**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D. C. 20549**

 

# ****

# ** **

# **FORM 10-Q**

**(Mark One)**

 

| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934.**                       |
|------------|---------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                      |
|       | **For the quarterly period ended March 31, 2004**                                                                    |
|       |                                                                                                                      |
|       | **or**                                                                                                                    |
|       |                                                                                                                      |
| **o**      | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934.**                      |
|       |                                                                                                                      |
|       | **For the transition period  from       to       ** |
|       |                                                                                                                      |
|       | **Commission File Number:  1-15177**                                                                                 |

 

**DIGITAL ANGEL CORPORATION**

(Exact name of registrant as specified in its charter)

 
| **DELAWARE**                                                    |   | **52-1233960**                     |
|-----------------------------------------------------------------|--------|------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (IRS Employer  Identification No.) |
|                                                            |
| **490 Villaume Avenue, South Saint Paul, Minnesota,  55075**    |
| (Address of registrant’s principal executive offices)      |
|                                                            |
| **(651) 455-1621**                                              |
| (Registrant’s telephone number, including area code)       |

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Exchange Act during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

Yes     ý    No     o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule12b-2 of the Exchange Act).

Yes     o    No     ý

 

Asof the close of business on April 29, 2004, there were 32,560,511 sharesoutstanding of the issuer’s $0.005 per share par value common stock.

 

 

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**DIGITAL ANGEL CORPORATION**

 

TABLE OF CONTENTS

 
| **Item**                             |   | **Description**                                                                             |   |
|--------------------------------------|--------|---------------------------------------------------------------------------------------------|--------|
|                                 |   |                                                                                        |   |
| PART I – FINANCIAL  INFORMATION |   |
|                                 |   |                                                                                        |   |
| 1.                                   |   | Financial  Statements                                                                       |   |
| 2.                                   |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
| 3.                                   |   | Quantitative and Qualitative  Disclosures About Market Risk                                 |   |
| 4.                                   |   | Controls and Procedures                                                                     |   |
|                                 |   |                                                                                        |   |
| PART II – OTHER  INFORMATION    |   |
|                                 |   |                                                                                        |   |
| 1.                                   |   | Legal Proceedings                                                                           |   |
| 2.                                   |   | Changes in Securities, Use of  Proceeds and Issuer Purchases of Equity Securities           |   |
| 6.                                   |   | Exhibits and Reports on Form 8-K                                                            |   |
|                                 |   |                                                                                        |   |
| SIGNATURE                            |   |
| CERTIFICATIONS                       |   |
| EXHIBITS                             |   |

 

2

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**PART I    FINANCIALINFORMATION**

 

Item1.             FinancialStatements.

 

**DIGITAL ANGEL CORPORATION AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

(In thousands, except par value)

 
|                                                                                                                                                                                   |   | **March 31,  2004** |       | **December 31,  2003** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|-----------------------------|--------|
|                                                                                                                                                                                   |   | **(Unaudited)**          |       |                        |   |
| **Assets**                                                                                                                                                                             |   |                     |       |                        |   |
| **Current Assets**                                                                                                                                                                     |   |                     |       |                        |   |
| Cash                                                                                                                                                                                   |   | **$**                    | **1,690**  | ** **                  | $      | 894 |   |
| Restricted cash                                                                                                                                                                        |   | **785**                  | ** ** | 765                         |   |
| Accounts receivable (net of allowance for doubtful accounts of $216  in 2004 and $212 in 2003)                                                                                         |   | **6,264**                | ** ** | 3,853                       |   |
| Inventories                                                                                                                                                                            |   | **5,989**                | ** ** | 6,589                       |   |
| Deferred costs                                                                                                                                                                         |   | **72**                   | ** ** | —                      |   |
| Applied Digital Solutions, Inc. common stock (Note 7)                                                                                                                                  |   | **3,913**                | ** ** | —                      |   |
| Other current assets                                                                                                                                                                   |   | **1,056**                | ** ** | 828                         |   |
| **Total Current Assets**                                                                                                                                                               |   | **19,769**               | ** ** | 12,929                      |   |
|                                                                                                                                                                                   |   |                     | ** ** |                        |   |
| **Property and Equipment, net**                                                                                                                                                        |   | **7,544**                | ** ** | 7,665                       |   |
|                                                                                                                                                                                   |   |                     | ** ** |                        |   |
| **Goodwill and Other Intangible Assets, net**                                                                                                                                          |   | **53,865**               | ** ** | 45,608                      |   |
|                                                                                                                                                                                   |   |                     | ** ** |                        |   |
| **Other Assets, net**                                                                                                                                                                  |   | **1,204**                | ** ** | 1,105                       |   |
|                                                                                                                                                                                   |   | **$**                    | **82,382** |                        | $      | 67,307 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                         |   |                     | ** ** |                        |   |
| **Current Liabilities**                                                                                                                                                                |   |                     | ** ** |                        |   |
| Line of credit and current maturities of long-term debt                                                                                                                                |   | **$**                    | **7,158**  | ** **                  | $      | 5,918 |   |
| Accounts payable                                                                                                                                                                       |   | **4,583**                | ** ** | 5,297                       |   |
| Accrued expenses and other current liabilities                                                                                                                                         |   | **4,293**                | ** ** | 3,232                       |   |
| Deferred revenue                                                                                                                                                                       |   | **1,367**                | ** ** | 1,212                       |   |
| Due to Applied Digital Solutions, Inc.                                                                                                                                                 |   | **115**                  | ** ** | 347                         |   |
| **Total Current Liabilities**                                                                                                                                                          |   | **17,516**               | ** ** | 16,006                      |   |
|                                                                                                                                                                                   |   |                     | ** ** |                        |   |
| **Long-Term Debt And Notes Payable**                                                                                                                                                   |   | **2,543**                | ** ** | 2,818                       |   |
|                                                                                                                                                                                   |   |                     | ** ** |                        |   |
| **Deferred Revenue**                                                                                                                                                                   |   | **347**                  | ** ** | —                      |   |
|                                                                                                                                                                                   |   |                     | ** ** |                        |   |
| **Total Liabilities**                                                                                                                                                                  |   | **20,406**               | ** ** | 18,824                      |   |
|                                                                                                                                                                                   |   |                     | ** ** |                        |   |
| **Commitments And Contingencies**                                                                                                                                                      |   |                     | ** ** |                        |   |
|                                                                                                                                                                                   |   |                     | ** ** |                        |   |
| **Minority Interest**                                                                                                                                                                  |   | **6**                    | ** ** | —                      |   |
|                                                                                                                                                                                   |   |                     | ** ** |                        |   |
| **Stockholders’ Equity**                                                                                                                                                          |   |                     | ** ** |                        |   |
| Preferred stock: Authorized 1,000 shares, of $1.75 par value, 100  shares issued and outstanding in 2004 and 0 issued and outstanding in 2003                                          |   | **175**                  | ** ** | —                      |   |
| Common stock: Authorized 95,000 shares, of $.005 par value; 32,626  shares issued and 32,576 shares outstanding in 2004 and  28,891 shares issued and 28,841  outstanding in 2003 |   | **163**                  | ** ** | 144                         |   |
| Additional paid-in capital                                                                                                                                                             |   | **188,925**              | ** ** | 171,909                     |   |
| Accumulated deficit                                                                                                                                                                    |   | **(127,261**             | **)**      | (123,517                    | )      |
| Treasury stock (carried at cost, 50 shares)                                                                                                                                            |   | **(43**                  | **)**      | (43                         | )      |
| Accumulated other comprehensive income (loss)                                                                                                                                          |   | **11**                   | ** ** | (10                         | )      |
| **Total Stockholders’ Equity**                                                                                                                                                    |   | **61,970**               | ** ** | 48,483                      |   |
|                                                                                                                                                                                   |   | **$**                    | **82,382** |                        | $      | 67,307 |   |

 

See the accompanying notes tocondensed consolidated financial statements.

 

3

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**DIGITALANGEL CORPORATION AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

(In thousands, except pershare data)

(Unaudited)

 
|                                                                            |   | **For the Three Months  Ended March 31,** |       |
|---------------------------------------------------------------------------------|--------|------------------------------------------------|------------|
|                                                                            |   | **2004**                                       |       | **2003** |   |
|                                                                            |   |                                           |       |   |   |
| Product revenue                                                                 |   | **$**                                          | **10,676** | ** ** | $ | 10,865 |   |
| Service revenue                                                                 |   | **450**                                        | ** ** | 533 |   |
| Total net revenue                                                               |   | **11,126**                                     | ** ** | 11,398 |   |
|                                                                            |   |                                           | ** ** |   |   |
| Cost of products sold                                                           |   | **6,195**                                      | ** ** | 5,639 |   |
| Cost of services sold                                                           |   | **348**                                        | ** ** | 395 |   |
|                                                                            |   | **6,543**                                      |       | 6,034 | ** ** |
| Gross profit                                                                    |   | **4,583**                                      | ** ** | 5,364 |   |
|                                                                            |   |                                           | ** ** |   |   |
| Selling, general and administrative expenses                                    |   | **4,824**                                      | ** ** | 4,280 |   |
| Research and development expenses                                               |   | **669**                                        | ** ** | 911 |   |
| Operating (loss) income                                                         |   | **(910**                                       | **)**      | 173 |   |
|                                                                            |   |                                           | ** ** |   |   |
| Interest income                                                                 |   | **8**                                          | ** ** | — |   |
| Interest expense                                                                |   | **(293**                                       | **)**      | (138 | ) |
| Realized and unrealized losses on Applied Digital Solutions, Inc.  common stock |   | **(2,586**                                     | **)**      | — |   |
| Other income                                                                    |   | **43**                                         |       | 42 |   |
|                                                                            |   |                                           | ** ** |   |   |
| (Loss) income before taxes and minority interest share of (income)  losses      |   | **(3,738**                                     | **)**      | 77 |   |
|                                                                            |   |                                           | ** ** |   |   |
| Provision  for income taxes                                                |   | **—**                                     | ** ** | — |   |
|                                                                            |   |                                           | ** ** |   |   |
| (Loss) income before minority interest share of (income) losses                 |   | **(3,738**                                     | **)**      | 77 |   |
|                                                                            |   |                                           | ** ** |   |   |
| Minority interest share of (income) losses                                      |   | **(6**                                         | **)**      | 33 |   |
|                                                                            |   |                                           | ** ** |   |   |
| Net (loss) income                                                               |   | **$**                                          | **(3,744** | **)** | $ | 110 |   |
|                                                                            |   |                                           | ** ** |   |   |
| Net (loss) income per common share - basic                                      |   | **$**                                          | **(0.12**  | **)** | $ | — |   |
| Net (loss) income per common share - diluted                                    |   | **(0.12**                                      | **)**      | — |   |
|                                                                            |   |                                           | ** ** |   |   |
| Weighted average number of common shares outstanding - basic                    |   | **30,468**                                     | ** ** | 26,663 |   |
| Weighted average number of common shares outstanding  diluted              |   | **30,468**                                     | ** ** | 30,638 |   |

 

See the accompanying notes tocondensed consolidated financial statements.

