VTEQ VeriTeQ Corporation (CE)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q/A

(Amendment No. 1)

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2008

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number: 000-26020

DIGITAL ANGEL CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

Delaware		43-1641533
(State or Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification Number)
490 Villaume Avenue, South Saint Paul, MN		55075
(Address of Principal Executive Offices)		(Zip Code)

(651) 455-1621
Registrant’s Telephone Number, Including Area Code

(Former Name, Former Address and Formal Fiscal Year, if Changed Since Last Report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes þ  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one).

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o
				(Do not check if smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Class		Outstanding at August 8, 2008
Common Stock, $.01 par value per share		125,049,561 shares

 

 

DIGITAL ANGEL CORPORATION

EXPLANATORY NOTE

Digital Angel Corporation (the “Company”) is filing this Form 10-Q/A to its Quarterly Report on Form 10-Q for the quarter ended June 30, 2008 containing the following clarifications and revisions:

	•		We have eliminated our pro forma presentation as if VeriChip and InfoTech had been accounted for under the equity method for the comparative periods and December 31, 2007 from our financial statements and related footnotes.
	•		We have presented our pro forma presentation in the Management’s Discussion and Analysis section and have included discussion on how we derived the pro forma results, why we believe this pro forma presentation is useful to investors and potential risks associated with using the pro forma presentation.
	•		We have more clearly presented separate historical and pro forma analysis which includes a discussion of the proforma balance sheet.

Except as expressly set forth in this Form 10-Q/A, the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2008 has not been amended, updated or otherwise modified.

This Form 10-Q/A does not reflect events occurring after the filing of the Form 10-Q or modify or update those disclosures affected by subsequent events. Consequently, all other information is unchanged and reflects the disclosures made at the time of the filing of the Form 10-Q. With this Amendment, the principal executive officer and principal financial officer of the Company have reissued their certifications required by Sections 302 and 906 of the Sarbanes-Oxley Act.

DIGITAL ANGEL CORPORATION

TABLE OF CONTENTS

		Page
PART I — Financial Information
Item 1. Financial Statements (unaudited):
Condensed Consolidated Balance Sheets — As of June 30, 2008 and December 31, 2007			4
Condensed Consolidated Statements of Operations — Three and Six-months ended June 30, 2008 and 2007			5
Condensed Consolidated Statement of Changes in Stockholders’ Equity — Six-months ended June 30, 2008			7
Condensed Consolidated Statements of Cash Flows — Six-months ended June 30, 2008 and 2007			8
Notes to Condensed Consolidated Financial Statements			9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			30
PART II — Other Information
Item 6. Exhibits			48
Signatures			49
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

DIGITAL ANGEL CORPORATION AND SUBSIDIARIES

Condensed Consolidated Balance Sheets
(in thousands, except par values)

See Notes to Condensed Consolidated Financial Statements.

DIGITAL ANGEL CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Operations (Unaudited)
(in thousands, except per share data)

		For the Three-				For the Three-
		Months Ended				Months Ended
		June 30, 2008				June 30, 2007
Revenue		$	20,703			$	27,723
Cost of sales			14,079				15,815
Gross profit			6,624				11,908
Selling, general and administrative expenses			9,066				14,453
Research and development expenses			731				2,541
Restructuring expenses			1,463				—
Asset impairment			4,369				—
Operating loss			(9,005	)			(5,086	)
Interest and other income			2,169				163
Interest expense			(1,523	)			(1,251	)
Equity in loss of affiliate			(877	)			—
Loss from continuing operations before taxes, minority interest and loss attributable to capital transactions of subsidiaries			(9,236	)			(6,174	)
Benefit (provision) for income taxes			269				(13	)
Loss from continuing operations before minority interest and loss attributable to capital transactions of subsidiaries			(8,967	)			(6,187	)
Minority interest			(55	)			2,378
Net loss on capital transactions of subsidiary			—				(604	)
Loss attributable to changes in minority interest as a result of capital transactions of subsidiaries			—				(1,040	)
Loss from continuing operations			(9,022	)			(5,453	)
(Loss) income from discontinued operations, net of income taxes of $0			(455	)			2,731
Net loss		$	(9,477	)		$	(2,722	)
Loss per common share — basic and diluted
Loss from continuing operations		$	(0.08	)		$	(0.08	)
(Loss) income from discontinued operations			(0.00	)			0.04
Net loss		$	(0.08	)		$	(0.04	)
Weighted average number of common shares outstanding — basic and diluted			118,223				67,567

See Notes to Condensed Consolidated Financial Statements.

DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
(in thousands, except per share data)

		For the Six-				For the Six-
		Months Ended				Months Ended
		June 30, 2008				June 30, 2007
Revenue		$	43,129			$	50,394
Cost of sales			28,206				28,979
Gross profit			14,923				21,415
Selling, general and administrative expenses			18,156				28,928
Research and development expenses			1,526				5,166
Restructuring expenses			1,924				—
Asset impairment			4,369				—
Operating loss			(11,052	)			(12,679	)
Interest and other income			2,574				1,131
Interest expense			(4,210	)			(2,166	)
Equity in loss of affiliate			(2,206	)			—
Loss from continuing operations before taxes, minority interest and gain (loss) attributable to capital transactions of subsidiaries			(14,894	)			(13,714	)
Benefit (provision) for income taxes			288				(83	)
Loss from continuing operations before minority interest and gain (loss) attributable to capital transactions of subsidiaries			(14,606	)			(13,797	)
Minority interest			(104	)			4,207
Net gain on capital transactions of subsidiary			—				4,750
Loss attributable to changes in minority interest as a result of capital transactions of subsidiaries			—				(5,860	)
Loss from continuing operations			(14,710	)			(10,700	)
Income from discontinued operations, net of income taxes of $0			457				2,829
Net loss		$	(14,253	)		$	(7,871	)
Loss per common share — basic and diluted
Loss from continuing operations		$	(0.12	)		$	(0.16	)
Income from discontinued operations			0.00				0.04
Net loss		$	(0.12	)		$	(0.12	)
Weighted average number of common shares outstanding — basic and diluted			116,307				67,353

See Notes to Condensed Consolidated Financial Statements.

DIGITAL ANGEL CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statement of Changes in Stockholders’ Equity (Unaudited)
For the Six-Months Ended June 30, 2008
(in thousands)

										Additional								Accumulated Other								Total
		Common Stock								Paid-In				Accumulated				Comprehensive				Treasury				Stockholders’
		Number				Amount				Capital				Deficit				Income (Loss)				Stock				Equity
Balance, December 31, 2007			105,082			$	1,051			$	572,645			$	(500,706	)		$	428			$	(2,423	)		$	70,995
Net loss			—				—				—				(14,253	)			—				—				(14,253	)
Comprehensive loss:
Foreign currency translation			—				—				215				—				(227	)			—				(12	)
Total comprehensive loss															(14,253	)			(227	)							(14,265	)
Acquisition of Geissler Technologies Corporation			11,548				116				6,609				—				—				—				6,725
Issuance of common stock for services			1,638				16				726				—				—				—				742
Issuance of common stock for financing			230				2				202				—				—				—				204
Issuance of restricted stock and stock options for services			250				3				186				—				—				—				189
Issuance of shares in connection with warrants exercised			176				2				(2	)			—				—				—				—
Re-pricing of common stock warrants			—				—				468				—				—				—				468
Stock issuance costs			—				—				(32	)			—				—				—				(32	)
Treasury shares issued to affiliate			—				—				(646	)			—				—				646				—
Balance, June 30, 2008			118,924			$	1,190			$	580,371			$	(514,959	)		$	201			$	(1,777	)		$	65,026

See Notes to Condensed Consolidated Financial Statements.

