VTEQ VeriTeQ Corporation (CE)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2009

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 Incorporation or Organization)		(I.R.S. Employer Identification Number)
490 Villaume Avenue, South St. Paul, Minnesota		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 has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes o 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 November 3, 2009
Common Stock, $.01 par value per share		20,933,851

 

 

DIGITAL ANGEL CORPORATION

TABLE OF CONTENTS

				Page
		PART I — Financial Information
Item 1.		Financial Statements (unaudited):
		Condensed Consolidated Balance Sheets — As of September 30, 2009 and December 31, 2008			3
		Condensed Consolidated Statements of Operations — Three and nine-months ended September 30, 2009 and 2008			4
		Condensed Consolidated Statement of Changes in Stockholders’ Equity — Nine-months ended September 30, 2009			6
		Condensed Consolidated Statements of Cash Flows — Nine-months ended September 30, 2009 and 2008			7
		Notes to Condensed Consolidated Financial Statements			8
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			25
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			37
Item 4.		Controls and Procedures			39
		PART II — Other Information
Item 1.		Legal Proceedings			39
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			39
Item 4.		Submission of Matters to a Vote of Security Holders			39
Item 6.		Exhibits			40
		Signatures
		Certifications			41
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)

		September 30,				December 31,
		2009				2008
		(unaudited)
Assets
Current assets
Cash and cash equivalents		$	2,027			$	1,807
Restricted cash			196				—
Accounts receivable, net of allowance for doubtful accounts of $659 and $503 at September 30, 2009 and December 31, 2008, respectively			10,590				10,945
Note receivable			450				450
Inventories			12,846				8,922
Deferred taxes			143				130
Other current assets			1,293				1,530
Current assets of discontinued operations			5				5
Total current assets			27,550				23,789
Property and equipment, net			8,352				8,834
Goodwill			8,514				8,386
Intangible assets, net			20,200				21,828
Note receivable			701				1,015
Other assets, net			624				322
Other assets of discontinued operations			5				32
Total Assets		$	65,946			$	64,206
Liabilities and Stockholders’ Equity
Current liabilities
Notes payable and current maturities of long-term debt		$	10,581			$	8,581
Accounts payable			14,079				9,704
Advances from factors			2,632				1,474
Accrued expenses			10,186				9,133
Deferred revenue			687				840
Current liabilities of discontinued operations			5				10
Total current liabilities			38,170				29,742
Commitments and contingencies
Long-term debt and notes payable			2,644				6,943
Deferred taxes			2,556				2,593
Other liabilities			891				2,223
Total Liabilities			44,261				41,501
Stockholders’ Equity:
Digital Angel Corporation stockholders’ equity:
Preferred shares ($10 par value; shares authorized, 5,000; shares issued, nil)			—				—
Common shares ($0.01 par value; shares authorized, 35,000; shares issued, 19,586 and 16,080; shares outstanding, 19,586 and 15,950)			196				161
Additional paid-in capital			585,781				584,466
Accumulated deficit			(562,640	)			(558,839	)
Accumulated other comprehensive loss — foreign currency translation adjustment			(1,746	)			(2,308	)
Subtotal			21,591				23,480
Treasury stock (carried at cost, nil and 130 shares)			—				(820	)
Total Digital Angel Corporation stockholders’ equity			21,591				22,660
Noncontrolling interest			94				45
Total Stockholders’ Equity			21,685				22,705
Total Liabilities and Stockholders’ Equity		$	65,946			$	64,206

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				For the
		Three-Months Ended				Three-Months Ended
		September 30, 2009				September 30, 2008
Revenue		$	15,663			$	18,856
Cost of sales			9,159				11,781
Gross profit			6,504				7,075
Selling, general and administrative expenses			6,967				8,169
Research and development expenses			468				730
Restructuring, severance and separation expenses			142				410
Goodwill and asset impairment			—				24,989
Total operating expenses			7,577				34,298
Operating loss			(1,073	)			(27,223	)
Interest and other income (expense), net			51				(1,159	)
Interest expense			(670	)			(3,178	)
Loss from continuing operations before taxes			(1,692	)			(31,560	)
Benefit for income taxes			68				150
Loss from continuing operations			(1,624	)			(31,410	)
(Loss) income from discontinued operations (attributable to Digital Angel Corporation)			(51	)			992
Net loss			(1,675	)			(30,418	)
Loss (income) attributable to the noncontrolling interest, continuing operations			2				(17	)
Net loss attributable to Digital Angel Corporation		$	(1,673	)		$	(30,435	)
(Loss) income per common share attributable to Digital Angel Corporation — basic and diluted:
Loss from continuing operations		$	(0.09	)		$	(2.04	)
(Loss) income from discontinued operations			(0.00	)			0.07
Net loss		$	(0.09	)		$	(1.97	)
Weighted average number of common shares outstanding — basic and diluted			18,271				15,418

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 Nine-				For the Nine-
		Months Ended				Months Ended
		September 30, 2009				September 30, 2008
Revenue		$	50,692			$	61,985
Cost of sales			29,863				39,987
Gross profit			20,829				21,998
Selling, general and administrative expenses			21,593				26,325
Research and development expenses			1,380				2,256
Restructuring, severance and separation expenses			455				2,334
Goodwill and asset impairment			—				29,358
Total operating expenses			23,428				60,273
Operating loss			(2,599	)			(38,275	)
Interest and other income, net			671				1,415
Interest expense			(1,738	)			(7,388	)
Loss from continuing operations before taxes			(3,666	)			(44,248	)
Benefit for income taxes			27				438
Loss from continuing operations			(3,639	)			(43,810	)
Loss from discontinued operations (attributable to Digital Angel Corporation)			(135	)			(757	)
Net loss			(3,774	)			(44,567	)
Income attributable to the noncontrolling interest, continuing operations			(27	)			(121	)
Net loss attributable to Digital Angel Corporation		$	(3,801	)		$	(44,688	)
Loss per common share attributable to Digital Angel Corporation — basic and diluted:
Loss from continuing operations		$	(0.20	)		$	(2.96	)
Loss from discontinued operations			(0.01	)			(0.05	)
Net loss		$	(0.21	)		$	(3.01	)
Weighted average number of common shares outstanding — basic and diluted			17,798				14,834

See Notes to Condensed Consolidated Financial Statements.

DIGITAL ANGEL CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statement of Changes in Stockholders’ Equity (Unaudited)
For the Nine-Months Ended September 30, 2009
(in thousands)

		Digital Angel Corporation Shareholders
																		Accumulated
										Additional								Other
		Common Stock								Paid-In				Accumulated				Comprehensive				Treasury				Noncontrolling				Total Stockholders’
		Number				Amount				Capital				Deficit				Income (Loss)				Stock				Interest				Equity
Balance, December 31, 2008			16,080			$	161			$	584,466			$	(558,839	)		$	(2,308	)		$	(820	)		$	45			$	22,705
Net (loss) income			—				—				—				(3,801	)			—				—				27				(3,774	)
Comprehensive income (loss):
Foreign currency translation			—				—				—				—				562				—				22				584
Total comprehensive income (loss)															(3,801	)			562								49				(3,190	)
Issuance of common stock under the Standby Equity Distribution Agreement			1,520				15				1,575				—				—				—				—				1,590
Issuance of common stock for equipment purchase			296				3				183				—				—				—				—				186
Issuance of common stock in a private placement sale			255				2				125				—				—				—				—				127
Issuance of common stock for price protection under the terms of a legal settlement			960				10				(10	)			—				—				—				—				—
Retirement of treasury stock issued for price protection under the terms of a severance agreement			295				3				(823	)			—				—				820				—				—
Issuance of common stock for services			101				1				125				—				—				—				—				126
Partial share repurchase			(8	)			—				—				—				—				—				—				—
Retirement of common stock			(1	)			—				—				—				—				—				—				—
Share-based compensation expense			—				—				302				—				—				—				—				302
Stock issuance costs			—				—				(108	)			—				—				—				—				(108	)
Issuance of common stock for SEDA commitment fee			88				1				124				—				—				—				—				125
Stock issuance costs — SEDA commitment fee			—				—				(125	)			—				—				—				—				(125	)
Reclassification of warrant as liability per EITF 07-5			—				—				(53	)			—				—				—				—				(53	)
Balance, September 30, 2009			19,586			$	196			$	585,781			$	(562,640	)		$	(1,746	)		$	—			$	94			$	21,685

See Notes to Condensed Consolidated Financial Statements.

