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

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

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 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).

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 13, 2010
Common Stock, $.01 par value per share		28,147,703 shares

 

 

DIGITAL ANGEL CORPORATION

TABLE OF CONTENTS

		Page
PART I — Financial Information
Item 1. Financial Statements (unaudited):
Condensed Consolidated Balance Sheets — As of June 30, 2010 and December 31, 2009			3
Condensed Consolidated Statements of Operations — Three and six-months ended June 30, 2010 and 2009			4
Condensed Consolidated Statement of Changes in Stockholders’ Equity — Six-months ended June 30, 2010			6
Condensed Consolidated Statements of Cash Flows — Six-months ended June 30, 2010 and 2009			7
Notes to Condensed Consolidated Financial Statements			8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
Item 4T. Controls and Procedures			31
PART II — Other Information
Item 1. Legal Proceedings			32
Item 6. Exhibits			32
Signatures			33
Exhibit 10.1
Exhibit 10.2
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)

		June 30,				December 31,
		2010				2009
		(unaudited)
Assets
Current assets
Cash and cash equivalents		$	2,903			$	1,895
Restricted cash			—				202
Accounts receivable, net of allowance for doubtful accounts of $847 and $906 at June 30, 2010 and December 31, 2009, respectively			6,160				6,370
Note receivable			99				450
Inventories			9,127				8,980
Other current assets			2,412				2,064
Current assets of discontinued operations			1,424				3,735
Total current assets			22,125				23,696
Property and equipment, net			6,068				6,998
Goodwill			3,332				3,343
Intangible assets, net			10,578				11,447
Note receivable			347				596
Other assets, net			791				599
Other assets of discontinued operations			—				365
Total Assets		$	43,241			$	47,044
Liabilities and Stockholders’ Equity
Current liabilities
Notes payable and current maturities of long-term debt		$	6,671			$	9,297
Accounts payable			7,395				7,905
Advances from factors			1,229				1,240
Accrued expenses			6,291				6,580
Deferred gain on sale			1,600				960
Deferred revenue			762				548
Current liabilities of discontinued operations			2,345				2,734
Total current liabilities			26,293				29,264
Long-term debt and notes payable			226				392
Other liabilities			1,688				1,445
Total Liabilities			28,207				31,101
Commitments and contingencies:
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, 50,000; shares issued and outstanding, 28,087 and 23,479)			281				235
Additional paid-in capital			590,517				588,652
Accumulated deficit			(574,085	)			(571,203	)
Accumulated other comprehensive income (loss) — foreign currency translation			(1,666	)			(1,737	)
Total Digital Angel Corporation stockholders’ equity			15,047				15,947
Noncontrolling interest			(13	)			(4	)
Total Stockholders’ Equity			15,034				15,943
Total Liabilities and Stockholders’ Equity		$	43,241			$	47,044

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, 2010				June 30, 2009
Revenue		$	8,678			$	10,297
Cost of sales			5,465				6,354
Gross profit			3,213				3,943
Selling, general and administrative expenses			4,708				5,567
Research and development expenses			235				263
Restructuring, severance and separation expenses			1,074				313
Total operating expenses			6,017				6,143
Operating loss			(2,804	)			(2,200	)
Interest and other income (expense), net			117				114
Interest expense			(318	)			(541	)
Loss from continuing operations before income tax provision			(3,005	)			(2,627	)
Provision for income taxes			(5	)			(52	)
Loss from continuing operations			(3,010	)			(2,679	)
Income from discontinued operations, net of income taxes of nil and $7			1,240				1,786
Net loss			(1,770	)			(893	)
Loss attributable to the noncontrolling interest, continuing operations			16				230
Income attributable to the noncontrolling interest, discontinued operations			(18	)			(247	)
Net loss attributable to Digital Angel Corporation		$	(1,772	)		$	(910	)
(Loss) income per common share attributable to Digital Angel Corporation common stockholders — basic and diluted:
Loss from continuing operations, net of noncontrolling interest		$	(0.10	)		$	(0.14	)
Income from discontinued operations, net of noncontrolling interest			0.04				0.09
Net loss		$	(0.06	)		$	(0.05	)
Weighted average number of common shares outstanding — basic and diluted			28,002				17,857

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, 2010				June 30, 2009
Revenue		$	19,592			$	22,726
Cost of sales			11,805				14,067
Gross profit			7,787				8,659
Selling, general and administrative expenses			9,768				11,681
Research and development expenses			509				568
Restructuring, severance and separation expenses			1,215				313
Total operating expenses			11,492				12,562
Operating loss			(3,705	)			(3,903	)
Interest and other income (expense), net			(355	)			135
Interest expense			(671	)			(1,068	)
Loss from continuing operations before income tax provision			(4,731	)			(4,836	)
Provision for income taxes			(15	)			(56	)
Loss from continuing operations			(4,746	)			(4,892	)
Income from discontinued operations, net of income taxes of nil and $15			1,860				2,793
Net loss			(2,886	)			(2,099	)
Loss attributable to the noncontrolling interest, continuing operations			29				233
Income attributable to the noncontrolling interest, discontinued operations			(25	)			(262	)
Net loss attributable to Digital Angel Corporation		$	(2,882	)		$	(2,128	)
(Loss) income per common share attributable to Digital Angel Corporation common stockholders — basic and diluted:
Loss from continuing operations, net of noncontrolling interest		$	(0.18	)		$	(0.28	)
Income from discontinued operations, net of noncontrolling interest			0.07				0.16
Net loss		$	(0.11	)		$	(0.12	)
Weighted average number of common shares outstanding — basic and diluted			26,934				17,558

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, 2010
(in thousands)