 

4

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**DIGITALANGEL CORPORATION AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**

**For TheThree Months Ended March 31, 2004**

(In Thousands)

(Unaudited)

 
|                                                         |   |             |   |       |   |       |   |   |   | **Additional  Paid-In  Capital** |   | **Accumulated  Deficit** |    | **Treasury  Stock** |   | **Accumulated  Other  Comprehensive  Loss** |   | **Total  Stockholders’    Equity** |   |
|--------------------------------------------------------------|--------|------------------|--------|------------|--------|------------|--------|--------|--------|----------------------------------|--------|--------------------------|---------|---------------------|--------|--------------------------------------------------|--------|----------------------------------------------|--------|
|                                                         |   |             |   |       |   |       |
| **Preferred Stock**                                          |   | **Common Stock** |
| **Number**                                                   |   | **Amount**       |   | **Number** |   | **Amount** |
|                                                         |   |             |   |       |   |       |   |   |   |                             |   |                     |    |                |   |                                             |   |                                         |   |
| **Balance - December 31, 2003**                         |   | —           |   | $          | — |       | 28,891 |   | $      | 144                              |   | $                        | 171,909 |                | $      | (123,517                                         | )      | $                                            | (43    | ) | $ | (10 | ) | $ | 48,483 |   |
| Net  loss                                                    |   |             |   |       |   | —     |   | — |   | —                           |   | (3,744                   | )       | —              |   | —                                           |   | (3,744                                       | )      |
| Comprehensive  loss - Foreign currency translation           |   | —           |   | —     |   | —     |   | — |   | —                           |   | —                   |    | —              |   | 21                                               |   | 21                                           |   |
| Total  comprehensive income (loss)                           |   | —           |   | —     |   | —     |   | — |   | —                           |   | (3,744                   | )       | —              |   | 21                                               |   | (3,723                                       | )      |
| Merger  consideration-OuterLink Corporation                  |   | 100              |   | 175        |   | —     |   | — |   | 8,125                            |   | —                   |    | —              |   | —                                           |   | 8,300                                        |   |
| Issuance  of common stock to Applied Digital Solutions, Inc. |   | —           |   | —     |   | 3,000      |   | 15     |   | 7,905                            |   | —                   |    | —              |   | —                                           |   | 7,920                                        |   |
| Exercise  of stock options                                   |   | —           |   | —     |   | 735        |   | 4      |   | 986                              |   | —                   |    | —              |   | —                                           |   | 990                                          |   |
|                                                         |   |             |   |       |   |       |   |   |   |                             |   |                     |    |                |   |                                             |   |                                         |   |
| **Balance – March 31, 2004**                       |   | 100              |   | $          | 175    |       | 32,626 |   | $      | 163                              |   | $                        | 188,925 |                | $      | (127,261                                         | )      | $                                            | (43    | ) | $ | 11 |   | $ | 61,970 |   |

 

See the accompanying notes tocondensed consolidated financial statements.

 

5

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**DIGITALANGEL CORPORATION AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

(In thousands)

(Unaudited)

 
|                                                                                  |   | **For the Three Months  Ended March 31,** |       |
|---------------------------------------------------------------------------------------|--------|------------------------------------------------|------------|
|                                                                                  |   | **2004**                                       |       | **2003** |   |
| **Cash Flows From Operating Activities**                                              |   |                                           |       |   |   |
| Net (loss) income                                                                     |   | **$**                                          | **(3,744** | **)** | $ | 110 |   |
|                                                                                  |   |                                           | ** ** |   |   |
| Adjustments to reconcile net (loss) income to net cash used in  operating activities: |   |                                           | ** ** |   |   |
| Equity-based compensation                                                             |   | **—**                                     | ** ** | 86 |   |
| Amortization of debt discount and deferred financing charges                          |   | **96**                                         | ** ** | — |   |
| Depreciation and amortization                                                         |   | **573**                                        | ** ** | 434 |   |
| Minority interest                                                                     |   | **6**                                          | ** ** | (33 | ) |
| Loss on ADS common stock                                                              |   | **2,586**                                      | ** ** | — |   |
| Loss on disposal of equipment                                                         |   | **—**                                     | ** ** | 8 |   |
| Change in assets and liabilities:                                                     |   |                                           | ** ** |   |   |
| Increase in restricted cash                                                           |   | **(20**                                        | **)**      | — |   |
| Increase in accounts receivable                                                       |   | **(1,928**                                     | **)**      | (3,607 | ) |
| Decrease (increase) in inventories                                                    |   | **935**                                        | ** ** | (974 | ) |
| Increase in deferred costs                                                            |   | **(72**                                        | **)**      | — |   |
| (Increase) decrease in other current assets                                           |   | **(122**                                       | **)**      | 375 |   |
| Decrease in due to ADS                                                                |   | **(232**                                       | **)**      | (139 | ) |
| (Decrease) increase in accounts payable, accrued expenses and  deferred revenue       |   | **(352**                                       | **)**      | 651 |   |
| **Net Cash Used In Operating Activities**                                             |   | **(2,274**                                     | **)**      | (3,089 | ) |
|                                                                                  |   |                                           | ** ** |   |   |
| **Cash Flows From Investing Activities**                                              |   |                                           | ** ** |   |   |
| Proceeds from sale of ADS common sotck                                                |   | **1,421**                                      | ** ** | — |   |
| Decrease in other assets                                                              |   | **(126**                                       | **)**      | 9 |   |
| Payments for property and equipment                                                   |   | **(100**                                       | **)**      | (250 | ) |
| Cash acquired through acquisition, net of acquisition costs                           |   | **85**                                         | ** ** | — |   |
| **Net Cash   Provided by (Used In) Investing Activities**                        |   | **1,280**                                      | ** ** | (241 | ) |
|                                                                                  |   |                                           | ** ** |   |   |
| **Cash Flows From Financing Activities**                                              |   |                                           | ** ** |   |   |
| Amounts borrowed on line of credit                                                    |   | **8,640**                                      | ** ** | 8,677 |   |
| Amounts paid on line of credit                                                        |   | **(7,826**                                     | **)**      | (5,677 | ) |
| Net amounts borrowed on notes payable                                                 |   | **367**                                        | ** ** | — |   |
| Payments on long-term debt                                                            |   | **(323**                                       | **)**      | (20 | ) |
| Exercise of stock options                                                             |   | **990**                                        | ** ** | 175 |   |
| **Net Cash Provided By Financing Activities**                                         |   | **1,848**                                      | ** ** | 3,155 |   |
|                                                                                  |   |                                           | ** ** |   |   |
| **Effect of Exchange Rate Changes on Cash**                                           |   | **(58**                                        | **)**      | (39 | ) |
|                                                                                  |   |                                           | ** ** |   |   |
| **Net Increase (Decrease) In Cash**                                                   |   | **796**                                        | ** ** | (214 | ) |
|                                                                                  |   |                                           | ** ** |   |   |
| **Cash - Beginning Of Period**                                                        |   | **894**                                        | ** ** | 214 |   |
|                                                                                  |   |                                           | ** ** |   |   |
| **Cash - End Of Period**                                                              |   | **$**                                          | **1,690**  | ** ** | $ | — |   |

 

See the accompanying notes tocondensed consolidated financial statements.

 

6

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**DIGITALANGEL CORPORATION**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Dollars inthousands)**

**(Unaudited)**

 

**1.****                                     ****Basis of Presentation**

 

On March 27, 2002,Digital Angel Acquisition Co. (“Acquisition”), then a wholly-owned subsidiaryof Medical Advisory Systems, Inc. (“MAS”), merged with and into Digital AngelCorporation, which was then a 93% owned subsidiary of Applied DigitalSolutions, Inc. (“ADS”). In the merger, the corporate existence of Acquisitionceased, Digital Angel Corporation became a wholly-owned subsidiary of MAS andwas renamed Digital Angel Technology Corporation (“DATC”), and MAS was renamed“Digital Angel Corporation.” In connection with the merger transaction, ADScontributed to MAS all of its stock in Timely Technology Corp., a wholly-ownedsubsidiary, and Signature Industries, Limited, an 85% owned subsidiary based inthe United Kingdom. These two subsidiaries, along with DATC, comprised theAdvanced Wireless Group (“AWG”). As a result of this contribution by ADS,Timely Technology Corp. became a wholly-owned subsidiary of the Company andSignature Industries, Limited became an 85% owned subsidiary. Prior to themerger with DATC, ADS owned 850,000 shares of MAS stock, representingapproximately 16.3% of the outstanding stock of MAS. (Unless the contextotherwise requires, the term “Company” means Digital Angel Corporation and itssubsidiaries). In the merger, the shares of DATC owned by ADS were convertedinto a total of 18,750,000 shares of MAS common stock. As a result of themerger, ADS owned 19,600,000 shares or 77.15% of the Company’s common stock.The merger was treated as a reverse acquisition for accounting purposes, withAWG treated as the accounting acquirer.

 

The accompanying unauditedcondensed consolidated financial statements of Digital Angel Corporation andsubsidiaries as of March 31, 2004 and for the three month periods endedMarch 31, 2004 and 2003 have been prepared in accordance with accountingprinciples generally accepted in the United States of America for interimfinancial information and with the instructions to Form 10-Q andArticle 10 of Regulation S-X under the Securities Exchange Act of1934.  Accordingly, they do not includeall of the information and footnotes required by accounting principlesgenerally accepted in the United States of America for complete financialstatements.  In the opinion of theCompany’s management, all adjustments (including normal recurring adjustments)considered necessary to present fairly the financial statements have been made.

 

The consolidated statements ofoperations for the three months ended March 31, 2004 and 2003 are notnecessarily indicative of the results that may be expected for the entireyear.  These statements should be readin conjunction with the Digital Angel Corporation’s audited consolidatedfinancial statements and related notes thereto for the year endedDecember 31, 2003 which are included in the Company’s Annual Report onForm 10-K.

 

The Company develops and deployssensor and communications technologies that enable rapid and accurateidentification, location tracking, and condition monitoring of high-valueassets.  Prior to January 22, 2004,the Company operated in four segements: Animal Applications, Wireless andMonitoring, GPS and Radio Communications and Medical Systems. With theacquisition of OuterLink Corporation in January 2004, the Companyreorganized into three segments: Animal Applications, GPS and RadioCommunications and  Medical Systems.  The GPS and Radio Communications segment,the Wireless and Monitoring segment and the OuterLink Corporation business,which was acquired on January 22, 2004, were combined to form the new GPSand Radio Communications segment, which is now managed as a single businessunit.

 

*AnimalApplications—*develops, manufactures, and marketsa broad line of electronic and visual identification devices for the companionanimal, livestock, laboratory animal, fish and wildlife markets worldwide. Thetracking of cattle and hogs are crucial both for asset management and fordisease control and food safety. The principal technologies employed by AnimalApplications are electronic ear tags and implantable microchips that use radiofrequency transmission.

 

*GPS andRadio Communications*-consists of the design,manufacture and support of  GPS enabledequipment. Applications for the segment’s products include location trackingand message monitoring of vehicles and aircraft in remote locations throughsystems that integrate GPS and geosynchronous satellite communications and GPSenabled equipment and intelligent communications products and services fortelemetry, mobile data and radio communications applications serving commercialand military markets. This segment  isalso developing technology, which it refers to as its “Digital AngelTMtechnology.” The Digital AngelTM technology is the integration andminiaturization into marketable products of three technologies: wirelesscommunications (such as cellular), sensors (including bio-sensors) and positionlocation technology (including global positioning systems (GPS) and othersystems).

 

*MedicalSystems—* consists of a staff of logistics specialists andphysicians that provide medical assistance services and interactive medicalinformation services to people traveling anywhere in the world. It also sells avariety of kits containing pharmaceutical and medical supplies. See Note 14 forthe subsequent sale of the assets of the Medical Systems segment.

 

7

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**2.****                                     ****Principles of Consolidation**

 

The March 31, 2004 and 2003condensed consolidated financial statements include the accounts of the Companyand its wholly-owned and majority-owned subsidiaries (OuterLink Corporationfrom the date of acquisition on January 22, 2004).  All significant intercompany accounts and transactions have beeneliminated in consolidation.

 

**3.****                                     ****Revenue Recognition**

 

The Company, except for itssubsidiary OuterLink Corporation, recognizes product revenue at the time product is shipped and title hastransferred, provided that a purchase order has been received or a contract hasbeen executed, there are no uncertainties regarding customer acceptance, thesales price is fixed and determinable and collectibility is deemed probable. Ifuncertainties regarding customer acceptance exists, revenue is recognized whensuch uncertainties are resolved. There are no significant post-contract supportobligations at the time of revenue recognition. Digital Angel Corporation’saccounting policy regarding vendor and post contract support obligations isbased on the terms of the customers’ contracts, billable upon occurrence of thepost-sale support. Costs of products sold and services provided are recorded asthe related revenue is recognized. Digital Angel Corporation offers a warrantyon its products.  For non-fixed feejobs, revenue is recognized based on the actual direct labor hours in the jobmultiplied by the standard billing rate and adjusted to net realizable value,if necessary. Revenues from contracts that provide services are recognizedratably over the term of the contract. Fixed fee revenues from contracts forservices are recorded when earned and exclude reimbursable costs. Reimbursablecosts incurred in performing such services are presented on a net basis andinclude transportation medical and communication costs. Other revenue isrecognized at the time service or goods are provided.  It is the Company’s policy to record contract losses in theirentirety in the period in which such losses are foreseeable.