DIGITAL ANGEL CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Unaudited)
(in thousands)

		For the Six-Months				For the Six-Months
		Ended June 30,				Ended June 30,
		2008				2007
Cash Flows From Operating Activities
Net loss		$	(14,253	)		$	(7,871	)
Adjustments to reconcile net loss to net cash used in operating activities:
Loss (income) from discontinued operations			457				(2,829	)
Equity compensation and other administrative expenses			536				1,844
Depreciation and amortization			2,456				2,449
Amortization of debt discount and financing costs			2,693				687
Allowance for doubtful accounts			(83	)			139
(Recovery) allowance for inventory excess and obsolescence			1,388				395
Reduction of derivative warranty			—				(296	)
Asset impairment			4,369				—
Loss on sale of equipment			—				8
(Gain) on capital transactions of subsidiaries			—				(4,750	)
Equity in loss of affiliate			2,206				—
Loss attributable to changes in minority interest as a result of capital transactions of subsidiaries			—				5,860
Minority interest in net income (loss) of subsidiaries			104				(4,207	)
Changes in assets and liabilities:
Decrease (increase) in restricted cash			86				(46	)
Decrease in accounts receivable			(1,232	)			(2,150	)
Increase in inventories			(1,589	)			(698	)
(Increase) decrease in other current assets			(320	)			(72	)
Increase in accounts payable, accrued expenses and other short term and long term liabilities			2,765				5,781
Net cash provided by discontinued operations			1,496				323
Net Cash Provided by (Used in) Operating Activities			1,079				(5,433	)
Cash Flows From Investing Activities
Decrease in notes receivable			3,421				60
Increase in other assets			(457	)			(191	)
Payments for costs of business acquisition			(58	)			(4,215	)
Cash of formerly consolidated entity			(7,221	)			—
Cash received from InfoTech			(485	)			(1,158	)
Net cash provided by (used in) discontinued operations			15				(449	)
Net Cash Used in Investing Activities			(4,785	)			(5,953	)
Cash Flows From Financing Activities
Net amounts borrowed on notes payable			107				276
Proceeds from long term debt			25,342				6,000
Payment of debt			(28,976	)			(1,564	)
Net proceeds from VeriChip’s IPO			—				15,458
Other financing costs			—				(686	)
Payment of dividend to subsidiaries’ minority shareholder			(36	)			(53	)
Issuance of common shares and warrants			—				287
Stock issuance costs			(32	)			(37	)
Net cash used in discontinued operations			—				(105	)
Net Cash (Used in) Provided by Financing Activities			(3,595	)			19,576
Net (Decrease) Increase In Cash and Cash Equivalents			(7,301	)			8,190
Effect of Exchange Rate Changes on Cash and Cash Equivalents			17				8
Cash and Cash Equivalents — Beginning of Period			9,443				7,068
Cash and Cash Equivalents — End of Period		$	2,159			$	15,266

See Notes to Condensed Consolidated Financial Statements.

DIGITAL ANGEL CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

1. Basis of Presentation

Digital Angel Corporation (formerly Applied Digital Solutions, Inc.), a Delaware corporation, and its subsidiaries, (referred to together as, “Digital Angel,” “the Company,” “we,” “our,” and “us”) develop innovative identification and security products for consumer, commercial and government sectors worldwide. Our products that are often proprietary, provide identification and security for people, animals, food chains, government/military assets, and commercial assets. Included in our product line are applications for radio frequency identification systems (“RFID”), global positioning systems (“GPS”) and satellite communications. When we refer to Destron Fearing, we are referring to our wholly-owned subsidiary, Destron Fearing Corporation (formerly Digital Angel Corporation), which previously traded on the American Stock Exchange. We acquired the minority owners’ interest in Destron Fearing effective December 28, 2007.

The accompanying condensed consolidated financial statements of the Company have been prepared in accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”) and with the instructions to Form 10-Q and Article 10 of Regulation S-X under the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The interim financial information in this report has not been audited. In the opinion of the Company’s management, all adjustments (consisting of normal recurring adjustments) considered necessary for fair financial statement presentation have been made. Results of operations reported for interim periods may not be indicative of the results for the entire year. These condensed consolidated financial statements and notes should be read in conjunction with the consolidated financial statements and notes included in our Form 10-K for the year ended December 31, 2007, filed with the Securities and Exchange Commission (“SEC”) on March 17, 2008.

The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Although these estimates are based on the knowledge of current events and actions that we may undertake in the future, they may ultimately differ from actual results. Included in these estimates are assumptions about allowances for inventory obsolescence, bad debt reserves, lives of long-lived assets and intangible assets, assumptions used in Black-Scholes valuation models, estimates of the fair value of acquired assets and the determination of whether any impairment is to be recognized on long-lived and intangible assets, among others.

Currently, we operate in two business segments; Animal Identification (formerly Animal Applications) and Emergency Identification (formerly GPS and Radio Communications). During the three and six-months ended June 30, 2007, we operated in four business segments: Animal Identification, Emergency Identification, Healthcare and Security and Industrial. Our Healthcare and Security and Industrial segments comprised the operations of VeriChip Corporation (“VeriChip”) (NASDAQ: CHIP). During the three-months ended March 31, 2008, our ownership interest in VeriChip fell below 50% and, therefore, during the three-months ended March 31, 2008, we began accounting for VeriChip under the equity method of accounting, as more fully discussed below. See Note 6 for further discussion on our segments.

The equity method of accounting is used for investments in affiliated companies, which we do not control and in which our interest is generally between 20% and 50% and we have significant influence over the entities. Our share of losses of such affiliated companies is included in our consolidated operating results. These affiliated companies are VeriChip, which is included in the results from continuing operations, and IFTH Acquisition Corp., formerly known as InfoTech USA, Inc. (“InfoTech”), which is included in the results of discontinued operations. As of December 31, 2007, we owned a majority interest in VeriChip and InfoTech. However, during the first quarter of 2008 our ownership interests fell below 50% and as of June 30, 2008, we owned approximately 48.5% and 49.9% of VeriChip and InfoTech, respectively. Therefore, effective January 1, 2008, we began accounting for VeriChip and InfoTech under the equity method of accounting. Prior period financial statements have been presented on a historical basis, and accordingly, include the results of operations of VeriChip and InfoTech under the consolidation method.

DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)

1. Basis of Presentation (continued)

Discontinued Operations

During the three-months ended March 31, 2008, we made a decision to sell our wholly-owned subsidiaries, Florida Decision Corporation (“FDC”, formerly Pacific Decision Sciences Corporation) and Thermo Life Energy Corp (“Thermo Life”). This decision was made as part of management’s strategy to streamline operations to focus more of its efforts on the Animal Identification and Emergency Identification businesses. During the quarter ended September 30, 2007, we made a decision to sell our wholly-owned subsidiaries, Computer Equity Corporation (“Computer Equity”) and Perimeter Acquisition Corp. (“Perimeter”). In addition, on July 2, 2007, Destron Fearing sold its subsidiary, OuterLink Corporation (“OuterLink”). During the three-months ended June 30, 2007, we made a decision to sell our then majority-owned subsidiary, InfoTech. As a result, FDC, Thermo Life, OuterLink, Computer Equity, Perimeter and InfoTech are now classified as discontinued operations for all periods presented in this report. Discontinued operations are more fully discussed in Note 13.

Revenue Recognition for Geissler Technology Corporation

Effective January 14, 2008, we acquired Geissler Technology Corporation (“GTC”). Consistent with our existing policy, GTC’s revenue is recognized at the time product is shipped and title has transferred, provided that a purchase order has been received or a contract has been executed, there are no uncertainties regarding customer acceptance, the sales price is fixed and determinable and collectability is deemed probable. If uncertainties regarding customer acceptance exist, revenue is recognized when such uncertainties are resolved. Costs of products sold are recorded as the related revenue is recognized. Other revenue is recognized at the time services or goods are provided.

Recent Events

VeriChip’s Stock Purchase Agreement

On May 15, 2008, VeriChip entered into a stock purchase agreement (the “VeriChip SPA”) to sell its wholly-owned subsidiary Xmark Corporation (“Xmark”) to The Stanley Works (“Stanley”) for $45 million in cash (the “Transaction”). In connection with the Transaction, we entered into the three following agreements with Stanley:

	•		A Voting Agreement (the “Voting Agreement”) in which we granted an irrevocable proxy in favor of the Transaction and against any alternative proposal. The Voting Agreement limited our ability to transfer shares of stock we held in VeriChip or vote for any alternative deal during the period prior to the consummation of the Transaction.
	•		A Guarantee (the “Guarantee”) in favor of Stanley in which we will hold Stanley harmless from certain liabilities under the VeriChip SPA.
	•		A Non-Competition Agreement (the “Non-Competition Agreement”) in which we agreed that we will not compete in the businesses in which Xmark is currently operating for 3 years following the consummation of the Transaction. We do not operate in any of these businesses today. The Non-Competition Agreement will terminate upon a Change in Control Effective Date (as defined in the Non-Competition Agreement).

