Exhibit 99.3
ADVANCED WIRELESS GROUP
FINANCIAL STATEMENTS
DECEMBER 31, 2001
CONTENTS
PAGE
FINANCIAL STATEMENTS
Report of Independent Accountants......................... 1
Combined Balance Sheets................................... 2
Combined Statements Of Operations......................... 3
Combined Statements Of Cash Flows......................... 4
Notes To Combined Financial Statements.................... 5 - 32
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REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Applied Digital Solutions, Inc. and Subsidiaries:
In our opinion, the accompanying combined balance sheets and the related
combined statements of operations and cash flows present fairly, in all
material respects, the financial position of the Advanced Wireless Group
(the "Company"), comprised of businesses of Applied Digital Solutions, Inc.
and Subsidiaries ("ADS") as described in the Basis of Presentation note 1 to
the combined financial statements, at December 31, 2001 and 2000, and the
results of their operations and their cash flows for each of the three years
in the period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements 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 combined financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 2 to
the financial statements, the Company has suffered significant losses from
operations and has not generated positive cash flows from operations in
either of the two years in the period ended December 31, 2001. Additionally,
the Company does not have an available line of credit. These factors raise
substantial doubt about the Company's ability to continue as a going
concern. The combined financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
PricewaterhouseCoopers LLP
St. Louis, Missouri
May 9, 2002
Page 1
ADVANCED WIRELESS GROUP
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COMBINED BALANCE SHEETS
(IN THOUSANDS)
ASSETS
DECEMBER 31,
2001 2000
--------- --------
CURRENT ASSETS
Cash and cash equivalents $ 596 $ 206
Accounts receivable
(net of allowance for doubtful accounts
of $296 in 2001 and $205 in 2000) 5,402 5,263
Inventories, net 5,819 5,370
Other current assets 733 602
--------- --------
TOTAL CURRENT ASSETS 12,550 11,441
PROPERTY AND EQUIPMENT, NET 14,476 5,408
GOODWILL, NET 72,876 77,645
INVESTMENT IN AFFILIATE, NET 6,779 --
OTHER ASSETS, NET 698 850
--------- --------
$ 107,379 $ 95,344
========= ========
LIABILITIES AND NET INVESTMENT IN ADVANCED WIRELESS GROUP
CURRENT LIABILITIES
Notes payable $ 4 $ 2
Current maturities of long-term debt 82,639 38
Accounts payable 3,757 2,591
Accrued expenses 2,044 1,829
--------- --------
TOTAL CURRENT LIABILITIES 88,444 4,460
LONG-TERM DEBT AND NOTES PAYABLE 2,425 2,463
--------- --------
TOTAL LIABILITIES 90,869 6,923
COMMITMENTS AND CONTINGENCIES
(SEE NOTES 2, 3, 13 AND 17)
MINORITY INTEREST 394 612
ADS'S NET INVESTMENT IN ADVANCED WIRELESS GROUP 16,116 87,809
--------- --------
$ 107,379 $ 95,344
========= ========
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See the accompanying notes to combined financial statements. Page 2
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ADVANCED WIRELESS GROUP
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COMBINED STATEMENTS OF OPERATIONS
(In Thousands)
FOR THE YEARS
ENDED DECEMBER 31,
2001 2000 1999
-------- ------- -------
REVENUE
Product revenue $ 33,220 $19,604 $14,380
Service revenue 2,518 2,647 --
-------- ------- -------
TOTAL REVENUE 35,738 22,251 14,380
COST OF PRODUCTS AND SERVICES SOLD
Cost of products sold 20,252 11,517 7,964
Cost of services 2,047 1,434 --
-------- ------- -------
TOTAL COST OF PRODUCTS AND
SERVICES SOLD 22,299 12,951 7,964
GROSS PROFIT 13,439 9,300 6,416
Selling, general and administrative
expenses 10,467 7,830 6,948
Research and development 5,071 2,235 --
Interest and Non-Cash Charges:
Asset Impairment 726 -- --
Depreciation and amortization 12,331 2,962 565
Interest income (17) (26)
Interest expense 2,119 115 41
LOSS BEFORE PROVISION FOR
INCOME TAXES AND MINORITY INTEREST (17,258) (3,816) (1,138)
PROVISION FOR INCOME TAXES 41 58 --
LOSS BEFORE MINORITY INTEREST (17,299) (3,874) (1,138)
MINORITY INTEREST (217) (4) (170)
EQUITY IN NET LOSS OF AFFILIATE 327 -- --
NET LOSS $(17,409) $(3,870) $ (968)
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See the accompanying notes to combined financial statements. Page 3
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ADVANCED WIRELESS GROUP
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COMBINED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEARS
ENDED DECEMBER 31,
2001 2000 1999
-------- -------- ------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(17,409) $ (3,870) $ (968)
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities:
Asset Impairment 726 -- --
Depreciation and amortization 12,331 2,962 565
Minority interest (217) (4) (170)
Non-cash compensation expense 119
Loss on sale of assets 7 132 8
Equity in Net Loss of Affiliate 327 -- --
Change in assets and liabilities:
(Increase) decrease in accounts receivable (137) (786) 750
(Increase) decrease in inventories (449) 1,266 375
(Increase) decrease in prepaid expenses and
other current assets 169 114 74
Increase (decrease) in accounts payable and
accrued expenses 1,337 (1,246) (620)
-------- -------- ------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (3,196) (1,432) 14
CASH FLOWS FROM INVESTING ACTIVITIES
(Increase) decrease in patents and other assets 3 (43) 18
Proceeds from sale of assets -- 15 --
Payments for property and equipment (1,310) (758) (106)
Cash balances acquired from asset and business
acquisition (net of cash used in purchase) -- 1,852 --
-------- -------- ------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (1,307) 1,066 (88)
CASH FLOWS FROM FINANCING ACTIVITIES
Amounts paid on notes payable -- (179) (747)
Net proceeds from long-term debt 11 -- --
Net transactions with ADS 4,882 612 959
-------- -------- ------
NET CASH PROVIDED BY FINANCING ACTIVITIES 4,893 433 212
NET INCREASE IN CASH AND CASH EQUIVALENTS 390 67 138
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 206 139 1
CASH AND CASH EQUIVALENTS - END OF YEAR $ 596 $ 206 $ 139
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes paid $ 28 $ 106 --
Interest paid 529 115 $ 41
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See the accompanying notes to combined financial statements. Page 4
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ADVANCED WIRELESS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
(IN THOUSANDS)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
On November 1, 2001, the Board of Directors of Applied Digital
Solutions, Inc. (ADS) approved in principle a plan for its wholly-
owned subsidiary, Digital Angel Corporation (Digital Angel) to
merge with Medical Advisory Systems, Inc. (MAS). Under the plan,
ADS will also contribute all of its stock in Timely Technology
Corporation (Timely Technology) and Signature Industries, Limited
(Signature Industries) to MAS. Digital Angel, Timely Technology
and Signature Industries are collectively referred to as the
Advanced Wireless Group (the Company). At December 31, 2001, ADS
owned 16.6% of MAS, which was acquired on February 27, 2001. At
the effective time of the merger, options and warrants to purchase
stock in Digital Angel will be converted into rights to purchase
MAS stock. Subsequent to the merger, MAS will be renamed "Digital
Angel Corporation".
On June 1, 1998, ADS purchased an 85% interest in Signature
Industries, a United Kingdom company and accounted for this
acquisition under the purchase method. Signature Industries is a
manufacturer of communication and safety devices which are
supplied to Search and Rescue Beacon Equipment (SARBE) and armed
forces worldwide.
On April 1, 2000, ADS acquired 100% of the common shares of Timely
Technology. Timely Technology's business consisted of software
consulting and development services as well as monthly hosting
services.
On September 8, 2000, ADS acquired a 100% interest in Destron
Fearing Corporation. Destron Fearing is a producer of animal
tracking and identification technology. Their products include ear
tags and implantable microchips that use radio frequency for
transmission. On September 8, 2000, Digital Angel was merged into
Destron and Destron's name was changed to Digital Angel.
On March 27, 2002, Digital Angel merged with MAS. Pursuant to the
merger agreement, ADS contributed all of its stock in Timely
Technology and Signature Industries to MAS. In satisfaction of a
condition to the consent to the merger by IBM Credit Corporation
(IBM Credit), ADS' lender, ADS transferred to a Delaware business
trust controlled by an advisory board all shares of MAS common
stock owned by it and, as a result, the trust has legal title to
approximately 77.15% of the MAS common stock. The trust has
voting rights with respect to the MAS common stock until ADS'
obligations to IBM Credit are repaid in full. ADS retained
beneficial ownership of the shares. The merger will be accounted
for using the purchase method of accounting as a reverse
acquisition of MAS by ADS.
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ADVANCED WIRELESS GROUP
Notes To Combined Financial Statements (Continued)
Signature Industries, Timely Technology and Digital Angel, all of
which are substantially wholly-owned subsidiaries of and under the
common control of ADS at December 31, 2001, have been included in
the combined balance sheets and statements of operations and of
cash flows of the Advanced Wireless Group since their respective
acquisitions. ADS's historical cost basis of the assets and
liabilities of the Advanced Wireless Group has been reflected in
these combined financial statements.
The financial statements include the financial position, results
of operations and cash flows of the Advanced Wireless Group. The
financial information in these financial statements include an
allocation of expenses incurred by ADS on behalf of the Advanced
Wireless Group as discussed in the related party section of this
Note. However, these financial statements may not necessarily be
indicative of the results that have occurred had the Advanced
Wireless Group been a separate, independent entity during the
periods presented or of future results of the Advanced Wireless
Group.
The Advanced Wireless Group is engaged in the business of
developing and bringing to market proprietary technology used to
identify, locate and monitor people, animals and objects. The
Advanced Wireless Group is currently organized into four segments:
Animal Tracking, Digital Angel Technology, Digital Angel Delivery
System and Radio Communications. Digital Angel operates the Animal
Tracking and Digital Angel Technology segments. Timely Technology
operates the Digital Angel Delivery System segment. Signature
Industries operates the Radio Communication and Other segment.
ANIMAL TRACKING - develops, manufactures, and markets a broad line
of electronic and visual identification devices for the companion
animal, livestock, laboratory animal, fish and wildlife markets
worldwide. The tracking of cattle and hogs are crucial both for
asset management and for disease control and food safety. The
principal technologies employed by the Animal Tracking Business
are electronic ear tags, and implantable microchips that use radio
frequency transmission.
DIGITAL ANGEL TECHNOLOGY - develops and markets advanced
technology to gather location data and local sensory data and to
communicate that data to an operation center. The Digital Angel
technology is actually the combination of three technologies:
wireless communication (e.g. cellular), sensors (including bio-
sensors) and position location technology (including GPS and other
systems). The Company plans to introduce this Digital Angel
technology into a variety of products to suit different
applications ranging from medical monitoring to asset management.
The Company began the rollout of Digital Angel on November 26,
2001.
