##### 



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 September 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 November 5, 2007Common Stock, $.005 par value per share
    
    45,894,933 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 September 30, 2007 and December 31, 2006
    
    
    3Condensed Consolidated Statements of Operations  Three months and nine months ended September 30, 2007 and 2006
    
    
    4Condensed Consolidated Statement of Changes in Stockholders' Equity  Nine months ended September 30, 2007
    
    
    5Condensed Consolidated Statements of Cash Flows  Nine months ended September 30, 2007 and 2006
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2.
    
    Management's Discussion and Analysis of Financial Condition and Results of Operations
    
    
    21Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    33Item 4T.
    
    Controls and Procedures
    
    
    34PART II  Other InformationItem 1.
    
    Legal Proceedings
    
    
    35Item 1A.
    
    Risk Factors
    
    
    35Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    35Item 6.
    
    Exhibits
    
    
    35Signatures
    
    
    36
  2




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##### 



PART I  FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 
 DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
 September 30,
    
    
    December 31,2007
    
    
    2006(unaudited)Assets (Note 6)Current assetsCash
    
    $
    1,461
    
    
    $
    1,521Restricted cash
    
    
    137
    
    
    
    81Accounts receivable, net of allowance for doubtful accounts of $184 and $203 at September 30,
2007 and December 31, 2006, respectively
    
    
    12,531
    
    
    
    9,609Accounts receivable from VeriChip Corporation
    
    
    
    
    
    
    425Inventories
    
    
    14,232
    
    
    
    9,897Other current assets
    
    
    1,929
    
    
    
    2,016Current assets from discontinued operations
    
    
    
    
    
    
    2,335Total current assets
    
    
    30,290
    
    
    
    25,884Property and equipment, net
    
    
    11,615
    
    
    
    9,985Goodwill
    
    
    53,335
    
    
    
    51,244Other intangible assets, net
    
    
    1,568
    
    
    
    1,633Other assets, net
    
    
    548
    
    
    
    619Other assets from discontinued operations
    
    
    
    
    
    
    531Total Assets
    
    $
    97,356
    
    
    $
    89,896Liabilities and Stockholders EquityCurrent liabilitiesLine of credit and current maturities of long-term debt
    
    $
    8,063
    
    
    $
    4,127Note payable with Applied Digital Solutions, Inc.
    
    
    1,167
    
    
    
    Accounts payable
    
    
    9,388
    
    
    
    6,024Due to Applied Digital Solutions, Inc.
    
    
    137
    
    
    
    11Accrued expenses and other current liabilities
    
    
    4,088
    
    
    
    2,793Current liabilities from discontinued operations
    
    
    
    
    
    
    2,448Total current liabilities
    
    
    22,843
    
    
    
    15,403Long-term debt
    
    
    3,837
    
    
    
    4,036Note payable with Applied Digital Solutions, Inc.
    
    
    4,405
    
    
    
    Other long-term liabilitiesDerivative warrant liability
    
    
    717
    
    
    
    Other long-term liabilities
    
    
    363
    
    
    
    386Other liabilities from discontinued operations
    
    
    
    
    
    
    1,060Total other long-term liabilities
    
    
    1,080
    
    
    
    1,446Total Liabilities
    
    
    32,165
    
    
    
    20,885Minority interest
    
    
    473
    
    
    
    465Stockholders equityPreferred stock ($1.75 par value; shares authorized, 1,000; shares issued and outstanding, nil)
    
    
    
    
    
    
    Common stock ($0.005 par value; shares authorized, 95,000; shares issued, 46,248 and 44,894;
shares outstanding, 45,870 and 44,516)
    
    
    231
    
    
    
    226Additional paid-in capital
    
    
    218,153
    
    
    
    214,509Accumulated deficit
    
    
    (152,564
    )
    
    
    (144,753
    )Treasury
stock (carried at cost, 378 common and preferred shares)
    
    
    (1,582
    )
    
    
    (1,580
    )Accumulated other comprehensive income
    
    
    480
    
    
    
    144Total Stockholders Equity
    
    
    64,718
    
    
    
    68,546Total Liabilities and Stockholders Equity
    
    $
    97,356
    
    
    $
    89,896
 See Notes to Condensed Consolidated Financial Statements.
  3




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##### 



DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
 For the Three Months
    
    
    For the Nine MonthsEnded September 30,
    
    
    Ended September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Revenue
    
    $
    20,335
    
    
    $
    12,400
    
    
    $
    55,166
    
    
    $
    40,147Cost of sales
    
    
    12,096
    
    
    
    7,150
    
    
    
    33,605
    
    
    
    23,425Gross profit
    
    
    8,239
    
    
    
    5,250
    
    
    
    21,561
    
    
    
    16,722Selling, general and administrative expenses
    
    
    8,517
    
    
    
    5,633
    
    
    