 

The Company’s subsidiary, OuterLinkCorporation, earns revenue from messaging services, which generally provide forservice on a month-to month basis and from the rental or sale of relatedproducts to customers (communication terminals and software).  OuterLink Corporation’s messaging service isonly available through use of its products, such products have no alternativeuse.  Accordingly, service revenue isrecognized as the services are performed. OuterLink Corporation’s product revenue, for which title and risk ofloss transfers to the customer on shipment, is deferred upon shipment and isrecognized ratable over the estimated customer service period, currently 30months.  Product rental revenue isrecognized over the rental period.

 

**4.****                                     ****Stock-Based Compensation**

 

The Company applies APB Opinion No.25 and related Interpretations in accounting for all the plans.  Accordingly, no compensation cost has beenrecognized under these plans.  TheCompany has adopted the disclosure-only provisions of SFAS No. 123, “Accountingfor Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-BasedCompensation-Transition and Disclosure,” which was released inDecember 2002 as an amendment to SFAS No. 123.  The following table illustrates the effect on net income (loss)and earnings per share if the fair value based method had been applied to allawards (in thousands, except per share data):

 
|                                                                                                                |   | **Three Months  Ended March 31,** |       |
|---------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|------------|
|                                                                                                                |   | **2004**                               |       | **2003** |   |
| Reported net (loss) income                                                                                          |   | **$**                                  | **(3,744** | **)** | $ | 110 |   |
| Stock-based employee compensation expense in reported net income  (loss), net of related tax effects                |   | **—**                             | ** ** | 86 |   |
| Stock-based employee compensation expense determined under the fair  value based method, net of related tax effects |   | **(1,501**                             | **)**      | (702 | ) |
| Pro forma net loss                                                                                                  |   | **$**                                  | **(5,245** | **)** | $ | (506 | ) |
|                                                                                                                |   |                                   | ** ** |   |   |
| (Loss) income per share (basic and diluted)                                                                         |   |                                   | ** ** |   |   |
| As reported                                                                                                         |   | **$**                                  | **(0.12**  | **)** | $ | — |   |
| Pro forma                                                                                                           |   | **$**                                  | **(0.17**  | **)** | $ | (0.02 | ) |

 

8

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**6.****                                     ****Inventory (in thousands)**

 
|                                  |   | **March 31,  2004** |       | **December 31,  2003** |   |
|---------------------------------------|--------|--------------------------|------------|-----------------------------|--------|
| Raw materials                         |   | **$**                    | **2,314**  | ** **                  | $      | 1,976 |   |
| Work in process                       |   | **139**                  | ** ** | 94                          |   |
| Finished goods                        |   | **5,546**                | ** ** | 6,340                       |   |
|                                  |   | **7,999**                |       | 8,410                       |   |
| Allowance for excess and obsolescence |   | **(2,010**               | **)**      | (1,821                      | )      |
| Net inventory                         |   | **$**                    | **5,989**  | ** **                  | $      | 6,589 |   |

 

**7.****                                     ****Stock Exchange with Applied Digital Solutions, Inc.**

 

On March 1, 2004, the Companyissued 3,000,000 shares of its common stock to ADS pursuant to the StockPurchase Agreement (“Stock Purchase Agreement”) with ADS dated August 14,2003.   The Stock Purchase Agreementprovided for ADS to purchase 3,000,000 shares of the Company’s common stock ata price of $2.64 per share and a warrant (the “ADS Warrant”) to purchase up to1,000,000 shares of the Company’s common stock, which is exercisable for fiveyears beginning February 1, 2004, at a price per share of $3.74 payable incash or shares of common stock of ADS. The consideration for the sale of the Company’s 3,000,000 shares and thewarrant was payable in 1,980,000 shares of ADS common stock.  The Company expects to sell the stock of ADSto generate additional funds which the Company believes will be necessary tosustain its operations for the next twelve months. As of March 31, 2004,the Company has sold 530,000 shares of ADS common stock.  The Company has accounted for the ADS stockas a trading security under SFAS 115, “Accounting for Certain Investments inDebt and Equity Securities”.   In thequarter ended March 31, 2004 the Company recorded realized losses of$702,000 on the 530,000 shares of ADS common stock sold and an unrealized lossof $1,884,000 on the remaining 1,450,000 shares held by the Company.  Fair value of the ADS common stock isdetermined by quoted values reported on NASDAQ.  Realized and unrealized losses on the ADS common stock areincluded as Other Expenses in the Company’s statement of operations for thethree months ended March 31, 2004.

 

**8.**                                      **Income (Loss) Per Share**

 

The following is a reconciliationof the numerator and denominator of basic and diluted income (loss) per share(in thousands, except per share data):

 
|                                                                    |   | **Three Months  Ended March 31,** |       |
|-------------------------------------------------------------------------|--------|----------------------------------------|------------|
|                                                                    |   | **2004**                               |       | **2003** |   |
| **Numerator:**                                                          |   |                                   |       |   |   |
| Net income (loss)                                                       |   | **$**                                  | **(3,744** | ) | $ | 110 |   |
| **Denominator:**                                                        |   |                                   |       |   |   |
| Denominator for basic income (loss) per share-                          |   |                                   |       |   |   |
| Weighted-average shares                                                 |   | **30,468**                             |       | 26,663 |   |
| **Basic income (loss) per share**                                       |   | **$**                                  | **(0.12**  | ) | $ | — |   |
| Denominator for diluted income (loss) per share-                        |   |                                   |       |   |   |
| Weighted-average shares                                                 |   | **30,468**                             |       | 26,663 |   |
| Potentially dilutive securities, calculated on the treasury method  (1) |   | **—**                             |       | 3,975 |   |
| Denominator for diluted income (loss) per share                         |   | **30,468**                             |       | 30,638 |   |
| **Diluted income (loss) per share**                                     |   | **$**                                  | **(0.12**  | ) | $ | — |   |

 

----

(1)     Potentiallydilutive securities are excluded from the computation of diluted loss per sharefor the three months ended March 31, 2004 because to include them wouldhave been anti-dilutive.

 

9

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**9.****                                     ****Segment Information**

 

The Company is an advancedtechnology company in the field of rapid and accurate identification, locationtracking, and condition monitoring of high-value assets.  Prior to January 22, 2004, the Companyoperated in four segements: Animal Applications, Wireless and Monitoring, GPSand Radio Communications and Medical Systems. With the acquisition of OuterLinkCorporation in January 2004, the Company reorganized into three segments:Animal Applications, GPS and Radio Communications and  Medical Systems.  The GPSand Radio Communications segment, the Wireless and Monitoring segment and theOuterLink Corporation business, which was acquired on January 22, 2004,were combined to form the new GPS and Radio Communications segment, which isnow managed as a single business unit. Prior period segment information has been restated to reflect theCompany’s current segment structure.  See Note 14 for the subsequent sale of the assets of the Medical Systemssegment.

 

It is on this basis that managementutilizes the financial information to assist in making internal operatingdecisions.  The Company evaluatesperformance based on stand-alone segment operating income.

 

Following is the selected segmentdata as of and for the three months ended March 31, 2004 (in thousands):

 
|                                                                       |   | **Animal  Applications** |   | **GPS and Radio  Communications** |   | **Medical  Systems** |   | **Consolidated** |   |
|----------------------------------------------------------------------------|--------|--------------------------|--------|-----------------------------------|--------|----------------------|--------|------------------|--------|
|                                                                       |   |                     |   |                              |   |                 |   |             |   |
| Net revenue from external customers:                                       |   |                     |   |                              |   |                 |   |             |   |
|                                                                       |   |                     |   |                              |   |                 |   |             |   |
| Product                                                                    |   | $                        | 7,009  |                              | $      | 3,502                |   | $                | 165    |   | $ | 10,676 |   |
| Service                                                                    |   | 63                       |   | 197                               |   | 190                  |   | 450              |   |
| Total revenue                                                              |   | $                        | 7,072  |                              | $      | 3,699                |   | $                | 355    |   | $ | 11,126 |   |
|                                                                       |   |                     |   |                              |   |                 |   |             |   |
| (Loss) before income taxes and minority interest share of (income)  losses |   | $                        | (2,643 | )                                 | $      | (717                 | )      | $                | (378   | ) | $ | (3,738 | ) |
|                                                                       |   |                     |   |                              |   |                 |   |             |   |
| Total assets                                                               |   | $                        | 65,320 |                              | $      | 16,498               |   | $                | 564    |   | $ | 82,382 |   |

 

Following is the selected segmentdata as of and for the three months ended March 31, 2003 (in thousands):

 
|                                                                     |   | **Animal  Applications** |   | **GPS and Radio  Communications** |   | **Medical  Systems** |   | **Consolidated** |   |
|--------------------------------------------------------------------------|--------|--------------------------|--------|-----------------------------------|--------|----------------------|--------|------------------|--------|
|                                                                     |   |                     |   |                              |   |                 |   |             |   |
| Net revenue from external customers:                                     |   |                     |   |                              |   |                 |   |             |   |
|                                                                     |   |                     |   |                              |   |                 |   |             |   |
| Product                                                                  |   | $                        | 7,801  |                              | $      | 2,699                |   | $                | 365    |   | $ | 10,865 |   |
| Service                                                                  |   | —                   |   | 154                               |   | 379                  |   | 533              |   |
| Total revenue                                                            |   | $                        | 7,801  |                              | $      | 2,853                |   | $                | 744    |   | $ | 11,398 |   |
|                                                                     |   |                     |   |                              |   |                 |   |             |   |
| Income (loss) before income taxes and minority interest share of  losses |   | $                        | 1,459  |                              | $      | (1,257               | )      | $                | (125   | ) | $ | 77 |   |
|                                                                     |   |                     |   |                              |   |                 |   |             |   |
| Total assets                                                             |   | $                        | 60,178 |                              | $      | 6,462                |   | $                | 4,885  |   | $ | 71,525 |   |

 

10

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**10.****                              ****Acquisition**

 

The following describes theacquisition by the Company (in thousands):

 
| **Company  Acquired** |   | **Date Acquired** |   | **Acquisition  Price** |   | **Value of  Series A  Preferred  Stock** |   | **Series A  Preferred  Shares  Issued** |   | **Goodwill  and  Other Intangibles  Acquired** |   | **Other Net  Assets and  Liabilities** |   | **Business Description** |   |
|-----------------------|--------|-------------------|--------|------------------------|--------|------------------------------------------|--------|-----------------------------------------|--------|------------------------------------------------|--------|----------------------------------------|--------|--------------------------|--------|
| OuterLink Corporation |   | 1/22/04           |   | $                      | 8,400  |                                     | $      | 8,300                                   |   | 100                                            |   | $                                      | 8,393  |                     | $      | 7 |   | Provider of  real-time, satellite-based automated tracking, wireless data transfer and  two-way messaging with large fleets of vehicles. |   |
|                       |        |                   |        |                        |        |                                          |        |                                         |        |                                                |        |                                        |        |                          |        |  |  |  |  |

 

On January 22, 2004, theCompany acquired OuterLink Corporation. OuterLink Corporation became a wholly-owned subsidiary of Digital AngelCorporation.  The acquisition wasaccounted for under the purchase method of accounting.   The excess of purchase price over the fairvalue of the assets and liabilities of OuterLink Corporation has been recordedas goodwill.  Identifiable intangibleassets have been recorded based upon preliminary estimates as of the date ofthe acquisition.  Any changes to thepreliminary estimates during the allocation period will be reflected as anadjustment to goodwill.

 

The cost of the acquisitionconsisted of 100,000 shares of Series A preferred stock valued at $8.3million  and acquisition costs of $0.1million.  The Series A preferred stockis convertible into four million shares of the Company’s common stock when thevolume weighted average price of the Company’s common stock equals or exceeds$4.00 per share for ten consecutive trading days.  The valuation of the stock is primarily based on historicaltrading history and stock prices of the Company’s common stock and amarketability discount of 30%.  The costof the acquisition consists of legal and accounting related services that weredirect costs of acquiring these assets.

 

In considering the benefits theOuterLink Corporation acquisition, the management of Digital Angel Corporationrecognized the strategic complement of OuterLink Corporation’s technologies andcustomer base with Digital Angel Corporation’s existing animal applications andmilitary GPS business lines.  Thiscomplement provides for a strong platform for further development of DigitalAngel Corporation’s capabilities in the area of high-value assetidentification, tracking and condition monitoring.

