**As filedwith the Securities and Exchange Commission on August 14, 2002**

 

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D. C.  20549**

 

# ****

# ** **

# **FORM 10-Q**

**(MarkOne)**

 

**ý****  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF**

**THE SECURITIES EXCHANGE ACT OF 1934.**

 

**Forthe quarterly period ended June 30, 2002**

 

**or**

 

**o****  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF**

**THE SECURITIES EXCHANGE ACT OF 1934.**

 

**Forthe transition period from        to      **

 

**Commission File Number: 1-15177**

 

**DIGITAL ANGELCORPORATION**

(Exact name of registrant asspecified 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  (651) 455-1621**                                                   |
| (Address, including zip code,  and telephone number,  including area code, of registrant’s principal executive offices) |

 

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the ExchangeAct during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

Yes    ý    No   o

 

The number ofshares outstanding of each of the issuer’s classes of common stock as of theclose of business on July 29, 2002:

 

| **Class**                      |   | **Number of Shares** |
|--------------------------------|--------|----------------------|
| Common Stock;  $.005 Par Value |   | 26,426,076           |

 

 

----

 

**DIGITALANGEL CORPORATION**

 

TABLE OF CONTENTS

 
| Item      | Description                                                                                                  |
|-----------|--------------------------------------------------------------------------------------------------------------|
|      |                                                                                                         |
|      | PART I – FINANCIAL  INFORMATION                                                                         |
|      |                                                                                                         |
| 1.        | Financial Statements                                                                                         |
|      | Condensed  Balance Sheets as of June 30, 2002 (unaudited) and December 31, 2001                              |
|      | Condensed Statements  of Operations (unaudited) - for the three and six months ended June 30, 2002  and 2001 |
|      | Condensed  Statement of Stockholders’ Equity (unaudited) - for the six months ended June  30, 2002      |
|      | Condensed Statements  of Cash Flows (unaudited) - for the six months ended June 30, 2002 and 2001            |
|      | Notes  to Condensed Financial Statements                                                                     |
| 2.        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                  |
| 3.        | Quantitative  and Qualitative Disclosures About Market Risk                                                  |
|      |                                                                                                         |
|      | PART  II – OTHER INFORMATION                                                                            |
|      |                                                                                                         |
| 1.        | Legal Proceedings                                                                                            |
| 2.        | Changes  In Securities and Use of Proceeds                                                                   |
| 3.        | Defaults Upon  Senior Securities                                                                             |
| 4.        | Submission  of Matters to a Vote of Security Holders                                                         |
| 5.        | Other Information                                                                                            |
| 6.        | Exhibits and  Reports on Form 8-K                                                                            |
|      |                                                                                                         |
| SIGNATURE |
| EXHIBITS  |

** **

2

----

 

PART I   FINANCIAL INFORMATION

Item 1.  Financial Statements.

 

**DIGITAL ANGEL CORPORATION AND SUBSIDIARIES**

 

**CONDENSED BALANCE SHEETS**

(Inthousands, except par value)

 
|                                                                                                                                                                                |   | **Digital Angel  Corporation and  Subsidiaries  (Consolidated)  June 30,  2002** |        | **Advanced  Wireless  Group  (Combined****)****December 31,  2001** |       |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------|-------------|---------------------------------------------------------------------|------------|
|                                                                                                                                                                                |   | **(Unaudited)**                                                                  |        |                                                                |       |
| **Assets**                                                                                                                                                                          |   |                                                                             |        |                                                                |       |
| **Current  Assets**                                                                                                                                                                 |   |                                                                             | ** **  |                                                                |       |
| Cash and cash  equivalents                                                                                                                                                          |   | **$**                                                                            | **584**     | ** **                                                          | $          | 596 |   |
| Accounts  receivable and unbilled receivables (net of allowance for doubtful accounts  of $318 in 2002 and $296 in 2001)                                                            |   | **4,494**                                                                        | ** **  | 5,402                                                               |       |
| Inventories                                                                                                                                                                         |   | **5,574**                                                                        | ** **  | 5,819                                                               |       |
| Other current  assets                                                                                                                                                               |   | **1,157**                                                                        | ** **  | 733                                                                 |       |
| **Total  Current Assets**                                                                                                                                                           |   | **11,809**                                                                       | ** **  | 12,550                                                              |       |
|                                                                                                                                                                                |   |                                                                             | ** **  |                                                                |       |
| **Property  And Equipment, net**                                                                                                                                                    |   | **14,951**                                                                       | ** **  | 14,476                                                              |       |
|                                                                                                                                                                                |   |                                                                             | ** **  |                                                                |       |
| **Goodwill  and Other Intangible Assets, net**                                                                                                                                      |   | **106,258**                                                                      | ** **  | 72,876                                                              |       |
|                                                                                                                                                                                |   |                                                                             | ** **  |                                                                |       |
| **Investment  In Affiliates**                                                                                                                                                       |   | **256**                                                                          | ** **  | 6,779                                                               |       |
|                                                                                                                                                                                |   |                                                                             | ** **  |                                                                |       |
| **Other  Assets, net**                                                                                                                                                              |   | **547**                                                                          | ** **  | 698                                                                 |       |
|                                                                                                                                                                                |   |                                                                             | ** **  |                                                                |       |
|                                                                                                                                                                                |   | **$**                                                                            | **133,821** | ** **                                                          | $          | 107,379 |   |
|                                                                                                                                                                                |   |                                                                             | ** **  |                                                                |       |
| **Liabilities and Stockholders’  Equity**                                                                                                                                      |   |                                                                             | ** **  |                                                                | ** ** |
|                                                                                                                                                                                |   |                                                                             | ** **  |                                                                |       |
| **Current  Liabilities**                                                                                                                                                            |   |                                                                             | ** **  |                                                                |       |
| Notes payable  and current maturities of long-term debt                                                                                                                             |   | **$**                                                                            | **387**     | ** **                                                          | $          | 82,643 |   |
| Accounts payable                                                                                                                                                                    |   | **3,416**                                                                        | ** **  | 3,757                                                               |       |
| Accrued expenses  and other current liabilities                                                                                                                                     |   | **4,341**                                                                        | ** **  | 2,044                                                               |       |
| Due to Applied  Digital Solutions, Inc.                                                                                                                                             |   | **153**                                                                          |        | —                                                              |       |
| **Total  Current Liabilities**                                                                                                                                                      |   | **8,297**                                                                        | ** **  | 88,444                                                              |       |
|                                                                                                                                                                                |   |                                                                             | ** **  |                                                                |       |
| **Long-Term  Debt And Notes Payable**                                                                                                                                               |   | **2,410**                                                                        | ** **  | 2,425                                                               |       |
|                                                                                                                                                                                |   |                                                                             | ** **  |                                                                |       |
| **Total  Liabilities**                                                                                                                                                              |   | **10,707**                                                                       | ** **  | 90,869                                                              |       |
|                                                                                                                                                                                |   |                                                                             | ** **  |                                                                |       |
| **Commitments  And Contingencies**                                                                                                                                                  |   |                                                                             | ** **  |                                                                |       |
|                                                                                                                                                                                |   |                                                                             | ** **  |                                                                |       |
| **Minority  Interest**                                                                                                                                                              |   | **351**                                                                          | ** **  | 394                                                                 |       |
|                                                                                                                                                                                |   |                                                                             | ** **  |                                                                |       |
| **Stockholders’  Equity (See Note 1)**                                                                                                                                         |   |                                                                             | ** **  |                                                                |       |
| Preferred  shares: Authorized 1,000 in 2002, of $1.75 par value, no shares issued or  outstanding                                                                                   |   |                                                                             |        |                                                                |       |
| Common shares:  Authorized 95,000 shares in 2002, of $.005 par value; 26,448 shares issued  and 26,398 shares outstanding in 2002 and 18,750 shares issued and  outstanding in 2001 |   | **132**                                                                          | ** **  | 94                                                                  |       |
| Additional  paid-in capital                                                                                                                                                         |   | **167,075**                                                                      | ** **  | 37,929                                                              |       |
| Accumulated  deficit                                                                                                                                                                |   | **(45,709**                                                                      | **)**       | (21,700                                                             | )          |
| Common stock  warrants                                                                                                                                                              |   | **1,638**                                                                        | ** **  | 300                                                                 |       |
| Treasury stock  (carried at cost, 50 shares in 2002)                                                                                                                                |   | **(43**                                                                          | **)**       | —                                                              |       |
| Accumulated  other comprehensive loss                                                                                                                                               |   | **(330**                                                                         | **)**       | (507                                                                | )          |
| Total  Stockholders’ Equity                                                                                                                                                    |   | **122,763**                                                                      | ** **  | 16,116                                                              |       |
|                                                                                                                                                                                |   |                                                                             | ** **  |                                                                |       |
|                                                                                                                                                                                |   | **$**                                                                            | **133,821** | ** **                                                          | $          | 107,379 |   |

 

See the accompanying notes to condensed financial statements.

 

3

----

 

**DIGITAL ANGEL CORPORATION AND SUBSIDIARIES**

 

**CONDENSEDSTATEMENTS OF OPERATIONS**

(In thousands, except pershare data)

(Unaudited)

 
|                                                                      |   | **Digital Angel  Corporation and  Subsidiaries  (Consolidated)** |       | **Advanced  Wireless  Group  (Combined)** |   | **Digital Angel  Corporation and  Subsidiaries  (Consolidated)** |       | **Advanced  Wireless  Group  (Combined)** |        |
|---------------------------------------------------------------------------|--------|------------------------------------------------------------------|------------|-------------------------------------------|--------|------------------------------------------------------------------|------------|-------------------------------------------|-------------|
|                                                                      |   | **For the Three Months  Ended June 30,**                         |       | **For the Six Months  Ended June 30,**    |   |
|                                                                      |   | **2002**                                                         |       | **2001**                                  |   | **2002**                                                         |       | **2001**                                  |        |
|                                                                      |   |                                                             | ** ** |                                      |   |                                                             | ** ** |                                      |        |
| Product revenue                                                           |   | **$**                                                            | **8,662**  | ** **                                | $      | 7,618                                                            |       | **$**                                     | **16,113**  | ** ** | $ | 16,752 |   |
| Service revenue                                                           |   | **577**                                                          | ** ** | 852                                       |   | **880**                                                          | ** ** | 1,922                                     |        |
| Total net  revenue                                                        |   | **9,239**                                                        | ** ** | 8,470                                     |   | **16,993**                                                       | ** ** | 18,674                                    |        |
|                                                                      |   |                                                             | ** ** |                                      |   |                                                             | ** ** |                                      |        |
| Cost of products  sold                                                    |   | **4,835**                                                        | ** ** | 4,600                                     |   | **9,135**                                                        | ** ** | 9,961                                     |        |
| Cost of services  sold                                                    |   | **247**                                                          | ** ** | 479                                       |   | **498**                                                          | ** ** | 1,028                                     |        |
|                                                                      |   |                                                             | ** ** |                                      |   |                                                             | ** ** |                                      |        |
| Gross profit                                                              |   | **4,157**                                                        | ** ** | 3,391                                     |   | **7,360**                                                        | ** ** | 7,685                                     |        |
|                                                                      |   |                                                             | ** ** |                                      |   |                                                             | ** ** |                                      |        |
| Selling, general  and administrative expenses                             |   | **3,713**                                                        | ** ** | 2,267                                     |   | **25,622**                                                       | ** ** | 4,768                                     |        |
| Management fees  - Applied Digital Solutions, Inc.                        |   | **—**                                                       | ** ** | 178                                       |   | **193**                                                          | ** ** | 371                                       |        |
| Research and  development expenses                                        |   | **782**                                                          | ** ** | 1,326                                     |   | **1,545**                                                        | ** ** | 2,410                                     |        |
| Depreciation and  amortization                                            |   | **1,095**                                                        | ** ** | 3,024                                     |   | **1,830**                                                        | ** ** | 5,383                                     |        |
| Interest income                                                           |   | **—**                                                       | ** ** | (8                                        | )      | **—**                                                       | ** ** | (11                                       | )           |
| Interest expense  - Applied Digital Solutions, Inc.                       |   | **—**                                                       | ** ** | **—**                                |   | **1,806**                                                        | ** ** | **—**                                |        |
| Interest expense  - others                                                |   | **67**                                                           | ** ** | 92                                        |   | **125**                                                          | ** ** | 151                                       |        |
|                                                                      |   |                                                             | ** ** |                                      |   |                                                             | ** ** |                                      |        |
| Loss before  taxes, minority interest and equity in net loss of affiliate |   | **(1,500**                                                       | **)**      | (3,488                                    | )      | **(23,761**                                                      | **)**      | (5,387                                    | )           |
|                                                                      |   |                                                             | ** ** |                                      |   |                                                             | ** ** |                                      |        |
| Provision  (benefit) for income taxes                                     |   | **—**                                                       | ** ** | (8                                        | )      | **—**                                                       | ** ** | 107                                       |        |
|                                                                      |   |                                                             | ** ** |                                      |   |                                                             | ** ** |                                      |        |
| Loss before  minority interest, and equity in net loss of affiliate       |   | **(1,500**                                                       | **)**      | (3,480                                    | )      | **(23,761**                                                      | **)**      | (5,494                                    | )           |
|                                                                      |   |                                                             | ** ** |                                      |   |                                                             | ** ** |                                      |        |
| Minority  interest                                                        |   | **(2**                                                           | **)**      | (5                                        | )      | **(43**                                                          | **)**      | (27                                       | )           |
|                                                                      |   |                                                             | ** ** |                                      |   |                                                             | ** ** |                                      |        |
| Equity in net  loss of affiliate                                          |   | **—**                                                       | ** ** | 49                                        |   | **291**                                                          | ** ** | 67                                        |        |
|                                                                      |   |                                                             | ** ** |                                      |   |                                                             | ** ** |                                      |        |
| Net loss                                                                  |   | **$**                                                            | **(1,498** | **)**                                     | $      | (3,524                                                           | )          | **$**                                     | **(24,009** | **)** | $ | (5,534 | ) |
|                                                                      |   |                                                             | ** ** |                                      |   |                                                             | ** ** |                                      |        |
| Net loss per  common share - basic and diluted                            |   | **$**                                                            | **(0.06**  | **)**                                     | $      | (0.19                                                            | )     | **$**                                     | **(1.06**   | **)** | $ | (0.30 | ) |
|                                                                      |   |                                                             | ** ** |                                      |   |                                                             | ** ** |                                      |        |
| Weighted average  number of common shares outstanding - basic and diluted |   | **26,169**                                                       | ** ** | 18,750                                    |   | **22,616**                                                       | ** ** | 18,750                                    |        |

 

See the accompanying notes to condensed financial statements.