    23,568
    
    
    
    17,264Research and development expenses
    
    
    830
    
    
    
    765
    
    
    
    3,634
    
    
    
    2,287Merger expenses
    
    
    560
    
    
    
    
    
    
    
    786
    
    
    
    Operating loss
    
    
    (1,668
    )
    
    
    (1,148
    )
    
    
    (6,427
    )
    
    
    (2,829
    )Interest income
    
    
    8
    
    
    
    64
    
    
    
    53
    
    
    
    238Interest expense
    
    
    (2,295
    )
    
    
    (117
    )
    
    
    (3,293
    )
    
    
    (323
    )Change in derivative warrant liability
    
    
    241
    
    
    
    
    
    
    
    537
    
    
    
    Other income
    
    
    858
    
    
    
    27
    
    
    
    921
    
    
    
    72Loss from continuing operations before income
taxes and minority interest
    
    
    (2,856
    )
    
    
    (1,174
    )
    
    
    (8,209
    )
    
    
    (2,842
    )Income tax (provision) benefit
    
    
    (359
    )
    
    
    (4
    )
    
    
    (397
    )
    
    
    68Minority
interest share of income
    
    
    (92
    )
    
    
    (2
    )
    
    
    (77
    )
    
    
    (59
    )Net loss from continuing operations
    
    
    (3,307
    )
    
    
    (1,180
    )
    
    
    (8,683
    )
    
    
    (2,833
    )Income (loss) from discontinued operations,
including gain on sale of $1,705 on July 2,
2007
    
    
    1,705
    
    
    
    (255
    )
    
    
    872
    
    
    
    (1,312
    )Net loss
    
    $
    (1,602
    )
    
    $
    (1,435
    )
    
    $
    (7,811
    )
    
    $
    (4,145
    )Earnings per common share  basic and dilutedLoss from continuing operations
    
    $
    (0.08
    )
    
    $
    (0.02
    )
    
    $
    (0.19
    )
    
    $
    (0.06
    )Income (loss) from discontinued operations
    
    
    0.04
    
    
    
    (0.01
    )
    
    
    0.02
    
    
    
    (0.03
    )Net loss
    
    $
    (0.04
    )
    
    $
    (0.03
    )
    
    $
    (0.17
    )
    
    $
    (0.09
    )Weighted average common shares outstanding 
basic and diluted
    
    
    45,023
    
    
    
    44,516
    
    
    
    44,701
    
    
    
    44,238
 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 Nine Months Ended September 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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,811
    )
    
    
    
    
    
    
    
    
    
    
    (7,811
    )Comprehensive loss:Foreign currency translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    336
    
    
    
    336Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,475
    )Issuance of stock to Applied Digital
Solutions, Inc.
    
    
    
    
    
    
    
    
    
    
    921
    
    
    
    4
    
    
    
    1,424
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,428Issuance of warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,044
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,044Compensation expense
    
    
    
    
    
    
    
    
    
    
    433
    
    
    
    1
    
    
    
    1,176
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,177Repurchase of preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    (2
    )Balance, September 30, 2007
    
    
    
    
    
    $
    
    
    
    
    46,248
    
    
    $
    231
    
    
    $
    218,153
    
    
    $
    (152,564
    )
    
    $
    (1,582
    )
    
    $
    480
    
    
    $
    64,718
 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 Nine MonthsEnded September 30,2007
    
    
    2006Cash Flows From Operating ActivitiesNet loss
    
    $
    (7,811
    )
    
    $
    (4,145
    )Adjustments to reconcile net loss to net cash used in operating activities:Equity-based compensation
    
    
    1,177
    
    
    
    566Depreciation and amortization
    
    
    1,801
    
    
    
    1,436Amortization of debt discount and financing costs
    
    
    2,048
    
    
    
    Change in derivative warrant liability
    
    
    (537
    )
    
    
    Minority interest
    
    
    77
    
    
    
    59Loss on disposal of equipment
    
    
    6
    
    
    
    6(Income) loss from discontinued operations
    
    
    (872
    )
    
    
    1,311Change in assets and liabilities:(Increase) decrease in restricted cash
    
    
    (57
    )
    
    
    187(Increase) decrease in accounts receivable
    
    
    (2,677
    )
    
    
    2,356Decrease (increase) in accounts receivable from VeriChip Corporation
    
    
    425
    
    
    
    (31
    )Increase in inventories
    
    
    (1,777
    )
    
    
    (1,811
    )Increase (decrease) increase in other current assets
    
    
    97
    
    
    
    (714
    )Decrease in deferred tax liability
    
    
    (18
    )
    
    
    (15
    )Increase (decrease) in accounts payable and accrued expenses
    
    
    4,657
    
    
    
    (3,338
    )Net cash (used in) provided by discontinued operations
    
    
    (258
    )
    