DIGITAL ANGEL CORPORATION AND SUBSIDIARIES

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

		For the Nine-				For the Nine-
		Months Ended				Months Ended
		September 30, 2009				September 30, 2008
Cash Flows From Operating Activities
Net loss		$	(3,774	)		$	(44,567	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Loss from discontinued operations			135				757
Equity compensation and other equity-based administrative expenses			428				2,085
Depreciation and amortization			3,334				3,716
Loss on disposal of equipment			25				30
Amortization of debt discount and financing costs			446				5,224
Allowance for doubtful accounts			123				(90	)
Allowance for inventory excess and obsolescence			—				(146	)
Loss on settlement of debt			—				2,512
Asset impairment			—				29,358
Change in fair value of warrant liability			(39	)			—
Other			—				(820	)
Changes in assets and liabilities:
(Increase) decrease in restricted cash			(196	)			90
Decrease in accounts receivable			745				253
(Increase) decrease in inventories			(3,274	)			1,324
Decrease (increase) in other current assets			293				(55	)
Increase (decrease) in accounts payable, accrued expenses and other liabilities			4,460				(177	)
Net cash (used in) provided by discontinued operations			(187	)			1,184
Net Cash Provided by Operating Activities			2,519				678
Cash Flows From Investing Activities
Decrease (increase) in notes receivable			314				(1,556	)
Proceeds from note receivable with VeriChip			—				9,500
Increase in other assets			(125	)			(451	)
Payments for costs of business acquisition			—				(200	)
Proceeds from special dividend received			—				7,230
Payments for property and equipment			(556	)			(976	)
Net cash (used in) provided by discontinued operations			(73	)			15
Net Cash (Used in) Provided by Investing Activities			(440	)			13,562
Cash Flows From Financing Activities
Net amounts paid on notes payable			(1,718	)			(697	)
Net payments proceeds from debt and advances from factors			(1,794	)			(15,043	)
Proceeds from warrant exercise			—				2,315
Payment of dividend to subsidiaries’ minority shareholder			—				(35	)
Issuance of common stock in private placement			127				—
Issuance of common stock under the SEDA Agreement			1,590				—
Stock issuance costs			(108	)			(82	)
Net Cash Used in Financing Activities			(1,903	)			(13,542	)
Net Increase In Cash and Cash Equivalents			176				698
Effect of Exchange Rate Changes on Cash and Cash Equivalents			44				(71	)
Cash and Cash Equivalents — Beginning of Period			1,807				2,222
Cash and Cash Equivalents — End of Period		$	2,027			$	2,849

See Notes to Condensed Consolidated Financial Statements.

DIGITAL ANGEL CORPORATION

Notes to Condensed Consolidated Financial Statements (Unaudited)

1. Basis of Presentation

Digital Angel Corporation, a Delaware corporation, and its subsidiaries, (referred to together as, “Digital Angel,” “the Company,” “we,” “our,” and “us”) develops innovative identification and security products for consumer, commercial and government sectors worldwide. Our unique and often proprietary products provide identification and security for people, animals, food chains, government/military assets, and commercial assets. Included in this diverse 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.

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, 2008, filed with the Securities and Exchange Commission (“SEC”) on March 31, 2009 and our Current Report on Form 8-K filed with the SEC on July 8, 2009 in which we represented our financial results for the year ended December 31, 2008 in accordance with the Consolidation Topic of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“Codification” or “ASC”). See Note 2 for further discussion.

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, which comprises the operations of our wholly-owned subsidiary, Destron Fearing Corporation (“Destron”), and Emergency Identification, which comprises the operations of our 98.5% subsidiary, Signature Industries Limited (“Signature”). Our segments are discussed in Note 6.

Discontinued Operations

During 2007 and 2008, we sold or made the decision to sell a number of non-core businesses. These decisions were made as part of management’s strategy to streamline operations to focus its efforts on the Animal Identification and Emergency Identification businesses. As a result, these non-core businesses are presented in discontinued operations for all periods presented. Discontinued operations are more fully discussed in Note 10.

As more fully discussed in Note 15, on November 2, 2009, we entered into a definitive agreement to sell Signature’s McMurdo unit for $10.0 million in cash. As such, we will report McMurdo’s results in discontinued operations beginning in the fourth quarter of 2009.

Related Party Transactions

During past fiscal years, we have entered into various related party transactions. Each of these transactions is described in Note 22 to our consolidated financial statements for the year ended December 31, 2008 included in our Current Report on Form 8-K filed with the SEC on July 8, 2009. During the three and nine-months ended September 30, 2009, we did not have any significant related party transactions.

Foreign Currency Adjustment of Intercompany Loans

In accordance with the Codification Topic 830-10, Foreign Currency Matters, when intercompany foreign currency transactions between entities included in the consolidated financial statements are of a long-term investment nature (i.e., those for which settlement

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

is not planned or anticipated in the foreseeable future) foreign currency transaction adjustments should not produce gains or losses that affect consolidated earnings. Gains and losses on such transactions are included in equity in the accumulated other comprehensive income (loss) — foreign currency translation account in consolidation. However, when intercompany transactions are deemed to be of a short-term nature, such gain and losses are required to affect consolidated earnings. Until July 6, 2009, management concluded that the intercompany loan from Destron to Signature was of a long-term nature. This was appropriate because management had no plans to require repayment of the intercompany loan. The funds were provided to Signature for new product development and the acquisition of McMurdo. Management of both entities verbally agreed that the intention was that the loan was not required to be repaid and no loan agreement was documented. The historical and projected cash flows of Signature did not support repayment of the loan and Signature’s invoice discount facility did not permit repayment of the loan. Accordingly, included in accumulated other comprehensive loss as of September 30, 2009 is approximately $1.3 million of losses associated with the intercompany loan between Destron and Signature. On July 7, 2009, upon entering into the Bibby Invoice Discounting Agreement, which is more fully discussed in Note 5 below, Destron and Signature entered into a loan agreement, which requires Signature to make quarterly principal payments. Management determined at this time that it was appropriate to treat the intercompany loan as short-term in nature because of several factors: (i) the Bibby Invoice Discount Agreement provided Signature additional working capital; (ii) the terms of the Bibby Invoice Discount Agreement allowed for the repayment of the loan per the terms of the intercompany loan agreement; and (iii) the planned sale of McMurdo provides the funds necessary for Signature to repay the loan. Therefore, we have determined that effective July 7, 2009, it was appropriate to begin recording transaction adjustments as gains/losses in the statement of operations and, accordingly, we have recorded approximately $0.1 million of foreign currency transaction losses during the three-months ended September 30, 2009. Going forward, changes in the foreign currency exchange rates between the U.S. dollar and the English pound will result in additional gains or losses in our consolidated earnings.