 

4

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**DIGITAL ANGEL CORPORATION AND SUBSIDIARIES**

 

**CONDENSEDSTATEMENT OF STOCKHOLDERS' EQUITY**

**For TheSix Months Ended June 30, 2002**

(In Thousands)

(Unaudited)

 
|                                                  |   |       |       | **Additional  Paid-In  Capital** |    | **Accumulated  Deficit** |   | **Common  Stock  Warrants** |       | **Treasury  Stock** |        | **Accumulated  Other  Comprehensive  Loss** |   | **Total  Stockholders’  Equity** |       |
|-------------------------------------------------------|--------|------------|------------|----------------------------------|---------|--------------------------|--------|-----------------------------|------------|---------------------|-------------|---------------------------------------------|--------|---------------------------------------|------------|
| **Common Stock**                                      |
| **Number**                                            |   | **Amount** |
|                                                  |   |       |       |                             |    |                     |   |                        |       |                |        |                                        |   |                                  |       |   |   |
| **Balance - December 31, 2001**                       |   | 18,750     |       | $                                | 94      |                     | $      | 37,929                      |       | $                   | (21,700     | )                                           | $      | 300                                   |       | $ | — |   | $ | (507 | ) | $ | 16,116 |   |
| Net loss                                              |   | —     |       | —                           |    | —                   |   | (24,009                     | )          | —              |        | —                                      |   | —                                |       | (24,009 | ) |
| Comprehensive loss -   Foreign currency translation   |   | —     |       | —                           |    | —                   |   | —                      |       | —              |        | —                                      |   | 177                                   |       | 177 |   |
| Total comprehensive loss                              |   | —     |       | —                           |    | —                   |   | (24,009                     | )          | —              |        | —                                      |   | 177                                   |       | (23,832 | ) |
| Transfer of MAS common shares to ADS                  |   | —     |       | —                           |    | (6,488                   | )      | —                      |       | —              |        | —                                      |   | —                                |       | (6,488 | ) |
| Contribution by ADS                                   |   | —     |       | —                           |    | 6,593                    |   | —                      |       | —              |        | —                                      |   | —                                |       | 6,593 |   |
| Exercise of stock options                             |   | 2,392      |       | 12                               |    | 589                      |   | —                      |       | —              |        | —                                      |   | —                                |       | 601 |   |
| Shares to be issued in settlement of liability        |   | 38         |       | —                           |    | 225                      |   | —                      |       | —              |        | —                                      |   | —                                |       | 225 |   |
| Merger consideration - Medical Advisory Systems, Inc. |   | 5,268      |       | 26                               |    | 28,163                   |   | —                      |       | 272                 |        | (43                                         | )      | —                                |       | 28,418 |   |
| Assumption of debt by ADS                             |   | —     |       | —                           |    | 81,383                   |   | —                      |       | —              |        | —                                      |   | —                                |       | 81,383 |   |
| Stock options remeasured in connection with merger    |   | —     |       | —                           |    | 18,681                   |   | —                      |       | —              |        | —                                      |   | —                                |       | 18,681 |   |
| Warrants remeasured in connection with merger         |   | —     |       | —                           |    | —                   |   | —                      |       | 1,066               |        | —                                      |   | —                                |       | 1,066 |   |
|                                                  |   |       |       |                             |    |                     |   |                        |       |                |        |                                        |   |                                  |       |   |   |
| **Balance - June 30, 2002**                      |   | **26,448** | ** ** | **$**                            | **132** | ** **               | **$**  | **167,075**                 | ** ** | **$**               | **(45,709** | **)**                                       | **$**  | **1,638**                             | ** ** | **$** | **(43** | **)** | **$** | **(330** | **)** | **$** | **122,763** | ** ** |

 

See the accompanying notes to condensed financial statements.

 

5

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**DIGITAL ANGEL CORPORATION AND SUBSIDIARIES**

 

**CONDENSED STATEMENTS OF CASH FLOWS**

(In thousands)

(Unaudited)

 
|                                                                         |   | **Digital Angel  Corporation and  Subsidiaries  (Consolidated)** |        | **Advanced  Wireless  Group  (Combined)** |    |
|------------------------------------------------------------------------------|--------|------------------------------------------------------------------|-------------|-------------------------------------------|---------|
|                                                                         |   | **For the Six Months  Ended June 30,**                           |        |
|                                                                         |   | **2002**                                                         |        | **2001**                                  |    |
| **Cash  Flows From Operating Activities**                                    |   |                                                             | ** **  |                                      |    |
| Net loss                                                                     |   | **$**                                                            | **(24,009** | **)**                                     | $       | (5,534 | ) |
|                                                                         |   |                                                             | ** **  |                                      |    |
| Adjustments to  reconcile net loss to net cash used in operating activities: |   |                                                             | ** **  |                                      |    |
| Non-cash  compensation expense                                               |   | **18,877**                                                       | ** **  | —                                    |    |
| Interest  allocated by ADS and contributed to capital                        |   | **1,806**                                                        | ** **  | —                                    |    |
| Deferred income  taxes                                                       |   | —                                                           | ** **  | 34                                        |    |
| Depreciation and  amortization                                               |   | **1,830**                                                        | ** **  | 5,383                                     |    |
| Minority  interest                                                           |   | **(43**                                                          | **) ** | (27                                       | )  |
| Equity in net  loss of affiliate                                             |   | **291**                                                          | ** **  | 67                                        |    |
| Loss on sale of  equipment                                                   |   | **7**                                                            | ** **  | 7                                         |    |
| Change in assets  and liabilities:                                           |   |                                                             | ** **  |                                      |    |
| Decrease in  accounts receivable                                             |   | **1,181**                                                        | ** **  | 228                                       |    |
| Decrease  (increase) in inventories                                          |   | **312**                                                          | ** **  | (930                                      | )  |
| Increase in  other current assets                                            |   | **(545**                                                         | **) ** | (514                                      | )  |
| Increase in due  to ADS                                                      |   | **153**                                                          | ** **  | —                                    |    |
| (Decrease)  increase in accounts payable and accrued expenses                |   | **(714**                                                         | **) ** | 530                                       |    |
| **Net  Cash Used In Operating Activities**                                   |   | **(854**                                                         | **)**       | (756                                      | )       |
|                                                                         |   |                                                             | ** **  |                                      |    |
| **Cash  Flows From Investing Activities**                                    |   |                                                             | ** **  |                                      |    |
| Decrease in  other assets                                                    |   | **63**                                                           | ** **  | 262                                       |    |
| Payments for  property and equipment                                         |   | **(673**                                                         | **) ** | (1,091                                    | )  |
| Proceeds from  sale of property and equipment                                |   | **23**                                                           |        | —                                    |    |
| Cash acquired  through acquisition, net of acquisition costs                 |   | **40**                                                           | ** **  | —                                    |    |
| **Net  Cash Used In Investing Activities**                                   |   | **(547**                                                         | **) ** | (829                                      | )  |
|                                                                         |   |                                                             | ** **  |                                      |    |
| **Cash  Flows From Financing Activities**                                    |   |                                                             | ** **  |                                      |    |
| Net amounts  borrowed on notes payable                                       |   | **136**                                                          | ** **  | (2                                        | )  |
| Payments on  long-term debt                                                  |   | **(32**                                                          | **) ** | (35                                       | )  |
| Exercise of  stock options                                                   |   | **601**                                                          | ** **  | —                                    |    |
| Net transactions  with Applied Digital Solutions, Inc.                       |   | **684**                                                          | ** **  | 1,416                                     |    |
| **Net  Cash Provided By Financing Activities**                               |   | **1,389**                                                        | ** **  | 1,379                                     |    |
|                                                                         |   |                                                             | ** **  |                                      |    |
| **Net  Decrease In Cash And Cash Equivalents**                               |   | **(12**                                                          | **)**       | (206                                      | )       |
|                                                                         |   |                                                             | ** **  |                                      |    |
| **Cash  And Cash Equivalents - Beginning Of Period**                         |   | **596**                                                          | ** **  | 206                                       |    |
|                                                                         |   |                                                             | ** **  |                                      |    |
| **Cash  And Cash Equivalents - End Of Period**                               |   | **$**                                                            | **584**     | ** **                                | $       | — |   |

 

See the accompanying notes to condensed financial statements.

 

6

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** **

**DIGITAL ANGEL CORPORATION**

**NOTES TOCONDENSED FINANCIAL STATEMENTS**

**(Dollarsin thousands)**

**(Unaudited)**

** **

**1.             Basisof Presentation**

 

On March 27, 2002, Digital Angel Acquisition Co.(“Acquisition”), then a wholly-owned subsidiary of Medical Advisory Systems,Inc. (“MAS”), merged with and into Digital Angel Corporation (“Digital Angel”),which was then a 93% owned subsidiary of Applied Digital Solutions, Inc.(“ADS”).  In the merger, the corporateexistence of Acquisition ceased, Digital Angel became a wholly-owned subsidiaryof MAS, and MAS was renamed “Digital Angel Corporation”.  In connection with the merger transaction,ADS contributed to MAS all of its stock in Timely Technology Corp., awholly-owned subsidiary, and Signature Industries, Limited, an 85% ownedsubsidiary.  These two subsidiariesalong with Digital Angel comprised the Advanced 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% subsidiary.  Prior to the merger with Digital Angel, ADSowned 850,000 shares of MAS stock representing approximately 16.6% of theoutstanding stock of MAS.  (The term“Company” means Digital Angel Corporation and its subsidiaries.)  In the merger, the shares of Digital Angelowned by ADS were converted into a total of 18,750,000 shares of MAS commonstock.  As a result of the merger, ADSowned 19,600,000 shares or 77.15% of the Company’s common stock.  In connection with the merger, ADStransferred to Digital Angel Share Trust all shares of the Digital AngelCorporation common stock owned by ADS. The trust is the owner of and, through its Advisory Board, votes allshares of Digital Angel Corporation owned by ADS, including all shares issuedto ADS in consideration of the Digital Angel Corporation merger, and has theability to elect the Board of Directors of the Company.  The Trust arose as a condition of themerger.  In connection with certainobligations of ADS the shares owned by the Trust may be sold or otherwisedisposed of to satisfy such obligations. Additionally, the Company has certain covenant obligations in connectionwith the ADS obligations (see Note 9).

 

The merger has been treated as a reverse acquisitionfor accounting purposes, with AWG treated as the accounting acquirer.  The historical combined financial statementsof AWG became those of the Registrant, and the assets and liabilities of MASwere accounted for as required under the purchase method of accounting.  Although the equity accounts of AWG survivethe merger, the capital structure of MAS survives the merger.  Accordingly, the equity accounts of AWG havebeen restated based on the common shares received by the former shareholders ofAWG in the merger.

 

On March 27, 2002, ADS amended and restated its debtagreement with IBM Credit Corporation, which, among other amendments, providedfor a release of AWG from the responsibility to repay an existing obligation.Accordingly, ADS assumed this obligation, which resulted in an increase toadditional paid-in capital of $81.4 million net of deferred financing fees ofapproximately $1.1 million on March 27, 2002.

 

Pursuant to the terms of the merger agreement, optionsto acquire shares of Digital Angel common stock were converted into options toacquire shares of MAS common stock effective March 27, 2002. The conversionresulted in a new measurement date for the options and, as a result, theCompany recorded a charge of approximately $18.7 million in non-cash compensationexpense during the three months ended March 31, 2002. For current employees ofthe Company, these options are considered fixed awards under APB Opinion No.25, and expense was recorded for the intrinsic value of the options converted.  For all others, expense was recorded for thefair value of the options converted using the Black-Scholes option-pricingmodel.

 

The accompanying unaudited condensed consolidated financial statementsof Digital Angel 

 

7

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Corporation andsubsidiaries as of and for three and six month periods ended June 30, 2002 andthe combined financial statements of AWG as of December 31, 2001 and for thethree and six month periods ended June 30, 2001 (unaudited) have been preparedin accordance with accounting principles generally accepted in the UnitedStates of America for interim financial information and with the instructionsto Form 10-Q and Article 10 of Regulation S-X under the Securities Exchange Actof 1934.

 

Accordingly, they do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States of America for complete financial statements.  In the opinion of the Company’s management,all adjustments (including normal recurring adjustments) considered necessaryto present fairly the financial statements have been made.

 

The consolidated statements of operations for thethree and six months ended June 30, 2002 are not necessarily indicative of theresults that may be expected for the entire year.  These statements should be read in conjunction with the AWG’scombined financial statements and related notes thereto for the year endedDecember 31, 2001 included as an exhibit to our form 8-K/A filed with theSecurities and Exchange Commission on July 19, 2002.

 

Certain items in the combined financial statements forthe 2001 period have been reclassified for comparative purposes.

 

The accompanyingcondensed consolidated financial statements have been prepared assuming thatthe Company will continue as a going concern. The Company has suffered significant losses from operations and has notgenerated positive cash flows from operations. Additionally, the Company does not have an available line ofcredit.  These factors raise substantialdoubt about the Company’s ability to continue as a going concern.  The consolidated financial statements do notinclude any adjustments that might result from the outcome of this uncertainty.  The Company has conducted discussions withseveral banks regarding a credit facility. Our capital requirements depend on a variety of factors, including, butnot limited to, the rate of increase or decrease in our existing business base;the success, timing, and amount of investment required to bring new productson-line; revenue growth or decline; and potential acquisitions. Providing weare successful in obtaining the credit facility, of which there can be noassurance, management believes that we will have the financial resources tomeet its future business requirements for at least the next twelve months.

 

The financialinformation in these financial statements includes an allocation of expensesincurred by ADS on behalf of the Company as discussed in Note 9.  However, these financial statements may notnecessarily be indicative of the results that may have occurred had AWG been aseparate, independent entity during the periods presented or of future resultsof the Company.

 

**AccountingChanges**

 

Effective January 1, 2002, the Company adoptedStatement of Financial Accounting Standard No. 142, Goodwill and OtherIntangible Assets (FAS 142).  FAS 142requires that goodwill and certain intangibles no longer be amortized butinstead tested for impairment at least annually.  There was no impairment of goodwill upon adoption of FAS142.  However, there can be no assurancethat future goodwill impairment tests will not result in impairment charges.

 

8

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The following table presents the impact of FAS 142 onnet loss and net loss per share had the standard been in effect for the threemonths and six months ended June 30, 2001:

 
|                                               |   | **Three  Months Ended  June 30, 2001** |   | **Six  Months Ended  June 30, 2001** |   |
|----------------------------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|
|                                               |   |                                   |   |                                 |   |
| **Net loss:**                                      |   |                                   |   |                                 |   |
| Net loss as reported                               |   | $                                      | (3,524 | )                                    | $      | (5,534 | ) |
| Goodwill amortization                              |   | 2,024                                  |   | 3,959                                |   |
| Equity method investment amortization              |   | 336                                    |   | 449                                  |   |
| Adjusted net loss                                  |   | $                                      | (1,164 | )                                    | $      | (1,126 | ) |
|                                               |   |                                   |   |                                 |   |
| **Basis and diluted loss per share:**              |   |                                   |   |                                 |   |
| Net loss per share, basis and diluted, as reported |   | $                                      | (0.19  | )                               | $      | (0.30 | )  |
| Goodwill amortization                              |   | 0.11                                   |   | 0.21                                 |   |
| Equity method investment amortization              |   | 0.02                                   |   | 0.03                                 |   |
| Adjusted net loss per share, basic and diluted     |   | $                                      | (0.06  | )                               | $      | (0.06 | )  |
|                                                    |        |                                        |        |                                      |        |  |  |  |

 

Amortization expense ofother intangible assets totaled $224 and $20 for the six months ended June 30,2002 and 2001, respectively.

 

**2.             Principlesof Consolidation and Combination**

 

The June 30, 2002 condensed consolidated financialstatements include the accounts of the Company and its wholly-owned andmajority-owned subsidiaries from the date of acquisition.  The combined financial statements at December31, 2001 and for the three and six months ended June 30, 2001 include theaccounts of AWG entities under common control. All significant intercompany accounts and transactions have beeneliminated in consolidation and combination. AWG used the equity method of accounting for its investments which areless than majority owned, but over which it had significant influence.