On May 15, 2008, we also entered into a letter agreement (the “Intercompany Letter Agreement”) with VeriChip, in which we and VeriChip agreed, among other things, that (i) we were permitted to name up to three designees to the Board of Directors of VeriChip after the closing of the Transaction, all of which shall be independent with the exception of Joseph J. Grillo, our President and Chief Executive Officer; (ii) VeriChip agreed to pay up to $250,000 of our expenses related to the Transaction and to pay us a Guarantee Fee of $250,000; (iii) VeriChip limited all bonus payments to those scheduled, with any changes or new payments to be pre-approved by us; (iv) Scott Silverman, the Chairman of the Board and Chief Executive Officer of VeriChip, entered into a separation agreement with VeriChip; and (v) we continue to have access to VeriChip’s financial information. The Intercompany Letter Agreement provided that the VeriChip SPA and the transactions contemplated thereby did not constitute an event of default under the (i) Commercial Loan Agreement dated December 27, 2005, as amended, between us and VeriChip, (ii) Security Agreement dated December 27, 2005, as amended, between us and VeriChip, and (iii) Third Amended and Restated Revolving Line of Credit Note dated as of February 8, 2007, as amended, from VeriChip in favor of us.

On the same date, we entered into a Consent and Waiver Agreement (the “Consent and Waiver Agreement”) with our lenders, Laurus Master Fund, Ltd. (“Laurus”), Kallina Corporation (“Kallina”), Valens U.S. SPV I, LLC, Valens Offshore SPV I, Ltd., Valens Offshore SPV II, Corp., and PSource Structured Debt Limited (the “Lenders”), in which the Lenders gave their consent to our entrance into the Guarantee and the Voting Agreement. The Consent and Waiver Agreement sets forth changes to our term loan agreements with the Lenders and also provided that we prepay a portion of our debt held by the Lenders from the proceeds of the Transaction.

DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)

1. Basis of Presentation (continued)

On July 18, 2008, VeriChip completed the transactions contemplated by the VeriChip SPA and sold Xmark for $47.9 million in cash including the $2.9 million of excess working capital. From the proceeds of the sale, VeriChip paid us approximately $5.3 million on July 18, 2008, $4.8 million of which was to prepay all of VeriChip’s outstanding obligations to us under the Commercial Loan Agreement, as amended, and $0.5 million was the reimbursement of transaction expenses and the guarantee fee per the terms of the Intercompany Letter Agreement. The $4.8 million debt repayment reflects the prepayment discount as provided by previously disclosed agreements. We repaid $3.2 million of our debt with Laurus with the funds received. As a result of the prepayment discount, we will record a loss on debt forgiveness of approximately $2.5 million in the three-months ended September 30, 2008. In addition, pursuant to the Intercompany Letter Agreement, our chief executive officer, Joseph Grillo was appointed chairman of the board of directors of VeriChip effective July 18, 2008, replacing Scott R. Silverman.

On Friday, August 8, 2008, VeriChip announced that it will pay a one-time special cash dividend of $1.35 per share on August 28, 2008 to shareholders of record on August 18, 2008. As a result, we expect to receive a special dividend associated with the approximately 5.4 million shares of VeriChip common stock that we own of approximately $7.2 million on August 28, 2008.

Sale of FDC

Effective June 2, 2008, we sold all of the assets of FDC pursuant to an Asset Purchase Agreement (the “FDC Agreement”) among us, FDC and Customer Service Delivery Platform (the “Buyer”). The purchase price for the assets was $2.0 million, of which $1.8 million is payable in 48 equal monthly installments pursuant to the terms of a non-interest bearing promissory note. Approximately $0.2 million was owed to the buyer at the time of the sale and, therefore, credited against the purchase price. The promissory note is secured by all of the assets of the Buyer, including the FDC assets it acquired in the transaction. We have received the first monthly payment and recorded a gain of $5 thousand since June 30, 2008.

Certain results of the Annual Meeting of Stockholders

We held our annual meeting of stockholders on June 20, 2008. At this meeting, the stockholders approved all the proposals stated in the Definitive Proxy Statement on Form DEF 14A filed with the Securities Exchange Commission on April 29, 2008, and as amended on May 16, 2008. Therefore, our Certificate of Incorporation was amended on June 20, 2008 to change our name from Applied Digital Solutions, Inc. to Digital Angel Corporation and to increase the number of authorized shares of common stock from 165,000,000 to 190,000,000 shares. In addition, the number of authorized shares of common stock issuable under the 2003 Flexible Stock Plan was increased from 5,200,000 to 7,000,000, effective June 20, 2008.

Effective May 13, 2008, our subsidiary, Destron Fearing Corporation (formerly Digital Angel Corporation), amended its Certificate of Incorporation to change its name from Digital Angel Corporation to Destron Fearing Corporation.

Restructuring Plan

On June 30, 2008 we announced a restructuring plan for our Animal Identification and Corporate segments. The restructuring plan is more fully discussed in Note 17.

2. Impact of Recently Issued Accounting Standards

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements (“FAS 157”). FAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. FAS 157 applies under other accounting pronouncements that require or permit fair value measurements. Accordingly, FAS 157 does not require any new fair value measurements. However, for some entities, the application of FAS 157 will change current practice. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We adopted FAS 157 on January 1, 2008, which did not have a material impact on our consolidated financial position, results of operations, cash flows or financial statement disclosures.

DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)

2. Impact of Recently Issued Accounting Standards (continued)

In February, 2007, FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities including an amendment of FASB Statement 115 (“FAS 159”). This statement provides companies with an option to report selected financial assets and liabilities at fair value. This statement is effective for fiscal years beginning after November 15, 2007 with early adoption permitted. We have not elected the option to report our financial assets and liabilities at fair value.

In June 2007, the Emerging Issues Task Force (“EITF”) reached a final consensus on EITF Issue No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities (“EITF 07-3”). EITF 07-3 requires nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities to be capitalized and recognized as an expense as the related goods are delivered or the related services are performed. We prospectively adopted EITF 07-3 on January 1, 2008, which did not have a material impact on our consolidated financial position, results of operations, cash flows or financial statement disclosures.

In December 2007, FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements — an amendment of ARB No. 51 (“FAS 160”). This statement amends ARB 51 to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. In addition, FAS 160 changes the way the consolidated income statement is presented by requiring consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest. This statement also establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation and requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. This statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 and earlier adoption is prohibited. FASB 160 must be applied prospectively as of the beginning of the fiscal year in which this statement is initially applied, except for the presentation and disclosure requirements which shall be applied retrospectively for all periods presented. We have not yet determined the impact that this requirement may have on our consolidated financial position, results of operations, cash flows or financial statement disclosures.

In December 2007, FASB issued SFAS No. 141R, Business Combinations (“FAS 141R”). FAS 141R replaces FASB Statement No. 141 Business Combinations but retains the fundamental requirements in FAS 141. This statement defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control. FAS 141R also requires that an acquirer recognize the assets acquired, the liabilities assumed and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values as of that date. In addition, this statement requires that the acquirer in a business combination achieved in stages to recognize the identifiable assets and liabilities, as well as the non-controlling interest in the acquiree, at the full amounts of their fair values. FAS 141(R) is applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply the standard before that date. We have not yet determined the impact that this requirement may have on our consolidated financial position, results of operations, cash flows or financial statement disclosures.

