an approximate
16% interest in ATEC Group, Inc. (AMEX:TEC) to us and exempt from
registration pursuant to Rule 4(2) of the Securities Act of 1933.
The number of common shares issued includes 2,077,150 shares
initially issued and 597,784 "price protection" shares issued on
February 28, 2001. The transaction document included an
acknowledgement that the sale was not registered, that the
shareholder was acquiring the shares for investment purposes and
not for resale, and that the shareholder acknowledged that he
must hold the shares until and unless registered or unless
transferred in another transaction exempt from registration. In
addition, certificates representing the shares were legended to
indicate that they were restricted.
6. Represents shares issued in connection with the rescission of our
acquisition of an approximately 16% interest in ATEC Group, Inc.
See note 5 above for further information regarding the underlying
transaction.
7. Represents shares issued to the selling shareholder(s) 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 transaction was exempt from registration pursuant to
Rule 4(2) of the Securities Act of 1933.
8. Represents shares issued to the selling shareholder(s) to acquire
such shareholder's interests in a transaction directly negotiated
by the shareholder(s) in connection with the sale of their
business to us and exempt from registration pursuant to Rule 4(2)
of the Securities Act of 1933. The transaction document included
an acknowledgement that the sale was not registered, that the
shareholder was
II-4
acquiring the shares for investment and not for resale and that the
shareholder acknowledged that he must hold the shares until and unless
registered or unless transferred in another transaction exempt from
registration. In addition, the certificates representing the shares
were legended to indicate that they were restricted.
9. Represents (a) 1,098,039 shares issued to the selling
shareholders to acquire such shareholders' interests in a
transaction directly negotiated by the shareholders in connection
with the sale of their business to us and exempt from
registration pursuant to Rule 4(2) of the Securities Act of 1933
and (b) 40,000 shares issued as a finder's fee in connection
therewith. The transaction document included an acknowledgement
that the sale was not registered, that the shareholder was
acquiring the shares for investment purposes and not for resale,
and that the shareholder acknowledged that he must hold the
shares until and unless registered or unless transferred in
another transaction exempt from registration. In addition,
certificates representing the shares were legended to indicate
that they were restricted.
10. Represents (a) 202,667 shares issued to the selling shareholder
to acquire such shareholder's 80% interest in a transaction
directly negotiated by the shareholders and exempt from
registration pursuant to Rule 4(2) of the Securities Act of 1933,
(b) 19,394 shares issued as a finder's fee in connection
therewith and (c) 582 shares issued for services in connection
with the acquisition. The transaction document included an
acknowledgement that the sale was not registered, that the
shareholder was acquiring the shares for investment purposes and
not for resale, and that the shareholder acknowledged that he
must hold the shares until and unless registered or unless
transferred in another transaction exempt from registration. In
addition, certificates representing the shares were legended to
indicate that they were restricted.
11. Represents (a) 7,530 shares issued to the stage I selling
shareholders to correct the initial issuance of shares, (b)
170,683 shares issued to the stage II selling shareholders upon
acquisition of their minority interests in 1998, (c) 109,774
shares issued to the stage I and stage II selling shareholders in
connection with the "price protection" provision of the agreement
of sale and (d) 34,525 shares issued as a finder's fee. These
shares were issued in a transaction directly negotiated by the
shareholders and exempt from registration pursuant to Rule 4(2)
of the Securities Act of 1933. The transaction document included
an acknowledgement that the sale was not registered, that the
shareholder was acquiring the shares for investment purposes and
not for resale, and that the shareholder acknowledged that he
must hold the shares until and unless registered or unless
transferred in another transaction exempt from registration. In
addition, certificates representing the shares were legended to
indicate that they were restricted.
12. Represents shares issued for consulting services rendered by Mr.
Newman.
13. Represents (a) 392,157 shares issued to the selling shareholder
to acquire such shareholder's 80% interest in a transaction
directly negotiated by the shareholders and exempt from
registration pursuant to Rule 4(2) of the Securities Act of 1933
and (b) 37,648 shares issued as a finder's fee in connection
therewith. The transaction document included an acknowledgement
that the sale was not registered, that the shareholder was
acquiring the shares for investment purposes and not for resale,
and that the shareholder acknowledged that he must hold the
shares until and unless registered or unless transferred in
another transaction exempt from registration. In addition,
certificates representing the shares were legended to indicate
that they were restricted.
14. Represents (a) 24,444 "price protection" shares issued to the
selling shareholder, (b) 805 "price protection" shares issued as
finder's fees and (c) 22,598 shares issued to the selling
shareholder(s) in connection with the "earnout" provision of the
agreement of sale, in connection a prior private transaction
directly negotiated by the shareholders in connection with the
sale of their business to us, which transaction was exempt from
registration pursuant to Rule 4(2) of the Securities Act of 1933.
15. Represents (a) 384,616 shares issued to the selling shareholders
to acquire such shareholder's interest a transaction directly
negotiated by the shareholders and exempt from registration
pursuant to Rule 4(2) of the Securities Act of 1933 and (b)
18,461 shares issued as a finder's fee in connection therewith.
The transaction document included an acknowledgement that the
sale was not registered, that the shareholder was acquiring the
shares for investment purposes and not for resale, and that the
shareholder acknowledged that he must hold the shares until and
unless registered or unless transferred in another transaction
exempt from registration. In addition, certificates representing
the shares were legended to indicate that they were restricted.
16. Represents shares issued in connection with settlement of
litigation against David Romano and Eric Limont, the former
owners of Bostek. See "Legal Proceedings" beginning on page 29.
