##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 Form 10-Q
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2007
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from            to
 Commission file number: 1-15177
 
 DIGITAL ANGEL CORPORATION
 (Exact name of Registrant as specified in its charter)
 Delaware(State or other jurisdiction of 
incorporation or organization)
    
    52-1233960(I.R.S. Employer
Identification Number)
 490 Villaume Avenue, South St. Paul, MN(Address of principal executive offices)
    
    55075(Zip Code)
 
 
 (
  þ o
  o o þ
 o þ
  Class
    
    Outstanding at August 8, 2007Common Stock, $.005 par value per share
    
    44,641,388 shares




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##### 



DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
 TABLE OF CONTENTS
 PagePART I  Financial InformationItem 1.
    
    Financial Statements (unaudited):Condensed Consolidated Balance Sheets  As of June 30, 2007 and December 31, 2006
    
    
    3Condensed Consolidated Statements of Operations  Three months and six months ended June 30, 2007 and 2006
    
    
    4Condensed Consolidated Statement of Changes in Stockholders' Equity  Six months ended June 30, 2007
    
    
    5Condensed Consolidated Statements of Cash Flows  Six months ended June 30, 2007 and 2006
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2.
    
    Management's Discussion and Analysis of Financial Condition and Results of Operations
    
    
    20Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    32Item 4T.
    
    Controls and Procedures
    
    
    33PART II  Other InformationItem 1.
    
    Legal Proceedings
    
    
    34Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    34Item 5.
    
    Other Information
    
    
    34Item 6.
    
    Exhibits
    
    
    35Signatures
    
    
    36Exhibit 10.29Exhibit 10.30Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
   2




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 
 DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
 June 30,
    
    
    December 31,2007
    
    
    2006(unaudited)AssetsCurrent assetsCash
    
    $
    1,004
    
    
    $
    1,521Restricted cash
    
    
    127
    
    
    
    81Accounts receivable, net of allowance for doubtful accounts of $183 and $203
at June 30, 2007 and December 31, 2006, respectively
    
    
    10,816
    
    
    
    9,609Accounts receivable from VeriChip Corporation
    
    
    35
    
    
    
    425Inventories
    
    
    13,294
    
    
    
    9,897Other current assets
    
    
    2,076
    
    
    
    2,016Current assets from discontinued operations
    
    
    3,069
    
    
    
    2,335Total current assets
    
    
    30,421
    
    
    
    25,884Property and equipment, net
    
    
    11,040
    
    
    
    9,985Goodwill
    
    
    53,276
    
    
    
    51,244Other intangible assets, net
    
    
    1,589
    
    
    
    1,633Other assets, net
    
    
    615
    
    
    
    619Other assets from discontinued operations
    
    
    1,040
    
    
    
    531Total Assets
    
    $
    97,981
    
    
    $
    89,896Liabilities and Stockholders EquityCurrent liabilitiesLine of credit and current maturities of long-term debt
    
    $
    9,294
    
    
    $
    4,127Accounts payable
    
    
    11,666
    
    
    
    6,024Due to Applied Digital Solutions, Inc.
    
    
    67
    
    
    
    11Accrued expenses and other current liabilities
    
    
    3,609
    
    
    
    2,793Current liabilities from discontinued operations
    
    
    2,266
    
    
    
    2,448Total current liabilities
    
    
    26,902
    
    
    
    15,403Long-term debt
    
    
    3,790
    
    
    
    4,036Other long term liabilitiesDerivative warrant liability
    
    
    958
    
    
    
    Other long term liabilities
    
    
    373
    
    
    
    386Other liabilities from discontinued operations
    
    
    2,585
    
    
    
    1,060Total other long term liabilities
    
    
    3,916
    
    
    
    1,446Total Liabilities
    
    
    34,608
    
    
    
    20,885Minority interest
    
    
    409
    
    
    
    465Stockholders equityPreferred stock ($1.75 par value; shares authorized, 1,000; shares issued, nil)
    
    
    
    
    
    
    Common stock ($0.005 par value: shares authorized, 95,000: shares issued,
45,019 and 44,894: shares outstanding, 44,641 and 44,516)
    
    
    226
    
    
    
    226Additional paid-in capital
    
    
    215,027
    
    
    
    214,509Accumulated deficit
    
    
    (150,962
    )
    
    
    (144,753
    )Treasury stock (carried at cost, 378 shares)
    
    
    (1,580
    )
    
    
    (1,580
    )Accumulated other comprehensive income
    
    
    253
    
    
    
    144Total Stockholders Equity
    
    
    62,964
    
    
    
    68,546Total Liabilities and Stockholders Equity
    
    $
    97,981
    
    
    $
    89,896
 See Notes to Condensed Consolidated Financial Statements.
  3




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##### Table of Contents



DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
 For the Three Months
    
    
    For the Six MonthsEnded June 30,
    
    
    Ended June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Total net revenue
    
    $
    19,533
    
    
    $
    12,428
    
    
    $
    34,831
    
    
    $
    27,747Cost of sales
    
    
    11,855
    
    
    