 

The results of OuterLinkCorporation have been included in the consolidated financial statements sincethe date of acquisition of January 22, 2004. Unaudited pro forma results of operations for the three months endedMarch 31, 2004 and 2003 are included below.  Such pro forma information assumes that the above acquisition hadoccurred as of January 1, 2004 and 2003, and revenue is presented inaccordance with the Company’s accounting policies.  This summary is not necessarily indicative of what the result ofoperations of the Company would have been had it been a combined entity duringsuch periods, nor does it purport to represent results of operations for anyfuture periods.

 
|                                          |   | **For the quarter ended March 31,** |   |
|-----------------------------------------------|--------|------------------------------------------|--------|
| **(In thousands)**                            |   | **2004**                                 |   | **2003** |   |
| Net revenue                                   |   | $                                        | 11,213 |   | $ | 11,663 |   |
| Net loss                                      |   | $                                        | (4,447 | ) | $ | (1,078 | ) |
| Net loss per common share - basic and diluted |   | $                                        | (0.15  | ) | $ | (0.04 | ) |

 

11

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**11.****                              ****Contingencies**

 

*Wurts Litigation*

 

In February 2003, an actionwas filed in the Middlesex County Superior Court in the Commonwealth ofMassachusetts.  The Company’ssubsidiary, OuterLink Corporation, as well as a significant stockholder ofOuterLink and a principal of the significant stockholder are named as defendants.  Such principal was a director of OuterLink.  The complaint alleged breach of anAugust 25, 1999 employment contract. The plaintiff was President and CEO of OuterLink Corporation fromJuly 1999 through August 2002.

 

The Complaint seeksdamages based principally on a contractual severance provision that allegedlyprovided for four months of compensation for every year or fraction thereofserved prior to termination.  At thetime of termination, the complaint alleges that the plaintiff’s salary was $250,000per year.  The defendants answered denyingall liability and counterclaimed. Discovery will be completed in this matter shortly and the Defendantsintend to vigorously defend this matter and pursue their counterclaims.  The ultimate outcome of this proceedingcannot be predicted at this time and the Company is currently unable todetermine the potential effect of this litigation on its consolidated financialposition, results of operation or cash flows.

 

*E-ResearchLitigation*

 

In June, 2002, eResearchTechnology, Inc. f/k/a Premier Research Worldwide, Ltd. (“ERT”) commenced aproceeding against U.S. Bank National Association, subsequently intervened inby the Company in the New Jersey state court and subsequently removed to theUnited States District Court for the District of New Jersey.  This suit was commenced to pursue allegeddamages of approximately $350,000 due to the Company’s and US Bank’s allegedfailure to register transfers of restricted Digital Angel shares sold by ERT inMay 2002.  The Company has agreed toindemnify US Bank for all damages and reasonable costs relating to thislitigation.  The Company has asserted acounterclaim against ERT based on ERT’s breach of a license agreement andservices agreements between the parties that resulted in the original issuanceof 550,000 restricted Digital Angel common shares to ERT.  The damages to the Company exceed $4 millionand this amount does not include the share of profits which the Company  seeks to recover had its relationship withthe ERT venture not been breached by ERT. Furthermore, the alleged damages sought by the Plaintiff in this matterdo not take into account plaintiff’s duty to mitigate damages which ifdischarged would have resulted in a profit to ERT.  The ultimate outcome of this proceeding cannot be predicted atthis time and the Company is currently unable to determine the potential effectof this litigation on its consolidated financial position, results of operationor cash flows.

 

*ElectronicIdentification Devices Litigation*

 

In February 2004, ElectronicIdentification Devices, Ltd. (“EID”) commenced a Declaratory Judgment Actionagainst the Company in the United States District Court for the WesternDistrict of Texas.  This action seeks adeclaration of patent non-infringement relating to the Company’s patented syringeimplantable identification transponder. The lawsuit alleges that EID has developed a new transponder that itbelieves does not infringe on the Company’s patent.  The lawsuit acknowledges that the Company obtained a Judgment ofinfringement and two contempt orders against EID based on selling certainsystems that infringed the Company’s patent in 1997, 1998 and 1999.  On March 10, 2004 the Company filed amotion seeking the dismissal of the Declaratory Judgment Complaint or, in thealternative, that the action be transferred to Minnesota.  The Court has not yet ruled on the Company’smotion. Given the very early stage of this matter, the ultimate outcome of thisproceeding cannot be predicted at this time. The Company is currently unable to determine the potential effect ofthis litigation on its consolidated financial position, results of operation orcash flows.

 

**12.****                              ****Supplemental Cash Flow Information (in thousands)**

 
|                                                 |   | **Three Months Ended March 31,** |      |
|------------------------------------------------------|--------|---------------------------------------|-----------|
|                                                 |   | **2004**                              |      | **2003** |   |
| Interest paid                                        |   | **$**                                 | **132**   |   | $ | 128 |   |
| Taxes paid                                           |   | **9**                                 |      | — |   |
| Non-cash activity:                                   |   |                                  |      |   |   |
| Issuance of preferred stock for business acquisition |   | **$**                                 | **8,300** |   | — |   |
| Issuance of common stock for ADS common stock        |   | **7,920**                             |      | — |   |
|                                                      |        |                                       |           |  |  |  |  |

 

12

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**13.****                              ****Related Party Activity**

 

In 2003, ADS charged the Companyfor research expenses and directors and officers insurance.  Amounts due to ADS were offset byreceivables due from ADS resulting from the Distribution and LicensingAgreement with Verichip Corporation, a wholly-owned subsidiary of ADS.  At March 31, 2004, these transactionsresulted in a net amount due to ADS of $0.1 million.

 

The Company has executed anexclusive eleven year Distribution and Licensing Agreement dated March 4,2002 with Verichip Corporation (Verichip), a wholly-owned subsidiary of ADS,covering the manufacturing, purchasing and distribution of Verichip’simplantable microchip and the maintenance of the Verichip Registry by theCompany.  The agreement includes alicense for the use of the Company’s technology in Verichip’s identifiedmarkets.  The Company will be the solemanufacturer and supplier to Verichip. Revenue recognized under the Distribution and Licensing Agreement was$49,000 and $108,000 for the three months ended March 31, 2004 and 2003,respectively.

 

See Note 7 for a description of thestock exchange transaction with Applied Digital Solutions, Inc.

 

**14.****                              ****Subsequent Event**

 

OnApril 19, 2004, the Company sold certain assets of its Medical Systemssegment’s medical services business pursuant to an Asset Purchase Agreementdated April 8, 2004 by and between Digital Angel Corporation and MedAire,Inc.  Assets sold include all of thetangible and intangible intellectual property developed for the operation ofthe Medical Systems segment’s medical services business, pharmaceuticalsupplies and other inventory items, customer and supplier contracts, computersoftware licenses, internet website and domain name and mailing lists.

 

Under theterms of the agreement, the purchase price, in addition to MedAire, Inc.’s assumptionof certain liabilities was $420,000 plus any prepaid deposits and the cost ofthe pharmaceutical inventory and supplies reduced by any pre-billing to orpro-rata prepayment by the Company’s customers.

 

Inconnection with exiting this activity, the Company recognized obligations andexpects to record a  loss ofapproximately $300,000.  Further, theCompany also expects to sell the segment’s land and buildings in a separatetransaction and expects the sale proceeds to be above its carrying cost.

 

13

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**Item 2.****          ****Management’s Discussion and Analysis of Financial Conditionand Results of Operations.**

 

The following discussion andanalysis of our financial condition and results of operations should be read inconjunction with the accompanying financial statements and related notesthereto.

 

We consist of Digital AngelCorporation and its four subsidiaries - Digital Angel Technology Corporation(“DATC”), Timely Technology Corp., Signature Industries Limited, and OuterLinkCorporation.

 

**RESULTS OFOPERATIONS**

 

The following tablesummarizes our results of operations as a percentage of net operating revenuefor the three months ended March 31, 2004 and 2003 and is derived from theaccompanying consolidated statements of operations included in this report.

 
|                                                                                           |   | **Three Months Ended  March 31,** |    |
|------------------------------------------------------------------------------------------------|--------|----------------------------------------|---------|
|                                                                                           |   | **2004  %**                            |    | **2003  %** |   |
| Product revenue                                                                                |   | 96.0                                   |    | 95.3 |   |
| Service revenue                                                                                |   | 4.0                                    |    | 4.7 |   |
| Total net revenue                                                                              |   | 100.0                                  |    | 100.0 |   |
| Cost of products sold                                                                          |   | 55.7                                   |    | 49.5 |   |
| Cost of services sold                                                                          |   | 3.1                                    |    | 3.5 |   |
| Total cost of products and services sold                                                       |   | 58.8                                   |    | 53.0 |   |
| Gross profit                                                                                   |   | 41.2                                   |    | 47.0 |   |
| Selling, general and administrative expenses                                                   |   | 43.4                                   |    | 37.5 |   |
| Research and development expenses                                                              |   | 6.0                                    |    | 8.0 |   |
| Operating (loss) income                                                                        |   | (8.2                                   | )       | 1.5 |   |
| Interest income                                                                                |   | 0.1                                    |    | 0.0 |   |
| Interest expense                                                                               |   | (2.6                                   | )       | (1.2 | ) |
| Realized and unrealized losses on ADS common stock                                             |   | (23.3                                  | )       | — |   |
| Other income                                                                                   |   | 0.4                                    |    | 0.4 |   |
| (Loss) income before provision for income taxes and minority interest  share of (income)losses |   | (33.6                                  | )       | 0.7 |   |
| Provision for income taxes                                                                     |   | 0.0                                    |    | 0.0 |   |
| (Loss) income before minority interest share of losses (income)                                |   | (33.6                                  | )       | 0.7 |   |
| Minority interest share of (income) losses                                                     |   | (0.1                                   | )  | 0.3 |   |
| Net (loss) income                                                                              |   | (33.7                                  | )       | 1.0 |   |

 

**Three Months EndedMarch 31, 2004 Compared to the Three Months Ended March 31, 2003**

 

**Revenue**

 

Revenue from operations forthe three months ended March 31, 2004 decreased $0.3  million, or 2.4%, to $11.1 million whencompared to $11.4 million in revenue for the three months ended March 31,2003.

 

Revenue for each of theoperating segments was as follows (in thousands):

 
|                         |   | **Three Months  Ended March 31,  2004** |   | **Three Months  Ended March 31,  2003** |   |
|------------------------------|--------|----------------------------------------------|--------|----------------------------------------------|--------|
| Animal Applications          |   | $                                            | 7,072  |                                         | $      | 7,801 |   |
| GPS and Radio Communications |   | 3,699                                        |   | 2,853                                        |   |
| Medical Services             |   | 355                                          |   | 744                                          |   |
| Total                        |   | $                                            | 11,126 |                                         | $      | 11,398 |   |

 

The Animal Applicationssegment’s revenue decreased**$0.7million, or 9.3%, in the three months ended March 31, 2004 compared to thethree month period ended March 31, 2003. The majority of the decrease wasdue to lower sales to fishery industry customers.  Shipments to fishery industry customers were lower in the firstquarter of 2004 when compared to sales in the first quarter of 2003.

 

14

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The GPS and RadioCommunications segment’s revenue increased $0.8 million, or 29.7% to $3.7million in the three months ended March 31, 2004 from $2.9 million in thethree months ended March 31, 2003. We attribute the increase primarily to increased sales in the Cliffordand Snell division of our subsidiary Signature Industries Ltd., increases inthe exchange rate and the inclusion of $0.3 million of revenue from OuterLinkCorporation. We acquired OuterLink Corporation on January 22, 2004.  We expect revenue to continue to increase in2004 due to the introduction of a new pilot locator beacon in the secondquarter of 2004 and the inclusion of OuterLink Corporation’s revenue.

 

The Medical Systemssegment’s revenue decreased $0.4 million, or 52.3%, to $0.4 million in thethree months ended March 31, 2004. Sales in the first quarter of 2003 included pharmaceutical sales tovessels directly related to the war in Iraq. These pharmaceutical sales did not occur in the first quarter of2004.  On April 19, 2004, theMedical Systems segment’s medical services business was sold to MedAire,Inc.  We do not expect any revenue fromthe Medical Systems segment after the date of the sale.

 

**GrossProfit and Gross Profit Margin**

 

Gross profit for the threemonth period ended March 31, 2004 was $4.6, a decrease**of $0.8 million, or 14.6%, compared to$5.4 million in the three month period ended March 31, 2003. As apercentage of revenue, the gross profit margin decreased to 41.2% for the threemonths ended March 31, 2004 from 47.0% for the three months endedMarch 31, 2003.