    
    240Net Cash Used in Operating Activities
    
    
    (3,719
    )
    
    
    (3,894
    )Cash Flows From Investing ActivitiesDecrease in other assets
    
    
    10
    
    
    
    139Payments for property and equipment
    
    
    (1,549
    )
    
    
    (1,767
    )Net cash paid for acquisition
    
    
    (4,277
    )
    
    
    (1,000
    )Net cash provided by (used in) discontinued operations
    
    
    258
    
    
    
    (264
    )Net Cash Used in Investing Activities
    
    
    (5,558
    )
    
    
    (2,891
    )Cash Flows From Financing ActivitiesBorrowings on line of credit
    
    
    12,363
    
    
    
    3,512Payments on line of credit
    
    
    (7,848
    )
    
    
    (2,678
    )Borrowings on debt
    
    
    6,022
    
    
    
    Payments on notes payable and long-term debt
    
    
    (7,036
    )
    
    
    (579
    )Borrowings on note payable with Applied Digital Solutions, Inc.
    
    
    7,000
    
    
    
    Exercise of stock options and warrants
    
    
    
    
    
    
    559Payments of dividends to minority shareholder in subsidiary
    
    
    (106
    )
    
    
    (140
    )Payments for financing costs
    
    
    (1,205
    )
    
    
    Purchase of treasury stock
    
    
    (2
    )
    
    
    Net Cash Provided by Financing Activities
    
    
    9,188
    
    
    
    673Effect of Exchange Rate Changes on Cash
    
    
    29
    
    
    
    25Net Decrease In Cash
    
    
    (60
    )
    
    
    (6,087
    )Cash  Beginning of Period
    
    
    1,521
    
    
    
    9,949Cash  End of Period
    
    $
    1,461
    
    
    $
    3,862
 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. Merger Agreement
   7




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##### 



DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 2. Merger Agreement (continued)
  3. Recent and Not Yet Adopted Accounting Pronouncements
     4. Acquisition
   8




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##### 



DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 4. Acquisition (continued)
   April 5, 2007(in thousands)Inventory
    
    $
    592Fixed assets
    
    
    2,178Goodwill and other intangibles
    
    
    1,972Total assets acquired
    
    $
    4,742
   Pro Forma for the
    
    
    Pro Forma for the
    
    
    Pro Forma for theThree Months Ended
    
    
    Nine Months Ended
    
    
    Nine Months EndedSeptember 30, 2006
    
    
    September 30, 2007
    
    
    September 30, 2006(unaudited, in thousands)Net operating revenue
    
    $
    15,707
    
    
    $
    59,344
    
    
    $
    48,892Net loss from continuing operations
    
    
    (1,439
    )
    
    
    (8,339
    )
    
    
    (4,026
    )Net loss from continuing
operations per common share 
basic and diluted
    
    
    (0.03
    )
    
    
    (0.19
    )
    
    
    (0.09
    )
  9




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##### 



DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 5. Discontinued Operations
 
   Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006(unaudited, in thousands)
    
    
    (unaudited, in thousands)Revenue
    
    $
    
    
    
    $
    791
    
    
    $
    1,417
    
    
    $
    1,822Cost of sales
    
    
    
    
    
    
    401
    
    
    
    853
    
    
    
    1,066Gross profit
    
    
    
    
    
    
    390
    
    
    
    564
    
    
    
    756Selling, general and administrative expenses
    
    
    
    
    
    
    313
    
    
    
    730
    
    
    
    916Research and development expenses
    
    
    
    
    
    
    332
    
    
    
    667
    
    
    
    1,152Interest income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2
    )Gain on sale
    
    
    1,705
    
    
    
    
    
    
    
    1,705
    
    
    
    Income (loss) from discontinued operations
    
    $
    1,705
    
    
    $
    (255
    )
    
    $
    872
    
    
    $
    (1,312
    )Earnings per common share  basic and diluted:Income (loss) from discontinued operations
    
    $
    0.04
    
    
    $
    (0.01
    )
    
    $
    0.02
    
    
    $
    (0.03
    )
   10




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##### 



DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 5. Discontinued Operations (continued)
  December 31,2006(in thousands)Current assetsCash
    
    $
    2Accounts receivable
    
    
    956Inventory
    
    
    503Other current assets
    
    
    874Total current assets
    
    
    2,335Property and equipment, net
    
    
    274Other assets, net
    
    
    257Total long-term assets
    
    
    531Total assets
    
    $
    2,866Current liabilitiesAccounts payable
    
    
    408Accrued expenses and other current liabilities
    
    
    270Deferred revenue
    
    
    1,770Total current liabilities
    
    
    2,448Other long-term liabilities
    
    
    1,060Total liabilities
    
    $
    3,508Net liabilities from discontinued operations
    
    $
    642
 6. Financing Arrangements
     11




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##### 



DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 6. Financing Arrangements (continued)
         12