    7,562
    
    
    
    21,509
    
    
    
    16,275Gross profit
    
    
    7,678
    
    
    
    4,866
    
    
    
    13,322
    
    
    
    11,472Selling, general and administrative expenses
    
    
    7,763
    
    
    
    5,685
    
    
    
    15,277
    
    
    
    11,631Research and development expenses
    
    
    1,585
    
    
    
    727
    
    
    
    2,804
    
    
    
    1,522Operating loss
    
    
    (1,670
    )
    
    
    (1,546
    )
    
    
    (4,759
    )
    
    
    (1,681
    )Interest income
    
    
    8
    
    
    
    81
    
    
    
    46
    
    
    
    174Interest expense
    
    
    (674
    )
    
    
    (110
    )
    
    
    (998
    )
    
    
    (206
    )Change in derivative warranty liability
    
    
    (105
    )
    
    
    
    
    
    
    296
    
    
    
    Other income
    
    
    30
    
    
    
    27
    
    
    
    62
    
    
    
    45Loss from continuing operations before income
taxes and minority interest
    
    
    (2,411
    )
    
    
    (1,548
    )
    
    
    (5,353
    )
    
    
    (1,668
    )Income tax (provision) benefit
    
    
    (13
    )
    
    
    (11
    )
    
    
    (38
    )
    
    
    72Minority interest share of loss (income)
    
    
    10
    
    
    
    (19
    )
    
    
    15
    
    
    
    (58
    )Net loss from continuing operations
    
    
    (2,414
    )
    
    
    (1,578
    )
    
    
    (5,376
    )
    
    
    (1,654
    )Loss from discontinued operations
    
    
    (313
    )
    
    
    (546
    )
    
    
    (833
    )
    
    
    (1,056
    )Net loss
    
    $
    (2,727
    )
    
    $
    (2,124
    )
    
    $
    (6,209
    )
    
    $
    (2,710
    )Earnings per common share  basic and dilutedLoss from continuing operations
    
    $
    (0.05
    )
    
    $
    (0.04
    )
    
    $
    (0.12
    )
    
    $
    (0.04
    )Loss from discontinued operations
    
    
    (0.01
    )
    
    
    (0.01
    )
    
    
    (0.02
    )
    
    
    (0.02
    )Net loss
    
    $
    (0.06
    )
    
    $
    (0.05
    )
    
    $
    (0.14
    )
    
    $
    (0.06
    )Weighted average common shares outstanding 
basic and diluted
    
    
    44,562
    
    
    
    44,286
    
    
    
    44,539
    
    
    
    44,097
 See Notes to Condensed Consolidated Financial Statements.
  4




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DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statement of Changes in Stockholders Equity (Unaudited)
For the Six Months Ended June 30, 2007
 AccumulatedAdditional
    
    
    
    
    
    
    
    
    
    
    Other
    
    
    TotalPreferred Stock
    
    
    Common Stock
    
    
    Paid-In
    
    
    Accumulated
    
    
    Treasury
    
    
    Comprehensive
    
    
    Stockholders'Number
    
    
    Amount
    
    
    Number
    
    
    Amount
    
    
    Capital
    
    
    Deficit
    
    
    Stock
    
    
    Income
    
    
    EquityBalance, December 31, 2006
    
    
    
    
    
    $
    
    
    
    
    44,894
    
    
    $
    226
    
    
    $
    214,509
    
    
    $
    (144,753
    )
    
    $
    (1,580
    )
    
    $
    144
    
    
    $
    68,546Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,209
    )
    
    
    
    
    
    
    
    
    
    
    (6,209
    )Comprehensive loss:Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    109
    
    
    
    109Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,100
    )Compensation expense
    
    
    
    
    
    
    
    
    
    
    125
    
    
    
    
    
    
    
    518
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    518Balance, June 30, 2007
    
    
    
    
    
    $
    
    
    
    
    45,019
    
    
    $
    226
    
    
    $
    215,027
    
    
    $
    (150,962
    )
    
    $
    (1,580
    )
    
    $
    253
    
    
    $
    62,964
 See Notes to Condensed Consolidated Financial Statements.
  5




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DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
 For the Six MonthsEnded June 30,2007
    
    
    2006Cash Flows From Operating ActivitiesNet loss
    
    $
    (6,209
    )
    
    $
    (2,710
    )Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Equity-based compensation
    
    
    518
    
    
    
    288Depreciation and amortization
    
    
    1,150
    
    
    
    925Amortization of debt discount and financing costs
    
    
    339
    
    
    
    Reduction in derivative warrant liability
    
    
    (296
    )
    
    
    Minority interest
    
    
    (15
    )
    
    
    58Loss on disposal of equipment
    
    
    8
    
    
    
    4Loss from discontinued operations
    
    
    833
    
    
    