17. Represents shares issued to Mr. Liso as a transaction fee in
connection with our acquisition of an approximately 16% interest
in ATEC Group, Inc. See note 5 above for further information
regarding the underlying transaction.
18. Represents shares issued to Mr. Baker as a transaction fee in
connection with our acquisition of Perimeter Technology, Inc., a
prior private transaction directly negotiated by the shareholders
in connection with the sale of their business to us, which
transaction was exempt from registration pursuant to Rule 4(2) of
the Securities Act of 1933.
19. Represents shares issued to Marc Sherman, one of our former
officers, at the market price on the effective date of the sale,
which sale was exempt from registration pursuant to Rule 4(2) of
the Securities Act of 1933.
20. Represents (a) 384,616 shares issued to the selling shareholder
to acquire such shareholder's 80% interest in a transaction
directly negotiated by the shareholders and exempt from
registration pursuant to Rule 4(2) of the Securities Act of 1933
and (b) 27,692 shares issued as a finder's fee in connection
therewith. The transaction document included an acknowledgement
that the sale was not registered, that the shareholder was
acquiring the shares for investment purposes and not for resale,
and that the shareholder acknowledged that he must hold the shares
until and unless registered or unless transferred in another
transaction exempt from registration. In addition, certificates
representing the shares were legended to indicate that they were
restricted.
21. Represents shares issued in connection with the issuance of
warrants which are exercisable into shares of our common stock.
22. Represents shares issued in connection with the issuance of
warrants which are exercisable into shares of common stock of
Digital Angel Corporation.
23. Represents 74,302 shares issued to Mr. Hayden as a transaction fee
in connection with our acquisition of an approximately 17%
interest in Medical Advisory Systems, Inc. See note 26 below for
further information regarding the underlying transaction and
200,000 shares issued in connection with services provided by Mr.
Hayden for assisting us in obtaining investment banking services.
24. Represents shares issued for professional services rendered.
25. Represents shares issued in connection with our acquisition of
internal use software from MCY.com, Inc.
26. Represents shares issued in connection with our acquisition of an
approximately 17% interest in Medical Advisory Systems, Inc.
(AMEX:DOC) in a transaction directly negotiated by the
shareholders in connection with the sale of their shares to us and
exempt from registration pursuant to Rule 4(2) of the Securities Act of
1933. The transaction document included an acknowledgement that the
sale was not registered, that the shareholder was acquiring the shares
for investment purposes and not for resale, and that the shareholder
acknowledged that he must hold the shares until and unless registered
or unless transferred in another transaction exempt from registration.
In addition, certificates representing the shares were legended to
indicate that they were restricted.
27. Represents shares issued in connection with the settlement of
certain litigation with Mr. Erickson pertaining to Mr. Erickson's
employment with us.
II-5
28. Represents shares issued to the selling shareholders in
consideration for their minority interests and in settlement of
future earnout payments.
29. Represents shares issued to the selling shareholder(s) to acquire
such shareholder's interests in a transaction directly negotiated
by the shareholder(s) in connection with the sale of their
business to us and exempt from registration pursuant to Rule 506
of Regulation D promulgated under the Securities Act of 1933. The
transaction document included an acknowledgement that the sale was
not registered, that the shareholder was acquiring the shares for
investment and not for resale and that the shareholder
acknowledged that he must hold the shares until and unless
registered or unless transferred in another transaction exempt
from registration. In addition, the certificates representing the
shares were legended to indicate that they were restricted.
30. Represents (a) 35,000 shares issued to the selling shareholder to
acquire such shareholder's 80% interest in a transaction directly
negotiated by the shareholders and exempt from registration
pursuant to Rule 4(2) of the Securities Act of 1933 and (b) 2,181
shares issued as a finder's fee in connection therewith. The
transaction document included an acknowledgement that the sale was
not registered, that the shareholder was acquiring the shares for
investment purposes and not for resale, and that the shareholder
acknowledged that he must hold the shares until and unless
registered or unless transferred in another transaction exempt
from registration. In addition, certificates representing the
shares were legended to indicate that they were restricted.
31. Represents shares issued to an employee for services under
employment or other such agreements.
32. Represents (a) 3,571,235 shares issued to the selling shareholder
to acquire such shareholder's 85% interest in a transaction
directly negotiated by the shareholders and exempt from
registration pursuant to Rule 4(2) of the Securities Act of 1933
and (b) 34,713 shares issued as a finder's fee in connection
therewith. The transaction document included an acknowledgement
that the sale was not registered, that the shareholder was
acquiring the shares for investment purposes and not for resale,
and that the shareholder acknowledged that he must hold the shares
until and unless registered or unless transferred in another
transaction exempt from registration. In addition, certificates
representing the shares were legended to indicate that they were
restricted.
33. Represents shares issued to 20 selling shareholders in connection
with the acquisition of minority interests of such shareholders in
STC Netcom, Inc. Our initial issuance of shares in connection with
our acquisition of STC Netcom, Inc. occurred in 1997 in a
transaction directly negotiated by the shareholders in connection
with the sale of their business to us, which transaction was
exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933.
34. Represents shares issued to a creditor of Caledonian Venture
Holdings Limited (CVH) in connection with the acquisition of CVH
and exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933. The transaction document included an
acknowledgment that the sale was not registered, that the party
was acquiring the shares for investment and not for resale, and
that the party acknowledged that it 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.