Liquidity

We believe that we will be able to generate enough cash from operations, our existing revolving credit facility and factoring lines, the potential sales of certain business units, including McMurdo, and through other investing and financing sources to operate our business for the twelve months ending September 30, 2010, including generating the cash required to repay the Laurus term debt and refinancing our revolving credit line, which matures in August 2010. On July 7, 2009, we entered into an invoice discounting agreement which replaced a previous agreement and increased the potential aggregate amount of borrowings available to us. In addition, on July 10, 2009, we entered into a Standby Equity Purchase Agreement under which we may sell, at our option, up to an additional $3.4 million of our common stock as of September 30, 2009, subject to certain terms and restrictions, including shareholder approval for issuances of shares of our common stock under the SEDA in excess of approximately 3.6 million shares. Each of these financings is more fully discussed in Note 5.

Our goal is to achieve profitability and to generate positive cash flows from operations. During 2008, we restructured our Animal Identification business which eliminated redundancies, improved gross margins and decreased expenses. Also, we generated positive cash flows from operations during the nine-months ended September 30, 2009 and the year ended December 31, 2008. Our capital requirements depend on a variety of factors, including but not limited to, the rate of increase or decrease in our existing business base; the success, timing, and amount of investment required to bring new products on-line; revenue growth or decline; and potential acquisitions or divestitures. We have established a management plan to guide us in our goal of achieving profitability and improving positive cash flows from operations during 2009 and 2010 although no assurance can be given that we will be successful in implementing the plan. Failure to generate positive cash flow from operations will have a material adverse effect on our business, financial condition and results of operations.

Our historical sources of liquidity have included proceeds from the sale of common stock and preferred shares, proceeds from the issuance of debt, proceeds from the sale of businesses, and proceeds from the exercise of stock options and warrants. In addition to these sources, other sources of liquidity may include the raising of capital through additional private placements or public offerings of debt or equity securities. However, going forward some of these sources may not be available, or if available, they may not be on favorable terms. We will be required to generate funds to repay certain of our debt obligations during 2009 and 2010, including our obligations to Laurus Master Fund Ltd, Kallina Corporation and their affiliates (collectively our “Laurus term debt”). We intend to use a portion of the proceeds from the sale of the McMurdo business unit, which is more fully discussed in Note 15, to fully repay our Laurus term debt. As of September 30, 2009, we had a working capital deficiency, which is primarily due to a number of our debt obligations becoming due or potentially due within the next twelve months. Specifically, these obligations include the following: (i) our Laurus term debt, which matures in February 2010. (As more fully discussed in Note 15, we have entered into an agreement with Laurus, which is contingent upon the completion of the McMurdo sale, to repay our Laurus term debt upon the closing and funding of the sale); (ii) our revolving line of credit with Kallina Corporation, which matures in August 2010; (iii) our factoring lines; and (iv) our credit facility with Danske Bank, which are more fully discussed in Note 5 below and in Note 9 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2008. Our debt obligation to Danske Bank is due on demand and beginning in July 2009, we are required to make monthly principal payments as more fully discussed in Note 5. Our factoring lines may also be amended or terminated at any time by the lenders. These conditions indicate that we may not be able to continue as a going concern, as we may be unable to generate the funds necessary to pay our obligations in the ordinary course of business, despite management’s plans and expectations to do so. The accompanying condensed consolidated financial statements do not include any adjustments that might result should we be unable to continue as a going concern.

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

2. Impact of Recently Issued Accounting Standards

In June 2009, FASB released the Codification which became the source of authoritative GAAP recognized by FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. For all financial statements issued after September 15, 2009, the Codification superseded all then-existing non-SEC accounting and reporting standards. All other nongrandfathered non-SEC accounting literature not included in the Codification has become nonauthoritative. The Codification does not change how we account for our transactions or the nature of related disclosures made. However, when referring to guidance issued by the FASB, we will refer to topics in the Codification rather than the superseded standards. The adoption of the Codification did not impact our consolidated financial position, results of operations, cash flows or financial statement disclosures.

In April 2009, FASB established general standards of accounting for, and the disclosure of, events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, the Subsequent Event Topic of the Codification sets forth: (1) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (2) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and (3) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. We adopted this standard as of June 30, 2009, which did not have a material impact on our consolidated financial position, results of operations or cash flows.

In June 2008, FASB established that an entity should use a two step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument’s contingent exercise and settlement provisions. It also clarified the impact of foreign currency denominated strike prices and market-based employee stock option valuation instruments on the evaluation. The standard was effective as of January 1, 2009. We adopted the Contracts in Entity’s Own Equity Subtopic of the Derivatives and Hedging Topic of the Codification on January 1, 2009 and as a result we have a liability associated with outstanding warrants of approximately $14 thousand at September 30, 2009 and have recorded other income of approximately $38 thousand and $43 thousand during the three and nine-months ended September 30, 2009 due to the change in values.

In March 2008, FASB required enhanced disclosures about an entity’s derivative and hedging activities which 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, and (3) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. This standard was effective for financial statements issued as of January 1, 2009. Comparative disclosures for earlier periods at initial adoption was encouraged but not required. We adopted the applicable requirements of the Derivative and Hedging Topic of the Codification on January 1, 2009, 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 modified certain requirements of the Business Combination Topic of the Codification. The changes provided new guidance that 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. It 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, the guidance 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. The guidance of modified sections is applied prospectively to business combinations for which the acquisition date is on or after January 1, 2009. An entity may not apply the standard before that date. We adopted these requirements effective January 1, 2009, which did not have any impact on our consolidated financial position, results of operations, cash flows or financial statement disclosures as we have not had any acquisitions since adopting the standard.

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

2. Impact of Recently Issued Accounting Standards (continued)

In December 2007, FASB established new accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarified 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, the modified Consolidation Topic of the Codification 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 also established 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. The modified sections are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 and earlier adoption is prohibited. Noncontrolling interests should be accounted for and presented as equity if material, rather than as a liability or mezzanine equity and significant changes in accounting related to noncontrolling interests; specifically, increases and decreases in our controlling financial interests in consolidated subsidiaries will be reported in equity similar to treasury stock transactions. If a change in ownership of a consolidated subsidiary results in loss of control and deconsolidation, any retained ownership interests are remeasured with the gain or loss reported in net earnings. We adopted these requirements on January 1, 2009 and as such, we have presented our statement of operations for the three and nine-months ended September 30, 2008 to include the income attributable to the noncontrolling interest in consolidated net income and our balance sheet at December 31, 2008 to include the noncontrolling interest in stockholders’ equity. In addition, on July 8, 2009, we filed a Current Report on Form 8-K in which we presented our financial results for the year ended December 31, 2008 which gave effect to our adoption of the new requirements of the Consolidation Topic.

3. Inventories

Inventories consist of the following:

		September 30,				December 31,
		2009				2008
		(in thousands)
Raw materials		$	11,973			$	8,584
Work in process			1,054				622
Finished goods			1,518				1,240
			14,545				10,446
Less: Allowance for excess and obsolescence			(1,699	)			(1,524	)
Total inventory		$	12,846			$	8,922

We had $11.1 million and $6.2 million of our inventory at foreign locations at September 30, 2009 and December 31, 2008, respectively.