 

**3.             RevenueRecognition**

** **

**For software consulting and development services,the Company recognizes revenue based on the percent complete for fixed feecontracts, with the percent complete being calculated as either the number ofdirect labor hours in the project to date divided by the estimated total directlabor hours or based upon the completion of specific task orders.  It is the Company’s policy to recordcontract losses in their entirety in the period in which such losses areforeseeable.  For non fixed fee jobs,revenue is recognized based on the actual direct labor hours in the job times thestandard billing rate and adjusted to realizable value, if necessary.  For product sales, the Company recognizesrevenue at the time products**

** **

9

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**are shipped and title has transferred, provided that a purchaseorder has been received or a contract has been executed, there are nouncertainties regarding customer acceptance, the sales price is fixed anddeterminable and collectability is deemed probable.  If uncertainties regarding customer acceptance exists, revenue isrecognized when such uncertainties are resolved.  There are no significant post-contract support obligations at thetime of revenue recognition.  TheCompany’s accounting policy regarding vendor and post-contract supportobligations is based on the terms of the customers’ contract, billable upon theoccurrence of the post-sale support. Costs of goods sold are recorded as the related revenue isrecognized.  The Company provideswarranties on certain of its products. Estimated warranty costs are accrued in the same period in which therelated revenue is recognized, based on anticipated parts and labor costs andutilizing historical experience.  TheCompany does not offer a warranty policy for services to customers. Revenuesfrom contracts that provide unlimited services are recognized ratably over theterm of the contract.  Fixed feerevenues from contracts for services are recorded when earned and excludesreimbursable costs.  Reimbursable costsincurred in performing such services are presented on a net basis and includetransportation, medical and communication costs.  Other revenues are recognized at the time services or goods areprovided.**

** **

**4.             Inventory**

 
|                                  |   | **June 30,  2002** |   | **December 31,  2001** |   |
|---------------------------------------|--------|--------------------|--------|------------------------|--------|
| Raw materials                         |   | $                  | 1,641  |                   | $      | 1,474 |   |
| Work in process                       |   | 216                |   | 176                    |   |
| Finished goods                        |   | 4,979              |   | 5,611                  |   |
|                                  |   | 6,836              |   | 7,261                  |   |
| Allowance for excess and obsolescence |   | (1,262             | )      | (1,442                 | )      |
| Net inventory                         |   | $                  | 5,574  |                   | $      | 5,819 |   |

 

 

10

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**5.**             **Loss Per Share**

 

The following is a reconciliation of the numerator anddenominator of basic and diluted loss per share:

 
|                                      |   | **Three  Months  Ended June 30,** |       | **Six Months    Ended June 30,** |       |
|-------------------------------------------|--------|-----------------------------------|------------|----------------------------------|------------|
|                                      |   | **2002**                          |       | **2001**                         |       | **2002** |   | **2001** |   |
| **Numerator:**                            |   |                              | ** ** |                             | ** ** |   | ** ** |   | ** ** |
| Net loss                                  |   | $                                 | (1,498     | )                                | $          | (3,524 | ) | $ | (24,009 | ) | $ | (5,534 | ) |
| **Denominator:**                          |   |                              | ** ** |                             | ** ** |   | ** ** |   | ** ** |
| Denominator for basic loss  per share -   |   |                              |       |                             |       |   |   |   |   |
| Weighted-average shares                   |   | 26,169                            |       | 18,750                           |       | 22,616 |   | 18,750 |   |
| Denominator for diluted loss per share(1) |   | 26,169                            |       | 18,750                           |       | 22,616 | ** ** | 18,750 | ** ** |
| **Basic and  diluted loss per share:**    |   | **$**                             | **(0.06**  | **)**                            | **$**      | **(0.19** | **)** | **$** | **(1.06** | **)** | **$** | **(0.30** | **)** |

 

----

(1) Potentiallydilutive securities excluded from the computation of diluted loss per sharebecause to do so would have been anti-dilutive.

 
|                   |   | **Three  Months   Ended June 30,** |   | **Six Months    Ended June 30,** |   |
|------------------------|--------|------------------------------------|--------|----------------------------------|--------|
|                   |   | **2002**                           |   | **2002**                         |   |
| Employee stock options |   | 3,967                              |   | 3,967                            |   |
| Warrants               |   | 1,239                              |   | 1,239                            |   |
|                   |   | 5,206                              |   | 5,206                            |   |

** **

11

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**6.             SegmentInformation**

** **

The Company is engaged in the business of developing and bringing tomarket proprietary technologies used to identify, locate and monitor people,animals and objects.  Prior to March 27,2002, the Company operated in four segments — Animal Tracking, Digital AngelTechnology, Digital Angel Delivery System, and Radio Communications andOther.  With the acquisition of MedicalAdvisory Systems, Inc. in March 2002, the Company re-organized into foursegments:  Animal Applications, DigitalAngel Systems, GPS and Radio Communications, and Physician Call Center andOther.  Animal Applications is the new nameof our segment previously identified as Animal Tracking.  We combined our Digital Angel Technologysegment with our Digital Angel Delivery System segment to form the new DigitalAngel Systems segment, which is now managed as a single business unit.  GPS and Radio Communications is the new nameof our segment previously identified as Radio Communications and Other andrepresents the activity of Signature Industries Limited, which is located inthe United Kingdom.  Physician CallCenter and Other reflects the newly acquired Medical Advisory Systems, Inc.business.  Prior period segmentinformation has been restated to reflect our current segment structure.

 

The accounting policies of the operating segments are the same as thosedescribed in the summary of accounting policies in the Company’s auditedfinancial statements for the year ended December 31, 2001.  It is on this basis that management utilizesthe financial information to assist in making internal operating decisions.  The Company evaluates performance based onstand-alone segment operating income.

 

Following is the selected segment data as of and forthe three months ended June 30, 2002:

 
|                                                                                                               |   | **Animal  Applications** |   | **Digital Angel  Systems** |   | **GPS and Radio  Communications** |   | **Physician Call  Center and  Other** |   | **Corporate /  Unallocated** |   | **Consolidated** |   |
|--------------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|----------------------------|--------|-----------------------------------|--------|---------------------------------------|--------|------------------------------|--------|------------------|--------|
|                                                                                                               |   |                     |   |                       |   |                              |   |                                  |   |                         |   |             |   |
| Net revenue from  external customers:                                                                         |   |                     |   |                       |   |                              |   |                                  |   |                         |   |             |   |
|                                                                                                               |   |                     |   |                       |   |                              |   |                                  |   |                         |   |             |   |
| Product                                                                                                            |   | $                        | 5,612  |                       | $      | —                            |   | $                                     | 2,480  |                         | $      | 570              |   | $ | — |   | $ | 8,662 |   |
| Service                                                                                                            |   | —                   |   | 577                        |   | —                            |   | —                                |   | —                       |   | 577              |   |
| Total revenue                                                                                                      |   | $                        | 5,612  |                       | $      | 577                               |   | $                                     | 2,480  |                         | $      | 570              |   | $ | — |   | $ | 9,239 |   |
|                                                                                                               |   |                     |   |                       |   |                              |   |                                  |   |                         |   |             |   |
| Income (loss) before  provision (benefit) for income taxes, minority interest and equity in net  loss of affiliate |   | $                        | 122    |                       | $      | (1,357                            | )      | $                                     | (25    | )                            | $      | (240             | )      | $ | — |   | $ | (1,500 | ) |
|                                                                                                               |   |                     |   |                       |   |                              |   |                                  |   |                         |   |             |   |
| Total assets                                                                                                       |   | $                        | 79,037 |                       | $      | 16,978                            |   | $                                     | 5,513  |                         | $      | 32,293           |   | $ | — |   | $ | 133,821 |   |

 

In the three month period ended June 30, 2002, 2 customers accountedfor approximately 15.8% and 15.1% of our Animal Applications revenue and onecustomer accounted for 49.2% of our Digital Angel Systems revenue.

 

12

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Following is the selected segment data as of and for the six monthsended June 30, 2002

 
|                                                                                                               |   | **Animal  Applications** |   | **Digital Angel  Systems** |   | **GPS and Radio  Communications** |   | **Physician Call  Center and  Other** |   | **Corporate /  Unallocated** |   | **Consolidated** |   |
|--------------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|----------------------------|--------|-----------------------------------|--------|---------------------------------------|--------|------------------------------|--------|------------------|--------|
| Net revenue from  external customers:                                                                              |   |                     |   |                       |   |                              |   |                                  |   |                         |   |             |   |   |   |   |   |   |   |
|                                                                                                               |   |                     |   |                       |   |                              |   |                                  |   |                         |   |             |   |   |   |   |   |   |   |
| Product                                                                                                            |   | $                        | 10,427 |                       | $      | —                            |   | $                                     | 5,116  |                         | $      | 570              |   | $ | — |   | $ | 16,113 |   |
| Service                                                                                                            |   | —                   |   | 880                        |   | —                            |   | —                                |   | —                       |   | 880              |   |
| Total revenue                                                                                                      |   | $                        | 10,427 |                       | $      | 880                               |   | $                                     | 5,116  |                         | $      | 570              |   | $ | — |   | $ | 16,993 |   |
|                                                                                                               |   |                     |   |                       |   |                              |   |                                  |   |                         |   |             |   |
| Income (loss) before  provision (benefit) for income taxes, minority interest and equity in net  loss of affiliate |   | $                        | 401    |                       | $      | (3,147                            | )      | $                                     | (288   | )                            | $      | (240             | )      | $ | (20,487) | (1) | $ | (23,761 | ) |
|                                                                                                               |   |                     |   |                       |   |                              |   |                                  |   |                         |   |             |   |
| Total assets                                                                                                       |   | $                        | 79,037 |                       | $      | 16,978                            |   | $                                     | 5,513  |                         | $      | 32,293           |   | $ | — |   | $ | 133,821 |   |

 

----

In the six month period ended June 30, 2002, 3 customers accounted forapproximately 15.0%, 12.4% and 10.8% of our Animal Applications revenue.  We buy most of our syringe-injectablemicrochips that are used in our electronic identification products from onesupplier.  In the six month period endedJune 30, 2002, one customer accounted for approximately 57.1% of our DigitalAngel Systems revenue.

 

(1)  Consistsof $18,681 non-cash compensation expense associated with Digital Angel optionsconverted into options to acquire Digital Angel Corporation stock and $1,806interest expense associated with ADS obligations to IBM Credit Corporation.

 

Following is the selected segment data as of and for the three monthsended June 30, 2001:

 
|                                                                                                               |   | **Animal  Applications** |   | **Digital Angel  Systems** |   | **GPS and Radio  Communications** |   | **Physician Call  Center and Other** |   | **Combined** |   |
|--------------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|----------------------------|--------|-----------------------------------|--------|--------------------------------------|--------|--------------|--------|
| Net revenue from  external customers:                                                                         |   |                     |   |                       |   |                              |   |                                 |   |         |   |
|                                                                                                               |   |                     |   |                       |   |                              |   |                                 |   |         |   |
| Product                                                                                                            |   | $                        | 4,877  |                       | $      | —                            |   | $                                    | 2,741  |         | $      | — |   | $ | 7,618 |   |
| Service                                                                                                            |   | —                   |   | 852                        |   | —                            |   | —                               |   | 852          |   |
| Total revenue                                                                                                      |   | $                        | 4,877  |                       | $      | 852                               |   | $                                    | 2,741  |         | $      | — |   | $ | 8,470 |   |
|                                                                                                               |   |                     |   |                       |   |                              |   |                                 |   |         |   |
| Income (loss) before  provision (benefit) for income taxes, minority interest and equity in net  loss of affiliate |   | $                        | (2,090 | )                          | $      | (1,461                            | )      | $                                    | 63     |         | $      | — |   | $ | (3,488 | ) |
|                                                                                                               |   |                     |   |                       |   |                              |   |                                 |   |         |   |
| Total assets                                                                                                       |   | $                        | 91,799 |                       | $      | 14,459                            |   | $                                    | 6,750  |         | $      | — |   | $ | 113,008 |   |

** **

**In the three month period ended June 30, 2001, 2customers provided for approximately 22.7% and 22.6% of our Animal Applicationsrevenue.**

13

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**Following is the selected segment data as of and forthe six months ended June 30, 2001:**

 
|                                                                                                               |   | **Animal  Applications** |   | **Digital Angel  Systems** |   | **GPS and Radio  Communications** |   | **Physician Call  Center and Other** |   | **Combined** |   |
|--------------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|----------------------------|--------|-----------------------------------|--------|--------------------------------------|--------|--------------|--------|
| Net revenue from  external customers:                                                                         |   |                     |   |                       |   |                              |   |                                 |   |         |   |
|                                                                                                               |   |                     |   |                       |   |                              |   |                                 |   |         |   |
| Product                                                                                                            |   | $                        | 11,260 |                       | $      | —                            |   | $                                    | 5,492  |         | $      | — |   | $ | 16,752 |   |
| Service                                                                                                            |   | —                   |   | 1,922                      |   | —                            |   | —                               |   | 1,922        |   |
| Total revenue                                                                                                      |   | $                        | 11,260 |                       | $      | 1,922                             |   | $                                    | 5,492  |         | $      | — |   | $ | 18,674 |   |
|                                                                                                               |   |                     |   |                       |   |                              |   |                                 |   |         |   |
| Income (loss) before  provision (benefit) for income taxes, minority interest and equity in net  loss of affiliate |   | $                        | (3,134 | )                          | $      | (2,028                            | )      | $                                    | (225   | )            | $      | — |   | $ | (5,387 | ) |
|                                                                                                               |   |                     |   |                       |   |                              |   |                                 |   |         |   |
| Total assets                                                                                                       |   | $                        | 91,799 |                       | $      | 14,459                            |   | $                                    | 6,750  |         | $      | — |   | $ | 113,008 |   |

** **

**In thesix month period ended June 30, 2001, 2 customers provided for approximately17.8% and 17.0% of our Animal Applications revenue.**

** **

14

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** **

**7.             Acquisitions**

 

The following describes the acquisition by the Company during the sixmonth period ended June 30, 2002:

 
| **Company  Acquired**          |   | **Date  Acquired** |   | **Acquisition  Price** |   | **Acquisition  Costs** |   | **Value of  Shares,  Warrants &  Options Issued or  Issuable** |   | **Common  Shares  Issued** |   | **Goodwill  and Other Intangibles Acquired** |   | **Business  Description** |   |
|--------------------------------|--------|--------------------|--------|------------------------|--------|------------------------|--------|--------------------------------------------------------------------|--------|----------------------------|--------|----------------------------------------------|--------|---------------------------|--------|
| Medical Advisory Systems, Inc. |   | 03/27/02           |   | $                      | 31,723 |                   | $      | 3,305                                                              |   | $                          | 28,418 |                                         | 5,218  |                      | $      | 29,901 |   | Provider of medical assistance and technical products and services |   |
|                           |   |               |   |                   |   |                   |   |                                                               |   |                       |   |                                         |   |                      |   |   |
|                                |        |                    |        |                        |        |                        |        |                                                                    |        |                            |        |                                              |        |                           |        |  |  |  |  |

 

On February 27, 2001, ADS acquired approximately 16.6% of the capitalstock of MAS (AMEX:DOC), a provider of medical assistance and technicalproducts and services, in a transaction valued at approximately $8.3 million inconsideration for 3.3 million shares of ADS’s common stock.  ADS controlled two of the seven seats on theCompany’s Board of Directors and became the largest single shareholder.  This investment was accounted for under theequity method from February 27, 2001 through March 27, 2002.  The excess of the purchase price over theestimated fair value of the shares acquired was approximately $6.8 million(goodwill) and was being amortized on a straight-line basis over five years,through December 31, 2001.