35. Represents (a) 140,138 shares issued to the selling shareholders
to acquire such shareholder's interest a transaction directly
negotiated by the shareholders and exempt from registration
pursuant to Rule 4(2) of the Securities Act of 1933 and (b) 4,690
shares issued as a finder's fee in connection therewith. The
transaction document included an acknowledgement that the sale was
not registered, that the shareholder was acquiring the shares for
investment purposes and not for resale, and that the shareholder
acknowledged that he must hold the shares until and unless
registered or unless transferred in another transaction exempt
from registration. In addition, certificates representing the
shares were legended to indicate that they were restricted.
36. Represents (a) 1,778,543 shares issued to the selling shareholders
to acquire such shareholder's interest a transaction directly
negotiated by the shareholders and exempt from registration
pursuant to Rule 4(2) of the Securities Act of 1933 and (b) 37,857
shares issued as a finder's fee in connection therewith. The
transaction document included an acknowledgement that the sale was
not registered, that the shareholder was acquiring the shares for
investment purposes and not for resale, and that the shareholder
acknowledged that he must hold the shares until and unless
registered or unless transferred in another transaction exempt
from registration. In addition, certificates representing the
shares were legended to indicate that they were restricted.
37. Represents shares issued in connection with the exercise of
outstanding warrants.
38. Represents shares issued upon exercise of certain options
previously issued under our 1999 Flexible Stock Plan, which shares
have not been registered.
39. Represents shares issued in connection with settlement of
litigation against us by John Mariano, Christopher Wiltsey, Dean
Gustafson, Anthony Pitman and Jeffery Kowalski, the owners of
South Seas Data, Inc. See "Legal Proceedings" beginning on page 29.
40. 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.
41. 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.
42. Represents shares issued in lieu of cash compensation. The
certificates representing the shares were legended to indicate
that they were restricted.
43. 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.
44. 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.
45. 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
II-6
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.
46. 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.
47. 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.
48. 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.
49. 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.
50. 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.
51. 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.
52. 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.
53. Represents shares issued in connection with the settlement of a
dispute between Mr. Munshour 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.
54. Represents shares issued in connection with the settlement of
certain litigation between us, and the former shareholders of
Computer Equity 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 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.
55. Represents shares issued in connection with consulting services
provided in connection with our VeriChip product, 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. Robert Levy, President, has sole voting and dispositive
power with respect to the shares held by EnviroCommunications, Inc.
56. Represents shares issued in connection with the settlement of a
debt for services performed, 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. Norman W.
Gorin, Chief Financial Officer, has sole voting and dispositive
power with respect to the shares held by Integral, Inc.
57. Represents shares issued in connection with the settlement of a
dispute between Mr. Kaplan 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.
58. Represents shares issued in connection with consulting services
provided, 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
II-7
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. Matthew Cossolotto, President, has sole voting and
dispositive power with respect to the shares held by Ovations
International, Inc.
59. Represents shares issued in connection with the settlement of a
dispute between Ms. Sheerr 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.
60. Represents shares issued in connection with the settlement of a
dispute between Mr. Ciofani 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.
61. Represents shares issued in connection with the settlement of a dispute
between Treeline, Inc. 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. Parviz Boudjeh, President, has sole voting and dispositive
power with respect to the shares held by Treeline, Inc.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) See Exhibit Index.
(b) Financial Statement Schedules.
Schedule II -- Valuation and Qualifying Accounts. See page
F-57. All other Financial Statement Schedules have been omitted
because of the absence of conditions under which they would be
required or because the required information has been included in
the financial statements.
Undertakings
(a) The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales
are being made, a post-effective amendment to this registration
statement:
(i) To include any prospectus required by Section
10(a)(3) of the Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events
arising after the effective date of this registration
statement (or the most recent post-effective amendment
hereof) which, individually or in the aggregate, represent a
fundamental change in the information set forth in this
registration statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the
total dollar value of securities offered would not exceed
that which was registered) and any deviation from the low or
high end of the estimated maximum offering range may be
reflected in the form of prospectus filed with the
Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than 20
percent change in the maximum aggregate offering price set
forth in the "Calculation of Registration Fee" table in the
effective registration statement; and
(iii) To include any material information with respect
to the plan of distribution not previously disclosed in the
registration statement or any material change to such
information in the registration statement.
(2) That, for the purpose of determining any liability
under the Securities Act of 1933, each such post-effective
amendment shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of
such securities at that time shall be deemed to be the initial
bona fide offering thereof.
II-8
(3) To remove from registration by means of a
post-effective amendment any of the securities being registered
which remain unsold at the termination of the offering.
(b) Insofar as indemnification for liabilities arising
under the Securities Act of 1933 may be permitted to directors, officers
and controlling persons of the registrant pursuant to the foregoing
provisions, or otherwise, the registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification
is against public policy as expressed in the Act and is, therefore,
unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the
registrant in the successful defense of any action, suit or proceeding)
is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will,
unless in the opinion of its counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of
such issue.
II-9
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
registrant has duly caused this registration statement to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Palm Beach, State of Florida, on June 16, 2003.
APPLIED DIGITAL SOLUTIONS, INC.