 

Gross profit from operationsfor each operating segment was as follows (in thousands):

 
|                         |   | **Three Months  Ended March 31,  2004** |   | **Three Months  Ended March 31,  2003** |   |
|------------------------------|--------|----------------------------------------------|--------|----------------------------------------------|--------|
| Animal Applications          |   | $                                            | 2,806  |                                         | $      | 3,660 |   |
| GPS and Radio Communications |   | 1,723                                        |   | 1,464                                        |   |
| Medical Services             |   | 54                                           |   | 240                                          |   |
| Total                        |   | $                                            | 4,583  |                                         | $      | 5,364 |   |

 

Gross profit margin fromoperations for each operating segment was:

 
|                          |   | **Three Months  Ended March 31,  2004  %** |   | **Three Months  Ended March 31,  2003  %** |   |
|-------------------------------|--------|-------------------------------------------------|--------|-------------------------------------------------|--------|
| Animal  Applications          |   | 39.7                                            |   | 46.9                                            |   |
| GPS and Radio  Communications |   | 46.6                                            |   | 51.3                                            |   |
| Medical Services              |   | 15.2                                            |   | 32.3                                            |   |
| Total                         |   | 41.2                                            |   | 47.0                                            |   |

 

The Animal Applicationssegment’s gross profit decreased $0.9 million, or 23.3%, in the three monthperiod ended March 31, 2004 compared to the three months endedMarch 31, 2003.  We attribute $0.6million of the decrease to lower gross profit margin in 2004 and $0.3 millionof the decrease to the previously mentioned sales decrease.**The gross margin percentage decreased to39.7% in the three month period ended March 31, 2004 as compared to 46.9%in the three month period ended March 31, 2003 due to high margin revenuein the first quarter of 2003 that did not occur in the first quarter of 2004.

 

The GPS and RadioCommunications segment’s gross profit increased $0.3 million, or 17.7%, in thethree month period ended March 31, 2004 as compared to the three monthperiod ended March 31, 2003.  Thegross margin percentage decreased to 46.6% in the three month period endedMarch 31, 2004 as compared to 51.3% in the three month period endedMarch 31, 2003.  The increase ingross profit relates primarily to increased sales at our subsidiary in theUnited Kingdom, Signature Industries, Ltd, offset by a decrease in gross profitof $0.1 million related to the cancellation of a software support contractacquired by Timely Technology in the first quarter of 2003.  The decrease in gross profit margin resultsfrom lower margins on OuterLink Corporation sales and a slight decrease ingross profit margin on Signature Industries, Ltd.’s sales from 50.6% in thefirst quarter of 2003 to 49.8% in the first quarter of 2004.  Decrease in gross profit margin at SignatureIndustries, Ltd relates to product mix in the first quarter of 2003 compared tothe first quarter of 2004

 

The Medical Servicessegment’s gross profit decreased $0.2 million, or 77.5%, in the three monthperiod ended March 31, 2004 as compared to the three month period endedMarch 31, 2003.  The gross marginpercentage decreased to 15.2% in the three month period ended March 31,2004 compared to  32.3% in the threemonth period ended March 31, 2003. The gross profit and gross marginpercentage decreased due to high margin pharmaceutical sales in the firstquarter of 2003 that did not occur in the first quarter of 2004.

 

15

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**Selling,General and Administrative Expenses**

 

Selling, general andadministrative expenses increased $0.5 million, or 12.7%, in the three monthperiod ended March 31, 2004 as compared to the three month period endedMarch 31, 2003. As a percentage of revenue, selling, general andadministrative expenses were 43.4% and 37.5% for the three months endedMarch 31, 2004 and 2003, respectively.

 

Selling, general andadministrative expenses for each of the operating segments were as follows(dollars in thousands):

 
|                         |   | **Three Months  Ended March 31,  2004** |   | **Three Months  Ended March 31,  2003** |   |
|------------------------------|--------|----------------------------------------------|--------|----------------------------------------------|--------|
| Animal Applications          |   | $                                            | 2,157  |                                         | $      | 1,590 |   |
| GPS and Radio Communications |   | 2,267                                        |   | 2,359                                        |   |
| Medical Services             |   | 400                                          |   | 331                                          |   |
| Total                        |   | $                                            | 4,824  |                                         | $      | 4,280 |   |

 

Selling, general andadministrative expenses as a percentage of revenue for each of the operatingsegments were:

 
|                         |   | **Three Months  Ended March 31,  2004  %** |   | **Three Months  Ended March 31,  2003  %** |   |
|------------------------------|--------|-------------------------------------------------|--------|-------------------------------------------------|--------|
| Animal Applications          |   | 30.5                                            |   | 20.4                                            |   |
| GPS and Radio Communications |   | 61.3                                            |   | 82.7                                            |   |
| Medical Services             |   | 112.7                                           |   | 44.5                                            |   |
| Total                        |   | 43.4                                            |   | 37.5                                            |   |

 

The Animal Applicationssegment’s selling, general and administrative expenses increased $0.6 millionin the three month period ended March 31, 2004 as compared to the threemonth period ended March 31, 2003 and as a percentage of revenue increasedto 30.5% from 20.4% in the same respective period.  The increase in selling, general and administrative expensesrelate to increased consulting expenses, travel, and investor relationsexpense.

 

The GPS and RadioCommunications segment’s selling, general and administrative expenses decreased$0.1 million to $2.3 million in the three month period ended March 31,2004 from $2.4 million in the three month period ended March 31, 2003.   The decrease in the selling, general andadministrative expenses relate primarily to the reduction of general andadministrative expense related to the continued scaleback of Digital AngelTMtechonology development, offset by increased expenses at our subsidiary in theUnited Kingdom, Signature Industries Ltd and $0.4 million of expense related toOuterLink Corporation. OuterLink Corporation was acquired on January 22,2004.  As a percentage of revenue, selling,general and administrative expenses decreased to 61.3% in the three monthperiod ended March 31, 2004 from 82.7% in the three month period endedMarch 31, 2003.  The decrease inselling, general and administrative expenses as a percentage of revenue relatesprimarily to the reduction of general and administrative expense related to thecontinued scaleback of Digital AngelTM techonology development.

 

The Medical Servicessegment’s selling, general and administrative expenses increased to $0.4million, or 20.8%,  in the three monthperiod ended March 31, 2004 as compared to $0.3 million in the three monthperiod ended March 31, 2003.  Theincrease results from increased personnel costs of $0.1 million offset bydecreased depreciation and amortization expense of $0.04 million.  As a percentage of revenue, selling, generaland administrative expenses increased to 112.7% in the three month period endedMarch 31, 2004 compared to 44.5% in the three month period endedMarch 31, 2003.  The increase as apercentage of sales relates to increased expenses and decreased sales in thefirst quarter of 2004.

 

**Researchand Development Expense**

 

Research and developmentexpense was $0.7 million in the three month period ended March 31, 2004, adecrease of $0.2 million, or 26.6%, from $0.9 million for the three monthperiod ended March 31, 2003.  As apercentage of revenue, research and development expense was 6.0% and 8.0% forthe three months ended March 31, 2004 and 2003, respectively.

 

Research and developmentexpense for each of the operating segments was as follows (in thousands):

 
|                         |   | **Three Months  Ended March 31,  2004** |   | **Three Months  Ended March 31,  2003** |   |
|------------------------------|--------|----------------------------------------------|--------|----------------------------------------------|--------|
| Animal Applications          |   | $                                            | 523    |                                         | $      | 550 |   |
| GPS and Radio Communications |   | 146                                          |   | 361                                          |   |
| Medical Services             |   | —                                       |   | —                                       |   |
| Total                        |   | $                                            | 669    |                                         | $      | 911 |   |

 

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The decrease in research anddevelopment expense is due primarily to the continued scaleback of research anddevelopment on the Digital AngelTM technology  in the Wireless and Monitoring segment andcompletion of development on the GPS and Radio Communications segment’s pilotlocator beacon.

 

**InterestExpense**

 

Interest expense was $0.3 millionand $0.1 million for the three month periods ended March 31, 2004 and2003, respectively.  The increaserelates to an increase in total debt of $2.6 million from $7.1 million as ofMarch 31, 2003 to $9.7 million as of March 31, 2004 and theamortization of deferred financing costs related to the 2003 financings.

 

**Loss on ADSCommon Stock**

 

On March 1, 2004,Digital Angel Corporation issued 3,000,000 shares of its common stock and awarrant to purchase up to 1,000,000 shares of the Company’s common stock to ADSin exchange for 1,980,000 shares of ADS’s common stock, exclusive of theproceeds which may be received when the warrant is exercised.  As of March 31, 2004, the Company hassold approximately 530,000 shares of ADS common stock.  The Company has accounted for the ADS stockas a trading security under SFAS 115, “Accounting for Certain Investments inDebt and Equity Securities”.  In thequarter ended March 31, 2004, the Company recorded realized losses of$702,000 on the approximately 530,000 shares of ADS common stock sold andunrealized losses of $1,884,00 on the 1,450,000 shares held by theCompany.  Fair value of the ADS commonstock is determined by quoted values reported on NASDAQ.

 

**IncomeTaxes**

 

The Company had an effectiveincome tax rate of 0.0% for the three month periods ended March 31, 2004and 2003.  The Company accounts forincome taxes under the asset and liability approach.  Deferred tax assets and liabilities are recognized for theexpected future tax consequences attributed to differences between thefinancial statement carrying amounts of existing assets and liabilities andtheir respective tax basis.  Deferredtax assets and liabilities are measured using the enacted tax rates expected toapply to taxable income in the years in which those temporary differences areexpected to reverse.  A valuationallowance is provided against net deferred tax assets when it is more likelythan not that a tax benefit will not be realized.  Income taxes included U.S. and foreign taxes.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

As of March 31, 2004,the Company had cash of $1.7 million compared to $0.9 million atDecember 31, 2003.  Cash used inoperating activities totaled $2.3 million and $3.1 million in the first threemonths of 2004 and 2003, respectively.

 

In the first three months of2004, the use of cash was due primarily to the net loss of $3.7 million and asignificant increase in accounts receivable of $1.9 million.  Accounts receivable, net of allowance fordoubtful accounts, increased by $2.4 million, or 62.6%, to $6.3 million atMarch 31, 2004 from $3.9 million at December 31, 2003.  This increase relates to $0.5 million ofaccounts receivable acquired in the acquisition of OuterLink Corporation and anincrease in shipments in the first quarter of 2004 compared to the fourthquarter of 2003.  Offsetting these usesof cash were a decrease in inventory of $0.9 million, depreciation andamortization of $0.6 million and realized and unrealized losses on ADS commonstock of $2.6 million.

 

Inventory levels decreasedby $0.6 million to $6.0 million at March 31, 2004 from $6.6 million atDecember 31, 2003 due to an accumulation of inventory in December 2003,offset by $0.4 million of  inventoryacquired in the OuterLink Corporation acquisition.

 

Accounts payable decreasedby $0.7 million to $4.6 million at March 31, 2004 from $5.3 million atDecember 31, 2003.

 

Accrued expenses and other currentliabilities increased by $1.0 million, or 32.8%, to $4.3 million atMarch 31, 2004 from $3.2 million at December 31, 2003.  The increase was due primarily to accruedexpenses and other current liabilities acquired in the OuterLink Corporationacquisition in January 2004.

 

Investing activitiesprovided cash of $1.3 million in the first quarter of 2004 and used cash of$0.2 million in the first quarter of 2003. In the first quarter of 2004, cashprovided was primarily from the sale of Applied Digital Solutions, Inc. stock.Expenditures for plant, property and equipment were $0.1 million and $0.3million in the first quarter of 2004 and 2003, respectively.

 

Financing activitiesprovided cash of $1.8 million and $3.1 million in the first three months of2004 and 2003, respectively.  In thefirst quarter of 2004, cash was provided primarily from net borrowings on ourline of credit $0.8 million and proceeds from stock option exercises of $1.0million.