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ADVANCED WIRELESS GROUP
Notes To Combined Financial Statements (Continued)
DIGITAL ANGEL DELIVERY SYSTEM - following the communication of data to
the operations center, the Digital Angel Delivery System manages the
data in an application-specific format. The Digital Angel Delivery
System works by combining software that is responsible for data
collection and delivery with the advanced infrastructure needed to
operate it. This segment also provides webhosting and transaction
processing support services. For example, medical applications gather
bio-readings such as pulse and temperature, and communicate that data,
along with location data, to a ground station or call center. If the
readings suggest a critical health situation, emergency aid could be
dispatched. For the pet location applications, the location information
is available via call center or a secure Internet site.
RADIO COMMUNICATIONS AND OTHER - consists of the design,
manufacture and support of secure GPS enabled search and rescue
equipment and intelligent communications products and services for
telemetry, mobile data and radio communications applications
serving commercial and military markets. In addition, it designs,
manufactures and distributes intrinsically safe sounders (horn
alarms) and other electronic components.
SUMMARY OF ACCOUNTING POLICIES
Significant accounting policies, which conform to generally
accepted accounting principles in the United States and are
applied on a consistent basis among all years presented, are
described below.
PRINCIPLES OF COMBINATION
The financial statements of the Advanced Wireless Group include
two wholly-owned subsidiaries and one majority-owned subsidiary of
ADS. All significant intercompany transactions have been
eliminated.
USE OF ESTIMATES
The preparation of the financial statements 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.
FOREIGN CURRENCIES
The Company's foreign subsidiary uses 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 which is a
component of ADS's Net
Page 7
ADVANCED WIRELESS GROUP
Notes To Combined Financial Statements (Continued)
Investment in Advanced Wireless Group (See Note 12).
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. Transaction gains and losses have not been material.
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.
INVENTORIES, NET
Inventories consist of raw materials, work in process and finished
goods. 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
inventory turns by product. Inventory items designated as
obsolete or slow-moving are reduced to net realizable value.
PROPERTY AND EQUIPMENT, NET
Property and equipment are carried at cost, less accumulated
depreciation and amortization computed using the straight-line
method. Building and leasehold improvements are depreciated and
amortized over periods ranging from 10 to 30 years and software
and equipment is depreciated over periods ranging from 2 to 10
years. Repairs 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, NET
Goodwill and other intangible assets are carried at cost and are
amortized on a straight-line basis, over the estimated future
periods to be benefitted (ranging from 5 to 10 years). 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 acquisitions and,
effective October 1, 2000, changed the lives to periods ranging
from 5 to 10 years, down from periods of 10 to 20 years. The
impact in 2001 and 2000 of this change was an increase in
amortization of $4,124 and $974, respectively. The Company
reviews goodwill and other intangible assets quarterly for
impairment whenever events or changes in business circumstances
indicate that the remaining useful life may warrant revision or
that the carrying amount of the long-lived asset may not be fully
recoverable. Included in factors to be considered are significant
customer losses, changes in profitability due to sudden
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ADVANCED WIRELESS GROUP
Notes To Combined Financial Statements (Continued)
economic or competitive factors, change in management's strategy
for the business unit, or other factors arising in the quarterly
period.
The Company annually performs undiscounted cash flow analyses to
determine if an impairment exists. Earnings before interest,
taxes, depreciation and amortization is used as the measure of
cash flow for these analyses. If an impairment is determined to
exist, any related impairment loss is calculated based on fair
value. Fair value is determined based on discounted cash flows.
The discount rate utilized by the Company would be the rate of
return expected from the market or the rate of return for a
similar investment with similar risks. As of December 31, 2001,
the net book value of goodwill is $72,876. Based on two
independent valuations of the Company and the market value of the
stock exchanged in the merger, we believe this goodwill is not
impaired.
REVENUE RECOGNITION
For software consulting and development services, 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 non fixed 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 exists, revenue is recognized when such
uncertainties are resolved. 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 provides warranties on certain of its
products. Estimated warranty costs are accrued in the same period
in which the related revenue is recognized, based on anticipated
parts and labor costs and utilizing historical experience. The
Company does not offer a warranty policy for services to
customers.
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ADVANCED WIRELESS GROUP
Notes To Combined 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.
INCOME TAXES
The Company's domestic subsidiaries are included in the
consolidated federal income tax return filed by ADS. U.S. income
tax payments, refunds, credits, provision and deferred tax
components have been allocated to the Company in accordance with
ADS's tax allocation policy. Such policy allocates tax components
included in the consolidated income tax return of ADS to the
Company to the extent such components were generated by or related
to the Company. The Company accounts for income taxes under the
asset and liability approach. 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.
COMPREHENSIVE LOSS
The Company's comprehensive loss consists of foreign currency
translation adjustments, and is reported in Net Investment in
Advanced Wireless Group (See Note 12).
RELATED PARTY ACTIVITY
Cash Management - The Company participates in a centralized cash
management system administered by ADS. Cash deposits from the
Company are transferred to ADS on a daily basis and ADS funds the
Company's disbursement bank accounts as required. Unpaid balances
of checks are included in accounts payable. Interest is charged or
credited on transactions with ADS.
Shared Services - ADS provides certain general and administrative
services to the Company including finance, legal, benefits and
other miscellaneous items. The costs of these services are
included in the Company's Combined Statement of Operations based
on utilization, which management believes to be reasonable. Cost
of these services to the Company were $771 and $262 for 2001 and
2000, respectively.
ADS's Net Investment in Advanced Wireless Group - Included in
ADS's net investment in the Advanced Wireless Group are cumulative
translation adjustments of $186 and $318 as of December 31, 2001
and 2000, respectively. Also included in
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ADVANCED WIRELESS GROUP
Notes To Combined Financial Statements (Continued)
ADS's net investment in the Advanced Wireless Group are advances
to and from ADS. (See Note 12)
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board (FASB)
issued SFAS 133, Accounting for Derivative Instruments and Hedging
Activities, which provides a comprehensive and consistent standard
for the recognition and measurement of derivatives and hedging
activities. The statement is effective for fiscal years
commencing after June 15, 2000. In June 2000, the FASB issued
SFAS 138, Accounting for Certain Derivative Instruments and
Certain Hedging Activities - an Amendment of SFAS statement 133,
which addresses implementation issues experienced by those
companies that adopted SFAS 133 early. The Company adopted these
statements as of January 1, 2001 and, because the Company does not
use derivative instruments, the adoption of these statements did
not have any effect on its results of operations, cash flows and
financial position.
In July 2001, the FASB issued SFAS, 141 Business Combinations and
SFAS 142, Goodwill and Other Intangible Assets. SFAS 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. SFAS 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 July 1, 2001, on January 1, 2002.
The adoption of these standards will have the impact of reducing
the Company's amortization of goodwill commencing January 1, 2002.
Amortization of $9,790 was recorded for the year ended December
31, 2001. The Company is in the process of completing its
impairment analysis. Future impairment reviews may result in
periodic write-downs.
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ADVANCED WIRELESS GROUP
Notes To Combined Financial Statements (Continued)
In June 2001, the FASB issued SFAS 143, Accounting for Asset
Retirement Obligations, which provides the accounting for the cost
of legal obligations associated with the retirement of long-lived
assets. SFAS 143 requires that companies recognize the fair value
of a liability for asset retirement obligations in the period in
which the obligations are incurred and capitalize that amount as a
part of the book value of the long-lived asset. That cost is then
depreciated over the remaining life of the underlying long-lived
asset. This statement is effective for fiscal years beginning
after June 15, 2002. The Company does not expect that the
adoption of SFAS 143 will have a material impact on its operations
or financial position.
In August 2001, the FASB issued SFAS 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. 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, 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. 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. SFAS 145 eliminates Statement 4 (and
Statement 64, as it amends Statement 4), which requires gains and
losses from extinguishment 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 fiscal 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
Company does not expect that the adoption of SFAS 145 will have a
material impact on its operations or financial position.
Page 12
ADVANCED WIRELESS GROUP
Notes To Combined Financial Statements (Continued)
2. DEBT COVENANT COMPLIANCE AND LIQUIDITY
ADS maintains a term and revolving credit agreement with IBM
Credit. The IBM Credit agreement provides for a USA revolving
credit line, a Canadian revolving credit line and certain term
notes. Under the credit agreement in effect at December 31, 2001,
IBM Credit maintains liens and security interests in the
outstanding capital stock of the businesses comprising the
Advanced Wireless Group as well as liens on and security interests
in the assets of the Advanced Wireless Group. These liens and
security interests collateralize borrowings under the USA revolving
credit line and term loans.
ADS was not in compliance with various financial covenants at June 30,
2001 September 30, 2001 and December 31, 2001. The IBM credit agreement
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. As
part of the amendments to the agreement with IBM Credit, warrants to
acquire 1.2 million shares of Digital Angel common stock valued at $0.3
million were issued to IBM Credit in April 2001.
As a result of the events of default by ADS under the IBM credit
agreement and continued operating losses in fiscal 2001, it was
determined during the third quarter of fiscal 2001, that
substantial doubt about ADS's ability to continue as a going
concern exists. At December 31, 2001, outstanding borrowings
under the USA revolving credit line and term loans totaled
$82,555. ADS does not currently have the funds available to repay
the borrowings under the IBM credit agreement. Accordingly, the
$82,555 of outstanding borrowings was allocated to the Advanced
Wireless Group at September 30, 2001 and has been reflected as a
current obligation in the December 31, 2001 combined balance
sheet. Interest associated with the borrowings was allocated to
the Advanced Wireless Group for the period from September 30, 2001
through December 31, 2001.
The Company has suffered significant losses from operations and
has not generated positive cash flows from operations in either of
the two years in the period ended December 31, 2001.
Additionally, the Company does not have an available line of
credit and there can be no assurance that the Company will have
access to funds necessary to provide for its ongoing operating
expenses to the extent not provided from its ongoing operating
revenue. These factors raise substantial doubt about the Company's
abilty to continue as a going concern.
Page 13
ADVANCED WIRELESS GROUP
Notes To Combined Financial Statements (Continued)
On March 1, 2002, ADS and Digital Angel Share Trust, a newly created
Delaware business trust, entered into a new credit agreement (new
Credit Agreement) with IBM Credit, which became effective on March 27,
2002, the effective date of the merger between Digital Angel
Corporation and MAS. On March 27, 2002, upon completion of the merger
between Digital Angel and MAS, in satisfaction of a condition to the
consent to the merger by IBM Credit, ADS transferred to the trust,
which is controlled by an advisory board, all shares of MAS common
stock owned by it and, as a result, the trust has legal title to
approximately 77.15% of the MAS common stock. The trust has voting
rights with respect to the MAS common stock until the entire amount of
ADS' obligations to IBM Credit are repaid in full. ADS retained
beneficial ownership of the shares. The trust may be obligated to
liquidate the shares of MAS common stock owned by it for the benefit of
IBM Credit in the event ADS fails to make payments, or otherwise
defaults, under the new Credit Agreement. Such liquidation of the
shares of MAS common stock will be in accordance with the SEC rules and
regulations governing affiliates.