 

On March 27, 2002, Digital Angel Corporation merged with a wholly-ownedsubsidiary of MAS.  For accountingpurposes, AWG is treated as the acquirer, and the assets and liabilities of MASwere recorded at fair value under the purchase method of accounting.  The consolidated financial statementsreflect the results of operations of MAS from the date of acquisition.  The costs of acquisitions include allpayments according to the acquisition agreements plus costs for investmentbanking services, legal and accounting services that were direct costs ofacquiring these assets.

 

The cost of the March 27, 2002 acquisition consisted of 5.218 millionshares of common stock valued at $25.0 million, 1.2 million options and 75,000warrants valued at $3.4 million, and acquisition costs of $3.3 million.  The valuation of the stock is based on thevalue of the shares of MAS held by stockholders other than Applied DigitalSolutions prior to the acquisition. Included in the acquisition costs are certain severance liabilities of$2.5 million, related to employment agreements of two officers of MAS.  The value of the options and warrants isbased on the fair value of the options and warrants of MAS at the date ofacquisition.  The fair value wasdetermined using the Black-Scholes option pricing model.

 

In considering the benefits of a merger of AWG and MAS, the managementof AWG recognized the strategic advantage of combining the advanced wirelesstechnologies being developed by AWG with the physician-staffed call centerinfrastructure of MAS.  One of theprincipal benefits of such a combination is the ability of the Company to offera complete “end-to-end solution” to the various vertical markets for DigitalAngelTM products.

 

Unaudited pro forma results of operations for thethree and six months ended June 30, 2002 and 2001 are included below.  Such pro forma information assumes that theabove acquisition had occurred

 

15

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as of January 1,2002 and 2001, respectively, and revenue is presented in accordance with theCompany's accounting policies.  Thissummary is not necessarily indicative of what the result of operations of theCompany would have been had it been a combined entity during such periods, nordoes it purport to represent results of operations for any future periods.

 
|                                           |   | **Three  Months Ended June 30,** | ** ** | **Six Months  Ended June 30,** | ** ** |
|------------------------------------------------|--------|----------------------------------|------------|--------------------------------|------------|
|                                           |   | **2002**                         | ** ** | **2001**                       | ** ** | **2002** | ** ** | **2001** | ** ** |
| Net operating  revenue                         |   | $                                | 9,239      |                           | $          | 9,387 |   | $ | 17,543 |   | $ | 20,665 |   |
| Net loss                                       |   | $                                | (1,498     | )                              | $          | (3,863 | ) | $ | (25,463 | ) | $ | (6,209 | ) |
| Net loss per  common share - basic and diluted |   | $                                | (0.06      | )                              | $          | (0.16 | ) | $ | (0.88 | ) | $ | (0.26 | ) |

 

**8.             Contingencies**

 

**Silva, et al. v. Customized ServicesAdministrators, Incorporated, dba CSA Travel Protection, Inc. et al., No.CV798528 (Santa Clara County Superior Court)**

 

On May 29, 2001, Janet Silva, individually and asGuardian*ad Litem* for JonathanSilva, a minor, and the Estate of Clarence William Silva, Jr. (collectively,“Plaintiffs”) filed suit against Customized Services Administrators,Incorporated (“CSA”), Pricesmart, Inc. (“Pricesmart”), Commercial UnionInsurance Company (“Commercial Union”), CGU Insurance Group, and the Company(collectively the “Defendants”) in the Superior Court of the State ofCalifornia in and for the County of Santa Clara.  The allegations of the complaint arise from a vacation guaranteeinsurance policy (the “Insurance Contract”) allegedly purchased by Plaintiffsfrom Defendants on March 6, 2000.  Thecomplaint alleges, among other things, that Defendants breached the InsuranceContract, defrauded Plaintiffs, acted in bad faith, engaged in deceptive andunlawful business practices, resulting in the wrongful death of ClarenceWilliam Silva, Jr. (the “Deceased”) and the intentional infliction of emotionaldistress on Plaintiffs.  The complaintseeks the cost of funeral and burial expenses of the Deceased and amountsconstituting the loss of financial support of the Deceased, general damages,attorney’s fees and costs, and exemplary damages.

 

CSA has filed a cross-claim against the Companyalleging that the Company should be held liable for any liability that CSA mayhave to Plaintiffs.  The Company hasdenied the allegations of the complaint and the CSA cross-claim and isvigorously contesting all aspects of this action.

 

The Company is party to various other legal proceedings.  In the opinion of management, theseproceedings are not likely to have a material adverse effect on the financialposition, cash flows or overall trends in results of the Company.  The estimate of potential impact on theCompany’s financial position, overall results of operations or cash flows forthe above legal proceedings could change in the future.

 

16

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**9.             RelatedParty Activity**

 

ADS provided certain general and administrative services to the Companyincluding finance, legal, benefits and other miscellaneous items.  The costs of these services are included inthe Company’s Statements of Operations based on utilization, which managementbelieves to be reasonable.  Costs of theseservices were $0.2 million for the three months ended June 30, 2001, and $0.2million and $0.4 million for the six months ended June 30, 2002 and 2001,respectively.  ADS also charged theCompany $1.8 million of interest expense in 2002, for which the liability wasconverted to a capital contribution.  Inaddition, accrued expenses of $0.3 million were relieved and contributed tocapital by ADS.  Other transactionsresulted in a due to ADS of $0.2 million at June 30, 2002.

 

ADS acquired Timely Technology Corp., a part AWG, in 2000 and themerger agreement included an earnout provision based on performance throughJune 30, 2002.  ADS has agreed to paythe selling shareholder of Timely Technology Corp., $3.6 million, payable inshares of ADS stock, as the final payment under the earnout provision.  This obligation has been reflected in theaccompanying financial statements as a capital contribution by ADS and anincrease to goodwill and other intangibles.

 

In connection with certain obligations of ADS, the Company has thefollowing covenants.  Minimum CumulativeEBITDA, as defined, in the credit agreement, excludes non-cash compensationexpense, one-time charges, impairment losses or any liability or claim thatwill be satisfied by issuance of the Company’s common stock.

 
| **COVENANT**                          |   | **COVENANTS  REQUIREMENT** |
|---------------------------------------|--------|----------------------------|
| Current Assets to Current Liabilities |   | June 30, 2002              | 1.8:1 |
|                                  |   | September 30, 2002         | 1.8:1 |
|                                  |   | December 31, 2002          | 2.0:1 |
|                                  |   |                       |   |
| Minimum Cumulative Modified EBITDA    |   | June 30, 2002              | $ | 577,000 |
|                                  |   | September 30, 2002         | $ | 1,547,000 |
|                                  |   | December 31, 2002          | $ | 3,329,000 |

 

At June 30, 2002, the Company and ADS are out ofcompliance with certain of the covenants. ADS has received a communication from its lender indicating that pendingthe expected execution of formal agreements the lender has agreed to waive suchnoncompliance of the Company and ADS.

 

**10.          Investmentin Affiliates**

** **

**Thechange in the Company’s affiliates is as follows:**

** **
| **Balance December 31, 2001**                         |   | **$**      | **6,779**  |       |
|-------------------------------------------------------|--------|------------|------------|------------|
| **Equity in net loss of affiliate**                   |   | **(291**   | **)**      |
| **MAS common shares transferred  to ADS**             |   | **(6,488** | **)**      |
| **MAS affiliates obtained through  merger (at cost)** |   | **256**    | ** ** |
| **Balance June 30, 2002**                             |   | **$**      | **256**    | ** ** |

 

**11.          OptionGrant**

** **

The Company adopted theDigital Angel Corporation Transition Stock Option Plan, which as amended,provides for 11.2 million shares of common stock for which options and othergrants may be granted.

 

On June 27, 2002, theCompany's Board of Directors granted 3,910,000 options to employees anddirectors of the Company.  The optionshave an exercise price of $3.39, the fair value of the Company's common stockon the date of grant, and expire in 10 years. 3,000,000 of the options vest one year from the date of grant and theremaining vest one-third annually on the first anniversary of the grantdate.  Pursuant to an amendment to theCompany's Certificate of Incorporation, required by the terms of the Digital AngelShare Trust Agreement, the option grant requires the approval of two thirds ofthe Company's stockholders.  Approval ofthe grant has not been obtained.

 

 

17

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**Item2.****                                   Management’sDiscussion and Analysis of Financial Condition and Results of Operations.**

 

The following discussion and analysis of our financial condition andresults of operations should be read in conjunction with the accompanyingfinancial statements and related notes thereto.

 

We consist of MAS and its three subsidiaries, which formerly weresubsidiaries of Applied Digital Solutions, Inc. (“ADS”) – Digital AngelCorporation (“DAC”), Timely Technology Corp. and Signature Industries,Limited.  These three subsidiaries wereknown as the Advanced Wireless Group (“AWG”). DAC is engaged in the business of developing and bringing to marketproprietary technologies used to identify, locate and monitor people, animalsand objects.  DAC is the result of themerger in September 2000 of Destron Fearing Corporation and Digital Angel.netInc., which was then a wholly-owned subsidiary of ADS. Before March 27, 2002,the business of DAC was operated in four segments:  Animal Tracking, Digital Angel Technology, Digital Angel DeliverySystem, and Radio Communications and Other. With the acquisition of MAS in March 2002, the Company re-organized intofour segments:  Animal Applications,Digital Angel Systems, GPS and Radio Communications, and Physician Call Centerand Other.  Animal Applications is thenew name of our segment previously identified as Animal Tracking.  We combined our Digital Angel TechnologySegment with our Digital Angel Delivery System segment to form the new DigitalAngel Systems segment, which is now managed as a single business unit.  GPS and Radio Communications is the new nameof our segment previously identified as Radio Communications and Other.  Physician Call Center and Other reflects thenewly acquired MAS business.  Priorperiod segment information has been restated to reflect our current segmentstructure.

 

18

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**RESULTS OF OPERATIONS**

 

The following table summarizes our results of operations as apercentage of net operating revenue for the three and six months ended June 30,2002 and 2001 and is derived from the accompanying consolidated and combinedstatements of operations included in this report.

 
|                                                                                                      |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|-----------------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                                                                                      |   | **2002**                         |   | **2001**                       |   | **2002** |   | **2001** |   |
|                                                                                                      |   | **%**                            |   | **%**                          |   | **%** |   | **%** |   |
| Product revenue                                                                                           |   | 93.8                             |   | 89.9                           |   | 94.8 |   | 89.7 |   |
| Service revenue                                                                                           |   | 6.2                              |   | 10.1                           |   | 5.2 |   | 10.3 |   |
| Total net revenue                                                                                         |   | 100.0                            |   | 100.0                          |   | 100.0 |   | 100.0 |   |
| Cost of products sold                                                                                     |   | 52.3                             |   | 54.3                           |   | 53.8 |   | 53.3 |   |
| Cost of services sold                                                                                     |   | 2.7                              |   | 5.7                            |   | 2.9 |   | 5.5 |   |
| Total cost of products  and services sold                                                                 |   | 55.0                             |   | 60.0                           |   | 56.7 |   | 58.8 |   |
| Gross profit                                                                                              |   | 45.0                             |   | 40.0                           |   | 43.3 |   | 41.2 |   |
| Selling, general and  administrative expenses                                                             |   | 40.2                             |   | 26.8                           |   | 150.7 |   | 25.5 |   |
| Management fees -  Applied Digital Solutions, Inc.                                                        |   | 0.0                              |   | 2.1                            |   | 1.1 |   | 2.0 |   |
| Research and  development expenses                                                                        |   | 8.4                              |   | 15.6                           |   | 9.1 |   | 12.9 |   |
| Depreciation and  amortization expenses                                                                   |   | 11.9                             |   | 35.7                           |   | 10.8 |   | 28.9 |   |
| Interest income                                                                                           |   | 0.0                              |   | (0.1                           | )      | 0.0 |   | (0.1 | ) |
| Interest expense                                                                                          |   | 0.7                              |   | 1.1                            |   | 11.4 |   | 0.8 |   |
| Loss before provision  (benefit) for income taxes, minority interest and equity in net loss of  affiliate |   | (16.2                            | )      | (41.2                          | )      | (139.8 | ) | (28.8 | ) |
| Provision (benefit) for  income taxes                                                                     |   | 0.0                              |   | (0.1                           | )      | 0.0 |   | 0.6 |   |
| Loss before minority  interest and equity in net loss of affiliate minority interest                      |   | (16.2                            | )      | (41.1                          | )      | (139.8 | ) | (29.4 | ) |
| Minority interest                                                                                         |   | (0.0                             | )      | (0.1                           | )      | (0.2 | ) | (0.1 | ) |
| Equity in net loss of  affiliate                                                                          |   | 0.0                              |   | 0.6                            |   | 1.7 |   | 0.3 |   |
| Net loss                                                                                                  |   | (16.2                            | )      | (41.6                          | )      | (141.3 | ) | (29.6 | ) |

 

**ThreeMonths Ended June 30, 2002 Compared to the Three Months Ended June 30, 2001**

 

**Revenue**

Revenue from operations for the three months ended June 30, 2002 was $9.2 million, an increase of $0.7 million, or 8.2%, from $8.5 million in thethree months ended June 30, 2001.

 

 

 

19

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Revenue for each of the operating segments was:

 
|                            |   | **Three Months Ended  June 30,** |   | **Three Months  Ended June 30,** |   |
|---------------------------------|--------|----------------------------------|--------|----------------------------------|--------|
|                            |   | **2002**                         |   | **2001**                         |   |
| Animal Applications             |   | $                                | 5,612  |                             | $      | 4,877 |   |
| Digital Angel Systems           |   | 577                              |   | 852                              |   |
| GPS and Radio Communications    |   | 2,480                            |   | 2,741                            |   |
| Physician Call Center and Other |   | 570                              |   | —                           |   |
| Total                           |   | $                                | 9,239  |                             | $      | 8,470 |   |

 

The Animal Applications segment’s revenue increased**$0.7 million, or 15.1%, in the threemonths ended June 30, 2002 compared to the three month period ended June 30,2001.  The increase is due primarily tosales of transponders to the fisheries industry customers.

 

The Digital Angel Systems segment’s revenue decreased $0.3 million, or32.3%, in the three month period ended June 30, 2002 compared to the three month period ended June 30, 2001 primarily due to a shift in emphasis to theDigital AngelTM products which are in the initial stages of development.

 

The GPS and Radio Communications segment’s revenue decreased $0.3million, or 9.5%, in the three month period ended June 30, 2002 compared to three month period ended June 30, 2001 primarily as a result of order fluctuations.

 

PhysicianCall Center and Other revenue was $0.6 million in the three months period endedJune 30, 2002.  The segment became partof the Company on March 27, 2002.

 

**Gross Profit and Gross Profit Margin**

 

Gross profit for the three month period ended June 30, 2002 was $4.2million, an increase**of $0.8million, or 22.6%, compared to $3.4 million in the three month period endedJune 30, 2001. As a percentage of revenue, the gross profit margin was 45.0 %and 40.0% for the three months ended June 30, 2002 and 2001, respectively.