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

4. Loss Per Share

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

		Three-Months Ended								Nine-Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Numerator for basic and diluted loss per share attributable to Digital Angel Corporation:
Loss from continuing operations		$	(1,622	)		$	(31,427	)		$	(3,666	)		$	(43,931	)
(Loss) income from discontinued operations			(51	)			992				(135	)			(757	)
Net loss attributable to common stockholders		$	(1,673	)		$	(30,435	)		$	(3,801	)		$	(44,688	)
Denominator for basic and diluted loss per share attributable to Digital Angel Corporation:
Basic and diluted weighted-average shares outstanding (1)			18,271				15,418				17,798				14,834
Loss per share attributable to Digital Angel Corporation — basic and diluted:
Continuing operations		$	(0.09	)		$	(2.04	)		$	(0.20	)		$	(2.96	)
Discontinued operations			(0.00	)			0.07				(0.01	)			(0.05	)
Total — basic and diluted		$	(0.09	)		$	(1.97	)		$	(0.21	)		$	(3.01	)

		September 30,
		2009				2008
Stock options			2,701				2,517
Warrants			314				385
Restricted stock			20				31
Total			3,035				2,933

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, 2008. The following are descriptions of our financing agreements that have been modified or terminated during 2009:

Danske Bank Line of Credit

DSD Holding and its wholly-owned subsidiary, Destron Fearing A/S (formerly Daploma International A/S) are party to a credit agreement with Danske Bank (the “Credit Facility”). On June 1, 2006, DSD Holdings and Destron Fearing A/S amended the borrowing availability from DKK 12.0 million (approximately $2.4 million at September 30, 2009) to DKK 18.0 million (approximately $3.5 million at September 30, 2009). In connection with the amendment, Destron Fearing executed a Letter of Support which confirms that it will maintain its holding of 100% of the share capital of Destron Fearing A/S, and will neither sell, nor pledge, nor in any way dispose of any part of Destron Fearing A/S or otherwise reduce Destron Fearing’s influence on Destron Fearing A/S without the prior consent of Danske Bank. Interest is determined quarterly and is based on the international rates Danske Bank can establish on a loan in the same currency on the international market plus 2.0%. Borrowing availability under the Credit Facility considers guarantees outstanding. The Credit Facility will remain effective until further notice. Destron Fearing A/S can terminate the Credit Facility and pay the outstanding balance, or Danske Bank may demand the credit line be settled immediately at any given time, without prior notice. Beginning in July 2009, Destron Fearing A/S and Danske Bank agreed to reduce the borrowing availability on the Credit Facility each month by DKK 500 thousand (approximately $0.1 million). As of September 30, 2009, DKK 16.5 million (approximately $3.2 million) was outstanding under the credit line and there was no additional availability.

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

5. Financings (continued)

RBS Invoice Discounting Agreement

Signature had 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 provided for Signature to sell with full title guarantee most of its receivables, as defined in the RBS Invoice Discounting Agreement. Under the RBS Invoice Discounting Agreement, as amended in December 2008, RBS prepaid 70% of the receivables sold in the United Kingdom and 70% of the receivables sold in the rest of the world, not to exceed an outstanding balance of £1.5 million at any given time, subject to restrictions on the use of proceeds. RBS paid Signature the remainder of the receivable upon collection. Receivables which remained outstanding 90 days from the end of the invoice month became ineligible and RBS could require Signature to repurchase the receivable. The discounting charge accrued at an annual rate of 1.5% above the base rate as defined in the RBS Invoice Discounting Agreement. Signature paid a commission charge to RBS of 0.16% of each receivable balance sold. The RBS Invoice Discounting Agreement required a minimum commission charge of £833 per month. Discounting charges of $5 thousand and $45 thousand are included in interest expense for the three-months ended September 30, 2009 and 2008, respectively. Discounting charges of $52 thousand and $0.2 million are included in interest expense for the nine-months ended September 30, 2009 and 2008, respectively.

In July 2009, we terminated the RBS Invoice Discounting Agreement and replaced it with the Bibby Invoice Discounting Agreement as discussed below.

Bibby Invoice Discounting Agreement

On July 7, 2009, Signature entered into an invoice discounting agreement (“Bibby Invoice Discounting Agreement”) with Bibby Financial Services (“Bibby”). The Bibby Invoice Discounting Agreement replaced the RBS Invoice Discounting Agreement in July 2009. The Bibby Invoice Discounting Agreement provides for Signature to sell, with full title guarantee, most of its receivables as defined in the Bibby Invoice Discounting Agreement. Bibby will prepay 80% of receivables sold in the United Kingdom (“U.K.”) and 70% of receivables sold in the rest of the world, not to exceed a balance of £2.5 million (approximately $4.0 million at September 30, 2009). Subsequent to continued satisfactory operation of the invoice discounting facility and Signature’s financial progress, Bibby will increase funding in two further tranches of £500 thousand each (approximately $0.8 million at September 30, 2009), up to a total balance of £3.5 million (approximately $5.6 million at September 30, 2009), based upon the cash needs of the business and ability to generate the required level of receivable funding. Bibby will repay Signature the remainder of the receivable upon collection.

Receivables which remain outstanding 90 days from the invoice date become ineligible and Signature will be required to repurchase the receivable. The Bibby Invoice Discounting Agreement requires a fee of 0.25% for each U.K. receivable sold and 0.3% for each receivable sold in the rest of the world. If the total of the yearly fee is less than £60,000, Signature will be required to pay Bibby the amount of such deficit. Signature is also required to pay a discounting charge of 2.0% above the higher of Barclays Bank Plc base rate or 3 month LIBOR subject to a minimum of 3.5% (3.5% at September 30, 2009). Discounting charges of approximately $66 thousand are included in interest expense for the three-months ended September 30, 2009. Either Signature or Bibby can terminate the Bibby Invoice Discounting Agreement by providing written notice to the other party six months prior to the intended termination date but neither party can terminate for eighteen months following the commencement date. As of September 30, 2009, we had approximately £1.4 million outstanding (approximately $2.2 million) and approximately £75 thousand available ($0.1 million) for borrowing under the Bibby Invoice Discounting Agreement.

Yorkville Standby Equity Distribution Agreement

On July 10, 2009, we entered into a Standby Equity Distribution Agreement (the “SEDA”) with YA Global Master SPV Ltd. (“YA SPV”), an affiliate of Yorkville Advisors, for the sale of up to $5.0 million of shares of our common stock over a two-year commitment period. Under the terms of the SEDA, we may from time to time, in our discretion, sell newly-issued shares of our common stock to YA SPV. We have issued shares of our common stock under the SEDA pursuant to a Registration Statement on Form S-3 (Registration No. 333-159880), declared effective by the SEC on July 9, 2009 wherein we registered 3.0 million shares of our common stock.

As provided in the SEDA, periodically we are able to issue advance notices to YA SPV requesting YA SPV to purchase a certain number of shares of our common stock (“Advance Notices”). The amount of shares we can request YA SPV to purchase under each

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

5. Financings (continued)

Advance Notice cannot exceed the lesser of (1) $500,000 worth, unless otherwise mutually agreed upon by both parties, or (2) 125% of the average of the “daily value traded” for each of the 10 trading days prior to the Advance Notice date (where “daily value traded” is the product obtained by multiplying the daily trading volume for such day by the daily volume weighted average price of the common stock for such day (“VWAP”)), or other amount mutually agreed to by the parties. The amount also cannot cause the aggregate number of shares of common stock beneficially owned by YA SPV and its affiliates to exceed 4.99% of the then outstanding common stock. If an Advance Notice requests the purchase of shares exceeding any of the amounts described above, that portion of the Advance Notice will be deemed as automatically withdrawn.