By: /s/ SCOTT R.SILVERMAN
------------------------------------------
Scott R. Silverman, Chairman and CEO
POWER OF ATTORNEY
The undersigned constitutes and appoints Evan C. McKeown as his or
her true and lawful attorney-in-fact and agent, with full power of
substitution and resubstitution, for him or her and in his name, place,
and stead, in any and all capacities, to sign the Applied Digital
Solutions, Inc. Registration Statement on Form S-1 and any and all
amendments thereto, and to file the same, with all exhibits thereto, and
other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorney-in-fact and agent full
power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully
to all intents and purposes as he might or could in person, hereby
ratifying and confirming all that said attorney-in-fact and agent, and
each or either of them or their substitutes, may lawfully do or cause to
be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
[Enlarge/Download Table]
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Scott R. Silverman Chairman of the Board of Directors, Chief June 16, 2003
-------------------------------- Executive Officer
(Scott R. Silverman) (Principal Executive Officer)
/s/ Kevin H. McLaughlin President and Chief Operating Officer June 16, 2003
--------------------------------
(Kevin H. McLaughlin)
/s/ Evan C. McKeown Senior Vice President and Chief Financial June 16, 2003
-------------------------------- Officer (Principal Financial and
(Evan C. McKeown) Accounting Officer)
/s/ Arthur F. Noterman Director June 16, 2003
--------------------------------
(Arthur F. Noterman)
/s/ Daniel E. Penni Director June 16, 2003
--------------------------------
(Daniel E. Penni)
/s/ Dennis G. Rawan Director June 16, 2003
--------------------------------
(Dennis G. Rawan)
/s/ Constance K. Weaver Director June 16, 2003
--------------------------------
(Constance K. Weaver)
/s/ Michael S. Zarriello Director June 16, 2003
--------------------------------
(Michael S. Zarriello)
II-10
ITEM 16. EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------ -----------
2.1 Agreement of Purchase and Sale dated as of June 4, 1999 by and
among Intellesale.com, Inc., Applied Cellular Technology, Inc.,
David Romano and Eric Limont (incorporated by reference to Exhibit
99.1 to the registrant's Current Report on Form 8-K filed with the
Commission on June 11, 1999, as amended on August 12, 1999)
2.2 Amendment No. 1 to the Agreement of Purchase and Sale, dated as of
June 9, 1999 by and among Intellesale.com, Inc., Applied Cellular
Technology, Inc., David Romano and Eric Limont (incorporated by
reference to Exhibit 99.2 to the registrant's Current Report on
Form 8-K filed with the Commission on June 11, 1999, as amended on
August 12, 1999)
2.3 Agreement and Plan of Merger, dated April 24, 2000, by and among
the Applied Digital Solutions, Inc., Digital Angel Corporation and
Destron Fearing Corporation (incorporated by reference to Exhibit
2.1 to the registrant's Current Report on Form 8-K filed with the
Commission on May 1, 2000)
2.4 Agreement dated as of November 28, 1999 by and between AT&T Canada
Corp. and TigerTel, Inc. (incorporated by reference to Exhibit
99.1 to the registrant's Current Report on Form 8-K filed with the
Commission on December 13, 1999, as amended on December 22, 1999
and January 11, 2000)
2.5 Agreement and Plan of Merger dated as of June 30, 2000 by and
among the Applied Digital Solutions, Inc. and Compec Acquisition
Corp. and Computer Equity Corporation and John G. Ballenger,
Christopher J. Ballenger and Frederick M. Henschel (incorporated
by reference to Exhibit 2 to the registrant's Current Report on
Form 8-K filed with the Commission on July 14, 2000, as amended on
September 11, 2000)
2.6 Agreement and Plan of Merger dated as of October 18, 2000, by and
among the Applied Digital Solutions, Inc. and PDS Acquisition
Corp., and Pacific Decision Sciences Corporation, and H&K Vasa
Family 1999 Limited Partnership, H&K Vasa Family 2000 Limited
Partnership, David Dorret, and David Englund (incorporated by
reference to Exhibit 2 to the registrant's Current Report on Form
8-K filed with the Commission on November 1, 2000, as amended on
December 29, 2000)
2.7 MCY Agreement dated as of October 19, 2000 by and between MCY.com,
Inc. and Applied Digital Solutions, Inc. (incorporated by
reference to Exhibit 2 to the registrant's Current Report on Form
8-K filed with the Commission on December 5, 2000)
3.1 Amended and Restated Bylaws of the Company dated March 31, 1998
(incorporated by reference to Exhibit 3.4 to the registrant's
Quarterly Report on Form 10-Q for the Quarter Ended June 30, 2002
filed with the Commission on August 14, 2002)
3.2 Amendment to Bylaws of the Company dated April 4, 2002
(incorporated by reference to Exhibit 3.4 to the registrant's
Quarterly Report on Form 10-Q for the Quarter Ended June 30, 2002
filed with the Commission on August 14, 2002)
3.3 Second Restated Articles of Incorporation of the Registrant
(incorporated herein by reference to Exhibit 4.1 to the
registrant's Post-Effective Amendment No. 1 on Form S-1 to
Registration Statement (Form S-3 File No. 333-64605) filed with
the Commission on June 24, 1999)
3.4 Amendment of Articles of Incorporation of the Registrant filed
with the Secretary of State of the State of Missouri on September
5, 2000 (incorporated herein by reference to Exhibit 4.3 to the
Registrant's Post-Effective Amendment No. 3 on Form S-3 to
Registration Statement on Form S-4 (File No. 333-38420-02) filed
with the Commission on September 29, 2000)