Under the terms of the agreement and plan of merger with MAS, the
common stock and assets of the three subsidiaries comprising the
Advanced Wireless Group will be released from all liens and
security interests under the new IBM Credit Agreement. As such,
the Advanced Wireless Group will have no obligations to repay any
amounts under the new IBM Credit Agreement.
3. ACQUISITIONS AND DISPOSITIONS
The following represents acquisitions within the Advanced Wireless
Group which were purchased by ADS:
Value of
Shares,
Warrants Common/
& Options Preferred
Date Of Percent Acquisition Cash Issued Or Shares of Goodwill
Acquisition Acquired Price Consideration Issuable ADS Issued Acquired Business Description
--------------------------------------------------------------------------------------------------------
2000 Acquisitions
Timely Technology Corp. 04/01/00 100% 6,281 375 5,906 8,482 5,954 Software consulting
and development
service provider
Destron Fearing Corporation 09/08/00 100% 84,534 1,264 83,270 20,821 74,729 Animal identification
and microchip
technology company
|
In each of the above transactions, the value of the consideration
paid by ADS was in accordance with the acquisition agreement.
Based on the contractually agreed to amounts, ADS calculated the
number of ADS shares issued to the sellers as of the closing date.
The price of the ADS's common stock used to determine the number
of shares issued was either the closing price set on a fixed date
or based on a formula as specified in the agreements.
Page 14
ADVANCED WIRELESS GROUP
Notes To Combined Financial Statements (Continued)
All acquisitions have been accounted for using the purchase method
of accounting and, accordingly, the combined financial statements
reflect the results of operations of each company from the date of
acquisition. The costs of acquisitions include all payments
according to the acquisition agreements plus costs for investment
banking services, legal and accounting services that were direct
costs of acquiring these assets.
Goodwill resulting from these acquisitions is being amortized on a
straight-line basis over periods ranging from five to ten years.
In conjunction with 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 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.
In addition, as part of the Company's on-going review of the
carrying value of goodwill, the Company recorded an impairment
charge of $726 during 2001.
EARNOUT AND PUT AGREEMENTS
The Timely Technology agreement includes additional consideration
contingent on future profits. Upon earning this additional
consideration, the value will be recorded as additional goodwill.
In connection with the earnout, assuming all earnout profits are
achieved, ADS is contingently liable for additional consideration
of approximately $3,610 in 2002 which would be payable by ADS in
shares of ADS's common stock.
MAJOR ACQUISITION
On September 8, 2000, the Advanced Wireless Group completed the
acquisition of Destron Fearing Corporation through a merger of its
wholly-owned subsidiary, Digital Angel into Destron Fearing. As a
result of the merger, Destron Fearing became a wholly-owned
subsidiary of ADS and was renamed Digital Angel Corporation. In
connection with the merger, each outstanding share of Destron
Fearing common stock was exchanged for 1.5 shares of ADS's common
stock, with fractional shares settled in cash. In addition,
outstanding options and warrants to purchase shares of Destron
Fearing common stock were converted into a right to purchase that
number of shares of ADS common stock that the holders would have
been entitled to receive had they participated in the merger. ADS
issued 20.5 million shares of its common stock in exchange for all
the outstanding stock of Destron Fearing and 0.3 million shares of
its common stock as a transaction fee. ADS will issue up to 2.7
million shares of its common stock upon the exercise of the
Page 15
ADVANCED WIRELESS GROUP
Notes To Combined Financial Statements (Continued)
Destron Fearing options and warrants. The aggregate purchase
price of approximately $84.5 million, including the liabilities
assumed, was allocated to the identifiable assets with the
remainder of $74.7 million recorded as goodwill, which is being
amortized over 10 years.
See Note 20 for the unaudited pro forma effect of the
acquisitions.
OTHER INVESTMENTS
On February 27, 2001, ADS 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 ADS's common stock. As of
December 31, 2001, ADS controlled two of the seven board seats.
ADS is the single largest shareholder and is accounting for this
investment under the equity method of accounting. The excess of
the purchase price over the estimated fair value of the shares
acquired was approximately $7.0 million (goodwill) and was being
amortized on a straight-line basis over five years.
As a result of the merger between Digital Angel Corporation and
MAS, which became effective on March 27, 2002, ADS now owns 77.15%
of the newly combined company. In satisfaction of a condition to
the consent to the merger by IBM Credit, ADS transferred to a
Delaware business trust controlled by an advisory board all shares
of the MAS common stock owned by it and, as a result, the trust
has legal title to approximately 77.15% of the MAS common stock.
The trust has voting rights with respect to the MAS common stock
until ADS's obligations to IBM Credit are repaid in full. ADS has
retained beneficial ownership of the shares. See Notes 2 and 9.
4. INVENTORIES, NET
2001 2000
------- -------
Raw materials $ 1,474 $ 1,374
Work in process 176 183
Finished goods 5,611 4,992
------- -------
7,261 6,549
Less: Allowance for excess and obsolescence (1,442) (1,179)
------- -------
$ 5,819 $ 5,370
======= =======
|
Page 16
ADVANCED WIRELESS GROUP
Notes To Combined Financial Statements (Continued)
5. OTHER CURRENT ASSETS
2001 2000
----- -----
Prepaid expenses and other current assets $ 491 $ 388
Deposits 242 214
----- -----
$ 733 $ 602
===== =====
|
6. PROPERTY AND EQUIPMENT, NET
2001 2000
-------- -------
Land $ 278 $ 278
Building and leasehold improvements 3,783 3,109
Equipment and furniture 3,573 2,892
Software 9,865 --
-------- -------
17,499 6,279
Less: Accumulated depreciation (3,023) (871)
-------- -------
$ 14,476 $ 5,408
======== =======
|
Included above are vehicles and equipment acquired under capital
lease obligations in the amount of $690 and $286 at December 31,
2001 and 2000, respectively. Related accumulated depreciation
amounted to $437 and $192 at December 31, 2001 and 2000,
respectively.
Depreciation charged against income amounted to $2,392, $428 and
$309 for the years ended December 31, 2001, 2000 and 1999,
respectively.
During 2001, the Company disposed of assets with accumulated
depreciation of $34.
Page 17
ADVANCED WIRELESS GROUP
Notes To Combined Financial Statements (Continued)
7. GOODWILL, NET
Goodwill consists of the excess of cost over fair value of
tangible and identifiable intangible assets of companies
purchased.
2001 2000
--------- --------
Original balance $ 85,201 $ 80,578
Less goodwill impairment (726) --
Accumulated amortization (11,599) (2,933)
--------- --------
Carrying value $ 72,876 $ 77,645
========= ========
|
Amortization expense, including goodwill amortization of $1,161 in
2001 associated with the Company's equity investment in MAS,
amounted to $9,790, $2,529 and $256 for the years ended
December 31, 2001, 2000 and 1999, respectively.
ADS has entered into various earnout arrangements with the selling
stockholders of Timely Technology. This arrangement provides for
additional consideration to be paid in future years if certain
earnings levels are met. These amounts are added to goodwill as
earned. These earnout arrangements totaled $5,041 for 2001 and was
paid through the issuance of 8,267 shares of ADS Common stock.
8. OTHER ASSETS, NET
2001 2000
----- -----
Patents and other amortizable assets $ 373 $ 373
Less: Accumulated amortization (154) (5)
----- -----
219 368
Other investments 435 434
Other 44 48
----- -----
$ 698 $ 850
===== =====
|
Patents and other amortizable assets are amortized on a straight-
line basis over lives ranging from two to fifteen years.
Amortization of other assets charged against income amounted to
$149 and $5 for the years ended December 31, 2001 and 2000,
respectively.
Page 18
ADVANCED WIRELESS GROUP
Notes To Combined Financial Statements (Continued)
9. NOTES PAYABLE AND LONG-TERM DEBT
Notes payable of $4 consists of an unsecured note due on demand.
Long-term debt consists of the following:
2001 2000
------- -------
Mortgage notes payable, collateralized by land
and building, payable in monthly installments of
principal and interest totaling $.03, bearing
interest at 8.18% in 2000, due through
November 2010 $ 2,465 $ 2,501
Capital lease obligations 44 --
Less: Current maturities 84 38
------- -------
$ 2,425 $ 2,463
======= =======
|
The scheduled maturities of long-term debt at December 31, 2001
are as follows:
Year Amount
---- ------
2002 84
2003 43
2004 46
2005 50
2006 54
Thereafter 2,232
-----
2,509
=====
|
Interest expense on the long and short-term notes payable amounted
to $529, $115 and $0 for the years ended December 31, 2001, 2000
and 1999, respectively.
10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the
fair value of each class of financial instruments:
CASH AND CASH EQUIVALENTS
The carrying amount approximates fair value because of the short
maturity of those instruments.
Page 19
ADVANCED WIRELESS GROUP
Notes To Combined Financial Statements (Continued)
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
The carrying amount approximates fair value because the interest
rate approximates the current rate at which the Company could
borrow funds on a similar note.
ACCOUNTS PAYABLE AND ACCRUED EXPENSES
The carrying amount approximates fair value because of the short-
term nature of those items.
11. INCOME TAXES
The provision for income taxes consists of:
2001 2000 1999
----- ------ ------
Current:
United States at statutory rates $ 41 $ 58 $ --
International -- -- --
Current income tax provision (credit) 41 58 --
Deferred:
United States -- -- --
International -- -- --
Deferred income taxes provision (credit) -- -- --
----- ------ ------
$ 41 $ 58 $ --
===== ====== ======
|
The tax effects of temporary differences and carryforwards that
give rise to significant portions of deferred tax assets and
liabilities consist of the following:
2001 2000
------- --------
Deferred Tax Assets:
Liabilities and reserves $ 299 $ 29
Net operating loss carryforwards 4,023 2,107
Gross deferred tax assets 4,322 2,136
Valuation allowance (4,322) (2,136)
------- --------
Net Deferred Tax Asset $ -- $ --
======= ========
|
Page 20
ADVANCED WIRELESS GROUP
Notes To Combined Financial Statements (Continued)
Domestic and international income (loss) from continuing
operations before provision for income taxes and minority interest
consists of:
2001 2000
---------- --------
Domestic $ (15,811) $ (3,788)
International (1,447) (28)
---------- --------
$ (17,258) $ (3,816)
========== ========
|
At December 31, 2001, the Company had aggregate net operating loss
carryforwards of approximately $10.2 million for income tax
purposes which expire in various amounts through 2021.