		Digital Angel Corporation Shareholders
																		Accumulated
										Additional								Other								Total
		Common Stock								Paid-In				Accumulated				Comprehensive				Noncontrolling				Stockholders’
		Number				Amount				Capital				Deficit				Income (Loss)				Interest				Equity
Balance, December 31, 2009			23,479			$	235			$	588,652			$	(571,203	)		$	(1,737	)		$	(4	)		$	15,943
Net loss			—				—				—				(2,882	)			—				(4	)			(2,886	)
Comprehensive loss:
Foreign currency translation			—				—				—				—				71				(5	)			66
Total comprehensive loss															(2,882	)			71				(9	)			(2,820	)
Issuance of common stock for services			815				8				458				—				—				—				466
Issuance of common stock and cash for price protection under the terms of a legal settlement			314				3				(43	)			—				—				—				(40	)
Sale of common stock			3,385				34				1,659				—				—				—				1,693
Sale of common stock under the Standby Equity Distribution Agreement			94				1				60				—				—				—				61
Financing fees			—				—				(165	)			—				—				—				(165	)
Share-based compensation			—				—				493				—				—				—				493
Stock issuance costs			—				—				(71	)			—				—				—				(71	)
Issuance of warrants			—				—				(526	)			—				—				—				(526	)
Balance, June 30, 2010			28,087			$	281			$	590,517			$	(574,085	)		$	(1,666	)		$	(13	)		$	15,034

See Notes to Condensed Consolidated Financial Statements.

DIGITAL ANGEL CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
(in thousands)

		For the Six-				For the Six-
		Months Ended				Months Ended
		June 30, 2010				June 30, 2009
Cash Flows From Operating Activities
Net loss		$	(2,886	)		$	(2,099	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Income from discontinued operations			(1,860	)			(2,793	)
Equity compensation and administrative expenses			505				219
Depreciation and amortization			1,634				1,917
Amortization of debt discount and financing costs			297				300
Allowance for doubtful accounts			(59	)			100
Allowance for inventory excess and obsolescence			(245	)			—
Change in fair value of warrant liability			87				(4	)
Changes in assets and liabilities:
Decrease (increase) in restricted cash			172				(179	)
Decrease in accounts receivable			147				855
Increase in inventories			(298	)			(1,611	)
Decrease in other current assets			268				155
Increase in accounts payable, accrued expenses and other liabilities			139				1,974
Net cash provided by discontinued operations			3,794				2,882
Net Cash Provided by Operating Activities			1,695				1,716
Cash Flows From Investing Activities
Decrease in notes receivable			594				209
Increase in other assets			(291	)			(55	)
Payments for property and equipment			(11	)			(373	)
Net cash used in discontinued operations			(38	)			(145	)
Net Cash Provided by (Used in) Investing Activities			254				(364	)
Cash Flows From Financing Activities
Amounts paid on notes payable			(1,712	)			(2,194	)
Net payments of debt			(730	)			(974	)
Sale of common stock			1,693				127
Sale of common stock under the Standby Equity Distribution Agreement			61				—
Stock issuance costs			(71	)			(43	)
Financing costs			(165	)			—
Net cash provided by discontinued operations			—				864
Net Cash Used in Financing Activities			(924	)			(2,220	)
Net Increase (Decrease) In Cash and Cash Equivalents			1,025				(869	)
Effect of Exchange Rate Changes on Cash and Cash Equivalents			(17	)			(4	)
Cash and Cash Equivalents — Beginning of Period			1,895				1,414
Cash and Cash Equivalents — End of Period		$	2,903			$	542

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.

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 8 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, 2009, filed with the Securities and Exchange Commission (“SEC”) on April 1, 2010.

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%-owned subsidiary, Signature Industries Limited (“Signature”). Our segments are discussed in Note 6.

Discontinued Operations

In 2008, our board of directors decided to sell our wholly-owned subsidiary Thermo Life Energy Corp. (“Thermo Life”) and in 2009, decided to sell our ownership in Signature’s business unit, McMurdo Limited (“McMurdo”). During the first and second quarter of 2010, we sold our Control Products business unit (“Control Products Group”) and Clifford and Snell business unit (“Clifford & Snell”), respectively, both of which were divisions of Signature. The decisions to sell these businesses were made as part of management’s strategy to streamline our operations to focus our efforts on the Animal Identification segment. As a result, these businesses are presented in discontinued operations for all periods presented. Discontinued operations are more fully discussed in Note 9.

Related Parties

We have in the past entered into various related party transactions. Each of these transactions is described in Note 20 to our Annual Report on Form 10-K for the year ended December 31, 2009. During the six months ended June 30, 2010, we had the following related party transactions:

	•		On January 21, 2010, we sold the assets of Thermo Life to Ingo Stark, an employee and scientist at Thermo Life.
	•		On January 25, 2010, we sold our Control Products Group to Gary Lawrence, the former manager of the Control Products Group for the past several years, and another former employee.

Both sales are more fully discussed in Note 9.

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

1. Basis of Presentation (continued)

Liquidity

We believe that we will be able to generate enough cash from operations, our existing revolving credit facility and factoring lines, the sales and potential sales of certain business units, and through other investing and financing sources to operate our business for the next twelve months ending June 30, 2011, including refinancing our revolving credit line, which matures on August 31, 2010 and a mortgage loan which matures on November 1, 2010.