3.5 Amendment of Second Restated Articles of Incorporation of the
Registrant filed with the Secretary of State of Missouri on July
18, 2001 (incorporated herein by reference to Exhibit 4.3 to the
Registrant's Quarterly Report on Form 10-Q filed with the
Commission on August 17, 2001)
II-11
4.1 Second Restated Articles of Incorporation, of the Registrant
(incorporated herein by reference to Exhibit 4.1 to the
registrant's Post-Effective Amendment No. 1 on Form S-1 to
Registration Statement (Form S-3 File No. 333-64605) filed with
the Commission on June 24, 1999)
4.2 Amendment of Articles of Incorporation of the Registrant filed
with the Secretary of State of the State of Missouri on September
5, 2000 (incorporated herein by reference to Exhibit 4.3 to the
registrant's Post-Effective Amendment No. 3 on Form S-3 to
Registration Statement on Form S-4 (File No. 333-38420-02) filed
with the Commission on September 29, 2000)
4.3 Amendment of Second Restated Articles of Incorporation of the
Registrant filed with the Secretary of State of Missouri on July
18, 2001 (incorporated herein by reference to Exhibit 4.3 to the
registrant's Quarterly Report on Form 10-Q filed with the
Commission on August 17, 2001)
4.4 Third Restated Articles of Incorporation of the Registrant filed
with the Secretary of State of Missouri on December 20, 2002
(incorporated by reference to Exhibit 4.4 to the registrant's
Pre-Effective Amendment No. 1 to Registration Statement on Form
S-1 (File No. 333-102165) filed with the Commission on February 6,
2003)
4.5 Certificate of Designation of Preferences of Series C Convertible
Preferred Stock (incorporated herein by reference to Exhibit 3.1
to the registrant's Current Report on Form 8-K filed with the
Commission on October 26, 2000)
4.6 Amended and Restated Bylaws of the Registrant dated March 31, 1998
(incorporated by reference to Exhibit 3.4 to the registrant's
Quarterly Report on Form 10-Q for the Quarter Ended June 30, 2002
filed with the Commission on August 14, 2002)
4.7 Amended and Restated Bylaws of the Registrant dated March 31, 1998
(incorporated by reference to Exhibit 4.7 to the registrant's
Post-Effective Amendment No. 1 to Registration Statement on Form
S-1 (File No. 333-102165) filed with the Commission on April 11,
2003)
5.1 Opinion of Holland & Knight LLP*
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 registrant's
Registration Statement on Form S-8 (File No. 333-91999) filed with
the Commission on December 2, 1999)
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 registrant'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
registrant's Registration Statement on Form S-8 (File No.
333-92327) filed with the Commission on December 8, 1999)
10.4 Credit Agreement between Applied Digital Solutions, Inc. and State
Street Bank and Trust Company dated as of August 25, 1998
(incorporated herein by reference to Exhibit 10.2 to the
registrant's Quarterly Report on Form 10-Q filed with the
Commission on November 16, 1998)
10.5 First Amendment to Credit Agreement between Applied Digital
Solutions, Inc. and State Street Bank and Trust Company dated as
of February 4, 1999 (incorporated by reference to Exhibit 10.3 the
registrant's Annual Report on Form 10-K filed with the Commission
on March 31, 1999)
10.6 Richard J. Sullivan Employment Agreement (incorporated by
reference to Exhibit 10.8 to the registrant's Annual Report on
Form 10-K filed with the Commission on March 30, 2000)
10.7 Garrett A. Sullivan Employment Agreement (incorporated by
reference to Exhibit 10.9 to the registrant's Annual Report on
Form 10-K filed with the Commission on March 30, 2000)
II-12
10.8 Letter Agreement, dated December 30, 2001, between Applied Digital
Solutions, Inc. and Garrett A. Sullivan (incorporated by reference
to Exhibit 10.13 to the registrant's Amendment to the Registration
Statement on Form S-1 (File No. 333-75928) filed with the
Commission on February 8, 2002)
10.9 Jerome C. Artigliere Employment Agreement (incorporated by
reference to Exhibit 10.11 to the registrant's Annual Report on
Form 10-K filed with the Commission on April 10, 2001)
10.10 Mercedes Walton Employment Agreement (incorporated by reference to
Exhibit 10.12 to the registrant's Annual Report on Form 10-K filed
with the Commission on April 10, 2001)
10.11 David I. Beckett Employment Agreement (incorporated by reference
to Exhibit 10.13 to the registrant's Annual Report on Form 10-K
filed with the Commission on April 10, 2001)
10.12 Michael E. Krawitz Employment Agreement (incorporated by reference
to Exhibit 10.14 to the registrant's Annual Report on Form 10-K
filed with the Commission on April 10, 2001)
10.13 Dr. Peter Zhou Employment Agreement (incorporated by reference to
Exhibit 10.19 to the registrant's Amendment to the Registration
Statement on Form S-1 (File No. 333-75928) filed with the
Commission on February 8, 2002)
10.14 Securities Purchase Agreement, dated as of October 24, 2000,
relating to the Registrant's Series C Convertible Preferred Stock
(incorporated by reference to Exhibit 10.1 to the registrant's
Current Report on Form 8-K filed with the Commission on October
26, 2000)
10.15 Form of warrant to purchase common stock of the Registrant issued
to the holders of the Series C Convertible Preferred Stock
(incorporated by reference to Exhibit 4.1 to the registrant's
Current Report on Form 8-K filed with the Commission on October
26, 2000)
10.16 Registration Rights Agreement between the Registrant and the
holders of the Series C Convertible Preferred Stock (incorporated