The purchase price of the shares of common stock will equal 96% of the market price. Market price is based on the lowest daily VWAP during the 5 consecutive trading days after the date the Advance Notice is delivered to YA SPV (“Pricing Period”). After the expiration of the Pricing Period, YA SPV will purchase the appropriate number of shares subject to us confirming that we have obtained all material permits and qualifications required for the issuance and transfer of the shares applicable under the Advance Notice. Afterwards, we can deliver an additional Advance Notice, and may continue until the commitment amount is purchased or the expiration of the two year period.

For each Advance Notice, we may indicate a minimum acceptable price (“Minimum Price”), which cannot be more than 90% of the last closing price of the common stock on Nasdaq before delivery of the Advance Notice. If during the Pricing Period for an Advance Notice, the VWAP for the common stock is below the Minimum Price, the amount of shares requested to be purchased under such Advance Notice will be reduced by 20% for each day it is below the Minimum Price during the Pricing Period (“Excluded Day”). In addition, each Excluded Day will be excluded from the Pricing Period for purposes of determining the market price.

In addition, the Agreement required payment of a commitment fee payable to YA SPV in an amount equal to $125,000. We delivered approximately 88 thousand shares of common stock under the Registration Statement to pay the commitment fee. The price of the shares delivered was the average of the daily VWAP for the three trading days after the date of the Agreement.

The aggregate commitment amount plus any shares paid to YA SPV as part of the commitment fee cannot equal or exceed 20% of the number of outstanding shares of our common stock as of the date of the Agreement, or approximately 3.6 million shares, unless our stockholders approve the issuance as required by Nasdaq. During the three-months ended September 30, 2009, we issued approximately 1.5 million shares of our common stock and received approximately $1.6 million in cash under the SEDA. As of November 3, 2009, we have issued an aggregate of approximately 2.5 million shares of our common stock and received an aggregate of approximately $2.5 million in cash under the SEDA.

The SEDA does not impose any restrictions on our operating activities. During the term of the SEDA and in accordance with the terms of the agreement and in compliance with all applicable federal and state securities laws, rules and regulations and Nasdaq’s rules and regulations, YA SPV is prohibited from engaging in any short selling or hedging transactions related to our common stock.

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 focuses on developing, manufacturing and marketing of 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, equine 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 we believe is crucial for asset management and for disease control and food safety.

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

6. Segment Information (continued)

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 focuses on developing and marketing GPS and GPS-enabled products used for location tracking and message monitoring of pilots, aircraft, maritime vehicles and outdoor adventurers in remote locations.

This segment’s principal products are:

•

GPS enabled search and rescue equipment and intelligent communications products and services for mobile data and radio communications applications, including our SARBE™ and McMurdo™ brands, which serve commercial and military markets; and

•

alarm sounders for industrial use and other electronic components.

“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. Included in the liabilities of “Corporate/Eliminations” as of September 30, 2009 is approximately $0.8 million of net liabilities related to companies that we sold or closed in 2001 and 2002. It is expected that these net liabilities will be reversed beginning in 2011, 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 unaudited segment data as of and for the periods ended:

														Total From
		Animal				Emergency				Corporate/				Continuing
		Identification				Identification				Eliminations				Operations
As of and For the Three-Months Ended September 30, 2009
Revenue		$	6,815			$	8,848			$	—			$	15,663
Operating (loss) income			(278	)			(1	)			(794	)			(1,073	)
(Loss) income from continuing operations before income taxes			(821	)			(164	)			(707	)			(1,692	)
Total assets of continuing operations		$	25,775			$	31,982			$	8,179			$	65,936
As of and For the Three-Months Ended September 30, 2008
Revenue		$	8,217			$	10,639			$	—			$	18,856
Operating (loss) income			(26,439	)			960				(1,744	)			(27,223	)
(Loss) income from continuing operations before income taxes			(26,859	)			918				(5,619	)			(31,560	)
Total assets of continuing operations		$	38,696			$	30,374			$	10,143			$	79,213

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

														Total From
		Animal				Emergency				Corporate/				Continuing
		Identification				Identification				Eliminations				Operations
As of and For the Nine-Months Ended September 30, 2009
Revenue		$	23,074			$	27,618			$	—			$	50,692
Operating (loss) income			(944	)			1,557				(3,212	)			(2,599	)
(Loss) income from continuing operations before income taxes			(2,530	)			1,845				(2,981	)			(3,666	)
Total assets of continuing operations		$	25,775			$	31,982			$	8,179			$	65,936
As of and For the Nine-Months Ended September 30, 2008
Revenue		$	29,566			$	32,419			$	—			$	61,985
Operating (loss) income			(33,988	)			2,402				(6,689	)			(38,275	)
(Loss) income from continuing operations before income taxes			(35,873	)			2,272				(10,647	)			(44,248	)
Total assets of continuing operations		$	38,696			$	30,374			$	10,143			$	79,213

7. Acquisitions

Acquisition of Geissler Technologies Corporation (“GTC”)

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.

Upon the closing of the GTC Merger, we paid approximately 1.3 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 be paid in cash or in shares of our common stock 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, April 2008 and September 2008, we paid an aggregate of approximately $0.8 million under the earn-out provision by issuing to the Holders a total of 42 thousand, 71 thousand and 44 thousand 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. The remaining $3.0 million of potential earn-out at September 30, 2009 shall be due based on the achievement of certain gross profit levels on sales of GTC-related products through December 2011. As of September 30, 2009, approximately $0.3 million of the minimum threshold for the earn-out has been achieved but not yet paid.

The total purchase price of GTC was allocated as follows, in thousands:

		GTC
Current assets		$	317
Intangibles:
Patented and non-patented proprietary technology			2,000
Trademarks and tradenames			390
Software			500
Customer relationships and non-compete			375
Goodwill			4,165
Current liabilities			(600	)
Total		$	7,147

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)

In determining the purchase price for GTC, we considered various factors including: (i) historical and projected revenue streams and operating cash flows; (ii) the complementary nature of each product offerings as an extension of the offerings of the other company and of our existing businesses; and (iii) the opportunity for expanded research and development of the combined or new product offerings. Based on our assessments, we determined that it was appropriate to offer a purchase price for this business that resulted in the recognition of goodwill. During the fourth quarter of 2008, we performed our annual assessment of the carrying value of our goodwill and we determined that it was appropriate to take a goodwill impairment charge of approximately $4.1 million associated with the GTC goodwill.

Proforma Information (Unaudited)

The acquisition was accounted for under the purchase method of accounting and, accordingly, the unaudited condensed consolidated financial statements reflect the results of operations of GTC from the date of acquisition. Unaudited pro forma results of operations of the Company for the nine-months ended September 30, 2008 are included below. Such pro forma information assumes that the above acquisition had occurred as of January 1, 2008 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 acquisition occurred at the beginning of the periods presented or the results which may occur in the future.

		Nine-Months Ended
		September 30, 2008
		(in thousands)
Net operating revenue		$	62,013
Net loss from continuing operations			(43,811	)
Net loss from continuing operations per common share — basic and diluted			(2.95	)

8. Stock Options and Restricted Stock

Stock Option Plans

We and our subsidiaries have stock-based employee plans, which were outstanding as of December 31, 2008, 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, 2008.

During the third quarter of 2009, our shareholders approved an amendment to our 2003 Flexible Stock Plan to increase the number of authorized shares of common stock issuable under the plan from 875,000 to 2,875,000. No other changes were made.