In February 2008, the FASB issued Staff Position No. FAS 157-1 (“FSP FAS 157-1”), Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement Under Statement 13 and Staff Position No. FAS 157-2 (“FSP FAS 157-2”), Effective Date of FASB Statement No. 157 . FSP FAS 157-1 excludes SFAS No. 13 (“SFAS 13”), Accounting for Leases , as well as other accounting pronouncements that address fair value measurements on lease classification or measurement under SFAS 13 from the scope of SFAS 157. FSP FAS 157-2 delays the effective date of SFAS 157 for all nonrecurring fair value measurements of nonfinancial assets and nonfinancial liabilities until fiscal years beginning after November 15, 2008. Both FSP FAS 157-1 and FSP FAS 157-2 are effective upon an entity’s initial adoption of SFAS 157, which is our first quarter of fiscal year 2009. We have not yet determined the impact that this requirement may have on our consolidated financial position, results of operations, cash flows or financial statement disclosures.

DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)

2. Impact of Recently Issued Accounting Standards (continued)

In March 2008, FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities (“FAS 161”). FAS 161 requires enhanced disclosures about an entity’s derivative and hedging activities and thereby improves the transparency of financial reporting. Entities are required to provide enhanced disclosures about; (1) how and why an entity uses derivative instruments, (2) how derivative instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities , and its related interpretations, and (3) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. This statement is effective for financial statement issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. Comparative disclosures for earlier periods at initial adoption is encouraged but not required. We have not yet determined the impact that this requirement may have on our condensed consolidated financial position, results of operations, cash flows or financial statement disclosures.

In May 2008, FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (“FAS 162”). FAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP (the “GAAP hierarchy”). This statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles . We have not yet determined the impact that this requirement may have on our consolidated financial position, results of operations, cash flows or financial statement disclosures.

3. Inventories

Inventories consist of the following:

		June 30,				December 31,
		2008				2007
		(in thousands)
Raw materials		$	13,149			$	12,819
Work in process			1,391				1,640
Finished goods			2,570				3,198
			17,110				17,657
Less: Allowance for excess and obsolescence			(2,613	)			(1,817	)
Total inventory		$	14,497			$	15,840

We had $9.9 million and $9.8 million of our inventory at non-domestic locations at June 30, 2008 and December 31, 2007, respectively.

4. (Loss) Income Per Share

A reconciliation of the numerator and denominator of basic and diluted (loss) income per share is provided as follows, in thousands, except per share amounts:

		Three-Months Ended								Six-Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
Numerator for basic and diluted (loss) income per share:
Loss from continuing operations		$	(9,022	)		$	(5,453	)		$	(14,710	)		$	(10,700	)
(Loss) income from discontinued operations			(455	)			2,731				457				2,829
Net loss attributable to common stockholders		$	(9,477	)		$	(2,722	)		$	(14,253	)		$	(7,871	)
Denominator for basic and diluted (loss) income per share:
Basic and diluted weighted-average shares outstanding (1)			118,223				67,567				116,307				67,353
(Loss) income per share — basic and diluted
Continuing operations		$	(0.08	)		$	(0.08	)		$	(0.12	)		$	(0.16	)
Discontinued operations			0.00				0.04				0.00				0.04
Total — basic and diluted		$	(0.08	)		$	(0.04	)		$	(0.12	)		$	(0.12	)

DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)

4. (Loss) Income Per Share (continued)

		June 30,
		2008				2007
Stock options (2)			20,222				5,973
Warrants			9,302				4,229
Restricted stock			—				50
Common stock to be issued in settlement of liability			—				1,885
Total			29,524				12,137

5. Financings

We have entered into various financing agreements as more fully described in Note 9 to our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2007. During the six-months ended June 30, 2008, we amended certain terms of three of our existing financing agreements as follows:

$13.5 Million Secured, Non-Convertible Term Note

On August 24, 2006, we entered into a $13.5 million secured, non-convertible term note (the “2006 Note”) with Laurus, in the original principal amount of $13.5 million. The 2006 Note, as amended on October 31, 2007, accrues interest at a rate of 12% per annum, payable monthly, and has a maturity date of February 1, 2010. The 2006 Note allows for optional redemption without a prepayment penalty. We were obligated to make monthly principal payments of $200,000 from November 1, 2007 to August 1, 2008 and $250,000 beginning on September 1, 2008 to the maturity date. On February 29, 2008, in connection with a financing between VeriChip and Kallina, an affiliate of Laurus, we entered into a letter agreement with Laurus, which further amended the 2006 Note. Per the terms of the letter agreement, we agreed to make a prepayment in the amount of $1.9 million, and as a result, we are not required to make a principal payment under the 2006 Note until October 1, 2008 at which time we will be required to make a principal payment of $22 thousand and to make principal payments each month thereafter for approximately $0.3 million. We used a portion of the proceeds from a prepayment that VeriChip made on its loan to us on February 29, 2008, which is more fully discussed in Note 15, to make the prepayment on the 2006 Note.

$7.0 Million Secured, Non-Convertible Term Note

On August 31, 2007, we entered into a $7.0 million secured, non-convertible term note (the“2007 Note”) with Kallina. The 2007 Note, as amended on October 31, 2007, accrues interest at a rate equal to the prime rate plus 3.0%, but no less than 11.0% (11.0% as of June 30, 2008), called for monthly principal payments of $0.2 million beginning on March 1, 2008 and matures on February 1, 2010. The 2007 Note allows for optional redemption without a prepayment penalty. On February 29, 2008, in connection with a financing between VeriChip and Kallina, we entered into a letter agreement with Kallina, which further amended the 2007 Note. Per the terms of the letter agreement, we agreed to make a prepayment in the amount of $1.1 million, and as a result, we are not required to make a payment under the 2007 Note until October 1, 2008, at which time we will be required to make a principal payment of $11 thousand and to make principal payments each month thereafter in the amount of approximately $0.1 million. We used a portion of the proceeds from a prepayment that VeriChip made on its loan to us on February 29, 2008, which is more fully discussed in Note 15, to make the prepayment on the 2007 Note.

In connection with the February 29, 2008 letter agreement amending the 2006 Note and the 2007 Note, we issued to Valens Offshore SPV II, Corp. (the “VeriChip Lender”), an affiliate of Laurus and Kallina, 230,000 shares of our common stock valued at approximately $0.2 million. The value of the common stock has been recorded as interest expense in the three-months ended March 31, 2008. In addition, as a result of the prepayment of the 2006 Note and the 2007 Note, during the three-months ended March 31, 2008, we amortized approximately $0.6 million of debt issue costs and original debt issue discount associated with these notes. This amortization is reflected as additional interest expense in the six-months ended June 30, 2008.

DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)

5. Financings (continued)

On July 21, 2008, we entered into an Omnibus Amendment (“Amendment”) with Laurus, Kallina, Valens Offshore SPV I, Ltd., Valens Offshore SPV II Corp, Valens US SPV I, LLC and Psource Structured Debt Limited (collectively, the “Lenders”, which are all affiliated) and LV Administrative Services, Inc., the administrative and collateral agent for the Lenders. Under the terms of the Amendment, we agreed to reduce the exercise price of previously issued and outstanding warrants to purchase an aggregate of 6,225,782 shares of our common stock on condition that the Lenders exercise such warrants in full in cash within two business days. The exercise prices of the warrants, which ranged from $0.70 to $2.414 per share and had a weighted average exercise price of $0.82 per share, were reduced to an exercise price of $0.40 per share. The Amendment also restricts the Lenders in the amount of common shares, issued upon exercise of the warrants, they can resell each month.

The Amendment further amended Section 6.17 of the Securities Purchase Agreement dated August 31, 2007, as amended, between us and Kallina, to provide that once our total amount of indebtedness under notes issued to the Lenders is $7 million or less, Kallina’s board observation rights will be terminated. To facilitate the exercise of Laurus’ rights under the Replacement Common Stock Purchase Warrant dated July 31, 2003 to purchase 175,000 shares (“Original Warrant”), we issued Laurus a Common Stock Purchase Warrant to purchase 175,000 shares (“Replacement Warrant”) in exchange for the Original Warrant. The Replacement Warrant increased the maximum beneficial ownership percentage allowable upon exercise of the warrant from 4.99% to 9.99%. The Replacement Warrant also terminated the registration rights Laurus previously had under the Original Warrant. On July 22, 2008, the Lenders exercised warrants to purchase an aggregate of 6,225,782 shares of our common stock for approximately $2.49 million in cash. As a result of the repricing of the warrants, we will record approximately $0.6 million of non-cash interest expense during the three-months ended September 30, 2008.