by reference to Exhibit 10.2 to the registrant's Current Report on
Form 8-K filed with the Commission on October 26, 2000)
10.17 Lock-Up Agreement dated as of November 28, 1999 by and among AT&T
Canada Corp. and Applied Digital Solutions, Inc. (incorporated by
reference to the Exhibit 99.2 to the registrant's Current Report
on Form 8-K filed with the Commission on December 13, 1999, as
amended on December 22, 1999 and January 11, 2000)
10.18 Voting Agreement by and among Applied Digital Solutions, Inc. and
certain security holders of Destron Fearing Corporation
(incorporated by reference to Exhibit 10.1 to the registrant's
Current Report on Form 8-K filed with the Commission on May 1,
2000)
10.19 Third Amended and Restated Term Credit Agreement dated March 1,
2002 among Applied Digital Solutions, Inc., Digital Angel Share
Trust and IBM Credit Corporation (incorporated by reference to
Exhibit 10.2 to the registrant's Current Report on Form 8-K filed
with the Commission on March 8, 2002)
10.20 Waiver Agreement from IBM Credit Corporation, waiving existing
defaults under the Third Amended and Restated Term Credit
Agreement as of June 30, 2002 (incorporated herein by reference to
Exhibit 10.20 to the registrant's Registration Statement on Form
S-1 (File No. 333-98799) filed with the Commission on August 27,
2002)
10.21 Amendment to The Third Amended and Restated Term Credit Agreement
dated as of September 30, 2002, amending certain financial
covenants under the Third Amended and Restated Term Credit
Agreement (incorporated herein by reference to Exhibit 10.21 to
the registrant's Post-Effective Amendment No. 1 to Registration
Statement on Form S-1 (File No. 333- 98799) filed with the
Commission on November 5, 2002)
10.22 Amendment to The Third Amended and Restated Term Credit Agreement
dated as of November 1, 2002, amending certain financial covenants
under the Third Amended and Restated Term Credit Agreement
(incorporated herein by reference to Exhibit 10.22 to the
registrant's Post-Effective Amendment No. 1 to Registration
Statement on Form S-1 (File No. 333- 98799) filed with the
Commission on November 5, 2002)
10.23 Warrant Agreement between Applied Digital Solutions, Inc. and IBM
Credit Corporation dated August 21, 2002 (incorporated herein by
reference to Exhibit 10.21 to the registrant's Registration
Statement on Form S-1 (File No. 333-98799) filed with the
Commission on August 27, 2002)
II-13
10.24 Warrant Agreement between VeriChip Corporation and IBM Credit
Corporation dated August 21, 2002 (incorporated herein by
reference to Exhibit 10.22 to the registrant's Registration
Statement on Form S-1 (File No. 333-98799) filed with the
Commission on August 27, 2002)
10.25 Agreement of Settlement and Release by and between Applied Digital
Solutions, Inc. and John G. Ballenger, Christopher J. Ballenger
and Frederick M. Henschel, dated July 17, 2002 (incorporated
herein by reference to Exhibit 10.23 to the registrant's
Registration Statement on Form S-1 (File No. 333-98799) filed with
the Commission on August 27, 2002)
10.26 Amendment to Agreement of Settlement and Release by and between
Applied Digital Solutions, Inc. and John G. Ballenger, Christopher
J. Ballenger and Frederick M. Henschel, dated August 23, 2002
(incorporated herein by reference to Exhibit 10.24 to the
registrant's Registration Statement on Form S-1 (File No.
333-98799) filed with the Commission on August 27, 2002)
10.27 Summary of Terms and Conditions setting forth the terms and
conditions of the Forbearance Agreement among IBM Credit LLC,
Applied Digital Solutions, Inc., Digital Angel Share Trust, and
their applicable subsidiaries (if any) dated March 24, 2003
(incorporated herein by reference to Exhibit 10.2 to the
registrant's Current Report on Form 8-K filed with the Commission
on March 27, 2002)
10.28 Forbearance Agreement, Consent and Amendment, dated as of April 2,
2003, with respect to the Third Amended and Restated Credit
Agreement, dated as of March 1, 2002 and amended as of September
30, 2002 and November 1, 2002 (as amended, supplemented, restated
or otherwise modified through the date hereof, the "Credit
Agreement"), among IBM Credit LLC, a Delaware limited liability
company, formerly IBM Credit Corporation ("IBM Credit"), Applied
Digital Solutions, Inc., a Missouri corporation ("ADS" or the
"Tranche B Borrower"), Digital Angel Share Trust, a Delaware
statutory business trust (in such capacity, the "Trust"; in its
capacity as a Borrower, the "Tranche A Borrower"; and together
with the Tranche B Borrower, the "Borrowers") and the other Loan
Parties party thereto (incorporated herein by reference to Exhibit
10.27 to the registrant's Post-Effective Amendment No. 1 to
Registration Statement on Form S-1 (File No. 333-102165) filed
with the Commission on April 11, 2003)
10.29 Letter Agreement between Applied Digital Solutions, Inc. and R.J.
Sullivan dated March 24, 2003 (incorporated herein by reference to
Exhibit 10.3 to the registrant's Current Report on Form 8-K filed
with the Commission on March 27, 2003)
10.30 Letter Agreement between Applied Digital Solutions, Inc. and J.C.
Artigliere dated March 24, 2003 (incorporated herein by reference
to Exhibit 10.29 to the registrant's Annual Report on Form 10-K
filed with the Commission on March 31, 2003)
10.31 Placement Agency Agreement by and between Applied Digital
Solutions, Inc. and J.P. Carey Securities Inc.(incorporated herein
by reference to Exhibit 10.31 to the registrant's Post-Effective
Amendment No. 2 to Registration Statement on Form S-1 (File No.