    1,056Change in assets and liabilities:(Increase) decrease in restricted cash
    
    
    (46
    )
    
    
    195(Increase) decrease in accounts receivable
    
    
    (1,073
    )
    
    
    3,383Decrease (increase) in accounts receivable from VeriChip Corporation
    
    
    391
    
    
    
    (45
    )Increase in inventories
    
    
    (1,074
    )
    
    
    (1,662
    )Increase in other current assets
    
    
    (78
    )
    
    
    (390
    )Decrease in deferred tax liability
    
    
    (12
    )
    
    
    (132
    )Increase (decrease) in accounts payable and accrued expenses
    
    
    6,265
    
    
    
    (2,905
    )Net cash
(used in) provided by discontinued operations
    
    
    (295
    )
    
    
    160Net Cash Provided by (Used in) Operating Activities
    
    
    406
    
    
    
    (1,775
    )Cash Flows From Investing ActivitiesDecrease in other assets
    
    
    66
    
    
    
    214Payments for property and equipment
    
    
    (886
    )
    
    
    (672
    )Net cash paid for acquisition
    
    
    (4,215
    )
    
    
    (1,000
    )Net cash used in discontinued operations
    
    
    (438
    )
    
    
    (175
    )Net Cash Used in Investing Activities
    
    
    (5,473
    )
    
    
    (1,633
    )Cash Flows From Financing ActivitiesBorrowings on line of credit
    
    
    2,458
    
    
    
    2,427Payments on line of credit
    
    
    (2,413
    )
    
    
    (2,004
    )Borrowings on debt
    
    
    6,000
    
    
    
    Payments on notes payable and long-term debt
    
    
    (764
    )
    
    
    (355
    )Exercise of stock options and warrants
    
    
    
    
    
    
    563Payments of dividends to minority shareholder in subsidiary
    
    
    (53
    )
    
    
    (140
    )Payments for financing costs
    
    
    (686
    )
    
    
    Net Cash Provided by Financing Activities
    
    
    4,542
    
    
    
    491Effect of Exchange Rate Changes on Cash
    
    
    8
    
    
    
    27Net Decrease In Cash
    
    
    (517
    )
    
    
    (2,890
    )Cash  Beginning of Period
    
    
    1,521
    
    
    
    9,949Cash  End of Period
    
    $
    1,004
    
    
    $
    7,059
 See Notes to Condensed Consolidated Financial Statements.
  6




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DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
 1. Basis of Presentation
        2. Recent and Not Yet Adopted Accounting Pronouncements
   7




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DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 2. Recent and Not Yet Adopted Accounting Pronouncements (continued)
 ze
  3. Acquisition
    April 5, 2007(in thousands)Inventory
    
    $
    592Fixed assets
    
    
    2,178Goodwill and other intangibles
    
    
    1,972Total assets acquired
    
    $
    4,742
  8




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DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 3. Acquisition (continued)
   Pro Forma for the
    
    
    Pro Forma for the
    
    
    Pro Forma for theThree Months
    
    
    Six Months Ended
    
    
    Six Months EndedEnded June 30,
    
    

June 30,
    
    
    June 30,2006
    
    
    2007
    
    
    2006(unaudited, in thousands)Net operating revenue
    
    $
    15,265
    
    
    $
    39,009
    
    
    $
    33,186Net loss from continuing operations
    
    
    (1,957
    )
    
    
    (5,032
    )
    
    
    (2,587
    )Net loss from continuing
operations per common share 
basic and diluted
    
    
    (0.04
    )
    
    
    (0.11
    )
    
    
    (0.06
    )
 4. Discontinued Operations
    9




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DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 4. Discontinued Operations (continued)
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(in thousands)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006(unaudited)
    
    
    (unaudited)Total net revenue
    
    $
    716
    
    
    $
    528
    
    
    $
    1,417
    
    
    $
    1,031Cost of sales
    
    
    401
    
    
    
    332
    
    
    
    853
    
    
    
    665Gross profit
    
    
    315
    
    
    
    196
    
    
    
    564
    
    
    
    366Selling, general and administrative expenses
    
    
    354
    
    
    
    318
    
    
    
    730
    
    
    
    604Research and development expenses
    
    
    274
    
    
    
    425
    
    
    
    667
    
    
    
    819Interest income
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    (1
    )Loss from discontinued operations
    
    $
    (313
    )
    
    $
    (546
    )
    
    $
    (833
    )
    
    $
    (1,056
    )Earnings per common share  basic and diluted:Loss from discontinued operations
    
    $
    (0.01
    )
    
    $
    (0.01
    )
    
    $
    (0.02
    )
    
    $
    (0.02
    )
   June 30,
    
    
    December 31,(in thousands)
    
    2007
    
    
    2006(unaudited)Current assetsCash
    
    $
    152
    
    
    $
    2Accounts receivable
    
    
    1,645
    
    
    