 

Gross profit from operations for each operating segment was:

 
|                            |   | **Three Months  Ended June 30,** |   | **Three Months  Ended June 30,** |   |
|---------------------------------|--------|----------------------------------|--------|----------------------------------|--------|
|                            |   | **2002**                         |   | **2001**                         |   |
| Animal Applications             |   | $                                | 2,266  |                             | $      | 1,680 |   |
| Digital Angel Systems           |   | 330                              |   | 372                              |   |
| GPS and Radio Communications    |   | 1,348                            |   | 1,339                            |   |
| Physician Call Center and Other |   | 213                              |   | —                           |   |
| Total                           |   | $                                | 4,157  |                             | $      | 3,391 |   |

 

Gross profit margin from operations for each operating segment was:

 
|                            |   | **Three Months  Ended June 30,** |       | **Three Months  Ended June 30,** |       |
|---------------------------------|--------|----------------------------------|------------|----------------------------------|------------|
|                            |   | **2002**                         |       | **2001**                         |       |
|                            |   | **%**                            | ** ** | **%**                            | ** ** |
| Animal Applications             |   | 40.4                             |       | 34.4                             |       |
| Digital Angel Systems           |   | 57.2                             |       | 43.7                             |       |
| GPS and Radio Communications    |   | 54.4                             |       | 48.9                             |       |
| Physician Call Center and Other |   | 37.4                             |       | —                           |       |
| Total                           |   | 45.0                             |       | 40.0                             |       |

 

20

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The Animal Applications segment’s gross profitincreased $0.6 million in the three month period ended June 30, 2002 comparedto the three months ended June 30, 2001**due to thepreviously mentioned sales increase.  The gross margin percentage increasedto 40.4% in the three month period ended June 30, 2002 as compared to 34.4% inthe three month period ended June 30, 2001 due to higher margin product mix.

 

The Digital Angel Systems segment’s gross profitdecreased $42,000, or 11.3%, in the three month period ended June 30, 2002 ascompared to the three month period ended June 30, 2001.  Margins increased to 57.2 % in the threemonth period ended June 30, 2002 from 43.7% in the three month period endedJune 30, 2001*. *The gross profit increase was primarily due to a shiftto higher margin contracts.

 

The GPS and Radio Communications segment’s grossprofit remained constant at $1.3 million for the three month period ended June30, 2002.  The gross margin percentageincreased to 54.4 % in the three month period ended June 30, 2002 as comparedto 48.9 % in the three month period ended June 30, 2001 due to a favorableshift in the product mix.

 

The Physician Call Centerand Other segment’s gross profit was $0.2 million for the three month period endedJune 30, 2002.  The gross margin was37.4% in the three month period ended June 30, 2002.  This segment became part of the Company on March 27, 2002.

 

**Selling, General and Administrative Expenses**

 

Selling, general and administrative expenses from operations increased$1.4 million, or 63.8%, in the three month period ended June 30, 2002as compared to the three month period ended June 30, 2001.  As a percentage of revenue, selling, generaland administrative expenses were 40.2% and 26.8% for the three months endedJune 30, 2002 and 2001, respectively.

 

Selling,general and administrative expenses for each of the operating segments were:

 
|                            |   | **Three Months  Ended June 30,** |   | **Three Months  Ended June 30,** |   |
|---------------------------------|--------|----------------------------------|--------|----------------------------------|--------|
|                            |   | **2002**                         |   | **2001**                         |   |
| Animal Applications             |   | $                                | 1,544  |                             | $      | 888 |   |
| Digital Angel Systems           |   | 843                              |   | 190                              |   |
| GPS and Radio Communications    |   | 1,051                            |   | 1,189                            |   |
| Physician Call Center and Other |   | 275                              |   | —                           |   |
| Total                           |   | $                                | 3,713  |                             | $      | 2,267 |   |

 

 

Selling, general and administrative expenses as a percentage of revenuefor each of the operating segments were:

 
|                            |   | **Three Months  Ended June 30,** |   | **Three Months  Ended June 30,** |       |
|---------------------------------|--------|----------------------------------|--------|----------------------------------|------------|
|                            |   | **2002**                         |   | **2001**                         |       |
|                            |   | **%**                            |   | **%**                            | ** ** |
| Animal Applications             |   | 27.5                             |   | 18.2                             |       |
| Digital Angel Systems           |   | 146.1                            |   | 22.3                             |       |
| GPS and Radio Communications    |   | 42.4                             |   | 43.4                             |       |
| Physician Call Center and Other |   | 48.2                             |   | —                           |       |
| Total                           |   | 40.2                             |   | 26.8                             |       |

 

The Animal Applications segment’s selling, general and administrativeexpenses increased $0.7 million in the three month period ended June 30,2002 as compared to the three month period ended June 30, 2001 and as apercentage of revenue increased to 27.5% from 18.2% in the same respectiveperiods.

 

21

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The increase is primarily due to increased expenses inlegal, accounting, and investor relations categories.

 

The Digital Angel Systems segment’s selling, generaland administrative expenses of $0.8 million increased**$653,000 in the three month period endedJune 30, 2002 as compared $0.2 million in the three month period ended June 30,2001.  Selling, general andadministrative expenses increased as apercentage of revenue to 146.1% in the three month period ended June 30, 2002compared to 22.3% in the three month period ended June 30, 2001 primarily as a result of softwareamortization expenses.

 

The GPS and Radio Communications segment’s selling,general and administrative expenses decreased $0.1 million in the three month period ended June 30, 2002 ascompared to the three month period ended June 30, 2001 primarily due toadministrative cost reductions. As a percentage of revenue, selling, generaland administrative expenses decreased to 42.4% in the three month period endedJune 30, 2002 from 43.4% in the three month period ended June 30, 2001.

 

The Physician Call Center segment’s selling, generaland administrative expenses were $0.3 million in the three month period endedJune 30, 2002.  As a percentage ofrevenue, selling, general and administrative expenses were 48.2% in the threemonth period ended June 30, 2002.  Thissegment became part of the Company on March 27, 2002.

** **

**ManagementFees**–**Applied DigitalSolutions, Inc.**

 

Management fees chargedby Applied Digital Solutions, Inc. amounted to $0.2 million for the threemonths ended June 30, 2001.  These feeswere for general and administrative services performed for us.  After March 31, 2002, we no longer pay amanagement fee to ADS.

** **

**Researchand Development Expense**

 

Research and development expense from operations was $0.8 million inthe three month period ended June 30, 2002, a decrease of $0.5 million, or41.0%, from $1.3 million for the three month period ended June 30, 2001.  As a percentage of revenue, research anddevelopment expense was 8.4% and 15.6% for the three months ended June 30, 2002and 2001, respectively.

 

Researchand development expense for each of the operating segments was:

 
|                            |   | **Three Months  Ended June 30,** |   | **Three Months  Ended June 30,** |   |
|---------------------------------|--------|----------------------------------|--------|----------------------------------|--------|
|                            |   | **2002**                         |   | **2001**                         |   |
| Animal Applications             |   | $                                | 361    |                             | $      | 253 |   |
| Digital Angel Systems           |   | 296                              |   | 1,073                            |   |
| GPS and Radio Communications    |   | 125                              |   | —                           |   |
| Physician Call Center and Other |   | —                           |   | —                           |   |
| Total                           |   | $                                | 782    |                             | $      | 1,326 |   |

 

The significant decrease isdue primarily to a reduction in basic research and development expensesassociated with the Digital AngelTM product.  Since the fundamental technology has nowbeen developed, research expenses have declined and expenses are now focused ondevelopment for specific vertical markets.

 

**Depreciation and Amortization**

 

Depreciation and amortization expense from operations was $1.1 millionin the three month period ended June 30, 2002, a decrease of $1.9 million, or 63.8%, from $3.0million in the three month period ended June 30, 2001.  As a percentage of revenue, the depreciationand amortization expense was 11.9% and 35.7% for the three months ended June30, 2002 and 2001, respectively.

 

The decrease was primarily due to the adoption of FAS 142, which tookeffect January 1, 2002.  The adoption ofFAS 142 requires the testing of goodwill for impairment at least annually,eliminating the need for monthly amortization of goodwill.  Accordingly, goodwill amortization was notrecorded during the three months ended June 30, 2002.

 

22

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Depreciation and amortization expense for each of the operatingsegments was:

 
|                            |   | **Three Months  Ended June  30,** |   | **Three Months  Ended June 30,** |   |
|---------------------------------|--------|----------------------------------------|--------|----------------------------------|--------|
|                            |   | **2002**                               |   | **2001**                         |   |
| Animal Applications             |   | $                                      | 195    |                             | $      | 2,360 |   |
| Digital Angel Systems           |   | 547                                    |   | 577                              |   |
| GPS and Radio Communications    |   | 177                                    |   | 87                               |   |
| Physician Call Center and Other |   | 176                                    |   | —                           |   |
| Total                           |   | $                                      | 1,095  |                             | $      | 3,024 |   |

 

**Interest Expense**

 

Interest expense was $0.1 million for the three month periods endedJune 30, 2002 and 2001.

** **

**Income Taxes**

 

The Company and AWG had effective income tax rates of 0% and a (0.2)%for the three month period ended June 30 of 2002 and 2001, respectively. Differences in the effective income tax rates from the statutory federalincome tax rate in 2002 arise primarily from valuation allowances recorded ondeferred tax assets resulting from net operating losses and in 2001 ariseprimarily from valuation allowances recorded on deferred tax assets resultingfrom net operating losses, non-deductible goodwill amortization associated withacquisitions and state taxes net of federal benefits. The U.S. companies in AWGwere included in ADS’s consolidated federal income tax return through March 27,2002.  MAS and its subsidiaries file aseparate consolidated federal income tax return.  After March 27, 2002, AWG’s U.S. subsidiaries will file aconsolidated federal tax return with MAS.

 

**SixMonths Ended June 30, 2002 Compared to the Six Months Ended June 30, 2001**

 

**Revenue**

 

Revenue from operations for the six months ended June 30, 2002 was$17.0 million, a decrease of $1.7 million, or 9.0%, from $18.7 million in thesix months ended June 30, 2001.

 

Revenue for each of the operating segments was:

 
|                            |   | **Six Months****Ended June 30,** |   | **Six Months****Ended June 30,** |   |
|---------------------------------|--------|----------------------------------|--------|----------------------------------|--------|
|                            |   | **2002**                         |   | **2001**                         |   |
| Animal  Applications            |   | $                                | 10,427 |                             | $      | 11,260 |   |
| Digital Angel Systems           |   | 880                              |   | 1,922                            |   |
| GPS and Radio Communications    |   | 5,116                            |   | 5,492                            |   |
| Physician Call Center and Other |   | 570                              |   | —                           |   |
| Total                           |   | $                                | 16,993 |                             | $      | 18,674 |   |

 

23

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The Animal Applications segment’s revenue decreased $0.8 million, or7.4%, in the six month period ended June 30, 2002 as compared to the six monthperiod ended June 30, 2001.  The declineis due primarily to the higher sales in the first quarter of 2001 to a largecustomer to prepare for the launch of the pet identification product in France.

 

The Digital Angel Systems segment’s revenue decreased $1.0 million, or54.2%, in the six month period ended June 30, 2002 as compared to the six month period ended June 30, 2001 due to completed client assignments thatwere not replaced and a shift in emphasis to the Digital AngelTM products whichare in the initial stages of development.

 

The GPS and Radio Communications segment’s revenue decreased** $0.4 million, or 6.8%, in the six month period ended June 30, 2002as compared to six monthperiod ended June 30, 2001 primarilyas a result of order fluctuations.

 

The Physician Call Center and Other revenue was $0.6 million for thesix months ended June 30, 2002.  Thissegment became part of the Company on March 27, 2002.

 

**GrossProfit and Gross Profit Margin**

 

Gross profit for the six months ended June 30, 2002 was $7.4 million, adecrease of $0.3 million, or 4.2%, from $7.7 million in the six months endedJune 30, 2001.  As a percentage ofrevenue, the gross profit margin was 43.3% and 41.2% for the six months endedJune 30, 2002 and 2001, respectively.

 

Gross profit from operations for each operating segment was:

 
|                            |   | **Six Months    Ended June 30,** |   | **Six  Months  Ended June 30,** |   |
|---------------------------------|--------|----------------------------------|--------|--------------------------------------|--------|
|                            |   | **2002**                         |   | **2001**                             |   |
| Animal Applications             |   | $                                | 4,145  |                                 | $      | 4,171 |   |
| Digital Angel Systems           |   | 382                              |   | 894                                  |   |
| GPS and Radio Communications    |   | 2,620                            |   | 2,620                                |   |
| Physician Call Center and Other |   | 213                              |   | —                               |   |
| Total                           |   | $                                | 7,360  |                                 | $      | 7,685 |   |

 

Gross profit margin from operations for each operating segment was:

 
|                            |   | **Six Months  Ended June 30,** |   | **Six Months  Ended June 30,** |   |
|---------------------------------|--------|--------------------------------|--------|--------------------------------|--------|
|                            |   | **2002**                       |   | **2001**                       |   |
|                            |   | **%**                          |   | **%**                          |   |
| Animal Applications             |   | 39.8                           |   | 37.0                           |   |
| Digital Angel Systems           |   | 43.4                           |   | 46.5                           |   |
| GPS and Radio Communications    |   | 51.2                           |   | 47.7                           |   |
| Physician Call Center and Other |   | 37.4                           |   | —                         |   |
| Total                           |   | 43.3                           |   | 41.2                           |   |

 

The Animal Applications segment’s gross profit of $4.1 million in thesix months ended June 30, 2002 decreased $26,000 compared to $4.2 million inthe six month period ended June 30, 2001*. *The gross profit margin increasedto 39.8% in the six month period ended June 30, 2002 as compared to 37.0% inthe six months ended June 30, 2001 due to a more favorable product mix.

 

The Digital Angel Systems segment’s gross profit decreased $0.5million, or 57.3%, in the six months ended June 30, 2002 as compared to the sixmonths ended June 30, 2001.  Marginsdecreased to 43.4% in the six months ended June 30, 2002 from 46.5% in the sixmonths ended June 30, 2001.  The gross profit decrease was primarily dueto the sales decline.  The margin percentage declined due to the retention of personnel subsequent to the sales clientcontract completion as resources were shifted to support the Digital AngelTMproducts.

 

24

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The GPS and Radio Communications segment’s gross profit remainedconstant at $2.6 million for the six months ended June 30, 2002.  The gross margin percentage increased** to 51.2% in the six months ended June 30, 2002 compared to 47.7%in the six months endedJune 30, 2001 due to a favorable shiftin the product mix.

 

The Physician Call Center and Other segment’s profit was $0.2 millionfor the six months ended June 30, 2002. The gross margin was 37.4% in the six months ended June 30, 2002.  This segment became part of the Company onMarch 27, 2002.

 

**Selling,General and Administrative Expenses**

 

Selling general and administrative expenses from operations increased $20.9 million, or 437.4%, in the six monthsended June 30, 2002 as compared to the six months ended June 30, 2001.  This increase was caused primarily by an$18.7 million charge arising from the remeasurement of options in connectionwith the merger.  Pursuant to the termsof the merger agreement, options to acquire shares of Digital Angel commonstock were converted into options to acquire shares of MAS common stockeffective March 27, 2002.  Theconversion resulted in a new measurement date for the options and, as a result,the Company recorded a charge of approximately $18.7 million in non-cashcompensation expense during the three months ended March 31, 2002.  For current employees of the Company, theseoptions are considered fixed awards under APB Opinion No. 25, and expense wasrecorded for the intrinsic value of the options converted.  For all others, expense was recorded for thefair value of the options converted using the Black-Scholes option-pricingmodel.  As a percentage of revenue,selling, general and administrative expenses were 150.7% and 25.5% for the sixmonths ended June 30, 2002 and 2001, respectively.