333-102165) filed with the Commission on April 17, 2003)
21.1 List of Subsidiaries of Applied Digital Solutions, Inc.*
23.1 Consent of Eisner LLP*
23.2 Consent of PricewaterhouseCoopers LLP*
23.5 Consent of Holland & Knight LLP (included in Exhibit 5.1)*
24.1 Power of Attorney (set forth on the signature page of this
registration statement)*
99.1 Form of Subscription Agreement between Applied Digital
Solutions, Inc. and Investor*
<FN>
* Filed herewith
II-14
Dates Referenced Herein and Documents Incorporated by Reference
| Referenced-On Page |
|---|
| This ‘S-1MEF’ Filing | | Date | | First | | Last | | | Other Filings |
|---|
| |  |
| | 10/1/04 | | 118 |
| | 3/31/04 | | 9 | | 155 | | | 10-Q, 10-Q/A |
| | 12/31/03 | | 10 | | 155 | | | 10-K, 10-K/A, 4, 424B3, 5/A |
| | 9/30/03 | | 9 | | 156 | | | 10-Q, 10-Q/A, 424B3 |
| | 9/27/03 | | 81 |
| | 8/31/03 | | 12 | | 163 |
| | 7/30/03 | | 84 |
| | 7/25/03 | | 11 | | 31 | | | DEF 14A, PRE 14A |
| | 7/13/03 | | 166 |
| | 7/1/03 | | 45 |
| | 6/30/03 | | 10 | | 155 | | | 10-Q, 10-Q/A, 8-K |
| Filed on / Effective on: | | 6/18/03 | | 1 | | 82 |
| | 6/17/03 | | 3 | | 83 | | | 424B3 |
| | 6/16/03 | | 2 | | 176 |
| | 6/15/03 | | 45 |
| | 6/4/03 | | 3 | | 84 | | | S-1 |
| | 6/1/03 | | 34 | | 35 |
| | 5/31/03 | | 45 |
| | 5/30/03 | | 90 | | | | | 424B3 |
| | 5/22/03 | | 3 | | 84 | | | PRE 14A |
| | 5/15/03 | | 36 | | | | | 424B4, 8-K |
| | 5/14/03 | | 79 | | | | | 10-Q |
| | 5/13/03 | | 8 | | 27 |
| | 5/12/03 | | 11 | | 164 |
| | 5/9/03 | | 11 | | 164 |
| | 5/8/03 | | 3 | | 84 |
| | 5/7/03 | | 150 | | | | | POS AM |
| | 5/2/03 | | 156 |
| | 5/1/03 | | 10 | | 31 |
| | 4/17/03 | | 180 | | | | | POS AM |
| | 4/11/03 | | 178 | | 180 | | | POS AM |
| | 4/4/03 | | 82 | | | | | 10-K/A |
| | 4/2/03 | | 9 | | 180 |
| | 3/31/03 | | 8 | | 180 | | | 10-K, 10-Q, 10-Q/A |
| | 3/27/03 | | 9 | | 180 | | | 8-K |
| | 3/25/03 | | 10 | | 155 |
| | 3/24/03 | | 10 | | 180 |
| | 3/21/03 | | 11 | | 162 | | | 8-K |
| | 3/7/03 | | 9 | | 154 | | | 8-K |
| | 3/6/03 | | 9 | | 155 | | | 8-K |
| | 3/3/03 | | 9 | | 154 |
| | 3/1/03 | | 10 | | 160 |
| | 2/28/03 | | 9 | | 155 | | | 8-K |
| | 2/6/03 | | 178 | | | | | S-1/A |
| | 1/1/03 | | 39 | | 131 |
| | 12/31/02 | | 9 | | 162 | | | 10-K, 10-K/A |
| | 12/20/02 | | 178 |
| | 12/15/02 | | 45 | | 109 |
| | 12/10/02 | | 70 |
| | 11/12/02 | | 11 | | 164 |
| | 11/8/02 | | 8 | | 27 |
| | 11/5/02 | | 179 | | | | | POS AM |
| | 11/1/02 | | 65 | | 180 |
| | 10/30/02 | | 18 | | 134 |
| | 10/25/02 | | 69 | | 164 |
| | 10/24/02 | | 8 | | 27 |
| | 10/22/02 | | 8 | | 27 |
| | 10/17/02 | | 23 |
| | 9/30/02 | | 65 | | 180 | | | 10-Q |
| | 9/27/02 | | 57 | | 81 |
| | 8/27/02 | | 179 | | 180 | | | S-1 |
| | 8/23/02 | | 90 | | 180 |
| | 8/21/02 | | 109 | | 180 |
| | 8/14/02 | | 177 | | 178 | | | 10-Q |
| | 7/31/02 | | 69 | | 164 |
| | 7/30/02 | | 11 | | 164 |
| | 7/18/02 | | 69 | | | | | 10-Q/A |
| | 7/17/02 | | 180 |
| | 7/15/02 | | 56 |
| | 7/12/02 | | 11 | | 164 |
| | 7/9/02 | | 7 | | 26 |
| | 6/30/02 | | 109 | | 179 | | | 10-Q |
| | 5/28/02 | | 68 | | | | | 8-K |
| | 5/24/02 | | 69 | | | | | 8-K |
| | 5/23/02 | | 68 | | 130 | | | 8-K, 8-K/A |
| | 5/22/02 | | 68 | | 69 | | | 8-K |
| | 5/21/02 | | 68 | | | | | 8-K |