---



##### 



DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 7. Accounts Receivable
 September 30,
    
    
    December 31,2007
    
    
    2006(in thousands)Receivables assigned to factor
    
    $
    2,249
    
    
    $
    1,094Advances from factor
    
    
    (1,799
    )
    
    
    (875
    )Amounts due from factor
    
    
    450
    
    
    
    219Unfactored accounts receivable
    
    
    12,265
    
    
    
    9,593Allowance for doubtful accounts
    
    
    (184
    )
    
    
    (203
    )$
    12,531
    
    
    $
    9,609
 
  8. Inventory
  September 30,
    
    
    December 31,2007
    
    
    2006(in thousands)Raw materials
    
    $
    6,306
    
    
    $
    3,291Work in process
    
    
    1,380
    
    
    
    402Finished goods
    
    
    7,918
    
    
    
    7,21515,604
    
    
    
    10,908Allowance for excess and obsolescence
    
    
    (1,372
    )
    
    
    (1,011
    )Net inventory
    
    $
    14,232
    
    
    $
    9,897
  9.
Other Income
   13




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##### 



DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 10. Stock Options and Restricted Stock
 Stock Option Plans
      Stock Option Activity
  2007
    
    
    2006Risk-free interest rate
    
    
    4.5  5.2
    %
    
    
    5.0
    %Expected life (in years)
    
    
    5.0
    
    
    
    8.4Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %Expected volatility
    
    
    80.9  131.2
    %
    
    
    106.1  113.3
    %Weighted-average volatility
    
    
    95.9
    %
    
    
    108.8
    %
  14




---



##### 



DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 10. Stock Options and Restricted Stock (continued)
   WeightedWeighted
    
    
    Average
    
    
    AggregateStock
    
    
    Average
    
    
    Contractual
    
    
    IntrinsicOptions
    
    
    Exercise Price
    
    
    Term
    
    
    ValueOutstanding at January 1, 2007
    
    
    11,705
    
    
    $
    3.84Granted
    
    
    520
    
    
    
    2.11Exercised
    
    
    
    
    
    
    Forfeited or expired
    
    
    (1,614
    )
    
    
    3.87Outstanding at September 30, 2007
    
    
    10,611
    
    
    $
    3.75
    
    
    
    6.85
    
    
    $
    470
    *Vested or expected to vest at September 30, 2007
    
    
    10,108
    
    
    $
    3.78
    
    
    
    6.75
    
    
    $
    470
    *Exercisable at September 30, 2007
    
    
    8,569
    
    
    $
    3.93
    
    
    
    6.59
    
    
    $
    470
    *
 *
    
    The intrinsic value of a stock option is the amount by which the market value of
the underlying stock exceeds the exercise price of the option. The market value of the Companys
common stock was $1.29 per share at September 30, 2007.
   WeightedAverageGrant-DateStock Options
    
    
    Fair ValueNonvested at January 1, 2007
    
    
    2,458
    
    
    $
    2.64Granted
    
    
    520
    
    
    
    1.39Vested
    
    
    (303
    )
    
    
    2.19Forfeited or expired
    
    
    (633
    )
    
    
    2.11Nonvested at September 30, 2007
    
    
    2,042
    
    
    $
    1.94
   Restricted Stock
   15




---



##### 



DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 10. Stock Options and Restricted Stock (continued)
    11. Segment Information
       16




---



##### 



DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 11. Segment Information (continued)
   
     .
  17




---



##### 



DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 11. Segment Information (continued)
  Total FromAnimal
    
    
    GPS and Radio
    
    
    
    
    
    
    ContinuingAs of and For the Three Months Ended September 30,
    
    Applications
    
    
    Communications
    
    
    Corporate
    
    
    Operations(in thousands)2007Revenue
    
    $
    10,346
    
    
    $
    9,989
    
    
    $
    
    
    
    $
    20,335Operating (loss) income
    
    
    (338
    )
    
    
    986
    
    
    
    (2,316
    )
    
    
    (1,668
    )Operating (loss) income from continuing
operations before income taxes and
minority interest
    
    
    (382
    )
    
    
    945
    
    
    
    (3,419
    )
    
    
    (2,856
    )Segment assets from continuing operations
    
    $
    77,723
    
    
    $
    19,513
    
    
    $
    120
    
    
    $
    97,3562006Revenue
    
    $
    8,254
    
    
    $
    4,146
    
    
    $
    
    
    
    $
    12,400Operating loss
    
    
    (155
    )
    
    
    (311
    )
    
    
    (682
    )
    
    
    (1,148
    )Operating loss from continuing
operations before income taxes and
minority interest
    
    
    (181
    )
    
    
    (326
    )
    
    
    (667
    )
    
    
    (1,174
    )Segment assets from continuing operations
    
    $
    78,041
    
    
    $
    8,303
    
    
    $
    
    
    