    956Inventory
    
    
    608
    
    
    
    503Other current assets
    
    
    664
    
    
    
    874Total current assets
    
    
    3,069
    
    
    
    2,335Property and equipment, net
    
    
    345
    
    
    
    274Other assets, net
    
    
    695
    
    
    
    257Total long-term assets
    
    
    1,040
    
    
    
    531Total assets
    
    $
    4,109
    
    
    $
    2,866Current liabilitiesAccounts payable
    
    
    274
    
    
    
    408Accrued expenses and other current liabilities
    
    
    439
    
    
    
    270Deferred revenue
    
    
    1,553
    
    
    
    1,770Total current liabilities
    
    
    2,266
    
    
    
    2,448Other long-term liabilities
    
    
    2,585
    
    
    
    1,060Total liabilities
    
    $
    4,851
    
    
    $
    3,508Net liabilities from discontinued operations
    
    $
    742
    
    
    $
    642
  10




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DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 5. Financing Arrangements and Liquidity
        11




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DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 5. Financing Arrangements and Liquidity (continued)
   6. Factored Accounts Receivable
 June 30,
    
    
    December 31,2007
    
    
    2006(in thousands)Receivables assigned to factor
    
    $
    4,490
    
    
    $
    1,094Advances from factor
    
    
    (3,592
    )
    
    
    (875
    )Amounts due from factor
    
    
    898
    
    
    
    219Unfactored accounts receivable
    
    
    10,101
    
    
    
    9,593Allowance for doubtful accounts
    
    
    (183
    )
    
    
    (203
    )$
    10,816
    
    
    $
    9,609
    12




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DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 7. Inventory
  June 30,
    
    
    December 31,2007
    
    
    2006(in thousands)Raw materials
    
    $
    5,470
    
    
    $
    3,291Work in process
    
    
    1,024
    
    
    
    402Finished goods
    
    
    7,953
    
    
    
    7,21514,447
    
    
    
    10,908Allowance for excess and obsolescence
    
    
    (1,153
    )
    
    
    (1,011
    )Net inventory
    
    $
    13,294
    
    
    $
    9,897
  8. Stock Options and Restricted Stock
 Stock Option Plans
     13




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DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 8. Stock Options and Restricted Stock (continued)
 Stock Option Activity
  2007
    
    
    2006Risk-free interest rate
    
    
    5.18-4.62
    %
    
    
    4.89
    %Expected life (in years)
    
    
    5
    
    
    
    4 - 10Dividend yield
    
    
    0.00
    %
    
    
    0.00
    %Expected volatility
    
    
    81.00-83.78
    %
    
    
    87.19
    %Weighted-average volatility
    
    
    83.57
    %
    
    
    87.19
    %
   WeightedWeighted
    
    
    Average
    
    
    AggregateStock
    
    
    Average
    
    
    Contractual
    
    
    IntrinsicOptions
    
    
    Exercise Price
    
    
    Term
    
    
    ValueOutstanding at January 1, 2007
    
    
    11,705
    
    
    $
    3.84Granted
    
    
    280
    
    
    
    2.68Exercised
    
    
    
    
    
    
    Forfeited or expired
    
    
    (1,246
    )
    
    
    3.85Outstanding at June 30, 2007
    
    
    10,739
    
    
    $
    3.81
    
    
    
    7.04
    
    
    $
    596
    *Vested or expected to vest at June 30, 2007
    
    
    10,235
    
    
    $
    3.83
    
    
    
    6.94
    
    
    $
    591
    *Exercisable at June 30, 2007
    
    
    8,858
    
    
    $
    3.94
    
    
    
    6.63
    
    
    $
    596
    *
 *
   WeightedAverageGrant-DateStock Options
    
    
    Fair ValueNonvested at January 1, 2007
    
    
    2,458
    
    
    $
    2.64Granted
    
    
    280
    
    
    
    1.81Vested
    
    
    (283
    )
    
    
    2.22Forfeited or expired
    
    
    (574
    )
    
    
    2.09Nonvested at June 30, 2007
    
    
    1,881
    
    
    $
    2.59
  14




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DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 8. Stock Options and Restricted Stock (continued)
    e
 Restricted Stock
   9. Segment Information
     15




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DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 9. Segment Information (continued)
         16




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DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 9. Segment Information (continued)
  Total FromAnimal
    
    
    GPS and Radio
    
    
    
    
    
    
    ContinuingAs of and For the Three Months Ended June 30,
    
    Applications
    
    
    Communications
    
    
    Corporate
    
    
    Operations(in thousands)2007Total net revenue
    
    $
    11,029
    
    
    $
    8,504
    
    
    $
    
    
    
    $
    19,533Operating loss
    
    
    (504
    )
    
    
    (510
    )
    
    
    (656
    )
    
    
    (1,670
    )Operating loss from continuing operations before
income taxes and minority interest
    
    
    (560
    )
    
    
    (562
    )
    