Our goal is to achieve profitability and to generate positive cash flows from operations. During 2008, we restructured our Animal Identification segment which eliminated redundancies, improved gross margins and decreased expenses. In the second quarter of 2010, we determined to substantially complete the restructuring of our Corporate segment which will result in the elimination of our corporate structure and the associated costs of a separate headquarters and several management positions. 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 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 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 2010. As of June 30, 2010, 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: (i) our revolving line of credit with Kallina Corporation (“Kallina”), which matures August 31, 2010; (ii) our mortgage note which matures November 1, 2010; (iii) our factoring lines; and (iv) our credit facility with Danske Bank, which are more fully discussed in Note 9 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2009. In addition, our debt obligation to Danske Bank is due on demand and we are required to make monthly principal payments as more fully discussed in Note 9 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2009. 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 operations as a going concern, as we may be unable to generate the funds necessary to pay our obligations in the ordinary course of business. The accompanying financial statements do not include any adjustments related to the recoverability and classification of asset carrying amounts or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

2. Impact of Recently Issued Accounting Standards

In February 2010, the Financial Accounting Standards Board (“FASB”) issued an amendment to the guidance on subsequent events that removed the requirement for an SEC registrant to disclose the date through which subsequent events are evaluated. It did not change the accounting for or disclosure of events that occur after the balance sheet date but before the financial statements are issued. This amendment was effective upon issuance.

3. Inventories

Inventories, net of writedowns for excess and obsolescence, consist of the following:

		June 30,				December 31,
		2010				2009
		(in thousands)
Raw materials		$	8,578			$	7,446
Work in process			195				738
Finished goods			354				796
Total inventory		$	9,127			$	8,980

We had $7.3 million and $7.1 million of our inventory at foreign locations at June 30, 2010 and December 31, 2009, 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) income per share is provided as follows, in thousands, except per share amounts:

		Three-Months Ended								Six-Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
Numerator for basic and diluted (loss) income per share attributable to Digital Angel Corporation:
Loss from continuing operations, net of noncontrolling interest		$	(2,994	)		$	(2,449	)		$	(4,717	)		$	(4,659	)
Income from discontinued operations, net of noncontrolling interest			1,222				1,539				1,835				2,531
Net loss attributable to common stockholders		$	(1,772	)		$	(910	)		$	(2,882	)		$	(2,128	)
Denominator for basic and diluted (loss) income per share attributable to Digital Angel Corporation:
Basic and diluted weighted-average shares outstanding (1)			28,002				17,857				26,934				17,558
(Loss) income per share attributable to Digital Angel Corporation — basic and diluted:
Continuing operations, net of noncontrolling interest		$	(0.10	)		$	(0.14	)		$	(0.18	)		$	(0.28	)
Discontinued operations, net of noncontrolling interest			0.04				0.09				0.07				0.16
Total — basic and diluted		$	(0.06	)		$	(0.05	)		$	(0.11	)		$	(0.12	)

		June 30,
		2010				2009
		(in thousands)
Stock options			3,169				2,765
Warrants			1,577				314
Restricted stock			412				25
Total			5,158				3,104

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, 2009. The following are descriptions of our financing agreements that have been entered into, modified or terminated during 2010:

Senior Secured Term Notes

In August 2006, we entered into a term note (“2006 Note”) with Laurus Master Fund, Ltd. (“Laurus”) in the original principal amount of $13.5 million. The 2006 Note, as amended, accrued interest at a rate of 12% per annum, was payable monthly and had a maturity date of February 1, 2010. In August 2007, we entered into a $7.0 million term note (“2007 Note”) with Kallina Corporation (“Kallina”) pursuant to the terms of a Securities Purchase Agreement between us and Kallina. The 2007 Note, as amended, accrued interest at a rate of 12% per annum, was payable monthly and had a maturity date of February 1, 2010. In October 2008, we entered into a letter agreement with Laurus, Kallina, Valens U.S. SPV I, LLC, Valens Offshore SPV I Ltd., Valens Offshore SPV II Corp and PSource Structured Debt Limited (collectively referred to as the “Lenders”) and issued a $2.0 million senior secured, non-convertible term note (the “2008 Note”) to the Lenders which accrued interest at a rate equal to 12% and was due in full on February 1, 2010. The 2006 Note, the 2007 Note and the 2008 Note (collectively the “Debt Obligations”) allowed for optional redemption without a prepayment penalty.

At December 31, 2009, the remaining amount owed under our Debt Obligations was approximately $1.4 million. On February 1, 2010, the maturity date, we paid the final balance of approximately $1.4 million on the Debt Obligations.

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

5. Financings (continued)

Registered Direct Offering

On February 9, 2010, we sold, in a registered direct offering, 3,385,000 shares of our common stock and warrants to purchase 1,354,000 shares of common stock to two institutional investors pursuant to the terms of a securities purchase agreement we entered into on February 3, 2010. The purchase price of the securities was $1.7 million in the aggregate. We entered into a placement agent agreement with Chardan Capital Markets, LLC (“Chardan”) relating to our registered direct offering where we agreed to pay Chardan a placement agent fee of 6.0% of the gross proceeds from the sale. The net proceeds from the sale, after deducting the placement agent fee and other offering expenses, were approximately $1.6 million and were used primarily to cover the repayment of the Debt Obligations discussed above.