    $
    86,344
 Total FromAnimal
    
    
    GPS and Radio
    
    
    
    
    
    
    ContinuingAs of and For the Nine Months Ended September 30,
    
    Applications
    
    
    Communications
    
    
    Corporate
    
    
    Operations(in thousands)2007Revenue
    
    $
    31,635
    
    
    $
    23,531
    
    
    $
    
    
    
    $
    55,166Operating loss
    
    
    (2,183
    )
    
    
    (97
    )
    
    
    (4,147
    )
    
    
    (6,427
    )Operating loss from continuing operations before
income taxes and minority interest
    
    
    (2,310
    )
    
    
    (215
    )
    
    
    (5,684
    )
    
    
    (8,209
    )Segment assets from continuing operations
    
    $
    77,723
    
    
    $
    19,513
    
    
    $
    120
    
    
    $
    97,3562006Revenue
    
    $
    28,131
    
    
    $
    12,016
    
    
    $
    
    
    
    $
    40,147Operating income (loss)
    
    
    8
    
    
    
    (666
    )
    
    
    (2,171
    )
    
    
    (2,829
    )Operating loss from continuing operations before
income taxes and minority interest
    
    
    (62
    )
    
    
    (702
    )
    
    
    (2,078
    )
    
    
    (2,842
    )Segment assets from continuing operations
    
    $
    78,041
    
    
    $
    8,303
    
    
    $
    
    
    
    $
    86,344
 12. Supplemental Cash Flow Information
 Nine Months EndedSeptember 30,2007
    
    
    2006(in thousands)Interest paid
    
    $
    1,241
    
    
    $
    316Taxes paid
    
    
    70
    
    
    
    80Non-cash activity:Issuance of common stock to former shareholders of DSD Holding A/S
    
    
    
    
    
    
    1,000Reclass of other assets to acquisition cost
    
    
    494
    
    
    
    Liability
recorded for warrants issued in connection with the debenture
    
    
    1,253
    
    
    
    Issuance of warrants to Kallina
    
    
    1,044
    
    
    
    Issuance of common stock to Applied Digital as a debt discount
    
    
    1,428
    
    
    
    Financing of equipment through capital lease
    
    
    871
    
    
    
    440
  18




---



##### 



DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 13. Income Taxes
   14. Related Party Activity
       19




---



##### 



DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)
 15. 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.
  Datamars and Crystal Import Settlements
  16. Recent Events
 Appointment of Barry Edelstein
as Interim President and Chief Executive Officer to
Replace Kevin McGrath
   20




---



##### 



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
      21




---



##### 



Recent Accounting Pronouncements
  Revenue Recognition for the McMurdo Business
   Consolidated Results of Operations
  For the Three Months
    
    
    For the Nine MonthsEnded September 30,
    
    
    Ended September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Revenue
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    59.5
    
    
    
    57.7
    
    
    
    60.9
    
    
    
    58.3Gross profit
    
    
    40.5
    
    
    
    42.3
    
    
    
    39.1
    
    
    
    41.7Selling, general and administrative expenses
    
    
    41.9
    
    
    
    45.4
    
    
    
    42.7
    
    
    
    43.0Research and development expenses
    
    
    4.1
    
    
    
    6.2
    
    
    
    6.6
    
    
    
    5.7Merger expenses
    
    
    2.7
    
    
    
    
    
    
    
    1.5
    
    
    
    Operating loss
    
    
    (8.2
    )
    
    
    (9.3
    )
    
    
    (11.7
    )
    
    
    (7.0
    )Interest income
    
    
    
    
    
    
    0.5
    
    
    
    0.1
    
    
    
    0.6Interest expense
    
    
    (11.3
    )
    
    
    (0.9
    )
    
    
    (6.0
    )
    
    
    (0.8
    )Change in derivative warrant liability
    
    
    1.2
    
    
    
    
    
    
    
    1.0
    
    
    
    Other income
    
    
    4.2
    
    
    
    0.2
    
    
    
    1.7
    
    
    
    0.2Loss from continuing operations before income
taxes and minority interest
    
    
    (14.1
    )
    
    
    (9.5
    )
    
    
    (14.9
    )
    
    
    (7.0
    )Income tax (provision) benefit
    
    
    (1.8
    )
    
    
    
    
    
    
    (0.7
    )
    
    
    0.2Minority interest share of loss (income)
    
    
    (0.4
    )
    
    
    
    
    
    
    (0.1
    )
    
    
    0.1Loss from continuing operations
    
    
    (16.3
    )
    
    
    (9.5
    )
    
    
    (15.7
    )
    
    
    (7.1
    )Net income (loss) from discontinued operations
    
    
    8.4
    
    
    
    (2.1
    )
    
    
    1.6
    
    
    