    
    (1,289
    )
    
    
    (2,411
    )Segment assets from continuing operations
    
    $
    77,103
    
    
    $
    18,301
    
    
    $
    (1,532
    )
    
    $
    93,8722006Total net revenue
    
    $
    8,375
    
    
    $
    4,053
    
    
    $
    
    
    
    $
    12,428Operating loss
    
    
    (718
    )
    
    
    (218
    )
    
    
    (610
    )
    
    
    (1,546
    )Operating loss from continuing operations before
income taxes and minority interest
    
    
    (743
    )
    
    
    (229
    )
    
    
    (576
    )
    
    
    (1,548
    )Segment assets from continuing operations
    
    $
    79,180
    
    
    $
    7,840
    
    
    $
    10
    
    
    $
    87,030
 Total FromAnimal
    
    
    GPS and Radio
    
    
    
    
    
    
    ContinuingAs of and For the Six Months Ended June 30,
    
    Applications
    
    
    Communications
    
    
    Corporate
    
    
    Operations(in thousands)2007Total net revenue
    
    $
    21,289
    
    
    $
    13,542
    
    
    $
    
    
    
    $
    34,831Operating loss
    
    
    (2,070
    )
    
    
    (1,083
    )
    
    
    (1,606
    )
    
    
    (4,759
    )Operating loss from continuing operations
before income taxes and minority interest
    
    
    (2,153
    )
    
    
    (1,160
    )
    
    
    (2,040
    )
    
    
    (5,353
    )Segment assets from continuing operations
    
    $
    77,103
    
    
    $
    18,301
    
    
    $
    (1,532
    )
    
    $
    93,8722006Total net revenue
    
    $
    19,877
    
    
    $
    7,870
    
    
    $
    
    
    
    $
    27,747Operating income (loss)
    
    
    163
    
    
    
    (355
    )
    
    
    (1,488
    )
    
    
    (1,681
    )Operating income (loss) from continuing
operations before income taxes and
minority interest
    
    
    119
    
    
    
    (376
    )
    
    
    (1,411
    )
    
    
    (1,668
    )Segment assets from continuing operations
    
    $
    79,180
    
    
    $
    7,840
    
    
    $
    10
    
    
    $
    87,030
 10. Supplemental Cash Flow Information
 Six Months EndedJune 30,2007
    
    
    2006(in thousands)Interest paid
    
    $
    232
    
    
    $
    199Taxes paid
    
    
    55
    
    
    
    59Non-cash activity:Issuance of common stock to former shareholders of DSD Holdings A/S
    
    
    
    
    
    
    1,000Reclass of other assets to acquisition cost
    
    
    494
    
    
    
    Financing of equipment through capital lease
    
    
    546
    
    
    
    352
  17




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##### Table of Contents



DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 11. Income Taxes
  12. Related Party Activity
   13. Legal Proceedings
 Digital Angel Corporation v. Datamars, Inc., Datamars, S.A., The Crystal Import Corporation and
Medical Management International, Inc.
  The Crystal Import Corporation v. Digital Angel, et al.
   18




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##### Table of Contents



DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 13. Legal Proceedings (continued)
 Settlement Negotiations
  14. Subsequent Events
      19




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
   Overview
  Animal Applications
 GPS and Radio Communications
 Significant Factors Affecting our Results of Operations and Financial Condition
   Recent Accounting Pronouncements
  Revenue Recognition for the McMurdo business
    20




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##### Table of Contents



Consolidated Results of Operations
  For the Three Months
    
    
    For the Six MonthsEnded June 30,
    
    
    Ended June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Total net revenue
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    60.7
    
    
    
    60.8
    
    
    
    61.8
    
    
    
    58.7Gross profit
    
    
    39.3
    
    
    
    39.2
    
    
    
    38.2
    
    
    
    41.3Selling, general and administrative expenses
    
    
    39.7
    
    
    
    45.7
    
    
    
    43.9
    
    
    
    41.9Research and development expenses
    
    
    8.1
    
    
    
    5.9
    
    
    
    8.0
    
    
    
    5.5Operating loss
    
    
    (8.5
    )
    
    
    (12.4
    )
    
    
    (13.7
    )
    
    
    (6.1
    )Interest income
    
    
    
    
    
    
    0.6
    
    
    
    0.1
    
    
    
    0.6Interest expense
    
    
    (3.4
    )
    
    
    (0.9
    )
    
    
    (2.9
    )
    
    
    (0.7
    )Change in derivative warrant liability
    
    
    (0.4
    )
    
    
    
    
    
    
    0.9
    
    
    
    Other income
    
    
    
    
    
    
    0.2
    
    
    
    0.1
    
    
    
    0.2Loss from continuing operations before
income taxes and minority interest
    
    
    (12.3
    )
    
    
    (12.5
    )
    
    
    (15.3
    )
    
    
    (6.0
    )Income tax (provision) benefit
    
    
    (0.1
    )
    