The exercise price of the warrants is $0.50 per share, and the warrants may be immediately exercised and expire seven years from the date of issuance. The warrants are not exercisable by a holder to the extent that such holder or any of its affiliates would beneficially own in excess of 4.9% of our common stock. If at the time of exercise, the registration statement relating to the shares underlying the warrants is not effective, or if the related prospectus is not available for use, then a holder of warrants may elect to exercise warrants using a net exercise (i.e., cashless exercise) mechanism. The warrants are entitled to “full-ratchet” anti-dilution protection. If we grant, issue or sell any options, convertible securities or rights to purchase stock, warrants, other securities or other property pro rata to the record holders of any class of the shares of common stock (the “Purchase Rights”), the holders of warrants are entitled to acquire such Purchase Rights which the holders could have acquired if the holders had held the number of shares of Common Stock acquirable upon the complete exercise of the holder’s warrants. We may not enter into certain fundamental transactions, such as a merger, consolidation, sale of substantially all assets, tender offer or exchange offer with respect to our common stock or reclassification of our common stock, unless the successor entity assumes in writing all of our obligations under the warrants. If certain fundamental transactions occur with respect to us or our “significant subsidiaries” as defined by Rule 1-02 of Regulation S-X, at the holder’s request within fifteen days after each fundamental transaction (“Holder Option Period”), we or the successor entity shall purchase the warrants from the holder for an amount equal to the value of the unexercised portion of the warrants that remain as of the time of such fundamental transaction based on the Black Scholes Option Pricing Model obtained from the “OV” function on Bloomberg, L.P. If such redemption option is not exercised by the holder during the Holding Option Period, we have an option to repurchase the unexercised portion of the warrants for the same amount within ten days after the expiration of the Holder Option Period. We have estimated the initial value of the warrants to be approximately $0.5 million based on the Black-Scholes valuation model and using the following assumptions: dividend yield of 0.0%; volatility of 124.14%; expected life of seven years; and a risk-free rate of 3.08%. The value of the warrants is reflected in our consolidated balance sheet as a liability and the warrants are required to be revalued at each reporting period. Based on the valuation at June 30, 2010, we recorded other income (expense) of approximately $0.1 million and $(0.1) million during the three and six-months ended June 30, 2010, respectively. We determined the value at June 30, 2010 to be approximately $0.6 million, based on the Black-Scholes valuation model and using the following assumptions: dividend yield of 0.0%; volatility of 127.4%; expected life of 6.5 years and a risk-free rate of 2.4%. Going forward, changes in the value of the warrants will result in additional increases or decreases in other income (expense) in our consolidated statement of operations.

Termination of 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 could from time to time, at our discretion, sell newly-issued shares of our common stock to YA SPV. We 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.

The SEDA required payment of a commitment fee 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 volume weighted average price for the three trading days after the date of the Agreement. We issued an aggregate of approximately 3.0 million shares of our common stock and received an aggregate of approximately $2.9 million in cash under the SEDA, of which 0.1 million shares of our common stock were issued and approximately $0.1 million in cash was received during the first quarter of 2010. In connection with the registered direct offering discussed above, we terminated the SEDA effective February 4, 2010.

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

5. Financings (continued)

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, livestock (e.g., cattle and hogs), horses, fish and wildlife worldwide, and, more recently, for animal bio-sensing applications, such as temperature reading for companion pet and equine 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 are 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, livestock, horses, fish and wildlife industries.

Emergency Identification

Our Emergency Identification segment develops, manufactures and markets GPS and GPS-enabled products used for emergency location and tracking of pilots, aircraft and maritime vehicles in remote locations. 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^TM brand, which serve military and commercial markets.

Corporate and Eliminations

Our Corporate and Eliminations category includes all amounts recognized upon consolidation of our subsidiaries, such as the elimination of inter-segment expenses, assets and liabilities. This category also includes certain selling, general and administrative expenses associated with corporate activities and interest expense and interest and other income associated with corporate activities and functions. Included in the Corporate and Eliminations category as of June 30, 2010 are approximately $0.8 million of liabilities related to companies that we sold or closed in 2001 and 2002. It is expected that these liabilities will be reversed during 2011 to 2016, 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 (in thousands):

														Total From
		Animal				Emergency				Corporate/				Continuing
		Identification				Identification				Eliminations				Operations
As of and For the Three-Months Ended June 30, 2010
Revenue		$	7,385			$	1,293			$	—			$	8,678
Operating income (loss)			295				(1,099	)			(2,000	)			(2,804	)
Income (loss) from continuing operations before income tax provision			16				(1,110	)			(1,911	)			(3,005	)
Total assets of continuing operations		$	23,608			$	12,807			$	5,402			$	41,817
As of and For the Three-Months Ended June 30, 2009
Revenue		$	7,499			$	2,798			$	—			$	10,297
Operating loss			(503	)			(676	)			(1,021	)			(2,200	)
Loss from continuing operations before income tax provision			(995	)			(691	)			(941	)			(2,627	)
Total assets of continuing operations		$	26,876			$	17,103			$	7,897			$	51,876

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

6. Segment Information (continued)

														Total From
		Animal				Emergency				Corporate/				Continuing
		Identification				Identification				Eliminations				Operations
As of and For the Six-Months Ended June 30, 2010
Revenue		$	16,375			$	3,217			$	—			$	19,592
Operating income (loss)			1,428				(2,001	)			(3,132	)			(3,705	)
Income (loss) from continuing operations before income tax provision			790				(2,023	)			(3,498	)			(4,731	)
Total assets of continuing operations		$	23,608			$	12,807			$	5,402			$	41,817
As of and For the Six-Months Ended June 30, 2009
Revenue		$	16,259			$	6,467			$	—			$	22,726
Operating loss			(666	)			(819	)			(2,418	)			(3,903	)
Loss from continuing operations before income tax provision			(1,709	)			(854	)			(2,273	)			(4,836	)
Total assets of continuing operations		$	26,876			$	17,103			$	7,897			$	51,876

7. Stock Options and Restricted Stock

Stock Option Plans

We and our subsidiaries have stock-based employee plans, which were outstanding as of December 31, 2009, and are more fully described in Note 11 to our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2009.

During the second quarter of 2010, 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 2,875,000 to 4,000,000. No other changes were made.