    (3.2
    )Net loss
    
    
    (7.9
    )%
    
    
    (11.6
    )%
    
    
    (14.1
    )%
    
    
    (10.3
    )%
  22




---



##### 



Results of Operations by Segment
 Three Months Ended September 30, 2007 Compared to Three Months Ended September 30, 2006
 Animal Applications
 Three Months Ended September 30,% of
    
    
    
    
    
    
    % of2007
    
    
    Revenue
    
    
    2006
    
    
    Revenue
    
    
    Change(in thousands, except percentages)Revenue
    
    $
    10,346
    
    
    
    100.0
    %
    
    $
    8,254
    
    
    
    100.0
    %
    
    $
    2,092
    
    
    
    25.4
    %Cost of sales
    
    
    7,132
    
    
    
    68.9
    
    
    
    5,152
    
    
    
    62.4
    
    
    
    1,980
    
    
    
    38.4Gross profit
    
    
    3,214
    
    
    
    31.1
    
    
    
    3,102
    
    
    
    37.6
    
    
    
    112
    
    
    
    3.6Selling, general and administrative expenses
    
    
    2,967
    
    
    
    28.7
    
    
    
    2,683
    
    
    
    32.5
    
    
    
    284
    
    
    
    10.6Research and development expenses
    
    
    585
    
    
    
    5.7
    
    
    
    574
    
    
    
    7.0
    
    
    
    11
    
    
    
    1.9Operating loss
    
    $
    (338
    )
    
    
    (3.3
    )%
    
    $
    (155
    )
    
    
    (1.9
    )%
    
    $
    (183
    )
    
    
    #
  Revenues
  Gross Profit and Gross Profit Margin
  Selling, General and Administrative Expenses
  Research and Development Expenses
   23




---



##### 



GPS and Radio Communications
 Three Months Ended September 30,% of
    
    
    
    
    
    
    % of2007
    
    
    Revenue
    
    
    2006
    
    
    Revenue
    
    
    Change(in thousands, except percentages)Revenue
    
    $
    9,989
    
    
    
    100.0
    %
    
    $
    4,146
    
    
    
    100.0
    %
    
    $
    5,843
    
    
    
    #
    %Cost of sales
    
    
    4,964
    
    
    
    49.7
    
    
    
    1,998
    
    
    
    48.2
    
    
    
    2,966
    
    
    
    #Gross profit
    
    
    5,025
    
    
    
    50.3
    
    
    
    2,148
    
    
    
    51.8
    
    
    
    2,877
    
    
    
    #Selling, general and administrative expenses
    
    
    3,794
    
    
    
    38.0
    
    
    
    2,268
    
    
    
    54.7
    
    
    
    1,526
    
    
    
    67.3Research and development expenses
    
    
    245
    
    
    
    2.5
    
    
    
    191
    
    
    
    4.6
    
    
    
    54
    
    
    
    28.3Operating income (loss)
    
    $
    986
    
    
    
    9.9
    %
    
    $
    (311
    )
    
    
    (7.5
    )%
    
    $
    1,297
    
    
    
    #
  Revenues
  Gross Profit and Gross Profit Margin
  Selling, General and Administrative Expenses
  Research and Development Expenses
   24




---



##### 



Corporate
 Three Months Ended September 30,2007
    
    
    2006
    
    
    Change(in thousands, except percentages)Revenue
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    
    
    %Cost of sales
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gross profit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Selling, general and administrative expenses
    
    
    1,756
    
    
    
    682
    
    
    
    1,074
    
    
    
    #Research and development expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Merger expenses
    
    
    560
    
    
    
    
    
    
    
    560
    
    
    
    #Operating loss
    
    $
    (2,316
    )
    
    $
    (682
    )
    
    $
    (1,634
    )
    
    
    #
  Selling, General and Administrative Expenses
  Merger Expenses
  Consolidated
 Interest Expense
  Derivative Warrant Liability
  Other
Income
  Income Taxes
   25




---



##### 



Net Loss from Continuing Operations
  Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006
 Animal Applications
 Nine Months Ended September 30,% of
    
    
    
    
    
    
    % of2007
    
    
    Revenue
    
    
    2006
    
    
    Revenue
    
    
    Change(in thousands, except percentages)Revenue
    
    $
    31,635
    
    
    
    100.0
    %
    
    $
    28,131
    
    
    
    100.0
    %
    
    $
    3,504
    
    
    
    12.5
    %Cost of sales
    
    
    21,632
    
    
    
    68.4
    
    
    
    17,572
    
    
    
    62.5
    
    
    
    4,060
    
    
    
    23.1Gross profit
    
    
    10,003
    
    
    
    31.6
    
    
    
    10,559
    
    
    
    37.5
    
    
    
    (556
    )
    
    
    (5.3
    )Selling, general and administrative expenses
    
    
    10,322
    
    
    
    32.6
    
    
    
    8,455
    
    
    