    
    (0.1
    )
    
    
    (0.1
    )
    
    
    0.2Minority interest share of loss (income)
    
    
    
    
    
    
    (0.1
    )
    
    
    
    
    
    
    (0.2
    )Loss from continuing operations
    
    
    (12.4
    )
    
    
    (12.7
    )
    
    
    (15.4
    )
    
    
    (6.0
    )Net loss from discontinued operations
    
    
    (1.6
    )
    
    
    (4.4
    )
    
    
    (2.4
    )
    
    
    (3.8
    )Net loss
    
    
    (14.0
    )%
    
    
    (17.1
    )%
    
    
    (17.8
    )%
    
    
    (9.8
    )%
  21




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##### Table of Contents



Results of Operations by Segment
 Three Months Ended June 30, 2007 Compared to Three Months Ended June 30, 2006
 Animal Applications
 Three Months Ended June 30,% of
    
    
    
    
    
    
    % of2007
    
    
    Revenue
    
    
    2006
    
    
    Revenue
    
    
    Change(in thousands, except percentages)Total net revenue
    
    $
    11,029
    
    
    
    100.0
    %
    
    $
    8,375
    
    
    
    100.0
    %
    
    $
    2,654
    
    
    
    31.7
    %Cost of sales
    
    
    7,214
    
    
    
    65.4
    
    
    
    5,568
    
    
    
    66.5
    
    
    
    1,646
    
    
    
    29.6Gross profit
    
    
    3,815
    
    
    
    34.6
    
    
    
    2,807
    
    
    
    33.5
    
    
    
    1,008
    
    
    
    35.9Selling, general and administrative expenses
    
    
    3,642
    
    
    
    33.0
    
    
    
    2,798
    
    
    
    33.4
    
    
    
    844
    
    
    
    30.2Research and development expenses
    
    
    677
    
    
    
    6.1
    
    
    
    727
    
    
    
    8.7
    
    
    
    (50
    )
    
    
    (6.9
    )Operating loss
    
    $
    (504
    )
    
    
    (4.5
    )%
    
    $
    (718
    )
    
    
    (8.6
    )%
    
    $
    214
    
    
    
    (29.8
    )
 Revenues
  Gross Profit and Gross Profit Margin
  Selling, General and Administrative Expenses
   22




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##### Table of Contents



Research and Development Expenses
  GPS and Radio Communications
 Three Months Ended June 30,% of
    
    
    
    
    
    
    % of2007
    
    
    Revenue
    
    
    2006
    
    
    Revenue
    
    
    Change(in thousands, except percentages)Total net revenue
    
    $
    8,504
    
    
    
    100.0
    %
    
    $
    4,053
    
    
    
    100.0
    %
    
    $
    4,451
    
    
    
    #
    %Cost of sales
    
    
    4,641
    
    
    
    54.6
    
    
    
    1,994
    
    
    
    49.2
    
    
    
    2,647
    
    
    
    #Gross profit
    
    
    3,863
    
    
    
    45.4
    
    
    
    2,059
    
    
    
    50.1
    
    
    
    1,804
    
    
    
    87.6Selling, general and administrative expenses
    
    
    3,464
    
    
    
    40.7
    
    
    
    2,277
    
    
    
    56.2
    
    
    
    1,187
    
    
    
    52.1Research and development expenses
    
    
    909
    
    
    
    10.7
    
    
    
    
    
    
    
    
    
    
    
    909
    
    
    
    #Operating loss
    
    $
    (510
    )
    
    
    (6.0
    )%
    
    $
    (218
    )
    
    
    (5.4
    )%
    
    $
    (292
    )
    
    
    #
  Revenues
  Gross Profit
  Selling, General and Administrative Expenses
   23




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##### Table of Contents



Research and Development Expenses
  Corporate
 Three Months Ended June 30,2007
    
    
    2006
    
    
    Change(in thousands, except percentages)Total net revenue
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    
    
    %Cost of sales
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gross profit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Selling, general and administrative expenses
    
    
    656
    
    
    
    610
    
    
    
    46
    
    
    
    7.5Research and development expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating loss
    
    $
    (656
    )
    
    $
    (610
    )
    
    $
    (46
    )
    
    
    7.5
 Selling, General and Administrative Expenses
  Consolidated
 Net Loss from Continuing Operations
  Interest Expense
  Derivative Warrant Liability
   24




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##### Table of Contents



Income Taxes
  Six Months Ended June 30, 2007 Compared to Six Months Ended June 30, 2006
 Animal Applications
 Six Months Ended June 30,% of
    
    
    
    
    
    
    % of2007
    
    
    Revenue
    
    
    2006
    
    
    Revenue
    
    
    Change(in thousands, except percentages)Total net revenue
    
    $
    21,289
    
    
    
    100.0
    %
    
    $
    19,878
    
    
    
    100.0
    %
    
    $
    1,411
    
    
    