Approximately $4 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. In addition, given the ownership structure
of the Company post-transaction, the Company will not be included
in ADS's consolidated tax return which could further limit the
utilization of the net operating loss carryforwards. The
reconciliation of the effective tax rate with the statutory
federal income tax rate is as follows:
2001 2000 1999
---- ---- ----
Statutory rate 34% 34% 34%
Non-deductible goodwill amortization (18) (23) (2)
State income taxes, net of federal benefits (1) (1) --
International tax rates different from the
the statutory US federal rate (3) -- (3)
Change in deferred tax asset valuation
allowance (11) (14) (28)
Other (1) 2 (1)
--- --- ---
0% (2)% 0%
|
Page 21
ADVANCED WIRELESS GROUP
Notes To Combined Financial Statements (Continued)
12. NET INVESTMENT IN ADVANCED WIRELESS GROUP
The following analyzes ADS's net investment in the businesses
comprising the Advanced Wireless Group for the years ended
December 31, 2001, 2000 and 1999:
ACCUMULATED TOTAL NET
PARENT OTHER INVESTMENT IN
(ACCUMULATED INVESTMENT COMPREHENSIVE ADVANCED
DEFICIT) IN SUBSIDIARY LOSS WIRELESS GROUP
-------------------------------------------------------------
BALANCE - DECEMBER 31, 1998 $ 547 $ 4,978 $ 22 $ 5,547
Net Income (loss) (968) -- -- (968)
Comprehensive income -
Foreign currency translation -- -- (25) (25)
-------------------------------------------------------------
Total comprehensive loss (968) (25) (993)
Net transactions with ADS -- 1,020 -- 1,020
----------------------------------------------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 1999 $ (421) $ 5,998 $ (3) $ 5,574
Acquisition of Digital Angel -- 84,621 -- 84,621
Acquisition of Timely Technology -- 1,240 -- 1,240
Net loss (3,870) -- -- (3,870)
Comprehensive loss -
Foreign currency translation -- -- (318) (318)
-------- --------------------------
Total comprehensive loss (3,870) (318) (4,188)
Net transactions with ADS -- 562 -- 562
----------------------------------------------------------------------------------------------------------------------
Balance - December 31, 2000 $ (4,291) $ 92,421 $ (321) $ 87,809
Net loss (17,409) -- -- (17,409)
Comprehensive loss -
Foreign currency -- -- (186) (186)
-------- --------------------------
Total comprehensive loss (17,409) (186) (17,595)
MCY Software Purchase -- 9,865 -- 9,865
IBM Debt -- (82,555) -- (82,555)
IBM Debt Interest -- 1,591 -- 1,591
Timely Technology Earnouts -- 5,041 -- 5,041
Digital Angel Stock Warrants -- 300 -- 300
Investment in MAS -- 8,250 -- 8,250
Stock Option Repricing -- 119 -- 119
Net advances (to) from ADS -- 3,291 -- 3,291
----------------------------------------------------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2001 $(21,700) $ 38,323 $ (507) $ 16,116
======================================================================================================================
|
Included in Net Investment in Advanced Wireless Group are advances
to and from ADS and the Advanced Wireless Group as follows:
Page 22
ADVANCED WIRELESS GROUP
Notes to Combined Financial Statements (Continued)
2001 2000
--------------------------------------------------------
Due from ADS $ 263 $ 97
Due to ADS (5,140) (1,683)
IBM Debt Interest (1,591) --
--------------------------------------------------------
Net due to ADS $ (6,468) $ (1,586)
|
13. NET COMMITMENTS AND CONTINGENCIES
Rentals of space, vehicles, and office equipment under operating
leases amounted to approximately $696, $569 and $550 for the years
ended December 31, 2001, 2000 and 1999 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, 2001 are:
MINIMUM EMPLOYMENT
YEAR RENTAL PAYMENTS CONTRACTS
---------------------------------------------------------
2002 659 350
2003 514 50
2004 356 --
2005 312 --
2006 312 --
Thereafter 11,108 --
---------------------------------------------------------
13,261 400
|
14. PROFIT SHARING PLAN
The Company participates in the 401(k) plan of ADS. ADS has a
401(k) Plan for the benefit of eligible United States employees.
ADS has made no contributions to the 401(k) Plan.
Signature operates certain defined contribution pension plans.
The Company's expense relating to the plans approximated $175,
$135 and $108 for the years ended December 31, 2001, 2000 and
1999, respectively.
Page 23
ADVANCED WIRELESS GROUP
Notes to Combined Financial Statements (Continued)
15. STOCK OPTIONS AND WARRANTS
During 1999, Digital Angel adopted a non-qualified stock option
plan (the Option Plan). Under the Option Plan, options for 5.5
million common shares were authorized for issuance to certain
officers and employees of Digital Angel at December 31, 2001 and
2000 respectively, of which 5.4 million have been issued through
December 31, 2001. The options may not be exercised until one to
two years after the options have been granted, and are exercisable
for a period of ten years. In conjunction with the completion of
the merger, all outstanding and unexercised options of Digital
Angel will be converted into an option to purchase shares of MAS
common stock having the same terms and conditions as in effect
prior to the completion of the merger.
A summary of stock option activity for 2001, 2000 and 1999 is as
follows:
2001 2000 1999
---------------------------------------------------------------------------------------------------------------------------
WEIGHTED- Weighted- Weighted-
AVERAGE Average Average
EXERCISE Exercise Exercise
SHARES PRICE Shares Price Shares Price
---------------------------------------------------------------------------------------------------------------------------
Outstanding on January 1 4,630 $ 0.36 2,425 $ 0.05 $ -
Granted 920 0.63 2,205 0.71 2,425 0.05
Exercised - - - - - -
Forfeited (125) (0.28) - - - -
Outstanding on December 31 5,425 0.41 4,630 0.36 2,425 0.05
Exercisable on December 31 4,555 0.37 2,155 0.05 - -
Shares available on December 31
for options that may be granted 75 870 3,075
|
Page 24
ADVANCED WIRELESS GROUP
Notes to Combined Financial Statements (Continued)
The following table summarizes information about Digital
Angel stock options at December 31, 2001:
OUTSTANDING STOCK OPTIONS EXERCISABLE STOCK
------------------------------------ ---------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
REMAINING AVERAGE AVERAGE
RANGE OF CONTRACTUAL EXERCISE EXERCISE
EXERCISE SHARES LIFE PRICE SHARES PRICE
---------------------------------------------------------------------------------------------------------------------
$0.01 to $0.50 2,425 9.06 $ 0.05 2,425 $ 0.05
$0.51 to $1.00 3,000 9.79 0.70 2,130 0.73
------------------------------------------------------------------
$0.01 to $1.00 5,425 $ 0.41 4,555 $ 0.37
====== ====== ====================
|
ADS has a non-qualified option plan (the ADS Plan). Under the
ADS Plan, options for ten million common shares were authorized
for issuance to certain officers and employees of ADS which
include officers and employees of the Advanced Wireless Group.
Under the ADS Plan, 373, 325 and 0 options were granted to
officers and employees of the Company during 2001, 2000 and
1999, respectively. The options may not be exercised until one
to three years after the grant date and are exercisable for a
period of five years.
A summary of stock option activity in 2001, 2000 and 1999 for
the ADS Plan as it relates to the Advanced Wireless Group
employees is as follows:
2001 2000 1999
---------------------------------------------------------------------------------------------------------------------
WEIGHTED- Weighted- Weighted-
AVERAGE Average Average
EXERCISE Exercise Exercise
SHARES PRICE Shares Price Shares Price
---------------------------------------------------------------------------------------------------------------------
Outstanding on January 1 389 $ 3.52 85 $ 3.09 100 $ 3.09
Granted 373 0.67 325 3.59 - -
Exercised - - (21) 2.75 - -
Forfeited (3) 1.09 - - (15) 3.09
Outstanding on December 31 759 2.13(1) 389 3.52 85 3.09
Exercisable on December 31 323 $ 3.19 50 $ 3.09 - $ -
(1) Options to acquire 429 shares of ADS common stock were
re-priced during 2001. See Note 16.
|
The following table summarizes information about stock options
under the ADS Plan as it relates to the Advanced Wireless Group
employees at December 31, 2001:
Page 25
ADVANCED WIRELESS GROUP
Notes to Combined Financial Statements (Continued)
OUTSTANDING STOCK OPTIONS EXERCISABLE STOCK
------------------------------------ ----------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
REMAINING AVERAGE AVERAGE
RANGE OF CONTRACTUAL EXERCISE EXERCISE
EXERCISE SHARES LIFE PRICE SHARES PRICE
------------------------------------------------------------------------------------------
$0.01 to $3.00 526 5.06 $ 1.24 179 $ 2.75
$3.01 to $6.00 173 3.99 3.32 124 3.29
$6.01 to $8.00 60 5.06 6.53 20 6.53
------------------------------------------------------------------
$0.01 to $1.00 759 $ 2.13 323 $ 3.19
====== ====== =====================
|
The Company applies APB Opinion No. 25 and related Interpretations
in accounting for all the plans. Accordingly, no compensation
cost has been recognized under these plans. Had compensation cost
for these plans been determined based on the fair value at the
grant dates for awards under these plans, consistent with the
alternative method set forth under SFAS 123, Accounting for Stock-
Based Compensation, the Company's net income applicable to common
stockholders and earnings per common and common equivalent share
would have been reduced. The pro forma amounts are indicated
below:
2001 2000 1999
---------------------------------------
NET LOSS
As reported $ (17,409) $ (3,870) $ (968)
Pro forma (17,674) (4,003) (991)
|
The fair value of each option granted is estimated on the date of
grant using the Black-Scholes option-pricing model. The following
weighted-average assumptions were used for grants under the Option
Plan in 2001, 2000 and 1999: dividend yield of 0% for the three
years; expected volatility of 0% for the three years; risk-free
interest rate of 4.49%, 4.98% and 6.36% for 2001, 2000 and 1999
respectively; and expected lives of ten years for the two years
ended December 31, 2001 and five years for the year ended December
31, 1999. The weighted-average fair value of options granted was
$.03 for the two years ended December 31, 2001 and $0.00 for the
year ended December 31, 1999. The weighted average assumptions
used for grants under the ADS Plan in 2001 and 2000 are as
follows: dividend yield of 0% for the two years; expected
volatility of 68.75% and 53.32% for 2001 and 2000, respectively;
risk-free interest rate of 4.49% and 4.98% for 2001 and 2000,
respectively; and expected lives of 5 years for the two years. The
weighted average fair value of the ADS options granted was $0.44
and $1.01 for the years ended December 31, 2001 and 2000,
respectively.
Page 26
ADVANCED WIRELESS GROUP
Notes to Combined Financial Statements (Continued)
QUALIFIED EMPLOYEE STOCK PURCHASE PLAN
During 1999, ADS adopted a 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
3.0 million common shares were authorized for issuance to
substantially all full-time employees of the Advanced Wireless
Group, of which 1.0 million shares have been issued and exercised
through December 31, 2001. Each participant's options to purchase
shares will be automatically exercised for the participant on the
exercise dates determined by the board of directors.