    30.1
    
    
    
    1,867
    
    
    
    22.1Research and development expenses
    
    
    1,864
    
    
    
    5.9
    
    
    
    2,096
    
    
    
    7.4
    
    
    
    (232
    )
    
    
    (11.2
    )Operating (loss) income
    
    $
    (2,310
    )
    
    
    (7.3
    )%
    
    $
    8
    
    
    
    
    %
    
    $
    (2,318
    )
    
    
    #
  Revenues
  Gross Profit and Gross Profit Margin
   26




---



##### 



Selling, General and Administrative Expenses
  Research and Development Expenses
  GPS and Radio Communications
 Nine Months Ended September 30,% of
    
    
    
    
    
    
    % of2007
    
    
    Revenue
    
    
    2006
    
    
    Revenue
    
    
    Change(in thousands, except percentages)Revenue
    
    $
    23,531
    
    
    
    100.0
    %
    
    $
    12,016
    
    
    
    100.0
    %
    
    $
    11,515
    
    
    
    95.8
    %Cost of sales
    
    
    11,973
    
    
    
    50.9
    
    
    
    5,853
    
    
    
    48.7
    
    
    
    6,120
    
    
    
    #Gross profit
    
    
    11,558
    
    
    
    49.1
    
    
    
    6,163
    
    
    
    51.3
    
    
    
    5,395
    
    
    
    87.5Selling, general and administrative expenses
    
    
    9,885
    
    
    
    42.0
    
    
    
    6,638
    
    
    
    55.2
    
    
    
    3,247
    
    
    
    48.9Research and development expenses
    
    
    1,770
    
    
    
    7.5
    
    
    
    191
    
    
    
    1.6
    
    
    
    1,579
    
    
    
    #Operating loss
    
    $
    (97
    )
    
    
    (0.4
    )%
    
    $
    (666
    )
    
    
    (5.5
    )%
    
    $
    569
    
    
    
    (85.4
    )
  Revenues
  Gross Profit and Gross Profit Margin
   27




---



##### 



Selling, General and Administrative Expenses
  Research and Development Expenses
  Corporate
 Nine Months Ended September 30,2007
    
    
    2006
    
    
    Change(in thousands, except percentages)Revenue
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    
    
    %Cost of sales
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gross profit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Selling, general and administrative expenses
    
    
    3,361
    
    
    
    2,171
    
    
    
    1,385
    
    
    
    63.8Research and development expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Merger expenses
    
    
    786
    
    
    
    
    
    
    
    786
    
    
    
    #Operating loss
    
    $
    (4,147
    )
    
    $
    (2,171
    )
    
    $
    (2,030
    )
    
    
    91.1
  Selling, General and Administrative Expense
  Merger Expenses
   28




---



##### 



Consolidated
 Interest Expense
  Derivative Warrant Liability
  Other Income
  Income Taxes
  Net Loss from Continuing Operations
  Liquidity and Capital Resources From Continuing Operations
   Cash Flows
   29




---



##### 



Financing and Liquidity
   September 30,2007Mortgage notes payable  Animal Applications and Corporate facilities
    
    $
    2,178Line of Credit  DSD Holding
    
    
    3,361Equipment Loans / Notes Payable  DSD Holding
    
    
    1,223Capital lease obligations
    
    
    1,807Revolving facility
    
    
    4,346Intercompany term loan
    
    
    7,000$
    19,915
 Equipment Loans-DSD Holding
  Line of Credit-DSD Holding
   30




---



##### 



Note Payable-DSD Holding
  Invoice Discounting Agreement
  Revolving Facility
   Intercompany Term Loan
    31




---



##### 



10.25% Senior Secured Debenture
     32




---



##### 



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    Cautionary Note Regarding Forward-Looking Statements
  
    
    our expectations regarding the timing of finalizing the purchase price for the McMurdo
transaction;
    
    our expectation that we will pay $2.2 million in additional purchase price
consideration for the McMurdo transaction in the fourth quarter of 2007 as McMurdos
revenue is expected to exceed the threshold and that the $2.2 million will be recorded as
additional goodwill or other intangible assets;
    
    our belief that McMurdo will provide us with more predictable revenue in our search and
rescue beacon business going forward;
    
    our expectations regarding that our legal expenses will decrease going forward;
    
    our expectations regarding the amount and timing of revenue to be earned from our
contract with the U.S. Air Force regarding the development of a new search and rescue
beacon;
    
    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 and from financing activities to fund our
business over the next 12 months.
  
    
    our ability to successfully implement our business strategy;
    
    our ability to successfully integrate the assets acquired in the McMurdo acquisition
and realize the anticipated savings;
  33




---



##### 




    
    our ability to generate cash from operations and financing activities in amounts
sufficient to fund our operations over the next twelve months;
    
    our ability to consummate the Merger with Applied Digital and fund the costs associated
with the Merger;
    
    our ability to comply with the obligations in the Revolving Facility, the intercompany
term loan and our 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 ability to fund our operations;
    
    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 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
   34




---



##### 



PART II  OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
  
 ITEM 1.A RISK FACTORS
 Our stock price and business
may be adversely affected if the Merger is not completed.
  