During the three-months ended June 30, 2010 and 2009, we recorded approximately $0.1 million and $0.1 million, respectively, in compensation expense related to stock options granted to our employees. During the six-months ended June 30, 2010 and 2009, we recorded approximately $0.2 million and $0.2 million, respectively, in compensation expense related to stock options granted to our employees.

Stock Option Activity

There were no options granted during the six-months ended June 30, 2010 and 2009. A summary of our stock option activity as of June 30, 2010, and changes during the six-months then ended, is presented below (in thousands, except per share amounts):

						Weighted				Weighted
						Average				Average				Aggregate
		Stock				Exercise				Contractual				Intrinsic
		Options				Price				Term				Value
Outstanding at January 1, 2010			3,189			$	15.05
Granted			—				—
Exercised			—				—
Forfeited or expired			20				61.57
Outstanding at June 30, 2010			3,169				14.75				5.4			$	11	*
Vested or expected to vest at June 30, 2010			3,029			$	13.88				4.5			$	11	*
Exercisable at June 30, 2010			2,349			$	19.44				4.1			$	11	*

There were no option exercises during the six-months ended June 30, 2010 and 2009. At June 30, 2010, we had approximately 1.7 million options available for issuance in our plans. The total cash value of potential option exercises at June 30, 2010 was approximately $20 thousand and would have a de minimus dilution impact to our stockholders’ ownership.

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

7. Stock Options and Restricted Stock (continued)

As of June 30, 2010, there was approximately $0.3 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 1.5 years. The total fair value of shares vested during the three-months ended June 30, 2010 and 2009, was approximately $34 thousand and $34 thousand, respectively. The total fair value of shares vested during the six-months ended June 30, 2010 and 2009, was approximately $0.2 million and $0.2 million, respectively.

A summary of the status of our nonvested stock options as of June 30, 2010 and changes during the six-months ended June 30, 2010, is presented below (in thousands, except per share amounts):

						Weighted
						Average
		Stock				Grant-Date
		Options				Fair Value
Nonvested at January 1, 2010			889			$	1.14
Granted			—				—
Vested			(70	)			2.84
Forfeited or expired			—				—
Nonvested at June 30, 2010			820			$	1.00

In addition to the stock options presented above, Thermo Life has approximately 4.4 million fully vested stock options outstanding. These stock options have no intrinsic value as of June 30, 2010 and Thermo Life’s two options plans have been discontinued with respect to future grants. On January 21, 2010, we sold the assets of Thermo Life as more fully discussed in Note 9.

Restricted Stock

In October 2009, we issued approximately 0.5 million shares of our restricted common stock to our directors and executive and senior management. We determined the value of the stock to be approximately $0.5 million based on the closing price of our stock on the date of the grant. The value of the restricted stock is being amortized as compensation expense over the vesting period which is three years. In January 2008, we issued approximately 31 thousand shares of our restricted common stock to our directors. We determined the value of the stock to be approximately $0.2 million based on the closing price of our stock on the date of the grant. The value of the restricted stock is being amortized as compensation expense over the vesting period which is five years. As a result, we recorded compensation expense of approximately $0.1 million and $10 thousand in the three-months ended June 30, 2010 and 2009, respectively, associated with such restricted stock grants. We recorded compensation expense of approximately $0.2 million and $22 thousand in the six-months ended June 30, 2010 and 2009, respectively, associated with such restricted stock grants.

8. Income Taxes

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. At June 30, 2010, we had aggregate net operating loss carryforwards of approximately $276.0 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 $266.1 million, $69.2 million relates to Destron Fearing and approximately $9.9 million relates to foreign loss carryforwards. These foreign net operating loss carryforwards are available to only offset future taxable income earned in the home country of the foreign entity. As of June 30, 2010, 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, 2010 and 2009.

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

8. Income Taxes (continued)

The amount of any benefit from our US 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 fifty percent change in ownership under Internal Revenue Code (“IRC”) section 382 would place 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, could effectively eliminate 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 2009, thus approximately $192.7 million is limited under IRC section 382. As a result of this limitation, we estimate that approximately $18.7 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 June 30, 2010, we had a liability for unrecognized tax benefits of $0.2 million primarily related to state income tax positions.

9. Discontinued Operations

We sold our ownership of McMurdo during the three-months ended December 31, 2009, our Control Products Group and Thermo Life during the three-months ended March 31, 2010 and Clifford & Snell during the three-months ended June 30, 2010. McMurdo is a manufacturer of emergency locator beacons; Thermo Life is a development company with patented rights to a thin-film thermoelectric generator; Control Products Group manufactures and distributes electronic relay switches for nuclear power applications; and Clifford & Snell manufactures electronic alarm sounders which are used to provide audible and or visual signals which alert personnel in hazardous areas, including the oil and petrochemical industry, and in the fire and security market. The decisions to sell these businesses were made as part of management’s strategy to streamline our operations to focus our efforts on the Animal Identification segment.

As a result of the board of directors’ decision and the subsequent sale of the operations of Thermo Life, McMurdo, Control Products Group and Clifford & Snell, the financial condition, results of operations and cash flows of each of these businesses have been reported as discontinued operations in our financial statements, and prior period information has been reclassified accordingly.

Sale of McMurdo

On November 2, 2009, we, together with Signature and McMurdo, entered into a definitive agreement to sell substantially all of the assets of Signature’s U.K.-based McMurdo business unit for $10.0 million in cash (“the McMurdo Purchase Agreement”). The purchaser was France-based Orolia Group (“Orolia”), a high-technology firm specializing in positioning, navigation and timing solutions for critical operations.