    7.1
    %Cost of sales
    
    
    14,500
    
    
    
    68.1
    
    
    
    12,420
    
    
    
    62.5
    
    
    
    2,080
    
    
    
    16.7Gross profit
    
    
    6,789
    
    
    
    31.9
    
    
    
    7,458
    
    
    
    37.5
    
    
    
    (669
    )
    
    
    (9.0
    )Selling, general and administrative expenses
    
    
    7,580
    
    
    
    35.6
    
    
    
    5,772
    
    
    
    29.0
    
    
    
    1,808
    
    
    
    31.3Research and development expenses
    
    
    1,279
    
    
    
    6.0
    
    
    
    1,521
    
    
    
    7.7
    
    
    
    (242
    )
    
    
    (15.9
    )Operating loss
    
    $
    (2,070
    )
    
    
    (9.7
    )%
    
    $
    163
    
    
    
    0.8
    %
    
    $
    (2,234
    )
    
    
    #
  Revenues
  Gross Profit and Gross Profit Margin
   25




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##### Table of Contents



Selling, General and Administrative Expenses
  Research and Development Expenses
  GPS and Radio Communications
 Six Months Ended June 30,% of
    
    
    
    
    
    
    % of2007
    
    
    Revenue
    
    
    2006
    
    
    Revenue
    
    
    Change(in thousands, except percentages)Total net revenue
    
    $
    13,542
    
    
    
    100.0
    %
    
    $
    7,870
    
    
    
    100.0
    %
    
    $
    5,672
    
    
    
    72.1
    %Cost of sales
    
    
    7,009
    
    
    
    51.8
    
    
    
    3,855
    
    
    
    49.0
    
    
    
    3,154
    
    
    
    81.8Gross profit
    
    
    6,533
    
    
    
    48.2
    
    
    
    4,015
    
    
    
    51.0
    
    
    
    2,518
    
    
    
    62.7Selling, general and administrative expenses
    
    
    6,091
    
    
    
    45.0
    
    
    
    4,370
    
    
    
    55.5
    
    
    
    1,721
    
    
    
    39.4Research and development expenses
    
    
    1,525
    
    
    
    11.2
    
    
    
    
    
    
    
    
    
    
    
    1,525
    
    
    
    #Operating loss
    
    $
    (1,083
    )
    
    
    (8.0
    )%
    
    $
    (355
    )
    
    
    (4.5
    )%
    
    $
    (728
    )
    
    
    #
  Revenues
  Gross Profit
   26




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##### Table of Contents



Selling, General and Administrative Expenses
  Research and Development Expenses
  Corporate
 Six Months Ended June 30,2007
    
    
    2006
    
    
    Change(in thousands, except percentages)Total net revenue
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    
    
    %Cost of sales
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gross profit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Selling, general and administrative expenses
    
    
    1,606
    
    
    
    1,489
    
    
    
    117
    
    
    
    7.9Research and development expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating loss
    
    $
    (1,606
    )
    
    $
    (1,489
    )
    
    $
    (117
    )
    
    
    7.9
 Selling, General and Administrative Expense
  Consolidated
 Net Loss from Continuing Operations
   27




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##### Table of Contents



Interest Expense
  Derivative Warrant Liability
  Income Taxes
  Liquidity and Capital Resources From Continuing Operations
  Cash Flows
      28




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##### Table of Contents



Financing and Liquidity
  June 30,2007Mortgage notes payable-Animal Applications and Corporate facilities
    
    $
    2,197Line of Credit  DSD Holdings
    
    
    3,067Equipment Loans / Notes Payable  DSD Holdings
    
    
    1,299Capital lease obligations
    
    
    1,56510.25% Senior Secured Debenture
    
    
    6,000$
    14,128
 Equipment Loans-DSD Holdings
  Line of Credit-DSD Holdings
  Note Payable-DSD Holdings
  Invoice Discounting Agreement
   29




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##### Table of Contents



Revolving invoice funding facility
  10.25% Senior Secured Debenture
        30




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31




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##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     Cautionary Note Regarding Forward-Looking Statements
  
    
    our expectations that orders for our companion pet
implantable microchips will exceed 4 million chips by year end;
    
    our expectations relating to increased sales to fish and
wildlife customers in the third quarter of 2007;
    
    our belief that McMurdo will provide us with more predictable
revenue in our search and rescue beacon business going forward;
    
    our expectations regarding the amounts, taxability and timing of the gain on the sale of OuterLink;
    
    our expectations regarding the timing of finalizing the
purchase price allocation for the McMurdo transaction;
    
    our expectations regarding the amount and timing of a write
off of deferred financing costs and debt discount in connection with
the debenture;
    
    our expectations regarding the amount and timing of revenue
to be earned from our contract with the U.S. Air Force regarding the replacement of the URT33 beacon;
    
    our expectations that our legal expenses will decrease going
forward;
    
    our expectation regarding the weighted average period over which the total unrecognized
compensation cost related to nonvested share-based compensation will be recognized;
    
    our expectations regarding the effect of the adoption of certain Accounting Standards;
    
    our intent to classify any future expense for income tax-related interest and penalties as a component of income taxes; and
    
    our expectations regarding the principal uses and sources of liquidity and our ability
to generate sufficient cash from operations to fund our business over the next 12 months.
  32