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  
 ITEM 6. EXHIBITS
  ExhibitNumber
    
    Description10.32
    
    Security Agreement, dated August 31, 2007, by and among Digital
Angel Corporation, certain of its Eligible Subsidiaries and
Kallina Corporation.10.33
    
    Secured Revolving Note, dated August 31, 2007, among Digital
Angel Corporation and certain of its Eligible Subsidiaries in favor of Kallina Corporation.10.34
    
    Subsidiary Guaranty, dated August 31, 2007, by Digital Angel
Corporation, Digital Angel Technology Corporation, Fearing
Manufacturing Co., Inc. and Digital Angel International in favor
of Kallina Corporation.10.35
    
    Common Stock Purchase Warrant, dated August 31, 2007, issued by Digital Angel Corporation to Kallina Corporation.10.36
    
    Stock Pledge Agreement, dated August 31, 2007, among Digital
Angel Corporation, Digital Angel Technology Corporation and
Kallina Corporation.10.37
    
    Intellectual Property Security Agreement, dated August 31, 2007,
by each of Digital Angel Corporation, Digital Angel Technology
Corporation and Fearing Manufacturing Co., Inc. in favor of
Kallina Corporation.10.38
    
    Registration Rights Agreement, dated August 31, 2007, by and
between Digital Angel Corporation and Kallina Corporation.10.39
    
    Secured Term Note, dated August 31, 2007, by Digital Angel
Corporation and certain of its Eligible Subsidiaries in favor of
Applied Digital Solutions, Inc.10.40
    
    Security Agreement, dated August 31, 2007, by Digital Angel
Corporation and certain of its Eligible Subsidiaries in favor of
Applied Digital Solutions, Inc.31.1
    
    Certification of the Interim Chief Executive Officer of Digital Angel
Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.31.2
    
    Certification of the Acting Chief Financial Officer of Digital
Angel Corporation pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.32.1
    
    Certification of the Interim Chief Executive Officer of Digital Angel
Corporation pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.32.2
    
    Certification of the Acting Chief Financial Officer of Digital
Angel Corporation pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
  35




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##### 



SIGNATURES
  DIGITAL ANGEL CORPORATION
(Registrant)Date: November 13, 2007
    By:
    /s/ Barry M. EdelsteinName:
    Barry M. EdelsteinTitle:
    Interim President, Chief Executive Officer
and Director
(Principal Executive Officer)Date: November 13, 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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##### 



INDEX TO EXHIBITS
 ExhibitNumber
    
    Description10.32
    
    Security Agreement, dated August 31, 2007, by and among Digital
Angel Corporation, certain of its Eligible Subsidiaries and
Kallina Corporation.10.33
    
    Secured Revolving Note, dated August 31, 2007, among Digital
Angel Corporation and certain of its Eligible Subsidiaries in favor of Kallina Corporation.10.34
    
    Subsidiary Guaranty, dated August 31, 2007, by Digital Angel
Corporation, Digital Angel Technology Corporation, Fearing
Manufacturing Co., Inc. and Digital Angel International in favor
of Kallina Corporation.10.35
    
    Common Stock Purchase Warrant, dated August 31, 2007, issued by Digital Angel Corporation to
Kallina Corporation.10.36
    
    Stock Pledge Agreement, dated August 31, 2007, among Digital
Angel Corporation, Digital Angel Technology Corporation and
Kallina Corporation.10.37
    
    Intellectual Property Security Agreement, dated August 31, 2007,
by each of Digital Angel Corporation, Digital Angel Technology
Corporation and Fearing Manufacturing Co., Inc. in favor of
Kallina Corporation.10.38
    
    Registration Rights Agreement, dated August 31, 2007, by and
between Digital Angel Corporation and Kallina Corporation.10.39
    
    Secured Term Note, dated August 31, 2007, by Digital Angel
Corporation and certain of its Eligible Subsidiaries in favor of
Applied Digital Solutions, Inc.10.40
    
    Security Agreement, dated August 31, 2007, by Digital Angel
Corporation and certain of its Eligible Subsidiaries in favor of
Applied Digital Solutions, Inc.31.1
    
    Certification of the Interim Chief Executive Officer of Digital Angel
Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.31.2
    
    Certification of the Acting Chief Financial Officer of Digital
Angel Corporation pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.32.1
    
    Certification of the Interim Chief Executive Officer of Digital Angel
Corporation pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.32.2
    
    Certification of the Acting Chief Financial Officer of Digital
Angel Corporation pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
  37