16. NON-CASH COMPENSATION EXPENSE
Non-cash compensation expense of $119 has been included in
selling, general and administrative expenses for 2001. The expense
resulted primarily from re-pricing 429 ADS stock options during
2001. The options had original exercise prices ranging from $0.69
to $6.34 per share and were modified to change the exercise price
to $0.15 per share. Due to the modification these options are
being accounted for as variable options under APB Opinion No. 25
and fluctuations in the common stock price will result in
increases and decreases of non-cash compensation expense until the
options are exercised, forfeited or expire.
17. LEGAL PROCEEDINGS
ADS is party to various legal proceedings. In the opinion of
management, these proceedings are not likely to have a material
adverse affect on the financial position, results of operations,
cash flows or overall trends in results of the Advanced Wireless Group
as none of the legal proceedings relate to Advanced Wireless
Group.
18. SUPPLEMENTAL CASH FLOW INFORMATION
In the years ended December 31, 2001 and 2000, the Advanced
Wireless Group had the following noncash investing and financing
activities:
Page 27
ADVANCED WIRELESS GROUP
Notes to Combined Financial Statements (Continued)
2001 2000
-----------------
Assets acquired for ADS common stock $17,823 -
Assets acquired for long-term debt and
capital leases - $1,992
|
ADS has entered into various earnout arrangements with the selling
stockholders of Timely Technology. During 2001, the Timely
Technology earned $5,041 for their earnout, which was paid through
the issuance of 8,267 shares of ADS's common stock.
During 2001, ADS issued 11.8 million shares of ADS common stock in
consideration for an exclusive perpetual license to a digital
encryption and distribution software system and contributed the
license to Advanced Wireless Group.
19. SEGMENT INFORMATION
Prior to 2000, the Company operated in one segment. With the
acquisition of two companies in 2000, the Company now operates in
four segments: Animal Tracking, Digital Angel Technology, Digital
Angel Delivery System, and Radio Communications and Other. The
accounting policies of the operating segments are the same as
those described in the summary of significant accounting policies,
except that 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.
Page 28
ADVANCED WIRELESS GROUP
Notes to Combined Financial Statements (Continued)
FOR THE YEAR ENDED DECEMBER 31, 2001
(IN THOUSANDS)
--------------------------------------------------------------------
RADIO
ANIMAL DIGITAL ANGEL DIGITAL ANGEL COMMUNICATIONS
TRACKING TECHNOLOGY DELIVERY AND OTHER COMBINED
--------------------------------------------------------------------
Product revenue $ 22,074 $ - $ 2 $ 11,144 $ 33,220
Service revenue - - 2,518 - 2,518
------------------------------------------------------------------------------------------------------
Segment revenue $ 22,074 $ - $ 2,520 $ 11,144 $ 35,738
======================================================================================================
Depreciation and amortization $ 9,385 $ 25 $ 2,310 $ 611 $ 12,331
Interest income (4) - (13) - (17)
Interest expense 1,777 2 215 125 2,119
Loss from operations before
provision for income taxes
and minority interest (9,806) (4,040) (1,965) (1,447) (17,258)
Segment assets 86,918 104 14,574 5,783 107,379
Expenditures for property and
equipment, net 947 - 188 175 1,310
FOR THE YEAR ENDED DECEMBER 31, 2000
(IN THOUSANDS)
--------------------------------------------------------------------
RADIO
ANIMAL DIGITAL ANGEL DIGITAL ANGEL COMMUNICATIONS
TRACKING TECHNOLOGY DELIVERY AND OTHER COMBINED
--------------------------------------------------------------------
Product revenue $ 6,618 $ - $ - $ 12,986 $ 19,604
Service revenue - - 2,647 - 2,647
------------------------------------------------------------------------------------------------------
Segment revenue $ 6,618 $ - $ 2,647 $ 12,986 $ 22,251
======================================================================================================
Depreciation and amortization $ 2,314 $ 15 $ 120 $ 513 $ 2,962
Interest income (7) - (2) (17) (26)
Interest expense 62 - 3 50 115
Income (loss) from operations
before provision for income
taxes and minority interest (2,335) (2,038) 584 (27) (3,816)
Segment assets 85,837 104 1,740 7,663 95,344
Expenditures for property
and equipment 241 59 250 208 758
|
Page 29
ADVANCED WIRELESS GROUP
Notes to Combined Financial Statements (Continued)
Revenues are attributed to geographic areas based on the location
of the assets producing the revenues. Information concerning
principal geographic areas as of and for the years ended
December 31, 2001, 2000 and 1999 was as follows (in thousands):
UNITED
UNITED STATES KINGDOM COMBINED
-------------------------------------------
2001
Net revenue $ 24,594 $ 11,144 $ 35,738
Long-lived assets excluding goodwill 13,558 918 14,476
-------------------------------------------
2000
Net revenue $ 9,264 $ 12,987 $ 22,251
Long-lived assets excluding goodwill 4,449 959 5,408
-------------------------------------------
1999
Net revenue $ 0 $ 14,380 $ 14,380
Long-lived assets excluding goodwill $ 0 $ 1,115 $ 1,115
|
Page 30
ADVANCED WIRELESS GROUP
Notes to Combined Financial Statements (Continued)
20. PRO FORMA INFORMATION
The following unaudited pro forma combined information of the
Company for the year ended December 31, 2000 and 1999 gives effect
to the acquisitions, disclosed in Note 3, as if they were
effective at January 1, 2000 and 1999. The Company did not
acquire any businesses during 2001. The statement gives effect to
the acquisitions under the purchase method of accounting.
The unaudited pro forma information may not be indicative of the
results that would have actually occurred if the acquisitions had
been effective on the dates indicated or of the results that may
be obtained in the future. The unaudited pro forma information
should be read in conjunction with the combined financial
statements and notes thereto of the Company.
UNAUDITED
PRO FORMA
DECEMBER 31,
---------------------------
2000 1999
---------------------------
Total revenue $ 35,443 $ 34,193
Net loss (7,059) (5,866)
|
21. SUMMARIZED QUARTERLY DATA (UNAUDITED)
FIRST SECOND THIRD FOURTH FULL
QUARTER QUARTER QUARTER QUARTER YEAR
--------------------------------------------------------------------
2001
Total revenue $ 10,204 $ 8,450 $ 9,200 $ 7,884 $ 35,738
Gross profit 4,294 3,392 3,324 2,429 13,439
Net loss (2,011) (3,844) (4,003) (7,551)(a) (17,409)
------------------------------------------------------------------------------------------
2000
Total revenue $ 3,923 $ 4,066 $ 6,732 $ 7,530 $ 22,251
Gross profit 1,691 1,861 2,925 2,823 9,300
Net income (loss) (64) 50 207 (4,063)(b) (3,870)
------------------------------------------------------------------------------------------
(a) The fourth quarter 2001 results include interest on IBM debt
in the amount of
-----------------------------------------------------------------------
Page 31
|
ADVANCED WIRELESS GROUP
-----------------------------------------------------------------------
Notes to Combined Financial Statements (Continued)
$1,591 and goodwill impairment in the amount of $726.
(b) The fourth quarter 2000 results include amortization of
Digital Angel goodwill in the amount of $2,180. Digital Angel
was acquired on September 8, 2000.
|
Page 32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis of our financial condition and results
of operations should be read in conjunction with the accompanying financials
statement and related notes thereto.
OUR BUSINESS
Our business consists of: Digital Angel Corporation (Digital Angel) and
Timely Technology Corp. (Timely), which are wholly-owned subsidiaries of
Applied Digital Solutions, Inc. (ADS), and Signature Industries, Limited
(Signature), which is an 85.0% owned subsidiary of ADS. We are engaged in
the development and commercialization of proprietary technologies used to
identify, locate and monitor people, animals and objects. Digital Angel is
the result of the merger in September 2000 of Destron Fearing Corporation
and Digital Angel.net, Inc. ADS purchased Timely in April 2000 and Signature
in June 1998. Our business is organized into four segments: Animal Tracking,
Digital Angel Technology, Digital Angel Delivery System and Radio
Communication and Other. Digital Angel operates the Animal Tracking and
Digital Angel Technology segments.
Animal Tracking
The Animal Tracking segment develops, manufactures, and markets radio,
electronic and visual identification devices for the companion animal,
livestock, laboratory animal, fish and wildlife markets worldwide. This
segment, which became part of us in September 2000, had gross sales of
approximately $22.1 million, or approximately 61.8% of the gross sales of
the Advanced Wireless Group for the year ended December 31, 2001.
The Animal Tracking segment's radio frequency identification products
consist of miniature electronic microchips, readers and injection systems.
Digital Angel holds patents on its syringe-injectable microchip, which is
encased in a glass or glass-like material capsule and incorporates an
antenna and a microchip with a unique permanent identification code for the
animal in which it is implanted. The microchip is typically injected under
the skin using a hypodermic syringe, without requiring surgery. An
associated reader device uses radio frequency to interrogate the microchip
and read the code.
The Animal Tracking segment's pet identification system involves the
insertion of a microchip with identifying information in the animal. Readers
at animal shelters, veterinary clinics and other locations can determine the
animal's owner and other information. This pet identification system is
marketed in the United States by Schering-Plough Pharmaceutical under the
brand name "Home Again(TM)," in Europe by Merial Pharmaceutical, and in
Japan by Dainippon Pharmaceutical. The Animal Tracking segment also includes
partnerships with a variety of other companies outside the United States to
market Digital Angel's products. The Animal Tracking segment has an
established infrastructure with readers placed in approximately 6,000
domestic animal shelters, which constitutes approximately 70.0% of the
market. Approximately 10,000 veterinary clinics, or an estimated 66.0% of
United States clinics, use the "Home Again(TM)" system for pet
identification. Over one million companion animals in the United States have
undergone microchipping resulting in approximately 3,000 pet recoveries in
the United States each month.
In addition to pursuing the market for permanent identification of
companion animals, the Animal Tracking segment also produces visual and
electronic identification products, principally for livestock producers.
Visual identification products typically include numbered ear tags.
The Animal Tracking segment also produces and markets products to
promote permanent electronic identification of livestock. The Advanced
Wireless Group's management believes that, as the size of farms has
increased, automated, permanent individual identification has become a
necessary tool for managing large livestock herds. The tracking of cattle
and hogs is crucial for asset management, disease control and food safety.
Advanced Wireless Group management believes that implantable electronic
identification devices will be used in an increasing number of programs to
manage herds, improve genetics, reduce the loss of livestock, implement
feeding programs, and track, control and eradicate diseased livestock.
Page 2
The United States Department of Agriculture (USDA) has given clearance
for implanting microchips in food animals, enabling the Advanced Wireless
Group to market its electronic identification products to the United States
livestock market. Implantation of the segment's electronic microchips was
previously cleared by the FDA, subject to a determination by the USDA as to
anatomical implant sites in livestock animals. The USDA has identified four
implantation sites, all in inedible tissue, where it has been demonstrated
there will be minimal or no migration of the implanted device. The Animal
Tracking segment is now able to promote actively its implantable system in
the United States, and anticipates that USDA clearance will result in
increased use of microchips in connection with disease control programs.