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##### Table of Contents




    
    our ability to successfully implement our business strategy;
    
    our ability to generate cash from operations and financing
activities in amounts sufficient to fund our operations over the next
twelve months and continue as a going concern;
    
    our ability to consummate the merger transaction with Applied
Digital and fund the costs associated with the transaction;
    
    our ability to successfully integrate the assets acquired in the McMurdo acquisition and realize the anticipated savings;
    
    our ability to comply with the financial covenants in our debenture and the obligations
in the registration rights agreements;
    
    the impact of Applied Digitals voting control over us;
    
    conflicts of interest among Applied Digital, VeriChip and us;
    
    our reliance on a single source supplier for our implantable microchip;
    
    our expectation that we will continue to incur consolidated operating losses for the foreseeable future;
    
    our ability to compete as our competitors improve the performance of and support for
their new products, and as they introduce new products, technologies or services;
    
    our ability to fund the severance payments and benefits due
to Mr. McGrath;
    
    our reliance on government contractors;
    
    the negative impact of the expiration of patents in 2008 and 2009 relating to the implantable microchip technology;
    
    our ability to successfully defend against infringements of our patents;
    
    our ability to comply with current and future regulations relating to our businesses;
    
    the impact of technological obsolescence;
    
    our ability to successfully mitigate the risks associated with foreign operations;
    
    the impact of new accounting pronouncements; and
    
    our ability to maintain proper and effective internal accounting and financial controls.
 
 ITEM 4T. CONTROLS AND PROCEDURES
 Evaluation of Disclosure Controls and Procedures
  Change in Internal Control Over Financial Reporting
 
  33




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##### Table of Contents



PART II  OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
  
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  
 ITEM 5. OTHER INFORMATION
 Appointment of Barry Edelstein as President and Chief Executive Officer to Replace Kevin McGrath
   ,
   34




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##### Table of Contents



ITEM 6. EXHIBITS
  ExhibitNumber
    
    Description10.29
    
    First Amendment to Amended and Restated Supply, License and
Development Agreement dated as of May 9, 2007 by and between
Digital Angel Corporation and VeriChip Corporation10.30
    
    Letter Agreement dated August 6, 2007 by and between Digital Angel
Corporation and Kevin N. McGrath31.1
    
    Certification of the Chief Executive Officer of Digital Angel
Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of
200231.2
    
    Certification of the Acting Chief Financial Officer of Digital
Angel Corporation pursuant to Section 302 of the Sarbanes-Oxley
Act of 200232.1
    
    Certification of the Chief Executive Officer of Digital Angel
Corporation pursuant to Section 906 of the Sarbanes-Oxley Act of
200232.2
    
    Certification of the Acting Chief Financial Officer of Digital
Angel Corporation pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
 
 
    
    Confidential treatment has been requested with respect to certain portions of this exhibit.
Omitted portions have been filed separately with the Securities Exchange Commission.  35




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##### Table of Contents



SIGNATURES
  DIGITAL ANGEL CORPORATION
(Registrant)Date: August 10, 2007
    By:
    /s/ Barry M. EdelsteinName:
    Barry M. EdelsteinTitle:
    President, Chief Executive Officer and
Director
(Principal Executive Officer)Date: August 10, 2007
    By:
    /s/ Lorraine M. BreeceName:
    Lorraine M. BreeceTitle:
    Vice President,
Treasurer and Acting
Chief Financial Officer(Principal Accounting and Financial Officer)  36




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##### Table of Contents



INDEX TO EXHIBITS
 ExhibitNumber
    
    Description10.29
    
    First Amendment to Amended and Restated Supply, License and
Development Agreement dated as of May 9, 2007 by and between
Digital Angel Corporation and VeriChip Corporation10.30
    
    Letter Agreement dated August 6, 2007 by and between Digital Angel
Corporation and Kevin N. McGrath31.1
    
    Certification of the Chief Executive Officer of Digital Angel
Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of
200231.2
    
    Certification of the Acting Chief Financial Officer of Digital
Angel Corporation pursuant to Section 302 of the Sarbanes-Oxley
Act of 200232.1
    
    Certification of the Chief Executive Officer of Digital Angel
Corporation pursuant to Section 906 of the Sarbanes-Oxley Act of
200232.2
    
    Certification of the Acting Chief Financial Officer of Digital
Angel Corporation pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
 
 
    
    Confidential treatment has been requested with respect to certain portions of this exhibit.
Omitted portions have been filed separately with the Securities Exchange Commission.  37