During the three-months ended September 30, 2009 and 2008, we recorded approximately $0.1 million and $0.1 million, respectively, in compensation expense related to stock options granted to our employees. During the nine-months ended September 30, 2009 and 2008, we recorded approximately $0.3 million and $0.3 million, respectively, in compensation expense related to stock options granted to our employees.

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

8. Stock Options and Restricted Stock (continued)

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 nine-months ended September 30, 2009 and 2008:

		Three-Months Ended								Nine-Months Ended
		September 30,								September 30,
		2009 (1)				2008 (2)				2009 (1)				2008 (2)
Risk-free interest rate			N/A				1.96-2.81%				N/A				1.96-3.57%
Expected life (in years)			N/A				5.0				N/A				5.0
Dividend yield			N/A				0.0%				N/A				0.0%
Expected volatility			N/A				60.0%				N/A				60.0%
Weighted-average volatility			N/A				60.0%				N/A				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 September 30, 2009, and changes during the nine-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, 2009			2,863			$	18.02
Granted			—				—
Exercised			—				—
Forfeited or expired			(162	)			24.81
Outstanding at September 30, 2009			2,701				17.61				5.3			$	248	*
Vested or expected to vest at September 30, 2009			2,676			$	16.07				5.3			$	239	*
Exercisable at September 30, 2009			2,193			$	21.22				4.5			$	61	*

There were no option exercises during the three and nine-months ended September 30, 2009 and 2008. At September 30, 2009, we had approximately 2.1 million options available for issuance in our plans.

As of September 30, 2009, there was approximately $0.2 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 approximately 3.9 years. The total fair value of shares vested during the three-months ended September 30, 2009 and 2008 was approximately $39 thousand and nil, respectively. The total fair value of shares vested during the nine-months ended September 30, 2009 and 2008 was approximately $0.2 million and $15 thousand, respectively.

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

8. Stock Options and Restricted Stock (continued)

A summary of the status of our nonvested stock options as of September 30, 2009 and changes during the nine-months ended September 30, 2009, is presented below (in thousands, except per share amounts):

						Weighted Average
						Grant-Date
		Stock Options				Fair Value
Nonvested at January 1, 2009			619			$	1.32
Granted			—				—
Vested			(111	)			2.13
Forfeited or expired			—				—
Nonvested at September 30, 2009			508			$	1.14

In addition to the stock options presented above, Thermo Life Energy Corp. (“Thermo Life”) has approximately 0.6 million fully vested stock options outstanding. As of September 30, 2009, the intrinsic value of these stock options was nil. The total cash value of potential option exercises at September 30, 2009 was approximately $33 thousand and would have a de minimus dilution impact to our ownership.

Restricted Stock

In January 2008, we issued approximately 31 thousand shares of restricted common stock to our board of directors, 20 thousand of which remain unvested at September 30, 2009. 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 $22 thousand and $18 thousand during the three-months ended September 30, 2009 and 2008, respectively. During the nine-months ended September 30, 2009 and 2008, we recorded compensation expense related to these shares of approximately $44 thousand and $49 thousand, respectively.

9. Income Taxes

We have recorded certain foreign income taxes benefits during the nine-months ended September 30, 2009 and 2008. Our effective income tax rate was 0.7% and 0.9% for the nine-months ended September 30, 2009 and 2008, 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 and other deferred tax assets and non-deductible intangible amortization associated with acquisitions. At September 30, 2009, we had aggregate net operating loss carryforwards of approximately $267.0 million for income tax purposes that expire in various amounts from 2013 through 2029. Through December 28, 2007, Destron Fearing filed a separate federal income tax return. Of the aggregate U.S. net operating loss carryforwards of approximately $268.0 million as of September 30, 2009, $71.0 million relate to Destron Fearing. Of the aggregate net operating loss carryforwards, approximately $5.2 million relates to foreign loss carryforwards. These net operating loss carryforwards are available to only offset future taxable income earned in the home country of the foreign entity. As of September 30, 2009, 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 three and nine-months ended September 30, 2009 and 2008. In addition, during the three-months ended September 30, 2009, a significant portion of our U.S. net operating loss carryforwards became limited under Internal Revenue Code (“IRC”) section 382 as discussed below.

The amount of any benefit from our US tax net operating losses is dependent on: (1) our ability to generate future taxable income and (2) the unexpired amount of net operating loss carryforwards available to offset amounts payable on such taxable income. Any greater than a fifty percent change in ownership under IRC section 382 places significant annual limitations on the use of such net operating losses to offset any future taxable income we may generate. Such limitations, in conjunction with the net operating loss expiration provisions, effectively eliminates our ability to use a substantial portion of our net operating loss carryforwards to offset future taxable income. Based on our current cumulative three-year change in ownership, we exceeded the fifty percent threshold during the three-months ended September 30, 2009. As a result, approximately $196.0 million of the U.S. net operating loss carryforwards is limited

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

9. Income Taxes (continued)

under IRC section 382. As a result of this limitation, we estimate that approximately $10 million of these losses will be available to offset future taxable income, with the remainder being available to offset certain built-in gains, with both amounts subject to expiration provisions. Certain transactions could cause an additional ownership change in the future, including (a) additional issuances of shares of common stock by us or our subsidiaries or (b) acquisitions or sales of shares by certain holders of our shares, including persons who have held, currently hold, or accumulate in the future five percent or more of our outstanding stock.

We, in combination with our subsidiary Destron Fearing, 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 2005, Danish tax examinations for years before 2005 and U.K. tax examinations for years before 2001. At September 30, 2009, we had a liability for unrecognized tax benefits of $0.2 million primarily related to state income tax positions.

10. Discontinued Operations

During the three-months ended June 30, 2007, our board of directors approved the sale of InfoTech USA, Inc. n/k/a IFTH Acquisition Corp. (“InfoTech”). On September 30, 2007, our board of directors made a decision to sell two of our wholly-owned subsidiaries: Computer Equity Corporation (“Computer Equity”) and Perimeter Acquisition Corp. (“Perimeter”). During the three-months ended March 31, 2008, our board of directors agreed to sell two of our wholly-owned subsidiaries: Florida Decision Corporation (“FDC”) and Thermo Life. During the three-months ended December 31, 2008, our board of directors decided to sell our ownership of VeriChip Corporation (“VeriChip”). InfoTech provided computer hardware and IT services; Computer Equity provided voice, data and video telecommunications products and services; Perimeter sold call center software and related services; FDC provided service relationship management software; Thermo Life is a development company with patented rights to a thin-film thermoelectric generator; and VeriChip developed and marketed RFID systems used to identify, locate and protect people and their assets for use in a variety of healthcare, security and identification applications. The decisions to sell these companies were made as part of management’s strategy to streamline our operations to focus our efforts on the RFID and the GPS and radio communication markets. With the exception of Thermo Life, each of these businesses had been sold as of December 31, 2008.

As a result of the sales of InfoTech, Computer Equity, Perimeter, FDC and VeriChip, and our board of directors’ decision to sell Thermo Life, the financial condition, results of operations and cash flows of InfoTech, Computer Equity, Perimeter, FDC, VeriChip and Thermo Life have been reported as discontinued operations in our financial statements, and prior period information has been reclassified accordingly. We no longer owned a majority of the outstanding stock of InfoTech or VeriChip beginning in the first quarter of 2008. Therefore, the summarized operating data and changes in capital for InfoTech and VeriChip are presented under the equity method of accounting during the three and nine-months ended September 30, 2008.