Digital Angel Technology
The Digital Angel Technology segment of the Advanced Wireless Group is a
development stage business. This segment develops and markets advanced
technology to gather location data and local sensory data and to communicate
that data to an operations center. This segment is continuously developing
its technology, which it refers to as its Digital Angel technology. Digital
Angel technology is the integration and miniaturization into marketable
products of three technologies: wireless communication (e.g. cellular),
sensors (including bio-sensors) and position location technology (including
global positioning systems (GPS) and other systems). After the Digital Angel
technology gathers location data and local sensory data and communicates
that data to an operations center, the operations center can then perform an
action based on the data received (e.g., alert a doctor or update shipment
information). The Advanced Wireless Group's management plans to introduce
this technology into a variety of products to suit different applications
ranging from medical monitoring to asset management. These products have
been in the developmental stage from April 1998 through November 2001. The
first Digital Angel technology product was launched in November 2001.
The Digital Angel Technology segment has not produced any products or
generated any substantial revenue. Additionally, there are no contracts in
place for the Digital Angel technology that will provide any significant
revenue in the future. Approximately $6.1 million has been incurred to-date
on the development of the Digital Angel technology. Previously, the
development and introduction of the Digital Angel products were funded
through the profits of the Animal Tracking segment and by advances from ADS.
The Advanced Wireless Group will need to obtain additional capital to
develop fully and market this technology.
Digital Angel Delivery System
We have developed a system for managing the data to be communicated from
products using the Digital Angel technology. We refer to this system as the
Digital Angel Delivery System (DADS). DADS manages data in an
application-specific format. DADS works by combining highly complex software
that is responsible for data collection and delivery with the advanced
infrastructure needed to operate it. The DADS software is divided into the
following interconnected functional segments:
o Data Collection. This component is responsible for acquiring
real-time data from the devices incorporating the Digital Angel
Technology (e.g., location, temperature and identifying
information). DADS collects the data received from devices using the
technology, identifies the source of data and routes it to the
appropriate middle tier components.
o Business Intelligence. This component incorporates the data storage
capabilities, data analysis functions, application specific
algorithms and the notification engine.
o Data Delivery. This component provides data storage, retrieval
services and a delivery service, which allow information delivery
via a variety of channels (e.g., web browsers, wireless devices,
cell phones, pagers, e-mail, embedded devices or other devices).
We anticipate that ongoing contracts to service products using the
Digital Angel technology will provide substantial revenues once the Digital
Angel technology is successfully developed and marketed. We have not yet
entered into any such contracts.
Page 3
Timely operates DADS. Timely is also engaged in the business of software
and systems development for Digital Angel, including management information
systems used in Digital Angel's Animal Tracking business, the design and
marketing of financial and accounting software packages for school
districts, processing the data associated with product returns for customers
on a contract basis and other services. The Digital Angel Delivery System
segment, which became part of us in April 2000, had gross sales of
approximately $2.5 million, or approximately 7.0% of the gross sales of the
Advanced Wireless Group for the year ended December 31, 2001.
Radio Communications and Other
Signature Industries operates the Radio Communications and Other
business. This segment consists of the design, manufacture and support of
secure GPS enabled search and rescue equipment (such as personal locator
beacons) and intelligent communications products and services for telemetry,
mobile data and radio communications applications serving commercial and
military markets. This segment includes the design, manufacture and
distribution of intrinsically safe sounders (horn alarms) for industrial use
and other electronic components. This segment also includes a growing
business in high-grade communications equipment leasing and complementary
data systems that customers can use to locate and monitor their assets.
The Radio Communications and Other segment had gross sales of
approximately $11.1 million, or approximately 31.2% of the gross sales of
the Advanced Wireless Group for the year ended December 31, 2001.
Digital Angel, Timely Technology and Signature Industries are
subsidiaries of ADS located at 490 Villaume Avenue, South St. Paul,
Minnesota 55075. Their telephone number is 651-455-1621. Digital Angel,
Timely Technology, Signature Industries and ADS are affiliates of MAS.
Page 4
FISCAL YEAR ENDED DECEMBER 31, 2001 COMPARED TO FISCAL YEAR ENDED DECEMBER
31, 2000 AND FISCAL YEAR ENDED DECEMBER 31, 1999.
NET LOSS
Net loss was $17.4 million, $3.9 million and $1.0 million in 2001, 2000
and 1999, respectively. The net loss in 2001 and 2000 was primarily the
result of goodwill amortization associated with the acquisitions of Digital
Angel and Timely during 2000 and research and development expenses incurred
in connection with the Digital Angel Technology and Animal Tracking
segments. Also, we attribute a portion of the loss for 2001 to the
allocation of interest expense associated with ADS's borrowings under their
credit agreement with IBM Credit Corporation. The net operating results for
1999 consist of the performance of the Radio Communications and Other
segment as more fully discussed below.
The following table summarizes our results of operations as a percentage
of net operating revenue for the years ended December 31, 2001, 2000 and
1999 and is derived from our financial statements.
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
------------ ------------ ------------
2001 2000 1999
------------ ------------ ------------
% % %
Product revenue.......................... 93.0 88.1 100.0
Service revenue.......................... 7.0 11.9 --
Cost of products sold.................... 61.0 58.7 55.4
Cost of services sold.................... 81.3 54.2 --
Total cost of products and services sold. 62.4 58.2 55.4
Gross profit............................. 37.6 41.8 44.6
Selling, general and administrative 29.3
expense................................ 35.2 48.3
Research and development expense......... 14.2 10.0 --
Depreciation and amortization............ 34.5 13.3 3.9
Interest income.......................... -- (0.1) --
Interest expense......................... 5.9 0.5 0.3
----- ----- -----
(Loss) income from operations before
provision for income taxes and minority
interest............................... (48.3) (17.1) (7.9)
Provision for income taxes............... 0.1 0.3 --
----- ----- -----
(Loss) income from operations before
minority interest...................... (48.4) (17.4) (7.9)
Minority interest........................ 0.6 -- 1.2
Equity in Net Loss of Affiliate.......... 0.9 -- --
----- ----- -----
(Loss) income from operations............ (48.7) (17.4) (6.7)
===== ===== =====
|
Page 5
NET LOSS
Net loss for the three years ended December 31, 2001, 2000 and 1999 each of
the operating segments was as follows:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
------------ ------------ ------------
2001 2000 1999
------------ ------------ ------------
(amounts in thousands)
Animal Tracking..................... $ (9,806) $(2,335) $ --
Digital Angel Technology............ (4,040) (2,038) --
Digital Angel Delivery System....... (2,333) 526 --
Radio Communications and Other...... (1,230) (23) (968)
-------- ------- -----
Total............................... $(17,409) $(3,870) $(968)
======== ======= =====
|
Net loss as a percentage of revenue for the three years ended December 31,
2001, 2000 and 1999 for each operating segment was as follows:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
------------ ------------ ------------
2001 2000 1999
------------ ------------ ------------
% % %
Animal Tracking..................... (44.4) (35.3) --
Digital Angel Technology............ N/A N/A --
Digital Angel Delivery System....... (92.6) 19.9 --
Radio Communications and Other...... (11.0) (0.2) (6.7)
----- ----- ----
Total............................... (48.7) (17.4) (6.7)
===== ===== ====
|
The Animal Tracking segment had a net loss of $9.8 million, or 44.4% of
revenue, for 2001 and $2.3 million, or 35.3% of revenue, for 2000 due
primarily to the amortization of goodwill associated with the acquisition of
Destron Fearing on September 8, 2000. In addition, we attribute a portion of
the net loss for 2001 to the allocation of interest expense associated with
ADS's indebtedness to its lender, IBM Credit Corporation. We did not
generate net income or loss from this segment during 1999.
The Digital Angel Technology segment had a net loss of $4.0 million for
2001 and $2.0 million for 2000. We attribute the losses primarily to
research and development expenses. The Digital Angel Technology segment was
founded in late 1999 and research and development of products began during
2000. The Digital Angel product was launched in late November 2001.
The Digital Angel Delivery System segment had a net loss of $2.3
million, or 92.6% of revenue, for 2001, and net income of $0.5 million, or
19.9% of revenue, for 2000. We attribute the loss for 2001 primarily to the
amortization of goodwill associated with the acquisition of Timely, acquired
on April 1, 2000 and the amortization of software acquired during the second
quarter of 2001. In addition, we attribute a portion of the net loss in 2001
to the allocation of interest expense associated with ADS's indebtedness to
its lender, IBM Credit Corporation. The net income generated during 2000
resulted from web hosting and transaction processing support services. We
did not generate net income or loss from this segment during 1999.
The Radio Communications and Other segment had a net loss of $1.2
million for 2001, $0.02 million for 2000 and $1.0 million for 1999. We
attribute the net loss for 2001 primarily to a decline in sales, and related
gross profits, in the electrical parts and mobile data businesses. In
addition, we attribute a portion of the net loss for 2001 to the allocation
of interest expense associated with ADS's indebtedness to its lender, IBM
Credit Corporation. We attribute the improved operating performance during
2000 primarily to a reduction in selling, general and administrative expense.
Page 6
REVENUE
Revenue from operations for 2001 was $35.7 million, an increase of $13.5
million, or 60.6%, from 2000. Revenue for 2000 was $22.3 million, an
increase of $7.9 million, or 54.9%, from $14.4 million for 1999.
Revenue for the three years ended December 31, 2001, 2000 and 1999 each of
the operating segments was as follows:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
------------ ------------ ------------
2001 2000 1999
------------ ------------ ------------
(amounts in thousands)
Animal Tracking -- Product........... $22,074 $ 6,618 $ --
Digital Angel Technology -- Product.. -- -- --
Digital Angel Delivery System -- 2,520 2,647 --
Service............................
Radio Communications and
Other -- Product................... 11,144 12,986 14,380
------- ------- -------
Total................................ $35,738 $22,251 $14,380
======= ======= =======
|
The Animal Tracking segment's revenue increased $15.5 million for 2001
compared to 2000, and increased $2.2 million for 2001 when compared to
2000 on an annualized basis. We attribute the increase in revenue on an
annualized basis to increased sales of pet ID products in the US and
European markets. The $6.6 million increase in revenue during 2000 was due
to the acquisition of Destron Fearing on September 8, 2000. We did not
generate revenue from this segment during 1999.
The Digital Angel Technology segment launched its first product in a
limited test market during the latter part of November 2001; accordingly,
revenue from this segment will commence during 2002.
The Digital Angel Delivery System segment revenue decreased $0.1 million
for 2001 compared to 2000, however, revenue decreased $1.0 million for 2001
when compared to revenue for 2000 on an annualized basis. We attribute the
decrease in revenue on an annualized basis primarily to the completion of
existing client projects. Revenue increased $2.6 million in 2000 compared to
1999. Timely Technology, acquired on April 1, 2000, contributed all of the
increase. We did not generate revenue from this segment during 1999.