| | 5/20/02 | | 69 | | | | | 10-Q |
| | 5/14/02 | | 68 | | | | | 8-K, 8-K/A |
| | 4/22/02 | | 68 | | | | | 8-K/A |
| | 4/17/02 | | 67 |
| | 4/12/02 | | 71 |
| | 4/11/02 | | 67 | | 68 | | | 8-K, 8-K/A |
| | 4/4/02 | | 177 |
| | 4/2/02 | | 109 | | 116 | | | POS AM |
| | 3/31/02 | | 32 | | 162 | | | 10-Q, 10-Q/A, NT 10-Q |
| | 3/27/02 | | 7 | | 180 | | | 4, 8-K |
| | 3/8/02 | | 17 | | 179 | | | 424B3, 8-K |
| | 3/1/02 | | 52 | | 180 |
| | 2/27/02 | | 109 | | 116 | | | 8-K |
| | 2/24/02 | | 121 |
| | 2/14/02 | | 68 |
| | 2/8/02 | | 179 |
| | 2/7/02 | | 8 | | 26 |
| | 1/31/02 | | 36 | | 130 |
| | 1/1/02 | | 11 | | 160 |
| | 12/31/01 | | 19 | | 135 | | | 10-K |
| | 12/30/01 | | 179 |
| | 12/15/01 | | 44 | | 108 |
| | 11/29/01 | | 130 |
| | 11/26/01 | | 7 | | 26 |
| | 11/15/01 | | 109 | | 116 | | | 8-K |
| | 11/1/01 | | 68 |
| | 10/1/01 | | 116 | | 130 |
| | 9/27/01 | | 57 | | 81 |
| | 9/15/01 | | 109 | | 116 |
| | 9/11/01 | | 24 | | 57 |
| | 8/17/01 | | 177 | | 178 | | | 10-Q |
| | 7/18/01 | | 177 | | 178 |
| | 7/1/01 | | 109 | | 116 |
| | 6/30/01 | | 44 | | 120 | | | 10-Q, 10-Q/A, NT 10-Q |
| | 6/15/01 | | 58 | | 131 | | | S-3/A |
| | 5/29/01 | | 36 |
| | 5/10/01 | | 130 | | | | | PRER14A |
| | 4/10/01 | | 179 | | | | | 10-K, S-3/A |
| | 3/31/01 | | 32 | | | | | 10-Q |
| | 3/30/01 | | 109 | | 116 | | | NT 10-K |
| | 3/1/01 | | 34 | | 160 |
| | 2/28/01 | | 170 |
| | 2/27/01 | | 111 | | | | | 3, 3/A |
| | 1/1/01 | | 20 | | 129 |
| | 12/31/00 | | 19 | | 135 | | | 10-K, 10-K/A, NT 10-K |
| | 12/29/00 | | 177 | | | | | 8-K |
| | 12/5/00 | | 177 | | | | | 8-K |
| | 11/1/00 | | 177 | | | | | 8-K |
| | 10/27/00 | | 126 |
| | 10/26/00 | | 120 | | 179 | | | 8-K |
| | 10/24/00 | | 179 | | | | | 424B3, 8-K |
| | 10/19/00 | | 177 |
| | 10/18/00 | | 177 |
| | 10/17/00 | | 109 | | 116 | | | 8-K |
| | 10/1/00 | | 54 | | 100 |
| | 9/29/00 | | 177 | | 178 | | | POS AM |
| | 9/27/00 | | 81 | | | | | S-8 POS |
| | 9/11/00 | | 177 | | | | | 8-K/A |
| | 9/5/00 | | 177 | | 178 | | | 425 |
| | 7/14/00 | | 177 | | | | | 8-K |
| | 6/30/00 | | 177 | | | | | 10-Q, 10-Q/A, 8-K, 8-K/A |
| | 6/1/00 | | 54 | | 55 |
| | 5/1/00 | | 177 | | 179 | | | 8-K |
| | 4/24/00 | | 177 | | | | | 425, 8-K |
| | 3/30/00 | | 178 | | | | | 10-K405 |
| | 3/6/00 | | 36 |
| | 1/11/00 | | 177 | | 179 | | | 8-K/A |
| | 1/1/00 | | 3 | | 115 |
| | 12/31/99 | | 37 | | 93 | | | 10-K/A, 10-K405 |
| | 12/22/99 | | 177 | | 179 | | | 8-K/A |
| | 12/13/99 | | 177 | | 179 | | | 8-K |
| | 12/8/99 | | 178 | | | | | S-8 |
| | 12/2/99 | | 178 | | | | | S-8 |
| | 11/28/99 | | 177 | | 179 | | | 8-K, 8-K/A |
| | 10/4/99 | | 178 | | | | | S-8 |
| | 9/23/99 | | 178 |
| | 8/12/99 | | 177 | | | | | 8-K/A |
| | 6/24/99 | | 177 | | 178 | | | POS AM |
| | 6/11/99 | | 177 | | | | | 8-K |
| | 6/9/99 | | 177 |
| | 6/4/99 | | 177 | | | | | 8-K, 8-K/A, POS AM |
| | 5/25/99 | | 116 | | | | | 8-K, 8-K/A |
| | 3/31/99 | | 178 | | | | | 10-K, 10-Q, POS AM |
| | 2/4/99 | | 178 |
| | 12/31/98 | | 37 | | | | | 10-K |
| | 11/16/98 | | 178 | | | | | 10-Q |
| | 8/25/98 | | 178 |
| | 6/13/98 | | 178 |
| | 3/31/98 | | 177 | | 178 | | | 10-Q |
| | 1/1/98 | | 168 |
| | 5/11/93 | | 7 | | 27 |
| List all Filings |
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