On November 20, 2009, pursuant to the terms of the McMurdo Purchase Agreement, we completed the sale of McMurdo. At closing, the parties amended the McMurdo Purchase Agreement to reduce the amount to be held in escrow to $1.0 million, to assign to the buyer the obligation for certain trade and vendor payables in existence at the time of closing, and to exclude certain product lines and related assets from the transaction (which product lines and assets were retained by Signature in exchange for a $250,000 credit against the purchase price). As a result of these amendments and the adjustment for actual inventory levels at the time of closing, the consideration paid at closing totaled approximately $9.6 million, of which approximately $8.8 million was paid to Signature in cash and approximately $0.8 million was retained by the buyer to pay the retained trade and vendor payables. The remaining $1.0 million of the proceeds will be held in escrow for 12 months. The proceeds were used to pay debt obligations and to fund working capital. Both the Company and Orolia guaranteed performance to the other, thus we have guaranteed Signature’s obligations under the McMurdo Purchase Agreement, on a fully subordinated basis to the senior notes.

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

9. Discontinued Operations (continued)

In the fourth quarter of 2009, we recorded a gain on the sale of McMurdo of approximately $2.1 million, net of U.K. income taxes of $0.5 million. Upon the receipt of the funds held in escrow in connection with the McMurdo sale, if any, such proceeds will be recorded as additional gain on sale.

Sale of Thermo Life

On January 21, 2010, we entered into agreements with Ingo Stark, the employee and scientist who was chiefly responsible for the development of Thermo Life’s patented technology, to sell him the remaining assets of Thermo Life for nil and granting him a license on the patents in exchange for any future royalty payments on any products that become commercialized using the patents. Thermo Life has never generated any revenue and has been included in our discontinued operations since 2008. The loss on this transaction was not significant.

Sale of Control Products Group

On January 25, 2010, we entered into an agreement to sell substantially all of the assets of a small division known as the Control Products Group, a group within the Clifford & Snell business unit of Signature. The buyer, C&S Controls Limited, is a U.K. entity controlled by Gary Lawrence, the former manager of the Control Products Group for the past several years, and another former employee. The purchase price of £0.4 million (approximately $0.6 million) was represented, in part, by a non-interest bearing promissory note in the original principal amount of £0.4 million (approximately $0.6 million) issued from the buyer to Signature, which calls for monthly cash payments for approximately 5 years. As of June 30, 2010, approximately $20 thousand has been collected on the promissory note. The promissory note is secured but subordinated to a £30 thousand (approximately $45 thousand) working capital loan issued by a third party to the buyers. We have imputed interest at a rate of 8.0% per annum which represents a discount of £67 thousand (approximately $0.1 million) which will be amortized as additional interest income as cash is collected over the life of the promissory note. Based on the small scale of this entity, we believe that our treatment of this transaction as a sale for accounting purposes is not materially different from treatment that does not recognize the legal transfer of the ownership of the business. The gain on sale of approximately $0.1 million was deferred and will be recognized in the future when circumstances have changed sufficiently to so warrant.

Sale of Clifford & Snell

On April 30, 2010, we entered into a definitive agreement to sell the assets of Clifford & Snell for £2.3 million in cash (approximately $3.5 million at current exchange rates) (“the Clifford & Snell Purchase Agreement”). The purchaser was R.Stahl Ltd., a subsidiary of R.Stahl AG, a public company based in Waldenburg, Germany (“R.Stahl”). R.Stahl develops, manufactures and markets explosion-protection products worldwide for industrial customers. During the three-months ended March 31, 2010 and 2009, Clifford & Snell’s revenues were approximately £0.5 million (approximately $0.8 million) and approximately £1.0 million (approximately $1.4 million), respectively, and did not represent a significant disposition in accordance with Article 1 of Regulation S-X.

Clifford & Snell’s assets were sold for a cash consideration of £2.3 million (approximately $3.5 million). The purchase price was structured into two payments; £2.1 million (approximately $3.1 million) upon closing of the Clifford & Snell Purchase Agreement and £0.2 million (approximately $0.4 million) on October 30, 2010 following a six-month supply agreement during which R.Stahl will purchase products from Signature. On April 30, 2010, we received approximately £1.2 million (approximately $1.7 million) in net cash proceeds, which represented the first payment of £2.1 million less £0.3 million (approximately $0.5 million) of repayment on our Bibby invoice discounting line, £0.2 million (approximately $0.3 million) in closing and transaction costs and £0.4 million (approximately $0.6 million) which is to be held in escrow and paid out in two equal installments, net of any claims, on January 30, 2011 and October 30, 2011. Both the Company and R.Stahl AG issued guarantees of subsidiary performance to the other.

In the second quarter of 2010, we recorded a gain on the sale of Clifford & Snell of approximately £0.7 million (approximately $1.0 million). Upon the receipt of the funds held in escrow in connection with the Clifford & Snell sale, if any, such proceeds will be recorded as additional gain on sale.