The Radio Communications and Other segment's revenue decreased by $1.9
million, or 14.2%, for 2001 compared to 2000 and decreased $1.4 million, or
9.7%, for 2000 compared to 1999. We attribute the decrease during 2001 to a
decline in sales of the electrical parts and mobile data businesses. We
attribute the decrease during 2000 to the loss of a manufacturing contract
in mid-1999.
GROSS PROFIT AND GROSS PROFIT MARGIN
Gross profit from operations for 2001 was $13.4 million, an increase of
$4.1 million, or 44.5%, from 2000. Gross profit from operations for 2000 was
$9.3 million, an increase of $2.9 million, or 45.3%, from $6.4 million in
1999. Gross profit margin was 37.6%, 41.8% and 44.6%, of revenue for the
years ended December 31, 2001, 2000 and 1999, respectively.
Page 7
Gross profit from operations for the three years ended December 31, 2001,
2000 and 1999 for each operating segment was as follows:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
------------ ------------ ------------
2001 2000 1999
------------ ------------ ------------
(amounts in thousands)
Animal Tracking -- Product............ $ 7,822 $ 2,201 $ --
Digital Angel Technology -- Product... -- -- --
Digital Angel Delivery System --
Service............................. 473 1,213 --
Radio Communications and
Other -- Product.................... 5,144 5,886 6,416
------- ------- -------
Total................................ $13,439 $ 9,300 $ 6,416
. ======= ======= =======
|
Gross profit margin from operations for the three years ended December 31,
2001, 2000 and 1999 for each operating segment was as follows:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
------------ ------------ ------------
2001 2000 1999
------------ ------------ ------------
% % %
Animal Tracking -- Product............ 35.4 33.3 --
Digital Angel Technology -- Product... -- -- --
Digital Angel Delivery System -- 18.8 45.8 --
Service.............................
Radio Communications and
Other -- Product.................... 46.2 45.3 44.6
---- ---- ----
Total................................. 37.6 41.8 44.6
==== ==== ====
|
The Animal Tracking segment's gross profit increased $5.6 million for
2001 compared to 2000 increase $1.2 million for 2001 when compared to 2000
and an annualized basis. We attribute the increase primarily to the
previously discussed increase in sales Gross profit increased $2.2 million
in 2000 from 1999 due to the acquisition of Destron Fearing on September 8,
2000. Margins were 35.4%, 33.3% and 0.0% in 2001, 2000 and 1999,
respectively. Gross profit and margins increased for 2001 compared to 2000
due to a favorable product mix in electronic products. This segment did not
contribute gross profit during 1999.
The Digital Angel Technology segment launched its first product in a
limited test market during the latter part of November 2001; accordingly,
gross profit from this segment will commence during 2002.
The Digital Angel Delivery System segment's gross profit decreased $0.7
million for 2001 compared to 2000 and decreased $1.1 million for 2001 when
compared to annualized gross profit for 2000. We attribute the decrease in
2001 gross profit to the previously discussed decline in sales and increased
investment in software engineering to support the development of
DigitalAngel(TM) product. Gross profit increased $1.2 million for 2000
compared to 1999. Timely Technology acquired on April 1, 2000, contributed
all of the increase. The gross profit generated during 2000 resulted from
sales of web hosting and transaction processing support revenues. The
Advanced Wireless Group did not generate gross profit from this segment
during 1999. The gross margin percentage was 18.8% and 45.8% during 2001 and
2000, respectively.
The Radio Communications and Other segment's gross profit decreased by
$0.7 million, or 12.6%, for 2001 compared to 2000 due to the previously
discussed decline in sales. Gross profit decreased by $0.5 million, or 8.3%,
for 2000 compared to 1999 due to the loss of a manufacturing contract in
mid-1999. The gross margin percentage was 46.2 %, 45.3% and 44.6% during
2001, 2000 and 1999, respectively. The increase in margins during 2001 was
attributed to improved product mix in the GPS locator products.
Page 8
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling general and administrative expense from operations was $10.5
million for 2001, an increase of $2.7 million, or 34.6%, from $7.8 million
in 2000. Selling, general administrative expense for 2000 increased $0.9
million, or 13.0%, from $6.9 million in 1999. As a percentage of revenue,
selling, general and administrative expense was 29.3%, 35.2% and 48.3%,
2001, 2000 and 1999, respectively.
Selling, general and administrative expense for the years ended December 31,
2001, 2000 and 1999 for each of the operating segments was as follows:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
------------ ------------ ------------
2001 2000 1999
------------ ------------ ------------
(amounts in thousands)
Animal Tracking................. $ 4,888 $ 1,955 $ --
Digital Angel Technology........ -- -- --
Digital Angel Delivery System... 451 508 --
Radio Communications and Other.. 5,128 5,367 6,948
------- ------- -------
Total........................... $10,467 $ 7,830 $ 6,948
======= ======= =======
|
Selling, general and administrative expense as a percentage of revenue for
the years ended December 31, 2001, 2000 and 1999 for each of the operating
segments was as follows:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
------------ ------------ ------------
2001 2000 1999
------------ ------------ ------------
% % %
Animal Tracking................. 22.1 29.5 --
Digital Angel Technology........ -- -- --
Digital Angel Delivery System... 17.9 19.2 --
Radio Communications and Other.. 46.0 41.3 48.3
---- ---- ----
Total........................... 29.3 35.2 48.3
==== ==== ====
|
The Animal Tracking segment's selling, general and administrative
expense increased $2.9 million for 2001 from 2000 and decreased $1.0 million
for 2001 compared to 2000 on an annualized basis. As a percentage of
revenue, selling, general and administrative expense decreased to 22.1% from
29.5% in 2000. We attribute the decrease in selling, general and
administrative expense on an annualized basis to reduced expenses for legal,
accounting and investor relations. The increase in 2000 was the result of
the acquisition of Destron Fearing in September 2000. Accordingly, selling,
general and administrative expense was not incurred for this segment during
1999.
The Digital Angel Technology segment was founded in late 1999 and was in
the product development stage during the majority of 2001, and all of 2000
and 1999. Accordingly, it did not incur selling, general and administrative
expenses during the periods presented.
The Digital Angel Delivery System segment's selling, general and
administrative expenses decreased $0.06 million in 2001 as compared to 2000.
Selling, general and administrative expense increased $0.2 million for 2001
when compared to 2000 on an annualized basis. We attribute the increase for
2001 to investment spending to support the introduction of the Digital
Angel(TM) products. Selling, general and administrative expense increased
$0.5 million in 2000 from 1999. Timely Technology, acquired on April 1,
2000, contributed all of the increase. Accordingly, the Advanced Wireless
Group did not incur selling, general and administrative expense from this
segment during 1999.
The Radio Communications and Other segment's selling, general and
administrative expenses decreased $0.2 million for 2001 and as a percentage
of revenue increased to 46.0% from 41.3% for 2000. Selling
Page 9
general and administrative expense decreased $1.6 million for 2000 compared
to 1999 and as a percentage of revenue decreased to 41.3% from 48.3% in 1999
primarily as a result of a staff reduction.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense from operations was $5.1 million for
2001, an increase of $2.9 million, or 131.8%, from $2.2 million in 2000. We
did not incur research and development expense during 1999. As a percentage
of revenue, research and development expense was 14.2% and 10.0% for 2001
2000, respectively.
Research and development expense for the years ended December 31, 2001, 2000
and 1999 for each of the operating segments was as follows:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
------------ ------------ ------------
2001 2000 1999
------------ ------------ ------------
Animal Tracking................. $ 1,057 $ 197 $ --
Digital Angel Technology........ 4,014 2,038 --
Digital Angel Delivery System... -- -- --
Radio Communications and Other.. -- -- --
------- ------- ----
Total........................... $ 5,071 $ 2,235 $ --
======= ======= ====
|
The Animal Tracking segment research and development expense increased
$0.9 million for 2001 from 2000 and increased $0.5 million for 2001 compared
to 2000 on an annualized basis. As a percentage of revenue, research and
development expense increased to 4.8% from 3.0% in 2000. We attribute the
increase in research and development expense to investments made to develop
products in the livestock and fisheries businesses. Research and development
expense increased in 2000 by $2.2 million. The increase in 2000 was the
result of the acquisition of Destron Fearing in September 2000. Accordingly,
research and development expense was not incurred for this segment during
1999.
The Digital Angel Technology segment was founded in late 1999 and
research and development of products began during 2000. We attribute these
expenses primarily to the development of the Digital Angel product.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense from operations was $12.3 million
in 2001, an increase of $9.4, or 316.3% from 2000. Depreciation and
amortization expense was $3.0 million in 2000, an increase of $2.4 million,
or 400.0%, from 1999. As a percentage of revenue, depreciation and
amortization expense was 34.5%, 13.3% and 3.9% for 2001, 2000 and 1999,
respectively.
In conjunction with the 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, reduced the
lives to periods ranging from 5 to 10 years, from periods ranging from 10 to
20 years, to reflect current economic trends associated with the nature of
recent acquisitions. The impact in 2000 of this change was an increase in
amortization of approximately $1.0 million.
Page 10
Depreciation and amortization expense for the three years ended December 31,
2001, 2000 and 1999 for each of the operating segments was as follows:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
------------ ------------ ------------
2001 2000 1999
------------ ------------ ------------
Animal Tracking................. $ 9,385 $ 2,314 $ --
Digital Angel Technology........ 25 15 --
Digital Angel Delivery System... 2,310 120 --
Radio Communications and Other.. 611 513 565
------- ------- -----
Total........................... $12,331 $ 2,962 $ 565
======= ======= =====
|
We attribute the increases in depreciation and amortization expense for
the Animal Tracking and Digital Angel Delivery System segments for 2001 and
2000 primarily to goodwill amortization resulting from the acquisitions of
Destron Fearing Corporation and Timely in 2000. We attribute the increase
for 2001 compared to 2000 for the Radio Communications and Other segment to
the change in the goodwill life from 20 to 10 years effective October 1,
2000, and the decrease for 2000 compared to 1999 to reduced levels of
capital investment during 1999.
ASSET IMPAIRMENT
Our Radio Communications and Other segment incurred an impairment
charge of $0.7 million for the year ended December 31, 2001 in connection
with the impairment of goodwill associated with a prior acquisition.
INTEREST EXPENSE
Interest expense was $2.1 million, $0.1 million and $0.04 million for
2001, 2000 and 1999, respectively. Interest expense for 2001 was attributed
primarily to an allocation of interest expense associated with the
borrowings under the IBM credit agreement for the fourth quarter of 2001.
Because the outstanding borrowings were not considered an obligation of ours
until September 30, 2001, interest has only been allocated to us during the
fourth quarter of 2001. Interest expense for 2000 and 1999 was a function of
the level of outstanding debt and is principally associated with notes
payable and advances from ADS.