Amendments of Warrants and Conditional Consent to Asset Sales

We entered into an Amendment of Warrants and Conditional Consent to Asset Sales, dated February 29, 2008, among us, Laurus and Kallina pursuant to which Laurus and Kallina provided a conditional consent to the sale of the capital stock of certain of our wholly-owned subsidiaries, as is required under the Securities Purchase Agreement, dated August 24, 2006, among us and Laurus and the Securities Purchase Agreement, dated August 31, 2007, among us and Kallina. The consent is conditioned on us obtaining Laurus’ and Kallina’s approval of the terms of each proposed sale, that the purchase price be paid in cash, and that no event of default shall have occurred and be continuing under the 2006 Note and the 2007 Note. In addition, all net proceeds in excess of $1.5 million generated from the sale of the capital stock of certain of the our wholly-owned subsidiaries must be used to repay the 2006 Note and the 2007 Note. As consideration for the amendment, we agreed to reduce the exercise price applicable to three warrants previously issued to Laurus and Kallina to $0.70 per share. The three warrants were collectively exercisable for a total of 4.3 million shares of our common stock. As a result of re-pricing the warrants, we recorded additional interest expense of approximately $0.5 million in the six-months ended June 30, 2008.

RBS Invoice Discounting Agreement

Destron Fearing’s majority-owned subsidiary, Signature Industries Limited (“Signature”) has entered into an Invoice Discounting Agreement, (as amended, the “RBS Invoice Discounting Agreement”) with The Royal Bank of Scotland Commercial Services Limited (“RBS”). The RBS Invoice Discounting Agreement provides for Signature to sell with full title guarantee most of its receivables, as defined in the RBS Invoice Discounting Agreement. In February 2008, the RBS Invoice Discounting Agreement was amended to increase the outstanding balance limit from £2.0 million to £2.5 million, subject to restrictions on the use of proceeds. Under the RBS Invoice Discounting Agreement, RBS prepays 80% of the receivables sold in the United Kingdom and 80% of the receivables sold in the rest of the world, not to exceed an outstanding balance of £2.5 million (approximately $5.0 million at June 30, 2008) at any given time. RBS pays Signature the remainder of the receivable upon collection of the receivable. Receivables which remain outstanding 90 days from the end of the invoice month become ineligible and RBS may require Signature to repurchase the receivable. The discounting charge accrues at an annual rate of 1.5% above the base rate as defined in the RBS Invoice Discounting Agreement (6.25% at June 30, 2008). Signature pays a commission charge to RBS of 0.16% of each receivable balance sold. The RBS Invoice Discounting Agreement requires a minimum commission charge of £833 (approximately $1,600) per month. Discounting charges of $54 thousand and $33 thousand are included in interest expense for the three-months ended June 30, 2008 and 2007, respectively. Discounting charges of $0.1 million and $57 thousand are included in interest expense for the six-months ended June 30, 2008 and 2007, respectively. As of June 30, 2008, £1.2 million (approximately $2.4 million) was outstanding and £0.9 million (approximately $1.8 million) was available under the RBS Invoice Discounting Agreement.

DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)

5. Financings (continued)

Nordisk Factoring Agreement

In March 2008, Destron Fearing’s wholly-owned subsidiary, Daploma International A/S (“Daploma”), entered into a factoring agreement (the “Nordisk Factoring Agreement”) with Nordisk Factoring A/S (“Nordisk”). Under the Nordisk Factoring Agreement, Nordisk advances 80% of Daploma’s eligible receivables, not to exceed a balance of DKK 6.0 million (approximately $1.3 million at June 30, 2008) at any given time. As security, Daploma assigns all invoice balances to Nordisk, regardless of whether advances were made on them, and warrants payments by its customers. Daploma pays a factoring commission charge to Nordisk of 0.15% of the gross volume of receivables factored. The Nordisk Factoring Agreement requires a minimum commission charge of DKK 36,000 (approximately $7,400) per year. As of June 30, 2008, Daploma had assigned DKK 2.8 million receivables (approximately $0.6 million) to Nordisk and had no availability under the agreement.

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Liquidity and Capital Resources from Continuing Operations,” which are presented below, for a discussion of the availability under our credit facilities.

6. Segment Information

Currently, we operate in two business segments: Animal Identification and Emergency Identification.

Animal Identification

Our Animal Identification segment develops, manufactures and markets visual and electronic identification tags and implantable RFID microchips, primarily for identification, tracking and location of companion pets, horses, livestock (e.g., cattle and hogs), fish and wildlife worldwide, and, more recently, for animal bio-sensing applications, such as temperature reading for companion pet and livestock applications. Our Animal Identification segment’s proprietary products focus on pet identification and safeguarding and the positive identification and tracking of livestock and fish, which is crucial for asset management and for disease control and food safety. This segment’s principal products are:

	•		visual and electronic ear tags for livestock; and
	•		implantable microchips and RFID scanners for the companion pet, horse, livestock, and fish and wildlife industries.

Emergency Identification

Our Emergency Identification segment’s proprietary products provide animal identification and emergency location of aircraft, people and maritime vessels. This segment’s principal products are:

	•		GPS enabled search and rescue equipment and intelligent communications products and services for telemetry, mobile data and radio communications applications, including our SARBE™ and McMurdo™ brands, which serve military and commercial markets;
	•		GPS and geosynchronous satellite tracking systems, including tracking software systems for mapping and messaging associated with the security of high-value assets under the brand name MOB (“man overboard”) Guardian; and
	•		alarm sounders for industrial use and other electronic components.

As more fully discussed in Note 1, during the three and six-months ended June 30, 2007, we operated in two additional segments, Healthcare and Security and Industrial. These segments comprised the operations of VeriChip, which we began accounting for under the equity method of accounting on January 1, 2008. Therefore, the selected data shown below does not include the Healthcare and Security and Industrial segment data for the three and six-months ended June 30, 2008. The Healthcare and Security and Industrial segments are more fully described in Note 21 to our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2007.

DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)

6. Segment Information (continued)

“Corporate/Eliminations” Category

The “Corporate/Eliminations” category includes all amounts recognized upon consolidation of our subsidiaries, such as the elimination of inter-segment revenues, expenses, assets and liabilities. “Corporate/Eliminations” also includes interest expense, interest and other income and administrative expenses associated with corporate activities and functions. Also included is other income associated with the reversal of certain liabilities related to companies that we sold or closed in 2001 and 2002. Included in the liabilities of “Corporate/Eliminations” as of June 30, 2008, are approximately $3.3 million of net liabilities related to companies that we sold or closed in 2001 and 2002. It is expected that $2.6 million of these net liabilities will be reversed during the remainder of 2008, as they will no longer be considered our legal obligations.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies in our Annual Report on Form 10-K except that inter-segment sales and transfers are generally accounted for as if the sales or transfers were to third parties at current market prices. It is on this basis that management utilizes the financial information to assist in making internal operating decisions. We evaluate performance based on segment income as presented below.