 

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*Debt, CovenantCompliance and Liquidity*

 

The following table summarizes theCompany’s fixed cash obligations as of March 31, 2004 over various futureyears (in thousands):

 
|                             |   |      |   | **Payments Due by Period** |   |
|----------------------------------|--------|-----------|--------|----------------------------|--------|
| **Contractual cash obligations** |   | **Total** |   | **Less than  1 Year**      |   | **1-3  Years** |   | **4-5  Years** |   | **After  5 Years** |   |
| Notes Payable and Long-Term Debt |   | $         | 9,701  |                       | $      | 7,158 |   | $ | 331 |   | $ | 124 |   | $ | 2,088 |   |
| Operating Leases                 |   | 18,753    |   | 808                        |   | 1,180 |   | 993 |   | 15,772 |   |
| Employment Contracts             |   | 1,912     |   | 865                        |   | 1,047 |   | — |   | — |   |
|                             |   | $         | 30,366 |                       | $      | 8,831 |   | $ | 2,558 |   | $ | 1,117 |   | $ | 17,860 |   |

 

*Convertible Note*-OnJuly 31, 2003, we entered into a Securities Purchase Agreement (“PurchaseAgreement”) to sell to Laurus Master Fund, Ltd. (“Laurus”) a two-year SecuredConvertible Note (the “Convertible Note”) in the original principal amount of$2,000,000 and a five-year warrant to purchase up to 125,000 shares of ourcommon stock.  The per share exerciseprice of the warrant is $2.68 for 75,000 shares, $2.91 for 35,000 shares and$3.38 for 15, 000 shares. The Convertible Note is convertible, at Laurus’soption, into shares of our common stock at a per share price of $2.33.  Laurus is not entitled to convert the amountevidenced by the Convertible Note into a number of shares of common stock whichwould exceed the difference between the number of shares of common stockbeneficially owned by Laurus and 4.99% of the outstanding shares of commonstock of us.  However, Laurus mayacquire more than 4.99% of our outstanding common stock upon 75 days’ notice tothe Company. The Convertible Note accrues interest at an annual rate equal tothe higher of the prime rate plus 1.75% or 6% per annum.  We allocated $143,000 of the proceeds to thewarrant issued.  The amount allocatedrepresents the fair value of the warrant calculated under the Black-Scholes method.  The value of the warrant is included inadditional paid in capital and is being amortized to interest expense over thelife of the Convertible Note.

 

In connection with the ConvertibleNote, we and Laurus entered into a Security Agreement granting to Laurus a lienand security interest in our assets. Additionally, the Securities Purchase Agreement includes defaultprovisions should an Event of Default (as defined in the agreement) occur.

 

*Revolving Noteand Minimum Borrowing Note*- On August 28, 2003,we entered into a Security Agreement with Laurus under which the Company mayborrow from Laurus the lesser of $5,000,000 or an amount that is determinedbased on percentages of the Company’s eligible accounts receivable andinventory as prescribed by the terms of the Security Agreement.  Under the Security Agreement, the Companyissued to Laurus a three-year Secured Revolving Convertible Note (“RevolvingNote”) in the original principal amount of $3,500,000 and a three-year SecuredMinimum Borrowing Convertible Note (“Minimum Borrowing Note”) in the originalprincipal amount of $1,500,000. We used proceeds from the Revolving Note andMinimum Borrowing Note to satisfy in full our credit facility from Wells FargoBusiness Credit.  The Revolving Note andMinimum Borrowing Note accrue interest at an annual rate equal to the primerate plus 2.5%.The availability under the Revolving Note was $379,000 atMarch 31, 2004.

 

Beginning May 28, 2004, the MinimumBorrowing Note and the Revolving Note are convertible, at Laurus’s option, intoshares of the Company’s common stock at a per price share of $2.64 (the “FixedConversion Price”).  The FixedConversion Price is adjusted upward following each conversion of $2,000,000, asdefined.  Laurus is not entitled toconvert the amount evidenced by the Minimum Borrowing Note and the RevolvingNote into a number of shares of common stock which would exceed the differencebetween the number of shares of the Company’s common stock beneficially ownedby Laurus or issuable upon the exercise of warrants held by Laurus and 4.99% ofthe outstanding shares of the Company’s common stock.  However, Laurus may acquire more than 4.99% of the Company’soutstanding common stock upon 75 days’ notice to the Company.  Additionally, the Securities PurchaseAgreement includes default provisions should an Event of Default (as defined inthe agreement) occur; furthermore, under a related registration rightsagreement, the Company has agreed to register the common stock underlying theRevolving Note and Minimum Borrowing Note.

 

The Company also issued to Laurus afive-year warrant to purchase up to 115,000 shares of the Company’s stock. Theper share exercise price of the warrant is $2.55 for 70,000 shares, $2.75 for35,000 shares, and $2.95 for 10,000 shares. The Company allocated $133,000 ofthe proceeds to the warrant issued.  The amount allocated represents the fair value of the warrant calculatedunder the Black-Scholes method.  Thevalue of the warrant is included in additional paid in capital and is beingamortized to interest expense over the life of the Revolving Note and MinimumBorrowing Note.

 

*WorkingCapital Loan-*On March 7, 2003, SignatureIndustries Ltd., our subsidiary in the United Kingdom, entered into a LoanAgreement with The Royal Bank of Scotland for £500,000 to finance the workingcapital requirements of their Indian Air Force contract.  The Loan bears interest at 2.25% above thebase rate, as defined in the agreement. The base rate may vary from time to time.  On January 22, 2004 the agreement was amended to increasethe loan amount to £1,000,000 ($1,830,000). Repayment of £200,000 is required by May 30, 2004 and each monththereafter until the loan is repaid in full.

 

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*InvoiceDiscounting Agreement-*On April 9, 2003, SignatureIndustries Ltd. entered into a two-year Invoice Discounting Agreement with TheRoyal Bank of Scotland Commercial Services Limited (“RBS”).  The Invoice Discounting Agreement, as amendedOctober 28, 2003, provides for Signature to sell with full title guaranteemost of its receivables, as defined in the Invoice Discounting Agreement, asamended.  RBS prepays 80% of thereceivables sold, not to exceed an outstanding balance of £750,000 ($1,333,500)at any given time.  RBS pays Signaturethe remainder of the receivable upon collection of the receivable.  Receivables which remain outstanding 90 daysfrom the end of the invoice month become ineligible and RBS may requireSignature to repurchase the receivable back. The discounting charge accrues daily at an annual rate 2.25% above thebase rate, as defined in the amended Invoice Discounting Agreement.  Signature pays a commission charge to RBS of0.2% of each receivable balance sold. The Invoice Discounting Agreement, as amended, requires a minimumcommission charge of £833 per month. Discounting charges of $32,000 are included in interest expense in the2003 statement of operations. Amount of receivables financed at March 31,2004 was $1,100,000.

 

*Stock Issuance toADS*-On March 1, 2004, the Company issued 3,000,000 sharesof its common stock to ADS pursuant to the Stock Purchase Agreement (“StockPurchase Agreement”) with ADS dated August 14, 2003.   The Stock Purchase Agreement provided forADS to purchase 3,000,000 shares of our common stock at a price of $2.64 pershare and a warrant (the “ADS Warrant”) to purchase up to 1,000,000 shares ofour common stock, which is exercisable for five years beginningFebruary 1, 2004, at a price per share of $3.74 payable in cash or sharesof common stock of ADS.  The purchaseprice for the sale of the Company’s 3,000,000 shares and the warrant waspayable in 1,980,000 shares of ADS common stock.  The Company expects to generate cash for operations by sellingthe shares of stock received by ADS.  Asof March 31, 2004, the Company has sold 530,000 shares of ADS common stockresulting in aggregate net proceeds of approximately $1,400,000.

 

As part of this transaction , theCompany issued five-year warrants to purchase up to 500,001 shares of theCompany’s stock at an exercise price of $2.64 per share anytime on or afterFebruary 1, 2004 to the holders of the ADS 8.5% Convertible ExchangeableDebentures.

 

Since January 1, 2004, theCompany received aggregate proceeds of $990,000 on the exercise of stockoptions.

 

**Forward -Looking Statements and Associated Risk**

 

This Form 10-Q containsforward-looking statements within the “safe harbor” provisions of the PrivateSecurities Litigation Reform Act of 1995 with respect to our financialcondition, results of operations and business, and it includes statementsrelating to:

 

•                  ourgrowth strategies including, without limitation, our ability to deploy**new products and services;

•                  anticipatedtrends in our business and demographics;

•                  ourability to successfully integrate the business operations of recently acquiredcompanies;

•                  ourfuture profitability and liquidity; and

•                  regulatory,competitive or other economic influences.

 

Words such as “anticipates,”“expects,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similarexpressions also identify forward-looking statements.  These forward-looking statements are not guarantees of futureperformance and are subject to risks and uncertainties that could cause actualresults to differ materially from estimates or forecasts contained in theforward-looking statements.  Some ofthese risks and uncertainties are beyond our control.

 

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**RiskFactors**

 

You should carefullyconsider the risk factors listed below. These risk factors may cause our future earnings to be less or ourfinancial condition to be less favorable than we expect.  You should read this section togetherwith the other information contained herein.

 

**Recent changes inour senior management could have an adverse effect on our financial results.**

 

We have recently experiencednumerous changes with respect to our senior management.  On September 4, 2003, Randolph K.Geissler resigned as Chief Executive Officer of Digital Angel Corporation afterserving in such position since the March 2002 merger between Digital AngelCorporation and Medical Advisory Systems. From September 2000 until March 2002, Mr. Geissler served asChief Executive Officer of Digital Angel Corporation, the predecessorcorporation to our Company.

 

Following Mr. Geissler’sresignation, the Company appointed Kevin McLaughlin as the interim ChiefExecutive Officer of Digital Angel Corporation while the Company conducted aformal search for a permanent Chief Executive Officer.  At the time of his appointment as interimChief Executive Officer, Mr. McLaughlin was serving as President and ChiefOperating Officer of Applied Digital Solutions.  On November 3, 2003, the Company announced that it hadagreed to appoint Van Chu as Chief Executive Officer of the Company.  At the time of this announcement, Mr. Chuwas Chief Executive Officer of OuterLink Corporation, a company that wasacquired by Digital Angel Corporation on January 22, 2004.  Mr. Chu assumed his duties as ChiefExecutive Officer of Digital Angel Corporation on November 7, 2003.

 

Mr. Chu was terminated as ChiefExecutive Officer of the Company on January 12, 2004.  On January 12, 2004, the Company’sboard of directors appointed Kevin N. McGrath as President and Chief ExecutiveOfficer of the Company.

 

Since we depend heavily on theskills of those persons holding senior management positions, the loss of anysenior executive could materially adversely affect our financial results.  These senior executives, in many cases, havestrong relationships with our customers and suppliers.  Therefore, the loss of the services of suchsenior executives or any general instability in the composition of our seniormanagement could have a negative impact on our relationship with thesecustomers and suppliers.  We cannotensure that we will be able to retain our senior executives and thisuncertainty could have a material negative impact on our business.

 

**As ofMarch 31, 2004, our majority stockholder, Applied Digital Solutions, owns68.5% of our common stock, is able to completely control the board of directorsand may support actions that conflict with the interests of the otherstockholders.**

 

As of March 31, 2004, AppliedDigital Solutions is the beneficial owner of 68.5% of our common stock, and itcontrols us with respect to all matters upon which our stockholders may vote,including the selection of the Board of Directors, mergers, acquisitions andother significant corporate transactions. There can be no assurance as to how Applied Digital Solutions maysupport actions that are contrary to or conflict with the interests of theother stockholders.

 

**Our stockholderswill experience dilution in the event Laurus Master Fund exercises its right toconvert certain debt owed by us into shares of our common stock.**

 

On July 31, 2003, the Companyissued to Laurus Master Fund a two-year secured convertible note in theoriginal principal amount of $2,000,000. The secured convertible note isconvertible, at Laurus Master Fund’s option, into shares of the Company’scommon stock at a per share price of $2.33. In connection with the issuance ofthe secured convertible note, we also issued to Laurus Master Fund a five-yearwarrant to purchase 125,000 shares of our common stock at exercise prices rangingfrom $2.68 to $3.38 per share. The Company has the ability to prepay thesecured convertible note at 110% to 125% of the prepayment amount.

 

On August 28, 2003, we issueda three-year secured revolving convertible note in the principal amount of $3,500,000and a three-year secured minimum borrowing convertible note in the principalamount of $1,500,000 to Laurus Master Fund. Beginning May 28, 2004, each ofthese notes is convertible, at Laurus Master Fund’s option, into shares of ourcommon stock at $2.64 per share. In connection with the issuance of thesenotes, Laurus Master Fund also acquired a five-year warrant to purchase 115,000shares of our common stock at exercise prices ranging from $2.55 to $2.95 pershare. The Company has the ability to prepay the secured minimum convertiblenote for a 1% to 3% fee.