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

9. Discontinued Operations (continued)

The following table, in thousands, presents the results of operations of our discontinued operations, excluding any allocated or common overhead expenses, for the three and six-months ended June 30, 2010 and 2009:

		Three-Months Ended								Six-Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
Revenue		$	1,360			$	6,925			$	2,771			$	12,302
Cost of sales			1,025				3,797				1,601				6,637
Gross profit			335				3,128				1,170				5,665
Selling, general and administrative expenses			118				1,665				480				3,087
Research and development expenses			—				184				—				344
Operating income			217				1,279				690				2,234
Interest and other income (expense), net			4				500				151				544
Gain on sale			1,019				—				1,019				—
Benefit for income taxes			—				7				—				15
Income from discontinued operations		$	1,240			$	1,786			$	1,860			$	2,793
Income from discontinued operations per common share — basic and diluted		$	0.04			$	0.10			$	0.07			$	0.16
Weighted average number of common shares outstanding — basic and diluted			28,002				17,857				26,934				17,558

The net (liabilities) assets of discontinued operations as of June 30, 2010 and December 31, 2009, which represented the net liabilities of McMurdo, Thermo Life, Control Products Group and Clifford & Snell, were comprised of the following (in thousands):

		June 30,				December 31,
		2010				2009
Cash		$	—			$	66
Accounts receivable			731				2,813
Inventory			693				856
Total current assets			1,424				3,735
Fixed assets			—				365
Total assets		$	1,424			$	4,100
Accounts payable		$	368			$	478
Accrued expenses and other current liabilities			1,977				2,256
Total liabilities		$	2,345			$	2,734
Net (liabilities) assets of discontinued operations		$	(921	)		$	1,366

10. 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								Six-Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
		(in thousands)
Net loss		$	(1,770	)		$	(893	)		$	(2,886	)		$	(2,099	)
Other comprehensive income, net of tax:
Foreign currency translation adjustments			159				1,234				66				1,111
Total comprehensive (loss) income		$	(1,611	)		$	341			$	(2,820	)		$	(988	)

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

10. Comprehensive Loss (continued)

The other comprehensive (loss) income during the three and six-months ended June 30, 2010 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 nil and $42 thousand of the foreign currency translation adjustments related to the noncontrolling interest during the three-months ended June 30, 2010 and 2009, respectively. Approximately $5 thousand and $2 thousand of the foreign currency translation adjustments related to the noncontrolling interest during the six-months ended June 30, 2010 and 2009, respectively.

11. Supplemental Cash Flow Information

In the six-months ended June 30, 2010 and 2009, we had the following non-cash financing activities:

		Six-Months Ended June,
		2010				2009
		(in thousands)
Non-cash operating activities:
Issuance of shares of common stock for settlement of payables		$	454			$	—
Non-cash financing activities:
Issuance of shares of common stock for purchase of equipment		$	—			$	186
Cash paid for:
Interest		$	400			$	768
Taxes			15				42

12. Restructuring Accrual

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. During the three and six-months ended June 30, 2010, we recorded approximately $1.1 million and $1.2 million, respectively, of severance expenses. During the three and six-months ended June 30, 2009, we recorded approximately $0.2 million of severance expenses and $0.1 million of contract termination costs.

As of June 30, 2010, our restructuring accrual was as follows (in thousands):

						Lease and
		Severance				Building Costs				Total
Balance, January 1, 2010		$	303			$	232			$	535
Additional expense			1,215				—				1,215
Cash payments			(511	)			(128	)			(639	)
Balance, June 30, 2010		$	1,007			$	104			$	1,111

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

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

13. Legal Proceedings

Former Officer

On June 19, 2009, Michael Krawitz, a former executive officer of ours, filed a lawsuit (Michael Krawitz v. Digital Angel Corporation Case No. 09-80910-CIV-RYSKAMP/VITUNAC in the U.S. District Court for the Southern District of Florida) against us and several members of our board of directors. The lawsuit alleged a variety of claims relating to the amounts owed to him under his employment agreement. We filed a Motion to Dismiss all claims except the breach of contract claim, which we are prepared to defend on the merits. In December 2009, the federal court granted our Motion to Dismiss in its entirety and granted Mr. Krawitz leave to re-file his lawsuit in light of the court’s decision. In January 2010, Mr. Krawitz amended his Complaint to re-file the breach of contract claim against us and filed notice that he voluntarily dismissed all other claims against us and the members of our board of directors. On the remaining breach of contract claim, we intend to vigorously defend against his claims.

Additionally, we are 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.

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, 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 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 name SARBE™. 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. 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.

Summary of our Results of Continuing Operations

During the three-months ended June 30, 2010, as compared to the three-months ended June 30, 2009, our consolidated revenue decreased approximately $1.6 million, or 15.7%, to $8.7 million. The decrease is primarily due to our Emergency Identification segment discussed further below. Our consolidated operating loss was $2.8 million in the three-months ended June 30, 2010 as compared to $2.2 million in the three-months ended June 30, 2009. Excluding approximately $1.1 million of restructuring, severance and separation expenses, our consolidated operating loss was $1.7 million for the three-months ended June 30, 2010. Excluding approximately $0.3 million of restructuring, severance and separation expenses, our consolidated operating loss was $1.9 million for the three-months ended June 30, 2009. We primarily attribute the improvement in our consolidated operating loss to the decrease in selling, general and administrative expenses company wide. During the six-months ended June 30, 2010, as compared to the six-months ended June 30, 2009, our consolidated revenue decreased approximately $3.1 million, or 13.8%, to $19.6 million. The decrease in consolidated revenue is primarily due to our Emergency Identification segment discussed further below. Our consolidated operating loss was $3.7 million in the six-months ended June 30, 2010 as compared to $3.9 million in the six-months ended June 30, 2009. Excluding approximately $1.2 million of restructuring, severance and separation expenses, our consolidated operating loss was $2.5 million for the six-months ended June 30, 2010. Excluding approximately $0.3 million of restructuring, severance and separation expenses, our consolidated operating loss was $3.6 million for the six-months ended June 30, 2009. We primarily attribute the improvement to the decrease in selling, general and administrative expenses company wide.

Critical Accounting Policies

Our Annual Report on Form 10-K for the year ended December 31, 2009 contains further information regarding our critical accounting policies.

Impact of Recently Issued Accounting Standards

For information regarding recent accounting pronouncements and their expected impact on our future consolidated results of operations or financial condition, see Note 2 to our accompanying condensed consolidated financial statements.