The following is selected segment data as of and for the periods ended:

																						Total From
		Animal				Emergency								Security and				Corporate/				Continuing
As of and For the Three-Months Ended June 30,		Identification				Identification				Healthcare				Industrial				Eliminations				Operations
2008
Revenue		$	9,606			$	11,097			$	—			$	—			$	—			$	20,703
Operating (loss) income			(7,235	)			881				—				—				(2,651	)			(9,005	)
(Loss) income from continuing operations before income taxes, minority interest and loss attributable to capital transactions of subsidiaries			(7,941	)			837				—				—				(2,132	)			(9,236	)
Total assets from continuing operations		$	73,191			$	33,452			$	—			$	—			$	26,688			$	133,331
2007
Revenue		$	11,029			$	8,504			$	5,863			$	2,327			$	—			$	27,723
Operating loss			(1,284	)			(387	)			(1,656	)			(414	)			(1,345	)			(5,086	)
Loss from continuing operations before income taxes, minority interest and gain attributable to capital transactions of subsidiaries			(1,972	)			(439	)			(1,976	)			(603	)			(1,184	)			(6,174	)
Total assets from continuing operations		$	79,114			$	18,301			$	44,925			$	9,063			$	17,562			$	168,965

																						Total From
		Animal				Emergency								Security and				Corporate/				Continuing
As of and For the Six-Months Ended June 30,		Identification				Identification				Healthcare				Industrial				Eliminations				Operations
2008
Revenue		$	21,349			$	21,780			$	—			$	—			$	—			$	43,129
Operating (loss) income			(7,549	)			1,442				—				—				(4,945	)			(11,052	)
(Loss) income from continuing operations before income taxes, minority interest and loss attributable to capital transactions of subsidiaries			(9,014	)			1,354				—				—				(7,234	)			(14,894	)
Total assets from continuing operations		$	73,191			$	33,452			$	—			$	—			$	26,688			$	133,331
2007
Revenue		$	21,289			$	13,542			$	11,174			$	4,389			$	—			$	50,394
Operating loss			(3,912	)			(847	)			(3,984	)			(1,027	)			(2,909	)			(12,679	)
Loss from continuing operations before income taxes, minority interest and gain attributable to capital transactions of subsidiaries			(4,430	)			(923	)			(4,472	)			(1,375	)			(2,514	)			(13,714	)
Total assets from continuing operations		$	79,114			$	18,301			$	44,925			$	9,063			$	17,562			$	168,965

DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)

7. Acquisitions

Acquisition of Geissler Technologies Corporation

On January 14, 2008, we entered into an Agreement and Plan of Merger (“the GTC Merger Agreement”) with GT Acquisition Sub, Inc. (our wholly-owned subsidiary), GTC and the five shareholders of GTC (the “Holders”) , pursuant to which GTC merged with and into GT Acquisition Sub, Inc. with GT Acquisition Sub, Inc. continuing as our wholly-owned subsidiary (the “GTC Merger”). Upon the closing of the GTC Merger, we assigned our ownership of GT Acquisition Sub, Inc. to Destron Fearing, such that GT Acquisition Sub, Inc. became a wholly-owned subsidiary of Destron Fearing.

Under the terms of the GTC Merger Agreement, upon the closing of the GTC Merger, we paid approximately 10.6 million shares of our common stock, valued at approximately $6.2 million to the Holders on January 14, 2008. In addition, upon the satisfaction of criteria contained in an earn-out provision of the GTC Merger Agreement, we are required to pay to the Holders up to $3.8 million, which may also be paid in cash, in shares of our common stock or VeriChip common stock that we own, or any combination thereof. Any consideration paid to the Holders is made pro rata based on the number of shares of GTC that the Holders owned when the GTC Merger was completed. We have registered for resale with the SEC the shares of our common stock issued and that may be issued to the Holders. In January 2008 and April 2008, we paid an aggregate of approximately $0.6 million under the earn-out provision by issuing to the Holders a total of 338,295 shares and 569,869 shares, respectively, of our common stock. The number of shares issued was based on a weighted average stock price for the ten days prior to the relevant patent filing date. We are currently in the process of determining the values and lives of the various acquired intangibles.

In connection with the GTC Merger, Kallina and its affiliates (collectively the “Lenders”) required that GT Acquisition Sub, Inc., as the surviving company of the GTC Merger, enter into Joinder Agreements with the Lenders. One of the Joinder Agreements provided that we pledge the stock of GT Acquisition Sub, Inc. to Kallina and join GT Acquisition Sub, Inc. as a party to the Security Agreement and IP Security Agreement, each dated August 31, 2007, entered into between Destron Fearing, certain of its subsidiaries and Kallina. The other Joinder Agreement provided that GT Acquisition Sub, Inc. become a guarantor under the Subsidiary Guaranty, dated August 31, 2007, entered into between us, certain of our subsidiaries and the Lenders and that the Stock Pledge Agreement, dated August 31, 2007, entered into between us, certain of our subsidiaries and the Lenders be amended to include the stock of GT Acquisition Sub, Inc.

Merger with Destron Fearing

On August 8, 2007, as amended on December 4, 2007, we and Destron Fearing entered into an Agreement and Plan of Reorganization (the “DA Merger Agreement”) by and among us, Destron Fearing and Digital Angel Acquisition Corp., a Delaware corporation and our wholly-owned subsidiary, (the “Acquisition Subsidiary”), pursuant to which the Acquisition Subsidiary was merged with and into Destron Fearing, with Destron Fearing surviving and becoming a wholly-owned subsidiary of ours (the “DA Merger”). Our board of directors and Destron Fearing’s board of directors each unanimously approved the DA Merger. The DA Merger was approved at a special meeting of our stockholders held on December 21, 2007.

On December 28, 2007, we consummated the DA Merger and each outstanding share of Destron Fearing’s common stock not owned by us was converted into 1.4 shares of our common stock. The shares of our common stock issued to Destron Fearing stockholders in connection with the DA Merger represented approximately 29% of the outstanding shares of our common stock immediately following the consummation of the DA Merger. In addition, at the effective time, each of Destron Fearing’s stock options and warrants existing on the effective date were converted into 1.4 options and warrants to acquire shares of our common stock. Total consideration paid for the minority owners’ interest was approximately $42.6 million determined as follows:

		(in thousands)
Number of Destron Fearing minority interest shares outstanding at the effective time of the merger			21,330
Exchange ratio per the terms of the DA Merger Agreement			1.4
Number of shares of our common stock issued			29,862
Value of our common stock issued (1)		$	1.152
Value of the shares exchanged		$	34,401
Value of the 13.3 million Destron Fearing options assumed (2)			5,430
Value of the 2.1 million Destron Fearing warrants assumed (3)			1,041
Transaction costs			1,691
Total purchase price		$	42,563

DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)

7. Acquisitions (continued)

The DA Merger was accounted for under the purchase method of accounting. The excess of purchase price over the fair value of the minority owners’ portion of the assets acquired was recorded as goodwill of $10.7 million. Intangible assets with an estimated fair value of $11.7 million were also recognized in the acquisition. These intangible assets consist of customer relationships, trademarks, patents and tradename. The customer relationships, patents and trademarks are being amortized over periods ranging from 3.75 to 12.2 years. The tradename has an indefinite life. Approximately $0.3 million and $0.7 million of amortization expense was recorded in the three and six-months ended June 30, 2008 for these intangible assets.

McMurdo Limited

In April 5, 2007, Signature acquired certain assets and customer contracts of McMurdo Limited (“McMurdo”), a United Kingdom based subsidiary of Chemring Group Plc (“Chemring”) and manufacturer of emergency location beacons. McMurdo develops and manufactures safety equipment technology. Its products, including the original Emergency Position Indicating Radio Beacon (“EPIRB”), the first Global Maritime Distress and Safety System (“GMDSS”) and the approved Search and Rescue Transponder, have become standard lifesaving equipment on many recreational, commercial and military marine vehicles. This acquisition was made to broaden Signature’s emergency location beacon product offering to serve the military and commercial maritime sectors and provide stability to Signature’s revenue base. The assets and contracts acquired included fixed assets, inventory, customer lists, customer and supplier contracts and relations, trade and business names, and associated assets. The assets excluded certain accrued liabilities and obligations and real property, including the plant facility. Signature entered into a sublease with Chemring to extend the lease of the McMurdo facility until 2022 with an opt-out provision after two or three years. Under the terms of the Asset Sale and Purchase Agreement (the “Agreement”), Signature retained McMurdo’s employees related to the marine electronics business. In addition, pursuant to the terms of the Agreement, Destron Fearing guaranteed to McMurdo, Signature’s obligations and liabilities to McMurdo under the Guaranteed Agreements (as defined in the Agreement) and Chemring guaranteed to Signature, McMurdo’s obligations and liabilities under the Guaranteed Agreements. Destron Fearing paid net consideration of approximately $7.3 million in cash, which included a payment of $0.5 million in the fourth quarter of 2006 and an additional purchase price payment of approximately $1.0 million in February 2008. Per the terms of the Agreement, Signature was obligated to make an additional purchase price payment of approximately $2.0 million. However, Signature held back approximately $1.0 million, of the additional purchase price payment because of certain warranty reimbursement claims and indemnity obligations under the Agreement. Chemring and Signature have since filed claims in the English courts seeking payment from the other. See Note 18 for further discussion on these claims.