 

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Our issuance of shares to LaurusMaster Fund from any conversion of these notes, or exercise of the warrants mayresult in substantial dilution to other Digital Angel Corporation stockholders.In addition, Laurus Master Fund may offer and sell any and all of the shares ofour common stock received in connection with conversion of the notes, orexercise of the warrants at prices and times to be determined in its solediscretion. There is no independent or third-party underwriter involved in theoffering of the shares of our common stock acquired by Laurus Master Fund andthere can be no guarantee that any disposition of those shares will be completedin a manner that is not disruptive to the trading market for our common stock.

 

**Our stockholderswill experience dilution upon conversion of the Series A Preferred Stock issuedby the Company in the OuterLink Corporation acquisition.**

 

On January 22, 2004, theCompany acquired OuterLink Corporation of Concord, Massachusetts, in a merger.In connection with the acquisition, Digital Angel Corporation issued 100,000shares of its Series A Preferred Stock. The Series A Preferred Stock isconvertible into four million shares of Digital Angel Corporation common stockwhen the volume-weighted average price of Digital Angel Corporation’s commonstock equals or exceeds $4.00 per share for ten consecutive trading days. Theissuance of Digital Angel common stock upon conversion of the Series APreferred Stock issued to the OuterLink stockholders will result in dilution toour current stockholders.

 

**The terms of ourdebt obligations to Laurus Master Fund subject us to the risk of foreclosure onsubstantially all of our assets.**

 

We may not have sufficient funds torepay Laurus Master Fund when the obligations on the convertible note, minimumborrowing note and revolving note mature. Accordingly, we may be required to obtain the funds necessary to repaythese obligations either through refinancing, the issuance of additional equityor debt securities or the sale of assets. There can be no assurance that we can obtain the funds needed, if any,to repay the obligations from any one or more of these other sources on favorableeconomic terms or at all.  If we areunable to obtain funds to repay this indebtedness, we may be forced to disposeof assets or take other actions on disadvantageous terms, which could result inlosses to Digital Angel Corporation and could have a material adverse effect onour financial condition.

 

To secure the payment of all debts, liabilities and obligations owed toLaurus Master Fund we have granted to Laurus Master Fund a security interest inand lien upon all of our property and assets, whether real or personal,tangible or intangible, whether now owned or hereafter acquired, or in which wenow have, or at any time in the future may acquire, any right, title orinterest.  The occurrence of an event ofdefault under the convertible note, minimum borrowing note or revolving notewould subject us to foreclosure by Laurus Master Fund on substantially all ofour assets to the extent necessary to repay any amounts due.  Any such default and resulting foreclosurewill have a material adverse effect on our financial condition.

 

**Our earnings willdecline if we write off goodwill and other intangible assets.**

 

As of March 31, 2004, we hadrecorded goodwill of $48.4 million. On January 1, 2002, we adopted SFASNo. 142, “Goodwill and Other Intangible Assets.”  SFAS No. 142 requires that goodwill and certain intangibles nolonger be amortized but instead tested for impairment at least annually byapplying a fair value based test. During the fourth quarter of 2003, the Companyperformed the annual impairment test for goodwill using a fair value basedapproach, primarily discounted cash flows. An evaluation of the Medical Systemsreporting unit indicated that $2.4 million of goodwill was impaired.Additionally, management estimated that certain intangible assets at ourMedical Systems reporting unit were impaired by $0.6 million.  Accordingly, the Company recorded animpairment charge of $3.0 million in the fourth quarter of 2003, which isincluded in asset impairment in the 2003 statement of operations.  During the fourth quarter of 2002, werecorded an impairment charge of $57.4 million for goodwill at our GPS andRadio Communications and Medical Systems reporting units.

 

We will assess the fair value ofour goodwill annually or earlier if events occur or circumstances change thatwould more likely than not reduce the fair value of our goodwill below itscarrying value. These events or circumstances would include a significantchange in business climate, including a significant, sustained decline in anentity’s market value, legal factors, operating performance indicators,competition, sale or disposition of a significant portion of the business, orother factors. If we determine that significant impairment has occurred, wewould be required to write off the impaired portion of goodwill. Impairmentcharges could have a material adverse effect on our financial condition andresults of operations.

 

**The exercise ofoptions and warrants outstanding and available for issuance may adverselyaffect the market price of our common stock*.***

 

As of March 31, 2004, we had10,102,000 options and 3,029,000 warrants outstanding to purchase from us atotal of 13,131,000 shares of common stock at exercise prices ranging from$0.05 to $10.50 per share. In addition, we are requesting our stockholdersapprove an amendment to one of our stock plans at our May 6, 2004 AnnualMeeting which would allow for 4,527,00 additional shares of common stock whichmay be issued in the future under our stock option plans. The exercise ofoutstanding options and warrants and the sale in the public market of theshares purchased upon such exercise may adversely affect the market price ofour common stock.

 

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**We may continue toincur losses.**

 

We incurred a net loss of $3.7million for the quarter ended March 31, 2004. We also recorded a net lossof $9.5 million, $92.4 million and $17.4 million for the years endedDecember 31, 2003, 2002 and 2001, respectively. Included in the $92.4million loss for the year ended December 31, 2002 is a goodwill impairmentcharge of $57.4 million, an asset impairment charge of $6.4 million, and a$18.7 million charge arising from the remeasurement of options in connectionwith the 2002 merger. No assurance can be given as to whether we will achieveprofitability, if at all. Profitability depends on many factors, including thesuccess of marketing programs, the maintenance and reduction of expenses, andthe ability to coordinate successfully the operations of our business units. Ifwe fail to achieve and maintain sufficient profitability within the time frameexpected by investors, the market price of our common stock may be adverselyaffected.

 

**The Digital AngelTMtechnology is not proven, and we may not be able to develop products from thisunproven technology.**

 

We have invested approximately$15.6 million in the Digital AngelTM technology for the period fromApril 1998 through March 31, 2004. The Digital AngelTM technology depends on the development,integration, miniaturization and successful marketing of several advancedtechnologies that have not previously been integrated or used. The DigitalAngelTM technology depends upon advanced technology, includingwireless communication, biosensors, motion determination and global positioningsystem capabilities. Many of these technologies are unproven or relativelynew.  The Digital AngelTM technologycontinues to be in the development stage and the Company is uncertain when thistechnology will be incorporated into any products. This technology has notgenerated any significant revenue through March 31, 2004. No assurancescan be given as to when or if a Digital AngelTM  technology will be successfully marketed.Our ability to develop and commercialize products based on our proprietarytechnology will depend on our ability to develop products internally on atimely basis or to enter into arrangements with third parties to provide thesefunctions.  Our failure to develop andcommercialize products successfully could have a material adverse effect on ourfinancial condition and results of operations.

 

**Infringement bythird parties on our intellectual property or development of substantiallyequivalent proprietary technology by our competitors could negatively affectour business.**

 

Our success depends significantlyon our ability to maintain patent and trade secret protection, to obtain futurepatents and licenses, and to operate without infringing on the proprietaryrights of third parties. There can be no assurance that the measures we have takento protect our intellectual property will prevent its misappropriation orcircumvention of our intellectual property. In addition, there can be no assurance that any patent application, whenfiled, will result in an issued patent, or that our existing patents, or anypatents that may be issued in the future, will provide us with significantprotection against competitors. Moreover, there can be no assurance that anypatents issued to or licensed by us will not be infringed upon or circumventedby others.  Litigation to establish thevalidity of patents, to assert infringement claims against others, and todefend against patent infringement claims can be expensive and time-consuming,even if the outcome is in our favor.  Wealso rely to a lesser extent on unpatented proprietary technology, and noassurance can be given that others will not independently develop substantiallyequivalent proprietary information, techniques or processes or that we canmeaningfully protect our rights to such unpatented proprietary technology.  Infringement on our intellectual property orthe development of substantially equivalent technology by our competitors couldhave a material adverse effect on our business.

 

**Domestic andforeign government regulation and other factors could impair our ability todevelop and sell our products in certain markets.**

 

The electronic animalidentification market can be negatively affected by such factors as food safetyconcerns, consumer perceptions regarding cost and efficacy, international technologystandards, national infrastructures, and slaughterhouse removal of microchips.

 

We are also subject to federal,state and local regulation in the United States, including regulation by theFDA, FCC and the USDA, and in other countries. We cannot predict the extent to which we may be affected by furtherlegislative and regulatory developments concerning our products andmarkets.  We are required to obtainregulatory approval before marketing most of our products.  The regulatory process can be very time-consumingand costly, and there is no assurance that we will receive the regulatoryapprovals necessary to sell our products under development.  Regulatory authorities also have theauthority to revoke approval of previously approved products for cause, torequest recalls of products and to close manufacturing plants in response toviolations.  Any such regulatory action,including the failure to obtain such approval, could prevent us from selling,or materially impair our ability to sell, our products in certain markets andcould negatively affect our business.

 

**We rely heavily onsales to government contractors of our animal identification products, and anydecline in the demand by these customers for our products could negativelyaffect our business.**

 

The principal customers forelectronic identification devices for fish are government contractors that relyon funding from the United States government. Since these contractors rely heavily on government funds, any decline inthe availability of such funds could result in a decreased demand by thesecontractors for our products.  Anydecrease in demand by such customers could have a material adverse effect onour financial condition and results of operations and result in a decline inthe market value of our common stock.

 

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**We depend on asingle production arrangement with Raytheon Microelectronics Espana, SA for ourpatented syringe-injectable microchips, and the loss of or any significantreduction in the production could have an adverse effect on our business.**

 

We rely solely on a productionarrangement with Raytheon Microelectronics Espana, SA for the manufacture ofour patented syringe-injectable microchips that are used in all of ourimplantable electronic identification products. In addition, we have no formalwritten agreement with Raytheon for the production of our microchips. Raytheonutilizes our proprietary technology and our equipment in the production of oursyringe-injectable microchips. The termination, or any significant reduction,by Raytheon of the assembly of our microchips or a material increase in theprice charged by Raytheon for the assembly of our microchips could have anadverse effect on our financial condition and results of operations.  In addition, Raytheon may not be able toproduce sufficient quantities of the microchips to meet any significantincreased demand for our products or to meet any such demand on a timely basis.  Any inability or unwillingness of Raytheonto meet our demand for microchips would require us to utilize an alternativeproduction arrangement and remove our automated assembly production machineryfrom the Raytheon facility, which would be costly and could delayproduction.  Moreover, if Raytheonterminates our production arrangement, we cannot ensure that the assembly ofour microchips from another source would be on comparable or acceptableterms.  The failure to make such analternative production arrangement could have an adverse effect on ourbusiness.

 

**We depend onprincipal customers.**

 

For the quarter endedMarch 31, 2004,  we had onecustomer which accounted for 12.6% of our consolidated revenue.  Our four largest customers, in aggregate,accounted for 33.0% of our consolidated revenue in the quarter endedMarch 31, 2004. Our subsidiary, Signature Industries, Ltd. is heavilydependent on contracts with domestic government agencies and foreigngovernments, including the United Kingdom, primarily relating to militaryapplications. The loss of, or a significant reduction in, orders from these orour other major customers could have a material adverse effect on our financialcondition and results of operations.

 

**We compete withother companies in the visual and electronic identification market, and theproducts sold by our competitors could become more popular than our products orrender our products obsolete.**

 

The market for visual andelectronic identification products is highly competitive. We believe that ourprincipal competitors in the visual identification market for livestock areAllFlex USA and Y-Tex Corporation and that our principal competitors in theelectronic identification market are AllFlex USA, Datamars SA and AvidIdentification Systems, Inc..

 

In addition, other companies couldenter this line of business in the future. Certain of our competitors have substantially greater financial andother resources than us. We may not be able to compete successfully with thesecompetitors, and those competitors may develop or market technologies and productsthat are more widely accepted than ours or that would render our productsobsolete or noncompetitive.

 

**Currency exchangerate fluctuations could have an adverse effect on our sales and financialresults.**

 

We generate a portion of our salesand incur a portion of our expenses in currencies other than U.S. dollars.  To the extent that we are unable to matchrevenues received in foreign currencies with costs paid in the same currency,exchange rate fluctuations in any such currency could have an adverse effect onour financial results.