Consolidated Results of Operations

The following table summarizes our results of operations as a percentage of net operating revenues and is derived from the accompanying unaudited condensed consolidated statements of operations in Part I, Item 1 of this quarterly report (in thousands except percentages).

		For the Three-Months Ended								For the Six-Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
Revenue			100.0	%			100.0	%			100.0	%			100.0	%
Cost of sales			63.0				61.7				60.3				61.9
Gross profit			37.0				38.3				39.7				38.1
Selling, general and administrative expenses			54.2				54.1				49.9				51.4
Research and development expenses			2.7				2.6				2.5				2.5
Restructuring, severance and separation expenses			12.4				3.0				6.2				1.4
Operating loss			(32.3	)			(21.4	)			(18.9	)			(17.2	)
Interest and other (expense) income, net			1.4				1.1				(1.8	)			0.6
Interest expense			(3.7	)			(5.2	)			(3.4	)			(4.7	)
Loss from continuing operations before income tax provision			(34.6	)			(25.5	)			(24.1	)			(21.3	)
Provision for income taxes			(0.1	)			(0.5	)			(0.1	)			(0.2	)
Loss from continuing operations			(34.7	)			(26.0	)			(24.2	)			(21.5	)
Income from discontinued operations			14.3				17.3				9.5				12.3
Net loss			(20.4	)			(8.7	)			(14.7	)			(9.2	)
Loss attributable to the noncontrolling interest, continuing operations			0.2				2.3				0.1				1.0
Income attributable to the noncontrolling interest, discontinued operations			(0.2	)			(2.4	)			(0.1	)			(1.2	)
Net loss attributable to Digital Angel Corporation			(20.4	)%			(8.8	)%			(14.7	)%			(9.4	)%

Results of Operations by Segment

Three-Months Ended June 30, 2010 Compared to Three-Months Ended June 30, 2009

Animal Identification

		Three-Months Ended June 30,
						% of								% of
		2010				Revenue				2009				Revenue				Change
		(in thousands, except percentages)
Revenue		$	7,385				100.0	%		$	7,499				100.0	%		$	(114	)			(1.5	)%
Cost of sales			4,823				65.3				4,915				65.5				(92	)			(1.9	)
Gross profit			2,562				34.7				2,584				34.5				(22	)			(0.9	)
Selling, general and administrative expenses			2,018				27.3				2,511				33.5				(493	)			(19.6	)
Research and development expenses			235				3.2				263				3.5				(28	)			(10.6	)
Restructuring, severance and separation expenses			14				0.2				313				4.2				(299	)			(95.5	)
Operating income (loss)		$	295				4.0	%		$	(503	)			(6.7	)%		$	798				(158.6	)

Revenues

Our Animal Identification segment’s revenue decreased approximately $0.1 million for the three-months ended June 30, 2010 compared to the three-months ended June 30, 2009. The decrease was primarily due to lower volumes of our fish chips sold compared to the first quarter of 2009 as well as decreased livestock sales in South America. The decrease was slightly offset by higher sales of our LifeChip product and electronic tag sales.

Gross Profit and Gross Profit Margin

Our Animal Identification segment’s gross profit decreased approximately $22 thousand in the three-months ended June 30, 2010 compared to the three-months ended June 30, 2009. The slight decrease in gross profit was primarily due to lower sales levels. The gross profit margin remained relatively constant at 34.7% in the three-months ended June 30, 2010 as compared to 34.5% in the three-months ended June 30, 2009.

Selling, General and Administrative Expenses

Our Animal Identification segment’s selling, general and administrative expenses decreased approximately $0.5 million in the three-months ended June 30, 2010 compared to the three-months ended June 30, 2009. The decrease in selling, general and administrative expenses was primarily the result of decreased salaries, legal and accounting costs, depreciation and amortization and travel. Selling, general and administrative expenses as a percentage of revenue decreased from 33.5% to 27.3% primarily due to the items discussed above.

Research and Development Expenses

Our Animal Identification segment’s research and development expenses remained relatively constant during the three-months ended June 30, 2010 as compared to the three-months ended June 30, 2009. Research and development expenses relate to new product development associated with RFID microchips and related scanners.

Restructuring, Severance and Separation Expenses

Our Animal Identification segment’s restructuring, severance and separation expenses recorded in the second quarter of 2010 related to additional severance expenses and the expenses recorded in the second quarter of 2009 related to approximately $0.2 million of severance expenses and $0.1 million of contract termination costs.

Outlook and Trends

We anticipate our Animal Identification segment’s sales and profits to increase in 2010 as compared to 2009. We expect to achieve higher gross profits and to reduce selling, general and administrative expenses as we continue to control costs and implement cost savings measures. However, we are unable to quantify such possible operating efficiencies at this time.

We believe our investment in technology and product development, such as the rTag™ and BioThermo^®, will enable future growth for our Animal Identification segment. We also believe that we face favorable long-term market trends, such as the technology migration from visual to electronic identification and increased government regulation in the area of food safety and traceability.

Emergency Identification

		Three-Months Ended June 30,
						% of								% of
		2010				Revenue				2009				Revenue				Change
		(in thousands, except percentages)
Revenue		$	1,293				100.0	%		$	2,798				100.0	%		$	(1,505	)			(53.8	)%
Cost of sales			642				49.6				1,439				51.4				(797	)			(55.4	)
Gross profit			651				50.4				1,359				48.6				(708	)			(52.1	)
Selling, general and administrative expenses			1,750				135.4				2,035				72.7				(285	)			(14.0	)
Operating loss		$	(1,099	)			(85.0	)%		$	(676	)			(24.1	)%		$	(423	)			(62.6	)