 

Selling, general and administrative expenses for each of the operatingsegments excluding the $18.7 million charge were:

 
|                            |   | **Six Months  Ended June 30,** |   | **Six Months  Ended June 30,** |   |
|---------------------------------|--------|--------------------------------|--------|--------------------------------|--------|
|                            |   | **2002**                       |   | **2001**                       |   |
| Animal Applications             |   | $                              | 2,559  |                           | $      | 1,762 |   |
| Digital Angel Systems           |   | 1,753                          |   | 404                            |   |
| GPS and Radio Communications    |   | 2,354                          |   | 2,602                          |   |
| Physician Call Center and Other |   | 275                            |   | —                         |   |
| Total                           |   | $                              | 6,941  |                           | $      | 4,768 |   |

 

Selling, general and administrative expenses as a percentage of revenuefor each of the operating segments excluding the $18.7 million charge were:

 
|                            |   | **Six Months  Ended June 30,** |   | **Six Months  Ended June 30,** |   |
|---------------------------------|--------|--------------------------------|--------|--------------------------------|--------|
|                            |   | **2002**                       |   | **2001**                       |   |
|                            |   | **%**                          |   | **%**                          |   |
| Animal Applications             |   | 24.5                           |   | 15.6                           |   |
| Digital Angel Systems           |   | 199.2                          |   | 21.0                           |   |
| GPS and Radio Communications    |   | 46.0                           |   | 47.4                           |   |
| Physician Call Center and Other |   | 48.2                           |   | —                         |   |
| Total                           |   | 40.8                           |   | 25.5                           |   |

 

The Animal Applications segment’s selling, general and administrative expenses increased**$0.8million in the six months ended June 30, 2002 compared to the six months June30, 2001 and as a percentage of revenue increased to 24.5 % from 15.6% in the same respective periods.  Theincrease in the dollars was primarily due to increased legal, accounting, andinvestor relations expenses.

 

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The Digital Angel Systems segment’s selling, general and administrativeexpenses increased**$1.3 million in the six months ended June30, 2002 as compared to the six months ended June 30, 2001.  Selling, general and administrative expensesincreased**as a percentage of revenue to 199.2% inthe six months ended June 30, 2002 compared to 21.0% in the six months endedJune 30, 2001 as a result of the scale up of marketing personnel, advertisingand media programs, and infrastructure to support the introduction of DigitalAngelTM products.

 

The GPS and Radio Communications segment’s selling, general andadministrative expenses decreased $0.2 million in the six monthsended June 30, 2002 as compared to the six months ended June 30, 2001.  As a percentage of revenue, selling, generaland administrative expenses decreased to 46.0% in the first six months of 2002from 47.4% in the first six months of 2001.

 

The Physician Call Center and Other segment’s selling, general andadministrative expenses were $ 0.3 million in the six months ended June 30,2002.  This segment became part of theCompany on March 27, 2002.

 

**Management Fees**–**Applied Digital Solutions, Inc.**

 

Management fees charged by Applied Digital Solutions, Inc. amounted to$0.2 million and $0.4 million for the six months ended June 30, 2002 and 2001,respectively.  These fees were forgeneral and administrative services performed for us.  After March 31, 2002, we no longer pay a management fee toApplied Digital Solutions, Inc.

 

**Researchand Development Expense**

 

Research and development expense from operations was $1.5 million inthe six months ended June 30, 2002, a decrease of $0.9 million, or 35.9%, from$2.4 million for the six months ended June 30, 2001.  As a percentage of revenue, research and development. expense was9.1% and 12.9% for the six months ended June 30, 2002 and 2001, respectively.

 

Research and development expense for each of the operating segmentswas:

 
|                            |   | **Six Months  Ended June 30,** |   | **Six Months  Ended June 30,** |   |
|---------------------------------|--------|--------------------------------|--------|--------------------------------|--------|
|                            |   | **2002**                       |   | **2001**                       |   |
| Animal Applications             |   | $                              | 605    |                           | $      | 555 |   |
| Digital Angel Systems           |   | 701                            |   | 1,855                          |   |
| GPS and Radio Communications    |   | 239                            |   | —                         |   |
| Physician Call Center and Other |   | —                         |   | —                         |   |
| Total                           |   | $                              | 1,545  |                           | $      | 2,410 |   |

 

The decrease in expense is primarily due to the completion of someDigital AngelTM trademark technology development.

 

**Depreciationand Amortization**

 

Depreciation and amortization expense from operations was $1.8 millionin the six months ended June 30, 2002, a decrease of $3.6 million, or 66.0%,from $5.4 million in the six months ended June 30, 2001.  As a percentage of revenue, the depreciationand amortization expense was 10.8% and 28.9% for the six months ended June 30,2002 and 2001, respectively.

 

The decrease was primarily due to the adoption of FAS142, which took effect January 1, 2002. The adoption of FAS 142 requires the testing of goodwill for impairmentat least annually, eliminating the need for monthly amortization of goodwill.  Accordingly, goodwill amortization was notrecorded during the first tsix months of 2002.

 

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Depreciation and amortization expense for each of theoperating segments was:

 
|                            |   | **Six Month  Ended June 30,** |   | **Six Months  Ended June 30,** |   |
|---------------------------------|--------|-------------------------------|--------|--------------------------------|--------|
|                            |   | **2002**                      |   | **2001**                       |   |
| Animal Applications             |   | $                             | 290    |                           | $      | 4,470 |   |
| Digital Angel Systems           |   | 1,074                         |   | 670                            |   |
| GPS and Radio Communications    |   | 290                           |   | 243                            |   |
| Physician Call Center and Other |   | 176                           |   | —                         |   |
| Total                           |   | $                             | 1,830  |                           | $      | 5,383 |   |

** **

**InterestExpense**

 

Interest expense was $1.9 million and $0.2 million forthe first six months of 2002 and 2001, respectively.  Interest expense in the first six months of 2002 includesinterest expense of $1.8 million on the debt owed to IBM Credit Corporation byApplied Digital Solutions, Inc.  Asdiscussed in Note 1 to the financial statements, this debt was recognized byAWG due to ADS’s default on the loan agreement.  On March 27, 2002, ADS restructured its loan agreement with IBMCredit Corporation.  The provisions ofthis restructuring included AWG being released from responsibility to repaythis debt.  Accordingly, ADS assumedthis liability on March 27, 2002.

 

**IncomeTaxes**

 

The Company and AWG had effective income tax rates of0.0% and 2.0% for the first six months of 2002 and 2001, respectively. Differences in the effectiveincome tax rates from the statutory federal income tax rate in 2002 ariseprimarily from valuation allowances recorded on deferred tax assets resultingfrom net operating losses and in 2001 arise primarily from valuation allowancesrecorded on deferred tax assets resulting from net operating losses,non-deductible goodwill amortization associated with acquisitions and statetaxes net of federal benefits. The U.S. companies in AWG were included in ADS’sconsolidated federal income tax return through March 27, 2002.  MAS and its subsidiaries file a separateconsolidated federal income tax return. After March 27, 2002, AWG’s U.S. subsidiaries will file a consolidatedfederal tax return with MAS.

 

**LIQUIDITYAND CAPITAL RESOURCES FROM OPERATIONS**

 

As of June 30, 2002, cashand cash equivalents totaled $0.6 million, unchanged from December 31,2001.  Through March 27, 2002, AWG useda cash management system to apply excess cash on hand against advances due toADS.  Cash used in operating activitiestotaled $0.9 million and $0.8 million in the first six months of 2002 and 2001,respectively.  In the first six monthsof 2002, the use of cash was due to the net loss, after adjusting for non-cashcharges, increases in other current assets, and decreases in accounts payableand accrued expenses.  Partiallyoffsetting these uses of cash were increases in cash from decreases in accountsreceivable.  Accounts receivable, net of allowance fordoubtful accounts, decreased by $0.9 million, or 16.8%, to $4.5 million at June30, 2002 from $5.4 million at December 31, 2001.  This decrease is primarily due to a slower rate of sales in thesix months ended June 30, 2002 as compared to the rate of sales in 2001.

 

Inventory levelsdecreased by $0.2 million to $5.6 million at June 30, 2002 from $5.8 million atDecember 31, 2001.  Inventory acquiredfrom our acquisition of MAS amounted to $0.1 million.

 

Investment in affiliatesdecreased by $6.5 million, or 96.2%, to $0.3 million at June 30, 2002 comparedto $6.8 million at December 31, 2001. This decrease was due to transferring our shares representing our 16.5%ownership in MAS to ADS.

 

Accounts payabledecreased by $341,000 to $3.4 million at June 30, 2002 from $3.8 million atDecember 31, 2001.  This was primarilydue to the previously mentioned sales change and corresponding change inpurchasing.

 

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Accrued expenses and other current liabilities increased by $2.3million, or 112.4%, to $4.3 million at June 30, 2002 from $2.0 million atDecember 31, 2001.  The increase was dueto accrued acquisition costs, and accrued expenses acquired from theacquisition of MAS.

 

Investing activities usedcash of $0.5 million in the first six months of 2002 and $0.8 million in thefirst six months of 2001.  During thefirst six months of 2002 and 2001, $0.9 million and $1.1 million, respectively,were spent to acquire property and equipment.

 

Financing activitiesprovided cash of $1.4 million in the first six months of 2002 and 2001,respectively.  Cash was providedprimarily by stock option exercises in 2002 and additional investments byApplied Digital Solutions, Inc. in the six months end June 30, 2002 and 2001.

 

*Debt, Covenant Compliance andLiquidity*

 

ADS maintains a term andrevolving credit agreement with IBM Credit (IBM Credit). Under the creditagreement in effect through March 27, 2002, IBM Credit maintained liens andsecurity interests in the outstanding capital stock of the three AWGsubsidiaries and on their assets to collateralize ADS’s obligations to IBMCredit under the IBM credit agreement.

 

ADS generated asignificant loss from operations in 2000. As a result, ADS was not incompliance with certain financial covenants of the IBM credit agreement as ofDecember 31, 2000. The IBM credit agreement was amended and restated on October17, 2000 and further amended on March 30, 2001. In connection with theamendment on March 30, 2001, Digital Angel granted IBM Credit Corporationwarrants to acquire 1.2 million shares of Digital Angel’s common stock valuedat $0.3 million. As of the March 30, 2001 amendment, ADS was in compliance withthe revised covenants.

 

The IBM credit agreementcontains certain quarterly financial covenants, which became more restrictiveduring 2001. ADS anticipated that it would continue to comply in 2001 with thequarterly financial covenants in the IBM credit agreement. However, ADS was notin compliance with its minimum EBITDA (as defined in the IBM credit agreement)or collateral shortfall covenants at June 30, 2001. ADS was also not incompliance with the minimum EBITDA, Tangible Net Worth and Current Assets toCurrent Liabilities covenant requirements at September 30, 2001 and it againhad a collateral shortfall.  As ofDecember 31, 2001, ADS was not in compliance with various financial covenants,including minimum Tangible Net Worth, EBITDA, the ratio of Current Assets toCurrent Liabilities, and collateral. The IBM credit agreement was amended andrestated on July 1, 2001, September 15, 2001, November 15, 2001, December 31,2001, January 31, 2002 and February 27, 2002. These amendments extended the due dates of principal and interestpayments under the credit agreement until April 2, 2002.

 

At December 31, 2001,ADS’s outstanding borrowings under the IBM credit agreement totaled $82.6million. At that time, ADS did not have the funds to repay the borrowings underthe IBM credit agreement. Accordingly, the $82.6 million of outstandingborrowings was allocated to AWG effective as of September 30, 2001 and wasreflected as a current obligation in the December 31, 2001 combined balancesheet. Interest associated with the borrowings was allocated to AWG for theperiod from September 30, 2001 to March 27, 2002.  Under the terms of the agreement and plan of merger with MAS, thecommon stock and assets of the three AWG subsidiaries were released from allliens and security interests under the IBM credit agreement, and the shares ofthe Company’s common stock beneficially owned by ADS upon completion of themerger were transferred to the Digital Angel Share Trust as

 

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collateral for thedebt.  ADS assumed the debt which wastreated as a capital contribution resulting in an increase in additionalpaid-in capital of approximately $81.4 million.

 

On March 1, 2002, ADS and Digital Angel Share Trust, anewly created Delaware business trust, and IBM Credit entered into a ThirdAmended and Restated Term Credit Agreement. The new credit agreement becameeffective on March 27, 2002, the effective date of the merger between DigitalAngel and MAS. Amounts outstanding under the new credit agreement bear interestat an annual rate of 17% and mature on February 28, 2003.  No principal or interest payments are due untilthe maturity date. However, the maturity date will be extended for consecutiveone-year periods if ADS repays at least 40% of the original principal amountoutstanding plus accrued interest and expenses prior to February 28, 2003, andan additional 40% of the original principal amount outstanding plus accruedinterest and expenses prior to February 28, 2004.  In any event, all amounts outstanding will be required to berepaid by August 15, 2005.  If allamounts are not repaid by February 28, 2003, the unpaid amount will accrueinterest at an annual rate of 25%, and it they are not repaid by February 28,2004, the interest rate increases to 35%.

 

ADS’s new credit agreement contains debt covenantsmade by ADS relating to its financial position and performance, as well as theCompany’s financial position and performance. The Company’s ability to meet its financial performance requirements andbe in compliance throughout 2002 with covenants in the new credit agreementthat apply to the Company cannot be assured. If business conditions are other than as anticipated or other unforeseenevents or circumstances occur, these may impact the ability of ADS and theCompany to remain in compliance with the covenants.  In the absence of waiver or amendment to such financialcovenants, such noncompliance would constitute an event of default under thenew credit agreement, and IBM Credit would be entitled to accelerate thematurity of all amounts ADS owes it.  AtJune 30, 2002 the Company and ADS are out of compliance with certain of thecovenants.  ADS has received acommunication from its lender indicating that pending the expected execution offormal agreements the lender has agreed to waive such noncompliance of theCompany and ADS.

 

On March 27, 2002, upon completion of the mergerbetween Digital Angel and MAS, in satisfaction of a condition to the consent tothe merger by IBM Credit, ADS transferred to a Delaware business trustcontrolled by an advisory board all of the shares of our common stock owned byit and, as a result, the trust has legal title to approximately 77.15% of ourcommon stock.  The trust has votingrights with respect to our common stock until ADS’s obligations to IBM Creditare repaid in full.  The trust may beobligated to liquidate the shares of our common stock owned by it for the benefitof IBM Credit if ADS fails to make payments, or otherwise defaults, under itsnew credit agreement with IBM Credit.

 

To date, financing from acquisitions, ADS’s advances and revenuegenerated from operations have been our primary sources of funding. However, wedo not anticipate receiving additional advances from ADS and the Company hasnot been able to generate positive cash flows from operations.  We estimate that we will need to obtainapproximately $5 million to $7 million in additional funding over the nexttwelve months in order to continue our efforts to implement our business plan.As a result, we will need to obtain additional capital in the near future. Asof the date of these statements, we have held discussions with several banksand an asset-based lender regarding a credit facility. Our capital requirementsdepend on a variety of factors, including, but not limited to, the rate ofincrease or decrease in our existing business base; the success, timing, andamount of investment required to bring new products on-line; revenue growth ordecline; and potential acquisitions. If we are successful in obtaining thecredit facility and in raising additional equity capital, of which there can beno assurance, management believes that we will have the financial resources tomeet its future business requirements for at least the next twelve months. See“RISK FACTORS — We Will Need Additional Financing.”