 

**We depend on asmall team of senior management, and we may have difficulty attracting andretaining additional personnel.**

 

Our future success will depend inlarge part upon the continued services and performance of senior management andother key personnel.  If we lose theservices of any member of our senior management team, our overall operationscould be materially and adversely affected. In addition, our future success will depend on our ability to identify,attract, hire, train, retain and motivate other highly skilled technical,managerial, marketing, purchasing and customer service personnel when they areneeded.  Competition for theseindividuals is intense.  We cannotensure that we will be able to successfully attract, integrate or retainsufficiently qualified personnel when the need arises.  Any failure to attract and retain thenecessary technical, managerial, marketing, purchasing and customer servicepersonnel could have a material adverse effect on our financial condition andresults of operations.

 

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**IMPACT OF RECENTLYISSUED ACCOUNTING STANDARDS**

 

In June 2002, the FinancialAccounting Standards Board issued Statement of Financial Accounting Standards(SFAS) No. 146, “Accounting for Costs Associated with Exit or DisposalActivities.” SFAS No. 146 requires recording costs associated with exit ordisposal activities at their fair values when a liability has been incurred.Under previous guidance, certain exit costs were accrued upon management’scommitment to an exit plan. The Company adopted SFAS No. 146 on January 1,2003. The adoption of SFAS No. 146 did not have a material impact on theresults of operations or financial position.

 

Effective January 1, 2003, theCompany adopted the recognition and measurement provisions of FASBInterpretation No. 45 (“Interpretation 45”), “Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others.” This interpretation elaborates on the disclosures tobe made by a guarantor in interim and annual financial statements about theobligations under certain guarantees. Interpretation 45 also clarifies that aguarantor is required to recognize, at the inception of a guarantee, aliability for the fair value of the obligation undertaken in issuing theguarantee. The initial recognition and initial measurement provisions of thisinterpretation are applicable on a prospective basis to guarantees issued ormodified after December 31, 2002. The Company does not currently providesignificant guarantees on a routine basis. As a result, this interpretation hasnot had a material impact on the Company’s financial statements.

 

In December 2003, the FASBissued FASB Interpretation No. 46 (revised December 2003) (“Interpretation46”), “Consolidation of Variable Interest Entities.” Application of thisinterpretation is required in the Company’s financial statements for interestsin variable interest entities that are considered to be special-purposeentities for the year ended December 31, 2003. The Company determined thatit does not have any arrangements or relationships with special-purposeentities.

 

Interpretation 46 addresses theconsolidation of business enterprises to which the usual condition (ownershipof a majority voting interest) of consolidation does not apply. Thisinterpretation focuses on controlling financial interests that may be achievedthrough arrangements that do not involve voting interests. It concludes that inthe absence of clear control through voting interests, a company’s exposure(variable interest) to the economic risks and potential rewards from thevariable interest entity’s assets and activities are the best evidence ofcontrol. If an enterprise holds a majority of the variable interests of anentity, it would be considered the primary beneficiary. The primary beneficiaryis required to include assets, liabilities and the results of operations of thevariable interest entity in its financial statements. The adoption of FIN 46did not have an impact on the financial position or operations of the Company.

 

In May 2003, the FASB issued SFAS150, Accounting for Certain Financial Instruments with Characteristics of BothLiabilities and Equity (SFAS No. 150). SFAS No. 150 establishes standards forhow an issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity. It requires that an issuerclassify a financial instrument that is within its scope as a liability (or anasset in some circumstances). Many of those instruments were previouslyclassified as equity. SFAS No. 150 is effective for financial instrumentsentered into or modified after May 31, 2003, and otherwise is effective at thebeginning of the first interim period beginning after June 15, 2003. It isto be implemented by reporting the cumulative effect of a change in accountingprinciple for financial instruments created before the issuance date of thestatement and still existing at the beginning of the interim period ofadoption. Restatement is not permitted. The Company adopted the provisions ofSFAS No.150 effective July 1, 2003. The adoption of SFAS No. 150 did nothave an impact on the Company’s financial position or results of operations.

 

**Item 3****.****          ****Quantitative and Qualitative Disclosures About Market Risk**

 

We have operations and salesin various regions of the world. Additionally, we may export and import to andfrom other countries.  Our operationsmay therefore be subject to volatility because of currency fluctuations,inflation, and changes in political and economic conditions in these countries.Sales and expenses may be denominated in local currencies and may be affectedas currency fluctuations affect our product prices and operating costs or thoseof our competitors.

 

We presently do not use anyderivative financial instruments to hedge our exposure to adverse fluctuationsin interest rates, foreign exchange rates, fluctuations in commodity prices orother market risks, nor do we invest in speculative financial instruments.

 

Due to the nature of ourborrowings and our short-term investments, we have concluded that there is nomaterial market risk exposure and, therefore, no quantitative tabulardisclosures are required.

 

**Item 4.****          ****Controls and Procedures**

 

Within the 90 days prior to thedate of this report, the Company carried out an evaluation, under thesupervision and with the participation of the Company’s management, includingthe Company’s Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures pursuant to Exchange Act Rule 13a-14 under the SecuritiesExchange Act of 1934.  Based upon thatevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat the Company’s disclosure controls and procedures are effective in timelyalerting them to material information relating to the Company (including itsconsolidated subsidiaries) required to be included in the Company’s periodic SECfilings with the Securities and Exchange Commission.  Since the date of their evaluation, there have been nosignificant changes in our internal controls or in other factors that couldsignificantly affect the Company’s internal controls.

 

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**PART II    OTHER INFORMATION**

 

**Item 1****.****          ****Legal Proceedings.**

 

*Wurts Litigation*

 

In February 2003, an actionwas filed in the Middlesex County Superior Court in the Commonwealth ofMassachusetts.  Our subsidiary,OuterLink Corporation, as well as a significant stockholder of OuterLink and aprincipal of the significant stockholder are named as defendants.  Such principal was a director ofOuterLink.  The complaint alleged breachof an August 25, 1999 employment contract.  The plaintiff was President and CEO of OuterLink Corporation fromJuly 1999 through August 2002. The Complaint seeks damages based principally on a contractual severanceprovision that allegedly provided for four months of compensation for everyyear or fraction thereof served prior to termination.  At the time of termination, the complaint alleges that theplaintiff’s salary was $250,000 per year. The defendants answered denying all liability and counterclaimed.  Discovery will be completed in this matter shortlyand the Defendants intend to vigorously defend this matter and pursue theircounterclaims.  The ultimate outcome ofthis proceeding cannot be predicted at this time and we are currently unable todetermine the potential effect of this litigation on our consolidated financialposition, results of operation or cash flows.

 

*E-ResearchLitigation*

 

In June 2002, eResearchTechnology, Inc. f/k/a Premier Research Worldwide, Ltd. (“ERT”) commenced aproceeding against U.S. Bank National Association, subsequently intervened inby us in the New Jersey state court and subsequently removed to the UnitedStates District Court for the District of New Jersey.  This suit was commenced to pursue alleged damages ofapproximately $350,000 due to the Company’s and US Bank’s alleged failure toregister transfers of restricted Digital Angel shares sold by ERT in May2002.  The Company has agreed toindemnify US Bank for all damages and reasonable costs relating to thislitigation.  We asserted a counterclaimagainst ERT based on ERT’s breach of a license agreement and servicesagreements between the parties that resulted in the original issuance by us of550,000 restricted common shares to ERT. The damages to us exceed $4 million and this amount does not include theshare of profits which we seek to recover had ERT not breached theagreements.  Further, the allegeddamages sought by the plaintiff in this matter do not take into accountplaintiff’s duty to mitigate damages which if discharged would have resulted ina profit to ERT.  The ultimate outcomeof this proceeding cannot be predicted at this time and we are is currentlyunable to determine the potential effect of this litigation on our consolidatedfinancial position, results of operation or cash flows.

 

*Electronic IdentificationDevices Litigation*

 

In February 2004, ElectronicIdentification Devices, Ltd. (“EID”) commenced a Declaratory Judgment Actionagainst us in the United States District Court for the Western District ofTexas. This action seeks a declaration of patent non-infringement relating toour syringe implantable identification transponders.  The lawsuit alleges that EID has developed a new transponder thatit believes does not infringe on our patent. The lawsuit acknowledges that we obtained a Judgment of infringement andtwo Contempt Orders against EID based on selling certain systems that infringedour patent in 1997, 1998 and 1999.  OnMarch 10, 2004 the Company filed a motion seeking the dismissal of the DeclaratoryJudgment Complaint or, in the alternative, that the action be transferred toMinnesota.  The Court has not yet ruledon the Company’s motion. Given the very early stage of this matter, theultimate outcome of this proceeding cannot be predicted at this time.  We are currently unable to determine thepotential effect of this litigation on its consolidated financial position,results of operation or cash flows.

 

**Item 2****.****          ****Changes in Securities, Use of Proceeds and Issuer Purchasesof Equity Securities**

 

On March 1, 2004, the Companyissued 3,000,000 unregistered shares of its common stock, $0.005 par value, toits majority shareholder, Applied Digital Solutions, Inc.  pursuant to a previously announcedtransaction.  The Company exchanged3,000,000 shares of its common stock, $0.005 par value, for 1,980,000 shares ofApplied Digital Solutions, Inc. common stock, $0.01 par value.  The shares received from Applied DigitalSolutions, Inc. were registered with the Securities and Exchange Commissionpursuant to a registration statement on Form S-1 that was declared effectiveFebruary 17, 2004.  As reported in thisForm 10-Q, the Company expects to sell the shares received and apply theproceeds to general working capital.  Asof the date hereof, the Company has sold 910,350 shares in normal agencytransactions at market through a registered broker-dealer and received netproceeds of $2.6 million.

 

**Item 6.****          ****Exhibits and Reports on Form 8-K.**

 

**(a)****                                 ****Exhibits**

 

The following exhibits are herebyincorporated into this Quarterly Report on Form 10-Q by reference to thereports and schedules identified below filed with the Securities and ExchangeCommission (“Commission”)**:**

 

3.1                                 Amendedand Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to Amendment No. 1 to ourRegistration Statement on Form S-3 (No. 333-110817) filed on January 23,2004)

 

3.2                                 Bylaws(incorporated by reference to Exhibit 3.2 to Amendment No. 1 to ourRegistration Statement on Form S-3 (No. 333-110817) filed on January 23,2004)

 

Thefollowing exhibits are filed with this Quarterly Report on Form 10-Q:

 

31.1                           Certificationof Chief Executive Officer under Rules 13a-14(a)/15d-14(a) under the Securitiesand Exchange Act and Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2                           Certificationof Chief Financial Officer under Rules 13a-14(a)/15d-14(a) under the Securitiesand Exchange Act and Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1                           Certificationof Chief Executive Officer Pursuant to 18 U.S.C Section 1350, as AdoptedPursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2                           Certificationof Chief Financial Officer Pursuant to 18 U.S.C Section 1350, as AdoptedPursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

**(b)****                                 ****Reports on Form 8-K**

 

During the three months endedMarch 31, 2004, the Company filed the following Current Reports on Form8-K:

 

(i)                                     OnMarch 15, 2004 the Company filed a Current Report on Form 8-K datedMarch 15, 2004 to report its financial results for the year endedDecember 31, 2004.

 

(ii)                                  OnMarch 8, 2004 the Company filed a Current Report on Form 8-K datedMarch 3, 2004 to report the resignation of Richard J. Sullivan from theCompany’s Board of Directors.

 

(iii)                               OnFebruary 3, 2004 the Company filed a Current Report on Form 8-K datedJanuary 27, 2004 to report the appointment of John R. Block to theCompany’s Board of Directors.

 

(iv)                              OnJanuary 23, 2004 the Company filed a Current Report on Form 8-K datedJanuary 22, 2004 to announce the completion of the OuterLink Corporationacquisition.

 

(v)                                 OnJanuary 15, 2004 the Company filed a Current Report on Form 8-K datedJanuary 15, 2004 to announcing the appointment of Kevin N. McGrath asPresident and Chief Executive Officer

 

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**SIGNATURE**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 

 
|               |   | DIGITAL ANGEL CORPORATION |
|--------------------|--------|---------------------------|
|               |   | (Registrant)              |
|               |   |                      |   |
| Dated: May 3, 2004 |   | By:                       | /S/ JAMES P. SANTELLI |
|               |   |                      | James P. Santelli |
|               |   |                      | Vice President - Finance  and Chief  Financial Officer |

 

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