In connection with the purchase of McMurdo, we acquired various trademarks, patents and customer relationships with lives ranging from 4 to 11 years. In the three and six-months ended June 30, 2008, we recorded approximately $21 thousand and $43 thousand, respectively, of amortization expense related to these intangible assets.

The total purchase prices of GTC, the minority owners’ interest in Destron Fearing and McMurdo were allocated as follows, in thousands:

						Minority Owners’
						Interest in
		GTC				Destron Fearing				McMurdo
Current assets		$	378			$	14,029			$	2,210
Equipment			59				5,569				636
Other assets			—				412				—
Intangibles:
Patented and non-patented proprietary technology			—				5,274				20
Trademarks and tradenames			—				4,978				2,860
Customer relationships and non-compete			—				9,069				840
Goodwill			6,952				26,773				1,350
Current liabilities			(571	)			(8,127	)			—
Long-term debt and other liabilities			—				(8,800	)			—
Deferred tax liability			—				(6,614	)			(614	)
Total		$	6,818			$	42,563			$	7,302

The estimated fair value of the acquired intangible assets, as presented above, was determined using discounted cash flow methodology.

DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)

7. Acquisitions (continued)

The purchase price allocation for GTC and for the minority owners’ interest in Destron Fearing as reflected in the table above is preliminary and subject to change. Any increase or decrease in the acquired assets and liabilities will result in an increase or decrease in goodwill.

In determining the purchase prices for GTC and McMurdo, we considered various factors including: (i) historical and projected revenue streams and operating cash flows of each company; (ii) their management teams; (iii) the complementary nature of each product offerings as an extension of the offerings of the other company and of our existing businesses; (iv) similarities in corporate cultures; and (v) the opportunity for expanded research and development of the combined or new product offerings. In determining the purchase price for the acquisition of the minority owners’ interest in Destron Fearing we considered: (i) the value of Destron Fearing’s common stock as traded on the AMEX; (ii) the expected cost savings as a result of eliminating public company expenses from Destron Fearing; (iii) the ability to streamline operations; (iv) the simplification of our corporate structure; and (v) the elimination of the overhang on Destron Fearing’s common stock, among other factors.

Based on our assessments, we determined that it was appropriate to offer purchase prices for these businesses that resulted in the recognition of goodwill.

Proformas (Unaudited)

The acquisitions were accounted for under the purchase method of accounting and, accordingly, the unaudited condensed consolidated financial statements reflect the results of operations of GTC, the minority owners’ interest in Destron Fearing and McMurdo from the date of acquisition. Unaudited pro forma results of operations of the Company for the three-months ended June 30, 2007 and six-months ended June 30, 2008 and 2007 are included below. Such pro forma information assumes that the above acquisitions had occurred as of April 1, 2007 and revenue is presented in accordance with our accounting policies. These unaudited pro forma statements have been prepared for comparative purposes only and are not intended to be indicative of what our results would have been had the acquisitions occurred at the beginning of the periods presented or the results which may occur in the future.

		Three-Months				Six-Months Ended
		Ended June 30,				June 30,
(in thousands)		2007				2008				2007
Net operating revenue		$	19,597			$	43,157			$	39,234
Net loss from continuing operations		$	(7,061	)		$	(14,711	)		$	(14,065	)
Net loss from continuing operations per common share — basic and diluted		$	(0.06	)		$	(0.13	)		$	(0.13	)

8. Capital Transactions of Subsidiaries

Gains where realized and losses on issuances of shares of stock by VeriChip have been reflected in the condensed consolidated statement of operations. For the three and six-months ended June 30, 2007, we recorded a loss of $0.6 million and a gain of $4.8 million, respectively on the issuance of shares of VeriChip’s common stock. The gain (loss) resulted from the difference between the carrying amount of our pro-rata share of our investment in VeriChip and the net proceeds from the issuance of the stock.

We recorded a loss of $1.0 million during the three-months ended June 30, 2007 and loss of $5.9 million during the six-months ended June 30, 2007 attributable to changes in the minority interest ownership as a result of the capital transactions of VeriChip and Destron Fearing.

DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)

9. Investments in Affiliate

The equity method of accounting is used for investments in affiliated companies, which are not controlled by us and in which our interest is generally between 20% and 50%, and we have significant influence over the entities. Our share of losses of such affiliated companies is included in our consolidated operating results. These affiliated companies are VeriChip, which is included in the results from continuing operations, and InfoTech, which is included in the results of discontinued operations. As of December 31, 2007, we owned a majority interest in VeriChip and InfoTech. However, in the three-months ended March 31, 2008 our ownership fell below 50%, therefore we began accounting for VeriChip and InfoTech under the equity method of accounting. As of June 30, 2008, we owned approximately 48.5% and 49.9% of VeriChip and InfoTech, respectively. Since we owned a majority of VeriChip and InfoTech at December 31, 2007 and during the three and six-months ended June 30, 2007, our condensed consolidated financial statements as of December 31, 2007 and for the three and six-months ended June 30, 2007 include VeriChip and InfoTech on a consolidated basis.

Changes in our interest arising from capital transactions of an investee are accounted for in the statement of operations. The table below summarizes the activity of our investment in VeriChip (our investment in InfoTech is presented in discontinued operations):

		VeriChip
Balance at January 1, 2008		$	12,293
Equity in loss			(2,751	)
Other			545
Balance at June 30, 2008		$	10,087
Ownership interest at June 30, 2008			48.5	%

The table below summarizes VeriChip’s balance sheet and statement of operations for the periods shown.

		June 30,
		2008
Total assets		$	47,108
Total liabilities			24,855
Total stockholders’ equity			22,253

		For the three-				For the six-
		months ended				months ended
		June 30,				June 30,
		2008				2008
		(in thousands)
Total revenues		$	9,739			$	18,337
Net loss			(4,528	)			(5,434	)

See Note 6 for a discussion of VeriChip’s operating segments for the three and six-months ended June 30, 2007.

10. Warrants Classified as a Liability

In February 2007, in connection with a prior financing, Destron Fearing issued warrants to two warrant holders. The warrants contained certain anti-dilution and cash settlement provisions and, accordingly, Destron Fearing accounted for the fair value of the warrants as a derivative liability subject to SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” At issuance, the fair value of the 0.7 million warrants, as calculated using the Black-Scholes valuation model, was $1.3 million using the following assumptions; volatility of 83.13%, risk free interest rate of 4.6%, dividend rate of 0.0% and expected life of 5 years. The fair value of the warrants was recorded as a discount to the debenture and amortized to interest expense over the life of the debenture, which was repaid on August 31, 2007. The warrants were required to be revalued at each balance sheet date using the Black-Scholes valuation model with changes in the fair value recorded as income or expense. Approximately $0.1 million of expense and $0.3 million of income was recorded in the three and six-months ended June 30, 2007, respectively, as a result of the change in the fair value of the warrants. In December 2007, pursuant to Securities Exchange Agreements with the holders, the warrants were exchanged for shares of Destron Fearing’s common stock.

DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)

11. Stock Options and Restricted Stock

Stock Option Plans

We and our subsidiaries have stock-based employee stock plans, which were outstanding as of December 31, 2007, and are more fully described in Note 12 to our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2007.

During the three-months ended June 30, 2008 and 2007, we recorded approximately $0.1 million and $0.2 million, respectively, in compensation expense related to stock options granted to our employees. During the six-months ended June 30, 2008 and 2007, we recorded approximately $0.2 million and $0.5 million, respectively of compensation expense related to stock options granted to our employees.