 

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**FORWARDLOOKING STATEMENTS AND ASSOCIATED RISKS**

 

**Forward****– Looking Statements and AssociatedRisk**.

 

This Form 10-Q contains forward-looking statements within the “safeharbor” provisions of the Private Securities Litigation Reform Act of 1995 withrespect to our financial condition, results of operations and business, andincludes statements relating to:

 

•      our growth strategies including, without limitation, ourability to deploy**new products and services;

 

•     anticipatedtrends in our business and demographics;

 

•       our ability tosuccessfully integrate the business operations of recently acquired companies;

 

•       our future profitabilityand liquidity; and

 

•       regulatory, competitive orother economic influences.

 

Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,”“seeks,” “estimates” and similar expressions also identify forward-lookingstatements.  These forward-lookingstatements are not guarantees of future performance and are subject to risksand uncertainties that could cause actual results to differ materially fromestimates or forecasts contained in the forward-looking statements.  Some of these risks and uncertaintiesare beyond our control.

 

**Risk Factors**

 

You shouldcarefully consider the risk factors listed below.  These risk factors may cause our future earnings to be less orour financial condition to be less favorable than we expect.  You should read this section together withthe other information contained herein.

 

***As a Result of the Merger and the Transfer of Shares of OurCommon Stock to the Digital Angel Share Trust, There is Uncertainty as to theFuture Control of Our Company.***

 

After the merger,in satisfaction of a condition to the consent to the merger of IBM CreditCorporation, ADS transferred to the Digital Angel Share Trust (the “Trust”) allshares of our common stock owned by ADS. As a result, the Trust is the beneficial owner of approximately 77% ofour common stock, and it controls us with respect to all matters upon which ourstockholders may vote, including the selection of the Board of Directors andmergers, acquisitions and other significant corporate transactions.  There can be no assurance as to how theTrust will exercise control over our Company.

 

Upon the requestof IBM Credit Corporation, the Trust will be obligated to sell the shares ofour common stock owned by ADS for the benefit of IBM Credit Corporation if ADSfails to make payments to IBM Credit Corporation beginning on February 28, 2003or at such time ADS otherwise defaults under the agreement. Such sales may bein private transactions or in the public market. We can give no assurance as towhen or how shares of our common stock will be sold, as to who will purchasesuch shares, or as to the number of shares that may be sold at any given time.As a result, duration of the Trust’s control over us and the identity of anyparties which may acquire control of us if and when such sales commence isuncertain.

 

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***Sales of Our Common Stock by the Trust May Cause a Reductionin the Market Value of Our Common Stock.***

 

If amounts due toIBM Credit Corporation by ADS are not paid when due, including at least $33million on February 28, 2003, plus accrued interest and expenses, or if ADS orthe Company is otherwise in default under its credit agreement and its obligationsare accelerated, IBM Credit Corporation will have the right to require sharesof our common stock held in the Trust to be sold to provide funds to satisfythe obligations of ADS. It is unlikely that ADS will have the funds requiredfor payment of such obligations. The sale of a significant amount of shares ofour common stock owned by the Trust in a single transaction or in a series oftransactions over a short period of time could result in a significant declinein the market value of our common stock.

 

***We May Face Operational and Strategic Challenges That MayPrevent Us From Successfully Integrating The MAS Business.***

 

The operation ofour Company after the merger involves risks related to the integration andmanagement of acquired properties and operations. We may encounter substantialdifficulties, costs and delays in integrating the operations of oursubsidiaries with our business, including:

 

•     perceived adverse changes in business focus;

 

•      potentialconflicts in marketing or other important relationships;

 

•      loss of keyemployees or customers;

 

•     possible inconsistencies in standards, controls,procedures and policies among the companies and the need to implement andharmonize company-wide financial, accounting, information and other systems;

 

•      failure tomaintain the quality of products and services that such companies havehistorically provided;

 

•      the need tocoordinate geographically diverse organizations; and

 

•      the diversionof management’s attention from the day-to-day operations.

 

If we fail tointegrate these businesses successfully and/or if we fail to realize theintended benefits of the merger, our financial condition and results ofoperations could be adversely affected and the market price of our common stockcould decline from its current market price.

 

***We May Continue to Incur Losses.***

 

We incurred a netloss of $24.0 million for the six month period ended June 30, 2002. We alsorecorded a net loss of $17.4 million and $3.9 million for the years endedDecember 31, 2001 and 2000, respectively. No assurance can be given as towhether or when we will be profitable. Profitability depends on many factors,including the success of marketing programs, the maintenance and reduction ofexpenses, and the ability to coordinate successfully the operations of businessunits. If we become profitable, of which there is no assurance, we may not beable to sustain or increase profitability. If we fail to achieve and maintainprofitability within the time frame expected by investors, the market price ofour common stock may be adversely affected.

 

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***We Depend on the Protection of Our Proprietary Technology.***

 

Our successdepends partly on our ability to maintain patent and trade secret protection,to obtain future patents and licenses, and to operate without infringing on theproprietary rights of third parties. There can be no assurance that themeasures we have taken to protect our intellectual property, including thoserelating to the Digital Angel Systems, will prevent its misappropriation orcircumvention. In addition, there can be no assurance that any patentapplication, when filed, will result in an issued patent, or that our existingpatents, or any patents that may be issued in the future, will provide us withsignificant protection against competitors. Moreover, there can be no assurancethat any patents issued to or licensed by us will not be infringed upon orcircumvented by others. Litigation to establish the validity of patents, toassert infringement claims against others, and to defend against patentinfringement claims can be expensive and time-consuming, even if the outcome isin our favor. We also rely to a lesser extent on unpatented proprietarytechnology, and no assurance can be given that others will not independentlydevelop substantially equivalent proprietary information, techniques orprocesses or that we can meaningfully protect our rights to such unpatentedproprietary technology.

 

***Many Factors Can Negatively Affect the Animal IdentificationMarket.***

 

The electronicanimal identification market can be negatively affected by such factors as foodsafety concerns, consumer perceptions regarding cost and efficacy,international technology standards, national infrastructures, United StatesFood and Drug Administration (FDA) reviews, United States FederalCommunications Commission (FCC) approvals, and slaughterhouse removal ofmicrochips. In addition, certain foreign governmental standards that requirespecific codes may limit our ability to sell microchips from our currentinventory in such countries. Many of the principal customers for fishelectronic identification devices are government contractors that rely onfunding from the United States government, and this market could be adversely affectedby any decline in the availability of government funds. We may be adverselyaffected by these and other factors affecting the animal identification market,which could have an adverse effect on our financial condition and results ofoperations.

 

***We Depend on a Single Supplier For Our ElectronicIdentification Products.***

 

We rely largely ona production arrangement with Raytheon Corporation for the manufacture of oursyringe-injectable microchips that are used in all of our electronicidentification products. The termination, or any significant reduction, byRaytheon of its production of these microchips could have a material adverseeffect on our financial condition and results of operations. In addition,Raytheon may not be able to produce sufficient quantities to meet anysignificant increased demand for our products or to meet any such demand on atimely basis. Any inability or unwillingness of Raytheon to meet potentiallyincreased demand for our product could have a material adverse effect on ourfinancial condition and results of operations. The Company also has its own microchip production operations located inanother contract facility that we intend to use more intensively to meetadditional product demand.

 

***We Depend on Principal Customers.***

 

For the six monthsended June 30, 2002, we had three customers of our Animal Applications segmentthat accounted for a large portion of our gross revenue.  Pacific States Marine, Schering-PloughPharmaceutical and Biomark, Inc. accounted for approximately 15.0%, 12.4% and10.8% of our gross Animal Applications revenues, respectively. In addition, theGPS and Radio Communications segment is heavily dependent on contracts withdomestic government agencies and foreign governments, including the UnitedKingdom, primarily relating to military applications. The loss of, or asignificant reduction in, orders from these or our other major customers couldhave a material adverse effect on our financial condition and results ofoperations.

 

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***Significant Competition Exists in the Visual and ElectronicIdentification Markets.***

 

The market forvisual and electronic identification for companion animals and livestock ishighly competitive. We believe that our principal competitors in the visualidentification market for livestock are AllFlex and Y-Tex, and our principalcompetitor in the electronic identification market that has developed permanentelectronic identification devices for the companion animal market is AllFlex.In addition, other companies could enter this line of business in the future.Certain of our competitors have substantially greater financial and otherresources than we do. We cannot ensure that we will compete successfully orthat our competitors will not succeed in developing or marketing technologiesand products that are more widely accepted than those being developed by us orthat would render our products obsolete or noncompetitive. We are not aware ofcompetitors currently marketing products that would compete with the DigitalAngel technology. However, we are aware of several potential competitors thathave expressed an interest in similar technologies. If such competitors enterthe market and compete with the Digital Angel technology, such competitioncould have a material adverse effect on our financial condition and results ofoperations.

 

***We Are Subject to Government Regulation.***

 

We are subject tofederal, state and local regulation in the United States and other countries,and we cannot predict the extent to which we may be affected by futurelegislative and other regulatory developments concerning our products andmarkets. We are required to obtain regulatory approval before marketing most ofour products. Our products are subject to FCC regulations governingelectromagnetic emissions, and our insecticide products have been approved bythe United States Environmental Protection Agency (EPA) and are produced inaccordance with EPA regulations. Sales of insecticide products are incidentalto our primary business and do not represent a material part of our operations.Our products also are subject to compliance with foreign government agencyrequirements. Our contracts with our distributors generally require thedistributor to obtain all necessary regulatory approvals from the governmentsof the countries in which the distributor sells our products. However, any suchapproval may be subject to significant delays. Some regulators 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 actions by these regulators could have a material adverseeffect on our business, financial condition and results of operations.

 

***The Digital Angel Systems Segment is a Development StageEnterprise.***

 

The Digital AngelSystems segment is in the initial stage of operations and is a developmentstage enterprise. As a result, it has no operating history upon which to basean evaluation of its current business and future prospects. The first DigitalAngel product was introduced in November 2001. Accordingly, this segment hasgenerated no substantial revenues. Moreover, this segment does not currentlyhave any contracts in place that will provide any significant revenue. Inaddition, because of this segment’s lack of an operating history, managementhas limited insight into trends that may emerge and could materially adverselyaffect its business. This segment’s prospects must be considered in light of therisks, expenses and difficulties frequently encountered by companies in new andrapidly evolving markets. Stockholders should consider the risks anddifficulties the Digital Angel Systems segment may encounter in its new andrapidly evolving market, especially given the segment’s lack of operatinghistory. These risks include the Digital Angel Technology segment’s ability to:

 

•              develop and marketthe Digital Angel technology by integrating and miniaturizing new technologies

 

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into marketableproducts and services;

 

•      build acustomer base;

 

•      generaterevenues;

 

•      competefavorably in a highly competitive market;

 

•      accesssufficient capital to support growth;

 

•      recruit andretain qualified employees;

 

•      introduce newproducts and services; and

 

•      buildtechnology and support systems.

 

***The Digital AngelTM Technology Is Not Proven AndWe May Not Be Able To Develop Products From This Unproven Technology.***

 

The Digital AngelTMSystems segment depends on the development, integration, miniaturization andsuccessful marketing of several pieces of advanced technology that have notpreviously been integrated or used as anticipated by this segment. The DigitalAngelTM Systems segment depends upon advanced technology, including:wireless communication, biosensors, motion determination and global positioningsystem capabilities. Many of these technologies are unproven or relatively new.In addition, these technologies have not been previously integrated orminiaturized into a commercial product. No assurances can be given as to whenor if the 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 our products internally on atimely basis or to enter into arrangements with third parties to provide thesefunctions. If we fail to develop and commercialize products successfully, itcould have a material adverse effect on our business, financial condition andresults of operations.

 

***The Digital Angel Systems Segment Expects to Incur FutureLosses and May Not Achieve Profitability.***

 

From the periodfrom January 2000 until June 30, 2002, approximately $7.3 million has beeninvested in research and development relating to the Digital AngelTMtechnology. Our management expects the Digital Angel Systems segment to incuradditional development, sales and marketing, and other general expenses. As aresult, the Digital Angel Systems segment may incur losses for the foreseeablefuture and will need to generate revenues to achieve profitability. Even if thesegment achieves profitability, it may not be able to sustain it.

 

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***We Depend on a Small Team of Senior Management and We MayHave Difficulty Attracting and Retaining Additional Personnel.***

 

Our future successis highly dependent upon the continued services and performance of seniormanagement and other key personnel.  Ifwe lose the services of any member of our senior management team, our overalloperations could be adversely affected. In addition, our future success willdepend on our ability to identify, attract, hire, train, retain and motivateother highly skilled technical, managerial, marketing, purchasing and customerservice personnel when they are needed. Competition for these individuals isintense. We cannot ensure that we will be able to successfully attract,integrate or retain sufficiently qualified personnel when the need arises. Anyfailure to attract and retain the necessary technical, managerial, marketing,purchasing and customer service personnel could have a material adverse effecton our financial condition and results of operations.

 

***We Will Need Additional Financing***

 

Our company,especially the Digital Angel Systems segment, currently relies upon the revenuegenerated by our Animal Applications segment. We estimate that we will need to obtain approximately $5.0 million to$7.0 million in additional funding over the next twelve months in order tocontinue our efforts to implement our business plan. As of the date of thesefinancial statements, we have held discussions with several banks and anasset-based lender regarding credit agreements.

 

Our actual capitalneeds will depend on operating losses, development expenses, working capitalneeds and other factors. Forecasts of such factors are inherently uncertain,and any variation in those factors from the levels used in current forecastscould result in us needing more capital, or capital earlier, than projected.Capital can be difficult and expensive to obtain, and there can be no assurancethat we will be able to obtain additional financing. If this capital is notraised, we may not be able to execute our business plan, may not be able successfullyto develop and market the Digital AngelTM technology, and ourfinancial condition and results of operations may be materially adverselyaffected. To date, we have not been able to obtain this capital. No assurancecan be given that we will be able to raise this additional necessary capital.

 

If funds are notavailable when required for working capital needs, our ability to carry out ourbusiness plan could be adversely affected and we may be required to scale backgrowth and operations to reflect the extent of available funding. Lendingarrangements will probably include limitations on our ability to incur otherindebtedness, pay dividends, create liens, sell or purchase shares of capitalstock, sell assets or make acquisitions, or enter into other transactions. Suchrestrictions may adversely affect our ability to finance future operations orcapital needs or to engage in other business activities. If additional fundsare raised by issuing equity or convertible debt securities, the value of ourstockholders’ investment may be diluted. These securities may have rights,preferences or privileges senior to those of our common stockholders.

 

Moreover, we mayissue additional shares:

 

•      to employees;

 

•      in connectionwith acquisitions and corporate alliances; and

 

•      to raisecapital.

 

Pursuant to aregistration rights agreement, the Digital Angel Share Trust and any of itstransferees of our common stock, subject to certain terms and conditions, havethe right to require us to register shares of 

 

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ourcommon stock beneficially owned by them upon demand and any other time weregister stock for sale.

 

In addition, IBMCredit Corporation currently holds a warrant to acquire 1,163,906 shares of ourcommon stock. The warrant is exercisable for five years beginning on April 5,2002, or earlier under certain circumstances. Under the warrant, IBM CreditCorporation, subject to certain terms and conditions, has the right to requireus to register shares of our common stock subject to the warrant.