The following table, in thousands, presents the results of operations of our discontinued operations for the three and nine-months ended September 30, 2009 and 2008:

		Three-Months Ended								Nine-Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Revenue		$	—				—			$	—			$	8,948
Cost of sales			—				—				—				5,447
Gross profit			—				—				—				3,501
Selling, general and administrative expenses			66				129				208				2,735
Research and development expenses			—				—				—				144
Goodwill and asset impairment			—				1,150				—				1,150
Operating loss			(66	)			(1,279	)			(208	)			(528	)
Interest and other income			15				53				73				4
Interest expense			—				—				—				(145	)
Equity in loss and capital transactions of affiliate			—				(957	)			—				(3,263	)
(Loss) income from discontinued operations		$	(51	)		$	992			$	(135	)		$	(757	)
(Loss) income from discontinued operations per common share — basic and diluted		$	(0.00	)		$	0.07			$	(0.01	)		$	(0.05	)
Weighted average number of common shares outstanding — basic and diluted			18,271				15,418				17,798				14,834

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

10. Discontinued Operations (continued)

The results above do not include any intercompany interest income/expense or allocated or common overhead expenses. FDC’s customer International Business Machines Corp. (“IBM”) terminated two statements of work (“SOWs”) during the nine-months ended September 30, 2008. As a result of the termination of the SOWs, we recognized previously deferred revenue associated with these SOWs of approximately $1.6 million in the nine-months ended September 30, 2008. We have not provided for income taxes or benefit on the income (loss) from discontinued operations due to our current tax status and net operating loss carryforwards.

Any additional operating losses for Thermo Life or changes in the value of its assets or liabilities, as well as the recognition of any gain or loss on the sale of our discontinued businesses, will be reflected in our financial condition and results of discontinued operations as incurred.

The net assets of discontinued operations as of September 30, 2009 and December 31, 2008, which represented the net assets of Thermo Life, were comprised of the following:

		September 30,				December 31,
		2009				2008
		(unaudited, in thousands)
Current assets		$	5			$	5
Property and equipment, net			5				32
Total assets			10				37
Current liabilities			5				10
Net assets of discontinued operations		$	5			$	27

The Company expects to complete the wind down of its Thermo Life operations on or before December 31, 2009.

As more fully discussed in Note 15, on November 2, 2009, we entered into an agreement to sell our McMurdo business unit. Accordingly, McMurdo’s results will be included in the results of discontinued operations beginning in the fourth quarter of 2009.

11. Comprehensive Loss

Comprehensive loss represents all non-owner changes in preferred stock, common stock and other stockholders’ equity and consists of the following:

		Three-Months Ended								Nine-Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
						(unaudited, in thousands)
Net loss (including $(2), $17, $27 and $121, respectively, of (loss) income attributable to the noncontrolling interest)		$	(1,675	)		$	(30,418	)		$	(3,774	)		$	(44,567	)
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments			(527	)			(684	)			584				(696	)
Total comprehensive income (loss)		$	(2,202	)		$	(31,102	)		$	(3,190	)		$	(45,263	)

The other comprehensive income (loss) during the three and nine-months ended September 30, 2009 related to the change in the foreign currency exchange rates of the British Pound, which is Signature’s functional currency, and the Danish Krone, which is Destron Fearing A/S’s functional currency. Approximately $(18) thousand and $22 thousand of the foreign currency translation adjustments related to the noncontrolling interest during the three and nine-months ended September 30, 2009, respectively. Approximately $(72) thousand and $(68) thousand of the foreign currency translation adjustments related to the noncontrolling interest during the three and nine-months ended September 30, 2008, respectively.

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

12. Supplemental Cash Flow Information

In the nine-months ended September 30, 2009 and 2008, we had the following non-cash investing and financing activities:

		Nine-Months Ended
		September 30,
		2009				2008
		(in thousands)
Non-cash investing activities:
Issuance of shares for acquisition		$	—			$	6,878
Issuance of shares for purchase of equipment			186				—
Non-cash financing activities:
Reclassification of other assets to acquisition cost		$	—			$	338
Issuance of common stock for SEDA commitment fee			125				—
Issuance of common stock for legal settlement			—				500
Issuance of common stock in connection with debt			—				204
Cash paid for:
Interest		$	1,153			$	2,206
Taxes			58				126

13. Restructuring, Severance and Separation Charges and Goodwill and Asset Impairment Charges

Restructuring, Severance and Separation Related Charges

During the second quarter of 2008, we initiated restructuring efforts to develop a strategic long-range plan focusing on restoring growth and profitability. With our restructuring, we sought to generate annual costs savings by exiting some costly facilities, outsourcing some manufacturing to lower cost suppliers, moving some operations to lower cost countries and reducing headcount. Our purpose in taking these actions was to increase profitability at the gross margin level, which management believes is necessary to competitively price products and achieve positive earnings. Our restructuring plan has been substantially implemented. Restructuring activities were recorded in accordance with the Exit or Disposal Cost Obligation Topic and the Compensation — Nonretirement Postemployment Benefit Topic of the Codification. Restructuring charges were as follows for the periods presented (in thousands):

		Three-Months Ended								Nine-Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Severance		$	142			$	174			$	305			$	1,790
Contract termination			—				121				150				409
Facility closing			—				115				—				135
Total restructuring, severance and separation expenses		$	142			$	410			$	455			$	2,334

In addition to the charges listed above, included in cost of goods sold for the three and nine-months ended September 30, 2008 was approximately $0.2 and $1.4 million, respectively, of inventory write-offs associated with the restructuring.

As of September 30, 2009, our restructuring accrual was as follows (in thousands):

						Contract
						Termination and
						Facility Closing
		Severance				Costs				Total
Balance, January 1, 2009		$	1,066			$	478			$	1,544
Additional expense			305				150				455
Cash payments			(1,143	)			(228	)			(1,371	)
Balance, September 30, 2009		$	228			$	400			$	628

We anticipate that cash covering the remaining restructuring costs will be expended over the next 12 months.

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

13. Restructuring, Severance and Separation Charges and Goodwill and Asset Impairment Charges (continued)

Goodwill and Asset Impairments

In accordance with the Intangibles — Goodwill and Other Topic of the Codification, we tested our goodwill for impairment in the third quarter of 2008. The performance of the test involved a two-step process. The first step of the impairment test involves comparing the fair values of the applicable reporting units with their aggregate carrying values, including goodwill. We generally determine the fair value of our reporting units using the income approach methodology of valuation that includes the discounted cash flow method as well as other generally accepted valuation methodologies. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, we perform the second step of the goodwill impairment test to determine the amount of impairment loss. The second step of the goodwill impairment test involves comparing the implied fair value of the affected reporting unit’s goodwill with the carrying value of that goodwill.

During 2008, as a result of the declines during 2008 in our equity market capitalization, which fell below our stockholders’ equity, we performed an interim goodwill assessment in the third quarter of 2008. This assessment resulted in a $25.0 million goodwill impairment charge in the quarter. In performing our impairment assessments, we placed emphasis on current trading values, including those of our competitors, as well as higher market-risk discount rates.

The following is a summary of goodwill and asset impairments for the three and nine-months ended September 30, 2008.