INCOME TAXES
The Advanced Wireless Group had an effective income tax rate of 0.0% and
2.0% for 2001 and 2000, respectively. We did not incur a provision for
income taxes for 1999. Differences in the effective income tax rates from
the statutory federal income tax rates arise primarily from the increase
or reduction of valuation allowances related to net operating loss
carryforwards, non-deductible goodwill amortization associated with
acquisitions and state taxes net of federal benefits. We have recorded
valuation allowances against certain of our gross deferred tax assets
because the realization of those assets is dependent on future earnings,
which are uncertain. During 2001 and 2000, Digital Angel and Timely, our
United States companies, were included in ADS's consolidated federal income
tax return.
Page 11
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2001, cash and cash equivalents totaled $0.6 million,
an increase of $0.4 million, or 200.0%, from $0.2 million at December 31,
2000. The Advanced Wireless Group utilized a cash management system to apply
excess cash on hand against advances due to ADS. Cash used in operating
activities totaled $3.2 million for 2001. The use of cash was due to the net
loss, after adjusting for non-cash charges, and increases in accounts
receivable and inventory. Partially offsetting these uses of cash were
increases in cash from accounts payable and accrued expenses and prepaid
expenses. During 2000, cash of $1.4 million was used. The use of cash was
due to the net loss, after adjusting for non-cash charges, and increases in
inventory and prepaid expenses. Partially offsetting the uses was $0.8
million from accounts receivable.
Accounts receivable, net of allowance for doubtful accounts, remained
relatively constant at $5.4 million at December 31, 2001 from $5.3 million
at December 31, 2000.
Inventory levels increased by $0.4 million, or 7.4%, to $5.8 million at
December 31, 2001 compared to $5.4 million at December 31, 2000. We
attribute the increase in inventory to normal seasonal fluctuations in
response to the timing of customer shipping orders.
Current assets increased by $1.1 million, or 9.6%, to $12.5 million at
December 31, 2001 compared to $11.4 million at December 31, 2000. We
attribute the increase primarily to increases in cash and inventories as
discussed above.
Property and equipment increased by $9.1 million, or 168.5%, to $14.5
million at December 31, 2001 compared to $5.4 million at December 31, 2000.
This increase was due primarily to the acquisition of software associated
with the Digital Angel Delivery System during 2001.
Goodwill decreased to $72.9 million at December 31, 2001 compared to
$77.6 million at December 31, 2000 due to amortization. The amortization was
partially offset by an increase in goodwill associated with an earnout
payment achieved in the second quarter of 2001.
Investment in Affiliate, was $6.8 million at December 31, 2001. This
investment relates to our acquisition of a 16.6% interest in MAS during
February of 2001.
Accounts payable increased by $1.2 million, or 46.2%, to $3.8 million at
December 31, 2001 from $2.6 million at December 31, 2000. The increase is a
result of improved management of cash.
Accrued expenses increased by $0.2 million, or 11.1%, to $2.0 million at
December 31, 2001 from $1.8 million at December 31, 2000. We attribute the
increase primarily to Digital Angel(TM) related expenses.
Current liabilities increased by $83.9 million, or 1864.4%, to $88.4
million at December 31, 2001 compared to $4.5 million at December 31, 2000.
This increase was primarily due to the allocation of ADS's outstanding
borrowings under its USA revolving credit line and term loans with IBM
Credit Corporation. These borrowings, which totaled $82.6 million, have been
reflected as a current obligation of ours at December 31, 2001 as a result
of ADS's determination that it would not be able to repay its obligations
under its credit line and term loans with IBM Credit Corporation. IBM Credit
Corporation maintains liens and security interests in the common stock and
assets of our businesses, which necessitated the allocation of ADS's
obligations to our financial statements at December 31, 2001. See Note 2 to
our Combined Financial Statements for the Years Ended December 31, 2001 and
2000 and the discussion below under the heading Debt Covenant Compliance and
Liquidity.
Long-term debt and notes payable remained relatively constant at $2.4
million and $2.5 million at December 31, 2001 and December 31, 2000,
respectively. Long-term debt and notes payable consists of mortgage notes
payable collateralized by land and buildings.
Investing activities used cash of $1.3 million for 2001 and provided
cash of $1.1 million for 2000.
Page 12
During 2001, $1.3 million was spent to acquire property and equipment.
During 2000, $1.9 million was provided by acquired businesses and $.08
million was spent to acquire property and equipment.
Financing activities provided cash of $4.9 million for 2001 and $0.4
million for 2000. We attribute this activity primarily to additional
investment by ADS. In addition, during 2000, we used $0.2 million to pay
notes payable.
We incurred research and development expense of $5.1 million and $2.2
million during 2001 and 2000, respectively. Since inception, the Advanced
Wireless Group has incurred research and development expense of
approximately $7.3 million. These expenses have been funded by a combination
of advances from ADS and from cash provided by operations. During the next
twelve months we are projecting that it will incur additional research and
development expense ranging from $2.0 million to $4.0 million and anticipate
funding this expense primarily from cash provided by operations.
DEBT, COVENANT COMPLIANCE AND LIQUIDITY
ADS maintains a term and revolving credit agreement with IBM Credit (IBM
Credit). The IBM credit agreement provides for a revolving credit line in
the United States, a revolving credit line in Canada and certain term loans.
Under the credit agreement in effect at December 31, 2001, IBM Credit
maintains liens and security interests in the outstanding capital stock of
the businesses comprising us as well as liens on and security interests in
the assets our businesses. These liens and security interests collateralize
borrowings under the United States revolving credit line and term loans.
ADS generated a significant loss from operations in 2000. As a result,
ADS was not in compliance with certain financial covenants of the IBM credit
agreement as of December 31, 2000. The IBM credit agreement was amended and
restated on October 17, 2000 and further amended on March 30, 2001. In
connection with the amendment on March 30, 2001, Digital Angel granted IBM
Credit Corporation warrants to acquire 1.2 million shares of Digital Angel's
common stock valued at $0.3 million. As of the March 30, 2001 amendment, ADS
was in compliance with the revised covenants.
The IBM credit agreement contains certain quarterly financial covenants,
which became more restrictive during 2001. ADS anticipated that it would
continue to comply in 2001 with the quarterly financial covenants in the IBM
credit agreement. Management's business plans for ADS anticipated year to
year increases in revenues due to increased volumes, improved working
capital management, reduced capital spending, successful implementation of
on-going cost savings initiatives, improved operating efficiencies, and the
disposition of non-core businesses.
ADS was not in compliance with its minimum EBITDA (as defined in the IBM
credit agreement) or collateral shortfall covenants at June 30, 2001. ADS was
also not in compliance with the minimum EBITDA, Tangible Net Worth and
Current Assets to Current Liabilities covenant requirements at September 31,
2001 and it again had a collateral shortfall. As of December 31, 2001, ADS
was not incompliance with various financial covenants, including: negative
Tangible Net Worth of $71.8 million, or $37.3 million less than the minimum
requirement, actual EBITDA was a negative $142.2 million, or $153.2 million
less than the Minimum EBITDA covenant, Current Assets to Current Liabilities
was 0.33 to 1.0 compared to a minimum requirement of 0.80 to 1.0 and ADS had
a collateral shortfall of $42.7 million, or $35.7 million more than the
allowable shortfall of $7.0 million. The IBM credit agreement 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.
The total amounts outstanding on March 27, 2002, the effective date of
the new credit agreement, were $82.6 million. As part of the amendments to
the agreement with IBM Credit, ADS paid bank fees of $0.4 million in April
2001 and $0.3 million in March 2002 and issued warrants to IBM Credit valued
at $1.9 million in April 2001. The bank fees and fair value of the warrants
are recorded as deferred financing fees
Page 13
and are being amortized over the life of the debt as interest expense.
As a result of the events of default under the IBM credit agreement and
continued operating losses in fiscal 2001, it was determined during the
third quarter of fiscal 2001, that substantial doubt exists about ADS's
ability to continue as a going concern. At December 31, 2001, outstanding
borrowings under the United States revolving credit line and term loans
totaled $82.6 million. ADS does not currently have the funds available to
repay the borrowings under the IBM credit agreement. Accordingly, the $82.6
million of outstanding borrowings was allocated to us at September 30, 2001
and has been reflected as a current obligation in the December 31, 2001
combined balance sheet. Interest associated with the borrowings was
allocated to us from the period September 30, 2001 to December 30, 2001.
Because the outstanding borrowings were not considered our obligation until
September 30, 2001, interest has only been allocated to the us from
September 30, 2001. Under the terms of the agreement and plan of merger with
MAS, the common stock and assets of the three subsidiaries comprising us
will be released from all liens and security interests under the IBM credit
agreement, and the shares of MAS common stock beneficially owned by ADS upon
completion of the merger will be pledged to IBM as collateral for the debt.
On March 1, 2002, ADS and Digital Angel Share Trust, a newly created
Delaware business trust, and IBM Credit entered into a Third Amended and
Restated Term Credit Agreement. The new credit agreement became effective on
March 27, 2002 the effective date of the merger between Digital Angel and
MAS. Amounts outstanding under the new credit agreement bear interest at an
annual rate of 17% and mature on February 28, 2003. No principal or interest
payments are due until the maturity date. However, the maturity date will be
extended for consecutive one-year periods if ADS repays at least 40% of the
original principal amount outstanding plus accrued interest and expenses
prior to February 28, 2003 and an additional 40% of the original principal
amount outstanding plus accrued interest and expenses prior to February 28,
2004. In any event, all amounts outstanding will be required to be repaid by
August 15, 2005. If all amounts are not repaid by February 28, 2003, the
unpaid amount will accrue interest at an annual rate of 25%. If not repaid
by February 28, 2004, the interest rate increases to 35%.
On March 27, 2002, upon completion of the merger between Digital Angel
and MAS, in satisfaction of a condition to the consent to the merger by IBM
Credit, ADS transferred to a Delaware business trust controlled by an
advisory board all of the shares of MAS common stock owned by it and, as a
result, the trust has legal title to approximately 77.15% of the MAS common
stock. The trust has voting rights with respect to the MAS common stock
until the ADS's obligations to IBM Credit are repaid in full. The trust may
be obligated to liquidate the shares of MAS common stock owned by it for the
benefit of IBM Credit Corporation in the event the ADS fails to make
payments, or otherwise defaults, under its new credit agreement with IBM
Credit.
To date, financing from acquisitions, ADS's advances and revenue
generated from operations have been our primary sources of funding. However,
we do not anticipate receiving additional advances from ADS. ADS's new
credit agreement does not provide for further advances by IBM Credit. We
estimate that we will need to obtain approximately $5 million to $7 million
in additional funding over the next twelve months in order to continue our
efforts to implement our business plan. As a result, the combined company
will need to obtain additional capital in the near future. As of the date of
these statements, we have held discussions with several banks and an asset
based lender regarding a credit facility. Our capital requirements depend on
a variety of factors, including, but not limited to, the rate of increase or
decrease in
Page 14
its existing business base; the success, timing, and amount of investment
required to bring new products on-line; revenue growth or decline; and
potential acquisitions. Providing we are successful in obtaining the credit
facility and in raising additional equity capital, of which there can be no
assurance, management believes that we will have the financial resources to
meet its future business requirements for at least the next twelve months.
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