 

**IMPACT OF RECENTLY ISSUED ACCOUNTINGSTANDARDS**

 

In July 2001, the FASB issued FAS No. 141 *BusinessCombinations* and FAS No. 142 *Goodwill and Other Intangible Assets. *FAS 141 requires businesscombinations initiated after June 30, 2001 to be accounted for using thepurchase method of accounting and broadens the criteria for recordingintangible assets separate from goodwill. Recorded goodwill and intangibles will be evaluated against these newcriteria and may result in certain intangibles being included in goodwill, oralternatively, amounts initially recorded as goodwill may be separatelyidentified and recognized apart from goodwill. FAS 142 requires the use of a non-amortization approach to account forpurchased goodwill and certain intangibles. Under a non-amortization approach, goodwill and certain intangibles willnot be amortized into results of operations, but instead would be reviewed forimpairment and written down and charged to results of operations only in the periodsin which the recorded value of goodwill and certain intangibles is more thanits fair value. We adopted the provisions of each statement, which apply togoodwill and certain intangibles acquired prior to June 30, 2001, on January 1,2002. The adoption of these standards will have the impact of eliminating ouramortization of goodwill commencing January 1, 2002. There was no impairment ofgoodwill upon adoption of FAS 142. Future impairment reviews may result in periodic write-downs.

 

In August 2001, the FASB issued FAS 144, *Accounting for the Impairment orDisposal of Long-Lived Assets*. This standard supersedes FAS 121, *Accounting for the Impairment of Long-Lived Assets toBe Disposed Of*, and provides a single accounting model forlong-lived assets to be disposed of. This standard significantly changes thecriteria that would have to be met to classify an asset as held-for-sale. Thisdistinction is important because assets to be disposed of are stated at thelower of their fair values or carrying amounts and depreciation is no longerrecognized. The new rules will also supercede the provisions of APB Opinion 30,*Reportingthe Results of Operations-Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions*, with regard to reporting the effects of a disposal ofa segment of a business and will require expected future operating losses fromDiscontinued Operations to be displayed in Discontinued Operations in theperiod in which the losses are incurred, rather than as of the measurement dateas presently required by APB 30. This statement is effective for fiscal yearsbeginning after December 15, 2001. We adopted this statement on January 1,2002. The adoption of FAS 144 did not have a material impact on our operationsor financial position.

 

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

 

We have operations and sales****in****various regions of the world. Additionally, wemay export and import to and from other countries.  Our operations may therefore be subject to volatility because ofcurrency fluctuations, inflation, and changes in political and economicconditions in these countries. Sales and expenses may be denominated in localcurrencies and may be affected as currency fluctuations affect our productprices and operating costs or those of our competitors.

 

We presently do not use any derivative financial instruments to hedgeour exposure to adverse fluctuations in interest rates, foreign exchange rates,fluctuations in commodity prices or other market risks; nor do we invest inspeculative financial instruments.

 

Due to the nature of our borrowings and our short-term investments, wehave concluded that there is no material market risk exposure and, therefore,no quantitative tabular disclosures are required.

 

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**PART II OTHER INFORMATION**

 

**Item 1.                    LegalProceedings.**

** **

**Silva, et al. v.Customized Services Administrators, Incorporated, dba CSA Travel Protection,Inc. et al., No. CV798528 (Santa Clara County Superior Court)**

 

On May 29, 2001, Janet Silva, individually and as Guardian*ad Litem* for Jonathan Silva, a minor, andthe Estate of Clarence William Silva, Jr. (collectively, “Plaintiffs”) filedsuit against Customized Services Administrators, Incorporated (“CSA”),Pricesmart, Inc. (“Pricesmart”), Commercial Union Insurance Company(“Commercial Union”), CGU Insurance Group, and the Company (collectively the“Defendants”) in the Superior Court of the State of California in and for theCounty of Santa Clara.  The allegationsof the complaint arise from a vacation guarantee insurance policy (the“Insurance Contract”) allegedly purchased by Plaintiffs from Defendants onMarch 6, 2000.  The complaint alleges,among other things, that Defendants breached the Insurance Contract, defraudedPlaintiffs, acted in bad faith, engaged in deceptive and unlawful businesspractices, resulting in the wrongful death of Clarence William Silva, Jr. (the“Deceased”) and the intentional infliction of emotional distress onPlaintiffs.  The complaint seeks thecost of funeral and burial expenses of the Deceased and amounts constitutingthe loss of financial support of the Deceased, general damages, attorney’s feesand costs, and exemplary damages.

 

CSA has filed a cross-claim against the Company alleging that theCompany should be held liable for any liability that CSA may have toPlaintiffs.  The Company has denied theallegations of the complaint and the CSA cross-claim and is vigorouslycontesting all aspects of this action.

 

We and our subsidiaries are party to various other legal actions aseither a plaintiff or a defendant.  Inour opinion, as of the date of this Form 10-Q, these proceedings will not havea material adverse effect on our financial position, our cash flows or ouroverall trends in results. The estimate of the potential impact on ourfinancial position, our overall results of operations or our cash flows forthese proceedings could change in the future.

 

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**Item 2.                    Changes in Securities andUse of Proceeds.**

** **

Recent Sales of Unregistered Securities

 

The following table lists all unregistered securities sold by theCompany between January 1, 2002 and June 30, 2002.  These shares were issued in acquisition transactions to thepersons or entities indicated. These shares were issued without registration inreliance upon the exemption provided by Section 4(2) of the Securities Act of1933, as amended, and Rule 506 of Regulation D promulgated thereunder.

 
| **Name/Entity/Nature**           |   | **Number of  Persons** |   | **Note** |   | **Issued For** |   | **Number of  Common  Shares** |   |
|----------------------------------|--------|------------------------|--------|----------|--------|----------------|--------|-------------------------------|--------|
|                             |   |                   |   |     |   |           |   |                          |   |
| Applied Digital  Solutions, Inc. |   | 1                      |   | 1        |   | Acquisition    |   | 18,750,000                    |   |
| Richard J. Sullivan              |   | 1                      |   | 2        |   | Acquisition    |   | 937,500                       |   |
| Garrett A. Sullivan              |   | 1                      |   | 2        |   | Acquisition    |   | 468,750                       |   |
| Evan C. McKeown                  |   | 1                      |   | 2        |   | Acquisition    |   | 30,468                        |   |
|                             |   |                   |   |     |   |           |   |                          |   |
|                             |   |                   |   |     |   |           |   |                          |   |
| Total                            |   |                   |   |     |   |           |   | 20,186,718                    |   |

 

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1.               Representsshares issued in connection with the merger of Applied Digital Solutions,Inc.’s Advanced Wireless Group in exchange for shares of Digital AngelCorporation, which was a subsidiary of Applied Digital Solutions, Inc.  No cash was involved in the transaction.

 

2.               Representsshares issued to minority shareholders of Applied Digital Solutions, Inc.’sAdvanced Wireless Group to effect the merger transaction.  No cash was involved in the transaction.

 

**Item3.                    Defaults Upon SeniorSecurities.**

 

Not applicable.

 

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**Item 4.                    Submission of Matters to aVote of Security Holders.**

 

Ata special meeting of the stockholders of MAS held on March 18, 2002, thefollowing matters were submitted to the stockholders for a vote:

 

•                  The approval of an Agreement and Plan of Merger,dated as of November 1, 2002, pursuant to which Digital Angel Acquisition Co.,a Delaware corporation and a wholly-owned subsidiary of MAS, would merge withand into Digital Angel Corporation, a Delaware corporation and a wholly-ownedsubsidiary of Applied Digital Systems, Inc. (3,396,247 shares voted for, 33,935shares voted against, 14,120 shares abstained from voting, and no brokernon-votes);

 

•                  Amending MAS’s Certificate of Incorporationto change its name to “Digital Angel Corporation” and to authorize 85,000,000additional shares of common stock, par value $0.005 per share (4,243,419 sharesvoted for, 40,514 shares voted against, 10,369 shares abstained from voting,and no broker non-votes); and

 

•                  To transact such other business as mayproperly come before the meeting or any adjournment or postponement of thespecial meeting (4,246,403 shares voted for, 6,635 shares voted against, 20,864shares abstained from voting, and no broker non-votes).

 

Themeeting did not involve the election of directors.

 

**Item 5.                    Other Information.**

 

None

 

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**Item 6.                    Exhibitsand Reports on Form 8-K.**

** **

**(a)           Exhibits**

** **

Thefollowing exhibits are hereby incorporated into this Quarterly Report on Form10-Q by reference to the reports and schedules identified below filed with theSecurities and Exchange Commission (“Commission”)**:**

 

2.1                               Agreementand Plan of Merger by and between Applied Digital Solutions, Inc., DigitalAngel Corporation, Medical Advisory Systems, Inc. and Acquisition Subsidiary,Inc. dated as of November 1, 2001 (incorporated herein by reference to AppendixA to final Proxy Statement filed by MAS with the Commission on February 14,2002).

 

2.2                                 First Amendment to Agreement and Plan ofMerger by and among Applied Digital Solutions, Inc., Digital Angel Corporation,Medical Advisory Systems, Inc. and Digital Angel Acquisition Co. dated as ofMarch 26, 2002 (incorporated herein by reference to Exhibit 2.2 toCurrent Report on Form 8-K filed by MAS with the Commission on April 11, 2002).

 

3.1                                 Amended and Restated Certificate ofIncorporation of MAS (incorporated herein by reference to MAS’s RegistrationStatement on Form S-18 (No. 2-98314) filed by MAS with the Commission on June7, 1985 and MAS’s Annual Report on Form 10-KSB filed by MAS with the Commissionon March 28, 1990).

 

3.2                                 Bylaws of MAS (incorporated herein byreference to MAS’s Registration Statement on Form S-18 (No. 2-98314) filed byMAS with the Commission on June 7, 1985).

 

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

 

3.3                                 Amendment to Certificate of Incorporation ofMAS filed with the Delaware Secretary of State on March 27, 2002.

 

3.4                                 Amendment to Certificate of Incorporation ofDigital Angel Corporation filed with the Delaware Secretary of State on May 14,2002.

 

3.5                                 Amendment to Bylaws of MAS dated March 27,2002.

 

10.1                           Employment Agreement dated as of March 8,2002 by and between Randolph K. Geissler and the Company

 

10.2                           Employment Agreement dated as of April 1,2002 by and between James P. Santelli and the Company

 

10.3                           Amendment to Employment Agreement dated as ofMarch 8, 2002 by and between Randolph K. Geissler and the Company

 

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

** **

**Thefollowing are the Current Reports on Form 8-K filed by MAS or the Companyduring the quarter ended June 30, 2002 or during the period from June 30, 2002to the date of this Quarterly Report on Form 10-Q/A:**

** **

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(i)                                     OnApril 11, 2002, we filed a Current Report on Form 8-K which disclosed a changein control, an acquisition of assets, information regarding a potential changein certifying accountants, and a change in fiscal year.

 

(ii)                                  OnApril 18, 2002, we filed a Current Report on Form 8-K which disclosed changesin our Board of Directors and Officers.

 

(iii)                               OnApril 25, 2002, we filed a Current Report on Form 8-K which disclosed a changein certifying accountants.

 

(iv)                              OnMay 1,2002, we filed a Current Report on Form 8-K/A which disclosed a change incertifying accountants, and a change in fiscal year.

 

(v)                                 OnMay 20, 2002, we filed a Current Report on Form 8-K which disclosed a change incertifying accountants.

 

(vi)                              OnMay 20, 2002, we filed a Current Report on Form 8-K/A which disclosed requiredfinancial statements and pro forma financial information.

 

(vii)                           On May28, 2002, we filed a Current Report on Form 8-K which disclosed a change incertifying accountants.

 

(viii)                        On June 6,2002, we filed a Current Report on Form 8-K/A which disclosed a change incertifying accountants.

 

(ix)                                OnJuly 23, 2002, we filed a Current Report on Form 8-K/A which disclosedfinancial statements and pro forma financial information.

 

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**SIGNATURE**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 
|                         |   | DIGITAL  ANGEL CORPORATION |                             |
|------------------------------|--------|----------------------------|----------------------------------|
|                         |   | (Registrant)               |                             |
|                         |   |                       |                             |
| Dated: August 14,  2002 |   | By:                        | /S/ JAMES P. SANTELLI            |   |
|                         |   |                       |                             |   |
|                         |   |                       | James P.  Santelli               |   |
|                         |   |                       | Vice President -  Finance, Chief |   |
|                         |   |                       | Financial  Officer               |   |

 

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**INDEX TO EXHIBITS**

 

The followingexhibits are filed with this Quarterly Report on Form 10-Q/A:

 

3.3                                 Amendmentto Certificate of Incorporation of MAS filed with the Delaware Secretary ofState on March 27, 2002.*

 

3.4                                 Amendmentto Certificate of Incorporation of Digital Angel Corporation filed with theDelaware Secretary of State on May 14, 2002.*

 

3.5                                 Amendmentto Bylaws of MAS dated March 27, 2002.*

 

10.1                           Employment Agreement dated as of April 1,2002 by and between Randolph K. Geissler and the Company.*

 

10.2                           Employment Agreement dated as of April 1,2002 by and between James P. Santelli and the Company.*

 

10.3                           Amendment to Employment Agreement dated as ofMarch 8, 2002 by and between Randolph K. Geissler and the Company.*

 

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* Filed previously.

 

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**Certification Pursuant to 18 U.S.C. Section1350,**

**as Adopted Pursuant to**

**Section 906 of the Sarbanes-Oxley Act of 2002**

 

In connection withthe Quarterly Report on Form 10-Q of Digital Angel Corporation (the “Company”)for the period ended June 30, 2002, as filed with the Securities and ExchangeCommission on August     , 2002 (the “Periodic Report”), I,Randolph K. Geissler , Chief Executive Officer of the Company, hereby certify,pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002, that:

 

1.               The Periodic Reportfully complies with the requirements of section 13(a) or 15(d) of theSecurities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and

 

2.               The informationcontained in the Periodic Report fairly presents, in all material respects, thefinancial condition and results of operations of the Company.

 
| Dated: | August 14, 2002 |   |   |                      |   | /s/ RANDOLPH K. GEISSLER |
|--------|-----------------|--------|--------|---------------------------|--------|--------------------------|
|   |            |   |   | Randolph K. Geissler      |
|   |            |   |   | Chief Executive Officer   |
|   |            |   |   | Digital Angel Corporation |
|        |                 |        |        |                           |        |                          |  |

 

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**CertificationPursuant to 18 U.S.C. Section 1350,**

**as Adopted Pursuant to**

**Section 906 of the Sarbanes-Oxley Act of 2002**

 

In connection withthe Quarterly Report on Form 10-Q of Digital Angel Corporation (the “Company”)for the period ended June 30, 2002, as filed with the Securities and ExchangeCommission on August     , 2002 (the “Periodic Report”), I,James P. Santelli, Chief Financial Officer of the Company, hereby certify,pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002, that:

 

1.               The Periodic Reportfully complies with the requirements of section 13(a) or 15(d) of theSecurities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and

 

2.               The informationcontained in the Periodic Report fairly presents, in all material respects, thefinancial condition and results of operations of the Company**.**

 
| Dated: | August 14, 2002 |   | /s/ JAMES P. SANTELLI     |
|--------|-----------------|--------|---------------------------|
|   |            |   | James P. Santelli         |
|   |            |   | Chief Financial Officer   |
|   |            |   | Digital Angel Corporation |

 

 

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