		Three-Months				Nine-Months
		Ended				Ended
		September 30, 2008				September 30, 2008
		(in thousands)
Asset impairments related to restructuring:
Goodwill — Animal Identification Denmark operations		$	—			$	1,913
Intangible Assets — Animal Identification Denmark operations			—				825
Fixed assets			—				1,631
Other goodwill and asset impairment:
Goodwill — Animal Identification			24,989				24,989
Total goodwill and asset impairment		$	24,989			$	29,358

Based on management’s discussion with potential buyers during the three-months ended September 30, 2008, we recorded an impairment charge of approximately $1.2 million for our investment in VeriChip which is included in discontinued operations.

We have not had any impairment expenses in the nine-months ended September 30, 2009. In accordance with the Intangibles — Goodwill and Other Topic of the Codification, we will perform our annual impairment tests during the fourth quarter of 2009.

14. Legal Proceedings

Former Officer

On June 19, 2009, Michael Krawitz, who was for many years our General Counsel and during 2007 our Chief Executive Officer, and was therefore intimately familiar with the Company’s operations and financial affairs, filed a lawsuit in the U.S. District Court for the Southern District of Florida against the Company. The lawsuit also names as defendants Joseph Grillo, our current Chief Executive Officer and Director, as well as Daniel Penni, Michael Zarriello, John Block and Dennis Rawan, who are members of our Board of Directors. The lawsuit alleges, among other things, that the defendants engaged in deceptive conduct in inducing Mr. Krawitz to amend his employment agreement to accept stock in lieu of cash owed for severance payments claimed to be due under this agreement. The alleged deceptive conduct includes allegations that the Company made misrepresentations to Mr. Krawitz during the time he was serving as the Company’s CEO and General Counsel. These alleged misrepresentations include issues regarding the financial health and operations of the Company and its consolidated subsidiaries and promises which the defendants allegedly knew could not be kept. The lawsuit alleges violations of state and federal securities laws and other common law claims including breach of contract, fraudulent inducement and common law fraud. Mr. Krawitz seeks damages in excess of $1,000,000 plus attorneys’ fees and expenses. The Company believes strongly that the complaint is frivolous and entirely without merit and intends to aggressively defend the lawsuit, including the assertion of all applicable defenses and potential counterclaims and no provision for this matter has been recorded in the condensed consolidated financial statements. In July, we filed a Motion to Dismiss and such motion is currently pending before the court.

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

14. Legal Proceedings (continued)

Chemring

In July 2008, our subsidiary Signature filed a claim against Chemring, the seller of the McMurdo business, which was acquired by Signature in April 2007. The claim falls into three parts: an indemnity claim in relation to the costs of repairing faulty McMurdo products sold under Chemring’s ownership, claims for breach of warranty, and a claim that had Chemring disclosed concerns being raised by a major customer for the particular McMurdo product, Signature would not have agreed to waive a minimum purchase obligation on the requirement. We then did not pay the final deferred purchase price payment of approximately £0.5 million on the McMurdo acquisition pending resolution on these warranty claims. Chemring counterclaimed against both Signature and us (as the parent of Signature) for the deferred purchase price, plus costs and interest, claiming that there is no right to set off warranty claims against the deferred purchase price. In June 2009, the parties agreed upon a mutually satisfactory settlement of this dispute, and a definitive settlement agreement has been finalized. As a result of the resolution, the warranty claims were offset against the deferred purchase price and we recorded approximately $0.5 million of other income during the nine months ended September 30, 2009.

Additionally, the Company is a party to various legal actions, as either plaintiff or defendant, arising in the ordinary course of business, none of which is expected to have a material adverse effect on our business, financial condition or results of operations.

15. Subsequent Events

We have evaluated events and transactions that occurred between October 1, 2009 and November 9, 2009, which is the date the financial statements were issued for possible disclosure and recognition in the financial statements. We have determined that there were no such events or transactions that warrant disclosure and recognition in the financial statements, except for those disclosed below.

Issuance of Restricted Stock and Stock Options

In October 2009, we granted approximately 0.4 million shares of restricted stock and approximately 0.5 million stock options to our directors and certain management.

Sale of McMurdo Assets

On November 2, 2009, we, Signature and Signature’s wholly-owed subsidiary, McMurdo Limited, entered into a definitive agreement to sell substantially all of the assets of its U.K.-based McMurdo business unit for $10.0 million in cash (“the McMurdo Purchase Agreement”). The purchaser is France-based Orolia Group (“Orolia”), a high-technology firm specializing in positioning, navigation and timing solutions for critical operations. The transaction is a structured sale of the McMurdo assets and equity in McMurdo Limited, a special purpose subsidiary set up for purposes of the transaction, for cash consideration of $10.0 million (“Purchase Price”). At closing, Orolia will pay $8.5 million of the Purchase Price, which will be subject to adjustment for the final inventory level (against estimated level) at closing. Closing will occur upon satisfaction of all conditions precedent, targeted for November 20, 2009. The remaining $1.5 million of the Purchase Price will be held in escrow for up to 12 months ($500,000 for 90 days, the remainder for 12 months) to cover potential unforeseen claims, warranty or indemnity issues. The McMurdo Purchase Agreement provides for a break-up fee of $0.5 million by either party to the other, if one party fails to close when all conditions are satisfied. At closing, existing accounts receivable will belong to Signature and existing accounts payable will be the obligation of Signature. In addition, we and Orolia are issuing each other guarantees of performance to the other.

Amendment to Laurus Term Debt

On November 5, 2009, we, entered into a letter agreement with Laurus Master Fund, Kallina Corporation and other affiliates of Laurus, the “Lenders.” Under the terms of the letter agreement, subject to the closing of the McMurdo transaction as set forth in the McMurdo Purchase Agreement, we will, within three business days of our receipt of proceeds from the Purchase Price paid at such closing, prepay the Laurus term debt, including all principal, interest and fees relating thereto (the “Prepayment”). In anticipation of a November 20, 2009 closing date, the Lenders waived the November monthly payments required under the 2007 Note and 2006 Note. Upon Prepayment, the Laurus term debt will be satisfied in full.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying financial statements and related notes included in Item 1 of this report as well as our Annual Report on Form 10-K for the year ended December 31, 2008, and the Risk Factors described therein, and our Current Report on Form 8-K filed with the SEC on July 8, 2009.

Overview

We currently operate in two business segments and engage in the following principal business activities:

Animal Identification - We develop, manufacture and market visual and radio frequency identification (“RFID”) products under the brand name Destron Fearing to customers worldwide. Destron Fearing products include visual and electronic tags and implantable RFID microchips that identify, track and locate animals, including bio-sensing chips that measure an animal’s temperature. These products promote recovery of lost pets, livestock herd management, environmental protection, and animal health while fulfilling the requirements of certain government regulations aimed at insuring the safety of food supplies throughout the world. Our Animal Identification business is headquartered in Saint Paul, Minnesota, with direct and indirect wholly and majority-owned subsidiaries located in Europe and South America.

Emergency Identification - We develop, manufacture and market emergency identification products that are enabled through global positioning system (“GPS”) technology, and sold worldwide under the brand names SARBE™ and McMurdo™. This segment’s principal products are search and rescue beacons that safeguard people and high-value assets utilizing intelligent communications and emergency messaging services for telemetry, mobile data and satellite radio communications. SARBE safety products are sold to government and military customers worldwide, while McMurdo safety products are sold to a variety of commercial maritime, aviation, and recreational customers. We also develop, manufacture and market alarm sounders for hazardous industrial areas under the brand name Clifford & Snell. The Emergency Identification segment includes our 98.5% owned subsidiary, Signature Industries Limited (“Signature”), which is headquartered in the United Kingdom.

Our business segments are more fully discussed in Note 6 to our accompanying condensed consolidated financial statements.