Stock Option Activity

The fair value of each option award is estimated on the date of grant using the Black-Scholes valuation model. The following assumptions were used for options granted during the three and six-months ended June 30, 2008 and 2007:

		Three-Months Ended								Six-Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
Risk-free interest rate			3.06 - 3.57	%			4.97%				2.80 - 3.57%				4.97%
Expected life (in years)			5.0				5.0				5.0				5.0
Dividend yield			0.0%				0.0%				0.0%				0.0%
Expected volatility			60.0%				60.0%				60.0%				60.0%
Weighted-average volatility			60.0%				60.0%				60.0%				60.0%

The computation of expected life was determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior. The interest rate was based on the U.S. Treasury yield curve in effect at the time of grant. Our computation of expected volatility was determined based on historical volatility.

A summary of our stock option activity as of June 30, 2008, and changes during the three months then ended is presented below (in thousands, except per share amounts):

						Weighted								Aggregate
		Stock				Average				Weighted Average				Intrinsic
		Options				Exercise Price				Contractual Term				Value
Outstanding at January 1, 2008			19,242			$	2.80
Granted			1,756				0.73
Exercised			—				—
Forfeited or expired			(776	)			3.18
Outstanding at June 30, 2008			20,222			$	2.61				5.7			$	539	*
Vested or expected to vest at June 30, 2008			20,115			$	2.62				5.7			$	529	*
Exercisable at June 30, 2008			18,448			$	2.79				5.3			$	374	*

The total intrinsic value of options exercised during the three-months ended June 30, 2008 and 2007 was nil and $2.0 million, respectively, and nil and $2.0 million for the six-months ended June 30, 2008 and 2007, respectively. At June 30, 2008, we had 2.7 million options available for issuance in our plans.

As of June 30, 2008, there was $0.5 million of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under our plans. That cost is expected to be recognized over a weighted-average period of 2.6 years. The total fair value of shares vested during the three and six-months ended June 30, 2008, was $15 thousand and $0.7 million, respectively.

Cash received from option exercises under all share-based payment arrangements for the six-months ended June 30, 2007 was $15 thousand. There were no exercises during the three-months ended June 30, 2008 and 2007 and the six-months ended June 30, 2008.

DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)

11. Stock Options and Restricted Stock (continued)

A summary of the status of our nonvested stock options as of June 30, 2008 and changes during the six-months ended June 30, 2008, is presented below (in thousands, except per share amounts):

						Weighted
						Average
						Grant-Date
		Stock Options				Fair Value
Nonvested at January 1, 2008			115			$	1.45
Granted			1,669				0.55
Vested			(10	)			1.52
Forfeited or expired			—				—
Nonvested at June 30, 2008			1,774			$	0.60

In addition to the stock options presented above, Thermo Life has 4.4 million fully vested stock options outstanding. As of June 30, 2008, the intrinsic value of these stock options was nil.

Restricted Stock

During the first quarter of 2005 and December 2006, we issued 0.3 million shares of restricted common stock which vested over periods ranging from 12 to 34 months. The total value of these shares was approximately $1.0 million and we recorded compensation expense of approximately $35 thousand and $0.1 million during the three and six-months ended June 30, 2007, respectively, associated with these shares.

In January 2008, we issued 0.3 million shares of restricted common stock to our board of directors. The restricted stock vests ratably over five years. The total value of these shares was approximately $0.2 million and we recorded compensation expense related to these shares of approximately $18 thousand and $31 thousand during the three and six-months ended June 30, 2008, respectively.

12. Income Taxes

Our effective income benefit (provision) tax rate was 2.0% and (6.1)% for the six-months ended June 30, 2008 and 2007, respectively. Differences in the effective income tax rates from the statutory federal income tax rate arise from state and foreign income taxes (benefits), net of federal tax effects, and the increase or reduction of valuation allowances related to net operating loss carryforwards, non-deductible intangible amortization associated with acquisitions and other deferred tax assets. As of June 30, 2008, we have provided a valuation allowance to fully reserve our U.S. net operating loss carryforwards and our other existing U.S. net deferred tax assets, primarily as a result of our recent losses and our current projections of future taxable U.S. income. As a result of fully reserving our U.S. deferred tax assets, we did not record a benefit related to our net U.S. losses during the six-months ended June 30, 2008 and 2007.

We, in combination with our 80% or more owned subsidiaries, file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions in which we operate. In general, we and Destron Fearing are no longer subject to U.S. federal, state or local income tax examinations for years before 2004. The Internal Revenue Service is currently examining our 2005 federal income tax return.

13. Discontinued Operations

During the three-months ended March 31, 2008, our board of directors made a decision to sell two of our wholly-owned subsidiaries: FDC and Thermo Life. Our decision was made as part of management’s strategy to streamline our operations to focus more of our efforts on the RFID and the GPS and radio communication markets. FDC provides service relationship management software, and Thermo Life is a development company with patented rights to a thin-film thermoelectric generator.

On September 30, 2007, our board of directors made a decision to sell two of our wholly-owned subsidiaries: Computer Equity and Perimeter. Our decision was made as part of management’s strategy to streamline our operations to focus more of our efforts on the RFID, and the GPS and radio communication markets. Computer Equity provides voice, data and video telecommunications products and services, and Perimeter sells call center software and related services.

DIGITAL ANGEL CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited) (continued)

13. Discontinued Operations (continued)

During the three-months ended June 30, 2007, our board of directors approved the sale of InfoTech. InfoTech provides computer hardware and IT services. In addition, on July 2, 2007, Destron Fearing completed its previously announced sale of its whollyowned subsidiary, OuterLink. OuterLink provides satellite-based mobile asset tracking and data messaging systems used to manage the deployment of aircraft and land vehicles. Pursuant to the terms of the Stock Purchase Agreement, dated May 7, 2007, Destron Fearing sold all of the issued and outstanding shares of stock of OuterLink for a purchase price of $1.0 million, subject to certain adjustments, based on OuterLink’s closing balance sheet. Consideration consisted of a cash payment of $0.8 million and a promissory note of $0.2 million which was repaid in November 2007. The Stock Purchase Agreement contained customary representations and warranties of the parties and indemnification provisions.

As a result of our board of directors’ decision to sell FDC, Thermo Life, InfoTech, Computer Equity and Perimeter and Destron Fearing’s board of directors’ decision to sell OuterLink, the financial condition, results of operations and cash flows of FDC, Thermo Life, InfoTech, Computer Equity, Perimeter and OuterLink have been reported as discontinued operations in our financial statements, and prior period information has been reclassified accordingly. In addition, on March 1, 2001, our board of directors approved a plan to offer for sale other non-core businesses, and accordingly, these businesses, which have all been sold or closed, are presented in discontinued operations for all periods presented. As discussed in Note 9, we no longer own a majority of the outstanding stock of InfoTech. Therefore, InfoTech’s summarized operating data and changes in capital are presented below, in thousands, under the equity method of accounting for 2008.

		Three-Months Ended								Six-Months Ended
		June 30,				June 30,				June 30,				June 30,
		2008				2007				2008				2007
Revenue		$	3,232			$	11,141			$	8,948			$	19,877
Cost of sales			2,281				6,295				5,447				11,957
Gross profit			951				4,846				3,501				7,920
Selling, general and administrative expenses			1,230				2,524				2,606				5,261
Research and development expenses			40				364				144				852
Interest and other income			53				916				49				956
Interest expense			(72	)			(61	)			(144	)			(122	)
Equity in loss and capital transactions of affiliate			(10	)			—				(100	)			—
(Loss) income before income taxes and minority interest			(455	)			2,813				457				2,641
Provision for income taxes			—				(297	)			—				(377	)
(Loss) income before minority interest			(455	)			2,516				457				2,264
Minority interest			—				215				—				563
Gain attributable to changes in minority interest as a result of capital transactions of subsidiaries			—				—				—				2
(Loss) income from discontinued operations, net of income taxes of $0		$	(455	)		$	2,731			$	457			$	2,829
(Loss) income from discontinued operations per common share — basic and diluted		$	(0.00	)		$	0.04			$	0.00			$	0.04
Weighted average number of common shares outstanding — basic and diluted			118,223				67,567				116,307				67,353